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Reminder: the Smart Guys were wrong on the ‘stimulus.’

By: Moe Lane (Diary)  |  December 19th, 2011 at 01:30 PM  | 

RESIZE: AAA

This Robert Samuelson piece on the inherent problem with Keynesian economic theory – which, in my opinion, can be summed up neatly as “First, assume that your planned economy will be managed forever by an immortal, unelected, and incorruptible Keynesian economist” – is pretty good, but it has one passage in it that makes my teeth ache. Here it is, in all of its questionable glory:

For the record, I supported Obama’s stimulus – though disliking some details – and, under similar circumstances, would again. The economy was in a tailspin; the stimulus provided a psychological and spending boost. But how much is less clear. As Romer notes, estimating the effect is “incredibly hard.” For example, the Congressional Budget Office’s estimate of added jobs from the stimulus ranged from 700,000 to 3.3 million for 2010.

We’re going to unpack this, sentence by sentence. Because it has to be unpacked.

  • “For the record, I supported Obama’s stimulus – though disliking some details – and, under similar circumstances, would again.” For the record, I did not. In fact, I was adamantly against calling it a ‘stimulus’ in the first place; it was in fact a demented (and nakedly partisan) Democratic wish list of pork projects and private shibboleths, and I saw no reason why I should pretend otherwise. I still don’t, in fact.
  • “The economy was in a tailspin; the stimulus provided a psychological and spending boost.” First: either ‘was’ or ‘tailspin’ can be contested; September ’08 was the really scary point in the economy and we’ve been pretty much grinding metal since January 2009. Also: ‘spending’ boost I’ll grant, but ‘psychological’ was not borne out by events.
  • “But how much is less clear.” Considering that I am contesting that there was a psychological boost in the first place, you may safely assume that this sentence is effectively a null statement from my point of view.
  • “As Romer notes, estimating the effect is “incredibly hard.”" Actually, no: it’s fairly easy. Time for that graph from Christina Romer that Christina Romer absolutely hates: below is what they promised us, so compare it to actual results and you get a fairly decent rough guide to how well the ‘stimulus’ worked. Spoiler alert: it didn’t.

  • “For example, the Congressional Budget Office’s estimate of added jobs from the stimulus ranged from 700,000 to 3.3 million for 2010.” I assume that Samuelson is referring to this November 2011 report. Rather than reinvent the wheel I’ll note Reason.com’s response to that: “[L]o and behold, if you create a model that predicts the law will create jobs, and then you rerun a mild variation of that model a few years later using updated figures about what money was actually spent, it still reports that the stimulus created jobs.” And considering that what we were promised by now was supposed to be 6% unemployment without the ‘stimulus’ and about 5.5% with it, it’s eminently fair to question the original model.

And now here’s the central problem. Back in 2009, a lot of self-identified Smart People – mostly on the Left, but the Right had its share – argued that a ‘stimulus’ was a good idea. And there were a lot of people – widely derided by those same Smart People as being stupid ignoramuses, partisan Republicans, hidebound conservatives, and just about everything else – who insisted that a ‘stimulus’ was a bad idea. And guess what? The Smart People were wrong. And the reason why goes back to my basic critique of Keynesian economic theory in the first paragraph: Keynesian economic theory is not sustainable over the long term in a truly pluralistic and democratic society. That’s because a politician given money without oversight will spend that money pretty much the same way that a drunk would, and for pretty much the same reasons.

Seriously, it was a trivial exercise in prognostication to predict that the public moneys given to the then-Democratic Congress would not end up being exclusively funneled to so-called ‘shovel-ready’ job programs. Or that our real problem – which is our long-overdue-for-pruning regulatory system – would not be affected at all by said stimulus. Or that supposed “Keynesian” politicians would blithely ignore Keynes’ own argument that governments need to be frugal when there isn’t a recession. That’s because none of these points are unique obstacles for the system to overcome. They are part of the system itself. All of which the aforementioned critics of the ‘stimulus’ did take into account, and the Smart Guys did not.

And it would be nice if the latter acknowledged it every so often.

Moe Lane (crosspost)

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COMMENTS

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  • Death_of_the_Donkey

    that the data that Romer et al had at the time they designed the stimulus, thus leading to garbage in, garbage out. The Q4 2008 GDP had just been released and showed an initial -3.8% annual pace (this is what Romer et al had at the time), since then, GDP for Q4 2008 has been revised to -8.9% (nearly 2.5x as bad)(http://www.bea.gov/newsreleases/national/gdp/2009/gdp408a.htm).

    Also, the unemployment rate at the time of the stimulus being passed was already higher than where the peak Romer et al estimated would be with the stimulus.

    Which leads us to the difficulties in attempting to forge economic policy in response to the currently available data. Had we known that GDP was declining at a -8.9% in Q4 2008, the stimulus plan would have been crafted at a much larger size, which would have lead to more debate and ultimately the potential that it would not have passed at all.

    Finally, as I have said before, I believe that Keynesian theory can work, but only under the conditions that Keynes assumed (since it was what he knew), ie that during normal times government would run balanced budgets/pay off incurred debts and that deficits would only be run to stimulate the economy in situations where consumer demand falls off a cliff (ie not a run of the mill recession like we had in 2001). Since we don’t have those underlying conditions, any exercise in stimulus spending is not exactly Keynesian and would likely have diminishing returns.

  • johnt

    If federal dollars, herein being dollars controlled by the Wizards of da guvmint, are spent, there is a curative effectiveness and power to alter and improve the economy as well the lives of the innumerable little people, living in darkness and filth, cursed by their status of not being civil servants and not receiving NY Times subscriptions.
    As above, no one can explain this magic, how a dollar spent by da guvmint has a power that all the other dollars spent, saved and invested don’t have. But that’s why it’s magic. Leave it in the hands of the Wizards, they have the secret formulas.
    Things could be worse, we could have cavemen running about believing in God and the Constitution, or what’s left of it.

  • Glaucon

    The big government advocates say after the fact “whoops, we were wrong, how could we have known”? Might I suggest that all of us screaming at the top of our lungs that TARP and the Stimulus were wrong were a big hint? Time for some house cleaning in the Congress…

  • romeg

    Many of these same people are convinced that Global Climate Change is anthropogenic (aka AGW). They want to shut down the free-enterprise system and tax everything in sight that produces CO2 all on the basis if computer models that are more complex by several orders of magnitude than the one used for these computations. And they argue that the science is “settled”.

    The leading contender for the Republican nomination believes the AGW meme but is “unsure” about the degree. Given his proclivity to want to attract swing voters either at the expense of conservative voters or on the assumption that conservatives will just take whatever we can get in order to be rid of Obama.

    Am I the only one beginning to feel more than a little nervous about the future prospects of our fair nation and its economy?

  • medamorphus

    The original stimulus graph compared to the “actual results” link shows something quite extraordinary. Not only were they “wrong” about the effect of the stimulus, they were 180 degrees wrong. Based on their very own calculations the stimulus produced worse results than if we had done NOTHING at all. Again, this is using their own projections to show the complete and absolute failure of the stimulus and Keynesian economic theory. $787 billion dollars to produce results worse than if we had done nothing….that should be one gigantic nail in the coffin of Keynesian economic theory once and for all.

  • jeffperren

    Economists (most of them dishonest) can argue forever about the economic effects of Federal ‘stimulus’ spending.

    That whole argument fails to address the main point: Keynesianism is immoral. It’s simply unjust for the Feds to take money from private citizens and spend it for the benefit of ‘the public’ or ‘the system’ – even if (in some magical land) it actually succeeds.

    The Federal government has no moral warrant for ‘managing the economy’ no matter the economic effects, good or ill (usually the latter).

    It’s not accident that Progressives – who believe that confiscation can be morally justified by utilitarian arguments – are the biggest proponents of this theory.

  • buddyp

    Moe,

    You write:
    ?As Romer notes, estimating the effect is ?incredibly hard.?” Actually, no: it?s fairly easy. Time for that graph from Christina Romer that Christina Romer absolutely hates: below is what they promised us, so compare it to actual results and you get a fairly decent rough guide to how well the ?stimulus? worked. Spoiler alert: it didn?t.

    That is faulty analysis, Moe. The question here is the extent to which the economy performed better by some metric — such as unemployment — than it would have performed otherwise (i.e., without the “stimulus”). Granted, that is measuring vs. a counterfactual, and given how complex calculations of that counterfactual could be, the size of this differential is difficult to estimate. But that shouldn’t be confused with what you are doing, which is assuming that the counterfactual scenario — in particular, what unemployment would have been without the “stimulus — equals the Obama Administration projected for that scenario. As I assume you know, economic projections are extraordinarily difficult, particularly in unusual or extreme times. It is not sensible to assume that their projection equals what would have been the reality.

    And given that economists of all stripes generally agree that unemployment was lower due to the stimulus than it would have been without it, the implication of your faulty analysis — which would be that the stimulus increased unemployment — is apparently invalid.

    There are reasonable reasons to think the “stimulus” was bad policy, but your argument that it had no positive short-term impact is not one of them. It is invalid, based entirely on an invalid assumption.

    The concern we should have about the “stimulus” is about long-term cost vs. short-term gain. As with deficit-financed stimulus generally, even conservative economists assume multipliers greater than zero in the short term (i.e., some degree of positive impact on GDP, and presumably on employment), with the exception of situations in which the incremental government borrowing puts enough upward pressure on private sector interest rates to “crowd out” private investment to such an extent as to fully offset the short-term boost to aggregate demand, a situation that, as Samuelson notes, doesn’t exist these days but could at some point in the future when bond markets change their sentiment about our debt.

  • floridaveteran

    The argument it would have been much worse if we didn’t do anything is an unmeasurable argument. Since it is unmeasurable it is a nullity.

    Look at the result that the Obama regime has published: “…700,000 to 3.3 million for 2010. Now assume the same growth for both stimulus years you get 1.4 to 6.6 million jobs. The stimulus was about 900 Billion dollars so the cost was 650K to 136 PER JOB. That sounds like a failed policy to me.

  • YnotNOW

    because we not only cannot measure what the actual short term “gain” is compared to a hypothetical future baseline, but also we cannot measure the TIME of short-vs-long term. In that, in anticipation of the costs to the economy of taxing or borrowing, businesses prepare NOW for their impact. And the borrowing starts immediately, even if the taxes are delayed for a few years.

    So we end up comparing academic models on economic predictions, which give you exactly the output that you program in. A worthless experiment.

    I’ll go with Moe’s comparison of projected vs. actual unemployment, which at least compares what the politicians (and their economic “experts”) promised us, compared to what they actually gave us. All other numbers are mythical.

  • buddyp

    Re: The argument it would have been much worse if we didn?t do anything is an unmeasurable argument. Since it is unmeasurable it is a nullity.

    First , you missed my point entirely, which is that Moe was implicitly assuming a specific counterfactual unemployment rate trend: the one projected by the Obama Administration. Do you understand what I’m saying?

    Second, it’s silly to say that we (or more precisely, experts in a given field, including economics, for all its significant limitations) cannot ever have any idea if some policy or action probably had some effect directionally different from the counterfactual. If that were the case, we’d never be able to learn any lesson about anything. But it’s obviously not the case. We make such educated guesses all the time, and often experts — including economists — have very reasonable bases for such assumptions. That’s why we have supply and demand curves and other theoretical constructs and estimates of effects via empirical analysis. But, given that you made that comment, I’m guessing you’re not getting any of this despite this reply of mine.

  • skorrent1

    The “smart people” didn’t know what the h___ they were doing! And, according to the Austrians, it is impossible for a few “smart people” ever to know as much about the true state and workings of the economy as the “free market” knows with its billions of private transactions.

  • buddyp

    First, re: your first paragraph, as I already stated, even the most conservative of the prominent economists assume the short-term multiplier is greater than zero, so there is incremental GDP growth from such stimulus (except in the extraordinary circumstances I mentioned re: “crowding out”). And you seem to be asserting a sort of twist on what economists call Ricardian Equivalence, but economists generally reject the notion of FULL Ricardian Equivalence, which is generally applied to tax cuts anyway rather than government spending, and the multiplier greater than zero states implicitly that the private sector does NOT shrink in direct (or greater) proportion to the incremental government spending.

    As I noted on a previous thread, Even the person who is probably the most prominent and aggressive critic of Keynesianism, Robert Barro, apparently does not argue that the multiplier from deficit-financed stimulus is zero. Rather his argument is that those who contend that it is greater than 1.0 are unjustifiably optimistic, and that it is difficult to sort out the data clearly, but that his own research shows multipliers generally greater than zero and below 1.0 at least in the short term, meaning that the amount that the incremental government spending adds to GDP is partly offset by a loss in the private sector?s contribution to GDP, but that the two net out to an increase in GDP in the short term. See his discussion of multiplier levels at http://online.wsj.com/article/SB10001424052748704471504574440723298786310.html . And note that he concludes, with emphasis mine:

    The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending.

    Second, re:
    …what the politicians (and their economic ?experts?) promised us, compared to what they actually gave us. All other numbers are mythical.

    Well, first of all, why are their projections then any less “mythical” than any estimates of effect now?? If anything, they were even more “mythical” by nature, since they were projections. So it’s wrong for Moe to assume those projections as the counterfactual of what would have happened without the stimulus. And that was my point.

    Moreover, it’s embarrassing for me as a fiscal conservative to see some conservatives making such silly statements as “they promised us” unemployment would be at X level. No, they didn’t promise that. That’s a silly word to use. They made projections, and the main intent of the projections was to claim a particualar size differential (in unemployment or whatever) between the scenario with “stimulus” vs. without. Everyone with a clue knows that the absolute levels of such economic projections, particularly in volatile and unusual times, are notoriously imprecise, to say the least. So, while they arguably can be faulted for being bad at economic projections in general, and perhaps they can be faulted for overestimating the differential (the effect of “stimulus”), it is just silly to fault them for “promising” we’d be at some level of some economic metric over a given time period, and it’s even sillier to assume that their projections represent the counterfactual.

    Bottom line is that we just don’t know what unemployment would have been without the stimulus, but there is strong consensus among economists that it would have been higher. How much higher is very difficult to know, and different economists have different views of the short-term multiplier effect (e.g., Barro at the low end).

    But we should approach this rationally, and consider drawbacks that are likely to actually exist. It is just silly to assert that we can see no effect (or negative effect) of the stimulus on unemployment on the basis of those projections vs. the reality.

    The legitimate concern is the long-term cost of the additional debt burden and future taxation. That’s the reasonable argument against stimulus.

  • http://www.neoavatara.com/blog neoavatara

    Like Moe, I didn’t believe the stimulus would work from the start.

    The problem is, the liberal argument is self-perpetuation fallacy. Basically they argue things would have been worse…which is fine and dandy, but unprovable. What we do know is that it had far less positive effect that ANY liberal economst predicted.

    And just for the sake of pointing out I like others were right:

    http://neoavatara.com/blog/?p=1173

  • buddyp

    Moe,

    I wrote in my initial comment:
    But that shouldn?t be confused with what you are doing, which is assuming that the counterfactual scenario ? in particular, what unemployment would have been without the ?stimulus ? equals the Obama Administration projected for that scenario. As I assume you know, economic projections are extraordinarily difficult, particularly in unusual or extreme times. It is not sensible to assume that their projection equals what would have been the reality.

    The above assumes you were making the point that unemployment is even higher than it would have been without the stimulus, basing your argument on the “non-stimulus” scenario projections by the Obama Administration, pointing out that unemployment is even higher.

    Alternatively, if you are simply pointing to the “stimulus” scenario and saying unemployment is higher than they projected it would be with stimulus, again, economic projections are notoriously imprecise, particularly in unusual times as we were (and are still) in, and the point of those projections was primarily to claim a differential.

    Economists differ in their opinions of whether or not they over-estimated the differential, and I’ve always had the same feeling expressed in the quote from Reason that you included re: the same models being used to estimate effects (vs. a counterfactual) as were used to project effects.

    But there is strong consensus among economists that such stimulus in the economic environment of the time causes higher GDP and lower unemployment in the short term, meaning as high as unemployment has been over the last couple of years, it would have been even higher if we had not had the stimulus.

  • buddyp

    You write:
    The stimulus was about 900 Billion dollars so the cost was 650K to 136 PER JOB. That sounds like a failed policy to me.

    That point has nothing to do with my point re: the error in Moe’s analysis. I was not arguing that the stimulus was good policy.

    I can’t confirm or refute your numbers because I don’t have the data and I won’t research it at the moment. By the way, I usually include URLs or links to my sources for data or expert opinion. You got those numbers from somewhere. It might be helpful if you provide a link or URL.

  • Menlo

    To the tune of well over one hundred million, it stimulated a whole bunch of TSA workers who get to watch x-rated x-rays. It was also an economic boon to the RapeScam Company who made them and the members of Congress to whom they contributed.

  • Death_of_the_Donkey

    Their lack of government intervention would have lead to the entire economy shutting down in 2008 as the private sector stopped working (fear and a lack of trust can shut down capitalism). What we need is anew “theory” that understAnds the need for intervention in certain dire circumstances, but that will leave the economy alone most of the time.

    Sadly though we could have likely avoided much of this had we not over-deregulated in the late 90s with Fsma and Cfma.

  • Flagstaff

    Following free market principles, we would never have been in the situation we were in in 2008. The private sector would have never “stopped working.”

    What we need is anew ?theory? that understAnds the need for intervention in certain dire circumstances, but that will leave the economy alone most of the time.

    If the economy is left alone “most of the time,” the dire circumstances won’t come about in the first place. As long as there is no centralized control of major parts of the economy, it works on its own to prevent or mitigate the “dire circumstances.” Only when central controls are applied, either by the government or by monopolistic practices, do major industry sectors fail to answer consumer demand efficiently.

    Obama told us that his stimulus should “timely, targeted, and temporary.” Of the three, the only one they followed through on was “targeted.” Stimulus money was not put into the economy quickly, nor have the outlays been temporary.

    Fiscal stimulus is like a laxative–OK to get a difficult temporary situation cleared, but if it’s applied too frequently or for too long a time it loses its effectiveness.

  • Flagstaff

    Although they were forced on us within a short time span, they were not synonymous. TARP was supposed to address a specific, allegedly catastrophic problem–the potential and imminent collapse of the banking industry, worldwide. Perhaps it accomplished that goal, because the banking industry didn’t collapse. We are told that most of the money we spent on TARP has been repaid to us. Its successor programs (Dodd-Frank) are still with us, still doing mischief, but it MIGHT be true that TARP was a necessary emergency measure to correct a disaster-in-waiting brought on by mis-directed government legislation. (We don’t actually know, because the underlying data are voluminous, arcane, and highly technical.) But a big feature of TARP was that it borrowed money for a short-term goal, and when that goal was achieved, most of the money (we’re told) came back. In effect, it was “timely, targeted, and temporary.”

    The Stimulus, OTOH, was a much broader proposition. Its target was much bigger, the entire US economy, and it was conducted by people without much knowledge or care about where they started, where it might lead, or how to determine if it really did any good. They said one thing and did another (as did the TARP administrators, as well) and because there is no way to measure if it’s working or not, they now want to continue it and add more. We were told that Stimulus should also be “timely, targeted, and temporary.” Yet it’s anything but.

    Stimulus is merely a mechanism to take money out of one part of the economy (debt to be repaid by taxpayers) and distribute it into certain other areas of the economy (green industries, labor unions, senior citizens, and states that have supported those sectors and the Democrat party). It’s merely “targeted.” As such, it simply CAN’T work as advertised, if for no other reason than that it is so huge, that it creates such a huge debt burden, that it suppresses and depresses the economy rather than stimulating it. The fact that a lot of it is being funneled into non-productive areas, some even being sent overseas, adds to the misery.

    It can’t create jobs, because it doesn’t add to the wealth of the country. At best, all it can do is create jobs in a favored sector at the expense of jobs somewhere else, and the way it’s been applied, it’s destroying more jobs than it’s producing.

  • Flagstaff

    Reminders are both good and necessary.

  • buddyp

    More from Robert Barro (February, 2010) on why Obama’s stimulus is a bad deal in the long run.
    http://online.wsj.com/article/SB10001424052748704751304575079260144504040.html

    Note, though, that even he, a conservative critic of ARRA (also one of the most prominent economists in the world), estimates multipliers in the first couple of years of greater than zero, and also states explicitly what that implies:

    I estimate a spending multiplier of around 0.4 within the same year and about 0.6 over two years. Thus, if the government spends an extra $300 billion in each of 2009 and 2010, GDP would be higher than otherwise by $120 billion in 2009 and $180 billion in 2010. These results apply for given taxes and, therefore, when spending is deficit-financed, as in 2009 and 2010.

    But Barro goes on to make his case about the eventual cost later:

    But these calculations are not nearly the end of the story, because the added $600 billion of government spending leads to a correspondingly larger public debt. These added obligations must be paid for sometime by raising taxes (unless future government spending declines below its 2008 level, an unlikely scenario).

    And Barro then proceeds to present estimates of the impact when that incremental taxation occurs, and (in crude terms) the net effect over the whole time horizon. And he finds that in the long run we end up with a net loss of GDP as a result of ARRA-type stimulus.

    That’s the type of argument against ARRA that makes sense.

    So let’s keep that argument in mind, and let’s dispense with the silly talking point that ARRA didn’t have any positive effect on employment or the economy (let alone worsened it) based on the silly argument that unemployment is higher than the Obama Administration predicted for the stimulus scenario and even the “no stimulus” scenario, as if either represents the actual counterfactual of a “no stimulus” scenario. Neither does. So, since I think it’s important that we make arguments that make sense and are well-informed (rather than just “working” politically due to public ignorance and insufficient analytical skills), I encourage everyone to stick to the reasonable argument and drop the silly, invalid one.

  • jimmyneutron

    as I watch so many people in our country (and around the world really) take all of this (stimulus, TARP, etc) at face value.

    They all start with the assumption that we really did spend XXXX gazillion dollars on bailing out this business or investing in the ‘economy’ or whatever.

    When I take my car to the local mechanic or I hire a local builder, plumber, etc I do not inherantly trust them. Whenever we do anything where I work we leave a well documented paper trail and we sign our work to indicate that we did it so that there is a record. Why is this so in these instances and so many others? Well, as conservatives we understand why and are not afraid to say – people are corrupt – at their most basic level! We hold those we hire locally accountable because experience (either our own or that of people we know) has taught us that if we don’t most people will lie, cheat and steal. They might not really mean to do so and they might otherwise be fine, upstanding wonderful people, but when push comes to shove andthe right amount of money is available, they will grab all they can while justifying it somehow to their conscience.

    Which brings me to the Stimulus (or really to any government program in which large sums of money are being shuffled hither and yon). How can any sane person belive that all or even most of that money went to stimulating anything other than the pockets of lots and lots of people who are in the know when it comes to working the system and robbing the DC piggy bank? How many times have we heard of friends of DC insiders (congressmen, senators, staffers, helpers,…) , relatives, friends of relatives, friends of friends, etc who setup ‘corporations’, ‘non-profilts’, ‘LLCs’, etc to get chunks of cash from this or that government program? I have heard it so often I no longer even get sick – much. A portion of the funds then get funneled back to Rep X or Sen Y as campaign funds or perhaps a sweetheart land deal or whatever.

    Thus, rather than arguing with progressives over things that simply can not be quantified and which neglect certain facts or make assumptions that are entirely at odds with experience and reality, we should be forcing the progresive statists to have the argument on our terms. And our terms, as conservatives, are based upon precident, experience and reality. We know, with certainty, that no one can ‘plan’ an economy (a jobs multiplier using a trillion borrowed dollars? Really?) . We know that people are corrupt and that this is the reason we prefer government to be local. Most people can barely find time to pay attention to what is going on in their city and have no idea, except for a very hazy outline, as to what goes on in DC. A

    re the people we send to DC really that noble, honest and good that we are willing to suspend disbelieve when we don’t even trust the person around the corner because we know that they will cheat us blind if they can? What helps keeps the local person honest is the knowledge that I will verify that things were done correctly – there is no such ability to verify what they do in DC.

  • Kyle-MI

    Good points on TARP vs. stimulus. I am very concerned about the TARP criticism. I agree that it has been mismanaged by Obama, but I am still of the opinion that it was initially needed. I am concerned because, if we should ever get into that type of situation again, there will be huge resistance to could lead to a banking and general economic collapse. Don’t think it can’t happen again. The Dems still haven’t learned anything about economics and are still eager to try to control it. The same thing can be said about a large chunk of the GOP.

  • Death_of_the_Donkey

    We had a financial sector that was virtually free of government interference in the 2000s (from 1999 on really) and it nearly took the global economy down. By repealing Glass-Steagall and passing the CFMA (both very deregulatory) along with the removal of leverage restrictions (again deregulation), we set up a situation where the big I-banks could essentially collapse the system (and they did in less than 10 years) if one big bet soured (housing).

  • Flagstaff

    The financial sector was far from “virtually free of government interference.” The government had its heavy hand in the housing finance industry up to its elbow.

    According to information generally available, lenders were being coerced into loaning money to people in a favored group–people who would eventually be unlikely to repay the loans. At the same time, the lenders were not allowed to charge interest rates that would compensate appropriately for that risk, while they were told that it didn’t matter because Fannie and Freddie who would mitigate that risk. Lenders made money on each loan they closed, then they sold off the risk to the public and other financial institutions, always with the included assurance that the US government would protect investors.

    Collateralized debt obligations became priced as if the underlying properties were worth more than the loans outstanding (they were not always so, as we were at the end of a decades long housing bubble being inflated by other government policies), and as if there really was enough government-held wealth to further back up any loans that defaulted. Since none of that was true to the extent necessary, when it started to unravel there was a danger of collapse, not because of lack of regulation but because too much centralized planning had created an unmanageable monster in the first place.

    Central interference in the marketplace tends to follow a predictable path. In the most benign cases, initial interference is intended to correct a real or perceived specific problem. The effect is either good or negligible. Regulators are encouraged to continue their work, and the impersonal bureaucratic equivalent of the Peter Principle takes effect–eventually, they go one regulation too far, something goes terribly wrong, and there is a worldwide banking crisis that can be averted only if the US government “borrows” a trillion dollars from the public and diverts it to its favored participants in the afflicted segment of the economy.

    And that is exactly what happened in the financial industry, the energy industry, the medical industry, the forestry industry, and even in the “government industry.” Government is now growing out of control because it started small, did some good work, and decided it could do better if it were bigger. Only that’s seldom true, and we’re suffering for it.

    Bernie Madoff hurt hundreds, maybe thousands of people grievously. He was aided and abetted by the government, specifically the SEC, which created an atmosphere where unsophisticated investors thought that the authorities were protecting their money, when the truth was closer to the authorities protecting Bernie Madoff. Still, it was at most thousands of people, not millions. OTOH, the government, by its actions in flouting its own laws, taking over GM, attempting to control health care activities, printing fiat currency, and misleading us in general, is in the position of being able to harm millions of us, some as badly as Madoff hurt his victims.

    So please don’t continue the mantra that we need more regulation because what we had wasn’t enough, and certainly don’t try to tell us that more regulation would have saved us. What happened was created outside the mundane regulations of the legal system; it was created in the halls of Congress.

  • Death_of_the_Donkey

    “According to information generally available, lenders were being coerced into loaning money to people in a favored group?people who would eventually be unlikely to repay the loans.”

    That is completely false (I assume you are referring to CRA here). Sadly, this has been proven false (with facts and data on actual loans made) and the Fed even did a study on this way back in 2008 (http://www.federalreserve.gov/newsevents/speech/kroszner20081203a.htm). The problem wasn’t CRA covered banks or communities, but unregulated mortgage brokers who sold their loans to Wall Street firms looking for yields better than they could get on a Treasury and with a ‘AAA’ rating.

    Second, the problem with (completely unregulated) CDS and other “insurance instruments” is that after CFMA, they were completely unregulated and had no reserve requirements so that say an AIG could sell $1 billion worth of insurance on a $100 million asset and hold 0 against those policies. And the free market (knowing exactly what was going on) had no problem taking advantage of this so long as money was getting made in droves.

    What we need aren’t the nit-picky type of regulations that we typically get, but the broad system oriented ones (like Glass-Steagall, general regulation of insurance products, leverage maximums, etc) that are in place to prevent a few bad actors from taking down the entire economy on a bad bet.

  • Flagstaff

    but your comment implies that all the big institutions made the same bad bet, purchasing so many CDO’s that when the house of cards started to fall, they were going to fall with it, and they couldn’t have done that had they not been so unregulated.

    If AIG overextended itself, that should have been a consideration for its creditors and its customers, and the rating agencies. I find the whole thing highly suspicious in the first place; that is, I’m not fully convinced that the end of the world awaited if the financial bailout wasn’t provided, but it was at least possible.

    Your final paragraph gives me a better idea of what you are getting at than what I had read before. Thanks.

  • Flagstaff

    I just read through the wikipedia entry on the CRA. All the left-wing experts agree with you it seems, regarding the CRA. Even they don’t claim that the CRA was entirely blameless.

    So I guess we’re supposed to believe that all those multi-billion dollar financial enterprises were taken in by the many little mortgage originators who made bad loans. Tell that to OWS, please, so they can go home.

    Or the story is that a strong “encouragement” by the government towards primary banks that they make loans they otherwise would not make or would make only at higher interest rates didn’t contribute to the problem. Not logical, Captain.

  • Death_of_the_Donkey

    that I linked to. They used actual mortgage data and showed no correlation at all. The bubble was from low interest rates, garbage ‘AAA’ ratings (that those big investment firms knew they could get), and a rapid decline in lending standards (especially at mortgage brokers). The CRA simply wasn’t a factor.

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