Paulson, Bernanke, and Lehman, continued

James B. Stewart writes,

One of the more intriguing questions Professor Ball tackles is why Mr. Paulson, rather than Mr. Bernanke, appears to have been the primary decision maker, when sole authority to lend to an institution in distress rests with the Fed. The answer, he suggests, is to be found more in psychology than data.

“By many accounts, Paulson was a highly assertive person who often told others what to do, and Bernanke was not,” Professor Ball writes. “Based on these traits, we would expect Paulson to take charge in a crisis.”

Pointer from Mark Thoma.

Stewart, who did his own reporting on the events, supports Professor Ball’s view. My reading of Paulson is that he is a high-testosterone guy. My reading of Bernanke is that he isn’t. I have always viewed Paulson as the great villain of the financial crisis response. I do not believe that any of the bailouts were justified, and I view him as the driver of the bailouts.

Suppose you take a Bagehot view, which is that in a crisis the central bank should lend freely, on good collateral, at a penalty rate. In the case of Bear Stearns, my recollection is that the Fed took on crummy collateral. Ball claims that Lehman had good collateral that the Fed could have lent against.

The Great Regulation

Guy Rolnik writes,

Looking at both intangible investments and political activities to explain the 20% rise in Tobin’s q in the U.S. since 1970, a new working paper by James Bessen from Boston University concludes that activity associated with increased Federal regulation is the most important explanatory factor, especially after 2000. In fact, spending on R&D and other intangibles has fallen relative to conventional assets since 2000.

Noting that operating margins for these firms have also risen since 1990 by over 2% in aggregate, Bessen’s study also found that variables associated with regulation and corporate campaign contributions account for about half of this increase.

Pointer from Mark Thoma. The article is a long interview with Bessen, interesting throughout. For example,

In 2011 a new patent law passed, the Leahy-Smith America Invents Act. This patent law was essentially negotiated between a small number of large pharma companies and a small number of large tech companies.

…all of a sudden you have a whole lot of small businesses in every state in the country who are now upset about getting sued for patent infringement over these very ridiculous claims.

Once again, I wonder how much of the trend toward industry consolidation and loss of dynamism in the past twenty years is due to regulation and rent-seeking.

The Book Sounds Interesting

Erwin Dekker writes,

The rise of fascism posed an even greater threat to the values of the liberal bourgeois, and at the same time it demonstrated that socialism might not be inevitable after all. One of my book’s major themes is the transformation from the resigned, and at times fatalistic, study of the transformation of the older generation, to the more activist and combatant attitude of the younger generation. Friedrich Hayek, Karl Popper, Peter Drucker as well as important intellectual currents in Vienna start to oppose, and defend the Habsburg civilization from its enemies.

I have seen many references to the article on Facebook and on blogs, including Mark Thoma’s link.

The book seems like it might be interesting, but the publishers are evidently worried that people might buy it, so they are charging a price that should deter that from happening.

Paul Romer on Economic Growth

He writes,

One of the biggest meta-ideas of modern life is to let people live together in dense urban agglomerations. A second is to allow market forces to guide most of the detailed decisions these people make about [how] they interact with each other.

Pointer from Mark Thoma.

Relevant because apparently he will be chief economist at he World Bank. I am not sure that his personality and that institution are meant for one another.

Larry Summers Rides the Populist Wave

He writes,

If Italy’s banking system is badly undercapitalised and the country’s democratically elected government wants to use taxpayer money to recapitalise it, why should some international agreement prevent it from doing so? Why should not countries that think that genetically modified crops are dangerous get to shield people from them? Why should the international community seek to prevent countries that wish to limit capital inflows from doing so? The issue in all these cases is not the merits. It is the principle that intrusions into sovereignty exact a high cost.

Pointer from Mark Thoma. My thoughts:

1. If Larry Summers has a natural affinity with ordinary people, then I was born to play in the NBA.

2. Note that he instinctively thinks that decisions should be made by governments. His concession to populism is that these decisions should be made by national governments rather than international bureaucrats.

3. I don’t think that we should sell free trade and increased legal immigration to people as “Take this pill, it will be good for you.” I think we should try to sell free trade by example, which means being willing to give up the protections against competition that we enjoy in our credentialist society.

The Bond Bubble

Balazs Csullag, Jon Danielsson, and Robert Macrae write,

A rational buy-and-hold investor who trusts the central banks should not buy long-dated bonds. While a high degree of central bank credibility used to be important to bond holders, today this seems to be no longer the case, especially for those buying German bonds.

The only way to get decent long-term returns with current yields so low is to go back to the persistent deflation of the gold standard, because most post-war inflation rates imply losses. For example, there are only eight years in Germany with lower than breakeven inflation for our 30-year buy-and-hold investor today.

Pointer from Mark Thoma.

The thing is, once interest rates start rising, they could explode, because at that point people may doubt the ability of governments to pay back their debts.

What if the central banks hold all of the bonds? That means that those central banks will be sitting on losses. If their cost of funds rises (say, because the central bank has to pay a higher interest rate on reserves), then central banks become a drain on the treasury.

Set Up for Failure

W. Scott Frame, Kristoper Gerardi, and Joseph Tracy write,

The extinction of the private subprime market and the rapid rise of the government insurance programs may strike many as a largely positive development. After all, it was the subprime segment of the mortgage market that triggered the global financial crisis and subsequent Great Recession as subprime loans defaulted at an astronomical rate during the housing bust. However, while government-insured mortgages are typically underwritten with more rigor and discipline than private subprime loans, they are not low-risk loans. The combination of high leverage and low credit scores documented above translates into extremely high default rates. The table above shows that five-year cumulative default rates (CDRs) by year of origination varied between 5 and 25 percent over our sample period. To put these numbers into perspective, the five-year CDRs associated with loans insured by Fannie Mae and Freddie Mac (the housing government-sponsored enterprises, or GSEs) are typically an order of magnitude lower. According to our calculations, the 2002 and 2009 vintages of GSE loans had five-year CDRs of approximately 2 percent, while Ginnie Mae’s same vintages had five-year CDRs of almost 10 percent and 13 percent, respectively.

Pointer from Mark Thoma.

The Federal Housing Administration, FHA, sets up many borrowers to fail. One could argue that these borrowers put up so little of their own money that this is a worthwhile risk from their point of view. It is the taxpayers that are being set up to fail.

Consolidating the Central Bank and the Treasury

Thomas Klitgaard and Harry Wheeler write,

The discussion above offers up a perspective on what is meant by “monetizing debt.” This term refers to a central bank buying government bonds and promising to keep them on its balance sheet with the result that the increase in reserves in the banking system translates into higher prices. This outcome, though, requires that the central bank not pay the appropriate interest rates on reserves. If it does, then an asset purchase program is just an effort that shortens the maturity of public-sector debt and will likely have few or no implications for future inflation.

Pointer from Mark Thoma.

Another implication is that it makes the interest cost of the government more sensitive to movements in short-term interest rates. So a sudden loss of confidence in the government by investors which raises interest rates would become self-reinforcing. And if the only way out of such a debt crisis is to print money, then there are implications for future inflation.

Jason Furman’s Puzzle

He writes,

In the absence of economic rents, the return on corporate capital should generally follow the path of interest rates, which reflect the prevailing return to capital in the economy. But over the past three decades, the return to productive capital generally has risen, despite the large decline in yields on government bonds.

Pointer from Mark Thoma.

For a moment, think that there is just one interest rate. If “the” interest rate is low, then the rate of return on new capital ought to be low. Otherwise, firms would borrow at the low interest rate in order to purchase new capital.

One possibility is that the marginal return on new capital is low, but the returns on existing capital are high. That would be true in an economy where there are economic rents available, due to monopoly power and/or government favoritism. I gather that this is the story that Furman thinks is right.

I would note that there is more than one interest rate. It could be that there is a high interest rate charged to firms that are trying to invest in new capital at the margin. Microsoft can borrow at a low interest rate, but when it buys Linked-In that is not new capital investment.

Despite that possibility, my inclination is to believe that Furman is onto something. Read his whole essay.

James Surowiecke on the Universal Basic Income

He writes,

One striking thing about guaranteeing a basic income is that it’s always had support both on the left and on the right—albeit for different reasons. Martin Luther King embraced the idea, but so did the right-wing economist Milton Friedman, while the Nixon Administration even tried to get a basic-income guarantee through Congress. These days, among younger thinkers on the left, the U.B.I. is seen as a means to ending poverty, combatting rising inequality, and liberating workers from the burden of crappy jobs. For thinkers on the right, the U.B.I. seems like a simpler, and more libertarian, alternative to the thicket of anti-poverty and social-welfare programs.

Pointer from Mark Thoma. A few thoughts of mine:

1. The apparent left-right consensus breaks down if in the last sentence the left is thinking that the word “alternative” should instead be “in addition to.”

2. There is a question of how to finance the UBI. For those on the right, the answer is by getting rid of the other programs. For those on the left, it may be less clear. See (1).

3. The existing approach to anti-poverty programs fits with what in my forthcoming book I describe as real-world economic policy: stimulate demand, restrict supply. Food stamps stimulate demand for food. Housing subsidies stimulate demand for housing. Student loan subsidies stimulate demand for accredited colleges. Medicaid stimulates demand for medical services.

A UBI would allow the recipients to decide on their own priorities. It thus lacks the base of support that the other programs have.