Wednesday, February 11, 2009


I meant to comment on Obama's news conference Monday night. Drudge linked to a very good article that touches on some of the misgivings I had, but also, the reason I still feel more comfortable with Obama in charge then McCain.
...On being presented the Nobel Prize in economics in 1974, Friedrich von Hayek devoted his Stockholm lecture to acknowledging the severe limitations of his profession. “It seems to me,” he said, “that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences—an attempt which in our field may lead to outright error.”

Tangentially, a few years ago, I attending a financial risk management conference where, I think it was Emanuel Derman made a similar point about the financial models that have since proven inadequate.
Government simply cannot know enough to direct an economy successfully, and when the President claims that his fiscal stimulus plan will create (or save) at least three million jobs, he is taking a wild, and dangerous, leap.

One of the things that has reduced my confidence in the President is the manner in which he has held up this "create (or save) at least three million jobs" formulation. He has to know that there is no real way to measure that, which leads to the conclusion that it has more to do with politics then economics.
Said Hayek:
If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants.

I think there is an essential, common sense, wisdom in Von Hayek's argument that the Government ought be more a gardener and less a sculptor. Strauss, I think, makes somewhat of a similar argument in On Tyranny.

Government-as-gardening is obviously more difficult then government-as-sculpting in that it requires greater understanding and patience, which is to say: wisdom.
What is that environment? ...Third, it recognizes that Americans have undergone a financial calamity and that we need time to adjust; we cannot, like a car battery, be shocked back to life, and we aren’t in the mood to have someone blow in our ear.

I don't really agree with the author's prescription, which is why I snipped out First and Second, but there is some truth to Third. Obama, Monday night, described the vicious cycle which he argued can only, or best, be broken by Government. <metaphor-alert>But there is a timing game. If government shoots its wad and fails, there is no second chance. The author may well be correct at least to the extent that the public now might not be as responsive to a stimulus package as required, and it may make sense to save bullets in the gun.</metaphor-alert>
In fact, stimulus may be precisely the wrong metaphor. Rather than getting jazzed up, we need to be calmed down and to take the time to learn from the Great Depression, a time when government did too much, not too little. Amity Shlaes makes the argument in The Forgotten Man, her book about the Great Depression, that the constant experimenting and meddling of the New Deal froze investors and business operators in fear: “Businesses decided to wait Roosevelt out, hold on to their cash, and invest in future years.”

One doesn't have to dig too deeply to see plenty of instances of that dynamic -- private sector activity frozen awaiting Government decisions/intervention -- at play in out current crisis.

I think, perhaps, the most promising thing in the Presidential transition, was Obama's stated desire to avoid insular groupthink. For that reason, the most disappointing part of his initial press conference was when he derided those who question the efficacy of the New Deal.
Despite the warnings of Keynes, the experience of the past half-century indicates that today’s low interest rates will start having a positive effect, though it still will take many months. Meanwhile, left alone, what Hayek called “spontaneous order” will find its way forward. Using a different metaphor, James Grant, in his history of credit, Money of the Mind, wrote, “The cycle of decay and renewal is as much a part of capitalism as it is of the forest floor.” But, in the 1930’s, “something in the normal regenerative process was missing. There was no decisive recovery from the business-cycle bottom. People had lost their speculative courage, and the more government legislated and taxed, the more that credit sulked.”

This is, I think, the key point here. It seems that the Bush and Obama economic teams have identified problems -- eg: "credit is not flowing" -- and pursued government-as-sculptor policies intended to directly fix the problem. The presidents description need for government action to break the vicious cycle is a perfect illustration of that approach. More often then not the scope of the problem and the consequences of the policy surpass the policymakers grasp and so the policy proves ineffective.

The wiser course of action, again, would be governing-as-gardening. In this case, the focus would not be on directly fixing direct problems, but on identifying and targeting the reasons why the natural regenerative processes are missing.

To give one concrete example, previously discussed on this blog:

In a functioning cycle, creditors work with borrowers to renegotiate terms such that creditors get a more certain cash flow and borrowers get to keep their homes. That is not happening as much as it should in this cycle, largely because mortgages are pooled and tranched, renegotiation is contra the interests of the lower tranches. Pool managers may themselves own lower tranches or face lawsuit from lower-tranche-owners if they renegotiate. As this failure to renegotiate results in far more uncertain cash flows, the securities derived from those pools are far harder to accurately price. The pricing difficulty is, of course, at the heart of why these securities are "toxic" and, therefore, why credit is crunched.

A government-as-gardener might, then, pursue policies that unblock loan-modification that would lead to greater cash flow certainty. It could create conflict of interest laws and protect managers who renegotiate from the threat of lawsuit. If need be, it could adjust tax laws to ensure the pool managers incentives are properly aligned. And so forth. With more certain cash-flows, the derived securities would have a more certain price and the process of sorting out winners and losers and starting a-new could begin in earnest.

Instead, the sculptor-policy-makers have pursued erratic ham-handed policy using borrowed money to subsidize market players whose main effect has been to create a line out the door and round the corner of private sector actors who now demand to be subsidized before they do what they would do anyways and raise market expectations of serious inflation, interest rate and tax hikes in the not too distant future. What attention has been paid towards encouraging renegotiation results in sculpting-policy-proposals involving government actively engaged in the actual renegotiation rather then gardening-policies along the lines outlined above.

There is no doubt in my mind that a President McCain would be pursuing government-as-sculptor policies as, if not more, aggressively then President Obama. President Obama prides himself on being thoughtful and non-ideological and so there is at least a chance that he will, better belatedly then never, come to understand the wiser course.

On the other hand, I am not quite sure that President is as non-ideological as he presents himself and there is a serious ideological point in play. It is a matter of liberal faith that FDR "saved capitalism from itself," which, can be understood as believing that markets, without the intervention of Government, do not naturally self-correct. From his press conference, it seems likely Obama adheres unquestioningly to this faith. And that it will be quite the stepping out of the bubble for him to consider the possibility of alternatives.

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