Monday, 19 September 2016

The Good, the Bad and the Ugly

is the title of Mervyn King's first chapter in his recently published The End of Alchemy (Mervyn King is the former Governor of the Bank of England). I yet have a few hundred pages left, so the review post will have to wait. However, since my professor during first day of classes brought up King's book as a must-read for this semester, the allegory is aptly and affectionately made.

My professor's intro lecture for this course on the Government & the Economy included fairly well-defined areas of exactly these elements: The Good, the Bad and the Ugly. Since we're on King already, let's start with the Good:

The Good

Having a post-GFC course on macro while neither discussing the real world of macro, nor the biggest elephant in the room  the last decade of financial turmoil – strikes pretty much anyone as awkward and slightly stupid. Therefore, I'm quite grateful that this initial lecture actually did discuss one of the most exciting developments in modern economics. The professor's references to King also gives the class an air of freshness and contemporary relevance – not to mention that when King speaks, we ought to at least listen. Overall, this course might not be entirely rubbish, after all. 

Further on, almost towards the end, he also indicated some variety in research about the stimulus package passed by U.S. Congress in 2009, showing first the CBO projections, followed by the CEA estimations and then some disputing research. That diversity of research and openness to multiplier fallacies was welcome indeed. 

The Bad

If I'm excited about this professor and the contents of the course, I could hardly say the same of his awkward and often outright incorrect statements. Let's start with his strange definition of "Systemic Crisis"  a situation where an (unspecified) large proportion of companies face (undefined) "distress" at the same time, which typically requires government assistance. I understand that he's trying to get at systemic-wide problems with large consequences like financial bubbles or the GFC, but most government actions in most countries for the last century or so qualify for this broad definition. Which begs the entire question, and raises the concern: What does a Non-Systemic Crisis look like, and what does even non-crisis look like?

To facilitate this claim and give the impression some apparent rigour, he presents us with a graph that shows the percentage of countries affected by "systemic crisis" over a longer period of time. It obviously spikes during the Great Depression and the 1970s, but is fairly low during the Golden Age, and then crazy-high again since the 1990s. The first reaction anybody presented with this graph has is: Well, isn't this simply an indication of inter-connectedness of the world economy? Global supply chains and instant communication simply means that regions cannot be isolated like the were in the past. That is, his graph neither measures what he intends it to, nor presents very convincing reasons for why "Systemic Crisis" would be an upward-sloping phenomenon (and hence relevant).

He moved on to discuss costs of the financial crisis, seriously stepping outside the bounds of our discipline and decides to proxy that aggregate, invisible and illusionary "cost" by direct bank recapitalisations. Really? As if that's the relevant metric? It's hardly even a cost, considering that most states resold that capital injection back to the private sector at considerable profits. When I questioned him, he admitted that it's not a very good metric, but since states took on debt to perform the bailouts, the burden on future taxpayers is still there. But not even that is entirely true, as can be seen by these numbers from Propublica: from a purely fiscal finance point of view the Gov seems to have been earning an overall profit on the bailouts and recapitalisation schemes.

Suffice to say, it's not the first time I've arrogantly thought "I can do this lecture better than this guy".

The Ugly

But it gets worse. Much worse.

He mentions "Housing Bubble", a minefield on which most people are bound to go wrong. Admittedly it was sort of off-the-trail, and he was showing us some standard Schiller statistics on real house prices over a long time period. But he neither discussed the criteria of bubbles, the disputing camps in the literature, if current generations may value housing differently than previous generations, nor any of the really interesting questions, like if we can explain current housing prices with fundamental factors (which most of the time we can). Instead he made a big deal out of default rates almost perfectly negatively correlate the fall of housing prices during late-2006, and portrayed subprime mortgages as The Big Explanation for how housing demand rose. He conveniently forgot to mention that subprime mortgages were never above 15% of outstanding loans  even less if weighted by value  and ignored the rather tiny increase in delinquent mortgage rates (a doubling of a very small number is still a very small number, as Ellenberg has taught us).

Then he mentioned how the U.S. government bailed out some institutions but not others, and that nobody knows why. Except we don't need to reach longer than chapter 12 of Bernanke's own memoir The Courage to Act and read his own words, since he explicitly answers that question (Lehman didn't have sufficient collateral nor direct link to Fed, whereas AIG & co did). Now, there's a fair amount of quite interesting discussions as to whether that's the full story or even true (see the New York Times, The Economist, the American Enterprise Institute) but it seems reasonably clear that Bernanke thought so.

And so the most infuriating part of the two hours. He brought up the fairy tale logic of the following two statements, as a way of preventing future crisis (of course presenting them as completely compatible):
  1. Private sector excesses combined with "Too-Big-To-Fail" forced Central Banks (and Treasuries) to intervene, bailing out and re-capitalize the financial sector, otherwise markets would tear themselves to pieces and society would collapse into Great Depression round 2. 
  2. To solve 1), we then introduce more regulation, accidently (intentionally...?) making the regulatory burden even heavier, which means that size becomes an even more important feature of financial businesses.
Let me explain. Large organisations with substantial compliance departments can more easily deal with the intricate and heavy regulations placed on them, giving large corporation an (unfair) advantage over smaller competitors. Big surprise, then, that we see particularly large firms in particularly regulation-heavy sectors such as financial markets. Hence, by invoking 2) in the naive belief that it somehow solves the financial sector-problem, we only end up making the problem of Too Big To Fail even worse – and so states have to intervene even more during the next crises, to prevent those TBTB firms from collapsing.

Mises' old claim is alive and well and highly relevant: that state interventions create new problems, and in order to solve those, you allegedly require even more interventions.

Or, as my friend Rok succintly put it did this morning: "Some people are just vaccinated against logic".

No comments:

Post a Comment