Category Archives: Financial Crises

The Fiscal Brouhaha

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First, some reality:

At the close of business on Jan. 20, 2009, the day Obama was inaugurated, the U.S. government debt held by the public was $6,307,311,000,000, according to the Daily Treasury Statement for that day.

At the close of business on Sept. 30, 2013—the last day of fiscal 2013—the Daily Treasury Statement said the U.S. government debt held by the public was $11,976,279,000,000.

I think that it is fair to attribute a lot of this debt increase to policies and economic conditions created under President Bush. Still, I find it ironic that President Obama would tell Wall Street that investors should be concerned about a potential default.

My views of the current situation:

1. Our politicians are like a family with a huge credit card debt. The Republicans are threatening not to make the minimum payment, and that is clearly a case of brinkmanship. However, the Democrats have no plan to keep the debt from growing out of control, and that in its own way is brinkmanship.

2. It is almost as if our political system and the news media are designed to conjure up short-term symbolic conflicts to distract attention from long-term problems.

3. A good rule of thumb in politics is that fiscal conservatives make noise, but spenders win in the end.

The Cochrane Tax

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John Cochrane proposes,

I think a simple tax is the answer – though since “tax” is a dirty word, let’s call it a “systemic externality fee” – on debt, and especially on short-term debt or any other contract where the investor has the right to demand payment, and fail the firm if not received. Every dollar of such funding will cost, say, a 10 cent fee. Payments due later generate smaller fees.

The idea is that all short-term debt contracts end up being implicitly insured by taxpayers. So from the standpoint of incentives and fairness, those contracts ought to be taxed.

Another Edition of “Did You Two Visit the Same Country?”

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1. Meg Jacobs writes,

Austerity has shaped American politics and policy for almost four decades. Over that period, the pressure for deficit reduction and spending cuts has been ongoing and intense. Even when liberals have found a modicum of political space to push through new social initiatives, such as President Obama’s Affordable Care Act, the agenda has quickly returned to constraining and limiting the growth of government. Democrats have generally joined Republicans in embracing this cause. The debate has centered on how far to go with austerity, rather than whether austerity is even the right objective.

That is the point of a recent spate of books from the unrepentant Keynesian left, which offers a potent, if largely unheeded, critique of contemporary public policy. These books argue that we’re in the mess we are in today—an anemic recovery, chronic underinvestment in the public sphere, and the specter of EU collapse—because of the austerity policies that the United States and Europe have chosen.

2. Ian Talley writes,

The U.S., Japan and Europe risk drowning in debt, with public obligations in rich countries hitting levels close to the historical peak reached in World War II.

How did the most advanced countries in the world get it so wrong?

Overly optimistic budget projections, poor data on government liabilities and a flawed understanding about how shocks can hurt public finances, the International Monetary Fund says in a new policy paper published Tuesday.

Popular Delusions

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The Harvard School of Public Health reports,

Many experts believe that future Medicare spending will have to be reduced in order to lower the federal budget deficit but polls show little support (10% to 36%) for major reductions in Medicare spending for this purpose. In fact, many Americans feel so strongly that they say they would vote against candidates who favor such reductions. Many experts see Medicare as a major contributor to the federal budget deficit today, but only about one-third (31%) of the public agrees.

Pointer from Phil Izzo. Somehow, I don’t think Tyler Cowen would be surprised by these results.

Keith Hennessey and Edward P.Lazear on the Financial Crisis

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They write,

The best evidence suggests that the financial crisis was caused in large part by an unprecedented flow of funds into the United States and other developed economies.

Thanks to Michael Barone for the pointer.

Their essay is very well organized and well written. That does not mean that I agree with it. It is true that there is a tendency for large capital inflows to end badly (think of Latin America in the 1980s or Asia in the 1990s). However, we could have used those capital inflows to finance something other than a consumption binge funded by unsound mortgage loans.

One of their arguments is that the financial crisis was more like popcorn (a lot of institutions faltering for the same reason) than like dominoes (one institutional failure leading to another). They say that this argues against case-by-case rescues, and I agree with that. But they say it argues in favor of TARP, which they describe as a systemic solution. But a solution to what? How does transferring the real losses from the owners and creditors of distressed firms to the taxpayers solve anything? They write,

Five years later, TARP and the other policy actions taken during the financial crisis nevertheless remain widely unpopular. This tension between a policy success and intense political unpopularity is a defining feature of the actions taking during the financial crisis.

Of course, we do not have the counterfactual, so they can say that all they want. Just as proponents of the stimulus can say that it saved lots of jobs. Both TARP and the stimulus were followed by horrible economic performance, but you can always argue that it would have been worse without them.

The authors, both of whom were important officials under President Bush in 2008, also defend the GM and Chrysler bailouts.

If [Bush] chose not to extend the loans, he was advised that these firms would likely liquidate within weeks. Private sources of debtor-in-possession financing that would have been necessary to allow GM and Chrysler to continue absent government aid were simply unavailable.

What Would Keynes Have Done?

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Bradley Bateman writes,

He never said that the government could exactly hit some target. This is an idea that came from one of the first great Keynesian texts published in the late 1940s, Functional Finance by Abba Lerner

Bateman writes in a collection of essays called The Economic Crisis in Retrospect, which tries to ask what great economists of the past might have said about the financial crisis of 2008. It is published by Edward Elgar, which typically prices its products for libraries as opposed to the mass public. I was sent a review copy.

Bateman also claims that Keynes did not believe in running government budget deficits. “In many ways he was Libertarian.” Of course, he was always in favor of public works as a stimulus package, but Bateman claims that Keynes proposed using the government’s sinking fund to finance this. It is not clear to me why this is not deficit spending.

In another essay, on Joseph Schumpeter, Richard N. Langlois quotes from Capitalism, Socialism, and Democracy.

Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary. And this evolutionary character of the capitalist process is not merely due to the…social and natural environment…The fundamental impulse that sets and keeps the capitalist engine in motion comes from new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.

Langlois says that Schumpeter explained the business cycle by saying that it takes a while for signals of obsolescence to reach the firms that are affected. Langlois writes,

They do not stop making carbon paper right away. So there is an economic boom that starts as the new technology spreads. It creates what Schumpeter calls a secondary boom that is artificial. Because what should be happening is that resources should be being withdrawn from carbon paper at the same time they are being put into computers. But that does not happen. The carbon paper is still there because those signals have not yet reached those who finance carbon paper. Yet there is a boom in computers. The whole process is not sustainable.

The book has other interesting essays including one by Perry Mehrling, who gives his view that we need to extend government protection to shadow banking, as well as one by Thomas Sargent, who raises some doubts about that approach.

Although I found the book worth reading, and I may re-read Sargent’s essay (I found a video of Sargent delivering his essay, and I passed it along to Scott Sumner, who seems to have had as much difficulty as I did following it.), I would not put it at the top of your wish list.

A Question

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From the comments on this post.

if it were made clear that in the event of a crisis the shareholders would be wiped out and the bondholders would take whatever loss was required, then why should anyone care what financial structure an institution chooses?

This approach could have been taken in 2008. Several economists argued that Citigroup could have been handed over to the bondholders. Why wasn’t this done? Here are some possible adverse consequences:

1. Depositors will hear “Citigroup is bankrupt” and rush to pull deposits out, even though they are safe.

2. Holders of bonds at other banks will sell those bonds in order to buy safer assets.

Of course, these concerns can always be raised about bank debt. If the government will never allow bank debtholders to take a loss, then in effect we have 100 percent government guarantees to bank debtholders. Russ Roberts has argued vociferously that this is in fact the regime we have been under, and the consequence is that banks have the incentive to maximize their debt financing.

It appears that the government cannot credibly commit to letting bank creditors bear some of the losses from an insolvency. If that is the case, then it would seem that taxpayers have an interest in forcing banks to have a capital structure with less debt and more equity.

Banks and Political Power

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Simon Wren-Lewis and I may disagree on many things, but not on this.

Most economists are instinctively against state subsidies, unless there are obvious externalities which they are countering. With banks the subsidy is not just an unwarranted transfer of resources, but it is also distorting the incentives for bankers to take risk, as we found out in 2007/8. Bankers make money when the risk pays off, and get bailed out by governments when it does not.

Read the whole thing. Pointer from Mark Thoma

Mind the Gap?

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Larry Kotlikoff writes,

The fiscal gap is a comprehensive measure of our government’s indebtedness. It is defined as the present value of all projected future expenditures, including servicing outstanding official federal debt, less the present value of all projected future tax and other receipts, including income accruing from the government’s current ownership of financial assets.

He wants to see CBO, OMB, and GAO all report on this measure.

I think I would prefer to see accrual accounting. That is, report the increase in government obligations each year. But the fiscal gap idea might be helpful.

John Cochrane on Valuing Government Pensions

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He writes,

A good response occurred to me, to those cited by Josh who want to argue that underfunding is a mere $1 trillion. OK, let’s issue the extra $1 trillion of Federal debt. Put it in with the pension assets. Now, convert the pensions entirely to defined-contribution. Give the employees and pensioners their money now, in IRA or 401(k) form. If indeed the pensions are “funded,” then the pensioners are just as well off as if they had the existing pensions. (This might even be a tricky way for states to legally cut the value of their pension promises)

I suspect the other side would not take this deal. Well, tell us how much money you think the pension promises really are worth — how much money we have to give pensioners today, to invest just as the pension plans would, to make them whole. Hmm, I think we’ll end up a lot closer to Josh’s numbers.

That is, one way to value government pensions is to ask workers how much they would be willing to take in the form of an individual retirement account to give up their pensions. Of course, if the government workers believe that their pensions are at risk, they might take a low figure. But if we take that possibility off the table, then workers are likely to demand a lot more money than the current stated value of the pension obligations.

I think others have pointed this out before, but when the subject of Social Security privatization comes up, aggressive assumptions about stock market returns seem reasonable to those on the Right and crazy to those on the Left. But their positions reverse when the subject changes to state and local pension funding. My own preference is to make conservative assumptions about stock market returns for both discussions.