Category Archives: books and book reviews

Clay Shirky’s Little Rice

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The book is centered on Xiaomi, a Chinese cell phone firm. I found the writing rather jumpy, almost ADD. Here are some random excerpts (each of these is from different parts of the book):

This focus on a handful of individual product lines in turn allows the company to stay small. Employees who have been through Xiaomi’s hiring process are told that the company’s goal is to hire as few people as possible, by concentrating on attracting and retaining talented employees.

China, remarkably, has managed to create an alternate path, building a country where information moves like people,, in highly identified and constrained ways

the usual modes of censorship and surveillance are no longer enough to keep control of public opinion, and the government is expanding its online propaganda efforts. The people who flood online conversations with pro-Beijing sentiment are . . .paid half a yuan for every post.

the People’s Liberation Army paper published one saying, “The Internet has grown into an ideological battlefield, and whoever controls the tool will win the war.”

Of course, the idea of trying to operate a firm with a relatively small cadre of talented employees sounds very reasonable to someone in the tech business. But note that it is quite different from old-fashioned economic models, in which you hire “labor” until marginal revenue equals marginal cost.

But the issue that I am still mulling is the role of social media in affecting the evolution of beliefs and behavior. My sense is that people’s dislike of “the other” has gone up quite a bit during the relatively short period in which social media went from a small niche phenomenon to a mass-market phenomenon.

Mishkin Before vs. Bernanke After

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In Greg Ip’s new book, Foolproof, he writes,

Frederic Mishkin, an expert on banking who had studied the Great Depression, examined what would happen if housing prices fell 20 percent. The Fed, he argued in a lengthy presentation to other central bankers, would lower interest rates quite quickly, the economy would shrink only 0.5 percent, and unemployment would barely rise.

I have not yet read Bernanke’s new book, but I gather that he thinks that without the bailouts the economy was headed toward another Great Depression. So my point is that there is quite a gap between what Mishkin thought would happen if housing prices fell and what Bernanke was afraid was going to happen. Some possibilities.

1. Mishkin actually was right. The economy easily could have withstood the housing price crash. The problem must have been something else. (Scott Sumner would say that it was tight money.)

2. Mishkin was working with a simplistic model of the economy, which did not include the fragility of the financial sector or the feedback from loss of confidence in banks to the rest of the economy. There are two variations on this view

a) the bailouts helped, just as Bernanke says they did.
b) the bailouts made no macroeconomic difference. They simply served to redistribute losses away from the some of the stakeholders in the bailed out firms.

3. Mishkin actually was right. The economy would have recovered quickly with only a small recession. However, Bernanke and other policy makers did the wrong thing and turned what would have been a short-term crisis and the failure of a few firms into a long, drawn-out period of slow growth.

I think that (2a) is the most generally accepted view. My own view is 2b. I could also make a case for (3). Note that in the Great Depression, both Hoover and Roosevelt thought that destructive competition was a major problem. Both tried to discourage businesses from competing, Hoover through exhortation and Roosevelt through the National Industrial Recovery Act. In hindsight, reducing competition was a counterproductive idea. Perhaps in hindsight TARP and the other bailouts will not look so good, either.

By the way, I can offer a lot of praise for Ip’s economic judgment. However, I think I will end up putting Foolproof in the “very good but could have been even better if. . .” category.

Bethany McLean responds

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In an email (which she gave me permission to post), she writes,

So first of all, thank you for your kind words about All the Devils. I’ve always been a fan of your work, and I wholeheartedly second the title of your blog! Secondly, I’m always fine with criticism of my work and disagreement with any interpretation I’ve made. In particular, the GSEs are a nuanced, difficult subject, and frankly, I learn new things all the time. I am always willing to change my mind if someone shows me that I’m wrong.

What I’m not ok with is mischaracterizations of my work, whether deliberate or because you didn’t actually read most of the book [her newest book, Shaky Ground]. My main reason for writing is that you say I dismiss Ed DeMarco as a free market ideologue. That is exactly the opposite of what I actually wrote, which is that you cannot dismiss him as just that! I think Ed is a good man who did the best job he could and held true to his beliefs – saving taxpayers money – under very difficult circumstances. I don’t want people reading your review to think I impugned someone’s character when in fact, I did the opposite. It’s really unfair of you.

You are intellectually dishonest about some other points as well, but frankly, everyone is intellectually dishonest about the GSEs, so I won’t bother with most of it. But since I’m writing, I’m going to point another one out.

You also say that the shareholders made a political bet, which they lost, fair and square. There are many different types of shareholders, but as I detail (gory detail – it’s hard to miss!) a number of them made a purely financial bet, and totally missed the poisonous politics. They did loan level analysis and saw that the GSEs were going to become profitable again. Their bet was not that they could buy special favors, but precisely the opposite: that the government would treat Fannie and Freddie as normal companies – ie, like AIG, like Chrysler, like the big banks. Which, not incidentally, is what Jim Lockhart said would happen at the time of conservatorship. And the government set up this situation by leaving the common and preferred shares outstanding. You can blame the investors for being politically naive, but I don’t see how you can fail to acknowledge that there’s a lot of blame to go around here. (It might be a fair point to say that the GSEs are only profitable again because of government support. But then, you’d have to say the same thing about the big banks. In fact, you’d have to say the same thing about our whole stock market, which is supported by the Fed! Etc, etc. )

I agree with your point about there being a powerful case to be made against the government caving into the housing lobby. Perhaps I do give in too easily to what I view as the political reality. That said, the history of the private market financing residential real estate is not a pretty one either! Look back to the booms and busts in the 1800s and the spectacular default rates in the Great Depression. I also would contest the idea that there is such a thing today as a private sector, as pertains to the mortgage market. If the big banks finance the mortgage market, they too will be GSEs, if they aren’t already. But on this, there is much grist for debate, and criticism is fair.

Anyway, the tag line on your blog, “taking the most charitable view of those who disagree,” is so important. Live up to it! Don’t set up straw men so that you can knock me down.

My remarks:

1. I am glad that she respects Ed DeMarco, and I am sorry that I interpreted her as siding with his opponents.

2. She and I will have to agree to disagree about the hedge fund investors in Freddie and Fannie stock. I see no role for financial calculation, or “loan-level analysis.” Instead, it would have been obvious that the GSEs could be restored to profitability if you kept them going long enough using Treasury funds to borrow while having the entire mortgage market to themselves. The wild, speculative bet was that in the meantime there would be no reform of the housing finance system and that politicians would then decide to return Freddie and Fannie to the status quo prior to 2008. However, neither the Bush Administration nor the Obama Administration indicated any intent to do that. If you bought GSE stock for pennies in 2009 or 2010, you were making a bet that could pay off spectacularly, but only if Congress and the Administration were to do something very different from what they were saying.

In dealing with the crisis, the only purist, follow-the-law approach would have been to put the firms (including big banks) through bankruptcy. I would have preferred that, although I understand the fears that policy makers had about such a process. In my view, the next best alternative would have been to nationalize the GSEs and the failed banks, on the grounds that taxpayers were on the hook for the losses of those firms. Then the government would gradually wind these firms down. Instead, the policy makers chose bailouts, which necessarily involved arbitrary treatment of stakeholders. I do not think that any of those stakeholders has a compelling legal complaint at this point, because the rule of law went out the window with TARP and the bailouts.

Just the other day, some bloggers at the New York Fed wrote,

our view is that an optimal intervention into Fannie Mae and Freddie Mac would have involved the following elements:

The firms would be able to continue their core securitization function as going concerns, supporting the supply of mortgage credit.

The firms would continue to honor their debt and mortgage-backed securities obligations.

The value of the common and preferred equity in the two firms would be extinguished, reflecting their insolvent financial position.

Note that last sentence.

3. For writing my earlier post, I have been subjected to vicious, ad hominem attacks from former members of the Fannie Mae lobbying arm. If nothing else were to convince me that restoring the status quo for the GSE’s is a bad idea, then these crude, juvenile social media posts would suffice. Perhaps government backing for housing finance is inevitable in America. But at least let us hope that the institutions that receive such support do not replicate Fannie Mae’s aggressive and unprincipled lobbying machine.

In an opinion piece in today’s WaPo, McLean dismisses this lobbying with an “everybody does it” line.

One legitimate complaint about the old Fannie and Freddie was the way they garnered political clout through their promotion of homeownership. In their heyday, it was immense and ugly. (“Fannie has this grandmotherly image, but they will castrate you, decapitate you, tie you up, and throw you in the Potomac,” a congressional source told the International Economy in the late 1990s. “They are absolutely ruthless.” That would pale next to the political clout of a big bank that also controlled the mortgage market, and whatever evils grew out of the GSEs’ need to please politicians, there could be worse. Imagine the conversation in a back room between the politicians and the bank executives, where they agree that if the bank will loosen up credit in their states, the politicians will go easy on, say, derivatives regulation. It almost makes the old Fannie and Freddie look pure.

No it doesn’t. And the rest of her piece consists of cheerleading for housing finance subsidies, which is exactly what makes her new book such a disappointment.

Two Stars for Shaky Ground

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For the first time in many years, I wrote a review for Amazon. About Bethany McLean’s book on Freddie and Fannie, I say,

I was disappointed with this book, because I think that her earlier work, All the Devils are Here, co-authored by Joe Nocera, is probably the best journalistic account of the run-up to the financial crisis.

On “Shaky Ground,” here are my thoughts:

1. This book might have been titled “Sympathy for the Devils.” There is way too much sympathy expressed for the hedge funds that bought preferred stock in Freddie and Fannie. They were making a bet that the political process would come out a certain way, and they lost that bet, fair and square. End of story, as far as I am concerned. I should note that on several occasions representatives of the hedge funds have felt me out about doing some “research” or writing an article to support their position. I would not have done it for any amount of money. I am not accusing McLean of having succumbed to this, but I would not completely rule it out.

2. The other devil who gets a ton of sympathy is former Fannie Mae executive Tim Howard. McLean endorses all of his self-serving views, which include a claim that he did nothing wrong in Fannie’s giant accounting scandal. Also, his view is that had the Fannie management not been replaced, his team would have averted the crisis. Both claims may be true. In my opinion, Freddie and Fannie were better managed before both of their management teams fell in accounting scandals. But I think that more journalistic skepticism is in order. Regardless of who was in charge, there was pressure on Freddie and Fannie management to dive into high-risk lending, with shareholders seeing profits and regulators seeing a mission to expand home ownership opportunity.

3. She is no fan of Ed DeMarco, who was the only person in Washington working to gradually wind down the GSE’s, which is supposedly what everyone wanted. I think it is fair to say his approach was too unpopular with key players to be sustained. But he does not deserve to be dismissed by McLean with boo-words, like “free-market ideologue.”

4. She says that if you take it as given that the government is going to promote what the housing lobby wants, namely “home ownership” with little actual equity and a mortgage market dominated by the 30-year fixed-rate loan, then keeping Freddie and Fannie is better than the alternatives. If you accept the premise, then I agree. But there is a powerful case to be made against government caving into the housing lobby. The costs of this, including serial financial crises (the S&L crisis, the crisis of 2008) and misallocation of capital, are huge, and the social benefits are miniscule. (The private benefits can be enormous–just ask Tim Howard.) McLean does mention some of the evils of this housing-industrial complex, but her bottom line is, in effect “you can’t beat ’em, so don’t try.”

Overall, this is not a terrible book. But if you read it, you should keep in mind that she gives the most favorable treatment possible to Freddie, Fannie, the hedge fund investors, and to policy makers who attempt social engineering using housing finance. Although the book is not completely one-sided, she does not give alternative points of view as much respect as I think they deserve.

Bethany McLean Slips

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In her new book, Shaky Ground: The Strange Saga of the U.S. Mortgage Giants, she writes,

Originally, Fannie and Freddie owned the mortgages they purchased. but over time, as the capital markets in this country evolved, Fannie and Freddie began to package up the mortgages they purchased, stamp them with a guarantee. . .and sell them as securities to investors.

This is true of Fannie. But for Freddie the history is the opposite. They were in the securitization business from the beginning in 1970, and only around 1990 did they start to hold a substantial share of mortgages and mortgage securities as assets. There were several reasons that Freddie shifted to holding a large portfolio, funded by debt.

1. By 1990 Freddie was a shareholder-owned company (before that, they were basically a government agency), and shareholders were interested in profits. Having a large portfolio was profitable.

2. Prior to that, Freddie was concerned about the risk of holding mortgage portfolio. If you fund with short-term debt and interest rates rise, you end up paying more in interest expense than you earn on mortgages. If you fund with long-term debt and interest rates fall, borrowers refinance at lower rates and you are stuck with the high long-term debt costs. But Fannie Mae found a solution, which consisted of issuing callable debt. For example, they might issue a 10-year bond that can be called in 5 years. The market charged a surprisingly low interest rate on such securities, so Freddie started issuing them. Combining callable debt with some interest-rate derivatives gave Freddie and Fannie something close to an arbitrage profit in portfolio lending. They were helped, of course, by their “too big to fail” status, which made investors treat their debt as risk free–until the summer of 2008.

Anyway, I am sorry McLean slipped up on this. I really liked her book with Joe Nocera, All the Devils are Here, and I still have high hopes for her new one, which I have just started. I expect to post more on it.

I found this interesting:

When they were taken over, Fannie and Freddie had a combined $5.3 trillion in outstanding debt,, which, had it been put on the government’s balance sheet, would have increased the public national debt by about 50 percent. Partly to avoid that, the government left 20.1 percent of Fannie’s common stock, as well as other securities known as preferred shares, in the hands of investors.

Fannie and Freddie were originally government agencies. Fannie was privatized not for ideological reasons, but because Lyndon Johnson wanted Fannie’s debt off the government balance sheet. He was trying to fund the Vietnam War, plus the war on poverty, and he did not want Congress bothering him with debt-ceiling issues.

So here we were in 2008, and Fannie and Freddie should have been re-nationalized, but once again, the cosmetics of the government balance sheet took precedence.

Cinnabonomics

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I review the latest book by George Akerlof and Robert Shiller. I generally admire both authors. Ordinarily, if I do not like a book, then I do not write a long review. However, because both authors are Nobel Laureates, and because the book has received some positive press, I made an exception and let go with both barrels.

The authors do not deny that markets often work. However, if phishing equilibrium is limited to specific types of products, then the authors do not say so, nor do they give any criteria or characteristics to look for in order to predict in which markets phishing equilibria will be most prevalent.

But you have to read to the whole review to get the flavor.

Recall that Alex Tabarrok did not much are for the book, either.

Matthew Kahn Asks the Tough Question

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He writes,

Is Professor Summers saying that the subset of scholars who were studying macro have been collectively wasting their lives?

Pointer from Mark Thoma. I believe that they have been wasting their lives. I believe it even more strongly after reading Randall Wray’s Why Minsky Matters. The time-wasters treat the history and institutional characteristics of financial intermediaries as irrelevant. Minsky, correctly, thought that these things were important.

Minsky Revisited

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Olivier Blanchard says,

mainstream macroeconomics had taken the financial system for granted. The typical macro treatment of finance was a set of arbitrage equations, under the assumption that we did not need to look at who was doing what on Wall Street. That turned out to be badly wrong. . .

…As a result of the crisis, a hundred intellectual flowers are blooming. Some are very old flowers: Hyman Minsky’s financial instability hypothesis. . .

Pointer from Mark Thoma.

I have just finished a first reading of a review copy of L. Randall Wray’s forthcoming Why Minsky Matters. It is certain to be on my list of best books of the year. In my opinion, Wray succeeds in clarifying Minsky and in making his views more interesting and persuasive to me than they were previously (I still have my quarrels).

If I think about the economy in terms of patterns of specialization and trade, then Minsky thought of it in terms of financial intermediation. For Minsky, all of us are intermediaries. Because we do not barter, we trade either by issuing IOU’s or by passing along the IOU’s of others (fiat currency being an IOU of the government, if you will).

I am working on a review, which probably will not be out before the book.

A Short Read

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I was sent a review copy of On Inequality, by Harry G. Frankfurt. On p. 11, he writes,

a preoccupation with the condition of others interferes with the most basic task on which a person’s intelligent selection of monetary goals for himself most decisively depends.

I imagine that an egalitarian could respond: yes, I need to focus on calculating what it is that I need to be happy. However, I also need to be concerned that others are taking more than they deserve. High levels of inequality are a symptom that some people are taking more than they deserve. They are defectors in that sense, and it is important that the rest of us punish defectors and reward cooperators, who are people who take only what they deserve.

In other words, I do not think that the book will persuade anyone who does not already agree.

A Fiery Analogy

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Robert Shiller writes,

The reluctance to acknowledge the need for immediate intervention in a financial crisis is based on a school of economics that fails to account for the irrational exuberance that I have explored elsewhere, and that ignores the aggressive marketing and other realities of digital-age markets examined in Phishing for Phools. But adhering to an approach that overlooks these factors is akin to doing away with fire departments, on the grounds that without them people would be more careful – and so there would then be no fires.

Pointer from Mark Thoma.

There is a school of thought (I am not a member) that would instead compare the Fed to the 10-year-old boy who starts a fire and then claims to be a hero because he then calls the fire department to come in to save it. Similarly, this school would argue, the Fed’s expansionary policies caused the housing bubble, and now the Fed earns praise for saving the economy from the resulting crisis.

Indeed, in recent interviews, Shiller has warned that stock prices are too high and we could see a crash. He would say that this is because markets are irrational. As far as I know, he is not calling on the Fed to raise interest rates in order to try to stop what he might call another financial epidemic. Again, I am not of the school of thought that thinks that the Fed is responsible for the stock market boom. But I think that Shiller ought to engage with those who are of that school of thought.

Incidentally, I received a review copy of Phishing for Phools, by Shiller and fellow Nobel Laureate George Akerlof. My views of the financial crisis are informed by my knowledge of institutional characteristics and history of housing finance. Their views are not. I find that this is the case with many economists who have written on the crisis, but their book left me especially frustrated. UPDATE: Alex Tabarrok also reviewed the book negatively.