Saturday, December 26, 2009

On Floyd Norris' Book Selections

In the business section of the New York Times on Christmas Day, Floyd Norris offered a short list of the best books in 2009. The list contains six books:

--Liaquat Ahamed, Lords of Finance: The Bankers Who Broke the World.
--Robert J. Barbera, The Cost of Capitalism: Understanding Market Mayhem and Stabilizing our Economic Future.
--Johan Cassidy, How Markets Fail: The Logic of Economic Calamities
--Justin Fox, The Myth of the Rational Market: A History of Risk, Reward and Delusion on Wall Street.
--Frank Portnoy, The Match King: Ivan Krueger, The Financial Genius Behind a Century of Wall Street Scandals.
--T.J. Stiles, The First Tycoon: The Epic Life of Cornelius Vanderbilt.

(Note that all six titles of colons and subtitles.)

I have not read the last two books and am not interested in them as far as the recent recession and financial crisis is concerned. Ahamed's book is fascinating, describing the relationahsips among the key central bankers in the years leading up to the Great Depression. I recently finished reading The Myth of the Rational Market and am ready to read How Markets Fail. The book by Fox focuses on the idea of efficient markets in finance. It is good in that it describes the theory relatively well, and presents some interesting anecdotes about the famous economists and finance professors who developed and tested the theories. But, Fox rejects efficient markets, and is much more favorable to behavioral finance. For all the labors he goes through, his bottom line solution is, "It leaves us with a need to find ways to temper speculative excess while acknowledging that we won't necessariyl be able to distinguish speculative excess from an entirely sustainable boom." (p. 319). Very helpful. With that we should be able to have a bright and riskless future.

In skimming through the introduction to the book, How Markets Fail, the topic is broader than the stock market, but looks at people like Hayek, Friedman, and others who advocated free marekts as the best way to organize economic activity. Cassidy also discusses behavior economics, but seeks to offer a broader critique that he calls reality-based economics. He criticizes the Fed for not trying to pop bubbles earlier.

This last point is interesting because it is a topic the members of the Open Market Committee had discussed. It is also a topic in Lords of Finance. Benjamin Strong, who was President of the New York Federal Reserve Bank until is death shortly before the stock market crash, believed there was a bubble but that the means that would be used to pop it could cause a big crash and a depression. After his death, the key decision makers in the Fed tried to pop the bubble, and we had a big crash and a severe recession. No one knows what a concerted effort to pop the housing or stock market bubbles in 2005 or 2006 would have brought about. Perhaps a less severe recession, and perhaps just as severe a recession only sooner.

I also have not read The Cost of Capitalism, but Norris describes it as an attempt to exlain the importance of Hyman Minsky and to demolish neoclassical economics. I have recently read Minsky's, Stabilizing an Unstable Economy (no subtitle). I found Minsky to be difficult to read--not because the ideas or writing was difficult but because I found so much of it to be nonsense. He described the period from 1946 to 1966 as one in which the U.S. had a stable economic and financial system, and that it has become more unstable since then. The reason for the increasing instability is financial innovation. In the end, he calls for a much larger role for government to keep the system more stable. I suspect that Minsky would have argued that he paid more attention to historical realities than traditional economists. I am not sure that is true though.

Many people around my age (baby boomers) recall the time Minsky said was stable in nostagic terms. The U.S. economy was strong and American firms dominated the world's economy. This was the time period when things were normal. But this is false; it was a time of abnormality. World War II left Europe and Japan in shambles. It took time for these economies to recover and rebuild. It took time before they could compete with American business. The world economy became more normal in the sixties.

There is another historical dimension glossed over by Minsky--the actions the government was taking. Lyndon Johnson won the presidency with a huge mandate and a Democratic Congress. He pushed for more government involvement in the economy through things like Medicare and the war on poverty. Meanwhile, we also had an actual war in Vietnam than picked up steam. The resulting pressure on prices led to the Fed mostly accommodating the fiscal policy, but sometimes trying to reduce inflation. The end result was often a stop-start monetary policy that saw inflation and unemployment increasing. The continued conflicts in the Middle East and the new-found power of OPEC led to large increases in oil prices. U.S. labor markets experienced a huge influx of young workers as baby-boomers entered in large numbers, and as women began seeking long-term careers rather than jobs until marriage and children. Minsky makes no reference to any of these changes in the U.S. that surely had repurcussions on the stability of the economy.

So, I must disagree about the greatness of several of the books selected by Norris. (I'll offer my own list in a later post). But I would like to finish the lengthy post with one other observation. The Federal Reserve was created in 1914 after the turmoil of the Panic of 1907. The Fed was supposed to make such panics a thing of the past. Yet, twenty-five years later we were in the worst depression the country ever experienced. Many economists blame the Fed for the severity and length of the depression. If people followed the pattern of many books today--the recession we just had shows the bankruptcy of economics and of markets. One could have concluded with better justification for the argument in 1930 that the Fed failed so miserably that it should have been disbanded.

Tuesday, December 22, 2009

Bad News and More Bad News

The government announced that the GDP figures for the third quarter have been revised downward again. (See WSJ article on it here.) The original estimate that was released in mid-October was 3.5% annual growth rate. It was revised down to 2.8% in November and now revised again to 2.2%. That is a substantial change in the figures. One thing it shows is that we should be cautious in our declarations about the strength or lack of strength of the recovery based on preliminary figures. A country hungry for good news in October jumped on the robust estimate. It is still positive growth, but more in line with the concern felt by many that unemployment will take a long time to return to levels we observed earlier in the decade.

Yesterday's Wall Street Journal reported that the decade of the '00s has seen the worst performance by the U.S. stock market for any decade, even worse than the '30s.

Hopefully, there is no where to go but up.

Tuesday, December 15, 2009

Quo Vadis?

Two articles in yesterday's Wall Street Journal relate to concerns I have raised in this blog before. The first article talks about the federal government through the Department of Energy becoming the largest "venture capitalist" in the country. A small automotive firm, Fisker Automotice, Inc., ran into financing difficulties with plans to build a plant in Finland. With the help of the U.S. government, and Vice-President Biden, the company received funds and set up the plant in Delaware. (Evidently, VP Biden still is a senator from Delaware.) According to the article, the DOE will lend or give out more than $40 billion to businesses that work in "clean" technology.

The second article describes how Edward Montgomery, the auto-communities recovery czar, is able to cut through red tape to help auto firms redevelop abandoned auto sites. In particular, he has been able to get the EPA to expedite and alter its brownfied site-assessment program. Perhaps it is a coincidence, but the auto industry, in which the federal govenrment now has ownership stakes in two of the leading auto makers, is the main beneficiary of the czar's activities.

We are moving from an economic system that relied on private firms and initiatives to one that is becoming more dependent on government. Of course, we did not have a "free-enterprise economy" before January 2009--there has always been a lot of government involvement in the economy. But there still seems to be a difference now. I suspect government officials argue much of it is due to the recession. The same thing happened during the Great Depression, and much of the government involvement persists to today. Are we in for another ratcheting up of government guidance (control?) of the economy?

Sunday, December 13, 2009

Tax Cuts versus Government Spending

Greg Mankiw's column in today's business section of the New York Times compares economic research on the stimulative impact of tax cuts relative to government spending. He cites research papers that find a larger impact for tax cuts, including work done by the President's advisor, Christina Romer. I know space is limited in a column, but I wish Mankiw had emphasized more the difference between temporary changes and permanent changes. As anyone who has had any microeconomics knows (or at least learned at one time) all elasticities are greater the longer the time period.

The stimulus offered while George W. Bush was still president was a tax cut, but a temporary tax cut. The effect was that most people used the tax cut to pay down debt or increase savings. I think these are good things, but they do not stimulate the economy. Similarly, increased spending that is know to be temporary in nature will not have as much effect as an increase in spending that should last a long time. If a firm wants to take advantage of a temporary increase in spending, it will not make long-term investments as part of the process. If the firm believed the spending might be available for many years, it would respond in a different manner. One of the reasons tax cuts provide more stimulus when the cuts are expected to be permanent, or as permanent as anything can be that involves the government, then there is both a spending effect and an incentive effect. The latter is not in place for temporary tax cuts or rebates. Probably the worst think Keynes ever said was, "In the long run, we are all dead." But time passes and constant focus on the short run leads to ad hoc measures that lead to more measures later on.

On Interest Rate Risk

The Sunday New York Times has an article about banks not refinancing mortgages much right now. In his speech on Saturday, the President blamed large financial institutions for the recession. Others in the article suggested that banks should be more willing to refinance mortgages, and many would want to because interest rates are low.

Financial institutions were at fault but so was the government. Government policy encourages homeownership in many ways, including pushing regulated banks to find creative ways to help poorer risk families obtain mortgage financing. Ultimately, banks and other financial institutions got on the bandwagon, ultimately paying very little attention to "due diligence."

Interest rates are low right now, but the article also points out that the low rates are due to government programs that probably will phase out soon. In other words, rates will be going up. A bank that refinances potentially locks in for 15 or 30 years at a low interest rate. If interest rates begin rising in a few years, the bank cannot force the borrower to accept a higher rate. That is, the banks bear the interest rate risk. Securitization has been one of the methods used to get rid of the interest rate risk. But securitization is part of the "risky loans and complex financial products," that the President complained about in his speech.

I had hoped that the current recession would lead to changes in behavior. There are signs that households are wising up and increasing their savings while reducing their debt. It is not clear that financial institutions have made changes other than ones necessary to comply with government concerns. And, it is not clear the government is making any lasting changes. There is still a push to encourage wider howeownership, the building of new homes despite the large inventory of unsold homes, and the ever-constant desire for low interest rates. We may have missed a depression in the economy, but I find the situation today depressing.

Tuesday, December 8, 2009

A Day of Infamy

The EPA announced that greenhouse gasses are a threat to public health, preparing the way for EPA regulation of the sources of greenhouse gasses. It is ironic that this announcement fell on December 7--the anniversary of the Japanese attack on Pearl Harbor and the day President Roosevelt called it a day which will live in infamy. EPA Administrato Lisa P. Jackson is quoted in the release, "These long-overdue findings cement 2009's place in hitory as the year when the Unted States Government began addressing the challenge of greenhouse-gas pollution and seizing the opportunity of clean-energy reform." As an editorial in the Wall Street Journal today notes, seizing is the correct verb. The EPA is seizing the political process and taking on the role of the legislative branch.

I am sure the EPA would dispute this claim, and would argue that their decision is legitimatized by past acts such as the Clean Air Act. But a policy as controversial as climate change policy has been should surely be handled through the legislative process. Instead, democratic principles are ignored in favor of administrative fiat. Perhaps Ms Jackson is so convinced in her rightness that grabbing power is justified in her mind. It may be the same attitude as displayed by the scientists whose e-mails have been released and indicated that they were trying to keep any dissenters to the climate change "consensus" from publication. They may be right, but in lands where the rule of law is supposed to apply and in which democratic procedures and institutions exist, the route taken is simply wrong.