Happy Halloween

Halloween is such a happy holiday.  No outsized expectations to get depressed about; just the blissful memory of too much candy.  And I'm lucky enough to live near gay areas, which always do halloween right; I passed some amazingly decorated houses and bars, costumed dogs, and festively garbed adults on my way to the grocery store today.  I wondered, briefly, if Halloween wouldn't eventually supplant Christmas in a secular America, and if so, whether people would then start having miserable holidays as they contemplated how inadequate their costuming is.  Then I realized that I have weird friends--the kind of people who when I joked last week that my costume was so complicated that I might have to take off work, looked startled and said "Well, yeah, of course."

Now I'm off to assemble my own insanely complicated costume.  Merry Halloween to all, and to all a Grim Night.

Question of the day

How come Freddie gets all the best guest bloggers?

Bashing on Brooks

I don't understand Ryan Avent's venom towards David Brooks at all.  Brooks wrote a thoroughly reasonable column about rationalizing our infrastructure investments:

Major highway projects take about 13 years from initiation to completion -- too long to counteract any recession. But at least they create a legacy that can improve the economic environment for decades to come...

Moreover, an infrastructure resurgence is desperately needed. Americans now spend 3.5 billion hours a year stuck in traffic, a figure expected to double by 2020. The U.S. population is projected to increase by 50 percent over the next 42 years. American residential patterns have radically changed. Workplaces have decentralized. Commuting patterns are no longer radial, from suburban residences to central cities. Now they are complex weaves across broad megaregions. Yet the infrastructure system hasn't adapted.

The smart thing to do is announce a short-term infrastructure initiative to accelerate all those repair projects that can be done within a few years. Then, begin a long-term National Mobility Project.

Create a base-closings-like commission to organize federal priorities (Congress has forfeited its right to micromanage). Streamline the regulations that can now delay project approval by five years. Explore all the new ideas that are burgeoning in the transportation world -- congestion pricing, smart highways, rescue plans for shrinking Midwestern cities, new rail and airplane technologies. When you look into this sector, you see we are on the cusp of another transportation revolution.

A mobility project would dovetail with the energy initiatives both presidential candidates have offered. It would benefit from broad political support from liberals and business groups alike. It would rebalance this economy, so there is more productive weight to go along with Wall Street wizardry.

For some reason, this makes Ryan, whose blogging is usually very well measured (as well as quite brilliant), go postal:

So, please, let's not pretend that a 14% increase in government spending has been all about stimulus packages, okay? And really, why in god's name does Brooks think he knows the first thing about whether stimulus does or does not work? All stimulus plans work, to some extent-$100 billion in spending or tax cuts doesn't just vanish.

The question is how well such plans work (and there's data available!), and how efficiently they can be crafted. These subtleties are seemingly lost on Op-Ed Doofus. But having accepted that the world is going to pass another round of stimulus, despite the rhetorical power of his inane, uninformed babbling, he suggests that infrastructure is the way to go. Which we can all get behind. Unfortunately, he immediately starts writing about more stuff he doesn't understand, namely, transportation economics . . . Now, perhaps I ought to read this charitably, as the harmless urgings of a writer who really wants us to build a better America. I'll leave it to you all to do that on your own time. To me, it sounds like Brooks really wants to make it easier to build a bunch of highways. Commuting patterns have changed, you see (in response to what, I wonder?), and transportation hasn't kept up. Plus we have to reduce congestion (which has grown in response to what, I wonder?), and somehow this would all "dovetail with the energy initiatives both presidential candidates have offered." O RLY?

Look, a broad project to improve the nation's infrastructure is very desirable. We should be spending a half a trillion dollars on this. But if we approach this effort from the position of willful ignorance that has created so many transportation problems, then we're not helping anyone. So let's review a few things, shall we?

Induced demand is no joke. If you build new infrastructure people will come, so it's important to think about where you'd like the people to go when you build new infrastructure. A massive wave of highway construction will push people outward. It will increase commuting times, and in the long-run it will increase congestion. It will increase energy demand, because no matter how you power your car, longer trips mean more energy consumed. In the short-run, it will mean an increase in dependence on fossil fuels. It will massively increase maintenance costs. If you think caring for today's highway network is expensive, then just try doubling it in size. If we try to accommodate a 50% increase in the country's population with entirely auto-dependent, horizontal growth, then we're all going to end up miserable and poor.

This is, quite frankly, the stupid way to think about transportation. Brooks did mention congestion tolling. The use of congestion pricing would immediately solve the congestion problem while raising billions of dollars that could be used for reinvestment in the nation's transportation systems. Instead of building more roads, we could focus on maintaining the ones we've got, and on upgrading the busiest corridors within and between cities to faster, greener, higher capacity transit and rail systems. That's how you tackle multiple problems at once. Make that shift, and you reduce maintenance costs, reduce congestion, reduce energy use, and increase economic productivity.

The downside is that there's a higher up-front capital cost. But that's a good thing, given that we're also talking about stimulus, correct? Right now, when we need to spend the money, and when government borrowing is fairly cheap, we should be investing a great deal in these projects. Then later, when the economy is rolling along and we want to reduce spending, we'll have an infrastructure that will allow us to do it.

For starters, Brooks's statement about stimulus doesn't strike me as particularly controversial.  The point of stimulus is to use the government to artificially expand aggregate demand by borrowing at fairly low interest rates and spending the money.  The problem is, if you send out checks, most of the checks seem to get saved, which creates a closed, useless cycle.  And spending, other than through channels like unemployment and welfare benefits which already have well defined and rapid cash-transfer mechanisms, take so long to get off the ground that they rarely come until it is too late.  Monetary stimulus is faster and usually more effective, unless you are, as we are now, in some kind of liquidity crisis where banks won't lend.  It is dispreferred mainly because it too needs to be applied early, and politicians have little control over it. This being about what Brooks says, in somewhat less technical language.

The rest of the column does not actually seem to be at odds with Avent's overheated rhetoric.  Brooks did not, to be sure, stand on his chair screaming "Spend it all on trains, you fools!  You'll kill us all!"  But spending it all on trains is first of all, not politically very likely, second of all, inappropriate to the many sparsely populated areas of the United States, and third, not desireable according to most of the experts I've talked to, not least because things have to get from the trains to other places.  If we want to, for example, expand our freight rail, this may imply more highways to rail hubs. 

Perhaps I'm just prejudiced because my father, a rock-ribbed Democrat and HUGE rail buff who sat on the Senate's recent commission on surface transporation finance, emailed me a loving note about that column this morning, saying that it read as if he'd been eavesdropping on the commission.  But even beyond that, the very worst you can say about Brooks' column is that it's not as gung ho about stimulus and rail as Ryan is.  I respect both of Ryan's positions, while disagreeing with them, but Brooks' positions are well within even the center-left mainstream.  For the life of me, I cannot imagine what there is in there to get angry about--unless you're a hard libertarian who hates any and all government spending.

Real estate porn

Seems there are some real bargains in the luxury home market.  I started saving today.  All I need is another $9.7995 million, and an urge to live in Dallas . . . 

All sugars are equal, but some are more equal than others

I've long been skeptical of the claim that high fructose corn syrup was especially evil; too many of these diet claims are the nutritional equivalent of "electromagnetic fields are giving me cancer!"  But Derek Lowe makes a convincing case that it's at least possible.

On Reserve

The Reserve fund announced last night that it was paying out 50% on investor accounts, with whatever balance remains when they can liquidate the rest of their assets.  This makes sense; the terms on their assets are short, and it's probably better for everyone to hold to maturity than to dump on the market at fire sale prices.

The question remains:  why didn't they say so?  The fund has handled its communications with investors and the press abominably, as Evan Cooper points out.  People who use the money for short term purposes should, at the very least, be informed when they might get their cash to pay off the loans they've had to take out.  And it certainly doesn't do the firm any good to have the press repeatedly print, as it has, "the company was unavailable for comment".  When uncertainty is feeding a raging liquidity crisis, you don't add to it by conducting all your investor and press relations through your website.

Tivo and Netflix: the underdogs band together

I love my TiVo Series III.  Indeed, I'm something of an evangelical about it.  But it's hard to convince someone that they should lay out several hundred dollars for a box, and another several hundred for the subscription, when their cable provider will give them a DVR for $5-10 bucks a month.  Yes, the TiVo provides superior menus, searching, and other services.  Yes, it plays podcasts.  Yes, you can copy video to your PC to carry around or edit--but how many people use this? (Aside from me).  And I've really been liking the ability to download movies and shows from Amazon Video On Demand (formerly Unbox).  But I'm not sure that this, too, isn't a minority taste.

As someone who would like to see the company keep going, I was pretty happy to see that yesterday, TiVo and Netflix finally announced that they would be partnering to deliver instant streaming video.  If you have a Netflix subscription (and a TiVo, of course), you can stream all the video you want at no additional charge.  The deal makes a lot of sense:  both companies are struggling, competing with Bittorrent and the cable companies to keep their business models alive.  But together they can offer something that the cable companies will have to step up their game considerably to compete with.  Indeed, the deal makes so much since that people have been waiting for it since 2004, when it was announced with much fanfare and then went nowhere.  Yesterday was the fruition of a long-held dream.

The service isn't perfect, since Netflix's library of movies available for streaming is limited thanks to licensing issues.  And I don't think they're available in Blu-Ray quality, though the Amazon videos I've downloaded have been competitive with my HD movie channels.  (That may be because Comcast compresses it HD signal heavily in order to cram more channels into the pipe).   But at least it will give two companies I'm very fond of a fighting chance.  It's worth remembering that at this point in its lifecycle, a lot of people thought Amazon was going to join the other etailers in bankruptcy.

Department of crazy government rules, part 11,901,362,986,081

Vietnam's health ministry proposes a ban on small-chested people riding motorbikes.  No, really.

Required reading

I was on a panel yesterday about the financial bailout, and someone there asked me what they could read to understand the financial crisis.  As I've said before, I don't think anyone understands the financial crisis.  Ben Bernanke is probably the one guy you would have picked out of all the economists in the US to be in charge during a major financial crisis, and he seems kind of stumped.  Nonetheless, you can understand it better.

So, books, a slightly updated version of the list I put up a few weeks ago:

• The Great Contraction by Milton Friedman and Anna Schwartz.  Just the 1929-1933 chapter of Friedman's massive work.  The book is somewhat technical, but with half an hour on investopedia looking up terms like velocity, it should be accessible to anyone decently intelligent and well informed.  Since this is the work that shaped the modern understanding of what happened in the Great Depression, it's well worth diving into.
• The Great Crash by John Kenneth Galbraith.  Basically the opposite of the Great Contraction:  often technically incorrect
  outdated, but very accessible, and while much of the economic theory is
  questionable, the history is extremely engaging and often quite funny.
• A Short History of Financial Euphoria by John Kenneth Galbraith Same caveats, and praise, as above apply.  The book is tiny-readable in one leg of a commute for an average reader.
• Once in Golconda by John Brooks an extraordinarily enjoyable account of life on Wall Street prior to, and just after, the 1929 crash.
• Liar's Poker by Michael Lewis  He didn't mean to, but he gave a pretty good primer of the explosion of the mortgage backed securities market in the 1980s.  It's also hilarious reading, and we could all use a laugh
• Manias, Panics and Crashes by Charles Kindleberger  the definitive primer.
• Extraordinary Popular Delusions and the Madness of Crowds  The first attempt to explain why people go so crazy over . . . well, nearly everything.  
• Risk and Business Cycles by Tyler Cowen.  The authorship speaks for itself.
• The Return of Depression Economics by Paul Krugman  Ten years old, but an excellent introduction to many of the current issues.
• The Black Swan and Fooled by Randomness by Nassim Taleb
• The Misbehavior of Markets by Bernard Mandelbrot
• Essays on the Great Depression by Ben Bernanke
• When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein
• The Panic of 1907: Lessons Learned from the Market's Perfect Storm by Robert Bruner and Sean Carr
  
• And the Money Kept Rolling In (and Out) Wall Street, the IMF, and the Bankrupting of Argentina by Paul Blustein.  This crisis is rapidly spreading to emerging markets; this is the best popular account I've seen of what a currency crisis looks like when you borrow in foreign currency
• Irrational Exuberance by Robert Shiller
  
• The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It by Robert Shiller
• Against the Gods: The Remarkable Story of Risk

For publications:  the FT, the Wall Street Journal, Barrons, The Economist

Blogs (in no particular order):

Brad Delong
Naked Capitalism
Marginal Revolution
Derivative Dribble
Calculated Risk
Felix Salmon
James Surowiecki
Free Exchange
EconLog
The Big Picture
Capital Gains and Games
Greg Mankiw
Paul Krugman
Dani Rodrik
Clive Crook
Daniel Davies
Mark Thoma
The Economics of Contempt
FT Alphaville

That's a big list; few of you will read them all.  But almost any of them is a good place to start.  I note that the temptation to read only people close to you on the ideological spectrum is a huge mistake; you should try to get as rounded a picture of the thought out there as possible.

Proper registration

It has come to my attention that someone posted as me in the comments section, claiming that I had registered as a Democrat.  This is not true; sorry for anyone who was misled.  I've never registered as a member of a major party, and I find it hard to imagine doing so for other than very temporary reasons, like having some desperately strong preference in a primary.

On a related note, a couple of people have asked me why I didn't just go up to New York to vote--or, more practically, since I'm covering the election, why I didn't vote absentee.  The answer is that I am not a legal resident of New York.  It is therefore illegal to vote there.

This is not particularly urgent, since my voting "options" were New York and DC; in both places, the question is not who will carry the state, but whether Obama will get a mere 80% or so of the vote, or achieve Saddam Hussein-like vote totals*.


*Before you say it--no, not by fixing the election, by being so popular that he achieves fairly what Saddam achieved by force.

Portfolio in trouble

I confess, I've never gotten Portfolio's business model--New York Magazine, for executives!  I rarely read anything vital in it, which means I rarely read it.  And it seems I'm not alone:

The business magazine Portfolio will be published 10 times a year, instead of 12, and Men's Vogue will come out twice a year instead of 10 times, said the executives, who asked not to be identified because they were not authorized to discuss the changes, which have not been announced.

In addition, some of Portfolio's online operations, including advertising sales, will be folded into those of Wired magazine.

Advertising revenue has sharply declined in the magazine industry this year. The luxury product advertising that Condé Nast relies on has held up better than most types, but eventhat has slipped and is expected to fall farther.

Portfolio, started last year amid much fanfare, is Condé Nast's first business magazine and its most expensive new project in years. Executives said the company was willing to lose more than $100 million on it. It had average circulation of 415,000 in the first half of the year, a healthy figure for a new magazine, but it has been roiled by internal disputes and high turnover.

Much of the operation of Men's Vogue, started in 2006, will be folded into Vogue, one of the company's flagship magazines. Men's Vogue has circulation of almost 370,000.

Condé Nast executives said spending had been under budget, with several positions unfilled, which would limit the impact of the 5 percent budget cut.

But the changes at Men's Vogue and Portfolio will result in significant layoffs. Staff cuts at other magazines will mostly be achieved by attrition, though there will some layoffs.

We can work it out . . .

One of the continuing problems with trying to straighten out the mortgage mess is that it's really hard to arrange a workout on a securitized mortgage, because the organization that collects the payment is not the organization that ultimately owns the payment stream; its just a hired manager.  Nor can the government do as some Democrats propose, and simply cram down the value of the mortgages, force a debt-for-equity swap, or one of the more exotic plans to make the banks subsidize homeowners in over their heads.  For one thing, the banking system is not exactly in a great position to eat more large losses in order to bail out homeowners.  For another, doing so would push up the price of credit to everyone, since banks will have to factor in the possibility of a government cramdown to their loan calculations.  And finally, banks could plausibly argue that this is a regulatory taking, which would leave the government holding the bill.

Greg Mankiw links to a plan to sidestep these issues:

we propose legislation that moves the reworking function from the paralyzed master servicers and transfers it to community-based, government-appointed trustees. These trustees would be given no information about which securities are derived from which mortgages, or how those securities would be affected by the reworking and foreclosure decisions they make. Instead of worrying about which securities might be harmed, the blind trustees would consider, loan by loan, whether a reworking would bring in more money than a foreclosure.

The government expense would be limited to paying for the trustees -- no small amount of money, but much cheaper than first paying off the security holders by buying out the loans, which would then have to be reworked anyway. Our plan would also be far more efficient than having judges attempt this role. The trustees would be hired from the ranks of community bankers, and thus have the expertise the judiciary lacks.

This wouldn't cost fragile banks any more money than they've already lost, and would cut through many of the coordination and information problems currently plaguing the market.  On the other hand, it wouldn't do what a lot of people want, which is to help people with unaffordable mortgages stay in homes above their pay grade.

Thought for the day

It is customary for the left and libertarian blogosphere to dismiss unrealistic desires with "and a pony!"  Will the right take up "and a unicorn"?

Reserve Funds investors still waiting for their money

This isn't good:

At least 400,000 people, and perhaps as many as a million, can't get access to their savings, a problem that has quietly persisted in spite of widely publicized federal efforts to restore confidence in money-fund investments.

Some of these customers -- who, like most Americans, assumed their money funds were as safe and accessible as bank accounts -- are getting desperate.

"Longer term, I just don't know how we'll deal with it," said John Oakes, a retired engineer in Austin, Tex., who can't tap $20,000 in a Reserve account to pay his mother's nursing home bill. "They say we may get some money this week, but we don't know if we'll get 100 percent, 90 percent or 30 percent."

Sandra and Lawton Dews, a retired couple in North Myrtle Beach, S.C., had more than $250,000 -- 35 percent of their retirement assets --invested in the Reserve US Government Fund.

"They even bragged that you could sleep at night if you invested in their funds," Mrs. Dews said. "In the past month and a half, we don't sleep at all."

Her insomnia began soon after Sept. 15, when the Reserve Fund was hit by a wave of redemptions, apparently because its largest fund had a stake in notes backed by the newly bankrupt Lehman Brothers.

The next day, its $62 billion Primary Fund and two small offshore funds "broke the buck," incurring losses that pushed their per-share price below a dollar.

Only one other money fund, a small bank fund, had ever broken the buck, and the announcement on Sept. 16 sent tremors from Wall Street to Washington. It ultimately played a role in persuading the Treasury to set up a temporary insurance program for money market funds.

And the Reserve Fund had seemed the least likely candidate for trouble, given its long and stable history -- its founder, the legendary Henry B. R. Brown, had invented money market funds.

Initially, the company simply announced that it would delay redemptions from the Primary Fund for up to seven days, as allowed by law. Customers were somewhat reassured, but anyone trying to get additional information was met with busy phone lines and unanswered e-mail.

The news occasionally posted on the fund's Web site got steadily worse. On Sept. 18, investors in a host of other Reserve money funds learned that their money would be tied up for as long as a week; that delay later became open-ended. On Sept. 19, the fund delayed redemptions from both the Primary Fund and the US Government Fund indefinitely.

Since then, investors have been on a roller coaster of broken promises, with the company repeatedly blaming its record-keeping systems for delays.

That sounds kind of suspicious; one can see the record system being overloaded by the volume of redemptins, but for over a month?  Can any of my readers comment?

Is war really the health of the state?

Fair warning:  today is going to be "Budget Day" here at Asymmetrical Information, as we contemplate what's ahead after the elections.

Small point, to start.  Libertarians are fond of saying "War is the health of the state".  So how does war compare to financial crisis at ratcheting up government spending?

Looking at government spending as a percentage of GDP, only vaguely well.  The biggest permanent leap comes not during World War II, but during the Great Depression; spending went from 3.4% of GDP in 1930 to 10% of GDP in 1940, and never again fell below that level.  By contrast, in 1948, the federal government's share of GDP had fallen back to 11.6%, after soaring higher than 40% during the war.  Thereafter, the permanent increases (rather than temporary war spending) don't track wars very well, unless you define the entire period from 1945 to 1989 as one big war.  Spending goes back up to 15.6% by 1950, and hits 20.4% in FY1953 as we wrap up the Korean War--but by 1956, it's back down to 16.5%.  By 1966 it has drifted up to a new bottom of 18%, which is not that much lower than the 18.7% we find it at in 1974.  It ratchets slightly right around the two Gulf Wars, up to the current 20%--but those wars both occur near recessions, which to judge from the 1970s, do a better job at explaining upward creep than wars.

This makes sense to me.  Social Security and Medicare, which together now account for more than half of the budget, were not sold as wartime measures; one does not usually tout spending on the elderly as critical to military preparedness.  One could argue that regulation expands during wartime, which it assuredly does . . . but as far as I can tell, it also expands in peacetime.  It's hard to quantify, of course, since there's no good proxy for the absolute level of regulation in society.  But much regulation is imposed by courts and state governments, neither of which peg most of their activity to the military.

A better term might be "crisis is the health of the state", which seems almost definitionally true; a crisis is something that private efforts have failed to stem.  To be sure, the government may be behind the crisis, but even if that's so, we have to look to the government for action.

The end of the war on fat?

John Tierney asks how long it will be until we have a drug that can make everyone thin.  I wonder whether, if we got one, everyone would still want to be thin.  The obsession with thinness is a wealth marker.  Just as it only became cool to get a tan when most working stiffs were pasty white from long hours indoors, the easier it is for poor people to get fat, the harder rich people work to get thin.  The rate of obesity is twice as high among the poor as among the rich.

I confess I still don't understand why poverty is so increasingly linked with obesity.  The common explanation is to blame the paucity of excellent cheap grocery stores in urban neighborhoods. But poverty is not exclusively an inner city phenomenon; poor people in more rural areas share grocery stores with the rich.  Besides, while this explains the latitudinal data, it does not account for the longitudinal issue.  No one thinks that New York's grocery stores, even in poor neighborhoods, have gotten worse since the 1970s; the evidence is that they've gotten better.  But the obesity rate has gotten much worse.

I wonder if George Orwell didn't offer the explanation, in the Road to Wigan Pier, when he compares the actual expenditure of coal miners to the model poverty diets pushed by reformers:

Please notice that this budget contains nothing for fuel. In fact, the writer explicitly stated that he could not afford to buy fuel and ate all his food raw. Whether the letter was genuine or a hoax does not matter at the moment. What I think will be admitted is that this list represents about as wise an expenditure as could be contrived; if you had to live on three and elevenpence halfpenny a week, you could hardly extract more food-value from it than that. So perhaps it is possible to feed yourself adequately on the P.A.C. allowance if you concentrate on essential foodstuffs; but not otherwise.

Now compare this list with the unemployed miner's budget that I gave earlier. The miner's family spend only tenpence a week on green vegetables and tenpence half-penny on milk (remember that one of them is a child less than three years old), and nothing on fruit; but they spend one and nine on sugar (about eight pounds of sugar, that is) and a shilling on tea. The half-crown spent on meat might represent a small joint and the materials for a stew; probably as often as not it would represent four or five tins of bully beef. The basis of their diet, therefore, is white bread and margarine, corned beef, sugared tea, and potatoes--an appalling diet. Would it not be better if they spent more money on wholesome things like oranges and wholemeal bread or if they even, like the writer of the letter to the New Statesman, saved on fuel and ate their carrots raw? Yes, it would, but the point is that no ordinary human being is ever going to do such a thing. The ordinary human being would sooner starve than live on brown bread and raw carrots. And the peculiar evil is this, that the less money you have, the less inclined you feel to spend it on wholesome food. A millionaire may enjoy breakfasting off orange juice and Ryvita biscuits; an unemployed man doesn't. Here the tendency of which I spoke at the end of the last chapter comes into play. When you are unemployed, which is to say when you are underfed, harassed, bored, and miserable, you don't want to eat dull wholesome food. You want something a little bit 'tasty'. There is always some cheaply pleasant thing to tempt you. Let's have three pennorth of chips! Run out and buy us a twopenny ice-cream! Put the kettle on and we'll all have a nice cup of tea! That is how your mind works when you are at the P.A.C. level. White bread-and-marg and sugared tea don't nourish you to any extent, but they are nicer (at least most people think so) than brown bread-and-dripping and cold water. Unemployment is an endless misery that has got to be constantly palliated, and especially with tea, the English-man's opium. A cup of tea or even an aspirin is much better as a temporary stimulant than a crust of brown bread.

In Orwell's time, the result was toothlessness and short, frail stature; in the days of nearly endless cheap calories, it is obesity.  It is undoubtedly easier to stay thin if you have nicely cooked low-calorie prepared food at easy disposal, a shiny gym with a personal trainer to go to, some control over your schedule so that you can use it, and lovely clothes to show off a well-toned figure.  The life of a welfare mother affords few pleasures beyond television, comfort food, and whatever entertainment she can get up with friends on a $0 budget.

But if a weight loss pill turns out to be relatively safe and effective?  For sure, Medicaid would cover it; obesity (hell, diabetes alone) costs more than the pill possibly could.  Suddenly, a major class marker would disappear.  And with it, hopefully, upper middle class women will stop thinking that the ideal woman closely resembles a flagpole in form and function.  I don't expect such a thing any time soon, but it is lovely to look forward to.

Braking the banks

In a really useful article about central bankers over at The American Prospect, Brad DeLong says:

The current financial crisis has its roots in Greenspan's decision to keep interest rates very low in 2002 and 2003 to head off the danger of a deflation-induced double-dip recession, and his subsequent decision that the costs of cleaning up after a housing bubble were likely to be less than the costs of the high unemployment that would be generated by a preemptive attempt to pop a housing-speculation bubble. Two years ago, I would have said that Greenspan's judgment here was correct. Six months ago, I would have said that his judgment was probably correct. Today -- in the middle of the largest nationalizations in history -- I can no longer state that Greenspan made the right calls with respect to the level of interest rates and the housing bubble in the 2000s.

Arnold Kling replies:

My view of history is rather different from Brad's. I think that the current financial crisis was not the product of Alan Greenspan. I think it was a phenomenon that emerged from a number of subtle factors, the most important of which was the anomaly in capital requirements. See my fantasy testimony and written remarks.

The central bank does not control the risk premium, which is perhaps the most important financial variable in the economy. Had there been no housing bubble, it is possible that the general drop in the risk premium that took place from approximately 2001 through 2007 would have created a crisis elsewhere. Perhaps it indeed did create a crisis in the debts of the so-called emerging-market countries.

I, like Arnold, find it hard to credit the American central bank with this crisis.  The disaster in Europe shows that lending standards fell everywhere--in the US, it was the mortgage market, in Europe, emerging market debt.  Yet the Bank of England, and especially the ECB, were inflation hawks.  Nor do falling interest rates explain the vast influx of foreign capital that unquestionably sustained the bubble; capital is supposed to follow rising rates. The global decline in lending standards seems to support Bernanke's "global savings glut", in which Asian savers recycled export earnings into American and European credit markets with insufficient regard to risk.

Even if we blame the post-9/11 interest rate drop, however, I think Brad's post hints at what I've been saying (I know--over and over and over):  how do we separate the decision making process from the result?  What looked like a sound decision in 2001 is now fairly obviously wrong.  But was there some systematic rule by which Greenspan could have known that a financial collapse was more likely than a post-attack deflationary spiral?  Because that's what we need in the future, if we want to prevent this from happening again.  As Arnold Kling points out:

Given that Ben Bernanke was appointed in 2005, it should be noted that the worst of the housing bubble took place under Ben Bernanke'.s watch. It should also be noted that Brad DeLong hates Greenspan and adores Bernanke.

Until just a few weeks ago, all of macroeconomic theory suggested that inflation targeting was sufficient for monetary policy. In The Economics of the Great Depression, Randall E. Parker interviews the top modern macroeconomists on their view of the 1930's. Ben Bernanke, in his interview, says (p. 65)

A price target that avoided deflation would have de facto forced abandonment of the gold standard and would have eliminated a major channel of depression...So I do agree that stabilizing prices is the ultimate lesson of the Great Depression and also of the 1970s. There really is nothing more a central bank can do for domestic economic stability than make sure that inflation remains low and stable over long periods.

Re-read that last sentence. Ben Bernanke, the Depression expert, or "technocrat-prince," as DeLong hails him, says nothing about the Fed needing to pop financial bubbles or to give Treasury Secretary Mussolini power to buy hundreds of billions of dollars of mortgage assets and then use that power to partially nationalize banks, insurance companies, auto companies, or anyone else of his choosing.

Targeting asset bubbles always seems like a slam dunk--after you know there was a bubble.  Prospectively, if you want to do it effectively, you probably need to intervene in the very early stages.  The Fed raised interest rates in the late 1920s, to no effect--indeed, it encouraged foreign capital to flow in.  Iceland's central bank, too, tried to quiet its financial bubble, but borrowers simply ignored them--borrowed at the higher rate, or stupidly took on currency risk by getting auto loans and mortgages from abroad.  Meanwhile, more lenders were attracted by the higher rates.  If you think house prices will go up 10% every year, a 1% increase in mortgage interest rates is not really that worrying.

So to squelch asset price bubbles you need to get in early, before the bubble takes off.  But in the early stages, an asset price bubble isn't necessarily distinguishable from actual economic growth, or real changes in the relative value of assets.  The various indices have fallen since the bubble peaked in 2000--but the S&P is still about twice what it was at the start of 1995, the year the bubble is generally agreed to have taken off.  Stomping down on bubbles before they get going will mean accepting higher unemployment and lower economic growth any time that any asset market starts to look the least bit frothy.

At that, we don't know if it is possible to prevent bubbles (and we definitionally won't--if a central bank succeeds, all we'll see is . . . no bubbles.  Which is also what we'll see in most cases if the central bank takes no action.)  Speculative mania precedes fractional reserve banking, central banking, and quite possibly, the invention of currency.  The central problem is that in an asset market, other people's opinions of an asset's future value are meaningful components of the asset's future value.  And since guessing other peoples' future opinions about cash flows is even harder than guessing the cash flows, there is a systemic tendency to over- or under-shoot.

Almost everyone attributes the quiescent markets of the 30's, 40's and 50's to FDR's sweeping regulatory changes.  But it seems to me that it's at least as plausible to think that investors simply got much more bearish on stocks, because the lesson of 1929 was fresh in their minds.  As that memory faded, markets headed north. 

Update:  Free Exchange adds

When does a bubble become a bubble? While it's certainly sometime before your waiter begins day-trading between courses and your son refinances his treehouse, it's definitely after awareness of the sure-fire profit opportunity in the relevant sector has hit some critical mass. That's really what a bubble is all about, after all--the departure of price growth from fundamentals thanks to a rapid broadening of players in the bubbly market. Before the Ponzi scheme is a Ponzi scheme, it isn't a Ponzi scheme.

But what that means is that by the time a bubble becomes a bubble (and certainly by the time it becomes a recognisable bubble) a lot of amateur investors are involved. A healthy chunk of the body politic will have entered an inflated market believing prices will continue to increase. And Mr Roach and Mr Thoma are saying, correctly, that someone important will need to tell them that they have made a very bad decision and are about to lose their money.

Mr Thoma says that popping such a bubble will take courage. For a politician to do it would take an extraordinary amount of courage--more than we could reasonably expect a politician to display. It's important then to place the bubble popping decision in the hands of officials that are entirely--inhumanly--apolitical and independent.

And frankly, I wonder if the standard of independence necessary for the job is realistic.

Iceland's central bank raises interest rates to 18%

We're going to be seeing a lot of this as the IMF swoops in with rescue money; raising interest rates and slashing government budgets are typically among the conditions that the IMF imposes.  These are inevitably rapidly followed by complaints that the IMF is making things worse, complaints that are generally vindicated by plummeting GDP and gross hardship due to the fiscal contraction.

But blaming the IMF may be cursing the cure rather than the disease.  Iceland is facing massive capital flight, for reasons that Felix Salmon points out:

The decision to raise rates is being painted as an attempt "to return to a market-based floating exchange rate regime". But the reason that regime fell apart was nothing to do with Iceland's monetary policy. Rather, it was a function of the fact that anybody looking to earn interest on Icelandic krona deposits would have to have that money on deposit with an Icelandic bank. Which, in turn, meant taking bank credit risk on top of FX risk. And if you wanted to take bank credit risk, you could make much more money by selling default protection.

So I suspect that this latest move by the central bank is largely symbolic. No liquid currency market can exist in a country without a functioning banking system. Unless and until Iceland gets solvent banks -- either new ones or restructured old ones -- the krona will continue to trade largely through newspaper classified ads.

This is a real problem, though the interest rates may help that recapitalization; they encourage saving and discourage consumption.  They may also compensate some outside investors for the bank/currency risk, which is huge; the Krona seems to have lost about 2/3 of its value since last year, though as far as I can tell, it still isn't really trading outside of Iceland.  At the very least, it will help control the inflation that will almost certainly result from the free-falling currency.

Of course, it won't be good for anyone who has to borrow money.  Opponents want the IMF to stop kicking countries when they're down.  But the conditions that force austerity aren't the making of the IMF; the IMF is there because of those conditions.  For example, when the price of oil fell in the 1980s, oil producing nations like Nigeria blamed IMF austerity measures for their plummeting standard of living.  But the IMF's job is not to insulate commodity-driven economies from falling prices; it's to prevent the resulting catastrophic financial collapse.  And if the government pursues inflationary policies and continues to run a giant deficit, capital will certainly flee. 

Witness Argentina recently nationalizing its private pension alternative, not because the pensioners were dissatisfied, but because the government needed the contributions to finance current spending.  In past years, the Argentinian government avoided austerity measures by massively defaulting on its foreign debts--but only at the price of systematically destroying investor willingness to lend it money.  Unless the world economy turns around in 2010, Argentina is going to end up with the austerity measures, and no recourse to outside help.

Ken Rogoff outlined the IMF's dilemma in a scathing response to Joseph Stiglitz's critique of the World Bank and the IMF:

Let's look at Stiglitzian prescriptions for helping a distressed emerging market debtor, the ideas you put forth as superior to existing practice. Governments typically come to the IMF for financial assistance when they are having trouble finding buyers for their debt and when the value of their money is falling. The Stiglitzian prescription is to raise the profile of fiscal deficits, that is, to issue more debt and to print more money. You seem to believe that if a distressed government issues more currency, its citizens will suddenly think it more valuable. You seem to believe that when investors are no longer willing to hold a government's debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF--no, make that we on the Planet Earth--have considerable experience suggesting otherwise. We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent. The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.

Joe, throughout your book, you condemn the IMF because everywhere it seems to be, countries are in trouble. Isn't this a little like observing that where there are epidemics, one tends to find more doctors?

You cloak yourself in the mantle of John Maynard Keynes, saying that the aim of your policies is to maintain full employment. We at the IMF care a lot about employment. But if a government has come to us, it is often precisely because it is in an unsustainable position, and we have to look not just at the next two weeks, but at the next two years and beyond. We certainly believe in the lessons of Keynes, but in a modern, nuanced way. For example, the post-1975 macroeconomics literature--which you say we are tone deaf to--emphasizes the importance of budget constraints across time. It does no good to pile on IMF debt as a very short-run fix if it makes the not-so-distant future drastically worse. By the way, in blatant contradiction to your assertion, IMF programs frequently allow for deficits, indeed they did so in the Asia crisis. If its initial battlefield medicine was wrong, the IMF reacted, learning from its mistakes, quickly reversing course.

No, instead of Keynes, I would cloak your theories in the mantle of Arthur Laffer and other extreme expositors of 1980s Reagan-style supply-side economics. Laffer believed that if the government would only cut tax rates, people would work harder, and total government revenues would rise. The Stiglitz-Laffer theory of crisis management holds that countries need not worry about expanding deficits, as in so doing, they will increase their debt service capacity more than proportionately. George Bush, Sr. once labeled these ideas "voodoo economics." He was right.

Keynesian stimulus may work in a large domestic economy that borrows in its own currency.  But in small countries like Iceland, which imports nearly everything it eats and has a small domestic capital base, the government must quickly restore the credibility of its financial system, or watch its people starve. Expect to see austerity pressed on Hungary and Ukraine as well--and a resulting backlash against capitalism in those countries.

The end of work

As Alex Massie notes, this is ingenious:

In 100 words or less, please answer the question, "What makes you so unhappy?" in the comments field below. Selected answers will appear in Dean Bakopoulos's new novel, My American Unhappiness, forthcoming from Houghton Mifflin Harcourt in late 2009 or early 2010.

Perhaps I should invite my readers to write blog posts in the comments.

Update from the swing voter

As I believe I've mentioned, I am the daughter of The Swing Voter:  my mother's vote does remarkably well at predicting the outcome of presidential elections.  Unsurprisingly, then, she's for Barack Obama, though due to apparently hereditary stupidity, the entire McArdle clan missed the deadline for transferring their voter registration to DC, and therefore will not actually be voting in the election. 

My mother's reason:  Sarah Palin.  She liked the convention speech, but said she wanted to see more . . . and now that she's seen more, she's an Obama supporter.  I find it hard to believe that she's the only one.  I mean, I already disliked McCain, but Palin hasn't exactly improved my opinion of the campaign.

Even more shocking is that my grandmother, a rock-ribbed Republican who to my knowlege has never voted Democratic and will not let a bad word be spoken about George W. Bush in her hearing . . . that GOP-lovin' granny almost voted for Obama.  At the last minute, she decided that since she lives in Western New York, and there's no chance of Obama losing the state, she could safely support her party.  But that she even thought about voting for the Democrat augers dire things for the McCain campaign.
  

Thought for the day

Considering that I'm going as a comic book graphic novel character for Halloween, you knew I was going to love this.  Now, if someone could only blend economics, comics, and cooking . . .

Update:  Readers request that I note that this contains Watchmen spoilers, since the movie is coming out in March. 

Is an MBA deductible?

Wish I'd known about this when I was in business schools:  most MBA's may be able to deduct their education expenses.

Short timers

We saw a pattern today that has been repeated several times in the last few weeks:  the markets trade up for most of the day, then suddenly crash just before the close.  The down lost a couple hundred points in a matter of minutes; the NASDAQ and the S&P 500 saw like losses.

How to explain this behavior?  Do investors just get sad at night?  Not exactly.  It seems like people's risk horizons have shortened to nearly nothing.  People don't want to hold things overnight, so they dump them near market close.  In the credit markets, we've seen a similar shift towards shorter and shorter credit terms.

Or perhaps there's another explanation I haven't thought of--readers invited to offer alternatives in the comments.

Understanding derivatives

Highly recommend this site for people who have trouble following all the chatter about CDSs, CDOs, and so forth.  It's pitched at an intelligent, but not particularly financially literate audience, and does a really nice job of explaining things.

Persecute or prosecute?

Mark Kleiman is angry because I accused him of wanting to prosecute the people who exposed the hole in Obama's credit card system.

Megan McArdle, who is usually a more careful reader, and Glenn Reynolds, who usually isn't, both accuse me of urging the prosecution of the wingnuts who have been submitting false-name contributions on the Obama website, and criticize me for trying to use the power of law enforcement to suppress criticism the people I support politically.

Just one thing: Nowhere in the post they refer to (reproduced in full after the jump) do I say a syllable about prosecution. I merely point out that the activity violates the law, which means that people doing it shouldn't crow quite so loudly. Of course no actual investigator or prosecutor would waste his time working on a case involving a $5 contribution to Obama in the name of "Mickey Mouse." Neither Megan, who isn't a lawyer, nor Glenn, who is, bothers to offer any reason why the activity in question, which both of them have publicized and praised, doesn't constitute wire fraud as defined in the statute.

I am happy to say that I was incorrect, but this seems to me like a distinction without a difference.  When your candidate is caught violating basic financial prosecuting standards, standards which should, if anything, be stricter for politicians, the correct response is not to point out that uncovering this problem involved technically committed a crime.  The correct response is "This is terrible.  What is the campaign going to do to fix this?" 

All the information that I have gathered indicates that this couldn't simply have happened by accident; you have to systematically uncheck all the security guards that prevent address verification.  I don't read the sinister signs into this that others do--having worked in technology, I can easily imagine half-a-dozen scenarios in which a lazy tech overrode the security rather than actually fix some annoying bug.  Nonetheless.  Whoever is responsible should be fired.

Testing for holes in the system is fraud in the sense that undercover journalists who falsify their resumes commit fraud:  a technical violation that society actively encourages, because it helps us uncover things that are wrong.  If it is possible to commit fraud on Obama's website, then a citizen who uncovers this should be applauded, not least by the Obama campaign, which at least putatively does not want to violate campaign finance standards, nor make it easy for criminals to misuse someone's credit card.

As this story from the National Journal makes clear, the candidate that Professor Kleiman and I both support seems to have systematically weaker protections against fraud than McCain.  That is worrying.  In the end, I don't think it has made much difference; Obama isn't winning because of his massive pocketbook, but because the Republicans got caught in bed with a naked financial crisis.  But the principle is rather important.

And while I'm no lawyer, I'm not sure you could argue that those people did commit fraud.  The crime is not really the individual transaction; it's setting up the system to enable fraudulent transactions.  And no one made the Obama campaign do that.

That's just tripe

The Cranky Professor sings the joys of tripe.  I don't have anything against tripe, per se; it's no more disgusting than eating any other part of the cow.  But there's nothing really for it, either.  It has an unpleasant texture, and no flavor that I've ever been able to discern; it's just a vehicle for whatever you cook with it.  It is, to be sure, cheap.  But so are lentils, and they taste like something.

Be kind to chickens week

I haven't mentioned it until now, but I'd like to urge California voters to support Proposition 2, which bans excessively confining situations for farm animals.  It is not perfect, but it does provide some protection for animals from the most grotesque penning practices.  You can read about it in a piece from this week's New York Times magazine.

In California, which doesn't have much of a dairy industry, this law will mostly affect egg producers.  The chicken farmers are complaining that this will raise the cost of eggs.  It's hard to see, however, that this is going to be a dreadful hardship for anyone.  Eggs are about the cheapest food there is, and I find it hard to believe that almost anyone shops for them on price.  Price may decide which brand you choose, but how many people actually substitute eggs out of their diet because they suddenly cost $1.75 a dozen instead of $1.50.  Even the very poor do not calculate meal prices to the $0.02 margin.

Here in DC, one of the most expensive food markets in the nation, chi-chi organic cage free eggs are less than $3 a dozen.  That's about 25 cents an egg.  I've lived on a very tight budget, but even in my most impecunious student days, I wouldn't have freaked out if my eggs had suddenly cost 5 cents more apiece.  I'm sure I could have found a few beverage containers to return for the deposit.  If there are really people so poor that paying 50 cents more for a dozen eggs will push them into starvation, then they need an increase in their food stamps.

America grows closer

Robert Frank points to something that I haven't seen a lot of commentary on:  the financial crisis is going to achieve one long-sought political goal, that of reducing inequality.

Recessions are bad for everyone, but they're worse for the wealthy, at least in some sense.  The wealthy have more assets to lose, and their income is more dependent on volatile sources like bonuses and stock options.  In terms of reducing inequality, the 1929 stock market crash and World War II did more to reduce inequality than changes in policy or the tax code, at least if Piketty and Saez are to be believed.  Similarly, the late widening of inequality pretty clearly started with the beginning of the Great Bull Market in 1982.

Of course, losing 2/3 of a fortune is not the same thing as losing your $40,000 a year job; in the most meaningful sense, recessions are still worst for the working stiffs and the poor.  As the Journal notes:

So could a narrower wealth gap become the silver lining of the crisis? "Only if you don't like rich people," says Len Burman of the Tax Policy Center. "It's not like their share decline brings improvements for the middle class or the rest of America."

Indeed, this is the problem with the shift towards relying on the wealthy for tax revenue:  as the wealthy's income falls faster than everyone else's, so will tax receipts.  In the article Saez urges more flattening tax rates, like those enacted by Roosevelt.  But Roosevelt was working from essentially a blank slate; income taxes were trivial prior to the Great Depression.  It's a lot harder to raise taxes to 70% than to 35%, especially with state and local governments taking a bigger rake.  Not least because 70% is a rate at which you almost certainly do end up on the wrong side of the Laffer Curve, reducing both tax take and economic growth.  How much are we willing to pay to soak the rich?

Kindle forever . . .

Both Oprah and Jim Henley endorse the Kindle.  And I still love mine--easy to read and sooooo easy to travel with.  Can world domination be far behind?

Seriously, I have to think that the Oprah endorsement is critical.  One of the reason people have been holding back is the same thing that kept people from buying Blu-Ray players--there are a lot of eBook Readers out there, and no one wants to commit to a device that will end up on the ashheap of history, leaving their eBook collection orphaned.  That means waiting until one of the readers goes mass-market.  If Oprah can marshall her legions in favor of the reader, that may put it over the edge in the format wars.

Update:  Apparently, you get $50 off if you type in the promotional code OPRAHWINFREY

Free Fallin'

The Nikkei peaked at 38,915.87 on December 29, 1989.  For years, it's been a watchword warning to people who say "in the long run, stocks always go up"; in the past two decades, it has struggled back towards 20,000 several times, but never anywhere near its former peak.  Today, it went even further, falling to a 26-year low.  The yen has been strengthening fast against the dollar and other currencies, which is very bad news for Japanese exporters. 

It's also wrecking the carry trade.  That's when you borrow at low interest rates in one place just to lend at higher rates somewhere else.  For a long time, Japan has been a popular place to do this, for two reasons:  the longtime recession has kept its interest rates low, and the government's committment to keep the currency cheap in order to subsidize exports has seemed like a shelter against a sharp currency move that would force borrowers to repay the loan in suddenly-more-expensive yen.  Now that the yen is rising seemingly uncontrollably, investors are racing to unwind their positions.

The sharp movements in the currency market are somewhat surprising, particularly the euro's decline.  Not very long ago, we were asking whether the euro would replace the dollar as the world's reserve currency; not it's the "sick man of Europe", as confidence in banks and businesses has been badly shaken.  Europe took on less mortgage risk than the US, but much more emerging markets exposure, which is looking like a very bad bet with commodity prices plunging and credit contracting.

All of this seems like a pretty stinging rejoinder to the notion that the problem is simply a failure of regulatory stringence.  The problems have spread across regulatory regimes, currencies, and banking systems; besides Canada, not a single large economy has escaped.  Perhaps the problem is Basel II--having a unified standard may have left us more vulnerable.  But there's something here deeper and more frightening than a lack of adequate rules. 

Update:  Tyler Cowen has more on the problems European banks have with emerging market exposure, and adds:

By the way, this is further evidence that the driving force behind the earlier boom was the global savings glut, and sheer giddiness, not the excessively loose monetary policy of Greenspan's Fed.  The ECB has pursued a relatively tight monetary policy since its origin.  It also will be interesting to see what trouble arises in Spain, since Spanish banking regulation has been considered a model of how to keep these problems under control.

LIRR goes on disability

Regulatory capture at its finest:  the LIRR seems to have become less a means to run commuter trains than a source of easy retirement for its workers:

In the years before the investigators arrived, the Long Island office of the Railroad Retirement Board had been a beacon to employees of the Long Island Rail Road, offering the prospect of a comfortable retirement, complete with a pension and disability payments -- all at an age when people in other industries were still working.

As word spread that disability payments were easy to get, L.I.R.R. workers trooped up to the office, hundreds at first and eventually thousands, all filing papers to begin the process of securing early retirement on disability.

Now, the retirement board's Long Island office, in Westbury, is attracting attention for another reason: It is the epicenter of major state and federal investigations into the legitimacy of many of those disability awards.

Of particular interest to investigators is a small group of disability consultants and physicians who have helped the L.I.R.R. attain the dubious distinction of having the nation's highest rate of disabled retirees even while it was earning awards for employee safety. The New York Times reported in September that nearly all of the railroad's career employees retire early and file for disability.

One consultant, Marie T. Baran, ran the board's Long Island office until she quit two years ago and began selling advice to rail workers on how to navigate the system of which she had been a part. Other disability advisers are prominent former union leaders, including one who once represented labor on the board of the L.I.R.R.'s parent agency, the Metropolitan Transportation Authority.

Government investigators are particularly interested in learning why L.I.R.R. retirees tend to use the same physicians, while citing the same ailments in numbers far out of line with other railroads. Investigators have issued dozens of subpoenas to consultants, doctors and retirees, among others.

None of the investigating agencies have accused the consultants or doctors of any wrongdoing.

There are other explanations for the Long Island Rail Road's high number of disability cases, including an unusual labor contract that allows many longtime workers to retire with a company pension as early as age 50. By combining that pension with tens of thousands of dollars in federal disability payments, retirees can draw about as much money as they did when they were working.

The federal retirement board, based in Chicago, also encourages disability applications by approving virtually every one it gets, regardless of where it comes from.

Even so, the L.I.R.R. stands apart.

For example, from 2001 through 2007, Metro-North Railroad, which serves commuters north of New York City, had 32 cases of disabling arthritis or rheumatism, compared with 753 at the L.I.R.R, which has a work force of similar size and composition.

Since 1990, the disability rate among career employees at the L.I.R.R. nearly doubled, reaching a high of 97 percent in 2004 -- a rate three times that of the average railroad, records show. Since 2000, retired L.I.R.R. workers have collectively received a quarter of a billion dollars in federal disability payments.

Perhaps oddly, I actually feel sorry for some of the workers and their enablers.  I imagine that a cultural norm built up slowly, so that by the time the later retirees faked disability, they thought of themselves as fulfilling an implicit contract, rather than defrauding the taxpayers.  Not an unreasonable belief, considering that it is simply impossible that management didn't know what was going on.

But then, I doubt the government will go after them.  They'll get the doctors, the officials, the consultants, but the people who actually committed the fraud?  Time consuming and unpopular.

The pain spreads

We may be headed for the first truly global recession.  The Wall Street Journal notes that Asia's dependence on exports is about to come back and bite them in the . . . current account surplus:

The meltdown in Asian stock prices on Friday stemmed in part from
the growing realization that the heavy reliance on exports that has
driven Asia's powerful growth is now turning into the its worst enemy.

The evaporation of consumer spending in the U.S. and Europe is
starting to hit deeply at Asian manufacturing titans that thrive on
sales to the rest of the world, and that are now rapidly scaling down
their capital spending.

On Friday, after reporting a 44% third quarter profit drop, South Korea's Samsung Electronics
Co. said it will reduce memory chip capital expenditure this year by an
unspecified amount due to weak market conditions, and may also lower
its overall capital-spending plans for next year in line with the weak
business environment. Japan's Sony
Corp. Thursday lowered its outlook for its fiscal year ending March
2009 and warned that the deteriorating business climate could force the
company to scale back capital spending, close plants and cut jobs to
shore up profit. The news sent Sony shares plunging 14% in Tokyo on
Friday.

The worsening gloom in Asia comes despite the fact that on the whole
the region -- sight of a major economic meltdown a decade ago -- today
has limited exposure to the debt that is now causing havoc with the
financial systems of the U.S. and Europe. While some countries, notably
South Korea, are reliant on funding through international credit
markets that have dried up in recent months, Asia's banks haven't
invested heavily in mortgage-debt derivatives or other products that
have poisoned the balance sheets of their Western counterparts.

But in the last 10 years, Asia has doubled down with another bet on
exports as an economic engine, at the expense of developing a domestic
consumer market that many economists believe will insure more
sustainable growth. Exports accounted for 46.7% of gross domestic
product in Asia, excluding Japan, in 2007. That is a jump of 11
percentage points more than the comparable figure in 1998, during the
last economic crisis in the region, notes Stephen Roach, Morgan
Stanley's Asia chairman. In other words, Asia is now 30% more reliant
on exports than it was less than a decade ago.

Asia "may not be levered in the strict sense of reliance on global
credit," says Mr. Roach. "But it's certainly levered to the global
economy."

Meanwhile, the New York Times reports that Iran and Venezuela are panicking about the falling price of oil, which traded as low as $62.57 this morning despite a sizeable cut in OPEC production:

As the lowest cost producer, Saudi Arabia can afford to let prices fall for a while without hurting its budget. Most analysts estimate the Saudis could live with oil between $55 and $65 a barrel. Other producers are not so fortunate. Nigeria's oil minister said his country would be more comfortable with $80, Qatar has set a range of $70 to $90, and Iran's representative has said that anything below $90 a barrel would hurt some producers.

Some analysts believe that Venezuela's president, Hugo Chávez, needs $100 a barrel to pay for his expensive social programs.

In fact, the traditional "price hawks" -- Iran, Venezuela, and Libya -- are in a state of near panic at the drop in price, which few experts had anticipated even a few months ago.

Domestically, Iran's president, Mahmoud Ahmadinejad, who was elected on a populist platform to share the country's oil wealth, faces a tough economy that could jeopardize his re-election next year.

Iran's oil minister, Gholam Hossein Nozari, set the bar high when he arrived in Vienna on Thursday, calling for OPEC to slash its production by 2 million barrels a day, more than 6 percent of the group's output. His call was echoed by Rafael Ramírez, the Venezuelan energy minister, who said the group should make a "substantial" cut, while the representative from Libya called for a "huge" reduction in the cartel's output.

At the same time, some analysts warn that the current decline in prices could set the stage for a new energy shock when the economy and demand eventually pick up.

Energy executives have said that as prices fall, some projects will be delayed, and oil companies will most likely curtail investments. This will probably slow the growth in oil supplies, which had already been sluggish in recent years.

Venezuela has, as I've been noting for some time, set itself up for a disaster.  Venezuelan crude, while plentiful, is difficult to both extract and refine; the state owned oil company needs to maintain a very high level of investment, relative to revenues, just to keep the production steady.  Even more is needed to increase it.  For years, Chavez has been diverting investment funds into social spending.  This has created a popular belief that he (and Kirchner in Argentina) had found an alternative to market capitalism.

Of course, all this was funded by commodity booms caused by rising demand in the capitalist world.  Now that capitalism is hurting, these economies are hurting even worse--they tend to import most everything besides the commodities they produce, so a fall in oil prices means a corresponding fall in consumption.  It's as if economic dependence on commodities were a highly leveraged bet on world GDP growth.

Because of the diverted investment, oil production in Venezuela has declined sharply since Chavez's election--the coup was, in part, a revolt of executives at the state-owned oil company, who were concerned that he was running it into the ground.

Women's lib

Just wanted to point to a pretty good discussion in Ta-Nehisi's comments thread on the rape scene in last week's Mad Men.

Barack Obama says grandmother may not see election day

According to the AP.  Old people often hang on until some special event, like a grandchild's wedding--or his election as President of the United States.  In fact, there's evidence that some people live--or die--to best time changes in the estate tax.  Here's hoping that his grandmother lives to see a happy, happy result.

More on fake crimes

From Psychology Today:

Among crime hoaxes, there's a subset of tricksters who concoct crimes for political causes, says Gregg O. McCrary, a retired FBI agent who profiles criminals as director of Behavioral Criminology International, a consultancy in Fredericksburg, Virginia. This kind of hoaxer is just as likely to be a man as a woman. A recent case occurred last November when Jaime Alexander Saide, a Northwestern University student in Evanston, Illinois, published a column about his Mexican heritage in the campus newspaper after he claimed to be the target of two hate crimes. Saide later confessed to filing false reports to bring attention to campus race relations.

While most reported hate crimes are real, hoaxes often occur on college campuses around the same time as antiracism forums, says Laird Wilcox, who's currently updating his book, Crying Wolf, to include more than 320 staged hate crimes that he's tracked in the U.S. since 1994. Consider the recent case of Kerri Dunn, a social psychology professor at Claremont McKenna College in Claremont, California, who police suspect may have slashed her own car's tires, smashed its windshield and spray-painted it with racial slurs just hours before speaking at a campus forum against hate crimes last spring. Two eyewitnesses identified her as the culprit shortly after hundreds of students marched to protest the crime. Dunn denies that she staged the attack.

Another big tip-off is when an alleged victim calls the press before calling the police. "These people are not knowledgeable about what a typical crime looks like," McCrary says. "You'll try to find support for their allegations and find the facts don't match up."

Apparently, though general crime hoaxes are committed by women, men are just as likely to stage political crime hoaxes.

On this day in history

Black Thursday, the start of the 1929 crash, hit on October 24th, 1929.   

Brown is back

Wow, Michael Brown has a blog.  Yes, that Michael Brown.  Truly, anyone can blog now.  I'd have thought he had changed his name and moved to a town where nobody had a television.

Home, sweet home

I don't know what to make of the fact that housing sales were apparently doing better in September, before the main crisis hit.  Just clearing out some foreclosed inventory, buyer capitulation, or some actual signs of stabilization?  I'm not sure it matters, as I'm pretty sure that next month's figures won't be so rosy.  A broker just told me about a client with several million in other real estate assets and a solid annual income losing a mortgage for less than 3X annual income.

McCain worker "victim" of self-hatred

I haven't expressed an opinion about the McCain supporter allegedly beaten up for her political views, because it seemed likely that she had made it up, but I didn't want to risk piling on an actual victim.  Now we know:  it was a fantasy.

I'm sure some bloggers will cast this as a dark Republican conspiracy, or somehow symptomatic of conservatism.  In reality, AFAIK, faked hate crimes are usually faked by left wing causes, if only because the left has more groups who can realistically complain of attack.  But while a few of them have been faked by student groups looking for attention, as far as I can tell the overwhelming majority are disturbed people looking for attention from their ideologically supportive peers, or, a la Tawana Brawley, trying to get out of some other trouble.  It isn't "symptomatic" of the fight for racial equality or gay rights that some sad members of those movements engage in false accusations; it's symptomatic of the fact that some people will do anything to feel important.  I expect the same applies here.

How dare he point out my error?

This is madness:

If a wingnut uses the Internet to give the Obama campaign a donation in a fake name, with the intent of fooling the website into accepting an invalid contribution, isn't that using interstate communications facilities to defraud under 18 USC 1343?

Here's part of the definition of "fraud" from Black's Law Dictionary:

a false representation of a matter of fact, whether by words or by conduct, by false or misleading allegations, or by concealment of that which should have been disclosed, which deceives and is intended to deceive another so that he shall act upon it to his legal injury

Seems like a pretty good fit to me.

It also seems like the only way to expose much wrongdoing or error.  The Obama campaign screwed up massively; it should not be possible to charge something to a credit card without matching the name to the name on the credit card.  Most responsible web processors also require that you provide a fair amount of other information, to ensure that people aren't using stolen cards.  And beyond that, last time I looked it was mandatory to get correct names to ensure that people aren't violating the campaign finance laws.  I don't support those laws, to be sure.  But as long as they are the law, all the campaigns have to abide by them.

Wondering if we can't prosecute the person who exposed the campaign's error smacks of police state tactics.  Yes, I still support Obama, and I have no reason to think that the error was deliberate.  But that doesn't mean that I think the Obama team has a right to have its errors protected from public exposure.

Nor is this quite the same thing as, say, bullying a right-wing militiaman into selling you guns, or talking a teenager into using drugs.  The guy went and saw if it was possible to commit a crime via Obama's website.  It was.  If it had been a corporation rather than a campaign whose shoddy protections were thus exposed, would Kleiman really be urging us to pursue a fraud claim?

Inner demons

Some years ago, I remember reading Jonathan Kellerman's Savage Spawn, a book on sociopathic children, and how nearly impossible it is to treat them.  The other day I heard about someone I know who is apparently going through this with their child, which prompted me to search for the term.  It's truly heartbreaking:  a child who doesn't seem capable of loving its parents, or anyone else.  It seems to be mostly genetic, and nearly completely immune to any current treaments.  I thought the story of the woman who inspired The Changeling was the most heartbreaking thing I had read in a while, but I wonder if there aren't worse ways to lose a child.

Why ask why?

Will Wilkinson wonders why Herb Gintis is so much harder on Paul Krugman than Naomi Klein.  I've been thinking about this lately:  why do the better class of critics, left and right, generally fail to engage the lunatics on the other side?  I do it to.  I am much more likely to write about my disagreements with Paul Krugman than with Naomi Klein, just as Paul Krugman is much more likely to write about his disagreements with Bush administration policy than with Ron Paul's more . . . er. . . idiosyncratic supporters.

But what's the point of disagreeing with Naomi Klein?  It's like having an argument about economic policy with an eight year old.  To have an interesting discussion, you would have to explain too many facts to the eight year old--facts that the child does't have any interest in learning.  And the eight-year-old lacks a coherent intellectual framework into which to fit those facts; his reactions are pure instinctive emotion.

Paul Krugman shares with his serious critics a committment to a common empirical framework.  It means that you don't end up in so many stupid epistemological arguments, as you do with Chomskyites who respond to argument by discounting any source of facts that disagrees with them.  It means that your opponents can be relied upon for a certain degree of intellectual honesty in dealing with facts, at least as long as they might get caught.  And it means that if you can make your case strongly enough, your opponents will be forced to change their minds.  (I don't say that this happens often.  But the possibility is there.)  This makes him worth arguing with.

Spider bites

Crikey, I may never sleep again.

The evil man theory of failure

Both right wing Austrians and many liberals have a common theory of how all this happened:  Alan Greenspan dunnit.  The mechanisms by which he accomplished his foul task are different in the two cases, of course.  Austrians, and many other free-market types, believe that by lowering short-term interest rates after 9/11, Alan Greenspan made the housing bubble, and its eventual bust, inevitable.  The liberals think that by failing to regulate . . . er, something (usually either mortgage originations or CDS's) more closely, he made the crisis inevitable.  In the latter case, sometimes Phil Gramm, with an assist from Conservative Ideology, fills in the role of convenient demon.

Here's the problem:  if markets are so great, how come the entire system can be brought low by a smallish injection of short-term capital?  The alternative question for the liberals:  if regulation is so great, how come one guy, or one fairly minor bill, can apparently single-handedly destroy the most heavily regulated industry in America that doesn't actively involve radioactive material?  If your preferred system is really that fragile, then maybe we should be looking into alternatives.

Update:  Let me expand a little.

Austrians:  If the market does not price the injection of short term capital into its actions, why would we trust it to price anything else correctly?  If the markets treat short-term capital as substantially equivalent to long-term capital, we have much bigger problems than Alan Greenspan.

Gramm/Greenspan haters from the left:  If regulation is so impotent that a single rule change, or even two, can leave the system vulnerable to this kind of collapse--indeed, make it worse with other rules that are still there--then why the hell do we bother regulating?  If your regulators need to get it right 100% of the time, we might as well pack it in now, because there is no system on earth that can guarantee no one will ever be wrong.  If one guy can leave us in a position where the regulatory system makes things worse rather than better, we may well be better off without the regulatory regime.

At last, some good news

Woo!  Free Dr. Pepper for everyone!

Memewatch

Tom Lee weighs in on Taibbi, and, I think, nails it:

Naturally, I have no idea about any of this stuff other than feeling vaguely hostile toward Byron York. Still, I was a little uncomfortable when I first read that exchange: Taibbi's scolding about credit default swaps came at a time when a lot of other people on the internet were also suddenly speaking knowledgeably about the financial meltdown and the rarified financial instruments to blame for it. That wave of spontaneous expertise seemed to occur suspiciously shortly after the air date of an episode of This American Life that discussed the crises and CDSes in particular.

Which is not to say that TAL is wrong; I listened to that episode, too, and it seemed excellent! But it's been both amusing and off-putting to see so many people brazenly parroting the same single News Source White People Like. I have no idea if this criticism actually applies to Taibbi, but the conversation between him and York certainly made it sound like it could.

I used to call it NYRB syndrome:  the mysterious process by which everyone in Manhattan read all the books reviewed in the NYRB, and also, agreed with the reviewer.  Now it seems like the disease may be multifactorial, and more prevalent than previously expected.  A little knowledge is a dangerous thing--at least until you learn enough to know how much you don't know.

Clothes horse

Those of us who fantasize about going on Tim Gunn's Guide to Style in order to get a few thousand dollars worth of free clothes are clearly in the wrong business.

Biden his time

I was at a friend's birthday party last night, and another financial/political journalist and I were marvelling at the way that Obama has been able to get away with complaining about deregulation while sharing a ticket with The Man from MBNA.  Why haven't journalists pointed this out?  I asked.  He shrugged, and then said it's really McCain's fault--it's his job to make that case, and he hasn't.

Which makes me wonder:  why hasn't he?  Sheer incompetence wouldn't exactly shock me from that campaign, but is there a more strategic explanation?

Quiet in the peanut gallery

Matt Taibbi shreds Byron York into little tiny pieces

B.Y.: Did I suggest that headwinds are unfair? But on the financial meltdown in particular, if you're suggesting that that is a Republican creation, or even more specifically a McCain creation, I think you're on pretty shaky ground.

M.T.: You don't think the unregulated CDS market was a major factor in the current crisis? Were you watching when AIG almost went under? Were you watching the Lehman collapse?

B.Y.: I think that Fannie Mae and Freddie Mac were also major factors. And I believe that many of the problems in the mortgage area can be attributed to the confluence of Democratic and Republican priorities: the Democrats' desire to give mortgages to people, particularly minorities, who could not afford them, and the Republicans' desire to achieve an "ownership society," in part by giving mortgages to people who could not afford them. Again, I believe that if you are suggesting that the financial crisis is a Republican creation, or even more specifically a McCain creation, I think you're on pretty shaky ground.

M.T.: Oh, come on. Tell me you're not ashamed to put this gigantic international financial Krakatoa at the feet of a bunch of poor black people who missed their mortgage payments. The CDS market, this market for credit default swaps that was created in 2000 by Phil Gramm's Commodities Future Modernization Act, this is now a $62 trillion market, up from $900 billion in 2000. That's like five times the size of the holdings in the NYSE. And it's all speculation by Wall Street traders. It's a classic bubble/Ponzi scheme. The effort of people like you to pin this whole thing on minorities, when in fact this whole thing has been caused by greedy traders dealing in unregulated markets, is despicable.

B.Y.: I was struck by the recent Senate testimony of James Lockhart, who is head of the Federal Housing Finance Agency, about the sheer recklessness of Fannie in recent years. Despite "repeated warnings about credit risk," Lockhart testified, Fannie became more reckless in 2006 and 2007 than they had been in the scandal-ridden tenure of Franklin Raines (who departed in 2004). In 2005, Lockhart said, 14 percent of Fannie's new business was in risky loans. In the first half of 2007, it was 33 percent. So something terribly wrong was going on there, and it became a significant part of the present problem.

M.T.: What a surprise that you mention Franklin Raines. Do you even know how a CDS works? Can you explain your conception of how these derivatives work? Because I get the feeling you don't understand. Or do you actually think that it was a few tiny homeowner defaults that sank gigantic companies like AIG and Lehman and Bear Stearns? Explain to me how these default swaps work, I'm interested to hear.

Because what we're talking about here is the difference between one homeowner defaulting and forty, four hundred, four thousand traders betting back and forth on the viability of his loan. Which do you think has a bigger effect on the economy?

B.Y.: Are you suggesting that critics of Fannie and Freddie are talking about the default of a single homeowner?

M.T.: No. That is what you call a figure of speech. I'm saying that you're talking about individual homeowners defaulting. But these massive companies aren't going under because of individual homeowner defaults. They're going under because of the myriad derivatives trades that go on in connection with each piece of debt, whether it be a homeowner loan or a corporate bond. I'm still waiting to hear what your idea is of how these trades work. I'm guessing you've never even heard of them.

I mean really. You honestly think a company like AIG tanks because a bunch of minorities couldn't pay off their mortgages?

B.Y.: When you refer to "Phil Gramm's Commodities Future Modernization Act," are you referring to S.3283, co-sponsored by Gramm, along with Senators Tom Harkin and Tim Johnson?

M.T.: In point of fact I'm talking about the 262-page amendment Gramm tacked on to that bill that deregulated the trade of credit default swaps.

Tick tick tick. Hilarious sitting here while you frantically search the Internet to learn about the cause of the financial crisis -- in the middle of a live chat interview.

B.Y.: Look, you can keep trying to make this a specifically partisan and specifically Gramm-McCain thing, but it simply isn't. We've gone on for fifteen minutes longer than scheduled, and that's enough. Thanks.

M.T.:  Thanks. Note, folks, that the esteemed representative of the New Republic has no idea what the hell a credit default swap is. But he sure knows what a minority homeowner looks like.

B.Y.: It's National Review.

I love Matt Taibbi's work.  I just wish that when he has no idea what he is talking about, he would shut the hell up, rather than making an awkward public.  Of course, in this exchange he looks good to people who have no knowledge of matters financial or economic.  But sounding plausible to the ignorant is a rather low hurdle for a journalist to set himself.

In point of fact, Byron York is much more correct than Taibbi.  CDS's (credit default swaps) are not the main cause of the crisis, and it seems more than possible that Taibbi has confused them with CDOs (collateralized debt obligations), the slice-and-dice securities that have done so much to destroy transparency in the mortgage securities market.  Professional traders do not claim to understand all that is going on with securities, which makes me skeptical that Taibbi could provide the clear and concise explanation he is demanding from York.  The only reason to fixate on CDS's in particular is that their deregulation can be attributed to a convenient Republican demon.

This brings me to a pet peeve that has been increasingly irritating me as the crisis wears on: people with little or no understanding of markets confidently opining on the causes of the crisis.  Funnily enough, the cause of the crisis is always exactly what they happened to be against before the crisis happened, and the solution is for the people they disagree with to be banned from polite society and exiled from the political process.

What is most infuriating is that the people who know the least are the most confident about their appraisals.  Anyone with any sort of expertise in the field knows that no one understands this crisis very well.  Economists all over the ideological spectrum are rethinking the lessons we thought we had learned from the Great Depression and the Japanese experience.  As it unfolds, we will no doubt be seriously rethinking our model of the relationship between the financial markets and the real economy.

The problem is, ignorant people who have somehow gotten hold of one or two precious facts, and brandish those facts like a mighty Sword of Truth, are superficially convincing.  They are convincing because they misunderstand the situation in, well, the way that ignorant people misunderstand it.  The stories they concoct are therefore very convincing to the ignorant, except those who have an ideological predisposition to doubt their story.  Those ignorant people are busy listening to some other huckster peddling financial snake oil.

No one who did not know what a CDO was before the crisis should be opining as to the causes or the possible solutions.  And anyone who tells you that they understand exactly why this happened, why we got this crisis instead of the dollar crisis we were expecting, and what kind of regulations will unquestionably fix it, is definitionally too ignorant to be opening their mouth.

Blessed are the poor . . .

Matt Frost on the pernicious notion that the coming economic hardship will somehow be good for the national soul:

The article goes on; according to Kotkin, our anomic communities will also be knit back together by high energy and food prices. A good pandemic flu, presumably, is all we need to complete the rebirth of American localities.

Hoping that austerity will force us into solving our social problems seems incongruous with what I know of Kotkin and his work, and it's a lousy mistake for anyone to make. A world of fewer jobs and higher prices will mean longer commutes, a frayed social contract, and tired grandparents. If we arrange our families and our living spaces poorly when affluence gives us choices, we are unlikely to suddenly flourish when those decisions are forced upon us. Hard times won't compel Americans into becoming their better selves, and if we are heading into some bleak days, it's best that we all understand that in advance.

It would be nice if Joel Kotkin had offered some evidence that previous spells of economic hardship had knit families into one big huggy bear collective.  Though I'm certainly no scholar of the Great Depression, as far as I know the economic hard times often devastated family life.  People put off marrying because they could not afford to support their own household, much less children.  The children they did have were often left with relatives as they were forced to move in search of work.

Moreover, the sociological evidence is quite clear that poverty is bad for families.  Poor people have higher rates of marital breakup, and much higher rates of child abuse.  Part of this is selection--people with violent tempers and impulse control problems are more likely than average to become poor.  But even people without such temperamental handicaps find it harder to sustain a good family life.  Economic hardship is, to state the obvious, very stressful.  Stressed people have less patience for difficult children or spouses depressed by their inability to find work.

Libertarianism is dead . . . vive le libertarianism!

Must one pile on Jacob Weisberg?  Why yes, one must.

Not because he is wrong that this crisis raises serious problems with market structure.  It does.  It also raises serious problems with regulatory structures.  It raises serious problems with everything we were doing.

I am not trying to sound like those dogmatic libertarians who declare, any time problems are detected in the markets, that they merely exist because we do not have "true" capitalism.  Sometimes this is true--the interstate trucking market has been indisputably improved by deregulation.  And sometimes it isn't; the market for banking services has been (to my mind) indisputably improved by the FDIC.  Markets are complicated things that rest on a mixture of law, custom, and individual action.  There is no libertarian state of nature in which human beings survived without some form of coercively enforced rules.  All libertarianism can do is maximize the scope for individual action within that framework.

To put it another way, society has multiple possible equilibria, and some of those equilibria are better than others. Removing the existing set of rules does not, of itself, guarantee or even make it particularly likely that we will arrive at a better one.

But that, of course, also holds true of government action.  Punishing the bankers, restraining them from taking certain sort of risks, or giving regulators vastly more power over them, does not in itself guarantee that we will get a better outcome.  I see many people who do not know very much about finance demanding that we reverse the much-vaunted deregulation of the 1990s.  I see very few of them proposing a coherent regulatory framework that will get us to that happy state, much less a political process that will achieve this desireable regulation rather than something else which better suits the legislators.

Nor is there any particular proposal for preventing that institution from falling prey to the same forces that grip the regulated industry.  I have said it before, but it is worth repeating:  the regulators became overconfident in the same way, and for the same reasons, that the bankers became overconfident.  Just as a long and unusually rosy period in the housing market convinced the bankers that they had gotten better at pricing credit risk, a long period without a large bank failure persuaded the regulators that they had gotten better at regulation.  They believed that their computer models, and an improved understanding of how markets and the economy worked, would allow them to see problems in time and halt them.  Obviously, they were wrong.

Now, obviously, you can tell the institution "Don't get overconfident!  Be extremely risk averse!" But for the next ten years or so, this is superfluous; the bankers themselves have learned to be extremely risk averse, a lesson that they will, at least for a while, employ in building their portfolios.  And longer than that, you cannot commit any political institution to a particular stance.  For one thing, extreme risk aversion has its own costs, and the fact that we currently wish we had been more risk averse does not mean that ultra-cautious regulatory policy is actually optimal, any more than it would be a good idea to act, permanently, on your wish that you hadn't left the house and walked into the path of that car.

Moreover, it is meaningless, in a mixed economy like ours, to attribute a massive failure like this to either "the market" or "government regulation".  The people who think that this can all be traced back to the CRA are wrong.  But so are the people who think that the only problem was too little regulation.  Just as some actions by private firms unquestionably put the economy at risk, so did some regulations.  It is indisputable that mark-to-market accounting caused potentially solvent firms to suffer ratings downgrades.  It is also not disputable that a slew of rules surrounding the credit quality of the securities that pension funds and insurance companies can invest in helped trigger the horrific cascading liquidity crises that, as much as anything, forced the government to step in and bail out the banks.  If these institutions had not been forced to keep their assets concentrated in "investment grade" securities, they would not all have had to run for the door at once as soon as there was a ratings downgrade.  Those downgrades, of course, hit the balance sheets of other institutions, some of which found themselves next in line to be trampled by the stampede.  Those regulations were good at protecting against individual firm failure.  But when there was a systemic problem, they made things worse, not better.

A doctrinaire libertarian might conclude, then, that what we need is to eliminate regulation.  And indeed, some have said just that. But the regulations are a very good idea 99% of the time when the problem is individual, not systemic.  More importantly, it's hard to think of an adequate substitute for those regulations in the face of a public that needs savings vehicles, but cannot do advanced financial accounting.  Preventing a cascade by allowing people to regularly lose their insurance coverage or pensions is not an obviously good tradeoff.  I'm hard pressed to say how it's a non-obviously good tradeoff, either.

Similarly, a doctrinaire liberal may declare, as many have, that the problem is "free markets".  But you can't pick "free markets" out of this knot any more than you can pick out "regulation".  The system went wrong as a system--it's not that there's some broken part you can swap out.  You can imagine an alternate world in which we did not have the institutional credit quality requirements, or mark-to-market accounting, in which the banks limped through a wave of mortgage defaults without systemic failures.  You can also imagine a world in which the regulators had somehow been better at regulation, and the market actors had been prevented from taking catastrophic risks.  But that's all we're doing:  imagining.  We have no proof that either state is safer than the current one. 

We can tell post-hoc stories; gold bugs favor various almost-panics in the nineteenth century, while liberals like to claim that it was the wisdom of FDR's regulation.  But much of this is post-hoc, ergo propter hoc.  What we know from behavioral and experimental economics suggests another explanation at least as plausible:  that as long as people think bubbles are very likely, you don't get bubbles.  For example, for thirty-five years, the memory of the 1929 crash was seared into the brains of the public consciousness, and the market remained relatively down to earth.  Then the generational memories faded, and you got the late-sixties bubble that led into a decade-long stagnation.

The farther I go into this crisis, the more leery I am of any neat narrative explanation of financial panics--or indeed, many other rare phenomena.  More on this later.  For now, a parting thought:  in complex systems, there can be no such thing as an individual villain.

No cause for alarm

Dr. Boli reminds us that in a crisis like this, it is crucial to restore confidence as quickly as possible.

Lost boys

I'm informed by a film critic friend that the new Angelina Jolie movie is awful.  But the story sure is creepily, tragically moving.

Social insecurity

The government of Argentina wants to nationalize its private pension funds:

The government said the takeover of the private system, created as an option to state pension funds in 1994, aimed to protect investors from losses due to the global market turmoil. But economists said the underlying motive would be to provide the government with about $5 billon in annual pension contributions that it needs to plug a gap in financing next year and avert a second debt default.

The measure would require the approval of Congress, where the governing Peronist party has a majority. Opposition leaders vowed to contest the proposal. "In the current context, the government measures aren't designed to better the retirement system, but rather to plunder the funds of the retirees and pay the bills," said opposition leader Elisa Carrió.

Meanwhile, one pension-fund head suggested that contributors inundate the government with lawsuits.

The move comes amid a sharp decline in agrarian commodity prices that Argentina has counted on to pay its debts and fuel growth. Coupled with unchecked government spending, the revenue decline has created a gap of around $10 billion to $11 billion in Argentina's debt service requirements by the end of next year, according to Buenos Aires economist Aldo Abram. Mr. Abram said the pension takeover would help the government close about half the gap, while the rest could be obtained from a state-run bank or by dipping into currency reserves. "It's clearly confiscatory," Mr. Abram said of the government proposal.

In theory, the advantage of government pensions over private ones is that tax revenues fluctuate by less than stock prices.  But tax revenues can fall by quite a lot during a recession, which is of course the worst time to raise taxes.  If the government has trouble borrowing, as Argentina's does, the national pension scheme gets into deep, deep trouble.  If Argentina can't plug its revenue hole now, what reason is there to think that they will be able to pay off pension claims?

Anything but lending

Paulson et. al. want to stuff money into the banks so that they will lend it, keeping the supply of money and credit from contracting dramatically.  Unfortunately, the banks seem rather determined not to go along:

WASHINGTON -- The federal government's $250 billion plan to bolster U.S. financial institutions is aimed at persuading healthy banks to lend again, but it's likely to foster further consolidation in the industry, with some banks already saying they intend to use the funds to help make acquisitions.

Treasury Secretary Henry Paulson has repeatedly emphasized that the government's investment is to restore confidence in the banking sector, so banks will lend again and private investors will put up capital for banks.

"Our purpose is to increase the confidence of our banks, so that they will deploy, not hoard, that capital," Mr. Paulson said on Monday.

If the banks use the government funds to pay for acquisitions, it could prove controversial. Taxpayers essentially would be footing the bill as strong banks gobble up their weaker peers. Such acquisitions probably would provide less of a boost to the economy than would new bank lending.

BB&T Corp.'s chief executive, John Allison, said his Winston-Salem, N.C., bank will "probably participate" in the government capital infusions, in part to help fund acquisitions. "We think that there are going to be some acquisition opportunities, either now or in the near future, and this is a relatively inexpensive way to raise capital" for that, Mr. Allison said in a conference call discussing the bank's third-quarter results.

Mr. Allison didn't say whether government money would prompt BB&T to open its lending spigot. He said regulators were encouraging the bank to apply to the program.

Of course, this may just be happy talk to reassure investors that things aren't really so bad.  And the banking sector does need to consolidate and shrink; that's what happens in the wake of a financial crisis.  But I can't see any particular reason why the US taxpayer should pay to send BB&T on a buying binge.

Stuffing our faces

Tom picks up on a piece of economic illiteracy from Michael Pollan:

Michael Pollan was on Fresh Air a moment ago. It's part of his world/public radio tour in support of Farmer In Chief, last week's NYT Magazine article asking the next president to adopt better agricultural policies. I heard him giving pretty much the same spiel on a Philadelphia-area NPR station over the weekend, too.

I don't want to quibble with the man's larger crusade, but he keeps making one particular point that really bugs me. Pollan is fond of pointing out that since 1960 the average American household's spending on food has dropped as a share of income, from 18 percent to 10.

I'm pretty sure this is dumb. Or half, dumb, anyway. I'm sure food has gotten cheaper in absolute terms, and that those savings have been paid for in animal suffering and environmental cost.

But it's also the case that household income tends to increase faster than the rate of inflation, while human nutritional requirements do not. Wikipedia says that real median income has increased about 30% since 1967. Unless I'm missing something, that means that if a family used to spend $1800 on food, today they spend $1300 -- not $1000, as Pollan implies. If median household income data was available for 1960, rather than 1967, you can bet that the differential would be smaller still. And if you consider the fact that household size has declined from 3 to 2.6 people since 1967, the gap shrinks even more.

I sort of approve of Michael Pollan's larger crusade.  I think in general it would be nice if we ate less processed food, and had a better idea about things like the American food chain's extraordinary reliance on corn.  I'm with him on farm subsidies.  I think things like fertilizer runoff need attention.  And obviously, I would like farm animals treated better.

On the other hand, processed food tastes good, and to note the obvious, not all of us can spend hours each day lovingly hand-preparing our food from scratch, nor afford to pay others to do same.  And the notion that cheaper food is some sort of a disaster is frankly terrifying.  Cheaper food is, literally, the foundation of modern civilization; it is why so many of us can afford to do something besides spend all day seeking sustenance.

How stimulating

Ben Bernanke is throwing his weight behind the idea of a fiscal stimulus package during the country's time of trouble. 

U.S. Federal Reserve Chairman Ben Bernanke on Monday threw his support behind a second round of fiscal stimulus by the government to limit the risk of a "protracted" slowdown in the economy.

"With the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate," Mr. Bernanke said in prepared remarks to the House Budget Committee. (Read the full text.)

Mr. Bernanke offered many caveats, however. Any stimulus should be "well-targeted," he said, and focused on ways to "help improve access to credit by consumers, homebuyers, businesses, and other borrowers."

Meanwhile, "any program should be designed, to the extent possible, to limit longer-term effects on the federal government's structural budget deficit," Mr. Bernanke said.

Democratic lawmakers are considering a stimulus package targeted at infrastructure spending, aid to states, food stamps and jobless benefits. The White House has so far been cool to the Democrats' proposals.

Certainly, if you want stimulus, it will have to be fiscal, since at this point all the money being pushed into the banks seems to be staying right there where the bankers can keep an eye on it.  No one wants to lend; they want to patch up the gaping holes in their balance sheets.

The Democrats' proposals will not do much to improve access to credit.  And infrastructure spending almost certainly won't work at all, because the time lags are too great.  Unless the government bypasses its procurement process, and also, suspends winter, infrastructure projects are not going to get done in the time frame that we'd like to see stimulus.

On the other hand, expanding jobless claims to 52 weeks seems like a no brainer--not because it's awesome stimulus, but because it would be nice if people who can't find jobs in a severe economic contraction don't have to take up a second career as bank robbers.  Likewise, expanding food stamp aid nods in the right direction, provided the money is used to expand the rolls rather than increase existing benefits, but it's a shameless giveaway to farmers and families might rather have the money to pay the electric bill.  It's also economically inefficient, sending farmers a signal to expand when we would rather have growth in other sectors of the economy--ones that don't make us fat.  Would it really be that much harder to temporarily relax the rules on qualifying for welfare, so that people who are shoved into part time work can scrape by?

And though the Democrats proposals should be justified on their own grounds, rather than as stimulus, exactly the same thing could be said for whatever tax cut plan the Republicans are pushing.   To be sure, the complaint that "people don't spend their stimulus checks, they save them" looks more like a feature than a bug in a time when the banking system seems to urgently need recapitalization.  But there must be more efficient ways of doing it than mailing $200 to everyone in the country.

The next bailout idea

Free lithium for every trader and major institutional investor.  We all need a rest.

Paul Krugman: brilliant economist != clairvoyant

Brian Beutler fights back in re: Krugman's powers of prognostication:

I'm not sure if I'm one of the liberal bloggers Megan McArdle's writing about here but I'll proceed as if I am. Distracted as I was by my out of control gloating yesterday, I never really made a point about Paul Krugman's predictive powers, but if I had, it would have been this: For literally years, Paul Krugman warned that we'd be in for some serious economic hard times when the housing bubble burst. This wasn't something he did as a game, but rather in the hope that rightly positioned people would address the problem. They didn't.

Time passed, and eventually conservative and libertarian writers--who either didn't understand what was happening, or didn't think all that highly of Krugman's liberalism, or both--began to mock him for getting his economic forecast wrong. Now, lo and behold, he wasn't wrong at all. And even if we presume that he thought a recession would come sooner than it did, the worst we can say about his economic punditry is that it took longer for him to be proven correct than he and others like him imagined it would.

This is what comes from not reading economics commentators besides Paul Krugman. Though I don't know how Brian can quote me on Krugman almost a year ago, while somehow not noticing that  I myself have been predicting that there would be economic trouble when the housing bubble popped.  Almost every commenter who is not named David Lereah both recognized that we were in a housing bubble, and expected that when the housing bubble popped, the economic results would be ugly.  My personal history with this prediction starts in 2004, when I started doing economic analyses for The Economist.  But others, such as The Economist's Pam Woodall, have been saying it even longer.

What I--and, as far as I know, Paul Krugman--did not expect was the magnitude or the direction of the problems it would cause.  We expected first, consumption contraction from a reversal of something known as the "wealth effect"--when assets appreciate, people feel richer, so they spend more; they also sometimes borrow against the current or future value of those assets.  When the asset prices fall, they contract their spending both because they feel poorer, and because they can't borrow any more money on the assets--indeed, may need to frantically start paying back the money they already borrowed.  This puts downward pressure on economic growth.

We also expected that it would hurt bank balance sheets, which would mean retrenchment and therefore a slowdown in lending to other areas.  I, and possibly Krugman--I don't really have time to comb through every column he's ever written right now--further expected that it would have deleterious effects on the government fiscal picture, especially in bubbly areas.  And, of course, we expected that the eventual decline in the construction boom would show up in GDP, since construction is a major component.

But I did not foresee how tightly coupled our financial system would prove to be.  I didn't see how far the problems would spread--I didn't even expect the magnitude of the crackdown in commercial real estate lending, much less the generalized credit freeze. Neither, AFAIK, did Paul Krugman.  And one of the areas that we were both very concerned about, the decline of the wealth effect, has proven to be relatively much less important than expected.

So the idea that Krugman has somehow won one for the team by predicting something that libertarian/conservative/free-market commentators didn't see coming is either misinformed, or lunatic.  We all saw the problems with the housing bubble; most of us thought a recession was getting pretty likely, given America's terrific overextension of its consumption, the falling housing market, rising commodity prices, and the simple fact that the longer you've gone without a recession, the more likely you are to get into one soon.

Krugman also thought we might be about to get into a recession several earlier times, when I was more skeptical; in that sense, I called it better than he did.  My care about calling a recession earlier in the year was not because I thought the economy was in fine fettle.  Rather, it was because Britain had, against all theory, dodged a recession despite a popping housing bubble even more impressive than ours.  This even though they'd gone more than a decade without one.  Having watched the British economy in my professional capacity for most of the current decade, I'd seen it declared on the verge of recession multiple times by various commenters, for what seemed like good and sound reasons; nonetheless, it never quite went there. This made me somewhat cautious about proclaiming that a recession was inevitable based on our fundamentals.

(At this point, let me point out the obvious:  a recession is, to a virtual certainty, either underway or about to hit.  But in January, we hadn't had a banking crisis yet.)

The belief that Paul Krugman is some sort of singularly talented prognosticator on matters of policy and the economy is almost entirely found among people who do not spend a lot of time reading the financial press, and also, have forgotten the many concerns he expressed that did not come to pass.  This is not to claim that Krugman makes more errors than usual, either.  He's a somewhat pessimistic columnist whose economic arguments almost always fall well within the mainstream of current debate among professionals.  That was the entire content of my crack about his having called eight of the last none recessions--for at least the last eight years, he's been dispositionally a bear.  I've made the same crack about Nouriel Roubini more than once, and I have no idea what his politics are.

Krugman is a great popularizer of economics, but his writing is not filled with unique insights that cannot be gleaned elsewhere.  He is a participant in arguments that range throughout the economics pages in more than a dozen publications, such as my old employer, the FT, the Wall Street Journal, Barrons, Bloomberg--plus economics blogs, a bunch of expensive newsletters you've probably never heard of, and the coffee machine of every economics department in the country.   I do not think it is possible to regularly read those publications and reasonably sustain the belief that Paul Krugman has been uniquely, or even especially, prescient about current conditions.  That's no slam on Krugman.  It's a slam on people who are unaware that there are really quite a lot of smart people out there writing about the economic issues of the day.

On a final note, several people who didn't read my post on Krugman's Nobel Prize seem to believe that denying Paul Krugman's ability to see the future is somehow to deny that he is a good economist.  Krugman's titanic achievements in economic work were not in the field of accurately predicting future GDP movements, which no one is (yet) very good at.  They were in developing new models to explain patterns of trade and production.  Those models would remain brilliant and useful even if every single prediction Krugman ever made about the US economy proved spectacularly wrong--just as Newtonian Physics would still be pretty cool even if Newton wasn't very good at catching baseballs.

More media me

Glenn Reynolds, Andy Roth of the Club for Growth, and I did a web video interview on the bailout and the financial crisis for Pajamas Media.

Meanwhile, I was also on OTB Radio last night.

Debate liveblogging

9:12 Having recently suffered a water pipe leak, I am second to none in my appreciation of the many contributions that plumbers make to Our American Way of Life.  Nonetheless, I am slightly concerned that we are spending so much time focusing on the effect of our national policy on Plumbing-Americans

9:13  Obama looks surprisingly hesitant.  I suppose he can afford to be--at this point, barring some shocking development, he is going to be the next occupant of the Oval Office.

Meanwhile, John McCain stands up for eliminating the corporate income tax.  I could hug him.  I still won't vote for him, but goddammit, someone had to say it.

9:18  The moderator, like every other moderator, tries to get the candidates to say what they will actually cut in order to deal with our sudden financial reversal.  Obama:  taking money away from Medicare insurers, which appears to be the entire budget problem facing These United States.  McCain:  I don't know, but I'm in favor of higher home prices, energy independance, and telling foreigners to go to hell.  Also, he will cut wasteful spending. Everyone's going to cut wasteful spending.  Then they get elected and realize that in Washingtonese, "Wasteful spending" means "money going to some voter who will get very angry if you take it away".

9:20  Barack Obama implicitly promises that if we elect a Democrat, we will have the economy of 1999.  I say we elect John McCain, who can bring back the Frug, and then we'll have the economy of 1962!

9:22  John McCain actually just claimed that he can balance the budget in four years.  Also, he invented cute puppies.

9:24  HDTV is not kind to John McCain.  In normal resolution, he looks vigorous.  On CNN HD, he looks like that guy in the science fiction movie who has had half his body replaced by bionics--which are slowly failing.

9:29  CSPAN has a pretty cool live site for the debate.  And don't forget AI favorite livebloggers Alex Massie and Culture11. 

9:30  I cannot believe that John McCain's extended whining about how mean Obama has been to him in his ads is proving so popular with CNN's uncommitted voters.

9:32  That said, Obama's defense of Lewis' over-the-top remarks is pretty weak.

9:39  Markets dropped 8% today, and John McCain wants to spend 20 minutes of the debate discussing the critical question of just how nice Obama was to Bill Ayers, and who has the meaner co-ideologists. 

9:40  The people with whom I am watching the debate have given up listening to the blather and are now focusing on the analyst ratings which CNN displays on either side of the screen.  Mostly, they are wondering whether David Gergen, who has barely updated for thirty minutes, has fallen asleep, or is simply refusing to analyze in protest of the utter banality of this discussion.

9:47  McCain tries to draw a distinction between good foreign oil from Canada, and bad foreign oil from Venezuela.  Can someone sit down with him and explain, using small words and charts, the meaning of the words "global market" and "fungible commodity"?

9:48  Not to be outdone, Barack Obama claims that he, too, thinks we can get off that nasty Venezuelan oil in 8-10 years.  All right, let's get down to brass tacks:  which one of these two candidates has more pull with the Fairy King?  Because that's where you get the really cool sustainable technology.  You never see fairies using fossil fuels, do you?  No you don't.

10:12 A friend who has a young special needs child emails:  "I like that McCain and Obama are using the VP question to talk about who will be better for families with autistic children and other special needs, but only McCain could take a great point about Palin's willingness to raise a special-needs kid and make a hash of it: he just said that Palin "understands (special needs families) better than almost every American I know." Let's be blunt here: she has NO [expletive deleted] IDEA what it is like to raise a special-needs kid -not because of any personal failing, but because her kid is only six months old and she hasn't had to deal with most of the issues that come up with raising a Down's kid yet. And yes, we have NO [censored] IDEA either, because we haven't experienced so much of what is undoubtedly in store for us over the next several years and decades. I am sure that if you check in with us then, we will look back at us now and say that we had no idea what we were doing."

10:13  Okay, I wasn't voting for him anyway, but I find McCain's focus on attacking Obama, rather than his own policy, unbelievably grating.  His strongest performance of the night has been talking about the benefits of his own health plan, drawing a reasonable distinction between his philosophy and Obama's, and coherently explaining that difference, without resorting to either whining or calumny.

10:16  I don't know why it's so hard for these two candidates to admit that each election is, in part, a war over Roe and who gets to cram the court with justices who support their position.  The kabuki ritual in which both claim there is no litmus test, while attempting to clearly indicate that they will not nominate any justice who disagrees with them, is both ridiculous and tiresome.  I believe we may have actual issues that could be discussed during this useless time.

Markets: down, down, down and the flames went higher . . .

After another disastrous day on Wall Street, the Nikkei is, as of this writing, down 10%.  The brief optimism of the earlier days this week is looking more and more like a dead cat bounce.

2-4-6-8! Time to overregulate!

Freddie has a typically thoughtful post on financial regulation:

In other words, what's good for individual banks and lenders is bad as a system, and so the markets need forceful intervention from a regulatory body. Now, Jim Manzi's true-blue capitalist cred is unimpeachable. As are those of the many i-bankers, venture capitalists, moneymen and corporate heads who have been applauding this near-nationalization of banks through direct investment to improve short-term solvency. So I don't think this is an example of just those who (like me) are inclined to be skeptical of some aspects of capitalism crowing about a turn towards socialism. I think it's a fact of most people who are invested (literally and figuratively) in the system on Wall Street recognizing that the best remedy for this problem involves ventures which might not fit with their usual ideological preferences.

Capitalism, after all, is the great adapter. I've idly wondered if a turn towards socialism might come not from a new peoples revolution, not from the ballot box, and not by government fiat, but through the capitalists becoming convinced that a socialist turn would be best for business. Of course, that's a hypothetical, largely, at this point. But it's possible. Capitalism has no ideology, it just has the profit motive, and I believe that if it became apparent that some system of government controls of wealth and industry led to greater profits, the Larry Kudlows of the world would run smiling into the arms of Trotsky.

As libertarians go, I'm relatively in favor of financial regulation.  But I think there are two ways to think about financial regulation:

1)  Wall Street people are tricky bastards who spend almost all of their time thinking of how they can best maximize their profits by screwing The Little People.  They must be rigidly controlled so that they cannot do most of the things they want to do, because almost anything they want to do is definitionally a bad idea.  It wouldn't hurt to punish them occasionally, for being such tricky, selfish bastards and taking all that money they don't really have any right to.  Most financial activity is useless paper shuffling that adds no value to society anyway, so there is no downside to clamping down on the banking system with an iron fist.

2)  There are multiple possible equilibria in financial markets, and one of the problems in those markets is that decisions which are individually highly rational can, in aggregate, move society to one of the bad equilibria.  Worse, those decisions may be sticky--it may be much harder to get out of the bad equilibria than into them.  The government should act to mitigate the systemic risks by doing the things that only it can do:  enforce transparency, solve collective action problems, and analyze the system for systemic rather than local risk.  This will necessarily involve sacrificing some potential upside in order to insure against catastrophic downsides.  But the government must remain aware of its own tendency to be excessively risk averse, because regulators are punished for visible failures, but not invisible lost benefits.  It must also worry about the way that the very regulations intended to ensure safety can create or enhance systemic risk, as has happened in this crisis with rules such as the mark-to-market rule, and various institutional requirements for high credit quality in investments.

Needless to say, I think the second approach is better.  Unfortunately, in crises like this, the general political attitude is closer to the first one.

Moreover, it seems to me that at least some of the people who are tremendously excited about the prospect of regulation are not excited because they are worried about the health of the financial system so much as they are intoxicated by the power that greater regulatory authority might give a liberal government to advance other goals, such as redirecting capital flows to more "deserving" uses, or reducing income inequality.  To the extent that you wish to reduce income inequality, there are much better ways to do it than crippling your banking system so that bankers can't get rich.  And the aggregate record of governments at directing capital flows in welfare-enhancing ways is, to put it mildly, abysmal.  Nor is there any evidence that the US government is better than average at making investment decisions--rather the reverse, in fact, since 540 legislators all want a piece of the action.

I think this is a very good time to strip down our regulatory system to its bare bones and rebuild it into something more effective:  streamlining regulatory authority, refocusing it on systemic risk and giving it the power to pursue those issues more effectively, purging the overreliance on single models that make things more convenient for the regulators, and figuring out how the hell Basel II went so deadly wrong.

But I do not think that this is anything close to what we will actually get.  We will get piecemeal patches designed to prevent the problems that just occurred without much attention to future issues (see, Enron and mark-to-market accounting).  We will probably see restrictions on various types of activity, without regard to lost upside from that activity.  There may well be some dramatic and pointless gesture, such as Glass-Steagall's drive to split off investment banking from commercial banking.  I expect some populist measures like letting judges rewrite mortgages in bankruptcy, which look swell until the cost of a mortgage goes up.  And we will very certainly increase the amount of paperwork that companies and financial institutions do, creating a larger mountain of data that our current regulatory structure will be unable to intelligently sift through.  As a side effect, it will raise the barriers to entry in both the market for public funds, and the financial industry, further consolidating power among the remaining incumbents.

This will make happy those who are definitionally in favor of more regulation.  But this approach sets up a direct tradeoff between growth and safety; in order to get more safety, we give up a lot of financial activity which ultimately reduces the supply of capital.  I don't think that's necessary. A lot of people writing today seem to think of regulatory agencies as quasi-prisons for Demon Finance, and think that the main problem with the current system is that it's mollycoddling the inmates.  Bankers are not criminals.  As a class, they are exactly as self-interested, self-destructive, and short-sighted as other classes of people that liberals want less highly regulated, such as unions and community organizers.  I don't view the purpose of regulation as punishment, or protection against a malevolent class.  I view it as an attempt to make our institutions more effectively channel self-interest into collectively welfare-enhancing activity.  Thus you can see why I might be somewhat uncomfortable with those who seem to view the crisis as an exciting opportunity to put those uppity bankers back in their place.

Art imitates life

Corporate art collections in the aftermath of failure.

Future shock

Several liberal blogs are chortling over this statement I made early in the year:

Will the economy decline in 2008?

Paul Krugman is voting for doom. It's worth keeping in mind, however, that Paul Krugman has predicted eight of the last none recessions under the Bush administration.

I think it's obvious we're in a slowdown, and a recession seems likely-ish, but Britain's skirted recession for over a decade now, so I can't be too fatalistic.

This is obviously hilarious--if you have an incredibly shaky understanding of statistics, and also, no knowledge of decision science.

If you keep predicting a recession, eventually you will be right.  Every time there was the slightest downturn in the numbers, Paul Krugman predicted a recession.  Eventually he was right.  Do we give him credit for the one he got right, or the multiple ones he got wrong?  To liberals, the answer seems obvious.  Which gives credence to the conservative belief that liberals are people who cannot do basic math. 

A more interesting question is what to do about doomsayers like Nouriel Roubini, who got the magnitude of the crisis right, but has similarly been predicting a financial holocaust for five years, with changing scenarios which mostly did not come to pass.  Obviously, he was right that the global financial system was shaky.  On the other hand, his understanding of why the global financial system was shaky does not seem to have been strong enough to predict the source of the failure--the current account deficit and the dollar have been at best minor players, at least in the way that he was worried about way back in 2004. 

There are a lot of financial pundits out there.  The law of large numbers means that one of them will turn out to have predicted almost any financial event.  How do you separate true genius from monkeys throwing darts?  That task is made much harder by the tendency of pundit partisans to look only at predictive successes, while discounting the failures.  If you eliminate all of Paul Krugman's predictions that did not come to pass from the sample set, he looks like a genius.  Unfortunately, the same is true of Larry Kudlow.

The people who, it seems to me, have been truly vindicated by this are Nassim Taleb and Benoit Mandelbrot.  They nailed what to me is the core issue:  bankers pricing security risk as if it were distributed along a normal curve with thin tails.

Night thoughts

Does any theory of rare financial crises survive contact with the enemy?  Discuss.

This is your head, blogging

Dan Drezner and I discuss the economy, regulation, and the future of the Republican Party.

College bound

Right now, Cato Unbound is having a pretty fascinating conversation about college, and whether it is overprescribed for American youth.  Bryan Caplan asks:

My key problems with Murray's essay are his arguments, not his conclusion.  I don't see that Murray has a coherent story about how the BA persists despite its inefficiency.  The signaling model does tell such a story, so Murray ought to at least take it seriously, and tell us how it relates to his thesis.

If he does embrace the signaling model, though, Murray's distributional analysis will probably turn out to be wrong.  The main losers are taxpayers who subsidize the wasteful signaling competition, and consumers who pay more for the labor that colleges divert away from the productive part of the economy.  Murray is right, of course, that talented workers without BAs suffer, too; but we should not forget that below-average people without BAs actually benefit from employers' imperfect information about their productivity.

I'm not sure this is right.  This presumes a few things, like that people who get useless BAs end up doing whatever they would have absent the BA.  But getting a BA has an opportunity cost.  For one thing, it may use up funds that could have gone for useful vocational spending.  For another, those who pursue college degrees they aren't really suited for give up several years of earnings, and more importantly, experience.  Early experience seems to matter; the minimum wage literature indicates that failure to get a job as a teenager can have a permanent negative impact on later earnings.

The use of a BA as a signal is helpful to those who are below-average academically only if we presume that there is no other, useful training they could undertake, or that there is no more efficient means of sorting workers.  If we instead imagine that three years of desultory course-flunking could instead be spent acquiring a marketable skill, or seeking out work that suits them, it seems more costly.

We should also consider that not everyone loves school.  To people who are academically inclined, three years of school that doesn't result in a degree doesn't seem so bad--a pity about the degree, of course, but at least you got a lovely long vacation.  For people who hate classwork, however, it's torture.  Encouraging people to spend years doing something they detest in order to acquire a not-very-useful signalling device seems like a fairly great social loss.

I'd hate to think of us adopting something like the German system, where kids are relentlessly tracked into their future lives by the time they're fourteen.  On the other hand, the Germans get one thing very right:  they provide an excellent career path for those whose talents lie outside of college.

No comment

Long, excellent post by AI favorite Freddie on God, conservatism, and postmodernism.  Nothing to add except that you should read the whole thing.

The New New Paulson Plan: You've got to fight, fight, fight! for that pooling equilibrium

I've been told by an experimental economist that in some market models, more (true) information actually makes the market outcomes less efficient.  This seems to be the mental model that Hank Paulson is working on:  he's essentially trying to enforce the pooling equilibrium that big financial players have been seeking for over a year.  That is, he wants to recapitalize all the big banks, because recapitalizing only the weak ones would send a message about their balance sheets that might trigger the run he is trying to prevent.
 

The government is set to buy preferred equity stakes in Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. -- including the soon-to-be acquired Merrill Lynch -- Citigroup Inc., Wells Fargo & Co., Bank of New York Mellon and State Street Corp., according to people familiar with the matter.

Some of the big banks were unhappy about the government taking equity stakes, but acquiesced under pressure from Treasury Secretary Henry Paulson in a meeting Monday. During the financial crisis, the government has steadily increased its involvement in financial markets, culminating with a move that rivals the breadth of the government's response to the Great Depression. It intertwines the banking sector with the federal government for years to come and gives taxpayers a direct stake in the future of American finance, including any possible losses.

Formulated jointly by the Treasury, the Fed and the FDIC, these moves announced Tuesday are designed to keep money flowing through the financial system, ensuring that banks continue lending to companies, consumers and each other. A freeze in these markets rippled through the economy and helped cause stocks to crater last week.

Along with the government's involvement come certain restrictions, such as caps on executive pay. For example, firms can't write new employment contracts containing golden parachutes and their ability to use certain executive salaries as a tax deduction is capped. These restrictions are relatively weak compared with what congressional Democrats had wanted when they approved this spending, a potential flash point.

Some critics also say Treasury should have formulated a comprehensive plan earlier in the crisis. Even if this move helps mend credit markets, the economy is likely to suffer in the months ahead from the aftershocks of the recent turmoil.

A central plank of these new efforts is a plan for the Treasury to take about $250 billion in equity stakes in potentially thousands of banks, using funds approved by Congress through the recently approved $700 billion bailout plan.

Treasury will buy $25 billion in preferred stock in Bank of America -- including Merrill Lynch -- as well as J.P. Morgan and Citigroup; between $20 billion and $25 billion in Wells Fargo; $10 billion in Goldman and Morgan Stanley; $3 billion in Bank of New York Mellon; and about $2 billion in State Street.

The government will purchase preferred stock, an equity investment designed to avoid hurting existing shareholders and deterring new ones. Such shares typically don't come with voting rights. They will carry a 5% annual dividend that rises to 9% after five years, according to a person familiar with the matter. By investing in several big firms at once, the government hopes to avoid placing a stigma on any one firm for getting government help.

The plan will be structured to encourage firms to bring in private capital. For instance, firms returning capital to the government by 2009 may get better terms for the government's stake, a person familiar with the discussions said.

It's a sort of interesting quandary for libertarians, and indeed most proponents of regulation, who want the government to enhance transparency.  In this case, the government is specifically fighting to keep the market from getting information about whose balance sheets are shakiest.  And I'm not sure they're wrong.

Paul Krugman wins the Nobel prize

I'm a little late to the party--my various ailments have taken longer than expected to recover from.  But though the timing may have been political, the prize is well deserved, indeed overdue, as plenty of other commenters have noted.  I would offer my congratulations if I thought that the good professor cared to get them.

One of the most interesting things that I've read in multiple commenters is that his most important insights seemed obvious.  I think perhaps the deepest economics insights do--after someone has pointed them out.  Everything from comparative advantage to the Coase Theorem makes you slap your head with the inescapable logic of it, and wonder how it can have escaped the human race for so long.  And still, it takes a genius to reveal these obvious truths to the rest of us poor slobs.  Krugman's math is far too impenetrable for this English major, but the conclusions are as clear and lovely as a bell.

More recommended reading

Somehow, I forgot a few books you should definitely check out:

The Black Swan and Fooled by Randomness by Nassim Taleb

The Misbehavior of Markets by Bernard Mandelbrot

All three deal with the same problem:  faulty probability models being used by financial wizards, who assumed that they could quantify risk along normal distributions.  The Mandelbrot is the most technical (he's the mathematician who brought you fractals), so read the Taleb first.

Here's an article about Nassim Taleb's investment strategy by Malcolm Gladwell, which is a little light but gives you a rough idea of what he's getting at.

Recommended reading

I'm rereading the Great Contraction chapter from Milton Friedman's Monetary History of the US.  It struck me that there are probably a lot of people out there who would like some books that might help them make sense of it all.  Here's my list:

• The Great Contraction by Milton Friedman and Anna Schwartz.  Just the 1929-1933 chapter of Friedman's massive work.  The book is somewhat technical, but with half an hour on investopedia looking up terms like velocity, it should be accessible to anyone decently intelligent and well informed.  Since this is the work that shaped the modern understanding of what happened in the Great Depression, it's well worth diving into.
• The Great Crash by John Kenneth Galbraith.  Basically the opposite of the Great Contraction:  often technically incorrect outdated, but very accessible, and while much of the economic theory is questionable, the history is extremely engaging and often quite funny.
• A Short History of Financial Euphoria by John Kenneth Galbraith Same caveats, and praise, as above apply.  The book is tiny-readable in one leg of a commute for an average reader.
• Once in Golconda by John Brooks an extraordinarily enjoyable account of life on Wall Street prior to, and just after, the 1929 crash.
• Liar's Poker by Michael Lewis  He didn't mean to, but he gave a pretty good primer of the explosion of the mortgage backed securities market in the 1980s.  It's also hilarious reading, and we could all use a laugh
• Manias, Panics and Crashes by Charles Kindleberger  the definitive primer.
• Extraordinary Popular Delusions and the Madness of Crowds  The first attempt to explain why people go so crazy over . . . well, nearly everything.  
• Risk and Business Cycles by Tyler Cowen.  The authorship speaks for itself.
• The Return of Depression Economics by Paul Krugman  Ten years old, but an excellent introduction to many of the current issues.
  

In exchange . . .

One of the smarter ideas I've heard for trying to prevent this sort of thing net time around is putting derivatives on exchanges.  Most derivatives are traded over the counter, in part because US bankruptcy law encourages it:  as I understand it, derivative counterparties don't have to get in line with the others, but can seize any collateral they can get their hands on.

Exchange trading enhances transparency, by making it clear what's out there and roughly who owns it.  It also moves the clearing risk to the exchange; while exchanges do fail, they do so much less often than financial firms, and if intervention is needed, they provide a centralized locus for any private or public action.

Apparently the Chicago Mercantile Exchange is looking at setting up a major derivatives exchange.  For those who are convinced that "more regulation", rather than "different regulation" is the answer, strongly encouraging trading on these exchanges would be a good place for the government to start.

Little links

Continuing fallout from the financial crisis:

• Icelanders turn from finance to fishing
• Grain piles up in ports as buyers can't get letters of credit
• Watching crime for signs of an upsurge
• Currency market goes crazy
• An interactive map of US financial troubles
• Ukraine wonders if it can afford an election
• GM now worth less than it was in 1929.
  

I'm back

Sorry for the absence, but I've been sick for almost two weeks now, and I needed a rest; even lying perfectly still in bed, I was wheezing so badly that a friend who brought me supplies started calling me "Darth".  Having recovered (just barely) enough to get on a train to New York for an afternoon panel, I am now back at the keyboard.

No liveblogging from me

I can't concentrate on the debate; I'm too busy concentrating on drawing breath.  Check out Culture11, Alex Massie, and Will Wilkinson for the finest in libertarian debate-blogging.

Finally, some helpful guidance on dealing with the crisis

For photo editors, anyway.

Sorry for the light blogging

My cold seems to have turned into bronchitis, and I'm having trouble remaining upright.  Am planning to blog tonight's presidential debate, and have a few new posts up before then.

The five is alive

Ta-Nehisi, like many liberals, likes the Obama campaign's new Keating 5 video:

Don't know what to make of this. Part of me thinks it's stronger than the Wright/Ayers stuff because it's a personal attack with substance and policy behind it. In other words, it goes hard at McCain, but it also keeps the economy in the conversation. It's not just a random insult.

I have no doubt that this will hurt McCain.  But here's the problem with it:  John McCain regrets the Keating 5.  Indeed, you could say that his entire subsequent career has been one long apology for it. Repudiating what happened has formed the cornerstone of his current career; in a very real sense, it was the father of McCain-Feingold.

Now, I don't like the lessons that McCain seems to have taken from his extremely minor connection to the events of the S&L crisis (even Democrats from the time seem to admit that he was basically just thrown to the wolves to make it look like the Democrats weren't the only ones who had screwed the pooch).  And in fact I think that the Ayers connection is too tenuous to be interesting.  But there is a nugget of a real critique at its heart, which is that the academic culture Obama belongs to thinks its just fine to be a former active terrorist who has refused to renounce support for the violence committed by his group; that culture has rewarded Bill Ayers with prestigious employment and other positions in a way that it wouldn't dream of rewarding a similarly "idealistic" abortion clinic bomber.  I know it's hard to imagine, but if you're conservative, that seems like a real problem.

The problem Obama's critics have is not that he once spent some time talking to Bill Ayers; it's that he refuses to apologize for it now.   That refusal to apologize is why the charge has proven hard to counter.  You can argue that it isn't a big deal, but you can't argue it isn't true, and unfortunately for Obama, some voters think it is a really big deal.

If I were the McCain campaign, I would be throwing a hell of a lot of resources into making my own video.  They have an actual factually accurate and coherent narrative about how McCain has spent the last 20 years atoning for the Keating 5; I would tell that story.  I would ask why Obama is choosing to bring up this 20 year old scandal without mentioning that McCain has repeatedly regretted it.  And then I would throw in Ayers and Rezko and ask when Obama's going to apologize for his lapses in judgement.

How to handle the crisis in your 401K

Don't look.  Seriously, don't look.  I have no idea what's going on with any of my equity investments, because that is not short term money that I need to keep my eye on.

If you look you will get upset, and you will be tempted to do something stupid.  I can't guarantee that the market won't drop further and you won't regret having held on.  But as a general rule, selling into a massive liquidity crisis is a pretty bad idea.  Selling in a panic because your assets just dropped 30% is almost certainly a bad idea.

The good news is that while the stock market can take a long time to recover, it historically doesn't actually go down for more than a couple of years. 

Yeah, that's not very good news.  But unless you're planning to retire right now, my advice remains the same:  don't look.

Quotes of the day

My cold having gone, like all my colds, directly to my chest, I'm slightly more worried about continuing to breathe than the continued solvency of the markets. Evolution is a harsh mistress. But still--only slightly.  Economics of Contempt does not share my primary concern, so the secondary one is really freaking him out:

Being in an office directly off the trading floor (and with a Bloomberg!) for the past 2 weeks, let me just say: things are very bad, and only getting worse. I'm honestly scared for the future of the financial system.

How did we get here? There are lots of reasons, but to me, the most important reason is that traders, CEOs, and even risk managers all seem to have forgotten one extremely important thing: In a financial crisis, the correlations always go to one.

Words to live by.  Literally.

Now to go off on a tangent:  fun uses of the word "literally".  I get a ton of blast emails from various PR people, publications, and random pundit larvae.  My personal favorite came in today, headlined:  "Barney Frank was in bed with Fannie.  Literally."

This was too marvelous to actually read the email, so I don't know if he was notifying me that Barney Frank has come out as a heterosexual, or implying that Barney Frank had required the entire staff of one of our GSEs to sleep with him in exchange for his protection.

Issue of the day: mark to market accounting

Andrew Leonard cuts loose:

So, mark-to-market accounting contributes both to credit bubbles, which no one on Wall Street ever complains about because they are too busy raking in the cash, and credit busts, at which point, Something Must Be Done.

There's just one big fat honking problem. If mark-to-market rules are suspended, what replaces them? Surely we don't trust the owners of these risky assets to decide for themselves what they're worth?

From the SEC's "Clarifications on Fair Value Accounting," released Sept. 30:

Can management's internal assumptions (e.g., expected cash flows) be used to measure fair value when relevant market evidence does not exist?

Yes. When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable.

Internal assumptions! Never mind what the market says, we'll just trust you to figure it out for yourselves, boys, because we know you would have no reason to lie about something as immaterial as the state of your own finances!

The attempt by members of both parties to suspend "fair value" accounting is outrageous. Despite Republican claims to the contrary, the United States is not facing a severe financial crisis because of accounting issues. The crisis was created by investors who made huge bets with borrowed money on risky loans and complex derivatives that they did not understand and that blew up in their face when the housing market collapsed. The crisis was created by greedy fools who blithely sold insurance against the possibility of anything bad happening to these securities, without ever dreaming that they might actually have to pay up. The crisis was created by politicians who explicitly made sure that these bond-default insurance policies -- credit default swaps -- were unregulated.

Don't blame the accountants. Listen to them: (Compiled by Calculated Risk.)

"Suspending mark-to-market accounting, in essence, suspends reality." -- Beth Brooke, global vice chair at Ernst & Young LLP, WSJ, Sept 30, 2008

"Blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick." -- analyst Dane Mott, JPMorgan Chase & Co., Bloomberg

"Suspending the mark-to-market prices is the most irresponsible thing to do. Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings." -- Diane Garnick, Invesco Ltd., Bloomberg

The just released draft of the Senate bailout bill, a 451-page monstrosity, includes a provision expressly giving the SEC authority to suspend mark-to-market accounting.

I think that Leonard is right, in that suspending mark-to-market accounting is fairly insane.  But I think he's wrong to short-shrift the very real problems with it.

For those who are perhaps not familiar with mark-to-market accounting, the basic idea is that you have to price the assets on your balance sheet at their market value, not at what you think they're worth.  This rule is a result of the Enron crisis; it was intended to keep companies from misrepresenting the assets on their balance sheet to the point of bankruptcy.

But it does create real problems in an illiquid market.  As Alan Blinder, channeled through Matthew Yglesias, explains:

The idea of mark-to-market accounting is that when you're reporting your balance sheet -- your assets and your liabilities -- you need to report the value of your alleged assets at what you could actually get for them on the market. In a normal highly liquid market, this is easy and non-problematic. But as Blinder says, in an illiquid and non-functioning market, as we currently have for our "troubled" assets, you get into trouble. Specifically, you get these huge spreads between the bid price and the ask price for the assets and no actual sales happening. Blinder's example is that if the highest bid is $20 and the lowest bid is $60, where do you value the asset? Thus, "there are legitimate problems that need some attention in how you apply mark-to-market accounting when markets aren't functioning."

The other problem is that in an illiquid market such as ours, where the risk premium on some assets has gone so irrationally high that they basically have no market value, revaluing those assets is not actually a fair estimate of what they're worth.  Beth Brooke says suspending these rules "suspends reality", but what is reality?  Is it what you could sell the asset for today, or the expected future cash flow?  In a rational market, those things are supposed to track fairly closely.  In the current market, they clearly arent'.  Which "reality" should we choose?

The first principle of accounting is to be "conservative", that is, to give executives as little room to play with the numbers as possible.  For that reason, I agree with Ms. Brooke that it's a bad idea to suspend these rules, much less abolish them.  But Leonard is dead wrong when he says "the United States is not facing a severe financial crisis because of accounting issues" and blames the problem exclusively on greed and deregulation. 

This crisis is so huge and complex that I don't think you can fairly cite anything as the main cause.  But it is certain that the way we account for securities has contributed, by turning illiquidity in various banks into insolvency.  Moreover, while deregulation played a role, so has regulation.  One of the reasons that severe markdowns are such a problem for banks is that the thin balance sheet triggers a ratings downgrade.  At that point, many large institutions are legally prohibited from investing in them; others are forbidden by charter.  The change in the government sanctioned rating kicks in government rules which ensure that bankruptcy rapidly follows a writedown.  Did I mention that financial firms are not allowed to restructure in bankruptcy?  They have to liquidate.

Here's the thing:  to say that government regulations have contributed does not mean that those government regulations are a bad idea.  Mark-to-market accounting is a good idea.  So are stringent limits on what types of securities pension funds and insurers can invest in.  Requiring companies to open their books to ratings agencies is a good idea, though I don't think the SEC-enforced monopoly of the big three was so grand.  There is probably a decent argument for the rules about broker-dealer bankruptcies, though I don't know enough about that particular area of bankruptcy law to say.

Good rules can produce bad results.  They can produce bad results simply because there is no such thing as a perfect rule, and with the abovementioned regulations, I think we're just going to have to live with their imperfections.  We are not going to find a flawless solution that will prevent any further problems in the financial markets without creating any other problems; you cannot make an omelette without breaking eggs.

There is one aspect I think we could and should address, however, and that's our basically piecemeal approach to enacting regulations.  Sarbanes-Oxley solved the last crisis, but didn't look towards any future ones it might be helping to create.  That's how financial regulation always is in this country (and probably most others); whatever problem we just had is the only problem worth solving.  Just as banks were looking only at individual securities, not the systemic risk of the way other market players were investing, regulators looked at each piece of the puzzle, rather than assessing how all the pieces fit together.  Had they done so, we might have had time to come up with some way to alleviate the regulatory issues that have exacerbated this crisis (though we might not have, either--I certainly can't think of any off the top of my head).

Instead, we're flailing.  Mark-to-market is causing problems?  Suspend it!  What about Enron?  WHY ARE YOU TALKING ABOUT ENRON?!  WE'RE HAVING A CRISIS!

Yes, we sure are.  Maybe that's because every time we have a crisis, we have that same damn conversation.

Bailout busts?

People tend to get fixated on things like major bank sales and the level of the various stock indices.  These are important, but they are symptoms, not the main show, which is in the credit markets.  Those remain frozen up.

Was I wrong to support the bailout?  Hard to say.  For one thing, it matters whether the alternative was doing nothing, or doing something better; for sure, it was not a very good design, and the bill that actually passed was worse than the one the House voted down.  For another, I was not positive that the bailout would solve things; it's just that it seemed like the best shot.  Since I can't compare the current world with some alternative in which it failed again, I need to think about what my metrics for assessing the decision should be.

Another way to understand the crash

Is by looking at another kind of crash:  exploding Space Shuttles.  This is Richard Feynman's appendix from the report on the Challenger; he was on the commission that investigated it, but refused to sign the final report unless his observations about NASA's safety culture were included.  You should really read the entire thing, but this is the nut section:

It is true that if the probability of failure was as low as 1 in 100,000 it would take an inordinate number of tests to determine it ( you would get nothing but a string of perfect flights from which no precise figure, other than that the probability is likely less than the number of such flights in the string so far). But, if the real probability is not so small, flights would show troubles, near failures, and possible actual failures with a reasonable number of trials. and standard statistical methods could give a reasonable estimate. In fact, previous NASA experience had shown, on occasion, just such difficulties, near accidents, and accidents, all giving warning that the probability of flight failure was not so very small. The inconsistency of the argument not to determine reliability through historical experience, as the range safety officer did, is that NASA also appeals to history, beginning "Historically this high degree of mission success..."

Finally, if we are to replace standard numerical probability usage with engineering judgment, why do we find such an enormous disparity between the management estimate and the judgment of the engineers? It would appear that, for whatever purpose, be it for internal or external consumption, the management of NASA exaggerates the reliability of its product, to the point of fantasy.

The history of the certification and Flight Readiness Reviews will not be repeated here. (See other part of Commission reports.) The phenomenon of accepting for flight, seals that had shown erosion and blow-by in previous flights, is very clear. The Challenger flight is
an excellent example. There are several references to flights that had gone before. The acceptance and success of these flights is taken as evidence of safety. But erosion and blow-by are not what the design expected. They are warnings that something is wrong. The equipment is not operating as expected, and therefore there is a danger that it can
operate with even wider deviations in this unexpected and not thoroughly understood way. The fact that this danger did not lead to a catastrophe before is no guarantee that it will not the next time, unless it is completely understood. When playing Russian roulette the
fact that the first shot got off safely is little comfort for the next. The origin and consequences of the erosion and blow-by were not understood. They did not occur equally on all flights and all joints; sometimes more, and sometimes less. Why not sometime, when whatever conditions determined it were right, still more leading to catastrophe?

In spite of these variations from case to case, officials behaved as if they understood it, giving apparently logical arguments to each other often depending on the "success" of previous flights. For example. in determining if flight 51-L was safe to fly in the face of
ring erosion in flight 51-C, it was noted that the erosion depth was only one-third of the radius. It had been noted in an experiment cutting the ring that cutting it as deep as one radius was necessary before the ring failed. Instead of being very concerned that
variations of poorly understood conditions might reasonably create a deeper erosion this time, it was asserted, there was "a safety factor of three." This is a strange use of the engineer's term ,"safety factor." If a bridge is built to withstand a certain load without the
beams permanently deforming, cracking, or breaking, it may be designed for the materials used to actually stand up under three times the load. This "safety factor" is to allow for uncertain excesses of load, or unknown extra loads, or weaknesses in the material that might have unexpected flaws, etc. If now the expected load comes on to the new bridge and a crack appears in a beam, this is a failure of the design. There was no safety factor at all; even though the bridge did not actually collapse because the crack went only one-third of the way through the beam. The O-rings of the Solid Rocket Boosters were not designed to erode. Erosion was a clue that something was wrong. Erosion was not something from which safety can be inferred.

There was no way, without full understanding, that one could have confidence that conditions the next time might not produce erosion three times more severe than the time before. Nevertheless, officials fooled themselves into thinking they had such understanding and confidence, in spite of the peculiar variations from case to case. A mathematical model was made to calculate erosion. This was a model based not on physical understanding but on empirical curve fitting. To be more detailed, it was supposed a stream of hot gas impinged on the O-ring material, and the heat was determined at the point of stagnation (so far, with reasonable physical, thermodynamic laws). But to determine how much rubber eroded it was assumed this depended only on this heat by a formula suggested by data on a similar material. A logarithmic plot suggested a straight line, so it was supposed that
the erosion varied as the .58 power of the heat, the .58 being determined by a nearest fit. At any rate, adjusting some other numbers, it was determined that the model agreed with the erosion (to depth of one-third the radius of the ring). There is nothing much so wrong with this as believing the answer! Uncertainties appear everywhere. How strong the gas stream might be was unpredictable, it depended on holes formed in the putty. Blow-by showed that the ring might fail even though not, or only partially eroded through. The
empirical formula was known to be uncertain, for it did not go directly through the very data points by which it was determined. There were a cloud of points some twice above, and some twice below the fitted curve, so erosions twice predicted were reasonable from that cause alone. Similar uncertainties surrounded the other constants in the formula, etc., etc. When using a mathematical model careful attention must be given to uncertainties in the model.

Distressingly, this appears to be exactly what happened with the Columbia.  Foam had come off the shuttle before, but never with disastrous results; NASA accordingly seems to have decided that it must therefore be safe to have the insulation break free.  This heuristic was probably the best we could do as East African Plains Apes.  In the modern world, however, we have better substitutes, like reason, if we'll only use them.

Of course, engineering a space shuttle, like the financial markets, is so complicated that we may never gain full understanding.  The most dangerous thing is that we are so confident in our assessments of the uncertainties.

Iceland: the canary in the gold mine?

Felix Salmon:

Iceland has indeed bailed out Glitnir. But here's the thing: Iceland's credit default swaps are now suggesting that the sovereign itself is a distressed credit.

Contracts on Iceland's debt jumped to 17.5 percent upfront and 5 percent a year to protect 10 million euros ($13.8 million) of bonds.

This is not how triple-A sovereigns behave. It's as though the analysts at Moody's were only able to see one step ahead, and not two: they could anticipate that Iceland would bail out its banks, but they couldn't anticipate that when a tiny country bails out a bank whose assets vastly exceed the country's own GDP, then the sovereign itself loses much creditworthiness. One scary datapoint: the assets of Kaupthing Bank amount to 623% of Iceland's GDP, which is possibly why its own credit default swaps are trading somewhere over 2500bp.

How bad can things get in Iceland? Here's what one local emailed Tom Braithwaite:

They are fighting powers that they are powerless to fight. It's like tackling a storm raging in the sea with a teaspoon.
The main supermarket can't get imported goods because they have no currency. The shops are half empty. One of the store managers has advised people to start hoarding. We're running out of oil. And winter came last night - about a month early.

Received opinion has it that if Iceland backstops the Icelandic banks, then the other Nordic countries, or someone, will backstop Iceland. Which might be true: we'll find out "very soon". But there's no news yet.

Lets hope this is not a model for our future.

Kindle 2!

It's leaked.  Looks pretty slick.

The war on naked shorts

I maintain my belief that shorting, naked or clothed, is not significantly at fault in the current crisis, nor is it generally a bad thing.  But this certainly doesn't help make that case:

In the wake of the SEC's crackdown, the mainstream financial press has acknowledged that widespread and deliberate naked shorting can artificially deflate stock prices, flooding the market with what amounts to counterfeit shares. But for years, The Journal and so many other news outlets ignored Byrne's warnings, with some journalists - most notably a Forbes.com columnist and former BusinessWeek reporter named Gary Weiss - painting the Overstock CEO as a raving madman.

Byrne has long argued that the press dismissed his views at least in part because Weiss - hiding behind various anonymous accounts - spent years controlling the relevant articles on Wikipedia, the "free online encyclopedia anyone can edit."

"At some level, you can control the public discourse from Wikipedia," Byrne says. "No matter what journalists say about the reliability of Wikipedia, they still use it as a resource. I have no doubt that journalists who I discussed [naked shorting] with decided not to do stories after reading Wikipedia - whose treatment [of naked short selling] was completely divorced from reality."

As recently as last week, Weiss told us he's never even edited Wikipedia. But emails shared with Byrne and The Register show that Weiss has in fact edited the encyclopedia's article on naked shorting. And they indicate he's behind an infamous Wikipedia account known as "Mantanmoreland," an account that - with the backing of the site's brain trust - ruled the articles on naked shorting, Patrick Byrne, and Overstock from January 2006 to March 2008.

This is journalistic malfeasance for which Weiss should be fired.  Weiss had a platform for making his views known; he had no right to back up his credibility by assuming the appearance of neutrality in a public forum through anonymous sock-puppets, and then using that power to block his critics from access to that forum.

Palin's "racist" comments

I would very much like to know how the hell this got published by the Associated Press:

WASHINGTON (AP) - By claiming that Democrat Barack Obama is "palling around with terrorists" and doesn't see the U.S. like other Americans, vice presidential candidate Sarah Palin targeted key goals for a faltering campaign.

And though she may have scored a political hit each time, her attack was unsubstantiated and carried a racially tinged subtext that John McCain himself may come to regret.

. . .

Palin's words avoid repulsing voters with overt racism. But is there another subtext for creating the false image of a black presidential nominee "palling around" with terrorists while assuring a predominantly white audience that he doesn't see their America?

This is . . . what's the correct word?  Right, lunatic.  Obama's connections to Bill Ayers are, to be sure, overblown by his opponents.  And I doubt they're doing the McCain campaign much good.  But connecting Barack Obama to a white radical hippie is not, as the article implies, the same thing as the Willie Horton ads.  Ayers was not a black panther, nor a member of Hamas. Palin is trying to paint Obama as an effete closet socialist, not a radical muslim.  Suggesting otherwise is far less credible than the original attack it criticizes. 

Meanwhile, across the pond . . .

Europe's ongoing disaster is starting to match ours.  This not only seriously challenge the idea that the main problem is American bank regulation--everyone is having the same problem, despite different regulatory regimes--but also puts us in much deeper jeopardy.  From the Wall Street Journal:

Germany issued a blanket guarantee of all its consumer bank deposits on Sunday, as a group of European countries adopted emergency measures to shore up the Continent's financial system against the widening international credit crisis.

In tandem with its surprise move to protect deposits, the government of Germany, Europe's largest economy, arranged a bailout for Hypo Real Estate Holding AG, a giant property lender that came close to collapsing after private lenders pulled out of an earlier €35 billion ($48.2 billion) aid plan last week.

Also Sunday, the governments of Belgium and Luxembourg arranged a deal under which French lender BNP Paribas SA will take over the Belgian and Luxembourg operations of Fortis NV for roughly €15 billion in cash and stock. The deal for the Dutch-Belgian-Luxembourg insurance-and-banking giant came after a previous rescue plan last week failed to prevent an exodus of customers, and the Netherlands nationalized the Dutch wing of the company.

In Italy, meanwhile, the board of banking giant UniCredit announced that it would launch a €3 billion emergency capital increase. Sunday's meeting was a surprise; just days earlier, UniCredit's chief executive had gone on national television to say that the bank was solid.

But executives decided to call the meeting after the bank's stock was pummeled last week, as investors fretted about the credibility of the bank's reassurances and persistent worries over its cash levels. At one point UniCredit's stock reached a 10-year low before rebounding.

The patchwork of measures all came less than 24 hours after the leaders of Europe's four largest countries pledged after a meeting in Paris to protect their financial system. "We are taking a solemn commitment to back banking and financial institutions," French President Nicolas Sarkozy said at a news conference after Saturday's summit.

In the U.S., fed officials have taken aggressive actions in recent weeks to try to alleviate the severe pressures weighing on damaged short-term funding markets. New measures from the central bank are likely in the days ahead. It is not yet clear exactly what steps the Fed will take, but it could be aimed at commercial-paper markets, which have been damaged by skittishness among money-market funds, a big investor in this asset class.

The crisis in Europe now has broadened from the implosion of U.S. mortgage-related assets to a mounting unwillingness among European banks to lend to one another and a growing loss of confidence among investors and in some cases depositors. Adding to the predicament, governments from Ireland to Germany are trying to reassure their increasingly anxious voters. Denmark and Austria were also preparing extra protection for consumer deposits in the wake of the German move.

Other European banks could face similar funding strains to those of Fortis and Hypo, requiring public or private financial aid, as investors avoid making the kind of short-term loans that banks depend on for funding. In a sign that banks' borrowing costs are rising, the euro London interbank offered rate, or Libor, a measure of the rates at which banks lend to one another, hit 5.33% Friday, compared with 4.95% on Sept. 1.

The European Central Bank still seems highly focused on inflation, in a worrying echo of the 1930s Federal Reserve.  It's going to be a very . . . er . . . interesting week.

How did it all happen?

As I write this, the dow is down 430 points, below 10,000 for the first time in four years.  Tyler Cowen has published his list of what went wrong, with which I largely concur.  Another way to think about it is as a series of cognitive errors that afflicted everyone:  investors, home buyers, lenders, regulators.  They're standard cognitive errors that so far, no one has a very good way of eradicating:

• Recency effect:  People tend to overweight recent events in considering the probability of future events.  In 2001, I would have rated the risk of another big terrorist attack on the US in the next two years as pretty high.  Now I rate it as much lower.  Yet the probability of a major terrorist attack is not really very dependent on whether there has been a recent successful one; it's much more dependent on things like the availability of suicidal terrorists, and their ability to formulate a clever plan.  My current assessment is not necessarily any more accurate than my 2001 assessment, but I nonetheless worry much less about terrorism than I did then.
• Bandwagon effect:  People tend to believe that something is a better idea if a lot of other people are doing it.  In essence, they are trying to free ride on other people's analysis, on the assumption that someone must have thought this thing out.  This has its uses--we don't all need to learn every hard lesson for itself.  But in markets it produces herding behavior, which makes outcomes more extreme on both the upside and the downside.  In other words, we get booms and busts.  In the professional world, this is exacerbated by the fact that you're less likely to get fired if you fail at the same time everyone else does.
• Availability heuristic:  People tend to overweight data that comes easily to mind, which is to say vivid (extreme) and recent examples.
• Beneffectance:  People tend to view success as a result of their own actions, while they view failures as having been due to factors largely outside of their control.
  
• Confirmation bias:  The tendency to look for data that confirms your theory, rather than data that falsifies it.  Yes, we all know how this works in politics, but it's a much broader problem.  People will repeatedly devise tests that give positive proofs of their theories, but much less often devise tests to falsify them.
• Hyperbolic discounting:  People value small short-term payoffs more than much higher long-term payoffs.
• Optimistic bias:  People tend to be overconfident about their own abilities and the outcome of their plans.  Something like 90% of people think that they are above average drivers less likely to get into an accident than the average joe.  This is so pervasive that there is actually a scientific name for the few people who accurately assess their own future, their abilities, and what other people think of them:  clinically depressed.
• Overconfidence bias:  Relatedly, people are too confident in the accuracy of their predictions.  When asked to estimate a range of possibilities where the true outcome is 95% likely to fall within that range, people's guesses are wrong 40% of the time.

As I see it, these affected everyone who was involved in the markets.

Homebuyers looked at 50 years of basically steadily rising home prices, with few and small declines, and concluded that rising home prices were some kind of natural law. In fact, the run-up in home prices was the idiosyncratic result of a lot of factors:  the move to long-term self-amortizing mortgages; the home mortgage interest tax deduction, which became steadily more valuable as income tax rates rose; the steady decline in nominal interest rates, which lowered monthly house payments for any given home price; severe regulatory contraction of supply in a few areas.

As capital flooded into the US debt markets in the wake of the Asian financial crisis--and I think that Asian savers and central banks bear much more of the responsibility for the credit bubble than can be plausibly pinned on either Alan Greenspan or Ben Bernanke--real interest rates also fell, which made housing an even better deal.  The recency effect kicked in:  as the bubble grew, it began to seem more, not less, likely that home prices would continue to rise.  The bandwagon effect also reared its ugly head.  Everyone else was buying a house on potentially catastrophic terms, so it must be safe! 

Any self-introspection on the safety of the housing market was also plagued by bias.  Examples of falling house prices were not available to memory; spectacular coups reaped by coworkers on a two bedroom fixer-upper were.  And in testing their theory of future house prices, people looked for reasons that housing prices might rise--the many amenities of homeownership wherever they happened to live--rather than thinking of reasons that it might fall.  Besides, the memory of the stock market crash was extremely recent and vivid.  People began to see a home less as a place to live than an investment, a safe alternative to the risky securities market.

Once they had decided that it was likely to rise, they were overconfident in this assessment, which made them rather careless about the terms under which they signed mortgages.

Lenders went through much the same pattern.  The revolution in credit scoring that took place in the 1990s actually did make lenders better at predicting default risk.  As we moved into the current decade, however, the steady rise of home prices started to skew the numbers.  Borrowers who historically might have defaulted simply sold their house into a rising market, recouping at least the value of their mortgage.  Or they refinanced, getting much better terms because the loan now represented a smaller proportion of the overall value of the house, meaning that lenders were more likely to get all their money back.

As default rates fell, lenders went through the same process borrowers had.  They too, overweighted recent events.  They, too, looked at other people lending and concluded that it was probably safe.  As I think I've mentioned before, several years ago, I had a conversation with an investment banker who did a lot of debt deals.  As a general thought, he stated that we'd gotten much better at managing credit risk in the last ten years.

"Have we actually gotten better?"  I asked.  "Or do we just think we've gotten better."

"Oh no, we've really gotten better," he assured me.  Oops.

Lenders built their risk models around pre-payment risk--the risk that buyers would refinance their mortgages, making your investment suddenly much less profitable.  That had historically been the main risk of mortgage lending.  As defaults stayed low, year after year, they revised down their expectations of default, viewing the current situation as a "new normal" rather than an unusually rosy time that might eventually regress to the mean.  They tended to be overconfident about the probability that they were right and the boom would continue, making little provision for an eventual rise in defaults, much less what Nassim Taleb calls a "black swan" event, the kind of broad crisis that we see today.  And they attributed the profits thus made to their own brilliance, rather than luck.

Lenders did have another set of pressures working on them.  For any individual lender, it was better to all fail together than to underperform separately, and not merely because a massive failure might bring on a bailout.  Any individual loan officer or risk manager would be much less likely to be blamed for incompetence if everyone else in the industry was having the same problem.  Moreover, the drive for the year-end bonus led people to hyperbolic discounting--to get it while the getting was good, and worry about the future later.  And, of course, if they did underperform, they would soon have no money to lend, because the investors would take it elsewhere.

So, too, the lenders confirmation bias and availability heuristics led them to construct stories about why the new situation was normal, and would not regress to the mean.  Credit scoring had gotten better, house prices had never suffered a broad and sustained decline since the Great Depression, and of course, our old favorite "Real estate is the only thing they're not making any more of". 

Investors--the people who bought the mortgage backed securities--participated in much the same madness.  Just as lenders had seen declining default rates as evidence that they could safely make riskier loans, investors looked at the recent performance of mortgage-backed securities as something of a natural law.  Hedge funds and investment houses ran more of their tests against historical data than against a broad range of individually unlikely scenarios.  Most importantly, they drastically underweighted systemic risk.  That is, they looked hard at the likelihood that an individual security would underperform.  But they didn't look at what might happen if house prices suddenly dropped ten percent, or credit markets violently contracted.  They chased high returns while underweighting risk, which put pressure on lenders to do the same--if they didn't, the investors wouldn't give them any money to lend.

Just like the lenders, investors saw their excellent performance in a boom market as evidence of their investing acumen, their ability to pick good securities or good sectors, rather than evidence that they had gotten lucky in a time of easy money.  And because many investors, like hedge funds, pension plans, and mutual funds, have their own investors chasing returns, they were subject to the same pressures to take on more more risk that the lenders were under.  In particular, they started taking on a lot more leverage, borrowing money in order to lend it.  This is the practice that brought down Long Term Capital Management.

Perhaps the most important point is that regulators, the bonny chaps who are supposed to save us from all this madness, displayed the same pattern.  So did the politicians behind them.  Over the past few weeks, much has been made of the various regulatory actions that enabled this mess.  Though some are wrong, two are not:  the Democrats protected OFHEO's shockingly loose regulation of Fannie and Freddie against the White House's attempt to toughen it; and the Republican-appointed SEC loosened the capital requirements for the five largest banks.

But why did they do this?  Democrats seem to believe that the Republicans and the SEC simply did this out of wanton greed and a blind faith in markets; Republicans seem to believe that OFHEO, the Democrats, and Fannie/Freddie did this because of political corruption and a blind belief in homeownership for poor people.  But neither side was simply accepting the risk that the whole thing might come crashing down leaving the economy in tatters and the taxpayers on the hook.  The regulators, too, were misled by recent history.  In recent history, lending had been safer, and risk models did seem to be performing better.  Both groups genuinely believed that improvements in both computer models, and in economic theory of regulation, would allow them to identify and halt any crisis before it occurred.  And just like everyone else, when no disaster occurred, they became ever more confident in their own genius.

What we need, fundamentally, is not simply stricter regulation or less greedy bankers.  What we need is better economic theory of how these things play out, so that the regulators have better tools to assess and prevent systemic risk.  But that's not how we're thinking right now.  What we're looking for is not better tools, but someone to blame.

Because, after all, we know that it wasn't us who was at fault.  We're just the victim of broad market forces outside our control.

The Senator from the GSEs?

There's an email going around claiming that Barack Obama has three former Fannie execs as key advisors; a reader just emailed me to ask if it was true.  No.  John McCain is going to have to bear his humiliating connections to lobbyists alone.

Lies, damned lies, and debaters

Paul Caron has a roundup of tax untruths from last night.

This season's must have

From the irreplaceable Dr. Boli.  Makes a great gift, too.

Media bias?

Soledad O'Brien polls the 32 "persuadables" by asking them to indicate, by a show of hands, who they thought won.  She calls the vote for Biden "overwhelming".  The magic of Tivo allows us to freeze frame and count:  11 or 12 for Palin, 12 or 13 for Biden (some people are hard to see).  Thanks, Soledad, for giving credence to everyone who thinks women are bad at Math.

Three . . . two . . . one . . . . liveblog

I'm at home in front of my television with a spectacular cold and a tall, frosty glass of diet coke.  Over the past six hours, I've been plagued with the recurrent suspicion that this is all some cosmic rope-a-dope, and Sarah Palin is going to kick some serious ass.  I think that's just the fever talking.

Meanwhile, the event is also being liveblogged by Alex Massie and the crew over at Culture11.  Let the games begin . . .

10:30  After running ahead for most of the debate, the Sarah Palin has now fallen narrowly behidn on most of the analyst scoring.  Suspect last impressions are most important.  I sure can't remember what we were talking about an hour ago.

10:28  Gwen Ifill asks if there's a time when they've been forced to change their mind about a policy issue.  Suspect she ran out of time and started copying questions out of Human Resources for Dummies.

10:26  After this election, I am going to have to hit myself in the head with a small hammer to get the monotonous thrum of the word "maverick" out of my head.

10:24  Joe Biden too, offers for the "Rambling Grandpa" style of response.  Still waiting for him to say that he's too much of a perfectionist, or has trouble delegating.

10:21  Not content with the earlier blather, Gwen Ifill actually asks them what their greatest weakness is.  Sarah Palin rambles about how great America is.  Has she forgotten the question?  Because I'm having trouble remembering what we're supposed to be talking about.  The persuadables, however, love it.  On topic responses are for weaklings!

10:17  Gwen Ifill says "The constitution might give the Vice President more power than that office has had in the past".  Is this some sort of Zen Koan whose intricate mysteries will be unveiled only after years of reflection?

10:14  Sarah Palin name checks, like, every teacher in the United States, including Biden's wife, in talking about the future of American education.  The crowd goes wild.

10:12  Joe Biden says, in re economic problems, "All you have to do is walk into Home Depot with me, where I spend a lot of time . . . "  Me Big Man!  Me Like Big Power tools!  Did I mention I have some REALLY big tools?   

I thought that was Joe Biden I saw regrouting the Capital Hill masonry last week . . .

10:11  I take it back--Palin boldly says they disagree about ANWR, and uses it to press the idea that she pushes McCain on the issue and he's never asked her to check her opinions at the door.  Then she launches into laudatory blather, similar to Biden's.  Both sets of blather poll really, really well.

10:09  Gwen Ifill asks how a Biden administration would be different from an Obama administration.  This is an interesting question, but it's pointless, like asking interviewees to name their biggest flaw.  All they're going to do is reiterate how awesome their candidate is.

10:00 Joe Biden:  "John McCain voted against the Nuclear Test Ban Treaty that every Republican supported".  I can't quite put my finger on it, but I think the math is off somewhere . . .

9:59  Is she mispronouncing Kim Jong Il's name, or am I?

9:57  Palin loves Israel too!  Big hugs for Israel!  I'm waiting for one of them to break into Havah Negillah.

9:55  Biden claims that this administration's Israel policy has been an abject failure.  Unlike, you know, all those earlier presidents who found simple and effective resolutions to the conflict.

9:50  Once again, Iran bashing is much more popular than Iraq.  Time to throw out that tatty old war you've been wearing for years and get something new, stylish, now.

9:45  The incestuous nature of this race is causing problems for everyone.  Joe Biden has to deal with the fact that he and Obama are from opposite wings of their party, and hence have fired a bunch of pot shots at each other--I'm reminded of the line about Lloyd Bentsen (Mondale's Dukakis' VP [oops, was watching the old Ferraro-Bush debates this morning and appear to have Mondale on the mind], for the young or forgetful), that he was only in the Democratic party to keep the Republicans from being embarassed by his ties to big business.  Meanwhile, Sarah Palin has to bash Obama on votes that McCain supported.  It's like watching an election for president of my grandmother's DAR chapter.

9:42  Iraq is clearly a losing issue for McCain; merely saying that he wants to win tanks the ratings.  The winning issue appears to be gay marriage and hating on bankers.  It is, however, one of the few issues where she does better with men.

9:41  Joe Biden's political differences with Obama start to hurt, as she uses his words against Obama's votes on the matter.

9:40  How come Sarah Palin gets more highly rated for being against gay marriage than Joe Biden does?  Neither of them said anything that was either controversial, or particularly different from the other.

9:38  Joe Biden just claimed that the right of same sex partners to visit their partners in a hospital is in the constitution.  I'm all for gay marriage and all, but I'm pretty sure that the Founding Fathers didn't put that in there, or even intend to.

9:34  Palin scores big points on anthropogenic global warming by saying that it's less important to argue about the cause than to talk about a solution.  Biden is still spewing statistics trying to recover what should have been a slam dunk topic for him.  Not sure why, as they're both offering the same ridiculous lies promises about weaning America off foreign oil.

9:33  In general, Palin is the much more volatile candidate.  There have been a few times when her ratings have plummeted, but she has also achieved much higher highs.

9:32  Oh, she's back up, with a reference to energy independence.  This is, of course, completely stupid; short of autarky, there's no way to keep the effects of foreign oil from hitting America's economy, because our trading partners will continue to use a lot of it.  But it is popular.

9:30  Palin keeps relentlessly dragging the topic back to energy.  It played well the first few times, but now the "persuadables"  seem to think she's trying to bs the final exam.

9:28  Every time Palin mentions John McCain her otherwise pretty positive ratings plummet.  The interesting thing is, however, that this seems to be the only point at which the men like her more than the women.

9:26  The women voters being polled are, overall, generally more positive about both candidates.  But the difference is much more noticeable when Sarah Palin is speaking.  Who's being sexist--the men or the women?

9:24  Sarah Palin comes back with her own snotty remarks about Barack Obama voting for the 2005 energy bill.  Snotty is not polling well this evening.

9:22  Gwen Ifill asks, as Lehrer did of the presidential candidates, what plans the candidates are prepared to give up on in order to finance the current problem fixes.  Joe Biden's answer:  we might have to slow down on doubling foreign aid.  Are the American people really prepared for this kind of fiscal sacrifice, Senator?  Oh, also, cutting wasteful spending!  We're saved!

9:18  Joe Biden is moving into full throated contempt mode.  The look on his face when Sarah Palin talked about being a member of the middle class all her life was one of the most condescending things I've ever seen, and he starts off his rebuttal with a fairly snotty-sounding "I don't even know where to start".  I suspect this was a bad mistake.

9:13  Don't forget to play Sarah Palin bingo!  I believe there are also Biden Bingo cards, but no need, really; just give yourself a point every time he complains about financial deregulation without mentioning that he has been one of its most consistent proponents, not to mention the abysmal giveaway to the credit card companies that was the 2005 Bankruptcy Reform.  Everyone's a winner!

9:11  Sarah Palin's popularity goes off the charts when she complains that predatory lenders persuaded people to borrow money to buy $300,000 houses when they could only afford $100,000.  Apparently, Sarah Palin voters are too stupid to figure how much house they can afford.

9:08  Sarah Palin winks at the camera.  I didn't believe it the first time I saw it; thank god for TiVo.  I think all three million viewers are supposed to come up to her hotel room with a bottle of champagne after the debate.

9:06 Sarah Palin is visibly nervous, but actually doing very well on her first question.  CNN once again has its "persuadable" voter EKG, which lets them express how they feel about the debate at any given time, and then averages then into a running graph of the voter mood.  They like her a lot . . . right up until the point where she mentions John McCain.  This strikes me as a slight problem for the campaign.

9:05 Joe Biden launches immediately into complaining that the current mess is all the fault of the Bush administration.  Number one, this is not true.  Number two, is there any more exquisite irony than watching Senator Joe Biden (D-MBNA) complain about financial deregulation?

9:03 Sarah Palin starts off strong by marching out in a really fetching black suit and perkily asking Joe Biden if she can call him Joe.  Score one for Miss Moose Shooting America 2008.

It's all about the benjamins

"Hard money" types tend to denigrate the dollar as little green pieces of paper, not a real thing that's actually worth something.  This seems to me like a version of the Marxist fallacy, the belief that value can be somehow intrinsic rather than relative.  Gold is pretty, of course, but not actually much more "useful" than a dollar bill.  It does have some industrial application, but the vast majority of the gold in the world is used for money or jewelry.

A dollar is a real thing:  a store of value and a medium of exchange.  These are extraordinary valuable uses.  Indeed, the need is so great that if currency is restricted or unavailable, people do not simply revert to barter; they turn something into a currency.

John Kenneth Galbraith amusingly recounts what happened in the American sector of occupied Germany, where the money supply was deliberately kept very tight by the economic planners.  People immediately turned to cigarettes, which were valuable to the Americans for smoking, but to the Germans both for smoking and for substitute currency.  The result was that the Germans scrounged even tiny cigarette butts, which were the equivalent of spare change.  Hence, when some Army sanitation engineer posted a sign in the men's room saying "Please do not throw your cigarette ends in the urinals", some wag scrawled underneath it, "it makes them soggy and hard to smoke."

Cigarettes, are, of course, also the traditional currency of prison.  However, in 2004, the Federal prison system banned smoking--as an aside, I ask if anyone knows whether this was officious health-nannying, or equally offensive gratuitous cruelty, or some combination of both (my guess).  At any rate, something had to emerge as a substitute.  I give you:  the mackeral economy.

There's been a mackerel economy in federal prisons since about 2004, former inmates and some prison consultants say. That's when federal prisons prohibited smoking and, by default, the cigarette pack, which was the earlier gold standard.

Prisoners need a proxy for the dollar because they're not allowed to possess cash. Money they get from prison jobs (which pay a maximum of 40 cents an hour, according to the Federal Bureau of Prisons) or family members goes into commissary accounts that let them buy things such as food and toiletries. After the smokes disappeared, inmates turned to other items on the commissary menu to use as currency...in much of the federal prison system mackerel has become the currency of choice.

What's fascinating is that it has apparently become the standard currency precisely because it has no intrinsic use, and therefore functions very well as a store of value:

...Mr. Muntz says he sold more than $1 million of mackerel for federal prison commissaries last year. It accounted for about half his commissary sales, he says, outstripping the canned tuna, crab, chicken and oysters he offers.

Unlike those more expensive delicacies, former prisoners say, the mack is a good stand-in for the greenback because each can (or pouch) costs about $1 and few -- other than weight-lifters craving protein -- want to eat it.

The only weirder currency I can think of offhand is the Yap, who used as currency stones so large that they couldn't really be moved; only ownership was transferred.  Indeed, when one was dropped into the sea while transporting it between islands, the Yap continued to recognize it as valid currency, and the family that owned it was viewed as having significant wealth on the basis of this thoroughly inaccessible stone.

(Hat tip Alex Tabarrok)

This is your head, blogging

Yves Smith and I did a Bloggingheads yesterday on the financial crisis, which is now up.  It's pretty good, mostly because she does all the talking.