Five Things About the Economy on Which We Should All Be Able to Agree

So, another day, another plunge in stock prices, another wave of aspiring moochers descending on Washington, and another God-knows-how-many billions set to be doled out under the Treasury’s “TARP” program.  (“TARP” is an acronym, of course, which stands for “Totally Arbitrary Rewards and Penalties.”  The goal of the program is to render unreliable the economic signals that have guided business activity for centuries, like interest rates, or profits or the lack thereof.  By replacing these traditional signals with totally arbitrary rewards and penalties, policy makers can simultaneously pretend to “rescue” one group after another while vastly expanding their power over the livelihoods of private citizens.)

Treasury Secretary Paulson, who in September told us that buying troubled assets from investment banks was the only way to avoid a total financial meltdown, now says that buying troubled assets was not the only way; in fact it wasn’t really a very good way after all so it’s time to try something different.  Apparently, Treasury is going to buy good assets rather than bad ones.  If the assets are good, I’m not sure why government needs to find a buyer for them; nor do I understand what this is supposed to accomplish except to give banks money, but this sort of vacillating “Hey, what if we try this” economic policy is more or less how FDR got through his first term from 1933-1937, so at least we know approximately what kind of results to expect.

auto-parachuteMeanwhile, President-Elect Obama wants President Bush to say yes to an auto industry bailout, which would make it easier for President Obama to say yes to other bailout requests in the future, but at the cost of making it much, much harder for him ever to say no.  And the fact that we don’t actually have any money to give away — which someone visiting from another time or place might well consider to be an insuperable obstacle to these plans — is instead considered completely irrelevant by nearly everyone involved.

In times like these, I find myself so out of step with the public debate that it’s downright disorienting.  In an effort to regain my bearings, I’d like to toss out five statements about the economy on which I think we should all agree.  Please, please, please respond if you disagree with any of them:

  1. Government does not know how many loans should be made or to whom.  This is not because government is bad; it is because no single actor can know this.  Henry Paulson doesn’t know, Robert Rubin doesn’t know, and Warren Buffett doesn’t know.  If it were possible for the government to manage the economy effectively through central planning, we’d do it all the time instead of just during crises like the present one.  The reason we don’t is because history has conclusively demonstrated that it does not work.
  2. All credit is debt.  If you have too much debt, more debt won’t solve your problems.  Therefore, if you have too much debt, more credit won’t solve your problems.  Credit can, however, mask the problems and postpone the time when you have to deal with them.
  3. Not everyone has too much debt.  Some banks are not overleveraged.  Some non-financial firms are perfectly capable of meeting payroll without drawing on lines of credit.  Some automakers actually produce good cars and earn healthy profits for doing so.  Bailing out failing firms keeps capital in the hands of people who are using it rather badly and keeps it from finding its way to others who either are already using capital well, or who wish to risk their own money on the chance that they can use the capital better than its current stewards.
  4. There may be good reasons for departing from market outcomes, but they are not economic reasons.  For example, we may redistribute money toward the poor in order to help the poor, or we may impose tariffs that make imported goods more expensive so that it is profitable to keep manufacturing them here.  We may even keep unprofitable automakers out of bankruptcy to avoid riots in Detroit.  But in all these cases, we are pursuing a social goal; we are not by any stretch of the imagination helping the economy.
  5. We could print up enough new currency to give every man, woman, and child $1 trillion, but that wouldn’t stimulate our economy in any way worth mentioning and it wouldn’t make anyone better off.

Can any of this really be controversial?  And if not, what the Hell is going on?

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10 Responses to “Five Things About the Economy on Which We Should All Be Able to Agree”

  1. Sonic Charmer Says:

    I don’t disagree with any of those. The problem is that elite opinion makers/intelligentsia seem to.

    1. They think they know how many loans should go where. So, for example, they will point out as if in self-evident critique that such-and-such group of people is getting fewer loans than so-and-so other group.

    2. They think credit can solve problems; you just have to mask the problems with a sufficiently long time horizon that no present electorate is ever allowed, let alone motivated, to deal with them.

    3. Keeping capital in the hands of people who do not use it maximally effectively (for example: them; or at least: the government) is intrinsic to their ideology.

    4. They make no sharp distinction between economic and social goals.

    5. They might actually be in favor of a $1 trillion EITC.

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  3. Timothy Peach Says:

    Imagine a world where, in every building, three out of every four bricks suddenly vanished. What would happen?

    That’s a little exaggerated, but in the financing world, that’s what has happened. 40 for 1 leverage is being replaced by 10 for 1 leverage over an astonishingly short period of time. 3 out of every 4 dollars of financing are vanishing.

    Two choices on how to do this:

    (1) The way Japan did, total denial. You get decades of grind down. Ugly and dementing. Plus it won’t work since we don’t have any US out there to balance the world out.

    (2) Just letting it all fall down (sort of what you’d prefer). No one knows what happens under this scenario exactly, but a quick analysis of the interconnectedness of things leads one to expect the complete collapse of the global financial system, an extended depression, and likely another World War, since folks rarely absorb the blame for domestic riots. They go get other peoples’ stuff to placate their masses and give them something to do (making guns and bombs, etc).

    (3) You try to cushion the fall with cheap money and bailouts. In a world where not getting a third widescreen TV is seen as poverty, this is the only choice possible.

    Under program 3, the best you can really hope for is to create more gentle stair steps down to the delevered world we need to get to, trying to salvage as much confidence in the integrity of the system as possible.

    So now to your postulates:

    1) This is true, they don’t know because no one can solve an equation in 100,000 variables. It’s as silly as thinking global warming is understood. The government should be making chunky judgments about who is “too big to fail”, like GM for instance, and letting the chips fall where they may otherwise. Is this “fair”? We need to stop asking that. It’s not relevant. And we need to stop worrying about the moral hazard. GM shareholders have been destroyed, as an example, and no bailout will fix that.

    2) Additional credit should only be extended where it is reasonably concluded that extending it will allow the recipient to survive and pay back the credit, or where not extending it will create so much collateral damage that it’s cheaper to extend it. Otherwise you are absolutely right — better to let the debtor go down. (P.S. George Bailey is going to leave a flaming bag of dog-doo on your doorstep for being a hardass about this.)

    3) True, but in a total collapse scenario, everyone ends up having “too much debt” (which is always an environment-calibrated notion, of course). No one can repay anything. Except for bodegas and lemonade stands, everyone depends on some level of credit to run their business, and almost everyone else at a minimum is “borrowing” on their expectation of continuing employment to maintain any asset at all (e.g. house and family).

    4) Here’s where the rubber meets the road. A functioning economy IS a social good. Ayn Rand thinks that pure economic Darwinism is an end in itself, but does any reasonable person? Maybe Ron Paul subscribes to this bizarre rule-based religion, but that’s about it. One should only believe categorically in “laissez faire” economics if one also believes that that really is the most likely way to have a healthy economy in all circumstances. Otherwise it’s just some sort of odd cult like extreme Dungeons and Dragons where if you roll 5 20’s in a row, you literally have to kill yourself. When the fifth 20 comes up, do you really actually do it? There is nothing intellectually inconsistent about saying that in normal times, the best thing to do is stay out of it, but in extreme times, all bets are off — social goods have to come first. The alternative is kind of like these quants looking at their screens insisting that what is happening really isn’t, because their model said it was a quadrillion to 1. Guess what dude — it wasn’t a quadrillion to 1, your model was wrong.

    5) Sometimes fun has to come first: http://www.marketoracle.co.uk/images/zimbabwe-billion-dollar-notes.jpg

  4. Mark Grannis Says:

    Welcome, Sonic, and thanks for the comment and the link.

    Tim, it seems to me the “vanishing dollars” in your set-up are an important feature of your overall view. I keep meaning to write a stand-alone post on the process by which money is “created” and later “vanishes.” But today’s not the day for that, so let me limit myself to observing that George Bailey had skin in the game. It was his own Savings & Loan and his own money, and he held onto the loans he made. I’m all for that. Thus, as far as public policy is concerned, your dichotomy between letting debtors fail and rescuing debtors is a false one. The choice we really face is whether we want to leave the extension of additional credit to people who are risking their own money, or whether we should instead allow the government to do it with other people’s money. The option that extends the most credit also happens to be the option that will make the worst underwriting decisions. Many of us think that is no accident.

    Furthermore, neither I nor anyone else I know of is saying that we shouldn’t pursue social goods like the alleviation of poverty or the strengthening of the manufacturing sector — only that we should acknowledge that what we’re doing is spending some of our resources on a goal that is in conflict with economic efficiency and which therefore makes our overall economic performance weaker.

    Why does truth in labeling matter here — practically speaking? Because if you bill these interventions as ways to “stimulate growth” or “create jobs,” the logical conclusion people should reach is that we should do as many of them as we can think of. On the other hand, if you tell the truth and acknowledge the tradeoff, then we can behave like responsible adults. The truth is that drags on the effective functioning of the market economy cannot be multiplied indefinitely. The engine can only pull so many cars. Overwhelming majorities of us will gladly “carry” some burdens: for the poor or infirm; for national defense; for clean water, clean air, highway safety, and more other public goods than we can name. But preserving equity for GM’s shareholders is way down near the bottom of my list, and letting the United Auto Workers avoid renegotiation of their contracts in a bankruptcy reorganization is not much higher. I can live with being outvoted by my fellow citizens if they feel it’s worth carrying GM and/or the UAW, but I would at least like the public debate on the issue to be honest. Saying that bailing out GM is actually good for the economy is not honest.

  5. Timothy Peach Says:

    That’s not right. Saving GM in a holistic sense is good for the economy, because not doing it will trigger a global depression.

    That creates a whole new class of “irresponsible” debtors who were, in a different environment, perfectly responsible.

  6. Mark Grannis Says:

    “Holistic” my hind end. Yes, we are all connected. No, that does not mean that a catastrophe for the auto industry entails catastrophe for all. I commend your boldness in offering a new prediction about what will or won’t trigger a global depression the day after the chief peddler of the last such prediction reversed course, but with all due respect I can just as easily say that saving GM is “in a holistic sense” bad for the economy because it will delay the mass-production of electric cars and other vehicles that people really want to buy. Neither your holistic evaluation nor mine is worth a tinker’s cuss.

    Go back and re-read postulate #1, then generalize it for the auto industry. You can’t even begin to argue that saving GM is good for the economy unless you know what would happen to the assets after bankruptcy. And no one knows that. What we do know is that bankruptcy allows either (a) reorganization of the business on terms that allow it prosper; or (b) transfer of the business’s assets to their highest alternative use. Either of those outcomes might easily produce either more cars or more planes or more of something else, not to mention more jobs or higher wages.

    “Capitalism” is less an ideology than a process — a characteristic it shares with democracy. We remain committed to the democratic process even when it produces results we’d like to avoid, because we know there’s no such thing as negating the will of the electorate by fiat “just this once.” Overriding market outcomes by fiat is not as binary because the economy is so vast and diverse, but a governing philosophy that does this as often and as extensively as we have been doing is ultimately just as destructive.

  7. Tim Naughton Says:

    “Saving Detroit” will not save Detroit. Let Bankruptcy law sanitize the assets sitting in Detroit and serve them up for re-deployment. If an investor can make those assets operate to build better cars post-Bankruptcy, rest assured they will. Otherwise, Toyota, Honda and Nissan, Hyundai, etc., will build and sell more cars. Giving them money in exchange for promises to build more environmentally friendly cars is a joke. The companies who want that market are pursuing it. Those who do not, have not. In Bankruptcy, the GM investments in that area (and according to 60 Minutes they are substantial), will get sold to the highest bidder. The union contracts meanwhile, will shrivel up and die.

    Remember, one factor that affects the # of troubled loans is, what is your target? “Financially in distress?” By what combination of the 1,000 possible variables will you measure that. TARP is a failure because banks have to take pain(discounts in value; executive comp limitations), in exchange for TARP relief.

    “In lending, the lender can only lose or tie.” [Al Lerner, late owner of the Browns.] The money either will come back, or it won’t. The collateral either is sufficient to pay off the loan, or it is not. (In theory therefore, no one, no one has a higher incentive than the lender to get this right.) One can address “too much debt” ten or more different ways. By granting borrower relief, you free them up. Some thereafter will perform. Others will dither. So far, no Treasury plan has blocked dithering. IF THEY COULD, I submit postponement / other borrower relief would be good right now. (So also good would be reinstating interest expense tax deduction, stricken by the Tax Reform Act of 1986.)

    You depart from market-driven outcome when you do not like the outcome. Home purchases are being delayed, and housing prices are being driven down in part, by the threat of foreclosures. This is long overdue, given both the baby boomer shift out of family home ownership and the overall artificial inflation of housing prices due to artificially low interest rates, as the fed left rate too low for too long. It may not help the economy, but I am working my azz off, and I would love to see my house not lose value right now. So, do it for Tim.

  8. Timothy Peach Says:

    Granulous, such language.

    GM needs a bailout. But not a TARP-style bailout. They need a pre-packaged bankruptcy with the gov’t supplying the DIP financing.

    This would permit GM to permanently change its cost structure. The unions would get stuffed, but jobs could be saved, and manufacturing could stay in the US on a viable basis.

    That’s what I meant. GM was failing when the economy was fine. As is, it’s an unfixable mess. The UAW cannibalized it. (I think it’s great Obama wants to spread that cannibalization everywhere.)

  9. Brian Freeman Says:

    Another example of the potential collateral effects of the potential GM/Ford/Chrysler hand-out that go a step beyond the potential “make green cars” smiley-face condition that Tim Naughton cites above: according to the environmental biz trade rags that I see at work, environmental activitist groups are lobbying hard for any hand-out to be conditioned on the automakers withdrawing certain lawsuits trying to prevent California from creating auto emission regulations inconsistent with federal standards.

    Whether you support those lawsuits or not, whether the lobbying actually succeeds or not: private companies will likely feel pressure to pull back on actions which they’d previously thought to be necessary to protect their legal interests, and which are wholly unrelated to the stated aims of the hand-out. In First Amendment law, there’s a analogous syndrome known as a “chilling effect.” In a hand-out context, it’s more a neutering effect. Not a good thing for either government or markets.

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