Like I Said…

May 20th, 2012 at 10:46 am

Three worthy pieces in the Sunday papes on themes I’ve raised here at OTE.

OTE’ers who’ve been with me from the beginning will recall that one of my very first posts stressed this same point made by Robert Shiller today and one of the most dangerous analogies in political economy: “families have to tighten their belts in tough times, so the government should too.”

“Dangerous” not just because it’s so very wrong—the opposite is true—but because it sounds so right.  When families, hit by recession and deleveraging, are hunkered down, we need gov’t spending to pick up the slack, and importantly, visa versa.

If anything, we’ve devolved to the point where we’ve got both sides of this wrong.  We’re austere when we need larger budget deficits (like now) and we’re generating structural budget deficits—ones that get larger even as the economy is in bona fide expansion—when they should be getting smaller.

Shiller touts the “balanced-budget multiplier” where you raise taxes and expenditures by similar amounts, which he argues, adds growth and jobs but doesn’t exacerbate the debt.

I think he’s right and, in fact, this maps onto a strain of the current policy debate where we a) allow the sunset of the high-end Bush tax cuts and b) build public infrastructure and help states and cities, which have to balance their budgets, avoid layoffs.

Second, Steve Pearlstein writes about JPM’s big loss and ends up in a similar place to my take here.  The key takeaways: a) hedges that increase risk and threaten large losses are not really hedges, and should be disallowed when they invoke bailout risk, and b) too many of these financial innovations are “allocative inefficient,”—they divert capital, both human and physical, from more optimal activities from the perspective of the broader society.

Finally, Gretchen Morgenson looks at the same Treasury Department evaluation of the TARP that I review here.  She’s less convinced than I that TARP “worked” in terms of avoiding far worse outcomes, but we both stress that a true evaluation must net out a lot of huge costs before settling on a legitimate count of TARP’s benefits.

That is, the fact that TARP will cost taxpayers far less than was widely expected is unequivocally good news, but before getting too excited, we’ve got to a) recognize the regulatory failure that helped inflate the housing bubble, and b) consider the costs—still mounting—of the Great Recession.

As I wrote in the oped linked above: “This is all strangely circuitous. Government regulation of financial markets failed miserably, but government actions helped put out the fire, albeit after badly burning the economy. It’s hard to applaud the fire department when it abetted the arsonists.”

That said, I think Gretchen focuses on the wrong part of this cost/benefit story.   She’s pumped up about the opportunity costs of other programs the bailout funds could have supported.  I’m always for thinking through the counterfactual, but in this case, it’s hard to imagine a bunch of spending on other useful stimulus, especially originating with the Bush administration.  Such counterfactuals make more sense in the context of things like dollars on training programs and components of a stimulus (e.g., we should have done more infrastructure and less tax cuts).  The counterfactual to the TARP is almost certainly no-TARP, not some better bailout.

Moreover, as noted, the costs you really want to net out here are less “the next best use of the TARP funds” and more the millions of hours of lost work, lost output, foreclosed homes, and damaged careers that are the ongoing legacy of the Great Recession.

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6 comments in reply to "Like I Said…"

  1. dilbert dogbert says:

    I was thinking that if one would apply the current republican solution to the US debt to the family tightening their belt to pay down debts, then the family should also voluntarily reduce their income. Yes with less income I can pay off my debts faster? Interesting concept.

  2. Mitchell Freedman says:

    Whenever I hear that family-government analogy, I say: Okay, let’s do this, even though it is ridiculous. If the family is in debt, it has to change its ways, right? So the first thing is to stop getting into so many fights with other people. That costs money, and it has forced us to buy a lot of weapons around the house, half of which we don’t need or don’t work like we though they would. And cost all that upkeep. If we look at the costs of the Iraq and Afghanistan wars alone, it is obvious that Social Security and Medicare are being blamed for those wars.

    Second, let’s see who in the family is struggling, and who is doing well. Turns out under Republicans and under this so-called Democrat, Dad’s doing well, going out for fancy dinners and takes vacations alone or with his mistress (named China) and leaves the wife and kids home searching through the garbage for a partial piece of cake or bread. So if the family wishes to stay together, Dad better spread the wealth around to help the family, especially Junior, who is starting college and is already borrowing money he doesn’t have.

    Then, I say, now why is it ridiculous to compare the family to government? First off, it’s because the government can print money. Second, the government can borrow vast sums and make infrastructure investments that benefit everyone and money comes back in the form of tax revenue. Third, as we noted above, the analogy fits to require rich people to pay more in taxes, not less, and I thought the purpose of the analogy from conservatives was to make us stop taxing rich people. If so, then maybe find another analogy.

  3. perplexed says:

    Or perhaps the more important counter-factual to explore is the one that ties the Pearlstein & Morgenson papers together and gives us more input into the “what should be done now?” question. Maybe we should be asking how this would have played out had banks & other TBTF institutions been charged market rate insurance premiums (or compelled to buy insurance in amounts necessary to protect the public interest from their gambling)? This would force us to put our actuaries to work to determine what the exposure is and what the premiums would have to be to offset the risk that the public is taking. If these premiums had been paid in to a fund after the overturn of Glass – Steagall Act, how much would have been available to offset the TARP money the public had to provide? How likely is it the insurance companies taking on the risk would have allowed securities base on fraudulently underwritten mortgages (and derivatives based on them) to make up such a huge percentage of TBTF assets and collateral? We would then know the approximate value of the free subsidy we are providing to the TBTF banks and could make an intelligent decision about whether or not to force them to break up or pay adequate insurance premiums to offset the risk the public takes on for the benefit of bank stockholders and employees. We would also realize that the incentives to game the system were so large that it would be unlikely that any but the most stringent regulatory structure would be adequate to secure the system as a whole from the risks of moral hazard created by these institutions.

    • Jared Bernstein says:

      Interesting–a market mechanism to discover true price of systemic risk.

      • perplexed says:

        It will likely take many more years for economic historians to sort out the specifics of the costs of bailing out the economy from this disaster. IMO, one of the question they will likely struggle the hardest to answer is why we didn’t do enough to address the known risks that led up to it in light of the enormous damage caused. Its not as if we don’t know what they are.

      • perplexed says:

        Even if the entire risk wasn’t offset by insurance, as long as the liability amounts were substantial, 1. we’d have an idea of the price (and the value of the subsidy) & 2. we’d be involving the insurance companies in the oversight of these institutions, a layer of protection that doesn’t currently exist.