Our Economic Crisis: The Grand Experiment 19 comments
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I have referred to the actions taken and contemplated by U.S. government and Federal Reserve as “A Grand Experiment”. A number of discussions have caused me to think an essay on this subject would be helpful.
The economic crisis we are now enduring has a history. It started in 2007 with the recognition that sub-prime mortgage lending had been over done. We were told by the Treasury Secretary and others that this was a problem localized to certain mortgages. The rest of the financial system and the economy would not be affected, that it was an isolated and contained problem. We were told wrong.
By the beginning of 2008 it became obvious that falling housing prices were not just associated with the sub-prime mortgage market, but impacting a wide variety of mortgages. We were told that the problem was still contained to one aspect of the financial system. We were told wrong.
In March 2008 (March 12, to be exact), the CEO of Bear Stearns said, in a public statement, that there was no threat to the liquidity of his firm. Within a week, with government backing, Bear Stearns was taken over by JP Morgan to avoid bankruptcy. We were told wrong.
In September we were told that another isolated problem had arisen that required the Fed to supply $85 billion to AIG in return for approximately 80% ownership. This was represented to be the solution to this problem. So far since, at least $40 billion more has been provided to AIG. We were told wrong.
By October of 2008, we were told that a crisis was developing that had caused credit to dry up and that the solution was to create an emergency appropriation of $700 billion to buy up some debt instruments that were too illiquid in the private market to support issuance of further credit. Everything could be stabilized if this was done. Several leaders made statements to the effect that “the fundamentals of the economy were strong.” We were told wrong.
By the beginning of November, the Treasury announced that, instead of buying up illiquid debt instruments, as originally proposed, equity was being provided directly to banks to shore up their reserves. By the end of November, the Treasury announced that they were going to stop putting equity in banks because “conditions had changed”. All this implied some analysis was involved. We were told wrong.
So here we are in December. What will we be told next? I, for one, am afraid to speculate. Information that is generally available indicates that there is no plan, only a wide variety of proposed actions. I have gone through the history of the crisis to point out that our economic policy appears to be invented on the fly, in an ad hoc manner.
If what we have is a series of ad hoc actions, how should the process be characterized? I have referred to the TARP, other bail outs and proposed stimulus as a Grand Experiment. This is not a precisely accurate characterization. An experiment implies activity with a certain structure (called the Scientific Method):
- Define a hypothesis.
- Design an experiment.
- Collect experimental data.
- Analyze and summarize the data.
- Support or disprove the hypothesis.
- Use one or a collection of proven hypotheses to develop a theory.
If a theory is not refuted by all available information, it may, by passing the test of time, become a scientific law. Such laws are usually defined by equations for which no exceptions have ever been observed or imagined. Newton’s Laws of Motion are an example. Einstein’s Theory of Relativity, also defined by equations (the most famous is E = mc^2) is not a law because there are some hypothetical contradictions that have not yet been resolved.
Economics is often referred to as a science (it has been called the “dismal science”), but the variables of economics include individual and group human behavior. There are no laws in economics because the number of variables can be as large as the human population. This is where economics and physical science separate. Whereas the knowledge of the physical world is defined within the concepts of scientific laws, economics is analyzed with models and probabilities.
During the Great Depression, Franklin Roosevelt said (my paraphrasing) that we must try some things to see what works, stop what doesn’t work and try something else. We appear to be in the same boat, 75 years later.
So if this is the Grand Experiment, it is not an experiment in the scientific sense, but in the FDR sense. If we are lucky (and maybe smart), after we have tried some things and find some that work, we will be able to define a hypothesis (or several) that will benefit us in the future. If there is anything like a hypothesis right now it is a fuzzy concept that we don’t want 2009 and 2010 to repeat 1931 and 1932 so we will not try anything that looks like policy from those years. This concept is a negative idea - not to do something. As a general rule, though, in science a hypothesis is a positive statement. Proof of the negative is usually not a scientific objective, because it is difficult to eliminate the entire universe. Negatives in science disprove positive statements; they don’t prove negative statements.
So, the Grand Experiment is to collect some data and see if we were clever enough in picking a set of experimental actions to get results that will allow us to propose a hypothesis. Some experiment! No wonder they call economics the dismal science.
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And so much as the "Great Experiment" goes, why don't we try something involving jobs, jobs, and more jobs for people and see how that works?
Remember these boys at the fed are experts at behavioral finance and propaganda. It would be a mistake to think that their public comments reflect their true views in any way. Why else have they denied recent freedom of information requests?
> If we can't
> count on the people that are supposed to represent us, who can we
> trust?
Bingo!
On Dec 15 10:25 AM xmplary wrote:
> We were told many things that were wrong. The politics here seems
> to be getting as corrupt as those of the 3rd world countries. Just
> look at the Illinois Governor for an example. Wall Street has become
> a place for even bigger and bolder scammers as well. If we can't
> count on the people that are supposed to represent us, who can we
> trust?
The rules of each game are serious and must be enforced by courts of law.
For example, when advertising a product, a company is not allowed to lie about its good and bad aspects or attract customers with a price that is only available for ten minutes at 6 a.m. on Monday morning and then, once customers are in the shop, double the price.
Banks are an example of such a business game/model.
First, not everyone is allowed to open a bank. To open a bank, you have to get a special authorization from legal and political authorities.
There is a certain amount of sanctified mumbo jumbo associated with opening businesses, just as there is with other games: not everyone is allowed to play, you have to show up to practice every day, you have to wear the uniform, be the right size, etc. In business you have to have advanced degrees from the "right" business schools, you have to prove your competence to run a franchise by previous work in a related business, you have to have the right connections, etc.
Banks, to continue the example, have to follow certain rules such as keeping a certain percentage of their assets as cash on hand for people who want to withdraw cash.
Experience shows us which of these game-models work well and which don't and provide hints at how to change to model/game so it works better.
For example, the panic of 1907 showed that banks needed to be able to get cash quickly to prevent panic withdrawals from nervous customers.
Banks were only required to have less than 10% of all deposited cash on hand and the rest could be invested just about anywhere, in stock markets, commodities, loans and other money making ventures.
Panic withdrawals caused panic selling, which resulted in losses of capital and inability of banks to raise enough cash for all their customers. This threatened to destroy the entire banking system.
The Federal Reserve Bank system was devised (another model-game) to prevent runs on banks by allowing quick loans from the 12 regional Federal Banks to member banks that needed cash to cover withdrawals and, later, the government provided "insurance" up to a certain amount in case the member bank failed.
But none of these measures can really stop bank panics or loss of deposits because banks are still only required to hold a certain amount of cash on hand and they are still allowed to, at least, loan the rest out even if they are more restricted in their investment policies.
(If banks were not allowed to invest their deposits to make a profit there would be no reason for their existence.)
So even in the most conservative of all scenarios, if most customers lose confidence in banks then they will fail and finally, the entire banking system will fail.
So it is better to think of the capitalist system as an interlocking system of games or models for exchanging goods and services, with rules that are based on legal and moral concepts of good and bad behavior and whose success rests on the confidence in the system along with willingness to play by the rules.
Also, there has to be a good legal system in place to punish obvious and flagrant violations of rules. But without self-motivated cooperation and good will/confidence no game/model can work, from soccer to the banking system.
I think we are facing a crisis of confidence in our present game/models now, for obvious reasons.
The root of all this mess was the flood of cheap unlimited credit. When money is plentiful and cheap, people look for ways to put it to work. When money is scarce and expensive they look for ways to safely invest and protect it. NO lender would have made subprime, alt A or other risky loans if money was scarce and expensive.
The US economy is broken and loaded with unsustainable debt. We need more cheap credit like a fish needs a bicycle.
It's time to pay the price for the stupidity of our "leaders". Double the staff of our bankruptcy courts and have at it.
It's either that or kill the goose that lays the golden eggs.
carey_jim - - - Your discussion is very worthwhile.
happysoul77777 - - - Did you want me to write a book? I stopped my history review when one page of Word was full. You are correct - the list of problems is long.
axelrod608 - - - Regarding Ponzi, see my comment to Robert Nabloid's article seekingalpha.com/artic...?
As for economic 'law', in one sense it can be summarized in two general principles:
1) Everyone acts in their own perceived best interest.
2) Everyone is 'rewarded' by the results of their actions and decisions (good or bad).
While these two principles can be stretched to large degrees, eventually they snap back and hold true in the long run.
What causes big problems in economics is the attempt by certain parties to subvert these rules by various means. Restricting free choice, forcing choices, or alleviating bad results by the gub'mint is what eventually leads to more bad behavior. This stretches the two principles ever further until the entire system is overwhelmed and the 'snap back' destroys far more than the stretching ever gained.
We are currently at a point where the stretching has maxed out and the gub'mint is struggling to hold on and prevent the snap back, with little to show for it.
If the current system is so obviously broken, corrupt and unjust, and we all see it, why can we not create a system that does work, that is fair and equitable, that rewards those that are honest and hardworking, and excludes those who reap monetary rewards on the backs of wage slaves?
Don't get me wrong, I'm no communist....but I know that people have the ability to create positive independent systems......barter and trade systems, local currencies, and nonmarket economies that are stronger, better, more resilient, and most importantly, more equitable than the one that currently dominates our society.
If we can all agree that the emperor is unclothed, can we not also be courageous enough to depose him?
On Dec 15 10:25 AM xmplary wrote:
> We were told many things that were wrong. The politics here seems
> to be getting as corrupt as those of the 3rd world countries. Just
> look at the Illinois Governor for an example. Wall Street has become
> a place for even bigger and bolder scammers as well. If we can't
> count on the people that are supposed to represent us, who can we
> trust?
On Dec 15 08:30 AM Alan von Altendorf wrote:
> Nothing that FDR tried was successful. His programs did more harm
> than good, especially in funding blatantly socialist Broadway playwrights,
> photojournalists, and authors.
would we have been eventually in a similar economic/financial dilemma based upon bad habits-- overconsumption, excessive borrowing, excessive debt, over reliance on "others" to perform our political and financial "diligence"?
was this "housing thing" just the trigger for events bound to happen?
I apologize to be so late in responding, but I haven't been back here since about 5:30 pm Dec 15.
I think the housing "thing" was just piling on (to borrow a football term) to the fundamental problem and is definitely the biggest factor affecting Main Street thus far in the crisis. The fundamental problem, in my opinion, was the misuse of debt. As I have commented before (elsewhere), good debt is used to create tools of production and bad debt is used to create more financial paper, in effect piling leverage on top of leverage.
The primary cause of the crisis was bad debt as defined above.