Credit crunch?

As we look at how to define the history of this crisis (read the Stiglitz piece in Vanity Fair, Capitalist Fools), we must question all our assumptions. An interesting question to answer is, was there a credit crunch?

I guess one could argue that credit is there for the taking and, beyond the original *confidence* crisis (where companies didn't trust each other's balance sheets), there is not broader credit crunch. Part of me says that banks must have retrenched to protect their balance sheets, but the other part says that if banks need to increase profitability, they need to take more risks and lend more. The evidence here suggests that there is credit available, and thus credit cannot be blamed for the crisis. The financial aspects of the crisis looks more and more like a bunch of bad acts by poorly regulated actors which have exploded in all our faces.

Pheonix rising (eventually)

A quick thought: as I read more and more of the continuous flow of bad news at the company level and of some investment funds, I keep thinking of how much better the system will be after the crisis is over. One hopes that the fraudulent investment funds, the poorly run companies, and the weaker business plans will all fall by the wayside. This crisis could see strong companies emerge, as a pheonix does, from the ashes of the current inferno. Of course, many bad companies will simply be bailed out, but I don't think that the government will save investment funds.

Recession

As expected, the US recession started in December 2007.

The NBER's Business Cycle Dating Committee has announced that the US economic cycle has entered into what they define as a recession. I had posted about this before ("You know this but do you feel it?"). The data from end-2007 all pointed to a recession.

Please now that the "traditional definition" is no such thing. 2 consecutive quarters of decline are not the definition of a recession, at least not in the US economy. The NBER defines it as:

“a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators”

Liar's Poker...4Evar!!!11!1

In a fascinating piece about Wall Street, Michael Lewis points to the elephant in the room. Wall Street is built upon a perverse set of incentives. No, greed isn't bad. It is the lack of accountability.

The hazardous and morally-challanged elephant

So the web is lit with talk of proposals for rescue packages, China, G20 meetings (both of them), a giant IMF, Bretton Woods II, etc. But nobody is addressing the cause of this and all the bubbles: moral hazard. The market has failures. Legislation and regulators must exist, but so far there has been very little mentioned about the droll issue of new regulatory tools and expanded powers of surveillance.

It feels nice to have hope that some huge bailout package (if you ignore the fact that you are paying for them) will swoop in and save the day. It is sexy, and it makes headlines. It is also necessary to minimize the current crisis. But if you want to look at the future, a new structure that works hand in hand with the market to create counter-bubbly incentives is required. If this is not given the importance it deserves, the next bubble will also take us by "surprise".

No one could've predicted that history would, and will repeat itself...

It's time to call in the big guns

Today's job report is dismal indeed;

Here is a chart showing the monthly numbers and consumer confidence:


And Krugman points out that:

Monetary policy obviously isn’t enough. It’s time to raise Keynes: we need big fiscal stimulus, now now now.

I agree with this. Financial stability is a necessary, but not sufficient condition for economic growth. The government needs to step in and provide real stimulus to the working class and the unemployed.

We are in for a lot of pain. Quoting Krugman again:

So the “worst recession in 25 years” thing is now baked in. The only question is whether we hit “worst slump since the Great Depression” territory.

Keep an eye on the ball

From the Dallas Fed, an interesting chart: International Economic Update, October 2008 - Globalization & Monetary Policy Institute - FRB Dallas

It shows what can clearly be seen as the start of the crisis (or when people noticed), but more worrisome is the aggravation that has occurred since the fall of Lehman.

I also should remind people against designing policy based on daily fluctuations of financial markets. It is tempting because detailed information on the health of financial markets is difficult to parse (which is why we let "the market" interpret it for us). So lets not be overly optimist, and rather be sober and professional in addressing the weaknesses that exist. /lecture

PS: can we please focus more on the crisis in the real economy? The consumer sector (~70% of US GDP) fell by 3.1%!! And as the rest of the world follows suit, what do you think will happen to US exports (the sole good news in the past few NIPA tables)?

The hazards of Moral

A friend has just started an interesting blog about economics with a Latin American bent. He writes in Spanish but I can vouch for his curiosity, open mindedness, and great work habit. Watch for him. Una Mente en Interdependecia

He brings up the issue of moral hazard and what to do about it. Of course, this is a topic where the discussion can easily turn to philosophy, but it is still a topic we must tackle for every major crisis has included this component. Investors price risks according to the possibility of being bailed out. "Too big to fail" etc. See Enron, S&L crisis, and today.

I don't think there is a way around it without regulation. I think this is the largest failure of the markets (benefits accrue to individuals while losses are socialized) and the greatest argument for regulation. In this sense, the price of deregulation, and the benefits of proper rules and enforcement must be included in any talk about the market. There is no such thing about public/private divide. The public sector is an actor, via policy and regulation, in the private sector. And the private sector is a strong influence on the public sector (sometimes vie large crises).

Back to your regularly scheduled crisis...

RGE - New recommendations to solve our financial crisis (and I admit that I was wrong)

One advantage we have over the folks of 1930: we know this song. The response of government leaders since the crisis started in December 2006 (when the mortgage brokers began collapsing) has been slow, reactive, and incremental. In many ways similar to that of President Hoover’s administration between 1929 and 1932. While recognition of the danger has been slow, action following recognition will be fast.

Also, we understand economics better. Keynes wrote The General Theory of Employment, Interest, and Money in 1936 (although the ideas it presents we in circulation much earlier). Plus we have the work of others during the past 70 years, such as Hyman Minsky and Milton Friedman. The gross policy errors made during the 1930’s — such as raising taxes and trade barriers — are far less likely today.

I made a comment to a coworker who asked me if I thought we had turned around after the latest round of announced stratospheric bailouts that I don't think we are near the end. I also said that the financial system won't collapse. Governments will pull out all stops to prevent it. There is no other option. My biggest worry wasn't in this troubling but needed market crisis, but rather on the impact on the real economy. Economic indicators have been pointing to a recession for some time now (see You know this but do you feel it) and lost production is a permanent loss in economic welfare.

I think we are or have been in a recession, but I don't much care about the label. Consumers have been feeling the pain for many years in the form of stagnating wages and wealth. Class warfare is very real in today's US economy (whether it is desired or not is up to another post). The ones who will need the greatest help will be the middle and lower classes. The ones loosing the most from the financial crisis are also the ones getting the huge bailouts, meaning they benefited from the risks without paying the consequences. But bailing them out won't help the real economy and if anyone thinks that consumers will borrow their way out of their slump, they are mistaken.