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”

Talking about the elephant...

Krugman, again, provides sane and measured advice. Here is what I think is key (see previous posts):

What we're going to have to do, clearly, is relearn the lessons our grandfathers were taught by the Great Depression. I won't try to lay out the details of a new regulatory regime, but the basic principle should be clear: anything that has to be rescued during a financial crisis, because it plays an essential role in the financial mechanism, should be regulated when there isn't a crisis so that it doesn't take excessive risks.

(my emphasis)

Succeed in doing this and you can greatly mitigate the public cost of the crisis. The problem is that regulating the companies that are big (and too big to fail) during prosperous times is difficult politically. It goes to the heart of the small government versus big government debate. Republicans would take chainsaws to the regulations, and democrats have a hard time winning elections on a platform of more regulation, particularly as the memory of the previous bubble fades.

FT.com / Comment / Opinion - Ways to avoid another stampede

The Financial Times has a few tips on how to regulate the financial markets to counteract the more perverse incentives that exist.
FT.com / Comment / Opinion - Ways to avoid another stampede

These are welcomed, particularly the variable leverage ratio. But "financial innovation" is precisely learning how to get around these, and creating new rules are often only effective until the next GOP admnistration takes a chainsaw to them.

Consider the press conference held on June 3, 2003 — just about the time subprime lending was starting to go wild — to announce a new initiative aimed at reducing the regulatory burden on banks. Representatives of four of the five government agencies responsible for financial supervision used tree shears to attack a stack of paper representing bank regulations. The fifth representative, James Gilleran of the Office of Thrift Supervision, wielded a chainsaw.

There needs to be a breakthrough in the issue of moral hazard.

Reviews of "The Bottom Billion"

Easterly has written a couple of good pieces on Foreign Affairs and on the New York Review of Books (pdf link).

someone else’s fault

The End of Wall Street's Boom

Now I asked Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of the other Wall Street firms—all said what an awful thing it was to go public and how could you do such a thing. But when the temptation arose, they all gave in to it.” He agreed that the main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders. “When things go wrong, it’s their problem,” he said—and obviously not theirs alone. When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government. “It’s laissez-faire until you get in deep shit,” he said, with a half chuckle. He was out of the game.

What to do about this?

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.

Trouble in paradise?

A New York Times report talks about the troubles brewing in China's export industries. What struck me about the piece was that this is the kind of crisis (and opportunity) that opens doors for the future giants. I suspect that in aftermath of the crisis, there will be a consolidation of the Chinese export sector and a flourish of M&A activity.

Too big to fail

Atrios makes another good point that touches on a topic I mentioned a few days ago. The incentives that exist in our "market" system are perverse in that they allow companies to take excessive risk while relying on their economic importance. They are considered "too big to fail", leading to the issue of moral hazard. Until this is tackled head on (somebody want a Nobel?), other bubbles will come and go.

US policies and impact on Latin America

Mariano once again makes a good point. Latin American countries shouldn't only be concerned over US policies that directly affect them, but also about US policies that change the geopolitical and global economic conditions.

Latin America needs to stop and think about the future of the region. Mercosur needs a new push, and the continent's energy policies need cohesion and a direction. Brazil likes to think of itself as the region's natural leader, but in the last few years, it has little to show for it.

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...