My former student writes,

I just read the post–thanks. But I now have more questions. Am I slow, or is the repo market really hard to understand?
When you talk about the original intent of repo, I have a few questions:

1) I understood from Metrick in class that the repo market functions as a type of banking system. Dealers take “deposits” and provide securities as collateral; these deposits are returned at some point with interest. Is that different than what you say the repo system used to be, or is that the same?

2) You say that Gorton/Metrick make no distinction with what the repo market used to do, and what it now does. That investment banks used to keep inventory and sell it, but now they have trading and investment portfolios. What does this mean with regard to the repo market? I.e. how does this change what’s happening?

3) Metrick did say that the securitization of real estate was what created new “safe” securities that people with assets they didn’t want to put at risk demanded. Is this the thing you find inherently dangerous? The idea of manufacturing new, relatively “safe”, liquid assets?

Sorry if these questions are stupid–or even embed inaccuracies/misunderstandings. I think I understand the type of transactions that takes place in the repo market, but I’m not at all sure who are the counterparties on opposite sides of the deal, why they want these deals in the first place for such brief periods, and why this market is as large as it is.

Here are my answers: Continue reading →

He writes,

Many of the most important inventions of the late nineteenth and twentieth centuries are things that we would not want to do without today; yet they had little effect on the national accounts because they were so inexpensive: aspirin, lightbulbs, water chlorination, bicycles, lithium batteries, wheeled suitcases, contact lenses, digital music, and more.

Later,

All the same, I will venture a guess about one feature of the future: technology will go “small.” Twentieth-century technology was primarily about “large” things. …Energy was generated by massive power stations. Materials were produced by gigantic steel mills. Huge airplanes and tall cell towers embodied what the twentieth century could do. But the twenty-first century may be very different. …sorting cells, and sequencing and splicing genes may offer a better path to a better future than building supersonic planes.

Read the whole thing. I think that it may deserve one of David Brooks’ annual awards for magazine pieces.

At this event, on Peter Schuck’s book on government failure. Peter Berkowitz liked the book more than I did. Berkowitz, a conservative, was not as troubled as I was by the elitist assumptions embedded in the author’s thinking.

Schuck talks about cultural impediments to better government in the United States. On p. 375, he writes

Of the particular cultural features identified in chapter 4, only four–decentralization, protection of individual rights, acceptance of social and economic inequality, and suspicion of technical expertise and official discretion–seem remotely tractable to policy-driven change.

What he describes as bugs, I would describe as features. In my remarks, I will suggest that the problem is not that the rest of America gives too little authority and autonomy to technical experts. The problem is that technical experts have too exalted a view of their own theories and capabilities.

I am in a bad mood about progressives these days, which is making it difficult for me to be charitable. Maybe it’s the long winter–I slipped and almost injured myself on another patch of global warming yesterday. But I am getting tired of the relentless support for grand social engineering notwithstanding its dismal track record, along with the bitter rhetoric against those of us who happen to disagree.

Atif Mian and Amir Sufi write,

when the wealthy save in the financial system, some of that saving ends up in the hands of lower wealth households when they get a mortgage or auto loan. But when lower wealth households get financing, it is almost always done through debt contracts. This introduces some potential problems. Debt fuels asset booms when the economy is expanding, and debt contracts force the borrower to bear the losses of a decline in economic activity.

Pointer from Mark Thoma.

So the wealthy lend to the non-wealthy, who use the loans to consume. At some point, this process becomes unsustainable, and bad things happen.

Why don’t the people who manage wealth for the rich folks try to find better investments? According to the secular stagnation story, there are no better investments. However, one can tell an Austrian story in which the consumption loans constitute malinvestment. I would argue that this malinvestment is not caused by the Fed keeping interest rates to low. It is caused by government credit-allocation policies, embedded in various bank regulations.

In a Keynesian story, in which the wealthy have excess saving that cannot find a good use, more government spending is the solution. In the more Austrian story of malinvestment, steering more saving toward government and away from private investment would be part of the problem, not part of the solution.

Noah Smith writes,

Back in 2008, as the financial crisis was unfolding, there was a big argument as to whether the crisis was a “liquidity crisis” or a “solvency crisis”. It’s a very important distinction. A “liquidity crisis” is when banks (or similar finance companies) are financially in the black – their assets are greater than their liabilities – but they can’t get the cash to keep paying their bills in the short term. A bank run is the classic example of a liquidity crisis – even if the bank could eventually pay everyone back, it can’t pay them back all at once, so if people get scared and all try to withdraw their money in a rush, they force the bank to collapse. A “solvency crisis”, on the other hand, is when finance companies are actually bankrupt, and no amount of short-term borrowing will change that fact.

This is difficult to unravel. The high officials talked as if it were a liquidity crisis. But one might argue that they acted as if it were a solvency crisis. The Fed could have lent to Citigroup through the discount window. Instead, they injected capital into Citigroup, via TARP.

I think that AIG suffered from a liquidity crisis, because the contractual arrangements in their credit default swaps evidently allowed their counterparties to make “collateral calls” as the underlying securities declined in market value. The way the government dealt with AIG’s liquidity crisis was to give AIG enough money to meet the collateral calls (to Goldman Sachs and others) and essentially taking away capital from AIG, so that AIG had to dismember itself in order to remain a company.

Among the many problems with sorting things out is the problem of valuing brand equity. If you think that Citigroup had brand equity, then they were not in a solvency crisis.

If you think that Freddie and Fannie had brand equity, then they suffered from a liquidity crisis, because once their borrowing costs were held down, they became profitable again.

So I don’t have a crisp answer to Noah’s question, even in hindsight.

The Krugosphere is hostile to the macroeconomics of the University of Minnesota. I understand that. Krugman has used the term “Dark Age Macroeconomics” to describe what took place between the late 1970s and today. I understand that, too.

But what happened in Minnesota could have stayed in Minnesota. Instead, Stan Fischer and Olivier Blanchard gave MIT’s blessing to DSGE models and vector autoregressions. To me, those two are the real villains.

Had Fischer taken his cues from, say, Clower and Leijonhufvud, rather than from Sidrauski and his ilk, macroeconomists might have spent the last 30 years working on interesting issues and gaining some better understanding of the economy. Instead, they spent the last thirty years diddling with fancy unverifiable equations and pouring a few globs of macro data into the VAR immersion blender.

Mark Perry finds an article by Richard Foster, who wrote,

US corporations in the S&P500 in 1958 remained in the index for an average of 61 years. By 1980, the average tenure of an S&P500 firm was 25 years, and by 2011 that average shortened to 18 years based on seven year rolling averages. In other words, the churn rate of companies in the S&P500 has been accelerating over time

It seems to me that this is just one of many important structural changes that have taken place in the U.S. economy since 1960. It seems very unlikely that the same macroeconomic behavior would be observed today as was observed in past decades when the labor force had different education levels and a different gender mix, when corporate turnover was lower, when we lacked computers for inventory management, when there were restrictions on interstate banking, and so on.

Pete Boettke has an essay on “Fearing Freedom” in the latest Independent Review. In an ungated earlier version, he writes,

The problem that confronts the modern classical liberal, Buchanan (2005) postulates, is not the managerial socialism of the 20th century, nor even the Nanny State of paternalistic socialism, but the desire on the part of the population to remain in the infantile state of demanding a parent to protect them from the vagaries of life and provide them with economic security.

This is an interesting idea to play with. On the one hand, I think there is a lot of truth to it. Recall that George Lakoff, in Moral Politics, says that progressives believe that government should act as a “nurturant parent.” He contrasts this with what he calls the conservative’s “strict father” model of the state.

On the other hand, I am not sure that we can use this idea in everyday political arguments. Nobody is going to say, “Oh, yes, you’re right. I have wanted to remain in an infantile state, and now I see the error of my ways.”

I also do not think it will work to say that the state is a bad parent. Most people do not think that the failings of their parents are enough to justify running away from them or denying them respect. Even if you get somebody to agree that the state is a bad parent, they are more likely to hope that the state can become a better parent than to say that they want to weaken the state/parent.

One of my favorite ideas, competitive government, comes across in this metaphor as though it means competitive parents. Nobody thinks that the way to solve the problem of bad parents is to introduce competition into the process and let you choose your parents.

At an intellectual level, of course, we can try to attack the analogy between the state and parents. But it me be difficult to dislodge the analogy at a gut level.

From The Guardian (the story has appeared in several outlets).

Turner said a “magic pill” that reverses ageing is several years away, partially due to the cost of the compound, which would be about $50,000 a day for a human.

The compound is called NAD. A more scientific report is here. I predict that if the compound works, I predict it will take less time for somebody to figure out how to make it cheaply than it will take for the FDA to approve it.

1. I am quoted by Caroline Baum.

2. I will soon be sharing a stage with George Gilder. You can watch (see the link to Cato live).