Grasping Reality with Both Hands: The Semi-Daily Journal Economist Brad DeLong

Party of the Damned

Dan Froomkin shows us what the print Washington Post could be, if anybody working for it had any ovaries:

Party of the Damned: As the Bush presidency staggers to an end, it's hard to say who has less to brag about: the president or the journalists who cover him. So it's fitting that the last White House Correspondents' Association dinner of the Bush era -- the ultimate celebration of chumminess between the most powerful people in the world and those who are supposed to hold them accountable -- was a dispiriting, mostly humorless affair.

President Bush phoned in his appearance, uttering a few topical one-liners but leaning primarily on greatest-hits footage from previous performances -- and wrapping up with a cartoonish but crowd-pleasing "conducting" of the Marine band. Comedian Craig Ferguson essentially apologized in advance for his understated headlining performance -- a far cry from the withering diatribe delivered by Stephen Colbert two years ago.... [T]he only time he really showed teeth was to attack the no-show New York Times. "The New York Times unfortunately did not buy a table," he said. "They felt that this event 'undercuts the credibility of the press.' It's funny, you see, I thought that Jayson Blair and Judy Miller took care of that. What? . . . Did I go too far? Now let me try this: Shut the hell up, New York Times, you sanctimonious whining jerks!"...

Key members of the White House's torture-management team-- Cheney, Secretary of State Condoleezza Rice, former secretary of state Colin Powell -- along with leading torture apologists -- Attorney General Michael Mukasey, CIA Director Michael Hayden, former White House spokesman Tony Snow and current spokeswoman Dana Perino -- were fawned over as honored guests....

Watch it yourself if you dare. Here is video of the red carpet arrivals and the entire dinner. Here is the Bush performance and the Ferguson performance. Here is footage of the swampy hell that was the Bloomberg after-party.

Michael Scherer writes for Time that Bush "rose to offer C-SPAN viewers another reason to doubt political journalists' ability to be anything but cowardly suck-ups to presidential pomp. In recent years, this event has been known mainly for the fantastic performance in 2006 of Stephen Colbert, the Comedy Central host, who addressed the crowd with a withering critique of both the failures of President Bush and the media. . . . Neither the press nor the president had a rebuttal to Colbert, then or now, so he was simply not invited back and officially forgotten. Ever since, the dinner had been a far less newsworthy affair. As is tradition, the president stood to do a short stand up act, which included the retelling of an old joke about Vice President Dick Cheney watching Bush through a peephole in the Oval Office door while masturbating. Such is the state of Washington humor....

[W]hat did British actor Rupert Everett thinks about the dinner? "'Hideous,' he said flatly. 'One of the most hideous events I've ever been to.'"...

Meanwhile. . . . Mark Mazzetti writes in the New York Times: "The Justice Department has told Congress that American intelligence operatives attempting to thwart terrorist attacks can legally use interrogation methods that might otherwise be prohibited under international law. The legal interpretation, outlined in recent letters, sheds new light on the still-secret rules for interrogations by the Central Intelligence Agency. It shows that the administration is arguing that the boundaries for interrogations should be subject to some latitude, even under an executive order issued last summer that President Bush said meant that the C.I.A. would comply with international strictures against harsh treatment of detainees.

"While the Geneva Conventions prohibit 'outrages upon personal dignity,' a letter sent by the Justice Department to Congress on March 5 makes clear that the administration has not drawn a precise line in deciding which interrogation methods would violate that standard, and is reserving the right to make case-by-case judgments. 'The fact that an act is undertaken to prevent a threatened terrorist attack, rather than for the purpose of humiliation or abuse, would be relevant to a reasonable observer in measuring the outrageousness of the act,' said Brian A. Benczkowski, a deputy assistant attorney general, in the letter, which had not previously been made public. . . . Some legal experts critical of the Justice Department interpretation said the department seemed to be arguing that the prospect of thwarting a terror attack could be used to justify interrogation methods that would otherwise be illegal.

"'What they are saying is that if my intent is to defend the United States rather than to humiliate you, than I have not committed an offense,' said Scott L. Silliman, who teaches national security law at Duke University....

Legal blogger Sandy Levinson writes that there is "a certain logical paradox here: The very fact that the some US interrogator would suggest that some particular conduct is 'reasonable' in some situation would, by definition, mean that there is not 'universal' condemnation of the practice. This is especially true if one accepts the DOJ argument that 'The fact that an act is undertaken to prevent a threatened terrorist attack, rather than for the purpose of humiliation or abuse, would be relevant to a reasonable observer in measuring the outrageousness of the act.' Once one allows what might be termed 'purity of utilitarian motive' to dominate the analysis, the game is over, for there will always be those who will argue that it is worth doing practically anything to forestall any 'terrorist attack.'"

Phillip Carter blogs for washingtonpost.com: "Among the more Kafkaesque arguments proffered by the Bush administration for its coercive interrogation (or torture) regime is this: Cruel, inhuman or degrading acts are not torture if they're done with good intentions."

Gitmo Watch

Jess Bravin writes in the Wall Street Journal (subscription required): "When military prosecutors enter Guantanamo's heavily guarded courtroom Monday, they can expect to face a spectacle: their former boss, in uniform, testifying against them. Col. Morris Davis, for two years the chief Guantanamo prosecutor, is expected to testify that the operation he once led has been infected with political agendas and corrupted by the Achilles' heel of military justice -- unlawful command influence. The Bush administration's military commissions plan has careered through internal disarray, administrative setbacks and legal debacles since the president announced it in November 2001, and still has yet to conduct a single trial. But Col. Davis's appearance may be the strangest twist yet. 'It's not that I'm sympathetic to the detainees or say they should get a free pass,' says Col. Davis, now director of the Air Force Judiciary. 'But I do think they are entitled to a fair trial.'"

Time for Hillary Rodham Clinton to Quit the Race

This is really embarrassing. Barack Obama needs to be the Democratic nominee.

Steve Benen writes:

Clinton, on the attack, takes to the airwaves on ‘gas-tax holiday’ - The Carpetbagger Report: It’s one thing for a good presidential candidate to embrace a bad idea. It’s worse when the candidate knows it’s a bad idea. It’s worse still when the candidate attacks her rival for failing to embrace a bad idea. And it’s the worst when the candidate feels so strongly about the bad idea that she starts running television commercials about it.

And that, unfortunately, is exactly what we have in the case of Hillary Clinton and the “gas-tax holiday.” Her campaign unveiled a new TV ad yesterday in North Carolina and Indiana attacking Obama for not supporting a temporary suspension of the 18.4-cent federal gas tax....

I don’t doubt that Clinton’s focus groups found all of this quite compelling.... But Clinton’s proposal has no merit, and would probably do nothing but boost the profits of oil companies. Clinton... no doubt knows this.... It’s rather transparent demagoguery. Worse, it’s crude and cheap demagoguery.

Harvard economist Greg Mankiw noted yesterday, “I don’t know any prominent economist who favors this McCain-Clinton proposal. More common is the reaction of a friend of mine (a veteran of the Clinton administration) who calls the idea ‘ludicrous.’”

Paul Krugman, usually a rather enthusiastic Clinton supporter, explains:

Why doesn’t cutting the gas tax this summer make sense? It’s Econ 101 tax incidence theory: if the supply of a good is more or less unresponsive to the price, the price to consumers will always rise until the quantity demanded falls to match the quantity supplied. Cut taxes, and all that happens is that the pretax price rises by the same amount. The McCain gas tax plan is a giveaway to oil companies, disguised as a gift to consumers.

Is the supply of gasoline really fixed? For this coming summer, it is. Refineries normally run flat out in the summer, the season of peak driving. Any elasticity in the supply comes earlier in the year, when refiners decide how much to put in inventories. The McCain/Clinton gas tax proposal comes too late for that. So it’s Econ 101: the tax cut really goes to the oil companies.

The Clinton twist is that she proposes paying for the revenue loss with an excess profits tax on oil companies. In one pocket, out the other. So it’s pointless, not evil. But it is pointless, and disappointing....

Good for Barack Obama for resisting this shameful pandering.

Alex Koppelman reminds me that “political campaigns are rarely about the actual merits of policy proposals.” That’s painfully true. Demagoguery works. Playing on voters’ fears and ignorance works. Confusing the public with bad ideas that sound good works. But I really don’t think Clinton wants to win this way. She’s smarter and better than cheap pandering.

Worse, all of this reinforces Obama’s argument that he’s more honest, principled, and willing to tell people the truth, even when they don’t want to hear it. Obama wants to present himself as a “different kind of politician,” and Clinton’s gas-tax attacks are making it easier for him to do so.

I’m absolutely certain that McCain and Clinton know full well this gimmick wouldn’t do anything to help consumers, and may actually make matters worse by encouraging consumption, pushing prices higher.

They know this, but are pushing the idea anyway, hoping, cynically, that it will pay political dividends anyway. What a shame.

Greg Anrig on Education Reform

Greg Anrig writes:

An Idea Whose Time Has Gone: The conservative infatuation with vouchers did contribute to one genuine accomplishment. The past thirty years have been a period of enormous innovation in American education.... In addition to charter schools, all kinds of strategies have taken root: public school choice, new approaches to standards and accountability, magnet schools, and open enrollment plans that allow low-income city kids to attend suburban public schools and participate in various curriculum-based experiments. To the extent that the threat of vouchers represented a "nuclear option" that educators would do anything to avoid, the voucher movement helped to prompt broader but less drastic reforms that offer parents and students greater educational choices.

Along the way, some success stories have emerged... strategies that combine school choice initiatives like magnet and charter schools with policies to integrate poor and middle-class students. Wake County, North Carolina, for instance, introduced a policy in 2000 mandating that no school could have more than 40 percent of its students eligible for free or reduced-price lunches. Because this program makes use of choice and incentives like magnet schools to integrate poor and middle-class kids, it avoids the political hazards of compulsory busing. So far, the results have been impressive. In 2006, 60.5 percent of low-income students in Wake County passed the high school End of Course exams, compared to 43 percent of low-income students in a nearby county of a comparable size.

Of course, the inherent limit to this idea is that many urban school districts are so uniformly poor that there are few, if any, middle-class communities with schools that low-income kids can attend. One way to get around this problem would be to amend the No Child Left Behind Act to give students in failing schools the ability to attend a school outside their own district.... [V]oucher proponents... motivated by a desire to help disadvantaged kids, and not merely an ideological urge to weaken public institutions... [should put] their prodigious energies and money behind choice programs like these that actually work.

links for 2008-05-01

• grad skool rulz #19: words for women « orgtheory.net
• Greg Anrig: An Idea Whose Time Has Gone

DeLong and Eichengreen: Post-WWII Europe in the Argentine Mirror

What Barry Eichengtreen and I wrote back in 1991:

The 1930’s in Europe had seen not chronic bottlenecks but chronic deficiencies of aggregate demand. Production had fallen far below normal for the entire decade; market forces had failed to restore demand to normal levels. Circumstances during the Great Depression had been exceptional, but circumstances in the aftermath of World War II were exceptional as well. Many feared the return of the Depression.

In fact (aside from the possibility that fear of a renewed Great Depression would act as a self-fulfilling prophecy) the return of the Great Depression was a less likely possibility in the 1940’s than was generally feared. The memory of the Depression, and the greater strength and incorporation of social democratic political movements in government kept right-wing governments from adopting policies of out-and-out national deflation. The availability of the large United States market to European exports--especially with the coming of the Korean War Boom and NATO in the early 1950’s--prevented any large world aggregate demand shortfall as in the Great Depression. With the American locomotive under full steam, Western European economies were unlikely to suffer from prolonged Keynesian demand-shortfall depressions.

Nevertheless, a live possibility in the absence of the Marshall Plan was that governments would not stand aside and allow the market system to do its job. In the wake of the Great Depression, many still recalled the disastrous outcome of the laissez-faire policies then in effect. Politicians were predisposed toward intervention and regulation: no matter how damaging “government failure” might be to the economy, it had to be better than the “market failure” of the Depression. Had European political economy taken a different turn, post-World War II European recovery might have been stagnant. Governments might have been slow to dismantle wartime allocation controls, and so have severely constrained the market mechanism. In fact the Marshall Plan era saw a rapid dismantling of controls over product and factor markets in Western Europe, and the restoration of price and exchange rate stability. An alternative scenario would have seen the maintenance and expansion of wartime controls in order to guard against substantial shifts in income distribution. The late 1940’s and early 1950’s might have seen the creation in Western Europe of allocative bureaucracies to ration scarce foreign exchange, and the imposition of price controls on exportables in order to protect the living standards of urban working classes.

The likely consequences of such alternative policies for post-World war II Europe can be seen in the Argentine mirror. In response to the social and economic upheavals of the Depression, Argentina adopted demand stimulation and income redistribution. These policies were coupled with a distrust of foreign trade and capital, and an attraction to the use of controls instead of prices as allocative mechanisms. Argentina’s growth performance in the post-World War II period was very poor. Even in the 1950’s, and even relative relative to Britain, Argentine growth was slow.

Díaz Alejandro (1970) provides a standard analysis of Argentina’s post-World War II economic stagnation. According to his interpretation, the collapse of world trade in the Great Depression was a disaster of the first magnitude for an Argentina tightly integrated into the world division of labor. While Argentina continued to service its foreign debt, its trade partners took unilateral steps to shut it out of markets. The experience of the Depression justifiably undermined the nation’s commitment to free trade.

In this environment Juan Domingo Perón gained mass political support. Taxes were increased, agricultural marketing boards created, unions supported, urban real wages boosted, international trade regulated. Perón sought to generate rapid growth and to twist terms of trade against rural agriculture and redistribute wealth to urban workers who did not receive their fair share. The redistribution to urban workers and to firms that had to pay their newly increased wages required a redistribution away from exporters, agricultural oligarchs, foreigners, and entrepreneurs.

The Perónist program was not prima facie unreasonable given the memory of the Great Depression, and it produced almost half a decade of very rapid growth. Then exports fell sharply as a result of the international business cycle as the consequences of the enforced reduction in real prices of rural exportables made themselves felt. Agricultural production fell because of low prices offered by government marketing agencies. Domestic consumption rose. The rural sector found itself short of fertilizer and tractors. Squeezed between declining production and rising domestic consumption, Argentinian exports fell. By the first half of the 1950’s the real value of Argentine exports was only 60 percent of the depressed levels of the late 1930’s, and only 40 percent of 1920’s levels. Due to the twisting of terms of trade against agriculture and exportables, when the network of world trade was put back together, Argentina was by and large excluded.

The consequent foreign exchange shortage presented Perón with unattractive options. First, he could attempt to balance foreign payments by devaluing to bring imports and exports back into balance in the long run and in the short run by borrowing from abroad.29 But effective devaluation would have entailed raising the real price of imported goods and therefore cutting living standards of the urban workers who made up his political base. Foreign borrowing would have meant a betrayal of his strong nationalist position. Second, he could contract the economy, raising unemployment and reducing consumption, and expand incentives to produce for export by decontrolling agricultural prices.30 But once again this would have required a reversal of the distributional shifts that had been the central aim of his administration.

The remaining option was one of controlling and rationing imports. Not surprisingly, Perón and his advisors chose the second alternative, believing that a dash for growth and a reduction in dependence on the world economy was good for Argentina. Díaz Alejandro writes:

First priority was given to raw materials and intermediate goods imports needed to maintain existing capacity in operation. Machinery and equipment for new capacity could neither be imported nor produced domestically. A sharp decrease in the rate of real capital formation in new machinery and equipment followed. Hostility toward foreign capital, which could have provided a way out of this difficulty, aggravated the crisis...

Subsequent governments did not fully reverse these policies, for the political forces that Perón had mobilized still had to be appeased. Thus post-World War II Argentina saw foreign exchange allocated by the central government in order to, first, keep existing factories running and, second, keep home consumption high. Third and last priority under the controlled exchange régime went to imports of capital goods for investment and capacity expansion.

As a result, the early 1950’s saw a huge rise in the price of capital goods. Each percentage point of total product saved led to less than half a percentage point’s worth of investment. Díaz Alejandro found “[r]emarkably, the capital... in electricity and communications increased by a larger percentage during the depression years 1929-39 than… 1945- 55,” although the 1945–55 government boasted of encouraging industrialization. Given low and fixed agriculture prices, hence low exports, it was very expensive to sacrifice materials imports needed to keep industry running in order to import capital goods. Unable to invest, the Argentine economy stagnated.

In 1929 Argentina had appeared as rich as any large country in continental Europe. It was still as rich in 1950, when Western Europe had for the most part reattained pre-World War II levels of national product. But by 1960 Argentina was poorer than Italy and had less than two-thirds of the GDP per capita of France or West Germany. One way to think about post-World War II Argentina is that its mixed economy was poorly oriented: the government allocated goods, especially imports, among alternative uses; the controlled market redistributed income. Thus neither the private nor the public sector was used to its comparative advantage: in Western Europe market forces allocated resources--even, to a large extent, for nationalized industries--the government redistributed income, and the outcome was much more favorable.

In the absence of the Marshall Plan, might have Western Europe followed a similar trajectory? In Díaz Alejandro's estimation, four factors set the stage for Argentina’s relative decline: a politically-active and militant urban industrial working class, economic nationalism, sharp divisions between traditional elites and poorer strata, and a government used to exercising control over goods allocation that viewed the price system as a tool for redistributing wealth rather than for determining the pattern of economic activity.

From the perspective of 1947, the political economy of Western Europe would lead one to think that it was at least as vulnerable as Argentina to economic stagnation induced by populist overregulation. The war had given Europe more experience than Argentina with economic planning and rationing. Militant urban working classes calling for wealth redistribution voted in such numbers as to make Communists plausibly part of a permanent ruling political coalition in France and Italy. Economic nationalism had been nurtured by a decade and a half of Depression, autarky and war. European political parties had been divided substantially along economic class lines for a generation.

Yet post-World War II western Europe avoided this trap. After World War II Western Europe’s mixed economies built substantial redistributional systems, but they were built on top of and not as replacements for market allocations of goods and factors. Just as post-World War II Western Europe saw the avoidance of the political-economic “wars of attrition” that had put a brake on post-World War I European recovery, so post-World War II Western Europe avoided the tight web of controls that kept post-World War II Argentina from being able to adjust and grow...

Why Is It Good for Central Bankers to Look Fierce?

• "Central Bank Consistency and Credibility: The Analytics"

Andrew Samwick on Spend-and-Borrow

He writes:

Taxing Our Way Out of a Problem: Greg Mankiw directs us to David Leonhardt's article on John McCain's chief economic advisor, Doug Holtz-Eakin.  I've known Doug for a number of years and admired his scholarship and his policy work.  It's got to be frustrating to be pushing the McCain economic agenda.  From the article, here's the crux of the problem:

In all, federal taxes now equal about 19 percent of the nation’s economic output, which is in line with the historical average. But the costs of Medicare and Medicaid, on their current path, would require that number to rise to an unmanageable 30 percent, and beyond, in coming decades.

“We as a nation cannot tax our way out of this problem,” Mr. Holtz-Eakin says. “It’s just not an option.” It is true that we cannot tax our way out of all of this problem.  But we could untax ourselves today into a bigger problem tomorrow.  As I've said before in the context of entitlement reform, all dollars matter:

If concern over tax burdens on future generations is what motivates you, then it is completely inconsistent with that motivation to pass a Medicare prescription drug bill that generates a projected unfunded obligation that is bigger than the projected unfunded obligation in Social Security. It is also completely inconsistent with that motivation to run General Fund deficits that are not balanced by later surpluses, raising the debt burden on future generations. This sort of inconsistency will doom any chance at prudent reform of any of the programs.

If I were a Republican, McCain's flunking the fiscal responsibility test is one of the many things that would make me a Democrat.

Felix Salmon Goes to the Milken Conference

He sees signs of increasing non-stupidity in the public discussion of economic policy:

Political Hacks: The Backlash: Macroeconomic discussions at the Milken Conference tend to feature a great deal of party-political Republican talking points... Steve Forbes... Paul Gigot... political speechifying and pandering to the assembled plutocrats tends to obscure any substantive points....

But when Tom Donohue, President and CEO of the US Chamber of Commerce, said this morning that "Nancy Pelosi is an agent for Chávez", he actually got booed.... The CBO's Peter Orszag, on the same panel, said that many of the free-trade types on the right were increasingly out of touch when it comes to the deep-felt anti-trade sentiments in most of the country; Donohue simply responded by saying that pro-trade proponents should work on their vocabulary.

Orszag touched on something real, not only in the nation but even at the conference. the mood... is one of pervasive worry and uncertainty. People are losing equity in their homes, they're scared of inflation, they fear the implications of a deep recession, they're more interested in not losing money than they are in making it.... [T]he kind of rah-rah rhetoric which went down well last year is increasingly sounding rather hollow. That's a good thing: it means that always-cut-taxes wing of the Republican Party is going to either moderate itself a bit or else become irrelevant. After the panel, one delegate came up to me and complained, apropos of nothing, that the panelists were "ideologues, when we're looking for objective analysis from an independent think tank"...

links for 2008-04-30

• Collected Advice for the Young Economist
• Interfluidity :: Counterparty of last resort?: MacroMan has a nice find, in a post aptly entitled Timmy Geithner, SIV Manager!?. He points us to details of the "loan" being arranged by the Fed to support J.P. Morgan's purchase of Bear Stearns.
• Gail Collins: McCain’s Compassion Tour
• Malaysia Kopitiam, 1827 M St. N.W., Washington DC

Washington Post Death Spiral Watch Watch: Tax Policy John-McCain-Wusses-Out 110% Edition

Why oh why can't we have a better press corps?

I have an email in my inbox from that practitioner of worthless "he said, she said" journalism, Jonathan Weisman of the Washington Post. Jonathan writes:

From: weismanj@washpost.com
Subject: Hello Prof. DeLong
Date: April 29, 2008 6:56:56 AM PDT To: delong@econ.Berkeley.EDU

Haven't spoken to you in awhile, but I was compelled to write, seeing that you read an entire front page story on John McCain's curiously changed positions on tax policy, and out of all that, you fixated on a single word.

I find that remarkable, but I did want to thank you for reading so attentively.

Jonathan Weisman
Washington Post congressional writer
weismanj@washpost.com
(202)334-7745
(202)689-9134 (cell)

What's Weisman talking about? Weisman had written:

McCain Offers Tax Policies He Once Opposed: To supporters, McCain has simply seen the light and now understands.... Said J.D. Foster, a former Bush White House and Treasury tax policy expert, now at the Heritage Foundation: "It's logical that he wouldn't be repeating the arguments he made then. We all learn from experience"...

Upon which I had snickered, commenting:

Jonathan Weisman Strikes Again!: Ah. Page A1 of the [Washington] Post. The [Washington Post's] death spiral continues.... First time I have ever seen anybody describe J.D. Foster as a tax policy "expert." Lobbyist, yes. Apparatchik, yes. Ideologue, yes. But expert? Never seen that before...

Why oh why can't we have a better press corps?

I note that Jonathan Weisman does not say a word defending his claim that the statement J.D. Foster is in any sense the view of tax policy "experts" who support McCain.

The natural questions for Weisman--that he has never tried to answer--are two:

• If Weisman isn't willing to defend what he writes, why write it in the first place?
• Why not go do something useful?

The natural questions for the Post management are three:

• Why does it retain and promote a reporter who doesn't even try to tell it straight?
• Who does it think will be reading it in five years if it doesn't try a lot harder than it is to regain its lost credibility as a news source?
• How stupid does it think its readers are?

If Weisman felt himself allowed to say what he really believes, and said it on the record, he would presumably say something like the following about how he and his fellow reporters at the Washington Post view their jobs:

Look, I know that the overwhelming opinion of McCain-supporting tax-policy experts--people like Greg Mankiw, Andrew Samwick, and Doug Holtz-Eakin--is that tax cuts don't raise revenue, that unfunded tax cuts are bad public policy, that McCain has caved to the ideological tax-cut lobby for the duration of the campaign, and that the tax-policy experts hope to recoup the ground they have given up and restore fiscal-policy sanity to the McCain operation after the election. I know that very well. I know that McCain has wussed out 110%. But I can't report it. I can't find McCain tax-policy expert supporters willing to say it on the record. And Len Downie won't allow me to print the story without a quote high up in the article making McCain look good.

Calling J.D. Foster a tax-policy "expert," and implying that the view that McCain has seen the light is a respectable view among the broader community of tax-policy experts is misleading, but only in a very minor way. I got a lot of good stuff out in that article, and I couldn't have gotten the article printed on page A1 without calling J.D. Foster a tax-policy expert. It was a very small price to pay.

But Weisman won't say anything like that on the record. The closest thing about the culture of reporting at the Washington Post was said by Weisman's colleague Mike Allen, who once traveled to Virginia Beach to say, as Matthew Yglesias reported:

Matthew Yglesias: He Said / She Said: I went down to Norfolk to be on a panel discussion with The Washington Post's Mike Allen.... Mike had something to say on the topic of "he said, she said" journalism that provided me with some valuable perspective.... Somebody from the audience asked a question which seemed to take as its premise that there was a strict dichotomy between "factual" writing, which is what you see on news pages, and "opinion" writing, which is what you see on editorial pages.... I took some issue with that characterization. News pages, I said, aren't so much giving a "just the facts, ma'am" approach to reporting. Rather, they're trying to act as neutral arbiters between contending parties. Oftentimes this means there will be political controversy about a basically factual subject ("what's the effect of X on the deficit?") that goes unresolved by a news writer. Instead of giving us the facts, the news writer gives us a set of meta-facts -- "Joe says 'X' but Same says 'Y.'"...

People... become partisans in large part because they think the facts are partisan. When I say that the Bush Social Security plan involves a huge quantity of transition debt that risks provoking a fiscal crisis, I'm trying to state some facts, as I see them. Others who disagree are likewise trying to argue facts. We're not offering "opinions" as such....

Allen took issue with that characterization of what news writers are doing. He said that news writers are trying to present both sides' points-of-view, hence the "he said, she said" quality to it, but that they're trying to present these points-of-view in such a way so that a discerning reader can tell who's right based on reading the story.

I tried then to revise my statement of the situation. A good news reporter, on my revised view, tries to "lead a horse to water."... He seemed happier with that restatement...

On my view, misleading "he said, she said"-lead-a-horse-to-water journalism--where what is really going on is apparent only to discerning readers willing to pay a lot of time and attention and who already know a lot about the issue--is not something that any reporter should be craven enough to practice or any reader willing to pay for. Jonathan Weisman and his bosses think differently.

What I don't understand is why Jonathan Weisman thinks that what he does has some right to my approval. I don't understand that at all.

Twenty First-Century Central Banking

The problem of dealing with moral hazard in twenty first-century central banking has taken an interesting twist. Twice in the past decade the Federal Reserve has intervened in cases in which specific institutions have gotten into serious trouble--specific institutions that the Federal Reserve, or at least the New York Federal Reserve Bank (lines of authority are somewhat unclear) has concluded are too big to be allowed to fail through standard processes. The two institutions are the hedge fund Long Term Capital Management--LTCM--in 1998, and the bank Bear-Stearns in 2008.

In 1998 LTCM had suffered major losses on a mark-to-current-market basis (although its long-term prospects in the event of global financial recovery from the crisis looked correspondingly good), and appeared both illiquid and--if forced to liquidate its positions at then-current values, especially if liquidation induced significant price pressure against it--insolvent. Alan Greenspan and Peter Fisher at the New York Fed gathered all of the Federal Reserve's major creditors in a room, told them that they had a problem, and told them that they should solve it: that systemic risk would be created by an LTCM bankruptcy and liquidation and that the Fed did not want to go there. The creditors agreed to cooperate and split both the liability and the upside (with the exception of Bear Stearns, that declined), and they made LTCM an offer. The only alternative bidder was said to be Warren Buffett, who claims to have not been focused on the situation because he was fishing in Alaska. With only one potential bidder, the equity of LTCM's principals and investors was confiscated--to the dismay of LTCM's principals and investors, some of whom believe that they would have been able to get a much better split of the upside had they been allowed to play their creditors off against each other.

In 2008 Bear Stearns had suffered major losses on a mark-to-current-market basis (although its long-term prospects in the event of global financial recovery from the crisis looked correspondingly good), and appeared both illiquid and--if forced to liquidate its positions at then-current values, especially if liquidation induced significant price pressure against it--insolvent. Ben Bernanke and Tim Geithner at the New York Fed declared that systemic risk would be created by a Bear Stearns bankruptcy and liquidation, that the Fed did not want to go there, and that the only deal they would fund and support would be a deal that sold Bear Stearns to J.P. MorganChase at $2 (later raised to $10) a share, and the Federal Reserve kicked into the deal a put on Bear Stearns assets that one might speculate had a full-information liquid-market value of perhaps $3 billion. Various speakers for principals and investors in Bear Stearns protested that this effective confiscation of their equity value was unfair and inappropriate, and that a better split of the upside or at least a payment of more than $2 a share was appropriate.

We now have two precedents. If the Federal Reserve judges that a major financial institution:

• is too big to fail in that its failure will generate systemic risk
• has followed portfolio strategies that have produced inappropriate and excessive leverage
• requires immediate action

then the Federal Reserve will intervene to structure and support a deal that leaves principals and investors in the offending systemic risk-creating institution with effectively zero equity. Counterparties will be rescued. Principals and investors will not--even if normal more lengthy legal and bargaining processes would give principals and investors a share of the equity value on the table.

This is not the arms-length equal-treatment impersonal-rule-of-law ideal to which a government should aspire. This does, however, seem to get the incentives about right.

Charlie Kindleberger once wrote, in Manias, Panics, and Crashes, that the key to avoiding both depression and moral hazard was for the lender-of-last-resort to always show up in a crisis but for its appearance to always be doubted until the very last moment. These two precedents suggest that the Federal Reserve is evolving a case-law-of-twenty-first-financial-crisis that is somewhat different: in a crisis the lender-of-last-resort will always show up, but investors and principals in individual institutions that need to be specially rescued will discover that the lender of last resort is not their friend.

Why Oh Why Can't We Have a Better Press Corps?

A correspondent emails me:

Gmail - [JournoList] WSJ: Newspaper Circulation Drop Sharpens: ANDREW LAVALLEE: April 29, 2008; Page B1: Most of the nation's biggest newspapers saw circulation tumble at an increased rate, a sign that the migration of readers online may be picking up speed.... [A]verage weekday circulation at 534 daily newspapers fell 3.6% for the six months ended March 31, compared with the year-earlier period.... Sunday circulation fell even more, losing 4.6% on average....

Nearly all of the 10 biggest newspapers in the U.S. posted circulation declines.... The New York Times' average weekday circulation fell 3.9% to 1.08 million. It saw an even steeper drop in Sunday circulation, which was down 9.3% to 1.48 million. "This was a decline that we planned and budgeted for," said New York Times spokeswoman Diane McNulty. The company has eliminated "bonus days," in which the Sunday paper was delivered to weekday subscribers, and has cut back on discounted and advertiser-paid distribution as it attempts to grow more-profitable circulation, she said. In that shift, she added, "We do expect to see some copy decline"...

The New York Times--between David Brooks, Tom Friedman, William Kristol, Ben Stein, Judy Miller, Elizabeth Bumiller, Larry Rohter, Michael Cooper, and a host of others, I know that I feel icky every time I pick up my New York Times and realize that my money is helping to feed them.

Perhaps the scariest person around is New York Times spokeswoman Diane McNulty, whose claim that a 9.3% decline in Sunday circulation was a decline "that we planned and budgeted for."

links for 2008-04-29

• Felix Salmon: Did Hedge Funds Help Stabilize the Mortgage Market?
• Matthew Yglesias: Today in Book Promotion: Ilya Goldenberg
• Matthew Yglesias on the Incompetent Mendacity of the American Press Corps
• James Fallows on the Incompetent Mendacity of the American Press Corps
• Ilya Goldenberg: My Head on the Sand
• Matthew Yglesias: Yet More Press Budget Idiocy
• New York Times Reporters: Too Stupid to Be Allowed to Write
• Menzie Chinn: Let's Think Long and Hard about [Not] Extending Those Bush Tax Cuts
• Lawrence Summers: America needs to make a new case for trade

Methinks Fareed Zakaria Will Vote for Barack Obama

He writes:

Mccain Vs. Mccain | Print Article | Newsweek.com: On March 26, McCain gave a speech on foreign policy... the most radical idea put forward by a major candidate for the presidency in 25 years. Yet almost no one noticed... McCain proposed that the United States expel Russia from the G8.... McCain also proposed that the United States should expand the G8 by taking in India and Brazil--but pointedly excluded China from the councils of power.

We have spent months debating Barack Obama's suggestion that he might, under some circumstances, meet with Iranians and Venezuelans. It is a sign of what is wrong with the foreign-policy debate that this idea is treated as a revolution in U.S. policy while McCain's proposal has barely registered. What McCain has announced is momentous--that the United States should adopt a policy of active exclusion and hostility toward two major global powers. It would reverse a decades-old bipartisan American policy of integrating these two countries into the global order... would alienate many countries in Europe and Asia who would see it as an attempt by Washington to begin a new cold war.

I write this with sadness because I greatly admire John McCain, a man of intelligence, honor and enormous personal and political courage.... McCain has turned into a foreign-policy schizophrenic.... His speech reads like it was written by two very different people, each one given an allotment of a few paragraphs on every topic. The neoconservative vision within the speech is essentially an affirmation of ideology. Not only does it declare war on Russia and China, it places the United States in active opposition to all nondemocracies.... What would be the gain from so alienating two great powers? How would the League of Democracies fight terrorism while excluding countries like Jordan, Morocco, Egypt and Singapore? What would be the gain to the average American to lessen our influence with Saudi Arabia...?

The single most important security problem that the United States faces is securing loose nuclear materials. A terrorist group can pose an existential threat to the global order only by getting hold of such material. We also have an interest in stopping proliferation, particularly by rogue regimes like Iran and North Korea. To achieve both of these core objectives--which would make American safe and the world more secure—--need Russian cooperation. How fulsome is that likely to be if we gratuitously initiate hostilities with Moscow? Dissing dictators might make for a stirring speech, but ordinary Americans will have to live with the complications after the applause dies down.

To reorder the G8 without China would be particularly bizarre. The G8 was created to help coordinate problems of the emerging global economy....

McCain appears to think that he can magically unite the two main strands in the Republican foreign-policy establishment. But he can't.... We have watched an American president unable to choose between his ideologically driven vice president and his pragmatic secretary of State--and the result was the catastrophe of George W. Bush's first term...

Did Hedge Funds Help Stabilize the Mortgage Market? II

The intelligent and thoughtful Felix Salmon answers "no" to the question: Did Hedge Funds Help Stabilize the Mortgage Market?

His answer, if I am interpreting it right, is that hedge funds betting that mortgage-backed securities were overpriced did not help correct the excesses of irrational exuberant because there were not enough of them: not enough hedge funds, not enough investors to capitalize them, not enough derivatives to make deep pools for them toswin in. Thus hedge fund portfolio managers who went short MBS, Salmon argues, made fortunes to themselves, their bosses, and their investors, but did little to push MBS prices--and thus the incentives to make dodgy subprime loans-- to where they always should have been.

I think that Felix may be wrong because of one of the peculiar things about financial as opposed to other markets. In most markets--the one in which I am participating at the moment, for example, the market for bagels on the Q level of the Johns Hopkins University Library--buyers and sellers know what their valuations are. I know that after the red-eye my valuation of a whole-wheat bagels with a triple helping of cream cheese on it is well-nigh infinite. I compare the price to my stomach-driven valuation. I buy.

But finance is different. If your valuation is different from--say it is greater than--the valuation of smart people who know more than you do, you should not buy. You should change your valuation. In a normal situation you can read some but not necessarily a lot of information about what SPWKMtYD think off of the current market price. In this context, extra markets--options markets, other derivatives markets, et cetera--are potentially valuable as additional channels of information about what the smart, or at least the technically sophisticated, money is thinking.

This was Sandy Grossman's argument about 1987: that if portfolio insurance had been an actual market-traded option rather than a synthetic option synthesized by a dynamic trading strategy, peple would have understood the shape of the demand curve. I think his argument is a strong one. And it seems quite likely to me that it applies in this case as well.

links for 2008-04-28

• Doug Henwood on Naomi Klein: History, but not exactly a secret
• InformIT: Interview with Donald Knuth > Interview with Donald Knuth
• Clay Shirky: Gin, Television, and Social Surplus - Here Comes Everybody

Doug Henwood on Naomi Klein

Doug writes, apropos of Naomi Klein:

History, but not exactly a secret: As is often the case with arguments organized around a conceit, Klein works hard to squeeze events into her model’s form. There’s the problem mentioned above—that Cameron and Pinochet cannot explain Ronald Reagan’s 59-41 victory over Walter Mondale in 1984. But there are also problems with many of Klein’s case studies.

In her chapter on post-apartheid South Africa, Klein notes how the hope generated by the ANC’s taking power was dashed by the orthodox economic policy the party pursued once in power. She explains that the country was “outnegotiated” by the World Bank and IMF. That is not how many on the South African left see the problem. Their analysis is that the ANC was never anti-capitalist, and was quite eager to join the world system and get its own piece of the action. As no less than Mandela himself put it: “The ANC has never...advocated a revolutionary change in the economic structure of the country, nor has it...ever condemned capitalist society.”

She also asserts that Israel is in the midst of a Chinese-style boom, which has been occurring because, not in spite of, the country’s constant state of war. The boom, she asserts, is being driven by the production and export of military and surveillance equipment. But in fact Israel’s economy isn’t booming, the military share of GDP is way down from its 1970s peaks and has been flat in recent years, and arms represent only a fraction of Israeli exports. Israel’s per capita GDP has been growing at about a quarter of the Chinese rate over the last couple of years; over the last seven years, it’s more like a tenth the Chinese rate. Electronics, including military–surveillance goods, have been declining as a share of Israeli exports, while that of drugs and chemicals has been rising. Israel’s share of the world’s arms trade is just over 1%, behind Sweden’s.

For Klein, the invasion of Iraq wasn’t a geopolitical adventure so much as an economically rational attempt to complete the Chicago-school counterrevolution that began in Chile in 1973: to bring the “Friedmanite” model to the Middle East. “The ‘fiasco’ of Iraq is one created by a careful and faithful application of unrestrained Chicago School ideology.” It was, in a phrase she likes, “Friedmanite to the core.” Among the problems with this reading are that things haven’t worked out as planned—Iraq barely has an economy to impose any policy on, though privatization decrees were certainly issued—and that Friedman himself opposed the invasion of Iraq. He told the Wall Street Journal’s Tunku Varadarajan in July 2006: “What's really killed the Republican Party isn't spending, it's Iraq. As it happens, I was opposed to going into Iraq from the beginning. I think it was a mistake, for the simple reason that I do not believe the United States of America ought to be involved in aggression.”

Miltie

Klein’s use of a one-dimensional caricature of Friedman as an all-purpose whipping boy may play to the choir, but he deserves more serious attention than this. His economics was in many ways wrong and vile, but over the course of a fifty-year career, he helped reshape not only his discipline, but the way politicians and regular people think and talk about the economy. He was an extremely effective popular writer; if only the left could have produced a book as persuasive as Capitalism and Freedom, the world might be a better place. (Yes, yes, his argument was nicely aligned with the needs of capital in the 1970s, but on the other hand, capital also needed some degree of popular assent, which Friedman helped produce—and, on the third hand, polemic doesn’t count for nothing, and material interest isn’t everything.)

One reason that Friedman became popular both within his own profession and in the larger world was that there were real economic problems in the 1970s. In the richer countries, Keynesian/welfare-state capitalism was in crisis because of stagflation. According to the economic consensus of the time, weak growth was supposed to mean low inflation—but weak growth coexisted with persistently high inflation throughout the 1970s. Friedman offered an explanation for that: monetary stimulus beyond a certain point results in inflation, not additional growth. Growth was being held back by unions and regulations, which were interfering with the magic self-adjusting powers of the market. The solution was tight money and deregulation. It worked, at least for a while, on its own terms, though at great human cost.

But there’s a radical way of expressing the insights of Friedman and the others who came to power and influence in the late 1970s. Capitalism simply cannot live with low unemployment rates. Workers gain confidence, resist the direction of the boss, and wages are forced up. Add to that a welfare state, which cushions workers against the risk of job loss, and things are even worse from the bosses’ point of view. Their plight was evident in the depressed profit rates of the leisure-suit decade.

Sure enough, the application of the Friedman agenda raised profit rates and ended the great inflation—though it put the working class into a semipermanent state of anxiety, which was part of the point. That does suggest a permanent shock strategy is part of the system’s normal operating procedure, not an extraordinary event.

Limits and beyond

An honest evaluation of this history would have to recognize that the Keynesian model in the northern hemisphere had reached an impasse in the 1970s. Either things had to break in the Friedmanite direction or a more anticapitalist direction. And in the southern hemisphere, import substitution was running into similar problems: rising inflation and low levels of productivity. Many governments borrowed heavily abroad in an attempt to keep things going, laying the groundwork for the debt crisis of the 1980s. Obviously Friedman, Pinochet, and Reagan do not represent the full range of possibilities, but something had to give, and the left worldwide was too weak to win the battle.

Though the analysis may be problematic, Klein’s closing chapter does inspire hope even in a skeptical reader. Shocks wear off, and some of the most inspiring agitation is coming from the region that suffered some of the worst abuses of the 1970s and 1980s, Latin America. The word “socialism” is even being dusted off in Venezuela and Bolivia. But the emphasis on shock as the organizing principle of the book even constrains the inspiration. Those recovering from shock, whether in the Southern Cone or in New Orleans, see themselves as “repair people, taking what’s there and fixing it, reinforcing it, making it better and more equal. Most of all, they are building in resistance—for when the next shock hits.” These are the concluding words of the book. Is this really all we can do? Tinker while the weather’s fair, and get ready to duck and cover on a moment’s notice?

The End of Securitized Mortgage Lending

Jim Hamilton sends us to:

http://www.econbrowser.com/archives/2008/04/Hooper_UCSD_apr_08.pdf

The Subprime Market and Derivatives Once Again...

A correspondent makes three points:

• First, Moody's response to requests to rate highly complex structured mortgage derivatives should have been: "We don't have enough historical data on securities like this in a housing price environment where rent-versus-buy ratios are this low. We cannot rate them to our usual standards."
• Second, if you are collecting a fee for rating things, and if your fee is based on your past reputation for providing good ratings based on long-term historical data, and if you use the same classification scheme to make ratings that are not based on sufficient historical data--then you do have a problem.
• Third, the fact that there was an ABX index and thus an easy way for people to bet that the mortage-backed securities market would crash probably cut short the bubble--the true hedge funds were stabilizing speculators; the destabilizing speculators were (i) the funds that were long CDOs and (ii) the banks and other issuers who retained the CDOs because their portfolio managers believed their marketeers. A world without derivatives but with mortgage-backed securities would probably be a world in which we have a bigger problem than we have now.

This third point is very much Sandy Grossman's point about the 1987 crash: that the problem with "portfolio insurance" was that it was a trading strategy rather than a derivative security traded by a market, and so nobody knew how large the demand for it was, and so those planning to implement the trading strategy in a market downturn had no way of assessing how expensive implementing it was going to be. On Black Monday everybody found out.

Roger Lowenstein on the Subprime Blowup

Roger Lowenstein almost makes me sorry for Moody's.

First: God! What a lousy lead!

Moody's - Credit Rating - Mortgages - Investments - Subprime Mortgages: In 1996, Thomas Friedman, the New York Times columnist, remarked on “The NewsHour With Jim Lehrer” that there were two superpowers in the world — the United States and Moody’s bond-rating service — and it was sometimes unclear which was more powerful. Moody’s was then a private company that rated corporate bonds, but it was, already, spreading its wings into the exotic business of rating securities backed by pools of residential mortgages...

I find it hard to imagine how anybody could think that this is an informative way to begin an article.

The body of Lowenstein's article is pretty good:

[S]uppose the security had a rating. If it were rated triple-A by a firm like Moody’s, then the investor... wouldn’t need to know what properties were in the pool, only that the pool was triple-A — it was just as safe, in theory, as other triple-A securities. Over the last decade, Moody’s and its two principal competitors, Standard & Poor’s and Fitch, played this game to perfection — putting what amounted to gold seals on mortgage securities that investors swept up with increasing élan.... By providing the mortgage industry with an entree to Wall Street, the agencies also transformed what had been among the sleepiest corners of finance. No longer did mortgage banks have to wait 10 or 20 or 30 years to get their money back from homeowners. Now they sold their loans into securitized pools and — their capital thus replenished — wrote new loans at a much quicker pace....

But who was evaluating these securities? Who was passing judgment on the quality of the mortgages, on the equity behind them and on myriad other investment considerations? Certainly not the investors. They relied on a credit rating. Thus the agencies became the de facto watchdog over the mortgage industry....

Moody’s and S&P... they reject the notion that they should have been more vigilant. Instead, they lay the blame on the mortgage holders who turned out to be deadbeats, many of whom lied to obtain their loans.... Moody’s recently was willing to walk me through an actual mortgage-backed security step by step. I was led down a carpeted hallway to a well-appointed conference room to meet with three specialists in mortgage-backed paper... the case they showed me, which they masked with the name “Subprime XYZ,” was a pool of.... All the mortgages in the pool were subprime.... In an earlier era, such people would have been restricted from borrowing more than 75 percent or so of the value of their homes, but during the great bubble, no such limits applied.

Moody’s did not have access to the individual loan files, much less did it communicate with the borrowers or try to verify the information they provided.... “We aren’t loan officers,” Claire Robinson, a 20-year veteran who is in charge of asset-backed finance for Moody’s, told me. “Our expertise is as statisticians on an aggregate basis. We want to know, of 1,000 individuals, based on historical performance, what percent will pay their loans?” The loans in Subprime XYZ were issued in early spring 2006.... The investment bank provided an enormous spreadsheet chock with data on the borrowers’ credit histories and much else that might, at very least, have given Moody’s pause. Three-quarters of the borrowers had adjustable-rate mortgages, or ARMs... 43 percent... did not provide written verification of their incomes... 12 percent of the mortgages were for properties in Southern California, including a half-percent in a single ZIP code, in Riverside.... 94 percent of those borrowers with adjustable-rate loans said their mortgages were for primary residences... all of the ARM loans in the pool were first mortgages (as distinct from, say, home-equity loans). Nearly half of the borrowers, however, took out a simultaneous second loan. Most often, their two loans added up to all of their property’s presumed resale value....

[T]he Moody’s analyst had only a single day to process the credit data from the bank. The analyst wasn’t evaluating the mortgages but, rather, the bonds issued by the investment vehicle created to house them.... [T]he S.P.V. would float 12 classes of bonds, from triple-A to a lowly Ba1.... It was this segregation of payments that protected the bonds at the top of the structure and enabled Moody’s to classify them as triple-A....

However elegant its models, forecasting the behavior of 2,393 mortgage holders is an uncertain business. “Everyone assumed the credit agencies knew what they were doing,” says Joseph Mason, a credit expert at Drexel University.... Mortgage-backed securities like those in Subprime XYZ were not the terminus... were, in fact, building blocks for even more esoteric vehicles known as collateralized debt obligations, or C.D.O.’s.... Miscalculations that were damaging at the level of Subprime XYZ were devastating at the C.D.O. level....

When a bank proposes a rating structure on a pool of debt, the rating agency will insist on a cushion of extra capital, known as an “enhancement.” The bank inevitably lobbies for a thin cushion (the thinner the capitalization, the fatter the bank’s profits).... [I]n structured finance, the agencies face pressures that did not exist when John Moody was rating railroads. On the traditional side of the business, Moody’s has thousands of clients (virtually every corporation and municipality that sells bonds). No one of them has much clout. But in structured finance, a handful of banks return again and again, paying much bigger fees. A deal the size of XYZ can bring Moody’s $200,000 and more for complicated deals. And the banks pay only if Moody’s delivers the desired rating. Tom McGuire, the Jesuit theologian who ran Moody’s through the mid-’90s, says this arrangement is unhealthy. If Moody’s and a client bank don’t see eye to eye, the bank can either tweak the numbers or try its luck with a competitor like S.&P., a process known as “ratings shopping.”...

[T]he analyst forecast losses for XYZ at only 4.9 percent of the underlying mortgage pool. Since even the lowest-rated bonds in XYZ would be covered up to a loss level of 7.25 percent, the bonds seemed safe. XYZ now became the responsibility of a Moody’s team that monitors securities and changes the ratings if need be.... [A] sliver of folks in XYZ fell behind within 90 days of signing their papers. After six months, an alarming 6 percent of the mortgages were seriously delinquent.... By the spring of 2007, 13 percent of Subprime XYZ was delinquent — and it was worsening by the month.... Poring over the data, Moody’s discovered that the size of people’s first mortgages was no longer a good predictor of whether they would default; rather, it was the size of their first and second loans — that is, their total debt — combined... credit scores, long a mainstay of its analyses, had not proved to be a “strong predictor” of defaults this time.... Amy Tobey, leader of the team that monitored XYZ, told me, “It seems there was a shift in mentality; people are treating homes as investment assets.” Indeed. And homeowners without equity were making what economists call a rational choice; they were abandoning properties rather than make payments on them.... By early this year, when I met with Moody’s, an astonishing 27 percent of the mortgage holders in Subprime XYZ were delinquent. Losses on the pool were now estimated at 14 percent to 16 percent — three times the original estimate. Seemingly high-quality bonds rated A3 by Moody’s had been downgraded five notches to Ba2....

Many of the lower-rated bonds issued by XYZ, and by mortgage pools like it, were purchased by C.D.O.’s, the second-order mortgage vehicles, which were eager to buy lower-rated mortgage paper because it paid a higher yield.... In 2006 and 2007, the banks created more than $200 billion of C.D.O.’s backed by lower-rated mortgage paper. Moody’s assigned a different team to rate C.D.O.’s. This team knew far less about the underlying mortgages than did the committee that evaluated Subprime XYZ.... [A]gencies rate pools with assets that are perpetually shifting. They base their ratings on an extensive set of guidelines or covenants that limit the C.D.O. manager’s discretion.

Late in 2006, Moody’s rated a C.D.O. with $750 million worth of securities. The covenants, which act as a template, restricted the C.D.O. to, at most, an 80 percent exposure to subprime assets, and many other such conditions.... Moody’s rated three-quarters of this C.D.O.’s bonds triple-A.... Moody’s had underestimated the extent to which underwriting standards had weakened everywhere. When one mortgage bond failed, the odds were that others would, too. Moody’s estimated that this C.D.O. could potentially incur losses of 2 percent. It has since revised its estimate to 27 percent.... A triple-A layer of bonds has been downgraded 16 notches, all the way to B....

However, the conclusion is very, very weak indeed:

[I]f the Fed or other regulators wanted to restrict what sorts of bonds could be owned by banks, or by pension funds or by anyone else in need of protection, they would have to do it themselves — not farm the job out to Moody’s.... Moody’s itself... like S&P, embraces the idea that investors should not “rely” on ratings for buy-and-sell decisions. This leaves an awkward question, with respect to insanely complex structured securities: What can they rely on? The agencies seem utterly too involved to serve as a neutral arbiter, and the banks are sure to invent new and equally hard-to-assess vehicles in the future. Vickie Tillman, the executive vice president of S&P, told Congress last fall that in addition to the housing slump, “ahistorical behavorial modes” by homeowners were to blame for the wave of downgrades. She cited S&P’s data going back to the 1970s, as if consumers were at fault for not living up to the past. The real problem is that the agencies’ mathematical formulas look backward while life is lived forward. That is unlikely to change.

The problem is not that the rating agencies' formulas look backward while life is lived forward. Rating agencies' business is to look backward: to say that this bond looks, historically, like that class of bonds which have in the past defaulted at such-and-such a rate. The proper business of investment is to take the rating agencies' work as a guide and ask two of the three standard questions:

• What is there in the situation that could make things different this time--that could generate "ahistorical behavioral modes"?
• How much of the risk that things are different this time are we willing to bear?

And then there is the third standard question:

• If this is such a good deal for me to buy it at this price, why is the seller selling--why isn't it a equally good deal for the seller to hold on to it?

Without satisfactory answers to these three questions, you are not investing: you are gambling in Las Vegas and you are not the house--you are, indeed, on a blind date with destiny and she has just ordered the lobster.

Lowenstein's lament in his last paragraph is implicitly a demand that investors not only not have to have answers to these three standard questions, but that they not even be expected to ask them--that investors find somebody else to "rely" on in the cases of "insanely complex structured securities" and of "new and equally hard-to-assess vehicles in the future" that "banks are sure to invent," somebody else who can predict the future. That seems completely wrongheaded. If you truly do not want to ask the three standard questions and evaluate credit risk you should be in U.S. Treasuries (and even there you have to assess inflation risk and, unless you are planning to hold to maturity, monetary policy risk). And if you want higher yields than Treasuries offer--well, then you are back to asking your three standard questions again.

In my view, there seem to be six problems here, rather different than one would think from reading Lowenstein's last paragraphs:

• First, the problem of private organizations where the higher-ups let their CFOs and their subordinates game them by letting them say "it's triple A" when they didn't have answers to any of the three standard questions. This seems to be a problem for shareholders and trustees to deal with.
• Second, the problem of local government officials who were reaching for yield and saying "it's all in triple-A." This seems to be a problem for voters to deal with, or perhaps it's time to require that local governments use the Treasury as some form of fiscal agent.
• Third, the problem of highly-leveraged large financial firms where the traders and portfolio managers asked the three standard questions with respect to CDOs and went ahead otherwise--either because they misjudged the risks, because they correctly concluded that the risks were acceptable but this time got caught, or because they correctly assessed the risks but indulged in moral hazard while thinking that they would have collected their bonuses and moved on by the time the thing blew up. This is a much more serious problem--but it has little to do with the rating agencies.
• Fourth, the problem of the systemic risk--the fact that millions of jobs are now at risk--because of the fallout from problem three. The Fed and the Treasury are now trying to deal with this problem.
• Fifth, the problem that a good many people who could afford to pay their mortgages and stay in their homes will not be able to do so because of crisis risk and default premia loaded onto their mortgage payments--a problem that Frank and Dodd are trying to deal with, that Obama and Clinton would deal with, and that McCain is trying to ignore.

And:

• Sixth, the problem that bond salesmen throughout the world have been deflecting customers' attempts to ask for answers to the three standard questions by saying, "it's triple A! And it offers you a higher yield than other triple A!" and that the rating agencies have been too eager to increase their business by making the fine print in their descriptions of what they do even finer.

Lowenstein's article is written as if problem six is in some sense the problem. And this seems to me to be badly misleading.

links for 2008-04-27

• Mick LaSalle: 'People' not as smart as it could be
• Mick LaSalle: Wong's passionate 'Blueberry'
• Maria Maria--Carlos Santana

Helium Mines

My problem--actually one of my many problems, but that's a long story--is that I don't understand where our supply of helium comes from. How is there helium trapped in the earth's crust that we can mine? Is it all from the decay of uranium?

Ah. Wikipedia comes through once again:

Helium - Wikipedia, the free encyclopedia: After an oil drilling operation in 1903 in Dexter, Kansas, U.S. produced a gas geyser that would not burn, Kansas state geologist Erasmus Haworth collected samples of the escaping gas and took them back to the University of Kansas at Lawrence where, with the help of chemists Hamilton Cady and David McFarland, he discovered that... 1.84% of the gas sample was helium. Far from being a rare element, helium was present in vast quantities under the American Great Plains, available for extraction from natural gas. This put the United States in an excellent position to become the world's leading supplier of helium.... World War I... 200 thousand cubic feet (5,700 m3) of 92% helium was produced in the program even though only a few cubic feet (less than 100 liters) of the gas had previously been obtained... the world's first helium-filled airship, the U.S. Navy's C-7, which flew its maiden voyage from Hampton Roads, Virginia to Bolling Field in Washington, D.C. on 1 December 1921.... National Helium Reserve in 1925 at Amarillo, Texas with the goal of supplying military airships in time of war and commercial airships in peacetime. Due to a US military embargo against Germany that restricted helium supplies, the Hindenburg was forced to use hydrogen... the reserve was expanded in the 1950s to ensure a supply of liquid helium as a coolant....

By 1995, a billion cubic metres of the gas had been collected... "Helium Privatization Act of 1996."...

For many years the United States produced over 90% of commercially usable helium in the world. Extraction plants created in Canada, Poland, Russia, and other nations produced the remaining helium. In the mid 1990s, A new plant in Arzew, Algeria producing 600 million cubic feet (1.7×107 m3) came on stream, with enough production to cover all of Europe's demand. Subsequently, in 2004–2006 two additional plants, one in Ras Laffen, Qatar and the other in Skikda, Algeria were built, but as of early 2007, Ras Laffen is functioning at 50%, and Skikda has yet to start up. Algeria quickly became the second leading producer of helium....

Nearly all helium on Earth is a result of radioactive decay. The decay product is primarily found in minerals of uranium and thorium, including cleveites, pitchblende, carnotite and monazite, because they emit alpha particles, which consist of helium nuclei (He2+) to which electrons readily combine. In this way an estimated 3.4 litres of helium per year are generated per cubic kilometer of the Earth's crust....

The world's helium supply may be in danger, according to Washington University in St. Louis chemist Lee Sobotka. The largest reserve is in Texas and would run out in eight years if consumed at the current pace.... [H]elium is extracted by fractional distillation from natural gas, which contains up to 7% helium.... 2005, approximately one hundred and sixty million cubic meters of helium were extracted from natural gas or withdrawn from helium reserves, with approximately 83% from the United States, 11% from Algeria, and most of the remainder from Russia and Poland. In the United States, most helium is extracted from natural gas in Kansas and Texas...

Then She Found Me...

Then She Found Me--movie trailer that actually made me want to see the movie.

That's a rare event...

links for 2008-04-26

• downtown Bar & Restaurant
• Daniel Shaviro: Start Making Sense: Final NYU Tax Policy Colloquium of 2008: Today Jason Furman presented a paper on healthcare, rightly (I'd say) lambasting the bizarre Cogan-Hubbard-Kessler plan to combat moral hazard in healthcare by increasing it, and
• NYTimes on John McCain: Trouble With Not Being Earnest
• Nicole Belle: Rick Perlstein vs. David Frum. Always Remember, Facts Have A Liberal Bias
• The Financial Crisis: An Interview with George Soros - The New York Review of Books
• Dan Froomkin: The Most Disappointing President

Asset Price Deflation

George Soros on the financial crisi:

The Financial Crisis: George Soros: I think it was, but it would have required recognition that the system, as it currently operates, is built on false premises. Unfortunately, we have an idea of market fundamentalism, which is now the dominant ideology, holding that markets are self-correcting; and this is false because it's generally the intervention of the authorities that saves the markets when they get into trouble. Since 1980, we have had about five or six crises: the international banking crisis in 1982, the bankruptcy of Continental Illinois in 1984, and the failure of Long-Term Capital Management in 1998, to name only three.

Each time, it's the authorities that bail out the market, or organize companies to do so. So the regulators have precedents they should be aware of. But somehow this idea that markets tend to equilibrium and that deviations are random has gained acceptance and all of these fancy instruments for investment have been built on them.... The large potential risks of such investments are not being acknowledged....

The authorities, the regulators--the Federal Reserve and the Treasury--really failed to see what was happening. One Fed governor, Edward Gramlich, warned of a coming crisis in subprime mortgages in a speech published in 2004 and a book published in 2007, among other statements. So a number of people could see it coming. And somehow, the authorities didn't want to see it coming. So it came as a surprise.... [Y]ou have a whole establishment involved. The economics profession has developed theories of "random walks" and "rational expectations" that are supposed to account for market movements. That's what you learn in college. Now, when you come into the market, you tend to forget it because you realize that that's not how the markets work. But nevertheless, it's in some way the basis of your thinking....

[T]he situation is definitely much worse than is currently recognized. You have had a general disruption of the financial markets, much more pervasive than any we have had so far. And on top of it, you have the housing crisis, which is likely to get a lot worse than currently anticipated because markets do overshoot.... I'm sure that it will be necessary to arrest the decline [in housing] because the decline, I think, will be much faster and much deeper than currently anticipated.... [F]oreclosures are going to add to the supply of housing a very large number of properties.... There are about six million subprime mortgages outstanding, 40 percent of which will likely go into default in the next two years.... Problems with... adjustable-rate mortgages are going to be of about the same magnitude as with subprime mortgages. So you'll have maybe five million more defaults facing you over the next several years....

[Y]ou need to reduce the number of foreclosures. You need to keep as many people as possible in their houses so that they don't come onto the market. You need to arrest the decline in house prices, but you also need to prevent human suffering and social disruption because it's going to be very, very severe....

[Rescue] is their [the Federal Reserve's] job, whether unhealthy or not... to save the system when it is in danger. However, because that is their job, it ought to be their job also to prevent asset bubbles from developing. And that task has not been recognized. Greenspan once spoke about the "irrational exuberance" of the market.... [I]t's generally accepted that the Fed tries to control core inflation, but not asset prices. I think that control of asset prices has to be an objective in order to prevent asset bubbles because they are so frequent.... You have to recognize that just controlling money doesn't control credit.... [Y]ou have to take into account the willingness to lend. And if it's too great—if borrowers can obtain large loans on the basis of inadequate security--you really have to introduce margin requirements for such borrowing and try to discourage it....

[W]e are close to a tipping point [for the dollar] where, in my view, the willingness of banks and countries to hold dollars is definitely impaired. But there is no suitable alternative so central banks are diversifying into other currencies; but there is a general flight from these currencies. So the countries with big surpluses—Abu Dhabi, China, Norway, and Saudi Arabia, for example—have all set up sovereign wealth funds, state-owned investment funds held by central banks that aim to diversify their assets from monetary assets to real assets. That's one of the major developments currently and those sovereign wealth funds are growing. They're already equal in size to all of the hedge funds in the world combined. Of course, they don't use their capital as intensively as hedge funds, but they are going to grow to about five times the size of hedge funds in the next twenty years.

I must say, these days when I read my backlist I feel like a genius--for example, back in 1998 I tried to convince the Brookings Panel that:

Why We Should Fear Deflation: Economies may well have more to fear than declines in broad goods-and-services price indices alone. If securities and real estate holdings have been pledged as collateral for debt contracts, then large-scale asset price declines also trigger the confusion of macroeconomic events with entrepreneurial failure that makes deflation feared.

Is the United States today potentially vulnerable to large-scale asset price declines in this way? In real estate no [this was written in 1999]. In the stock market yes [ditto]. Perhaps fundamental patterns of equity valuation have truly changed, as investors have recognized that the equity premium over the past century was much too large--in which case stock prices have reached a permanent and high plateau. But it seems more likely that there are substantial risks of stock market declines on the order of fifty percent back to Campbell-Shiller fundamentals...

http://www.jstor.org/stable/pdfplus/2534666.pdf

Why Oh Why Can't We Have a Better Press Corps? (Ramesh Ponnuru Edition) (January 08, 2007) - Watch that Passive Voice! (Domestic Policy)

A number of people--people who I regard as suffering from Stockholm Syndrome--have other the years claimed that Ramesh Ponnuru is a reasonable person, unlike the bulk of the ignorant and corrupt hacks who write and have always written for National Review.

Can this please stop?

Nobody with any non-hackish tendencies would side with Larry Kudlow against John Podhoretz on this one.

Outsourced to Matthew Yglesias:

Watch that Passive Voice!: John Podhoretz offers the observation that "If Democrats offer a genuinely serious AMT reform that manages to cut taxes for tens of millions of middle-class people, the constituency for vetoing such a reform on the grounds that it would involve a tax-rate increase on those making more than $150,000 a year could fit comfortably into a Tokyo hotel room."

Larry Kudlow responds that "Using $150K as a threshold means a school teacher and a cop. Not exactly rich people." J-Pod with a help from some readers notes in response that "Only 5 percent of American households report earnings higher than $157,000 a year" and follows up arguing that precise salaries for cops and teachers is irrelevant, the point is that "Five percent is a lot of households, true — 5 million or so. But to write as though a $150,000 salary in America puts you smack dab in the middle of the middle class, which was Larry's rhetorical purpose, just doesn't jibe with the way lives are lived in America."

Kudlow doesn't seem to have an answer to that, but Ramesh Ponnuru manages to weigh-in on Kudlow's side with a further observation:

The Clintonites thought that they were raising taxes only on the top 2 percent of Americans and cutting taxes for a lot of people (by expanding the earned income credit). They got branded as tax hikers anyway. (And it would have been a tough vote for them even if they hadn't raised the gas tax as part of the deal.)

Advice to always eschew the passive voice can be abused, but Ponnuru should consider the lack of agency in that story. Who branded the Clinton administration as "tax hikers" for their plan to raise taxes on a tiny minority of wealthy Americans while cutting taxes for a larger class of working poor people? Could that have been conservative politicians? And how well would that campaign have worked had the conservative politicians not been assisted by conservative pundits? These things don't just happen.