More Bad News

From Matt Yglesias,

The only way to clean [Financial Crisis] up on a tractable time frame is to take insolvent banks into receivership, explicitly pay off enough outstanding bank obligations to get things in decent shape, break up and reprivatize new healthy institutions, and manage “legacy assets” for the long-run.

But basically nobody wants to do this. Obama and congressional liberals want to focus on their core agenda—health care, energy, labor law, education. Republicans don’t want to appropriate money. And bank managers want to continue to take advantage of implicit government guarantees and recapitalize themselves out of operating profits while paying themselves multi-million dollar strategies. Given enough time, that should work. But it could easily take years and give us a prolonged period of sluggish growth.

The political economy here is really messed up.  Because the government cannot spend enough money or muster the political capital to really deal with the banking crisis, the problem continues to fester.  But because the government has some influence, it tries desperately to prevent institutions from failing, and so throws money around, preventing the banks from bothering to solve the problem themselves.  Continued political meddling from Congress makes any private actor very reluctant to trust government policies.

I suspect that had the government taken a clear stance early on not to bail out financial institutions, we would be in a much better place.  In the end, how bad was Lehman's failure?  We've already endured all of the problems that would supposedly happen if banks failed.  Without implicit government guarantees, and government meddling, people on their own would have much bigger stake to solve the problems themselves.  

But if you are going to bring the government into it, you might as well do so in a way that manages to fix the problems, while not risking taxpayer money.  That's not happening.

The Republicans/populists now stand in the way of the kind of spending and policies necessary to fix the banks.  But the Democrats too are unfocused on the problem, preferring to capitalize on the crisis to pass sweeping reforms on the domestic front rather than solve the crisis.  As the economy fails to recover, because we will still have a financial crisis, these debts will pile up.  And they will be inflated away at massive cost to ordinary Americans.  

Bank Nationalization

From the WSJ:

We've come to this pass in part because the Obama Administration is afraid to ask Congress for the money for a meaningful bank recapitalization. And it may need that money now in part because Mr. Paulson's Treasury insisted on buying preferred stock in all the big banks instead of looking at each case on its merits. That decision last fall squandered TARP money on banks that probably didn't need it and left the Administration short of funds for banks that really do.

The sounder strategy -- and the one we've recommended for two years -- is to address systemic financial problems the old-fashioned way: bank by bank, through the Federal Deposit Insurance Corp. and a resolution agency with the capacity to hold troubled assets and work them off over time. If the stress tests reveal that some of our largest institutions are insolvent or nearly so, it's then time to seize the bank, sell off assets and recapitalize the remainder. (Meanwhile, the healthier institutions would get a vote of confidence and could attract new private capital.)

Bondholders would take a haircut and shareholders may well be wiped out. But converting preferred shares to equity does nothing to help bondholders in the long run anyway. And putting the taxpayer first in line for any losses alongside equity holders offers shareholders little other than an immediate dilution of their ownership stake. Treasury's equity conversion proposal increases the political risks for banks while imposing no discipline on shareholders, bondholders or management at failed or failing institutions.

Populist anger is building, and will soon be so strong as to prohibit any useful action to save the economy from taking off.  Obama needs to get on TV right now and build political capital to make the unpleasant and necessary spending to fix the banking sector while he's still popular.  

Instead, he's saving a few million here, overhauling the autos, etc etc.  Fixing the banks should have been the priority for the last year.  It's a lot more important than the million and one commitments the government has recently entered into.  And Geither has neither the money or people to do his job.  We're tracing one by one the steps Japan took into its lost decade.  

 

Freshwater Economists

This is getting a little out of hand--Brad DeLong and Krugman know more about Chicago economic theory than Chicago economists.  I'm not a fan of the Treasury's plan to fix the banks--I don't think anyone is--and I'm fairly mistrustful of the stimulus as passed.  The administration's plans on energy, healthcare, and education leave me a little worried.

But even more scary is the complete lack of credible opposition.  A world in which Cochrane and Lucas are apparently willing to have the government do nothing about a massive credit crunch and economic downturn is one that spells complete intellectual disrepute for the conservative movement.  Add the fact that the media foot soldiers--your Rush Limbaughs and so forth--are completely radioactive.  And then that Republicans in Congress can't think beyond spending freezes, and apparently don't realize that Americans want affordable healthcare.  

Sure, Republicans will win again after liberal overreach.  But the quality of that governance will depend on people thinking now about how to apply their principles to pressing issues.  

No More Brain Research!

I'm not sure why I keep bothering with this, but there's another neuroscience article going around on how poverty causes stress which causes inter-generational poverty; a fact that scientists discover by peering into stress levels in the brain.  

I don't even care for the moment whether the causal link is true or not; for all I know, it may be.  The broader point is that things can be real without you finding where they are in the brain.  Moreover, you finding a correlation between something in the brain and something in the real world does not let you ascribe full causal force to the thing in the brain.  And if you want to link the thing in the brain to future poverty, you might as well actually test that link, instead of saying "it hurts working memory by a little!  Our work is done."  Plus, how many interesting dynamic things are the in the world, where, say, poverty changes or income changes or something happens.  This kind of stuff happens all of the time.  Notice how you can explain exactly none of those changes using something that is a fixed human constant.  

This stress thing is really popular among people who study healthcare too.  But there's really nothing you can do about stress without radical social engineering.  On the other hand, there are a million and one interventions you can think of on education and healthcare that can radically improve both.  DC's voucher program, for instance, improves kids reading scores by a half grade. Except that program just got killed by Congress.  Awesome.  

Defense Cuts

If Gates gets away with his sweeping budget cuts in Defense spending, I'll be really happy. Cutting the F-22? Cutting white-knight, pie in the sky projects like the Future Combat Systems? Cutting missile defense spending? That's amazing. It'll be even more amazing if this can survive Congress.

Unfortunately, Defense spending is still going up, because spending on unconventional wars is rising. Obviously some of this is necessary for Afghanistan and Iraq. But how much of that reflects the conflicts America will get into after these wind down? One school of thought suggests that American strategic interests will demand future interventions in failing states to curb instability and terror. This is no doubt what will actually happen.

Alternatively, people could set 'Defense Priorities' with actual resources in mind. We could say that sending soldiers into every last rotten country around the globe doesn't represent an affordable goal. We could say that Europe and South Korea can shoulder their own defense needs on their own, instead of piggy-backing on American tanks. They also depend on American pharma research because they've destroyed their own industry with price controls, and need to be gifted iPods because their firms are too lazy and their consumers too complacent to develop technology.

Anyway, back to the point: Serious draw-downs in military spending will only happen when the last neoconservative is strangled with the entrails of the last humanitarian hawk.

Post-Modern Journalism

People are concerned about trends in journalism which elevate partisan and political folk over your tried and true journalists.  It's true; the lines between objective media and normal, partisan, rabble-rousers are blurring.  But there are reasons to think that this was never a particularly strong link to begin with, and that breaking it may even have some good effects.

Consider all that we know from psychology about the impact of beliefs on behavior.  Even when the NYT puts up a solid, grounded article, the biases of the author are going to show up.  It's impossible to judge facts or events without a worldview, and it's better to be forthright about what that position is (like British newspapers, or American ones in the 19th century), than to studiously pretend that some sort of 'objective' middle ground can be reached.  

This is also part of the trend where we get rid of 'jounalists' who use their intrepid fact-finding abilities to ferret out the truth, regardless of the subject at hand or their initial knowledge.  Now, people can turn to actual experts (or smart lay-people) on the subject, who can communicate directly with readers instead of being intermediated by journalists.  I can't imagine a world in which the only news I had about the financial crisis came from the NYT, instead of, say, commentary from Brad DeLong, Tyler Cowen, and so forth.

Populist Outrage

Looks like Goldman Sachs is about to return its bailout money, as a number of other banks are about to do as well.  While Goldman might be doing fine, it points to a general problem: No one thinks that the banks are capitalized.  They're still short of capital, and billions of public dollars are necessary so that people trust the banking system and credit starts flowing again.  This is unpopular, but nothing short of ruining the taxpayer will prevent large-scale economic chaos.  

But that's not what people are focusing on, reflecting a lack of coherence across two administrations.  Paulson and Bernanke ignored the problem as long as they could, then came into Congress with the half-assed TARP plan.  This wasn't a great idea, but at least it did something--and was eventually used to pump in capital at a time after Lehman when people were really afraid about general collapse.  

Then six months passed, and the best government plan is still TARP, plus some private additions.  The ruckus over the AIG bonuses has destroyed whatever credibility that bailouts had in the first place, so Geithner is left cobbling together a solution without additional funds from Congress.  Nobody thinks this will be enough.  Worse, he's doing this while trying to create a new regulation regime, and has for months been working in an office which has been understaffed due to tight ethics standards for appointees.  Everybody else has been working on the stimulus package.

This is exactly the road Japan went down, and they found that nothing will get better until you tackle the banks, no matter how hard it is, or how much you work on rebooting the economy in other ways.  Everything can wait until the banks are fixed.