What Was Glass-Steagall?

I don’t think that Robert Reich actually knows.

Some argue Glass-Steagall wouldn’t have prevented the 2008 crisis because the real culprits were non-banks like Lehman Brothers and Bear Stearns. But that’s baloney. These non-banks got their funding from the big banks in the form of lines of credit, mortgages, and repurchase agreements. If the big banks hadn’t provided them the money, the non-banks wouldn’t have got into trouble. And why were the banks able to give them easy credit on bad collateral? Because Glass-Steagall was gone.

Pointer from Alex Tabarrok. Reich seems to think that Glass-Steagall was some sort of magical regulation that allowed regulators to keep banks from making unwise loans.

In fact, my understanding (like most commentators, I have not actually read the law itself) is that it was intended to separate commercial banking from investment banking. That is, one type of institution could take deposits and make loans, and another type of institution could underwrite securities. It started to fall apart in the 1970s, when money market funds were invented, allowing investment banks to issue debt that looked a lot like deposits. This caused banks to complain that financial activity was going to shift out of banks, which was going to hurt banks and make bank regulation irrelevant. The 1980s were spent with lobbyists and legislators trying to work out a fair way for commercial banks to compete in investment banking and vice-versa.

Ironically, what Reich is describing, with commercial banks lending to investment banks, shows that the two were still somewhat separate even ten years ago. I am willing to be corrected, but as far as I know, there was nothing in Glass-Steagall to stop a commercial bank from lending to an investment bank. Repurchase agreements and lines of credit were not forbidden. And when Reich says that non-banks received mortgages from commercial banks, he is completely unhinged.

I continue to believe that the Nirvana Fallacy it what drives a lot of analysis of the financial crisis, and of government intervention in general. That is, if you believe that Nirvana is achievable through government intervention, then if we have disappointing outcomes it must be because government is being held back from intervening the way it should.

The overall Atlantic piece to which Tyler refers includes comments from some left-leaning economists that are actually reasonable concerning the irrelevance of Glass-Steagall. But on the whole, the left is locked into its Nirvana fallacy of financial regulation.

Margins of Adjustment

Tyler Cowen quotes from the abstract of a paper by André Kurmann, Erika McEntarfer, and James Spletzer

In our data, only 13 percent of workers who remain with the same firm (job stayers) experience zero change in their nominal hourly wage within a year, and over 20 percent of job stayers experience a reduction in their nominal hourly wage. The lower incidence of downward wage rigidity in the administrative data is likely a function of our broader earnings concept, which includes all monetary compensation paid to the worker (e.g. overtime pay, bonuses), whereas the previous literature has almost exclusively focused on the base rate of pay. When we examine firm labor cost adjustments on both the hours and wage margins, we find that firms have substantially more flexibility in adjusting hours downward than wages. As a result, the distribution of changes in nominal earnings is less asymmetric than the wage change distribution, with only about 6 percent of job stayers experiencing no change in nominal annual earnings, and over 25 percent of workers experiencing a reduction in nominal annual earnings.

A few comments.

1. At the link, it says, “Preliminary and incomplete. Do not cite without permission of authors.”

2. This finding, if established, would only damage macro theory to the extent that bonuses and other fringe benefits are the alternative margins of adjustment. If the alternative margin of adjustment is hours, then that would actually serve to reinforce the macro theory that says that real output falls when nominal GDP growth is slower than expected because nominal wages are sticky.

3. I should note that there also are alternative margins of adjustment that can reduce price stickiness relative to list prices. For example, a restaurant could keep its prices constant but reduce portion sizes or quality. A clothing store could keep its list prices constant but change the size and frequency of discounts.

Rights and Consequences

I read the latest (final? I hope not, because I have some critical comments) draft of Tyler Cowen’s Stubborn Attachments, which he describes as follows:

I outline a true and objectively valid case for a free and prosperous society, and consider the importance of economic growth for political philosophy, how and why the political spectrum should be reconfigured, how we should think about existential risk, what is right and wrong in Parfit and Nozick and Singer and effective altruism, how to get around the Arrow Impossibility Theorem, to what extent individual rights can be absolute, how much to discount the future, when redistribution is justified, whether we must be agnostic about the distant future, and most of all why we need to “think big.”

One of the issues that Tyler raises that I think ought to be resolved somewhat differently is that of the role of rights in consequentialism. In a sense, basic rights, like property rights, dangle awkwardly in a consequentialist philosophy. If I can create more happiness by giving your corn to someone else, why should you have the right to keep it?

I am inclined to give a Hayekian account of why you should have the right to choose whether to eat, plant, trade, or donate your corn. That is, you are likely to know the best of use of your corn, including the best moral use of it, thanks to your local knowledge. Thus, the consequences are likely to best if you make the decision rather than I make the decision.

In fact, in cases where we think that you are not competent to make the decision (a child, or someone with severe mental deficiencies), we do not treat property rights as absolute. Thus, our intuition about rights is tied up with the issue of how much we respect the person’s local knowledge.

One view of moral philosophy is that our intuitions are basically right, and it is the philosopher’s job to come up with a system of thought that accounts for and perhaps codifies our intuitions. While I would not go to this extreme, it is always something to consider in moral philosophy.

On the other hand, if you told me that economists’ intuitions about what constitute high-quality research are basically right, and the job of economic epistemology is to come up with a system of thought that accounts for and perhaps codifies our intuitions, I would be inclined to object. But perhaps I am willing to say that it something to consider in economic epistemology.

A More Timely Measure of Rent Inflation

Adam Ozimek writes,

As I proposed in my work, CoreLogic utilizes an approach that mirrors the S&P/Case-Shiller house price index. This approach measures current market prices by using only new leases, and controls for housing quality by tracking the same units over time.

Pointer from Tyler Cowen.

The standard BLS measure is more like a smoothed lagging indicator. Relative to the BLS path for rental inflation since 2008, Ozimek’s revised path shows inflation dipping by more early in the recession and then climbing by more during the recovery (should I say “recovery”?).

Unlike Ozimek, I see this as having zero impact for the macroeconomic theory of the Phillips Curve. That theory deals with the rate of wage change, and changing how you measure rent inflation does not change the history of wage inflation. To show a meaningful trade-off between wage growth and unemployment in recent years, you are going to have to find another data-massaging trick.

Of course, I admit that I used consumer prices in my recapitulation of Phillips Curve history. If I were extending that essay today, I would say that the Phillips Curve died again in 2008-2016, which is another period in which conventional macro does poorly. The Kling/FischerBlack view of inflation, which is not confounded by recent data, is presented in my latest book.

Finance, Fragile, and Anti-Fragile

Tyler Cowen writes,

The first factor driving high returns is sometimes called by practitioners “going short on volatility.” Sometimes it is called “negative skewness.” In plain English, this means that some investors opt for a strategy of betting against big, unexpected moves in market prices. Most of the time investors will do well by this strategy, since big, unexpected moves are outliers by definition. Traders will earn above-average returns in good times. In bad times they won’t suffer fully when catastrophic returns come in, as sooner or later is bound to happen, because the downside of these bets is partly socialized onto the Treasury, the Federal Reserve and, of course, the taxpayers and the unemployed.

America’s mortgages are structured so that the lender-investor is going short on volatility. If interest rates do not move much, the lender does well. If home prices do not move much, the lender does well. But if interest rates rise, the lender is stuck with a below-market asset. And if home prices fall, the lender gets stuck with a house with a value below the amount of the loan.

Tyler is saying that for the typical financial market player, going short on volatility is a great personal strategy. When it works, you get a nice salary and bonus. When it fails, someone else–a shareholder, a taxpayer–bears much of the cost.

If you know your Nassim Taleb, you will recognize going short volatility as “fragile,” with the opposite strategy as “anti-fragile.”

I wonder if stock market investment is one of those fragile strategies nowadays. You can make money year after year going long the market–until it stops.

Anyway, Tyler argues that the changes in the income distribution of recent decades

a) have been focused at the top 1 percent, not between the 99th percentile and the lowest percentile

b) been driven by finance

c) and within finance have been driven by these short-volatility, fragile strategies.

He is pessimistic about regulators’ ability to stop the short-volatility strategies. I think he is wise in that regard.

Wither the Suburban Homeowner?

The American Interest has a special issue devoted to Plutocracy and Democracy. On Thursday, the Hudson Institute hosted a discussion featuring various speakers, including Tyler Cowen. I watched some of it from home.

Apart from Tyler, the speakers in the first hour were dreadful. When a poli sci professor starts telling me that the root cause of the Trump phenomenon is people resenting the Citizens United Supreme Court case, I think that it is more likely that the root cause of the Trump phenomenon is people resenting narrow intellectuals like this poli sci professor.

As for the magazine, on line I read the article by Walter Russell Mead, which I strongly recommend. (Be careful–you are only allowed to read one article unless you subscribe. Keep an extra web browser handy.) He draws an interesting parallel.

The contemporary crisis of the middle strata in American society is perhaps best compared to the long and painful decline of the family farm. The American dream we know in our time—a good job and a nice house in a decent suburb with good schools—is not the classic version. The dream that animated the mass of colonists, that drove the Revolution and that drew millions of immigrants to the United States during the first century of independence, was the dream of owning one’s own farm. Up until the 20th century, most Americans lived in rural communities.

What Mead goes on to sat is that the family-farmer dream came to be replaced by the suburban (and small town) homeowner dream. However, he raises the prospect that this latter dream may be in the process of fading out. I wish he had developed this idea further. Let me try:

In the three decades following World War II, the lifestyle that people aspired to, and often could achieve, involved ownership of a house with a yard and reliance for transportation on a family car. Nowadays, many young professionals do not aspire to that lifestyle, preferring to live in urban condos and apartments and to dispense with personal automobiles. Meanwhile, the postwar lifestyle has become harder to achieve for many people.

Mead refers to the threatened class of homeowners and homeowner-aspirants as Crabgrass Jacksonians.

Crabgrass Jacksonians do not trust the professional class anymore: not the journalists, not the professors, not the bureaucrats, not the career politicians. They believe that if these folks get more resources and power they will simply abuse them. Give the educators more money and the professors will go off on more weird and arcane theoretical tangents and the teachers’ unions will kick back and relax. In neither case will they spend more time helping your kids get ready for real life. Give the bureaucrats more power and they will impose more counterproductive regulations that throttle small business. Give the lawyers more power and they will raise prices and clog commerce with lawsuits and red tape. Give the politicians more time in office and more tax money to spend and they will continue stroking the fat cats while calling rhetorically for change.

Again, I recommend the entire essay.

Tyler Cowen on Brexit, Steven Pinker, and Joseph McCarthy

And also other topics. The link goes to a Twitter post with a video.

Judge for yourself, but to me it sounds like he is telling a PSST story. He says that, for better or worse, the UK spent the last twenty years working with a set of rules on trade in services with other European countries, and now that those rules have been cast into doubt by the Brexit vote, the British economy is in trouble. It is a very different take from that of those who think in GDP-factory terms.

Also, in my other post today, I mention an event on plutocracy co-sponsored by the Hudson Institute and The American Interest. Tyler Cowen makes remarks that have little or nothing to do with the article that he wrote for the event. Two of his more provocative opinions:

1. Steven Pinker may be wrong. Rather than mass violence following a benign trend, it could be cyclical. When there is a long peace, people become complacent, they allow bad leaders to take power and to run amok, and you get mass violence again. (Cowen argues that there are more countries now run by bad people than was the case a couple of decades ago)

2. Joseph McCarthy was not wrong. There were Soviet agents in influential positions. Regardless of what you think of that, the relevant point is that today Chinese and Russian plutocrats may have their tentacles in the U.S. and may be subtly causing the U.S. to be less of a liberal capitalist nation and more of a cronyist plutocracy.

An Outbreak of Laziness, or ?

Andre Boik, Shane Greenstein, and Jeffrey Prince write (the link goes to an ungated but outdated version),

We find that higher income households spend less total time online per week. Our results suggest that a household making $25-35K a year spends 92 more minutes a week online than a household making $100K or more a year in income, and differences vary monotonically over intermediate income levels. Relatedly, we also find that the level of time on the home device only mildly responds to the menu of available web sites and other devices – it slightly declines between 2008 and 2013 – despite large increases in online activity via smartphones and tablets over this time. At the same time, the monotonic negative relationship between income and total time remains stable, exhibiting the same slope of sensitivity to income.

Think of allocating your time among three activities: work, online leisure, and off-line leisure (plus housework). Are we seeing some households choosing to work less and instead consume more online leisure (thus earning less income), or are we seeing households who earn less per hour worked finding offline leisure activities too expensive (Tyler Cowen seems to think it’s the latter).

An Outbreak of Laziness

Erik Hurst says,

In our culture, where we are constantly connected to technology, activities like playing Xbox, browsing social media, and Snapchatting with friends raise the attractiveness of leisure time. And so it goes that if leisure time is more enjoyable, and as prices for these technologies continue to drop, people may be less willing to work at any given wage. This explanation may help us understand why we see steep declines in employment while wages remain steady – a trend that has been puzzling economists.

Right now, I’m gathering facts about the possible mechanisms at play, beginning with a hard look at time-use by young men with less than a four-year degree. In the 2000s, employment rates for this group dropped sharply – more than in any other group. We have determined that, in general, they are not going back to school or switching careers, so what are they doing with their time? The hours that they are not working have been replaced almost one for one with leisure time. Seventy-five percent of this new leisure time falls into one category: video games. The average low-skilled, unemployed man in this group plays video games an average of 12, and sometimes upwards of 30 hours per week.

Pointer from Tyler Cowen.

Back in the 1980s, during the Macro Wars, Franco Modigliani taunted freshwater economists with the line, “Was the Great Depression an outbreak of laziness?”

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.