(HT: Steve Hsu)
Saturday, October 11, 2008
Friday, October 10, 2008
What should be done?
With the markets, in both US and elsewhere, responding to the series of individual bailout plans and co-ordinated interest rate cuts with even more steeper declines, Paul Krugman feels that the only way forward would appear to be a co-ordinated British type bailout plan.
The British Plan seeks to recapitalize the banks by direct infusion of about 50 bn pounds, in return for Government stake taken through issuance of preferred shares, and providing guarantees for inter-bank lending and banks issuing short and medium term unsecured debt. Until markets stabilise, the Bank of England would continue to conduct auctions to lend sterling for three months and also to lend US dollars for one-week periods against a wider range of collateral. The Bank would also provide at least £200bn under its special liquidity scheme – under which banks can swap illiquid loans for risk-free government securities.
Barry Eichengreen and Richard Baldwin, sums up the recommendations of thirteen economists (full pdf here) commissioned by VoxEU
1. A quick bank recapitalisation with global coordination
2. A guarantee of deposits and/or loans with global coordination
3. Co-ordinated macroeconomic stimulus.
Bradford DeLong calls for immediate and co-ordinated monetary and fiscal expansion with banking sector recapitalizations, and in the long term, policies to make executive compensation incentive-compatible and a more progressive tax system.
As can be seen, the international finance multiplier makes co-ordinated action pre-requisite for any effort to restore confidence in the global financial markets.
However, Casey Mulligan thinks there is no need to panic and the economy really does not need any saving. since we are only in a "financial crisis" and not an "economic crisis", and the economy is resilient enough to tide out the financial turmoil. The basis for this optimism is that the real economy market equivalent of PE multiple for financial markets, marginal product of capital employed, was at a historic high of 10% (profit per dollar of capital invested) in the first half of 2008, and the third quarter profits reports of the non-financial sector private firms are encouraging.
Laurence Kotlikoff and Perry Mehrling argue that with the US Government assuming the role of a unversal banker and insurer of last resort, the worst may yet be over, and most of the physical and human capital are still intact.
But such optimism may be misplaced given the fact that it does not take much for the real economy to get trapped in a stagnant or low growth and jobless equilibrium. The credit squeeze coupled with the recessionary expectations will surely dry up corporate investments, and lead to postponement of hiring decisions. Consumers, facing a "negative wealth effect" will in all likelihood sharply cut back and even stop spending, and use any fiscal stimulus or tax credits to repay their debts. This will impact demand, which will remain weak, and this in turn further depress investment. We have seen it before in the late nineties and early this decade in Japan. No amount of human and physical capital could prevent the financial crisis becoming an economic crisis!
The British Plan seeks to recapitalize the banks by direct infusion of about 50 bn pounds, in return for Government stake taken through issuance of preferred shares, and providing guarantees for inter-bank lending and banks issuing short and medium term unsecured debt. Until markets stabilise, the Bank of England would continue to conduct auctions to lend sterling for three months and also to lend US dollars for one-week periods against a wider range of collateral. The Bank would also provide at least £200bn under its special liquidity scheme – under which banks can swap illiquid loans for risk-free government securities.
Barry Eichengreen and Richard Baldwin, sums up the recommendations of thirteen economists (full pdf here) commissioned by VoxEU
1. A quick bank recapitalisation with global coordination
2. A guarantee of deposits and/or loans with global coordination
3. Co-ordinated macroeconomic stimulus.
Bradford DeLong calls for immediate and co-ordinated monetary and fiscal expansion with banking sector recapitalizations, and in the long term, policies to make executive compensation incentive-compatible and a more progressive tax system.
As can be seen, the international finance multiplier makes co-ordinated action pre-requisite for any effort to restore confidence in the global financial markets.
However, Casey Mulligan thinks there is no need to panic and the economy really does not need any saving. since we are only in a "financial crisis" and not an "economic crisis", and the economy is resilient enough to tide out the financial turmoil. The basis for this optimism is that the real economy market equivalent of PE multiple for financial markets, marginal product of capital employed, was at a historic high of 10% (profit per dollar of capital invested) in the first half of 2008, and the third quarter profits reports of the non-financial sector private firms are encouraging.
Laurence Kotlikoff and Perry Mehrling argue that with the US Government assuming the role of a unversal banker and insurer of last resort, the worst may yet be over, and most of the physical and human capital are still intact.
But such optimism may be misplaced given the fact that it does not take much for the real economy to get trapped in a stagnant or low growth and jobless equilibrium. The credit squeeze coupled with the recessionary expectations will surely dry up corporate investments, and lead to postponement of hiring decisions. Consumers, facing a "negative wealth effect" will in all likelihood sharply cut back and even stop spending, and use any fiscal stimulus or tax credits to repay their debts. This will impact demand, which will remain weak, and this in turn further depress investment. We have seen it before in the late nineties and early this decade in Japan. No amount of human and physical capital could prevent the financial crisis becoming an economic crisis!
Marc Faber's advice to Americans!
Fund manager Marc Faber had this advice for Americans about how to spend the $145 bn fiscal stimulus, involving tax credits, announced by the Government in April this year.
(HT: From an email message)
"The federal government is sending each of us a $600 rebate. If we spend that money at Wal-Mart, the money goes to China . If we spend it on gasoline it goes to the Arabs. If we buy a computer it will go to India . If we purchase fruit and vegetables it will go to Mexico , Honduras and Guatemala . If we purchase a good car it will go to Germany . If we purchase useless crap it will go to Taiwan and none of it will help the American economy. The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in US. I've been doing my part."
(HT: From an email message)
Crisis of capitalism, not failure of government!
Richard Posner makes an excellent point that the ongoing crisis should be seen as a "crisis of capitalism" than as a "faliure of government". He writes,
Further, it is now well acknowledged that the real estate and the sub-prime mortgage bubbles which tirggered off this present crisis, were the makings not of Government, but Alan Greenspan, with his unflinching faith that markets can regulate themselves.
As an afterthought. It is now widely accepted that years of historically low interest rates fuelled and sustained the loose borrowing and investing practices of Wall Street. However, this reality is clearly at variance with standard economic models, which proclaim the primacy of prices as the most fundamental signalling and allocative mechanism. If this were true then interest rates should have corrected itself upward as the bubbles got inflated!
Update 1
Paul Volcker weighs in, "In the U.S., the market took over. The market has flopped."
"Bernanke and Paulson are neither politicians nor civil servants; Bernanke is an economics professor and Paulson an investment banker. Their principal advisers are investment bankers rather than Fed and Treasury employees. Even the prohibition of short selling, which seems like a product of the kind of mindless hostility to speculation that one expects from politicians, has been strongly urged by Wall Streeters, including the CEO of Morgan Stanley. The White House, the Congress, and even the SEC have been only bit players in the response to the crisis. In effect, the government's power to repair the crisis that Wall Street created has been delegated to Wall Street."
Further, it is now well acknowledged that the real estate and the sub-prime mortgage bubbles which tirggered off this present crisis, were the makings not of Government, but Alan Greenspan, with his unflinching faith that markets can regulate themselves.
As an afterthought. It is now widely accepted that years of historically low interest rates fuelled and sustained the loose borrowing and investing practices of Wall Street. However, this reality is clearly at variance with standard economic models, which proclaim the primacy of prices as the most fundamental signalling and allocative mechanism. If this were true then interest rates should have corrected itself upward as the bubbles got inflated!
Update 1
Paul Volcker weighs in, "In the U.S., the market took over. The market has flopped."
Thursday, October 9, 2008
Chinese bailout of US!
Arvind Subramanian is cheeky in suggesting that the Chinese Central Bank could step in and provide liquidity to the financial markets, by lending say, $500 bn, to the Fed, which could then use it to bailout the distressed firms. He writes,
Interestingly, the ongoing crisis appears to be a mirror inversion of the 1997 crisis in many emerging economies. The only difference now is that there have been not even a single case of bank failure in any of the emerging economies. Even as the Central Banks of developed world, cut rates in a co-ordinated manner, many major Asian Banks have deemed it not necessary to respond. Incidentally, the only two economies to have emerged unscathed (beyond the inevitable contagion effects) from the two biggest financial crisis of the past two decades are India and China. Do we have Central Banking lessons there? Talk about empire striking back!
(HT: Gadde Swarup)
"China’s loan offer would be direct to the US government to be spent in the current financial crisis. More important, it would come with strings attached. Tied aid, the preferred mode of operation of western donors since the postwar period, would now be embraced by China.
China would impose two conditions. First, it would declare that the offer of money was conditional on the US government’s adopting a particular approach to rescuing the banks, namely to favour in the next round the use of government money to recapitalise the banks. Europe has been using this approach and evidence suggests it is the most effective way of dealing with large-scale financial crises.
The US government – like third world governments in the past – has been unable to adopt the most efficient course of action. This stems from an ideological obsession against 'socialising' banks or because inducement is necessary to overcome any domestic opposition to it.
The second condition would relate to 'social safety nets', which had become standard embellishments to World Bank/IMF adjustment programmes. China would stipulate that monies be devoted to cushioning the impact on vulnerable homeowners, so that they would not be forced into forgoing the American dream of home ownership. Chinese conditionality on this front would achieve an outcome that several economists on the left and right have argued for on grounds of fairness, and also to address the fundamental problem in the housing market."
Interestingly, the ongoing crisis appears to be a mirror inversion of the 1997 crisis in many emerging economies. The only difference now is that there have been not even a single case of bank failure in any of the emerging economies. Even as the Central Banks of developed world, cut rates in a co-ordinated manner, many major Asian Banks have deemed it not necessary to respond. Incidentally, the only two economies to have emerged unscathed (beyond the inevitable contagion effects) from the two biggest financial crisis of the past two decades are India and China. Do we have Central Banking lessons there? Talk about empire striking back!
(HT: Gadde Swarup)
Selling broadcast rights
Barry Nalebuff and Ian Ayres feels that selling the broadcast rights on the party conventions in the lead up to the US Presidential elections is a good way to raise campaign funds. And they also suggest selling the broadcast rights to high-profile court cases, and use the proceeds to pay for both the defense and the prosecution, and space landings to support space exploration.
(HT: Freakonomics)
(HT: Freakonomics)
LoJack for tracking stolen goods!
LoJack is small, hidden radio-transmitter device, embedded inside cars, and that can be activated after your car is stolen and therefore used to track down stolen vehicles. As Ian Ayres and Steve Levitt showed, LoJack's utility lies in the large extent of positive externality it delivers. Uncertain about whether the car they are stealing contains LoJack, car thieves become wary, thereby reducing such crimes and also protecting cars without LoJack.
The concept behind LoJack can be used to protect any valuable good from theft. As Freakonomics writes, The University of Washington has just released a free program, Adeona, that will track your laptop if it’s stolen. If the program is installed on a computer with a built-in camera, it will even send you a photo of the thief at the keyboard.
Given the large positive externalities associated with them, LoJack type tracking systems, will be under supplied by the market. It is therefore appropriate for governments to incentivize the erection of such systems.
The concept behind LoJack can be used to protect any valuable good from theft. As Freakonomics writes, The University of Washington has just released a free program, Adeona, that will track your laptop if it’s stolen. If the program is installed on a computer with a built-in camera, it will even send you a photo of the thief at the keyboard.
Given the large positive externalities associated with them, LoJack type tracking systems, will be under supplied by the market. It is therefore appropriate for governments to incentivize the erection of such systems.
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