Too Cute By Half

An op-ed piece in the times makes a variant on the cutesy argument that conservatives are the real empathetic judicial activists.

The author makes a few arguments, none particularly cogent. A sample:

...when it comes to the race cases before the Supreme Court, too many conservatives abandon both originalism and judicial restraint.

The Voting Rights Act decision was a case in point. Eight justices avoided weighing in on the constitutionality of the law... But Justice Clarence Thomas went further, declaring the provision unconstitutional. Congress, he argued, was justified in the 1960s in responding to the denial of the voting rights guaranteed by the 15th Amendment, but things have changed and the provision is no longer needed... is that really for him to say? Congress is the proper body to make that judgment. none of the justices... discussed any historical evidence about what the ratifiers of the 15th Amendment intended. It is hard to believe that, back in 1870, they wished to empower courts to determine which voting rights laws were necessary. The occasion for the amendment was, after all, the end of a civil war brought about in significant part by judicial overreaching in the Dred Scott case.

The actual facts are these: Under the constitution, State governments have fundamental rights protected from intrusion by the Federal government. A majority of justices likely believe, for good "originalist" reasons, that section 5 of the VRA would have been an unconstitutional intrusion of the Federal Government in state affairs prior to the adoption of the 15th Amendment. The plain text of the 15th Amendment gives Congress the power to protect voting rights, but not to otherwise arbitrarily intrude into sensitive areas of state and local policymaking. Historically, the Supreme Court, not Congress, has the responsibility of Judicial Review, which, in this case, involves determining whether this legislation is a constitutional protection of voting rights or an unconstitutional intrusion on State autonomy. The suggestion that somehow because of Dred Scott the 15th Amendment is governed by an original intent to assign Judicial Review to Congress is, to my mind, rather fanciful.

In stretching to make a less tenable point, the Author actually missed a more accurate, if limited, one. The politics of this case are such that a court finding Section 5 of the VRA unconstitutional would be almost as political valuable for Democrats as Roe v Wade has been for Republicans. It is easy to believe that the Conservative Justices in the majority, had the politics in mind, as they, best I can tell, found a creative way to gut the law -- by discovering an expanded “bailout” provision -- without, technically, overturning it.

In the end, however, there is all the difference in the world between Justices, perhaps like Roberts, who may, on occasion, creatively, or expansively, interpret in an effort to avoid making political waves, and those who do so -- as conservatives fear (perhaps unjustly) of Sotomayor -- without similar concern.

Of Fictions

In a nytimes op-ed piece, Tony Judt says that settlements are bad.

His (jumbled) argument amounts to something along the lines of: He spent some time on a kibbutz. Israelis self-identify as a settler-nation. Some settlements are large demographically and geographically. All settlements, authorized by the Israeli government or not, are illegal under international law which "prohibits the annexation of land consequent to the use of force." Settlers amount to ~10% of Israeli Jews. American aid subsidizes the price of Israeli settlements, which are much cheaper than homes in Israel. No Israeli government will dismantle settlements under any peace deal. Netanyahu, and Israel, is playing Obama "for a fool" and America "for a patsy". From this he concludes that it is not enough to stop Settlement expansion and that Obama should "remind Israelis that all their settlements are hostage to American goodwill" and that they "have nothing to do with Israel’s defense, much less its founding ideals of agrarian self-sufficiency and Jewish autonomy." If he does not, "the United States would be humiliated in the eyes" of the world.

In claiming that American aid subsidizes settlement activity, he is correct to the degree that different Israeli governments have subsidized settlement activity to varying degrees. However, without any subsidy, homes in settlements would naturally be much cheaper then homes in Israel proper both because of the cramped-ness of Israeli cities and because of the risks inherent to settlement living.

He creates a false dichotomy out of settlement dismantling. It is not an all or nothing question. While no Israeli government will likely agree to dismantle all settlements, Israeli government have twice now -- in Sinai and Gaza -- dismantled settlements, and twice now -- in 2000 and 2007 -- agreed, in the context of a final status offer, to dismantled some West Bank settlements.

His core premise is that all settlements are illegal as annexations of land consequent to the use of force. Putting aside arguments along the lines of wondering why Israel's borders need be amongst the few in the world not such, there is still room to question. If the prohibition is, as Judt, describes it "annexation", then Israel is in the clear so long as it does not annex settlements without an agreement. If the original "use of force" is some sort of original sin that can not be cleansed via agreement, then it is not simply the post-67 settlements at stake. After all, the '67 borders were themselves established through force in 47-49. Which would argue that only the UN partition plan borders are "permitted". In the end, of course, even the UN partition plan was not peace-ably accepted: without the "use of force" there is no Israel.

I find it easy to agree with the longstanding American position that settlement activity is an obstacle to peace. Peace requires space between Israelis and Palestinians, settlement activity creates an unhelpful proximity. I also have no quibble with the argument that American tax payer dollars ought not be going to subsidize settlement activity. But I see no reason, as some do, to take for granted that the '67 borders are this bright unassailable green line, behind which Israel is safe and secure. It is not clear to me that this International Law which we are told states explicitly that no Jew may live in Hebron does not apply equally to Jerusalem or Tel-Aviv.

In other words -- and this should go without saying -- that it is not at all unreasonable, if it is is debatable, to believe that settlements have a great deal to do with Israel’s defense and Jewish autonomy. And, so, Judt's inflammatory rheteric (eg: patsy, fool, humiliated) wildly off-base. It continues to amaze me that otherwise sensible people -- on all sides of the issue -- start to froth at the mouth when discussing Israel.

Of Scalping

The ethicist@nytimes (here and here) argues that concert tickets ought not be resell-able:

Markets function best when supply can adjust to demand... Given her popularity, her shows will necessarily be in short supply. The question of how to allocate that supply is thus inescapable... I’m not persuaded that virtue requires the most popular singers to perform for only the people with the most money...

Scalper markets exist because performers consistently set their ticket prices below market value. This is generally explained as because setting ticket prices at the, often obscene, market value would generate bad press, in particular the claim that the performer cares little for average fans. I think that explanation is questionable. Specifically: It argues for ensuring that some tickets are priced afford-ably, but not for pricing the best tickets at a discount.

I more suspect that tickets are priced to sell out accounting for the depth of the market. A performer wants sell more tickets because an empty arena diminishes the show. If there are, for example, 5,000 tickets to sell in a section, the price should be around what the 5,000th person (ranked by amount willing to pay) is reliably willing to fork over. It is similar, to some degree, in this regard, to Stock IPOs. As with stock IPOs, selling into (secondary) markets will be profitable because the person who did not partake in the initial allocation willing to pay the highest price for a ticket, will likely be willing to offer a substantive premium on top of that "5000th" price.

The smaller the percentage of tickets resold out of total tickets is, the more likely that this explains pricing. Further, if this is the dynamic, face prices should go down if the resale option is taken away.

In any case, it is clear that none of the Ethicist, Miley Cyrus and, the Champion Contra-Ticketmaster, Bruce Springsteen have ever been faced with buying tickets they could only marginally afford. Otherwise, they would understand how secondary markets actually serve to make tickets more affordable to average fans in two ways. First, the option to sell the tickets if for some reason they are unable to attend is more valuable to average fans, for whom the face price is meaningful. Second, many fans are able to afford the face price on their own tickets only by profiting on the sale of extra tickets.

One final note in regards to Springsteen. The secondary market for his tickets is unusually pricey. This is, in part, due to the affluence of his fans, but also because Springsteen fans, far more, I suspect, than other fans, are likely to attend multiple shows in a given tour, dramatically increasing demand). Springsteen encourages this by giving fans something new/different each and every show. In other words, if Springsteen was truly concerned about secondary market prices, he would adopt a clear policy of playing identical shows night to night.

Babies with Candy

Krugman argued that ending the current "unconventional" economic measures would be a mistake since history shows that the two times they were previously tried in response to a "liquidity trap" they were ended "too soon".

Occam's razor might argue: The current "unconventional" measures are a mistake since they have been tried twice under similar circumstances and did not work.

The President, of course, expressed His understanding, contra- conservative critics (and it turns out Krugman), that it was pretty well settled that these sort of unconventional measures worked in the past.

Iranian Government

One interesting pattern in reporting on Iran is that the liberal media generally asserts that Ahmadinejad and Khamenei are a duo and that the former is sub-ordinated to the latter, whereas more conservative media reports a power struggle between the two.

The most likely motivation behind this is that it is quite difficult to argue for engagement with a Government substantively controlled by Ahmadinejad. It is easier to argue for engagement with a Government in which he is a mere figurehead.

I suppose time will tell which side is reporting the straight facts and which is subsuming "journalism" to a political agenda.

Efficiency

Poking Holes in a Theory on Markets

...the efficient market hypothesis is ... a theory that ... the stock market can’t be beaten on any consistent basis because all available information is already built into stock prices. The stock market, in other words, is rational.

In the last decade, the efficient market hypothesis, which had been near dogma since the early 1970s, has taken some serious body blows. First came the rise of the behavioral economists ... who convincingly showed that mass psychology, herd behavior and the like can have an enormous effect on stock prices... Then came a bit more tangible proof: the dot-com bubble, quickly followed by the housing bubble...

These days, you would be hard-pressed to find anybody, even on the University of Chicago campus, who would claim that the market is perfectly efficient.

The financial services industry, of course, has a great interest in undermining the efficient market thesis. To the degree it holds true, active fund managers (which is to say all of them) are snake oil salesmen, plain and simple.

Markets should be mostly rational, by the simple syllogism that markets are made up of people, and people, when it comes to their money, are mostly rational. Certainly, as the behavioralists show, people are never entirely rational and so markets are, perhaps, never entirely rational.

That said, the focus on broad behaviorism obscures, I think, a more fundamental irrationality embedded in markets, which is: People, acting rationally within in their individual constraints, do not always produce a rational outcome in aggregate.

More directly: In the current regime, what an investment manager thinks about a company is only a part (perhaps even a small part) of an investing decision. There are all sorts of additional concerns that factor in. For example, a manager has to be concerned about the optics of the investment her own, often under-informed, investors. A manager has to consider the changing regulatory and political environment in which the company operates (its fair to say that the investors the past nine months have been betting more about "what the government will do" than "what a company will do"). There are all sorts of constraints that operate in the name of "Risk Management" that seem to do far more to distort prices then reduce risk. Above all, a manager has to consider the regulatory environment in which she operates. All these considerations alter investment decisions.

In other words, the market is composed of people who are making decisions that only partially reflect economic information and expectations and so market prices only partially reflect that information and expectation. The more these external factors dominate investment decision making, the less rational markets are. And the more irrational markets appear the more likely these external factors are dominating.

Yet ... In Mr. Grantham’s view, the efficient market hypothesis is more or less directly responsible for the financial crisis.

“In their desire for mathematical order and elegant models,” he wrote in his firm’s quarterly letter to clients earlier this year, “the economic establishment played down the role of bad behavior” — not to mention “flat-out bursts of irrationality.”

He continued: “The incredibly inaccurate efficient market theory was believed in totality by many of our financial leaders, and believed in part by almost all. It left our economic and government establishment sitting by confidently, even as a lethally dangerous combination of asset bubbles, lax controls, pernicious incentives and wickedly complicated instruments led to our current plight. ‘Surely, none of this could be happening in a rational, efficient world,’ they seemed to be thinking. And the absolutely worst part of this belief set was that it led to a chronic underestimation of the dangers of asset bubbles breaking.”
...
Justin Fox’s ... thesis, essentially, is that the efficient marketeers were originally on to a good idea. But sealed off in their academic cocoons — and writing papers in their mathematical jargon — they developed an internal logic quite divorced from market realities. It took a new group of young economists, the behavioralists, to nudge the profession back toward reality.
...
As Mr. Fox describes it, much of the early academic work that led to the efficient market theory was aimed at simply showing that most predictive stock charts were glorified voodoo... Dissertations were written showing how 20 randomly chosen stocks outperformed actively managed mutual funds...

In time, this insight led to the rise of passive index funds that simply matched the market instead of trying to beat it. Unless you’re Warren Buffett, an index fund is where you should put your money. Even people who don’t follow that advice know they should...

As Mr. Grantham sees it, if professional investors had been willing to acknowledge these aberrations — and trade on the fact that the market was out of whack — they should have been able to beat the market. But thanks to the efficient market hypothesis, no one was willing to call a bubble a bubble — because, after all, stock prices were rational...

The notion that no one was willing to call a bubble a bubble is silly. I don't think it would be difficult to find mountains of published quotes from the peak of the respective "booms" calling them "bubbles".

The job of an investment manager is not to avoid bubbles, on the contrary. Bubbles -- which make it very easy to buy low and sell high -- are an investment managers best friend. The job of an investment manager is to time her trades properly.

Finally, again, the notion that "professional investors" were captive to efficient market theory defies reason. If one is captive to efficient market theory, one does not actively trade.

Meanwhile, government officials, starting with Alan Greenspan, were unwilling to burst the bubble precisely because they were unwilling to even judge that it was a bubble...

There is a stronger argument in regards to government officials. For example, regulators have long operated under the "theory" -- one that perhaps ought be revisited -- that introducing externalities into investment making decisions does not reduce the efficiency of markets.

On the other hand, Alan Greenspan -- given his famous "irrational exuberance" speech -- is an ill-fitting posterboy for "government officials unwilling to even judge that it was a bubble". The decision, on the part of government officials, of if, when and how to burst a bubble is a tremendously complicated one. There are many reasons (good and bad) why a government official might recognize a bubble but be unwilling to burst it.

Mr. Fox sees it somewhat differently. On the one hand, he says, the efficient market theoreticians always assumed that smart market participants would force stock prices to become rational. How? By doing exactly what they don’t do in real life: take the other side of trades if prices get out of whack. Their ivory tower view reflected an idealized market that simply doesn’t exist.

The crucial question, to my mind, is why that market does not exist. I don't believe the evidence supports the (behavioralist) assumption that smart market participants were entirely oblivious to the bubble around them. To understand why the efficient market theory failed, one has to understand the many reasons why a smart market participant who recognized the bubble around her might not force stock prices to become rational.

Empathy

Empathy and the Law

President Obama wants Supreme Court justices who have empathy. What could be wrong with that, asks Dahlia Lithwick (“Once More, Without Feeling,” Slate.com): “When did the simple act of recognizing that you are not the only one in the room become confused with lawlessness, activism, and social engineering?”

It may not be that simple. Obama’s invocations of empathy combine a concern for the less advantaged with a theory of constitutional interpretation. Speaking to his choice to fill the seat soon to be vacated by Justice Souter, Obama said, “I will seek someone who understands that justice isn’t about some abstract legal theory or footnote in a casebook; it is also about how our laws affect the daily realities of people’s lives.” That kind of judge, Obama explained, will have empathy: “I view the quality of empathy, of understanding and identifying with people’s hopes and struggles as an essential ingredient for arriving at just decisions and outcomes.”

The phrase “just decisions and outcomes” seems beyond reproach (who could object to it?), but many will hear it with suspicion and say, “Just outcomes would be nice and let’s hope we have some, but what courts should deliver is legal outcomes.” You might think that “legal” and “just” go together, and sometimes they do; but in the real world “just” and “legal” can come apart. A decision is just when it reflects an overarching vision of what is owed is to each man and woman. A decision is legal when it can be said to follow from established rules, statutes, precedents.

It is possible then that a legal decision, a decision that has a source and a pedigree in the laws that have been formally set down, could offend one’s sense of justice. And, conversely, it is also possible that a decision widely regarded as substantively just — yes, that’s the way things should be — could at the same time be seen as illegal, that is, as not following from the rules and principles of settled law. This is precisely the criticism that has been made of Brown v. Board of Education (most notably by Herbert Wechsler in his influential Harvard Law Review article “Toward Neutral Principles”); yes, the result is good, the critics acknowledge, but where, they ask, is its legal — as opposed to its empathetic — basis? And on the other side it was said, and is still said, that any jurisprudence that cannot accommodate Brown v. Board is a jurisprudence we must reject...

Obama’s critique of formalism as a “cramped and narrow” way of interpreting the Constitution “in which the . . . courts essentially become the rubber stamps of the powerful.” A better way of interpreting, he believes, would be to begin with the conviction that “the courts are the refuge of the powerless who often lose in the democratic back and forth.” Therefore we need judges “who have the empathy to recognize what it’s like be a young teen-aged mom; the empathy to understand what it’s like to be poor, African American or gay.”


A few thoughts on this:

A more sophisticated defense of a more narrow jurisprudence, I suspect, would advocate empathy in its broadest form most discerningly applied.

The notion that the highest courts decide between the simply powerful and the simply powerless is, frankly, cartoonish. More generally courts are forced to navigate between conflicting sets of compelling hopes and struggles. The decisions made by the highest courts are, of course, applied far beyond the particular claimants in front of them. It is rather much to expect of a Justice, that she understand and identify with the hopes and struggles of the countless people her decision will touch. In any case, were it possible, it is hard to see how, in any non-trivial case, such empathy-for-all would lead to anything other than indecision.

To be clear, the President's understanding of empathy, in the quotation cited, appears itself "cramped and narrow". He advocates empathy-for-some -- the poor, African-American and homosexual -- but not all -- the middle class, Caucasian and Christian. Unlike empathy-for-all, empathy-for-some provides clear guidance in judging. In the end, what the President is looking for, appears, more or less, reducible to "empathy for key Democratic Party constituencies". Put crudely: Judges biased towards his political supporters. In other words, the President proposes an overtly politicized judiciary.

An overtly politicized judiciary -- a judiciary that is an extension of the political system -- is, of course, a reasonable desire of a politician, but no way to help the politically powerless. Politically powerful interests will, in the end, push through Justices biased in their general direction. In other words, a judiciary's ability to be a refuge for the politically powerless is strongly correlated to its degree of independence from the political process.

Read carefully, the President's view is even more anti-democratic then it appears at first glance. The notion that the highest courts are the refuge of the politically powerless is empirically false. The doors of the Supreme Court are not simply open to all. Those with the resources to get their case before the highest courts, likely also have the wherewithal to strongly influence the political process. More subtly, it is unexpected to hear this President of the United States assign the role of "refuge of the powerless" to a different branch of government. Is he not himself Champion of the Powerless? And if a Champion of the Powerless can become President, why must the courts be their refuge?

Read carefully, then, the sort of powerless that the President sees the court as a refuge for are not those who lack the resources to engage fully in the democratic back and forth, as they also likely lack the resources to present their case before the court. They are also likely not the powerless whom the President himself champions. In other words, they are not what is brought to mind by "poor" and "African American".

The third sort of recipient of empathy advocated by the President does fit the bill. Advocates of legally recognizing gay marriages are in no way disadvantaged economically and culturally, but they clearly lose out in the democratic back and forth -- to the extent that the President, the empathy in his heart notwithstanding, lacks the ability, or political courage, to champion them himself. The conclusion, then -- and I do not think this is too far a limb -- is that "empathy" in this context is code for "someone who will discover a constitutional right to Gay Marriage".

The only dimension within which advocates of legally recognizing gay marriages are in any way disadvantaged is democratically. For all their economic and cultural power -- witness Carrie Pejean -- these advocates appear near powerless politically. Which is to say, despite having every advantage in making their case, they are generally unable to convince their fellow Americans of the correctness of their cause.

To apply, then, the same sort of lens the President would apply to "formalism" to his own view: He views the courts as essentially a mechanism by which the ruling elite can impose their will in matters they cannot prevail within a democratic back and worth.

The counter-argument to this is Brown v Board. Sometimes, (or, if one is elitist: usually), the views of the ruling elite are preferable even when they cannot prevail democratically. The ruling elite ought then have an outlet with which to impose their will in that circumstance.

Putting aside any arguments of democracy, this is, on its own terms, not a particularly strong argument.

To start with, it takes a stunning lack of empathy -- in the sense, employed by the President, of "understanding" -- to identify the condition of a (perhaps well-heeled) same sex couple joined in a state sanctioned civil union which politicians refuse to legislatively label marriage as being of a kind, or one level, with the evils of segregation. Further while Brown may have been part of the historical process by which segregation ended, to give it any credit for that result is to take a particularly unsympathetic view of African- and ordinary-Americans. It is to believe that without Brown v Board, which is to say the intervention of the ruling elite, African-Americans would have continued indefinitely to sit only in the back of buses and ordinary Americans would have continued indefinitely to view that as acceptable. Factually, the times were already a-changing before Brown.

Finally, while it was certainly ground in the best of intents, it requires a further failure of empathy, in this sense of understanding, to view Brown as successful even in its most direct aim. How can one claim today, 50 years later, that we no longer have a pressing problem of unequal (and even largely separate) education? Further, without denying the unquestionable progress we have made as a society, African American families and communities have been -- in many obvious and important measures -- damaged far more then assisted by the past 50 years of "empathetic" engagement by our government -- and, in particular, our courts.

As a thought problem, imagine if the court, in Brown, had ruled more narrowly that for separate, but equal to be constitutional there had to be measurable equality. Imagine if the effort that went into defining and implementing the Brown integration mandate had instead gone into defining and implementing a "measurable equality" mandate. Segregation would today likely be just as over, and we might have had real educational equality. In other words, Brown, I think, thoughtfully considered, illustrates how a more cramped and narrow jurisprudence might better refuge the powerless then a more expansive nominally, or superficially, empathetic one.

Empty Calculus

Netanyahu defies Obama on Israeli settlement freeze

JERUSALEM, May 24 (Reuters) - Israeli Prime Minister Benjamin Netanyahu on Sunday rebuffed U.S. calls to impose a freeze on all settlement activity in the occupied West Bank, setting the stage for friction with President Barack Obama.

"We do not intend to build any new settlements, but it wouldn't be fair to ban construction to meet the needs of natural growth or for there to be an outright construction ban," Netanyahu told his cabinet, according to officials.

The note of defiance came less than a week after Netanyahu held talks in Washington with Obama, who wants Israel to halt all settlement activity, including natural growth, as called for under a long-stalled peace "road map"... By natural growth, Israel refers to construction within the boundaries of existing settlements to accommodate growing families...

"Defiance" would seem an odd characterization of a statement that is virtually apologetic.

Abbas has ruled out restarting those talks until Netanyahu, whose right-leaning government took office on March 31, commits to a two-state solution and halts settlement expansion... Palestinians see the settlements as a land grab meant to deny them a state in the West Bank and the Gaza Strip.

Middle East peace-making often appears a glorified game of chicken. Unfounded assertions common in the media aside, Israelis and Palestinians, on the whole, do not want any peace the other would accept. When Israelis talk about accepting a two state solution, they generally view a Jewish and Palestinian state co-existing side by side indefinitely. When Palestinians talk about accepting a two state solution, they generally see a Palestinian State side by side with an Israeli State, with a Palestinian right of return that would, over time, "Palestinize" Israel. Put simply: Palestinians will not agree to a peace that envisions the long term survival of the Jewish State while Israelis will not agree to a peace that does not. (The "right of return" is the concretization of this, Palestinians will not agree to a deal without a meaningful right of return to Tel-Aviv, and Israelis will not agree to a deal with it).

The Palestinians -- perhaps because they have less to lose -- appear to understand more thoroughly that the game is not "getting to yes", but making sure the other party is seen as the obstacle. This natural growth talk is a great illustration. The notion that settlement expansion serves in any way to prevent Palestinian statehood is impossible to honestly defend. Twice now -- in Sinai and in Gaza -- Israel has evacuated settlements. On the other hand, if a permanent deal is on the horizon, freezing construction in the interim as a goodwill gesture seems a small matter, and Israel's refusal makes them appear the obstacle. The reality, of course, understood by both sides, is that no deal is on any horizon and the open-ended demand that, in whole towns, not an addition be built nor a kitchen remodeled, is simply unbearable.

In response, Israeli leaders generally appear (with the possible exception of Ehud Barak monday morning) touchingly earnest. Arguing, as Netanyahu did, that a total construction freeze is "unfair", is besides the point.

Israeli leaders do have savvier options available. For example: Netanyahu could agree to accept Abbas' demand he commit to a two state solution, if Abbas does the same, which is to say, he commits to there being no right of return to Tel Aviv. Netanyahu could also agree, after such a commitment from Abbas, to a fixed-duration (eg: six months) total settlement freeze, as a show of good faith while negotiations are underway. Abbas would, then, be painted into a rather tight corner. It is unlikely he has the ability to "give up" the "right" of return. If he cannot commit himself to a meaningful two state solution, he will have diminished ability to credibly demand the same of Netanyahu.

The problem with this course is that, for Israel, this is not simply a game and the goal is not simply to win points and buy time.

Babies With Candy 3/16

A Continent Adrift

...the situation in Europe worries me even more than the situation in America.

Just to be clear, I’m not about to rehash the standard American complaint that Europe’s taxes are too high and its benefits too generous... they’re actually a mitigating factor.

The clear and present danger to Europe right now comes from a different direction — the continent’s failure to respond effectively to the financial crisis...

On the fiscal side, the comparison with the United States is striking... America’s actions dwarf anything the Europeans are doing.

The difference in monetary policy is equally striking. The European Central Bank has been far less proactive than the Federal Reserve; it has been slow to cut interest rates (it actually raised rates last July), and it has shied away from any strong measures to unfreeze credit markets.

The only thing working in Europe’s favor is the very thing for which it takes the most criticism — the size and generosity of its welfare states, which are cushioning the impact of the economic slump... these programs will also help sustain spending in the slump.

But such “automatic stabilizers” are no substitute for positive action.

In previous columns, Krugman has questioned positive action being able to lift us out of the crisis (noting, for example, that it took a world war to get us out of the great depression). He also has expressed concern for long-term costs. Expectations of efficacy and cost aside, he never wavers from cheer-leading such policy.

Why is Europe falling short? Poor leadership is part of the story. European banking officials, who completely missed the depth of the crisis, still seem weirdly complacent. And to hear anything in America comparable to the know-nothing diatribes of Germany’s finance minister you have to listen to, well, Republicans.

This is an odd mirror to the run-up to the iraqi war. Then, in the eyes of Democrats, Europeans were wise friends whose council and co-operation we ought never reject unilaterally. To Republicans, they were weak and mushy and incapable of responsibility. Now, the views are reversed. The commonality may be a lack of decisiveness.

But there’s a deeper problem: ...unlike America, Europe doesn’t have the kind of continentwide institutions needed to deal with a continentwide crisis.

This is a major reason for the lack of fiscal action: there’s no government in a position to take responsibility for the European economy as a whole. What Europe has, instead, are national governments, each of which is reluctant to run up large debts to finance a stimulus that will convey many if not most of its benefits to voters in other countries.

...there is a European Central Bank. But the E.C.B. isn’t like the Fed, which can afford to be adventurous because it’s backed by a unitary national government — a government that has already moved to share the risks of the Fed’s boldness, and will surely cover the Fed’s losses if its efforts to unfreeze financial markets go bad. The E.C.B., which must answer to 16 often-quarreling governments, can’t count on the same level of support.

Europe, in other words, is turning out to be structurally weak in a time of crisis.

It turns out, somewhat ironically, that we have the state dominated economy we thought Europeans had, and they have the divided government we thought we had.

To Krugman this is a factor in our favor.

The biggest question is what will happen to those European economies that boomed in the easy-money environment of a few years ago, Spain in particular.

For much of the past decade Spain was Europe’s Florida, its economy buoyed by a huge speculative housing boom. As in Florida, boom has now turned to bust...

In the past, Spain would have sought improved competitiveness by devaluing its currency. But now it’s on the euro — and the only way forward seems to be a grinding process of wage cuts. This process would have been difficult in the best of times; it will be almost inconceivably painful if, as seems all too likely, the European economy as a whole is depressed and tending toward deflation for years to come.

This argument assumes that there is a pain free path out of a Spain, or Florida, style bust. There may well be not, and all the positive expensive attempts to avoid any pain may, in the end, only serve to radically increase it.

An economist like Krugman should welcome different governments pursuing different policies in response to the crisis as that will produce more and better data for economists to study. The partisan political commentator in Krugman may fear the tale that data will tell.

Babies With Candy 3/22

Catching up Financial Policy Despair

This is a mostly repetitive column. Krugman's tone getting increasingly more shrill as it appears Obama will not adopt the policy he prefers.

...Tim Geithner, the Treasury secretary, has persuaded President Obama to recycle Bush administration policy — specifically, the “cash for trash” plan proposed, then abandoned, six months ago by then-Treasury Secretary Henry Paulson.

This is more than disappointing. In fact, it fills me with a sense of despair.

...now Mr. Obama has apparently settled on a financial plan that, in essence, assumes that banks are fundamentally sound and that bankers know what they’re doing.

These plans, as observed here previously assume no such thing. Rather, they assume that the economy would be healthier if the banks were healthier, that the banks would be healthier if they had more cash and fewer toxic assets, that the cash the private sector is currently willing to provide in exchange for those toxic assets is not enough to restore the banks to help, but that with government incentives the private sector will provide sufficient cash.

There are good reasons to be skeptical about a number of these assumptions, but they are all far more solid then "bankers know what they are doing"

...Right now, our economy is being dragged down by our dysfunctional financial system, which has been crippled by huge losses on mortgage-backed securities and other assets.

This is a semi-truth. For a good 10 years before our economy was dragged down by a supposed dysfunctional financial system it was inflated by a government encouraged hyper-functional one. We have 10 years of economic growth that may well be every bit as real as Madoff profits.

Given that, its not clear to me that the financial system is entirely dysfunctional. What would be the response of a functional financial system to the recognition that it was flooded -- from housing, to student loans, to credit cards, to corporate financing -- with bad debt?

Put differently: Are our economic troubles a symptom of the financial system clamping down on credit dragging or is the credit crunch an inevitable consequence of an economy in which the repayment of too much debt was entirely dependent on increasingly easy credit?

If it is the former, the policies being pursued to "ease" credit are sensible. If it is the latter then such policies will prove cataclysmic.

As economic historians can tell you, this is an old story, not that different from dozens of similar crises over the centuries. And there’s a time-honored procedure for dealing with the aftermath of widespread financial failure. It goes like this: the government secures confidence in the system by guaranteeing many (though not necessarily all) bank debts. At the same time, it takes temporary control of truly insolvent banks, in order to clean up their books.

That’s what Sweden did in the early 1990s. It’s also what we ourselves did after the savings and loan debacle of the Reagan years. And there’s no reason we can’t do the same thing now.

Its not clear to me that governments have, for centuries, been pursuing these policies.

As argued here before, one reason why doing this now might now might not be sensible is scale. Does the government really have no reason not to want to put all that bad debt on the federal balance sheet?

Also, given the scale, if the government takes "temporary" control over citibank it will likely find itself in long term control of Morgan Stanley.

Truly insolvent is a fuzzy word in this context. It will be a long time till we know the true value of many of the toxic assets and, so, whether or not a given bank was insolvent. On the other hand, a bank that loses the confidence of the market and so can't raise capital is, simply, insolvent. The more banks the government nationalizes the less confidence the market will have in the survivors and, therefore, the less solvent they will be. In other words, a policy of nationalizing banks will render banks that are absent that policy solvent, trully insolvent.

The temporary notion is downright silly. Control can be temporary if there are markets to sell assets into. But if the government seizes the largest banks there will be no such markets. Control, therefore -- even without the likely political meddling -- will be inevitably long term.

...The common element to the Paulson and Geithner plans is the insistence that the bad assets on banks’ books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that if they were properly priced, banks wouldn’t be in trouble.

And so the plan is to use taxpayer funds to drive the prices of bad assets up to “fair” levels... Mr. Geithner instead proposes a complicated scheme in which the government lends money to private investors, who then use the money to buy the stuff. The idea, says Mr. Obama’s top economic adviser, is to use “the expertise of the market” to set the value of toxic assets.

Again, this assumption is besides the point. None of these plans care about the true value of these assets as much as getting them off the balance sheets of banks at a price that won't bankrupt all the banks.

I am, certainly, giving Geithner a bit of the benefit of the doubt here. But as much as I am skeptical of his competence, I have a hard time imagining the he hasn't figured out that the value a market assigns is a strong function of the financing available to market participants. He has to know that, by the terms of the offered financing, he -- more than the expertise of the market -- will be substantively setting the price. The idea then, must be to get these assets of bank balance sheets and into private hands better suited to hold on to them.

But the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.

This is an oversimplification and misrepresentation of the payouts. Depending on how much investors have to put down, they won't walk away if it simply goes down a little. The investors therefore own the first chunk of loss. On the other side, the Government, by virtue of being owed interest payments, owns the first chunk of gain. The Government even profits if the value decreases slightly.

While this seems a reasonable deal for the government -- especially given the primary goal is to clear assets from bank balance sheets, not profit from financial transactions -- I suppose one could argue. It borders on mindless, however, to brand it a one way bet.

...By my count, this is the third time Obama administration officials have floated a scheme that is essentially a rehash of the Paulson plan, each time adding a new set of bells and whistles and claiming that they’re doing something completely different. This is starting to look obsessive.

The technical term for this, I think, is projection. The administrations flip flopping policy is anything but obsessive. Krugman's commentary on the other hand.

The administration flip-flops are likely a result of the politics. The administration would prefer avoid the political cost of another expensive bank bailout. On the other hand, the administration cannot bear the political cost of the DOW dropping to 6500 and below. When the markets are in free fall these plans are introduced, when they stabilize they are shelved.

But the real problem with this plan is that it won’t work... the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus — for that is what the Geithner plan amounts to — will change that fact...

I do love Krugman-the-economist who, in most every column, feels the need to undermine Krugman-the-political-columnist.

It was not merely a few financial executives that bet their banks on the belief that unprecedented levels of household (and corporate) debt were no problem, it was the industry as a whole. In fact, it wasn't simply private industry, but government policy makers. They, we, all lost that bet, and are left with a truly insolvent economy as opposed to just a few banks that are truly insolvent.

Given the real problem, then, Krugman's partisan proposal solves little.

The Mind of Obama

Brooks, a bit back When Obamatons Respond

On Tuesday, I wrote that the Obama budget is a liberal, big government document that should make moderates nervous. The column generated a large positive response from moderate Obama supporters who are anxious about where the administration is headed. It was not so popular inside the White House. Within a day, I had conversations with four senior members of the administration and in the interest of fairness, I thought I’d share their arguments with you today.

In the first place, they do not see themselves as a group of liberal crusaders. They see themselves as pragmatists who inherited a government and an economy that have been thrown out of whack. They’re not engaged in an ideological project to overturn the Reagan Revolution, a fight that was over long ago.

There are, no doubt, those within the administration that do not see themselves as liberal crusaders. There are also, equally certain, those within the administration that do.

It would almost be comforting if Obama was among the latter. I am starting to suspect that he is amongst the former. He likes thinking of himself as thoughtful and moderate. It would be a reflection of the bubble in which he lives, if he views as thoughtful and moderate policies which Americans increasingly see as being hard left.

...Second, they argue, the Obama administration will not usher in an era of big government. Federal spending over the last generation has been about 20 percent of G.D.P. This year, it has surged to about 27 percent. But they aim to bring spending down to 22 percent of G.D.P. in a few years... I was invited to hang this chart on my wall and judge them by how well they meet these targets. (I have.)

As Brooks suspects, this is very likely bs. Even Krugman expects the over. Which argues that "Obamatons" responding were -- less than effectively -- in the business of dis-information.

I suspect that they understand that if the economy is doing well in 3 years, they will be able to persuasively argue "see 30+% is good for the economy" and if the economy is still doing poorly, they will be able to persuasively argue "We obviously can't now cut programs Americans are depending on to get them through crisis". Leaving Brooks' chart politically meaningless.

Third, they say, Republicans should welcome the budget’s health care ideas. The Medicare reform represents a big cut in entitlement spending. It amounts to means-testing the system. It introduces more competition and cuts corporate welfare. These are all Republican ideas...

I agree with this. Obama has shown a willingness to measure the efficacy of government programs. I think this a process Republicans ought to embrace and ought to ensure that the metrics used are as objective and comprehensive as possible.

We believe that free people making free decisions produce better results then centralized, politicized, bureaucrats making decisions for everyone else, and we should welcome initiatives that offer to provide data which demonstrates that.

Fifth, the Obama folks feel they spend as much time resisting liberal ideas as enacting them. The president resisted union pressure and capped pay increases for government workers. He resisted efforts to create mandatory veterans’ health benefits. The administration plans to tackle the suspiciously large increase in the number of people claiming disability benefits.

Obama was the candidate of ivy-league, not blue collar, liberals. That he is resisting pressure from blue collar liberals, while enacting, virtually wholesale, the agenda of ivy-league liberals, is hardly comforting to moderates.

I didn’t finish these conversations feeling chastened exactly... Nonetheless, the White House made a case that was sophisticated and fact-based. These people know how to lead a discussion and set a tone of friendly cooperation...

If these conversations where, in fact, sophisticated and fact-based, Brooks failed to do them justice. What these people understand, I more suspect, is how to humor a somewhat conservative columnist.

Babies With Candy V

Krugman opines The Big Dither

Here’s how the pattern works: first, administration officials, usually speaking off the record, float a plan for rescuing the banks in the press. This trial balloon is quickly shot down by informed commentators.

Then, a few weeks later, the administration floats a new plan. This plan is, however, just a thinly disguised version of the previous plan, a fact quickly realized by all concerned. And the cycle starts again.

Why do officials keep offering plans that nobody else finds credible? Because somehow, top officials in the Obama administration and at the Federal Reserve have convinced themselves that troubled assets, often referred to these days as “toxic waste,” are really worth much more than anyone is actually willing to pay for them — and that if these assets were properly priced, all our troubles would go away.

While Krugman may not find the plans credible, there are certainly informed commentators who do. He is certainly not the only political commentator dismissive of those who disagree with him.

A more rigorous analyst would question the process.

While it may well be true that bold steps are required, its hard to imagine that any set of bold steps will be greeted without resistance by "informed commentators". To give "informed commentators" a policy veto is to preclude adopting bold steps.

Its clear that the administration is attuned to the politics. It is natural for political policy makers to be attuned to the political implications of policy. It also may reflect sympathy for the school of thought which believes recessions to be, above all, crises of confidence and the way out of recessions to restore confidence. Bold steps, in that view, are less medication than placebo; The actual steps are less important that the public's confidence in them.

Krugman, to my mind, also mis-states the motivation behind the policies. The concrete problem that the administration is trying to address is the banks have on difficult to price, and therefore "toxic", assets on their balance sheets that impair their ability to serve their nominal economic role. Were we to price these assets at their current, fire sale, market price most of these banks be seriously under capitalized, if not insolvent. Its reasonable to believe that getting these assets off bank balance sheets at an non-ruinous price will go along way towards pushing our troubles away.

Thus, in a recent interview Tim Geithner, the Treasury secretary, tried to make a distinction between the “basic inherent economic value” of troubled assets and the “artificially depressed value” that those assets command right now. In recent transactions, even AAA-rated mortgage-backed securities have sold for less than 40 cents on the dollar, but Mr. Geithner seems to think they’re worth much, much more.

And the government’s job, he declared, is to “provide the financing to help get those markets working,” pushing the price of toxic waste up to where it ought to be.

Geithner is certainly right to a point.

These assets being loans, have a long-term value: Some amount of money will be paid back. In healthy, liquid markets, the market price is the best estimate available of the expected long-term-value. The current market prices are almost certainly depressed, as they more reflect fear of short term price fluctuations. An investment manager who has to mark her portfolio to market and report P&L to clients on a monthly, or quarterly, basis and whose clients are likely to substantively withdraw money in response to paper losses, is rationally more concerned with short-term-price rather than long-term-value expectations.

To the degree that our economy depends on these markets functioning, the government has a responsibility to help get those markets working again.

Financing buyers, however, is not, to my mind, really a means to get these markets working again. The price will be dependent on the terms of the financing. To work, I think, Geithner will have to set the terms such that the price approaches the long-term-value. A price set too high will save the banks, but not restore investor confidence in price stability. Krugman is right to question Geithner's -- any individual's -- ability to gauge that long-term-value.

A more thoughtful policy would be to adjust tax policy to encourage investment pools with longer lockups, and with P&L measured in cash returns not market values. The price managers of those pools would be willing to pay for assets will be far more based on expectation of long term value.

That said, if the goal is getting these assets off bank balance sheets as quick as possible, subsidizing buyers may well be the most sensible policy.

...The truth is that the Bernanke-Geithner plan — the plan the administration keeps floating, in slightly different versions — isn’t going to fly.

Take the plan’s latest incarnation: a proposal to make low-interest loans to private investors willing to buy up troubled assets. This would certainly drive up the price of toxic waste...

But would it be enough to make the banking system healthy? No.

Think of it this way: by using taxpayer funds to subsidize the prices of toxic waste, the administration would shower benefits on everyone who made the mistake of buying the stuff. Some of those benefits would trickle down to where they’re needed, shoring up the balance sheets of key financial institutions. But most of the benefit would go to people who don’t need or deserve to be rescued.

And this means that the government would have to lay out trillions of dollars to bring the financial system back to health, which would, in turn, both ensure a fierce public outcry and add to already serious concerns about the deficit...

Krugman's argument appears to be: Subsidizing private investors will not make the banking system healthy because benefit will be going to undeserving people. While, perhaps, rhetorically appealing, it is logically empty.

Krugman believes that de-zombification will make banking system healthy (I am skeptical). If these toxic assets on zombie bank balance sheets are replaced with enough cash, the banks will be de-zombified.

That cash can come from the government -- per Paulson's initial plan or proposed nationalization schemes -- or from subsidized, if undeserving, private investors (the subsidy is required because private investors are not currently willing to pay sufficient cash).

So why has this zombie idea ... taken such a powerful grip? The answer, I fear, is that officials still aren’t willing to face the facts. They don’t want to face up to the dire state of major financial institutions because it’s very hard to rescue an essentially insolvent bank without, at least temporarily, taking it over. And temporary nationalization is still, apparently, considered unthinkable.

Krugman has yet to explain how nationalization is a panacea. In a vanilla nationalization model, the government will replace these toxic assets on zombie bank balance sheets with sufficient public capital, then sell the recapitalized banks and toxic assets separately into the market over some period of time.

This seems to me, on the surface, to be far a more complicated, risk laden and expensive means to the same end as a well calibrated buyer subsidy. Which more simply explains this idea's powerful grip.

One suspects that Geithner, with a much better view of the matter, understands the dire state of major financial institutions far better then Krugman. And it may well be the very dire-ness and attending expense of recapitalization, that precludes Geithner, as Paulson before him, from considering a public-capital-only solution.

Babies with Candy IV

Krugman's latest Climate of Change:

...Obama’s new budget represents a huge break ... with policy trends over the past 30 years ... he will set America on a fundamentally new course.

The budget will, among other things, come as a huge relief to Democrats ... fears that Mr. Obama would sacrifice progressive priorities in his budget plans, and satisfy himself with fiddling around the edges of the tax system, have now been banished.

For this budget allocates $634 billion over the next decade for health reform. That’s not enough to pay for universal coverage, but it’s an impressive start. And Mr. Obama plans to pay for health reform, not just with higher taxes on the affluent, but by putting a halt to the creeping privatization of Medicare, eliminating overpayments to insurance companies.

Obama, it seems, after studying Clinton's failure to enact health care reform, appears to have identified the problem: Clinton made the mistake of announcing he was setting off to reform health care, with town halls and committees and negotiations. Obama has, evidently, decided fundamental change is best attempted under-the-table. Hidden in fiscal stimulus bills and buried in budgets.

He has also, apparently discovered the generally un-acknowledged reality that we already have nationalized health care. The government already -- via tools such as existing regulatory authority, Medicare policies, etc -- fundamentally controls our health system. Sweeping changes can be made without dramatic new legislation and attending political debate.

His approach may be a blessing in disguise for his political opponents in that it will make it easier for them to argue that the problems we have had with health care all along were due to too much, not too little, government control+interference.

On another front, it’s also heartening to see that the budget projects $645 billion in revenues from the sale of emission allowances. After years of denial and delay by its predecessor, the Obama administration is signaling that it’s ready to take on climate change.

As far as I can tell the only benefits a cap-and-trade system has over a carbon tax are political -- allowing democrats to misleadingly claim they are not creating new taxes. The costs are likely to be substantive. Government created artificial markets exist to be gamed by savvy players. All sorts of perverse economic incentives are inevitable. And from what I've read, these systems don't actually do a particularly good job of reducing emissions.

I tend to support a Carbon Tax. Conservatives, at least, are willing to acknowledge that when the government taxes an activity it discourages it. In as much as the Government needs revenue, it therefore ought be taxing activity we would benefit from discouraging. Whether or not one believes the earth will be destroyed by melting ice caps in 2012 unless we act RIGHT THIS MINUTE, its not hard to imagine that reducing our environmental footprint is a good idea. Ergo, taxes on environmentally destructive activities make sense.

It says a lot then about the administrations reading of public opinion that they prefer a less effective under the table policy, to a more effective above board policy.

In any case, Krugman should not be over-heartened. The administration has to project what revenue it can to project a semblance of fiscal responsibility.

And these new priorities are laid out in a document whose clarity and plausibility seem almost incredible to those of us who grew accustomed to reading Bush-era budgets, which insulted our intelligence on every page...

Many will ask whether Mr. Obama can actually pull off the deficit reduction he promises. Can he actually reduce the red ink from $1.75 trillion this year to less than a third as much in 2013? Yes, he can.

Right now the deficit is huge thanks to temporary factors (at least we hope they’re temporary): a severe economic slump is depressing revenues and large sums have to be allocated both to fiscal stimulus and to financial rescues.

But if and when the crisis passes, the budget picture should improve dramatically. Bear in mind that from 2005 to 2007, that is, in the three years before the crisis, the federal deficit averaged only $243 billion a year. Now, during those years, revenues were inflated, to some degree, by the housing bubble. But it’s also true that we were spending more than $100 billion a year in Iraq.

So if Mr. Obama gets us out of Iraq (without bogging us down in an equally expensive Afghan quagmire) and manages to engineer a solid economic recovery — two big ifs, to be sure — getting the deficit down to around $500 billion by 2013 shouldn’t be at all difficult.

Krugman notes that this years deficit is about 7 times the average deficit from 2005 to 2007 and that Obama aspires only to "reduce" the deficit to twice what it was then by 2013. Krugman describes the assumptions required to achieve even Obama's limited fiscal responsibility goals as being "Big ifs" yet somehow he lauds their plausibility.

The politics of war open a bit of a can of worms for Obama. He campaigned on the need to draw down in Iraq more to re-focus on Afganistan then to save money to spend on health care. If he does recognize substantial cost savings, he will be politically vulnerable if one or both of those wars goes poorly. On the other hand -- and this may be his calculation -- so long as the economy is awful in 2012, foreign policy will not be high amongst voter's priorities.

Which actually gets to the heart of Obama's re-election calculus. He and his advisors have to recognize that the economy is unlikely to recover by 2012. He needs to figure out, then, how to get re-elected having presided over economic catastrophe. His apparent strategy seems to be taken from FDR's playbook: create spending programs that people grow dependent on, associated with you, and which your defeat will jeopardize. The more people he can make more dependent on his programs the next four years the better his chances of re-election.

...What’s not to like about this budget? Basically, the long run outlook remains worrying.

According to the Obama administration’s budget projections, the ratio of federal debt to G.D.P., a widely used measure of the government’s financial position, will soar over the next few years, then more or less stabilize. But this stability will be achieved at a debt-to-G.D.P. ratio of around 60 percent. That wouldn’t be an extremely high debt level by international standards, but it would be the deepest in debt America has been since the years immediately following World War II. And it would leave us with considerably reduced room for maneuver if another crisis comes along.

Furthermore, the Obama budget only tells us about the next 10 years... But America’s really big fiscal problems lurk over that budget horizon...

I at least find it hard to see how the federal government can meet its long-term obligations without some tax increases on the middle class...

But I don’t blame Mr. Obama for leaving some big questions unanswered in this budget. There’s only so much long-run thinking the political system can handle in the midst of a severe crisis; he has probably taken on all he can, for now. And this budget looks very, very good.

In summary then, Krugman describes a budget which, in its favor allocates $600 billion over 10 years to healthcare reform, expects to raise a similar amount from a cap and trade scheme and whose plausibility is merely highly suspect unlike those damn bush budgets which insulted the intelligence.

On the other hand it will likely require middle class tax-hikes down the road to pay for it, it doesn't address America’s really big fiscal problems, which lurk past its horizon, and it projects to stabilize public indebtedness at record levels which leave us with considerably reduced room for maneuver in facing those problems.

I think an ordinary observer, given those trade-offs, would be substantively less enthusiastic then Krugman apparently is.

Babies with Candy III

Commenting on Krugman's latest offering:

Comrade Greenspan wants us to seize the economy’s commanding heights.

O.K., not exactly. What Alan Greenspan, the former Federal Reserve chairman — and a staunch defender of free markets — actually said was, “It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring.” I agree.

I don't. The idea is, on the surface, appealing. As was Paulson's asset buyout plan, and for the same reason. The promise of a single (more or less) bold, swift, unapologetic government action, which will stop the bleeding and right the ship. But, as I'll describe below, upon anything close to rigorous reflection, its hard to conclude that it stands much chance of working as advertised.

The case for nationalization rests on three observations.

First, some major banks are dangerously close to the edge — in fact, they would have failed already if investors didn’t expect the government to rescue them if necessary.

Second, banks must be rescued. The collapse of Lehman Brothers almost destroyed the world financial system, and we can’t risk letting much bigger institutions like Citigroup or Bank of America implode.

Third, while banks must be rescued, the U.S. government can’t afford, fiscally or politically, to bestow huge gifts on bank shareholders...

Let’s be concrete here. There’s a reasonable chance — not a certainty — that Citi and BofA, together, will lose hundreds of billions over the next few years. And their capital, the excess of their assets over their liabilities, isn’t remotely large enough to cover those potential losses.

Arguably, the only reason they haven’t already failed is that the government is acting as a backstop, implicitly guaranteeing their obligations. But they’re zombie banks, unable to supply the credit the economy needs.


While Krugman's observations are entirely correct, the conclusion he draws will not directly follow. He -- and this appears a tendency amongst liberal commentators -- conflates the two objectives of supplying banks with public capital.

As he noted, without the public backstop, these banks would likely implode. From the Lehman experience, we understand that the public has an strong interest in avoiding said imposion.

The second objective is that the banks need more capital "to supply the credit the economy needs."

The amount of capital required for the second is far in excess of the amount required for the first. Zombie banks may not juice the economy, but they don't threaten to destroy the global financial system the way a disorganized bankruptcy would.

Additionally, as I argued previously on this blog, claiming that credit is what the economy needs is akin claiming that alcohol is what Mickey Mantle needed. We are in economic pain due to systematic over-reliance on credit. For our long-term economic health, we need credit-withdrawal, not another fix.

To end their zombiehood the banks need more capital. But they can’t raise more capital from private investors. So the government has to supply the necessary funds.

But here’s the thing: the funds needed to bring these banks fully back to life would greatly exceed what they’re currently worth. Citi and BofA have a combined market value of less than $30 billion, and even that value is mainly if not entirely based on the hope that stockholders will get a piece of a government handout. And if it’s basically putting up all the money, the government should get ownership in return.

As discussed, Krugman pulled a logical fast one. He substituted the factual observation that we can't let Citibank go the way of Lehman, with the less solid assertion that we need to restore Citi fully back to life.

He is correct in noting that these banks cannot be recapitalized privately. He does not explain why this is the case. The reasons include: regulations that limit who can invest capital in banks and, more importantly, private capital is scared off by the spectre of nationalization.

Put differently: if the government formalized its role as backstop, which is required in any event, guaranteed that it would not punish new private capital, and reduced restrictions on where that capital could come from at least some banks would likely be able to recapitalize privately.

Tangentially, it seems like much of Obama's policy has reflected this pattern: He pursues some policy which restrains, or crowds out, private activity, and then uses that private inaction to justify dramatically increased government intervention. I am unsure if this is innocent or intentional, but its hard to imagine that Obama suddenly lost the rigor and discipline that characterized his campaign.

In any case, the "should" in "should get ownership in return" is, then, perhaps political necessity, but its not simply in the public's economic interest.

Still, isn’t nationalization un-American? No, it’s as American as apple pie.

Lately the Federal Deposit Insurance Corporation has been seizing banks it deems insolvent at the rate of about two a week. When the F.D.I.C. seizes a bank, it takes over the bank’s bad assets, pays off some of its debt, and resells the cleaned-up institution to private investors. And that’s exactly what advocates of temporary nationalization want to see happen, not just to the small banks the F.D.I.C. has been seizing, but to major banks that are similarly insolvent.

The real question is why the Obama administration keeps coming up with proposals that sound like possible alternatives to nationalization, but turn out to involve huge handouts to bank stockholders.

As Krugman notes later, the phrase "nationalization" is inapt if what is being advocated in a government ordered liquidation akin to what the FDIC does. Nationalization implies something different.

The idea that the government can, with the insolvent big banks do what the FDIC does with small banks -- in effect government-ordered bankruptcies-- bears little srutiny.

For one, if I understand correctly, the FDIC seizing is generally less akin to chapter 11 then chapter 7, which is to say, it more generally liquidates bank assets and pays back debt-holders in an orderly fashion, then restructures failed banks into viable ones. The former, obviously, requires far less business savvy -- and therefore is far more safely entrusted to the government -- then the latter. The nationalization Krugman appears to have in mind is very much the latter, and therefore the FDIC analogue-justification inapt.

Furthermore, consider that there are some 8000 FDIC insured banks in the US. Two banks seized a week adds up to a little over 1% a year. Even with the increase in bank failures the FDIC has a robust private market into which the it sells the institution or its assets.

Imagine, by way of comparison, of what would happen if the FDIC was seizing 50 banks a week. There would be at least two easy to foresee effects:

One, it would have far less ability to move seized institutions back into private hands. More likely it would be "forced" to operate those institutions for an indefinite amount of time.

Secondly, seizures are more likely to snowball. So long as seizures number 1% per year, they serve -- by avoiding fire-sales -- to strengthen healthy banks. Seizing 20% a year may well -- by undermining the sector -- serve to weaken healthy banks.

The same is true of Citibank and BofA. Any nationalization is unlikely to be particularly temporary and nationalizing Citibank and BofA may predictably weaken Goldman, Morgan and JPM to the point where they too "require" nationalization.

For example, the administration initially floated the idea of offering banks guarantees against losses on troubled assets. This would have been a great deal for bank stockholders, not so much for the rest of us: heads they win, tails taxpayers lose.

Now the administration is talking about a “public-private partnership” to buy troubled assets from the banks, with the government lending money to private investors for that purpose. This would offer investors a one-way bet: if the assets rise in price, investors win; if they fall substantially, investors walk away and leave the government holding the bag. Again, heads they win, tails we lose.

Krugman's arguments here are blatantly dishonest. Earlier he observed the motivation for government involvement as avoiding a Lehman style implosion and Japanese style zombie banks. As that is the case, taxpayers wins and losses are measured by whether implosion is avoided and credit starts flowing again.

Also the public-private partnerships being discussed are not the simplistic heads they win, tails we lose scenario Krugman dishonestly describes.

To take a concrete example, lets say there is an asset that right now a bank will sell for $100, but outside investors would only buy for a far lower price, say $25. Which leads to it being stuck on the bank balance sheet inhibited lending.

The government is offering to finance ~90% of the purchase price of such assets which dramatically raises the price outside investors are willing to pay (the cost to the investor is now 10% * $100 + interest on $90). If an investor is now willing to buy the asset, the bank has cash instead of a toxic asset on its books and the amount of money it can lend out is increased (which is, for Krugman, a win).

The investor has put down $10 of their own money and borrowed $90. So long as the asset retains most of its value the investor will repay the loan and the government profits. If the asset value drops more substantially, the investor may walk away from the loan and leave the government holding the asset, which it, in effect bought for 9/10ths the asking price. The asset may well, at that point be worthless, but it also may have the capacity to recover with the government now owning the upside.

Contrast this with the nationalization Krugman desperately prefers. If the government seizes the bank, it now owns this asset. To restore the bank to health -- Krugman's avowed goal -- entails either writing the value of the asset down to near zero or selling the asset into the market. (Either action is likely to create further downward pressure on still-surviving banks.) The market is only willing to buy the asset at $25. (In the case of the nationalized Swedish banks, the government actually offered guarantees and subsidies to the buyers of some assets.) To keep the bank well capitalized (its assets safely greater then its liabilities) the government would then have to make up for the $75 loss with public money, only some of which it would get back if it sold the bank back into market. If it writes the asset value down to near zero, and the perceived riskiness of the asset drops substantively while the bank is nationalized, the government does stand to make some return. Still, it will likely be a long time before the perceived riskiness of most of these asset drops substantively.

In sum, there is no strong reason to believe that nationalization stands to be a better deal for the taxpayer then alternatives that promise roughly the same outcome.

Why not just go ahead and nationalize? Remember, the longer we live with zombie banks, the harder it will be to end the economic crisis.

I am not sure what he wants us to remember. He never explained why this is the case, and I rather suspect it is not the case.

The longer we live with zombie banks, the more we learn to live in a world of constricted credit. The economy that will emerge from that world will be far more sustainable then the product of free-flowing credit.

How would nationalization take place? All the administration has to do is take its own planned “stress test” for major banks seriously, and not hide the results when a bank fails the test, making a takeover necessary. Yes, the whole thing would have a Claude Rains feel to it, as a government that has been propping up banks for months declares itself shocked, shocked at the miserable state of their balance sheets. But that’s O.K.

The stress test is, likely, more about politics then economics. In practice, the outcome of a stress test is controlled by embedded assumptions. It will be easier politically to seize a bank that fails the stress test.

And once again, long-term government ownership isn’t the goal: like the small banks seized by the F.D.I.C. every week, major banks would be returned to private control as soon as possible. The finance blog Calculated Risk suggests that instead of calling the process nationalization, we should call it “preprivatization.”

And once again, this is either foolish or dishonest. If the government seizes Citibank and BofA it will likely be "forced" in short order to seize the rest. And if the government seizes the sector its hard to imagine that long term government ownership isn't the most likely outcome.

To put my money where my mouth is, I'll offer Paul Krugman the following $1000 bet straight-up. If the government seizes Citibank and BofA, five years later, Morgan Stanley will be bankrupt or in government hands.

The Obama administration, says Robert Gibbs, the White House spokesman, believes “that a privately held banking system is the correct way to go.” So do we all.

Gibbs finished that phrase by calling for government regulation. The difference between regulation and ownership is a fuzzy one. Its not clear to me what control the government would have as owner that it does not have as regulator.

I suspect Obama understands this, which is why he isn't eager to nationalize the banks. He can control the banks entirely without bearing the political cost of nationalizing them.

But what we have now isn’t private enterprise, it’s lemon socialism: banks get the upside but taxpayers bear the risks. And it’s perpetuating zombie banks, blocking economic recovery.

What we want is a system in which banks own the downs as well as the ups. And the road to that system runs through nationalization.

We own the downs because we are overly dependent on the overflow of credit the banks provide. If the banks suffer, they tighten the credit we can't live without. The road to that system, then, leads to an economy that is less dependent on credit. Alternatively, perhaps, the road to that system leads to an economy in which the flow of credit is less dependent on the health of a few large banks. The reasons it does in our economy are less market or structural and more legislative/regulatory in nature.

Its hard to see how the road to either place runs through nationalization. It is hard to see any sensible argument explaining nationalization gets us to a place where banks own the downs.

Finally, to krugman, zombie banks block economic recovery because they don't extend the credit the economy needs. It is illuminating to review precisely how that works. Crudely: the large banks take cash from lenders and investors, they, generally, "lend" by creating securities backed by loans (which they either originate themselves or support a market for originators), which they mostly sell of to investors in exchange for cash, which they can put right back to work. Part of what is going on now is that there is a dramatically reduced market for these securities. There are a number of reasons for this including: the opacity of some of the most complex derivatives, dramatically increased sale of government-debt securities crowding out the market for private-debt securities, and, perhaps, above all, the market questioning the credit worthiness of borrowers.

This is, in other words, another question and egg problem. The return of credit requires the return of debt securities markets. It is unclear that it is zombie banks causing frozen debt security markets as opposed to frozen debt security markets causing zombie banks.

Uncle David

David Brooks, who spent the last 8 years as an apologist for the Bush administration, has found a new calling fawning over the new administration. Brooks appears, above all, beholden to, or at least, unseemingly enamored with, power.

In his latest column he writes:

Our moral and economic system is based on individual responsibility. It’s based on the idea that people have to live with the consequences of their decisions. This makes them more careful deciders. This means that society tends toward justice — people get what they deserve as much as possible

Over the last few months, we’ve made a hash of all that. The Bush and Obama administrations have compensated foolishness and irresponsibility...

The stimulus ... will almost certainly force people who were honest on their loan forms to subsidize people who were dishonest on theirs.

These injustices are stoking anger across the country...

Let me put it this way: Psychologists have a saying that when a couple comes in for marriage therapy, there are three patients in the room — the husband, the wife and the marriage itself...

In the same way, ... a common economic landscape emerges, which frames and influences the decisions everybody makes.

A few years ago, the global economic culture began swaying. The government enabled people to buy homes they couldn’t afford. The Fed provided easy money. The Chinese sloshed in oceans of capital. The giddy upward sway produced a crushing ride down.

These oscillations are the real moral hazard. Individual responsibility doesn’t mean much in an economy like this one. We all know people who have been laid off through no fault of their own. The responsible have been punished along with the profligate.

It makes sense for the government to intervene to try to reduce the oscillation. It makes sense for government to try to restore some communal order. And the sad reality is that in these circumstances government has to spend money on precisely those sectors that have been swinging most wildly — housing, finance, etc. It has to help stabilize people who have been idiots.

The way I remember it, "Moral Hazard" refers to policy that rewards, and therefore encourages, bad behavior. "These oscillations", Brook's mindless assertion aside, are of course, the opposite of a moral hazard, they are the natural consequence of our collective economic behavior.

Brook's seems to feel "moral hazard" is something akin to theodicy. To him, these oscillations present moral hazard apparently because the righteous are suffering. Were that the case, capitalism itself is a moral hazard -- doing the "right thing" improves ones chances, but does not guarantee, success. Even within his frame, his analysis is poor. In as much as we, as a society, tolerated -- and all, in the short term benefited from -- bad economic policies that led us naturally to where none among us is without sin.

In as much as these oscillations are the products of the invisible hand trying to return sick markets to health, its does not make sense at all for government to intervene to protect the disease.

Government can, of course, act to reduce the pain. The happy reality is that it can do so without showering money on Brook's "idiots". It can change tax policy to help good companies squeezed by unnaturally tight credit. Arguably, if it can be done in a reasonably fair and corruption-free manner, government ought to be lending directly. It certainly should be helping people who have lost their homes incomes and health care. Even some level of deficit spending on infrastructure projects.

In other words, we can all agree with Brooks, that government should help people -- including those who were irresponsible -- suffering in this economic downturn. But its hard to agree with Brooks that the government should be trying to preserve those economic structures that led us here. Concretely: Its hard to defend the proposition that propping up failed banks, and then demanding that they engage behavior they would otherwise themselves deem too risky and pouring 200 million more into Fannie Mae and Freddie Mac and increasing the riskiness of their portfolios are parts of the sensible way forward.

Actually executing this is a near-impossible task. Looking at the auto, housing and banking bailouts, we’re getting a sense of how the propeller heads around Obama operate... they seem to be driven by a spirit of moderation and restraint. They seem to be trying to keep as many market structures in place as possible so things can return to normal relatively smoothly.

What is apparent to Brooks, may not be apparent to all. Whatever drives policy like mortgage cramdowns it is neither the spirit of moderation and restraint nor a fundamental respect for market structures.

Of course, the nominally conservative Brooks apparently shares with Obama the belief that only the government can (best) address our current problems. The liberal Krugman disagrees with them. Of course, Krugman is, in his heart, an economist while they are both products of politics.

And they seem to understand the big thing. The nation’s economy is not just the sum of its individuals. It is an interwoven context that we all share. To stabilize that communal landscape, sometimes you have to shower money upon those who have been foolish or self-indulgent. The greedy idiots may be greedy idiots, but they are our countrymen. And at some level, we’re all in this together. If their lives don’t stabilize, then our lives don’t stabilize.

That is a rather perverse spin on it.

In the end, these people -- "our countrymen" -- run a protection racket. They hold our economic well being hostage to their over-sized profits. If we don't pay them off, we risk our store being burnt down.

Brooks, enamored with power, would make an odd virtue out of paying protection money or negotiating with terrorists.

In all these examples, the short term interest is contra the long term interest. It used to be that liberals, following Keynes, more privileged the short term against the long term and nominal conservatives were more willing to bear short term pain in the service of long term gain.

Babies With Candy II

As much as I have been hoping to hate on him, in Friday's column, Paul Krugman (mostly) sensibly extends and refines arguments from his previous column. That said, its still easy to see Krugman-the-partisan-columnist censoring Krugman-the-nobel-winning-economist.

...people at the Fed are troubled by the same question I’ve been obsessing on lately: What’s supposed to end this slump? No doubt this, too, shall pass — but how, and when?

To appreciate the problem, you need to know that this isn’t your father’s recession. It’s your grandfather’s, or maybe even (as I’ll explain) your great-great-grandfather’s.

Your father’s recession was something like the severe downturn of 1981-1982. That recession was, in effect, a deliberate creation of the Federal Reserve, which raised interest rates to as much as 17 percent in an effort to control runaway inflation. Once the Fed decided that we had suffered enough, it relented, and the economy quickly bounced back.

Your grandfather’s recession, on the other hand, was something like the Great Depression, which happened in spite of the Fed’s efforts, not because of them. When a stock market bubble and a credit boom collapsed, bringing down much of the banking system with them, the Fed tried to revive the economy with low interest rates — but even rates barely above zero weren’t low enough to end a prolonged era of high unemployment.

Its obviously not quite accurate to summarily characterize that the post-war recessions as because of the Fed's efforts. I rather believe that a meaningful understanding of the structural problems that brought us, almost inevitably, into the current mess requires a detailed understanding of progression (which is not quite the right term) of our economy from the late sixties on. Be that as it may, Krugman is, I suppose, entitled to a bit of creative license.

More interestingly, I seem to remember that during the Great Depression, in addition to the rough zero-interest-rate-policy Krugman mentions, the Government tried to revive the economy with some other set of programs that weren't enough to end that prolonged era of high unemployment. What was it called?

Oh yes: The "New Deal". Odd Krugman neglecting to mention it.

Now we’re in the midst of a crisis that bears an eerie, troubling resemblance to the onset of the Depression; interest rates are already near zero, and still the economy plunges. How and when will it all end?

To be sure, the Obama administration is taking action to help the economy, but it’s trying to mitigate the slump, not end it. The stimulus bill, on the administration’s own estimates, will limit the rise in unemployment but fall far short of restoring full employment. The housing plan announced this week looks good in the sense that it will help many homeowners, but it won’t spur a new housing boom.

Its not clear to me that Obama's rhetoric in selling the stimulus bill well-matches Krugman's lowered expectations. It is, in any case, not difficult to see in the above paragraph the conflict between Krugman-the-economist, who understands the stimulus bill to be minimally effective, and Krugman-the-partisan-columnist who is obliged to cheer his party's policy.

What, then, will actually end the slump?

Well, the Great Depression did eventually come to an end, but that was thanks to an enormous war, something we’d rather not emulate...

This is an improvement from his last column when he seemed to imply we should be considering policy to parallel WWII.

So will our slump go on forever? No. In fact, the seeds of eventual recovery are already being planted.

Consider housing starts, which have fallen to their lowest level in 50 years. That’s bad news for the near term. It means that spending on construction will fall even more. But it also means that the supply of houses is lagging behind population growth, which will eventually prompt a housing revival...

The same story can be told for durable goods and assets throughout the economy: given time, the current slump will end itself, the way slumps did in the 19th century. As I said, this may be your great-great-grandfather’s recession. But recovery may be a long time coming.

The closest 19th-century parallel I can find to the current slump is the recession that followed the Panic of 1873. That recession did eventually end without any government intervention, but it lasted more than five years, and another prolonged recession followed just three years later...

Its almost as if Krugman read my post on his last column!

Its worth noting that five years is a long time, but that the Great Depression did last longer. Its obviously not an apples to apples comparison, but superficially it would appear that the more active Government policies of the 1930s did not serve to shorten, or substantially mitigate, that downturn.

Krugman-the-economist, more or less, directly disagrees with the President who argued that "the federal government is the only entity left with the resources to jolt our economy back into life." But Krugman-the-partisan-columnist is always at the ready:

Let’s be clear: the Obama administration’s policy initiatives will help in this difficult period — especially if the administration bites the bullet and takes over weak banks. But still I wonder: Who’ll stop the pain?

,

Babies With Candy

Heretofore my posts have been sort of whatever-grabbed-my-attention. I think the blog would be better was posting more systematic. To that end, I introduce, what I hope will be the first of many recurring topics: Babies With Candy.

The theme of this topic is to comment, hyper-critically, on Paul Krugman's NY Times columns, to argue generally that he is more then a bit of a hyper-political fraud of an economist. The title of the topic stems from my sense that the task isn't particularly difficult.

Unfortunately for me, I am mostly in agreement with his latest column Decade at Bernie’s. Anyways, without further ado:

By now everyone knows the sad tale of Bernard Madoff’s duped investors. They looked at their statements and thought they were rich. But then, one day, they discovered to their horror that their supposed wealth was a figment of someone else’s imagination.

Last week the Federal Reserve released the results of the latest Survey of Consumer Finances, a triennial report on the assets and liabilities of American households. The bottom line is that there has been basically no wealth creation at all since the turn of the millennium: the net worth of the average American household, adjusted for inflation, is lower now than it was in 2001.

At one level this should come as no surprise. For most of the last decade America was a nation of borrowers and spenders, not savers...

Yet until very recently Americans believed they were getting richer, because they received statements saying that their houses and stock portfolios were appreciating in value faster than their debts were increasing. And if the belief of many Americans that they could count on capital gains forever sounds naïve, it’s worth remembering just how many influential voices — notably in right-leaning publications like The Wall Street Journal, Forbes and National Review — promoted that belief, and ridiculed those who worried about low savings and high levels of debt.

Krugman is certainly correct in arguing that we should have borrowed less and saved more. He is also certainly right that its worth remembering who encouraged such irresponsible behavior. In as much as American personal indebtedness begins with student and home loans, it silly to suggest that the chorus was strictly on the right. More productive then looking back, of course, is looking forward. For example, which congressman were demanding of Bank CEOs that they lend more.

Then reality struck, and it turned out that the worriers had been right all along. The surge in asset values had been an illusion — but the surge in debt had been all too real.

More accurately: The surge in asset values was a partial function of the surge in debt. (It was also, in part, a function of the Fed's easy monetary policy.)

So now we’re in trouble — deeper trouble, I think, than most people realize even now. And I’m not just talking about the dwindling band of forecasters who still insist that the economy will snap back any day now.

For this is a broad-based mess. Everyone talks about the problems of the banks, which are indeed in even worse shape than the rest of the system. But the banks aren’t the only players with too much debt and too few assets; the same description applies to the private sector as a whole.

And as the great American economist Irving Fisher pointed out in the 1930s, the things people and companies do when they realize they have too much debt tend to be self-defeating when everyone tries to do them at the same time. Attempts to sell assets and pay off debt deepen the plunge in asset prices, further reducing net worth. Attempts to save more translate into a collapse of consumer demand, deepening the economic slump.

With this, I am in perfect agreement and have posted similarly here.

Its worth, in this vein, noting the effect of easy credit + leveraged buy outs on the economy. The banks did not only lend recklessly to consumers, they lent recklessly to private equity. These shops used the easy money available to buy healthy businesses, raid them of their cash, and saddle them with debt, that they are now, increasingly, unable to repay.

Are policy makers ready to do what it takes to break this vicious circle? In principle, yes. Government officials understand the issue: we need to “contain what is a very damaging and potentially deflationary spiral,” says Lawrence Summers, a top Obama economic adviser.

In practice, however, the policies currently on offer don’t look adequate to the challenge. The fiscal stimulus plan, while it will certainly help, probably won’t do more than mitigate the economic side effects of debt deflation. And the much-awaited announcement of the bank rescue plan left everyone confused rather than reassured.

If the situation is as dire as Krugman describes, why-does-he-believe-that/in-what-way-will an inadequate (and somewhat unfocused) stimulus plan will help at all?

Its also not clear to me that some deflation is not a good, or at least necessary, thing. Can prices be sustainably maintained at levels that were artificially inflated by unsustainable lending practices (and monetary policy). A little deflation might bring us closer to more sustainable price levels. Put differently: Would the economic shock and awe that the administration has planned and Krugman deems inadequate be more effective were it aimed at preserving more sustainable price levels.

There’s hope that the bank rescue will eventually turn into something stronger. It has been interesting to watch the idea of temporary bank nationalization move from the fringe to mainstream acceptance, with even Republicans like Senator Lindsey Graham conceding that it may be necessary. But even if we eventually do what’s needed on the bank front, that will solve only part of the problem.

On some level, it does, generally, seem like a government run sorting out, in which some banks a scrubbed and blessed as healthy and others are forced out of business may be the least bad option available. However politicized, corrupt and wasteful the process is bound to be, there are worse outcomes if you are left, at the end, with at least some reasonably healthy banks.

On the other hand, I think there is good reason to fear that the scrubbed, newly healthy banks, will as quickly as they can -- and with the encouragement of government -- get back into the business of making reckless loans they haven't the skill to manage. That, especially as they will be survivors of a government scrubbing, the will be far more attentive to regulator- and legislator- than risk- management.

If you want to see what it really takes to boot the economy out of a debt trap, look at the large public works program, otherwise known as World War II, that ended the Great Depression. The war didn’t just lead to full employment. It also led to rapidly rising incomes and substantial inflation, all with virtually no borrowing by the private sector. By 1945 the government’s debt had soared, but the ratio of private-sector debt to G.D.P. was only half what it had been in 1940. And this low level of private debt helped set the stage for the great postwar boom.

Since nothing like that is on the table, or seems likely to get on the table any time soon, it will take years for families and firms to work off the debt they ran up so blithely. The odds are that the legacy of our time of illusion — our decade at Bernie’s — will be a long, painful slump.

One interesting thing about Krugman -- captured above -- is the way as an economist he seems to feel some professional obligation to write accurately even while, as a partisan columnist, covering over the truth in a politicized attempt to mislead his readers.

To recognize that it was WWII that pulled the US out of the Great Depression is to acknowledge that the New Deal was fundamentally ineffective (although he no doubt believes it "certainly" helped). Branding WWII as a "large public works program" rhetorically covers over the failure of the New Deal.

Identifying WWII as a "large public works program" is, of course, more spin then reality. During WWII the economy was effectively nationalized and many people -- draftees -- were coerced into working. The implication that he would prefer to see some parrelel option on the table is a bit perverse.

More fundamentally, if it is true -- as Krugman claims -- that given time, even without coercing labor, families and firms can work off their debt and that will lift us out of our slump, its why was WWII required to lift us out of the Great Depression? It started more then a decade after the stock market crash. Shouldn't we have been able to lift ourselves out of the depression without it?

The depression of the 1930s was, of course, neither the first, and apparently not the last, depression we have experienced. Nor was it the shortest historical depression. The simple truth, covered over in Krugman's column, is that we got out previously without "large public works programs" and we can do so again.

The conservative claim, with which Krugman-the-economist apparently agrees, is that free markets are intrinsically self-correcting and regenerative. That, given the time and opportunity, free people making free choices will rebuild vibrant economies out of the carcasses of dead ones. It follows that that ham handed intrusive Government economic meddling can crowd out private initiative and dampen the regenerative process. It is easy to see that happening now. Conservatives, though not Krugman, attribute the failure of the economy to recover in the 1930s to this.