What if World Governments Had Washed Their Hands of the Financial Crisis?

For Project Syndicate:

Slouching Toward Sanity: In America today – and in the rest of the world – economic-policy centrists are being squeezed.

The Economic Policy Institute reports a poll showing that Americans overwhelmingly believe that the economic policies of the past year have greatly enriched the bankers of Midtown Manhattan and London’s Canary Wharf (they really aren’t concentrated on Wall Street or in the City of London anymore). In America, the Republican congressional caucus is just saying no:

• no to short-term deficit spending to put people to work,
• no to supporting the banking system,
• and no to increased government oversight or ownership of financial entities.

And the banks themselves are back to business-as-usual: anxious to block any financial-sector reform and trusting congressmen eager for campaign contributions to delay and disrupt the legislative process.

I do not claim that policy in recent years has been anything close to ideal.

If I had been running things 13 months ago, the United States Treasury and Federal Reserve would have let Lehman and AIG fail – but would have taken the obligations of those entities for cash at face value provided that the obligations also came with sufficient equity warrants to give the government a proper share of the upside. That would have preserved the functioning of the system. That would have punished--severely--the banking and shadow-banking systems’ equity holders who had not performed sufficient due diligence. That would have kept any bankers today from claiming that their risk management practices were adequate and did not need reform.

If I had been running things 19 months ago, I would have nationalized Fannie Mae and Freddie Mac. For the duration of the crisis shifted monetary and financial policy from targeting the Federal Funds rate to targeting the price of mortgages. Ever since 1825, the purpose of monetary policy in a crisis has been to support asset prices to prevent the financial markets from sending to the real economy the price signal that it is time for mass unemployment. Nationalizing Fannie and Freddie, and using them to peg the price of mortgages, would have been the cleanest and easiest way to accomplish that.

Nevertheless, policy over the past two and a half years has been good.

A fundamental shock bigger than the one in 1929-1930 hit a financial system that was much more vulnerable to shocks than was the case back then. Despite this, unemployment will peak at around 10%, rather than at 24%, as it did in the US during the Great Depression. Nonfarm unemployment will peak at 10.5%, rather than at 30%. Nor will we in the end have a lost decade of economic stagnation, as Japan did in the 1990’s.

Admittedly, this comparison bar is low.

But our policymakers have cleared it. They might have well not have.

Thus it is worth stepping back and asking: What would the economy look like today if policymakers had acceded to the populist demand of no support to the bankers? What would the economy look like today if Congressional Republican opposition to the Troubled Asset Relief Program (TARP) program had won the day? What would the economy have looked like today had Senators Nelson, Snowe, and company done to Obama's discretionary deficit-spending plan what their predecessors did to Clinton's in 1993 and blocked it?

The only point of reference is the Great Depression itself. That is the only time in more than a century when (a) a financial crisis caused a widespread, lengthy, and prolonged reinforcing chain of bank failures, and (b) the government by and large washed its hands--neither intervened on a large scale itself nor passed the baton to a consortium of private banks (usually, in the U.S., headed by Morgan) to support the system as a whole.

It is now 19 months after Bear Stearns failed and was taken over by JP MorganChase (JPM), with the assistance of up to $30 billion of Federal Reserve money on March 16, 2008. Industrial production now stands 14% below its peak in 2007.

By contrast, 19 months after the Bank of United States, with 450,000 depositors, failed on December 11, 1930 – the first major bank collapse in New York since the Knickerbocker Trust failure during the panic and depression of 1907 – industrial production, according to the Federal Reserve index, was 54% below its 1929 peak.

Opponents of recent economic policy rebel against the hypothesis that an absence of government intervention and support could produce an economic decline of that magnitude today. After all, modern economies are stable and stubborn things. Market systems are resilient webs that offer the best possible incentives to people to make deals and use resources productively. A 54% fall in industrial production between its 2007 peak and today is inconceivable – isn’t it?

If so, then the unavoidable conclusion must be that things would not have been so bad if the government had refused to implement an expansionary fiscal policy, recapitalize banks, nationalize troubled institutions, and buy financial assets in non-standard ways.

The problem, though, is that all the theoretical arguments that depressions as deep as the Great Depression simply do not happen to modern market economies – well they applied just as well to the 1930s as they do to today.

But the Great Depression did happen. And it could have happened again. All that had to happen then was for the logic of the financial crisis to roll through to its conclusion, in the absence of extraordinary government intervention to stem it.

Comments

[dingding:]

And so all have to pay for the greed of a few.

Nov 05 03:15 AM

[Dave Wrixon:]

Nationalization of the non-functional parts of the financial system was the way to go, provided it was understood that the final goal was to kick them back out into the private sector under new ownership. Of course it would not have protected Tax Payers money totally but at least you would not have the worst of all possible worlds, and the fees being squeezed out the system from the Feds generosity would have stayed in the Tax Payers pot. It would also have meant that the banks would have been under more pressure to lend and have much more difficulty misappropriating tax payer's support. Furthermore, the current corrupt management teams could have been removed and remuneration packages based on market fundamentals could have been introduced. Moreover, there would have been no need to come off the mark to market principles. We would have company results that reflect reality rather than myth. There would have been no need to pretend securities were worth anything close to their issue price. In brief, the markets could have been allowed to function.

Nov 05 03:19 AM

[Jasper M:]

Author seems to be among the many, Many who feel the bullet has been dodged, successfully, and there is no more peril of depression. That reamins to be seen, and my bets are on far worse to come.

And I second Mr. Wrixon. above, on all points.

Nov 05 03:34 AM

[Al-USA:]

They are still trying to spin it that the banksters had to be made solvent, on the "backs" of present and future taxpayers... It's not going to fly now, although it might after the generation that lived through it dies off, maybe.

Did Mr. DeLong see the financial crisis coming? I have yet to research his archives, but unless he did, I would not put too much credence into his spin of things.

For the record, Mr. DeLong does have other more interesting articles.

Nov 05 03:50 AM

[aussiereader4:]

Everyone paid for the great depression and the war that followed. Read your history books.


On Nov 05 03:15 AM dingding wrote:

> And so all have to pay for the greed of a few.

Nov 05 04:12 AM

[User 353732:]

The Great Depression was caused by a malign combination of egregiously bad Govt and equally bad Wall St. It was not an event but a sequence of bad self aggrandizing and hugely destructive resource malallocation decisions.
The current Great Debt Delusion and the many bubbles and implosions it spawned was and is also a result of bad and mad WashDc-Wall St decisions that sesrve only to concentrate power, income, resource allocation decisions and wealth in the hands of the Co-Dominium. It is aided and abetted by a subservient and complicit MSM.

Big Govt, Big Money and Big Media are not the solution to economic and financial devastations: they are the source and proximate cause. The Troika is the malign enemy, not the benevolent savior, of Main St and ordinay Americans.

Nov 05 05:40 AM

[socrateaz:]

Interesting. I think the bank problems are symptoms of many current problems. A wealth distribution problem is apparent. Too much wealth in the hands of unproductive also seems ovious. Too much government overgrowth bothers me! A foriegn trade deficit still bites. I liken the government interventions to a doctor giving asprin to a person with whose back is out. It helps the pain but does little to fix the actual problem! I say the problems have been delayed but not fixed. If we are lucky, things will improve without medicine for the real problem. But I think we are just moving judgement down the road!

Nov 05 06:02 AM

[DL1947:]

The author compares the Great Depression 30% unemployment with today's 10% ; I thought the calculation method had been tampered with over the years , is it rather not 30% against 20% in real comparable terms ?

Nov 05 06:26 AM

[chap08:]

Mr Delong understates his case. If govts/central banks had washed their hands of the crisis, it would have been much worse than the 30s. Changes in globalization, and more importantly the nature of the banking industry, mean that economic collapse would have been global, fast and deadly. Should the authorities have allowed such a situation to develop? Absolutely not. Should they have made a better job of the rescue? Absolutely yes, but in my view they were right to do something, rather than nothing.

User 353732 is wrong to say that the Great Depression was caused by "a sequence of bad self aggrandizing and hugely destructive resource malallocation decisions". The build up of debt and leverage clearly set the scene, but Milton Friedman showed what really turned a potentially bad recession in to the depression. It was a number of deliberately destructive decisions. These decisions:
- allowed a widespread collapse of the banking system
- allowed a massive contraction in the money supply
- allowed real interest rates to rise.
You can argue about how the depression should have been resolved, but these were the things which tipped us in to it.

This time, the authorities were determined to avoid these mistakes and, in that aim, they succeeded. That is the fundamental difference between now and the 30s. From fall 2008 onwards, the 30s no longer served as a reference point. In some senses we are in completely new territory, but in another sense we are just back in the same old territory again. In some senses we are just back where we started because the fundamental problems remain.

I support the authorities efforts to avoid a global depression, but those efforts are pointless if we just allow the situation to continue. We need a clear change in direction, including a fundamental restructuring of the banking industry. Mr DeLong is right that equity holders should have been wiped out in favor of the tax payer, but so, very importantly, should bond holders. We need to create the mechanisms where capital is priced appropriately for risk. We still don't have that and don't look like getting it.

In my view, the authorities got the most important aspects of the rescue stage right. But after rescue, we need reform. Reform of our institutions, economy and individual expectations. In this stage, so far, we seem to be failing.

Nov 05 06:46 AM

[Michael Clark:]

That's the point, isn't it? The greed of the bankers fastened in an obscene position to the government destroys the financial system....and then everyone else has to pay to right the wrongs they've done. This happens over and over again and we still don't learn: the banks cannot run the world, the world has to run the banks. Nearly every depression in American history (and one comes along about every 18 years) has been caused by a banking concern or the whole banking industry. It's time to perform an emergency surgery that makes them less dangerous to the rest of us. We DO NOT have to endorse a system wherein the bankers get whatever they want and the rest of the world gets hosed. Banks should be controlled to make small profits and, primarily, serve their constituencies....and that is the end of the banking story. Wall Street's investment banks, with their billions is profits and payouts and bonuses, is very sexy....but it's time to shut them down, put a leash on them. They are actually predators that don't serve the business community as much as they cannibalize it through the mysticism of debt financing. Of course, the thing about debt is....the devil always comes back, in the end, claiming your soul.


On Nov 05 04:12 AM aussiereader4 wrote:

> Everyone paid for the great depression and the war that followed.
> Read your history books.

Nov 05 07:13 AM

[Davewmart:]

To mix my mataphors, rather than a bullet being dodged the can has been kicked down the road - at massive cost.

The US Government has taken on vast debt, and so is fundamentally far weaker than in 2007, but has not reformed the financial institutions.
This meand that the money provided is not being put to any productive use, but is simply enabling reckless gambling to continue.
Since huge amounts of bank loans are worth far less than their book value, they are incentivised to double down on their bets, especially the ones that are 'too big to fail'
Meanwhile the banks are opting out of their real mission, to provide capital to expand business, so for non-financial institutions credit is in short supply.

An effective policy reponse might have been on the lines of the earlier Swedish reforms of their banking system.

No one, so far as I know, is suggesting that no action at all should have been taking, and so your argument seems something of a straw man.

The problem, as so ably laid out by Simon Johnson, is that the cliques of crony capitalism, typical of the Third World and now of the US, are in charge.

So it is not surprising that in every measurable way the policies instituted simply allow the looting to continue, and in the absence of real reform guarantee disaster, although a bit delayed for the people who matter, ie the wealthy.

The disater is already here for food stamp America, and is going to get worse.

Nov 05 07:21 AM

[Michael Clark:]

Chap: If we look back to 1933, we'll see that we're in a very similar place today. In 1933 everyone was breathing a sigh of relief, the recession was over, GDP was rising again, unemployment was still a problem, but unemployment was a lagging indicator....

The similarity between the 1930's and today is the staggering amount of debt we've taken on as a culture. This means all the financing of inflation won't really stem the tide of deflation, because no one is solvent; and every day now the world becomes less solvent. And this will continue to be the case until interest rates go up.

In the 1970's, another Dark Age for the economy, we had deflation, unemployment....but we did not have the huge debt load to deal with. So the Fed lower interest rates, trying to spur inflation and they got stagflation....the lending did not lead to an economic recovery, but the cheap money to borrow did fuel inflation, since borrowed money chasing products and services pushed prices through the roof. People could afford to borrow in the 1970's because they were solvent them.

Next year, we will have another downturn in the economy -- and the idea that we did EVERYTHING right this time will become something to laugh bitterly about and something for future PHD students to try to digest.

The truth is: there is no 'fix' for deflation. There is a time to inflate the economy through debt accumulation, the Day-Cycle; and there is a time to deflate the economy through debt destruction, the Night-Cycle. These cycles cannot be fixed, or tricked, or short-circuited. There is nothing any government or federal banking system can do to solve this 'problem'.

During the Day humanity builds cities, pursues dreams, creates businesses, works the farm-fields; at Night, humanity rests. The world rests in status quo from dusk to dawn. Few changes really. But the building of civilization stops (in large part). When dawn comes, the building of civlization re-begins were it left off at dusk. Human history is similar: there is a period of outward direction, empire-building, expansion. This is followed by a time of rest.

We have not seen the worst in our economic downturn. 2010 to 2019 will be the darkest part of the cycle, similar to the earlier periods 1938-1947, and 1974-1983. Still a lot of global creative destruction to get through.

We all remember what happened in 1938-1947, World War II, the murder of millions at the hands of German and Japanese fascists, the continuing downward spiral of global economics. The use of two atomic bombs against Japan to stop World War II. 1974-1983: the loss of the American war in Vietnam; the murder of millions in Cambodia by communist zealots; the influence of communism spreading throughout the world; the Iranian revolution and the hostage-taking of the American Embassy officials in Tehran; the rise of Stagflation in America (10% unemployment plus rocketing commodity inflation): America's reputation in the world has never been so low. President Carter essentially told Americans it was time to surrender our dreams, to accept that prosperity would never be ours again; it was time to learn to live with less and time to dismantle the American military, the official police force of capitalism.

Yes, we are in the eye of the storm at the moment.


On Nov 05 06:46 AM chap08 wrote:

> Mr Delong understates his case. If govts/central banks had washed
> their hands of the crisis, it would have been much worse than the
> 30s. Changes in globalization, and more importantly the nature of
> the banking industry, mean that economic collapse would have been
> global, fast and deadly. Should the authorities have allowed such
> a situation to develop? Absolutely not. Should they have made a better
> job of the rescue? Absolutely yes, but in my view they were right
> to do something, rather than nothing.
>
> User 353732 is wrong to say that the Great Depression was caused
> by "a sequence of bad self aggrandizing and hugely destructive resource
> malallocation decisions". The build up of debt and leverage clearly
> set the scene, but Milton Friedman showed what really turned a potentially
> bad recession in to the depression. It was a number of deliberately
> destructive decisions. These decisions:
> - allowed a widespread collapse of the banking system
> - allowed a massive contraction in the money supply
> - allowed real interest rates to rise.
> You can argue about how the depression should have been resolved,
> but these were the things which tipped us in to it.
>
> This time, the authorities were determined to avoid these mistakes
> and, in that aim, they succeeded. That is the fundamental difference
> between now and the 30s. From fall 2008 onwards, the 30s no longer
> served as a reference point. In some senses we are in completely
> new territory, but in another sense we are just back in the same
> old territory again. In some senses we are just back where we started
> because the fundamental problems remain.
>
> I support the authorities efforts to avoid a global depression, but
> those efforts are pointless if we just allow the situation to continue.
> We need a clear change in direction, including a fundamental restructuring
> of the banking industry. Mr DeLong is right that equity holders should
> have been wiped out in favor of the tax payer, but so, very importantly,
> should bond holders. We need to create the mechanisms where capital
> is priced appropriately for risk. We still don't have that and don't
> look like getting it.
>
> In my view, the authorities got the most important aspects of the
> rescue stage right. But after rescue, we need reform. Reform of our
> institutions, economy and individual expectations. In this stage,
> so far, we seem to be failing.

Nov 05 07:27 AM

[kingaj12:]

Following Soros' well made points on radical fallibility, we must assume that it is highly unlikely that we have got all of the most important things right. The things we can't know (closed systems) are likely to be the source of the next trouble.

The best we can do is to insist on more transparency into the most strategic parts of the economy. It would be good to know that someone is watching balance sheets of systemically important institutions, for example, so that all the liquidity generated by new taxpayer debt doesn't just go into building the next unproductive bubble (USD carry trade anyone?).

Wouldn't it be nice to know that of all our precious new debt some of it was funding something important -- like new energy sources?

Nov 05 08:04 AM

[lower98th:]

The Nothing/Something argument doesn't wash. Something was necessary. That the Something selected absolved the banks of any accountability, further damaged the middle class, and enriched and retained discredited bank management is a tragedy.

Nov 05 08:29 AM

[Leftfield:]

The author considers that the main things were done right, excusing it by comparing it with doing nothing. But, Roosevelt got something (regulation) for his bank bailouts, such as Glass-Steagall. Obama, like Roosevelt, had enough time before he took office to think things through.
TARP could be seen by anyone as a clear ripoff. The largest reverse-Robin Hood socialization of losses by the wealthy ever made; nothing compares with it. It was carefully enough worded to make the actors immune from liability and to hide the use of the funds. Again, there was lead time as the crisis built throughout '07.
Somehow, our leaders always conveniently forget to protect the rights of taxpayers when the richest crony sharks are involved. All upside for Wall St., only downside for Main St., except the offer we can't refuse: They'll wreck the economy if they don't get what they want. Maybe they are anyway, now.
The only common sense and understanding of incentives at the top seems to be only exhibited in the service of selfish, greedy and often, criminal ends. For the taxpayers, it's always, massive waste, fraud and abuse. And, heads, they win, tails, you lose.

Nov 05 08:45 AM

[gu econ:]

Mr. DeLong states that allowing AIG and Lehman to fail "would have punished--severely--the banking and shadow-banking systems’ equity holders who had not performed sufficient due diligence."

I question whether bank and financial equity holders will ever be capable of exercising this type of oversight. They have, in fact, suffered substantial losses - as they should - during this crisis, in some cases suffering total (Lehman) or near total (WaMu, Fannie, even AIG, etc., etc.) wipe outs. Bond holders and institutional lenders would be better positioned to exercise such oversight through negotiated loan covenants and so forth; however, except in Lehman's case, they have been largely spared any downside, so the incentive for them to do so seems to be absent. Instead, the taxpayers paid...

Also, Mr. DeLong, just because the Fed and Treasury had to step in to shore up the financial system does not mean the other steps taken by the federal government (i.e., stimulus spending) have been necessary or efficacious. I just heard today about a wind power stimulus project in Texas that is a JV with a Chinese concern. All the wind mills will be built in China!

Nov 05 08:59 AM

[chap08:]

Davewmart

I am surprised that you say "No one, so far as I know, is suggesting that no action at all should have been taken". Many people on SA, if not the majority, say exactly that. The argument is that the free market should be left to be itself. As Peter Schiff said "Only free market forces are capable of sorting through the mess".

To be fair, many of these people understand the devastation that would have been caused, but argue that this would have been for the long term good. In effect they argue for a return to the 1930-32 period, without the FDR intervention that followed. I respect that argument, but disagree with it. Unfortunately, there are others who call for the banks to be let go without understanding the implications. They fail to understand the depth of America's problems and the severity of the medicine that, one way or another, will still be required.


On Nov 05 07:21 AM Davewmart wrote:

> To mix my mataphors, rather than a bullet being dodged the can has
> been kicked down the road - at massive cost.
>
> The US Government has taken on vast debt, and so is fundamentally
> far weaker than in 2007, but has not reformed the financial institutions.
>
> This meand that the money provided is not being put to any productive
> use, but is simply enabling reckless gambling to continue.
> Since huge amounts of bank loans are worth far less than their book
> value, they are incentivised to double down on their bets, especially
> the ones that are 'too big to fail'
> Meanwhile the banks are opting out of their real mission, to provide
> capital to expand business, so for non-financial institutions credit
> is in short supply.
>
> An effective policy reponse might have been on the lines of the earlier
> Swedish reforms of their banking system.
>
> No one, so far as I know, is suggesting that no action at all should
> have been taking, and so your argument seems something of a straw
> man.
>
> The problem, as so ably laid out by Simon Johnson, is that the cliques
> of crony capitalism, typical of the Third World and now of the US,
> are in charge.
>
> So it is not surprising that in every measurable way the policies
> instituted simply allow the looting to continue, and in the absence
> of real reform guarantee disaster, although a bit delayed for the
> people who matter, ie the wealthy.
>
> The disater is already here for food stamp America, and is going
> to get worse.

Nov 05 08:59 AM

[John Galt:]

<unemployment will peak at around 10%, rather than at 24%, as it did in the US during the Great Depression.>

Compare apples to apples.

We don't calculate unemployment the same way we used to. They changed the rules... over a decade ago.

Nov 05 09:14 AM

[chap08:]

Michael, I guess we just disagree whether there is a long term fix for deflation. What we both have to agree on though, is that there is at least a temporary fix for deflation - because that's exactly what happened in 33. I would argue that the minor deflation that returned at the end of the decade could also have been avoided, if they had not reversed policy. Whether or not you agree with the policies, the data says that they fixed deflation.

If, as you say, we are in a similar place to 33, then I would say, in some respects "if only we were". After 1933, unemployment began to fall and never returned to its peak. Also, after 1933, they had several years of double digit growth in real GDP. It would be nice, but highly unlikely, to see that combination now.


On Nov 05 07:27 AM Michael Clark wrote:

> Chap: If we look back to 1933, we'll see that we're in a very similar
> place today. ...

Nov 05 09:28 AM

[gu econ:]

Chap08, NBER marks the end of the Great Depression in March 1933, the same month FDR took office, thus one can question how his policies ended the economy's slide.

Nov 05 09:29 AM

[doubleguns:]

These banks are presently adding nothing to wealth creation in our country. (except for themselves) They have become a great big sucking sound pulling the capital from our country and our citizens and depositing it into the pockets of the elite, corrupt and connected.

We need jobs and companies that create jobs. We should have salvaged the portions of the banks that were geared to job creation and allowed the casino portions of these banks to fail.

Seems our politicians got it a$$backwards.

Nov 05 09:34 AM

[Davewmart:]

Chap 08 said:
'I am surprised that you say "No one, so far as I know, is suggesting that no action at all should have been taken". Many people on SA, if not the majority, say exactly that. The argument is that the free market should be left to be itself. As Peter Schiff said "Only free market forces are capable of sorting through the mess". '

Certainly many here advocate that market forces should have been allowed to play a larger part, for example by allowing Crysler to fail and it's market share to go to more competitive firms.

However, presumably most accept that capitalism happens within a regulatory framework, and Greenspans idea that it is not the job of authorities to seek to prevent bubbles but to pick up the pieces afterwards is pretty thoroughly discredited in most quarters.

It appears though that in the US there are still a number of adherents to extreme laissez-faire ideas of capitalism.
This is rather difficult for me to evaluate, as in practise no economy in the world has ever acted in conformity with these ideas, and in any case at least in Europe where I live the notion of self-regulating markets is dead, dead dead.
So you may be correct that some here do advocate an extreme libertarian position, but AFAIK most see a place for legislation such as banking controls etc.

In the real world there is always going to be some mixture between letting hopelessly uneconomic firms go out of business and reforming the regulatory framework.

My main point, whatever the position of most on this site, is that the measures taken to date have managed to get the worst of all worlds, by socialising the losses of the big players whilst doing nothing to help the many businesses who actually produce goods and services and are not part of the big financial institutions.

This is unsuprising, as the people who are running things are deeply involved with actors who should mainly be in jail, under the Rico act for fraud, misrepresentation and lack of fiduciary responsibility.

I don't believe many would think of Volker as some sort of Communist, but he and the responsible ideas he advocates have been marginalised.

The real choice has been between responsible reform allied with the application of market forces to severely failing firms, and the present system of bialing out the connected.

Whether or not some still believe in just doing nothing, it was never a real option and setting that up as the alternative is a red herring, distracting attention from the unconstitutional crony capitalist measures taken.

Nov 05 09:42 AM

[LouieK:]

When Brad DeLong can make a set of predictions about the future and then have those predictions compared to that of other economists and financial analysts, then we can see just how smart Dr. DeLong is. Writing smart critiques looking backwards can fool some people, but not all people. From his piece written here, I am of the impression he is a Liberal ideologue masquarading as an economist. Did he predict the housing bubble? He showed how a housing bubble could be in play in 2004 (I looked this up), but as far as I can tell, made no predictions. And if he would have predicted that a housing bubble would pop in 2004, or, say in the following three years, then we would have lost money by following his advice. If we ask our economists to actually predict events; that is, to make predictions from which we will either make money or lose money, then we can give credit or discredit where it is due. The real test is the ability of an economist to make predictions about the future that are correct and consistently correct. Otherwise, all their intellectual meanderings are just so much blowhearted pop.

Nov 05 09:44 AM

[LouieK:]

To continue my comments regarding DeLong's predictions, I found one by him in Aug'2008 which says the recession may start soon. Well, the recession already started around Dec'07, one which Nouriel Roubini predicted. So we were well into the recession, but DeLong missed it and by a wide margin. I am not trying to say it is not worthwhile to listen to and read DeLong, just that a reader should always think about these guys with more skepticism and attention to their track records in making predictions.

Nov 05 10:20 AM

[chap08:]

gu econ, this makes a nice change from reading on SA that FDR actually CAUSED the great depression; but is there something that I said that you disagree with?


On Nov 05 09:29 AM gu econ wrote:

> Chap08, NBER marks the end of the Great Depression in March 1933,
> the same month FDR took office, thus one can question how his policies
> ended the economy's slide.

Nov 05 10:38 AM

[Pat C:]

Bondholder's of the banks should have taken losses before general taxpayers. Much of the problem is due to the expanded debt market. If all banks, and other businesses for that matter, would have used equity financing this would not have happened. Our obsession with return on equity, economic value added etc. etc. allowed number crunching to take precedence over sound business practices.

Nov 05 10:56 AM

[bob adamson:]

A timely perspective Mr. DeLong and chap08 adds useful comments. Another way of putting the same point is to observe that there is a great deal of displaced anger and impatience among people generally today and, as individuals, it is wise (if difficult) to try and step back and take a more dispassionate longer term view.

Arguably the displaced anger and impatience that many of us are inclined to feel is an understandable reaction to the timing, depth and extent of the economic crisis that crested in October of 2008 (not many anticipated that it would be as sharp, general and deep as it turned out to be) and to the way the investment banking sector was supported by governments and central banks as part of the efforts (apparently successful) to stabilize credit markets and the general economy. At some level, because we don’t believe that the crisis should have been potentially as great as it was, we (to take the example of stock market investors) don’t accept as real or legitimate the losses we suffered prior to March of this year and take the massive gains since March as simply our due (something less than our due, actually) and late in coming. If you don’t believe that last statement, try the following: Compare the value of your stock investments as of the end of February with the their value at the end of October of this year and ask yourself this – If this was any year in memory except 2009 would I not feel wonderful to have made such gains in only 8 months and isn’t my current mood very different from what it would have been in any other year if such gains had been experienced then?

For the same reasons (shock and anger) we don’t accept that harsh justice could not have been meted out without delay to the failed banks and senior bankers by the markets and authorities. Calmer reflection suggests that there will be a proper time for this and that that time was not while the whole financial system faced possible collapse. There is a need, however, not to forget to call to account and reform at that later date.

The foregoing is not intended to suggest that we should feel good, grateful complacent or unduly forgiving, merely that the shocks of 2008 should not cloud our capacity to judge current events on their own merits. The recovery will be long and difficult but the potential for disaster and chaos has been avoided. The short term need to protect and reassure the investment banking system (and save the hides of some senior bankers as a collateral effect) need not prevent an appropriate day of reckoning and reform in due course.

Nov 05 03:20 PM

[thiazole:]

So why didn't unemployment plummet the day they changed the rules?
Comparing this little 4% GDP contraction recession to the Great Depression is ludicrous. More like 1937, 1974, or 1982.


On Nov 05 09:14 AM John Galt wrote:

> <unemployment will peak at around 10%, rather than at 24%, as it
> did in the US during the Great Depression.>
>
> Compare apples to apples.
>
> We don't calculate unemployment the same way we used to. They changed
> the rules... over a decade ago.

Nov 05 03:23 PM

[Davewmart:]

'it is wise (if difficult) to try and step back and take a more dispassionate longer term view.'

Whilst those in charge of legislation are taking a 'dispassionate view' those who have profitted by looting the economy contunue to make off with the swag.
This alledged 'long view' is causing vast sums of taxpayer money to be committed to bail out those such as Goldman Sachs who have recklessly gambled and used every form of market manipulation, misrepresentation of accounts and outright fraud, together with placemen within government and the Fed to wreck the economy and enrich themselves.
It was notable that huge numbers of people contacted their representatives to protest against the great $700bn Paulson scam, but the views of the likttle people were entirely ignored after a bit of tokenism whilst the interests of the rich and connected were protected at all costs.

The problem is that people are not angry enough at the activities of these shameless fraudsters, bought politicians and sycophantic apologists.

Nov 05 06:26 PM

[chap08:]

Bob, good points as always. I guess my fear is that we will forget to "call to account and reform". The financial crisis seems very real and large to us now, but life moves on. If there is no secondary shock for a while, then politics will gain a new focus. Something else will seem like the enormous problem that has to be fixed. Unless we seize the day now, our chance for reform may be lost.


On Nov 05 03:20 PM bob adamson wrote:

> A timely perspective Mr. DeLong and chap08 adds useful comments.
> Another way of putting the same point is to observe that there is
> a great deal of displaced anger and impatience among people generally
> today and, as individuals, it is wise (if difficult) to try and step
> back and take a more dispassionate longer term view.
>
> Arguably the displaced anger and impatience that many of us are inclined
> to feel is an understandable reaction to the timing, depth and extent
> of the economic crisis that crested in October of 2008 (not many
> anticipated that it would be as sharp, general and deep as it turned
> out to be) and to the way the investment banking sector was supported
> by governments and central banks as part of the efforts (apparently
> successful) to stabilize credit markets and the general economy.
> At some level, because we don’t believe that the crisis should have
> been potentially as great as it was, we (to take the example of stock
> market investors) don’t accept as real or legitimate the losses we
> suffered prior to March of this year and take the massive gains since
> March as simply our due (something less than our due, actually) and
> late in coming. If you don’t believe that last statement, try the
> following: Compare the value of your stock investments as of the
> end of February with the their value at the end of October of this
> year and ask yourself this – If this was any year in memory except
> 2009 would I not feel wonderful to have made such gains in only 8
> months and isn’t my current mood very different from what it would
> have been in any other year if such gains had been experienced then?
>
>
> For the same reasons (shock and anger) we don’t accept that harsh
> justice could not have been meted out without delay to the failed
> banks and senior bankers by the markets and authorities. Calmer reflection
> suggests that there will be a proper time for this and that that
> time was not while the whole financial system faced possible collapse.
> There is a need, however, not to forget to call to account and reform
> at that later date.
>
> The foregoing is not intended to suggest that we should feel good,
> grateful complacent or unduly forgiving, merely that the shocks of
> 2008 should not cloud our capacity to judge current events on their
> own merits. The recovery will be long and difficult but the potential
> for disaster and chaos has been avoided. The short term need to protect
> and reassure the investment banking system (and save the hides of
> some senior bankers as a collateral effect) need not prevent an appropriate
> day of reckoning and reform in due course.

Nov 06 07:44 AM

[bob adamson:]

Chap08 –

All the more reason to move beyond sterile debates about the abstract utility of stimulus vs. laissez-faire response circa fall of 2008 and on to serious discussion about, among other things, the shape to be of the principal investment banking institutions (private and public) in the US, UK and elsewhere.

You are quite right to observe that it will be tempting for the banks and near banks, governments and the public to just move on once some pseudo-recovery á là 2002 is achieved. After all, reform will be complex, difficult and contentious and entails the risk of short term stock and investment market upset.

This is why the informed public needs to begin discussing the nature, form and timing of reform of investment banking now and not let sideshows such as executive compensation divert attention from the need for a more fundamental debate.


On Nov 06 07:44 AM chap08 wrote:

> Bob, good points as always. I guess my fear is that we will forget
> to "call to account and reform". The financial crisis seems very
> real and large to us now, but life moves on. If there is no secondary
> shock for a while, then politics will gain a new focus. Something
> else will seem like the enormous problem that has to be fixed. Unless
> we seize the day now, our chance for reform may be lost.

Nov 06 01:24 PM

[Kimball Corson:]

Reactionary sentiment is wrong and ill-considered. Clearly the government had to intervene.

AIG got bailed because Goldman Sachs' fat was in the fire and Paulson heard and took care of his own.

I think your 13 and 19 months ago plans are probably better solutions then what we got, but that is hindsight. What we have not gotten is a sound, functional banking system and in substantial regards we have paid mega-buck to get essentially nowhere. The new misnamed regulatory reform bill is I think closer to the market of what we needed back then and it all but concedes the point. The notion that all banks need is time and assistance to rebuild their balance sheets is not working, as they try to trade themselves out of their messes.

I am less saguine then you that we could have avoided the serious unemployment problem we have; too much of it relates back I think to the growth in productivity in the manufacturing sector and the exportation of jobs from the labor intensive portion of that sector. The ongoing trade deficit difficulty we face (in small part arsing out of our lack of labor compeitiveness in the broad area of manufacturing we lost) is a major rub and think Keynes was right when he said that countries that run persistent trade deficits will face persistent depression of their economies. i.e., the new lower normal, with higher unemployment.

The structural problems we face of the trade deficit, dysfuntional and insolvent banks, the skewed distribution of income that places half of it in the hands of those earning $85k or more with lower average propensities to consume, and manufacturing sector employment are not being adequately or effectively addressed.

I also worry about the zero interest rate policy and QE: they are creating a worldwide asset bubble and they seem to be an expensive and ineffective way to lower mortgage rates. That they are not substantially helping our unemployment problem quickly or effectively seems clear. A WPA program would be better and have fewer collateral problems.

The bailout programs seem to be a failure. That is all but conceded in the new misname regulatory reform act. You suggest as much as well. Those programs have been very expensive and were really only of value to the extent they helped head us off the credit crisis, in regard to which I think other policies helped more.

We do have a mess and aside from not addressing our other structural problems, you and others are now at least beginning to see what our banking system requires. Not cash handed to it without restrictions, not tough love, just neutral, even-handed FDIC proceedings and supervision like treatment.

Now for our other problems . . .

Nov 07 07:25 AM