Greenspanism and Its Discontents

I had hoped to finish this before I had to turn my attention to my Great Depression lectures. But no dice:

"Greenspanism and Its Discontents":

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Now I have to think about my Great Depression lectures: what have I learned from the financial crisis of the past fourteen months that should change what I think about the Great Depression? And how should I change what I think?

Comments

[roublen]

"how should I change what I think?"

well, if we're putting in requests, I never hear anything from mainstream economists about the negative economic effects of rentiers, and rentier-seeking. If someone passes on a large fortune to their heirs, allowing them not to work, their not working has a negative effect on economic growth, as negative an effect as if they had received government pensions at 35. And more harmful than rentiers themselves may be rentier-seeking, i.e. if the nation's business elite adopts the attitude of "make my pile and then retire early", instead of "build a great organization that does great things".

There's economic discussion of rents, and rent-seeking, but that discussion tends to assume that rents come only from excessive goverment policies, and not the reverse - i.e. from not enough taxes on large inheritances, large incomes, and large estates.

This may not be directly relevant to how to get out of a Great Depression, but I think it is relevant. When a large portion of the nation's business elite adopts the mindset "make my pile and then retire early", bad things happen.

I guess I'm outing myself as a crank, but I found this essay illuminating on these issues:

http://geolib.pair.com/essays/sullivan.dan/royallib.html

[spencer]

So much of what I read about the great depression is based on the premise that at the time the correct policy moves were obvious and that every intelligent analyst agrees on the correct policy.

But wht we are seeing now is that the lverl of uncertainty is tremendous and that many people are supporting policies that they really do not agree with because it is the best alternative being considered. For example, we support a good policy over a great policy because the good policy can be enacted now rather than next month.

The lessons of today on studies of the great depression reveal that our analysis massively underestimates the role of uncertainty in the creation of the depression that virtually all of the standard studies massively underestimate.

[Phil P]

Maybe there's a middle ground between Greenspanism and Mussaism. Greenspan may have been guilty of a double error, failing to be proactive in terms of regulation, AND keeping interest rates too low. Was it really necessary to take the federal funds rate to the almost unprecedented level of 1% and keep it there so long even after the economy had started growing again, because of a misguided fears based on the Japanese experience? On the other hand we don't want to throw the baby out with the bath water and lose money policy as a tool of economic stabilization. Don't forget that many critics of Greenspan as a serial bubble blower also think he kept interest rates too low in the 1990s. Does Brad think that was a mistake too? There's bound now to be regulatory changes that will prevent this type of disaster from recurring again. So are we going to lock the barn door after the horses have fled, and meanwhile throw away our fire extinguishers so if ten years from now the barn starts to burn down we have nothing to extinguish it with? (How's that for mixed metaphors!)

[howard]

spencer pretty much beats me to the punch: the main thing to learn from this crisis is that it is very hard in real time to grasp - and then build the political support for - the "correct" policy choices.

one thing that tells me is that fdr (from what modest amount i know) had the perfect attitude: we're going to try things and some won't work and we'll accept that and move on (whether he actually did that, another story, as some would say!).

[J Thomas]

We should notice how long our various OODA loops take. Don't try to respond too quickly because if you respond inside your OODA loop your chance of doing the right thing approaches a limit of no better than 50%, from below.

[Shander]

Some use of some very simple metrics could gauge risk.

Instead of ever believing we are in a "New era" prices should be compared to 20 year moving averages of similar assetts. Interest rate adjustments must be considered as a secondary, not a primary metric.

If earnings of public company were factored upon the 5 year averages, and the discount rate to value those companies were based upon a risk margin over a 5 year average of non real economic growth rate...(a better inflation inflation metric that basket of goods which ignores productity increases which should fall to holders of investments).

If home prices were calculated at per square foot cost and price increases above a cost of construction index (perhaps some wage rate increase for supply constrained areas) a red flag could go up that prices were increasing due to monetary policy and credit supply.

While hereusitics are frowned upon they provide common sense checks. Most economic models seem altogether too focused upon the last 5 years rather than the last 40 years. People focussed on the last 40 years found themselves idle for the last 5 while those focused on the present using other peoples capital were getting paid healthily. There was no reward in being right ... easy credit drowned out the slowing effect private investors withdrawal from the market would have had to ease prices due to lack of confidence and belief that metrics would sink back to historic heuristical norms.

[Neil B]

The United States went through a mortgage-sparked credit crisis in 1873, W & M History Prof. Scott Nelson writes about in an essay (link to story below.) I think he's got a point, that the parallels with the Panic of 1873 are greater than to the Great Depression.

{begin quote}
About 1870, European leaders supported the growth of new lending institutions that issued mortgages for city and residential construction. Easy credit led to a building boom in Vienna, Berlin, Paris and elsewhere. Land values climbed, and borrowers took on more and more debt, using unbuilt or half-built houses as collateral.

...

Something had to prick this economic balloon. In 1873, it was American wheat. Wheat producers in Russian and Central Europe lost income when Britain and others started buying much cheaper wheat imports from the United States' booming Midwest farms. Europeans called the wheat and factory exports "The American Commercial Invasion," and as European incomes fell, mortgages went flop and banks began to fail.

Then, as today, banks began to hold onto their capital, unsure of which fellow banks were sound. The cost to lend money from bank to bank skyrocketed — and protests against a fast-paced global economy grew louder.

"The phrasing and the criticisms of global, international trade we hear today could be verbatim from the 1870s, from the French or the Czech or the Hungarian writers," Nelson said.

When this credit freeze bounced back at America, railroad companies started to have trouble raising money with bond sales that were as shaky then as the market derivatives based on mortgages were this decade, Nelson said. Rather than cut back, railroad companies began to grasp for more and more short-term bank loans to continue laying track.

High-profile railroad financier Jay Cooke failed to pay his debts, and the American stock market crashed in September 1873. Hundreds of banks closed in the next three years. Small factories failed, and unemployment climbed — it hit 25 percent in New York City alone.

But the wealthiest people who had cash to buy the failing companies did very well. Andrew Carnegie and John D. Rockefeller bought out their smaller competitors at what Nelson called "fire-sale prices" (similar to the way Warren Buffett got a chunk of Goldman Sachs two weeks ago.)
{end quote}

BTW, Warren Buffett for Sec. Treas. or Fed Chair? Both McCain and Obama talked it up!

www dot dailypress dot com/news/dp-local_wmprof_1006oct06,0,3600990.story

[Matt]

If I get this, (maybe I don't) then the risk of asset failure determines the natural interest rate and the specifies the optimum capital ratio.

Hence, given a natural interest rate, there is not much the fed can do except follow it.

[Matt]

Fine work by Brad, and some other implications.

Regarding the LIBOR rate, the difference between interbank and treasury rate, the interbank rate is probably pricing risk more correctly than treasuries, a big whoops.

Second, the effect of bubble is to re-enforce old technology at the expense of new, as in, what if we correctly invested over the past 8 years? We might have solved a chunk of the global warming problem.

Third, if Treasuries are over pricing risk, then, left unabated, the federal government will end up buying about $20 trillion in risk using inflated prices (an impossibility). In other words, the bubble has gone to government, and will burst from there.

If we assume that Instability Theory is incorrect (I doubt it), then there is an ideal solution.

The ideal solution is simple. Tell Paulson to minimize federal interest payments across the term structure. Again, follow the logic (but remember, Instability likely prevents this solution).

If Hank minimized interest payments, then the term structure of the federal government debt will be optimum in the sense of packing the most volatility into the smallest price. This is a Gaussian term structure. Since the term structure of the government is a proxy for the Fourier transform of government output, then government output will be a spectrally free Gaussian white noise. In order for Congress to produce an output without measurable cycles, then Congress will have to act with optimum efficiency, managing short term, medium term, and long term finances in a timely manner by delegation or direct involvement, like the California Gubernator calling the special session of the assembly to manage short term finances.

Because the federal government is the biggest, at 19.7%, the government will influence the private sector to operate from a similar optimum term structure. This in turn will force Chinese authorities to release their financial class and attempt to match efficiency for efficiency.

Trade will balance, efficiency across the board increases, and good times for all.

But I doubt it. I think, once again, as we approach optimum efficiency, equilibrium points become deep and vision becomes fooled; we go back to bubblies. But, why not try?

Regarding the fact that seemingly innocuous error cause economic depressions, I doubt it. I think innocuous monetary errors happen all the time, bankers make many midnight mistakes, political rebellion start and fizzle. The difference is Instability Theory, when the restructuring comes, the most recently volatile event looks like a trigger.

[christofay]

Matt, you are approaching Greenspanism in discussion. Maybe Colin Denby can take a break from reading the most brilliant Bernanke paper and enlighten us.

For a reading-only explanation, Austrian theory seems to explain how we got to this mess.

Also you can't look at Greenspan just as in a theoretical bubble. He was being called to the White House 3 times a week; the Fed had become open to political influence; the mensch probably wanted to be on the winning Football Team too. Greenspan-Rove, Greenspan-Cheney, who won those stare down contests?