... is "change" ...
We're Not Headed for a Depression (Gary Becker, 10/7/2008):
In order to promote a much smoother functioning of the financial system, it is paramount to distinguish between the immediate steps needed to cope with the present crisis and the long-run reforms needed to reduce the likelihood of future crises. Let's start with the short-run fixes.
First of all, the magnitude of this financial disturbance should be placed in perspective. Although it is the most severe financial crisis since the Great Depression of the 1930s, it is a far smaller crisis, especially in terms of the effects on output and employment. The United States had about 25% unemployment during most of the decade from 1931 until 1941, and sharp falls in GDP. Other countries experienced economic difficulties of a similar magnitude. So far, American GDP has not yet fallen, and unemployment has reached only a little over 6%. Both figures are likely to get quite a bit worse, but they will nowhere approach those of the 1930s...
While the comparative strength of the real economy should be borne in mind, Becker's guess about the effect of the Bear Stearns bailout...
The moral-hazard consequences for banks receiving a bailout now is worrisome since they may expect to get rescued again by the government if their future investments turn sour. Yet while I find helping these banks highly distasteful, moral-hazard concerns should be temporarily relaxed when the whole short-term credit system is close to collapse. Still, the bank bill with its huge bailout does suggest that the $29 billion bailout of the bondholders of Bear Stearns in March was a mistake...
... makes the TARP (the big bank bailout bill) all the more worrisome. Nobody really knows, right now, what moral hazard problems we're creating, or what their ramifications will be. In itself, though, the bailout bill is not necessarily too expensive...
Taxpayers may be stuck with hundreds of billions of dollars of losses from the various government insurance provisions and government purchases of assets. Although the media has made much of this possibility through headlines like "$700 Billion Bailout," such large losses are highly unlikely except in the low probability event that the economy falls into a sustained major depression. Indeed, with efficient auctions, the government may well make money on its actions, just as the Resolution Trust Corporation that took over many savings-and-loan banks during the 1980s crisis did not lose much, if any, money. By buying assets when they are depressed and waiting out the crisis, the government may have a profit on these assets when they are finally sold back to the private sector. Making money does not mean the government involvement is wise, but the likely losses to taxpayers are being greatly exaggerated.
... and is it possible Paulson and Bernanke will see lessons in the Bear Stearns bailout and run this one better? (Not likely, though: too difficult.)
Becker is ultimately comparatively upbeat...
Is this a final "Crisis of Global Capitalism" -- to borrow the title of a book by George Soros written shortly after the Asian financial crisis of 1997-98? The crisis that kills capitalism has been said to happen during every major recession and financial crisis ever since Karl Marx prophesized the collapse of capitalism in the middle of the 19th century. Although I admit to having greatly underestimated the severity of the current crisis, I am confident that sizable world economic growth will resume before very long under a mainly capitalist world economy.
... as is a prominent Great Depression scholar, Lee Ohanian (hat tip Tyler). Take a look at these numbers:
Despite the September employment report, there are no signs that the economy is on the verge of a depression. Real GDP rose at an annual rate of 2.7% over the last five quarters, which is on trend, once a correction is made for the decline in the growth rate of the working-age population. Productivity growth remains rapid. Consumer installment borrowing, which represents most consumer nonmortgage borrowing, is up 5% year over year, and the interest rates on these loans are equal to, or below, the levels that prevailed over the last five years. Commercial and industrial loans are up 9% year over year. And to those with good credit histories, conforming mortgages are available at 30-year fixed rates of around 6%. That represents an inflation-adjusted mortgage rate that is low by historical standards. So the current financial crisis is not as deep or as broad as some have feared.
The weird thing is that so far we're not, conclusively, even in a recession (let alone a depression!). And here's a helpful dose of history:
Moreover, financial panics and crises are not as depressing as many believe. Current discussions point to the banking crises of the Great Depression as the best evidence that the financial crisis would devastate the U.S. economy. This is based on the very common misperception that the banking crises of the 1930s helped turn a garden variety recession into the Great Depression.
Banking panics did not create the Great Depression, nor did the elimination of panics via the introduction of deposit insurance generate economic recovery. The first banking crisis of any national significance didn't occur until the fall of 1931. Before this, there were regional banking crises that had no measurable impact on capital markets, as the spreads between Treasurys and risky obligations changed very little. However, the Great Depression was already "great" at this point -- industrial production and employment had fallen by more than 35%. The genesis of the Great Depression was not a banking crisis.
In a way, we rely too much on historical analogies. But it's inevitable: what else are we supposed to do? Maybe comparing the present to the Great Depression is the only way we can try to understand it, yet the fact that the real economy is basically doing just fine, so far, at least until quite recently, makes the analogy so remote that it can hardly be of much real use. Another difference is that the Fed's behavior is-- inevitably; there's a complete academic consensus here that the Fed could not but implement-- just the opposite of what it was then: they're pumping the economy full of liquidity. Milton Friedman and others blame the Great Depression mostly on the stupidity of the Fed, which shrunk the money supply sharply. So, if neither the performance of the real economy, nor the direction of policy, is similar, there's not much of an analogy to 1929 here. To extend the non-analogy further, there's been no run-up in the stockmarket, which has been treading water for a few years. On the other hand, the federal government-- Treasury and Congress, that is the democratic part of the government, as opposed to the Fed's insulated technocracy-- is also being very activist, which is not a contrast with the 1930s: Hoover was activist, too (as was FDR).
Note that there was a run-up in the stockmarket in the 1990s, which did resemble the 1920s. I think Bush ensured that the aftermath of the bursting of the tech bubble would be different than the aftermath of the 1929 stockmarket crash by being a vigorous Keynesian: cutting taxes, increasing spending, running a deficit. Did he just delay the damage? Still, the balance of evidence does not really suggest that the Great Depression was inevitable, even after the stockmarket crash. As Ohanian says:
There are many historical precedents of bad policies following crises. The worst case was after the stock-market crash in October 1929, which produced a truly perfect storm of bad policies. Tax rates rose, tariffs rose (reflecting special interest groups attempting to insulate domestic producers from foreign competition), and both Presidents Herbert Hoover and Franklin Roosevelt strongly promoted industry-labor cartels that were designed to stifle domestic competition.
In the absence of these policies, the Great Depression would almost certainly have been like every other U.S. recession -- short-lived and relatively mild. Normal recovery didn't begin until the most onerous of these policies were reversed, a process that didn't begin until the end of the 1930s when antitrust activity was resumed, and during World War II when the National War Labor Board reduced union bargaining power by limiting negotiated wage increases to cost-of-living adjustments only.
Bad polices impact the two most important determinants of living standards: output per worker and the amount of time devoted to market work. We need look no further than Western Europe to see how bad policies have depressed a number of advanced market economies. Hours worked per adult in the average Western European country have declined nearly 30% since the 1960s, as tax rates on labor are up 15 to 20 percentage points.
One thing Ohanian is right about: only governments can make Great Depressions. The myriad private-sector actors that comprise markets are just not powerful enough to do that much harm. I wonder, though, whether in the age of the internet and globalization it might be harder for governments to do as much harm as in the past. Free trade is critical right now, a lifeline; because economic integration pools the world's economic fortunes together to some extent, limiting the harms that can be done by one stupid government if other governments are smarter. Even better would be this recommendation:
What should be done? We should encourage the immigration of prime-age individuals. Beginning in 2007, net immigration fell to half of its level over the previous five years. Increasing immigration would increase the demand for housing and raise home prices. And note that the benefit would be immediate. Home prices -- and the value of subprime obligations -- would rise in anticipation of a higher population base. The U.S. particularly needs highly skilled workers. These workers not only would purchase homes, but would generate higher living standards for all Americans.
Absolutely! No single measure would be as brilliant right now as allowing more immigration, which could reflate housing prices without costing taxpayers. The benefits of a full-fledged don't-restrict-immigration-tax-it open-borders plan would far outweigh any losses in the latest turmoil. How long can we afford to turn our backs on this jackpot? The converse is also worth noting. The Bush administration has stepped up enforcement against immigration in the last couple of years. Result: less demand for housing; housing prices fall; mortgages go bad; banks fail. It's not the only reason... or, just maybe, it is. Anyway, it's a safe bet that the nativists are burning your money.
The bottom line, though, is: when the government has left the private economy to its own devices, or intervened in modest, traditional ways, we've sometimes had sharp recessions but we've always rebounded quickly. Whereas the 1930s were a time of dramatic and newfangled interventions, of, if you will, "change." We've been talking about change for the past year and a half, and we've sure seen a lot of it! Do we really want more?
MORE ("Obama and McCain are out of their depth"):
Similarly, the $US300billion mortgage relief plan completely contradicts McCain's central economic message of reining in government spending. McCain's plan is for the government to buy up bad mortgages, then renegotiate the loan with the home owner on the basis of the home's new low value.
This is extremely bad policy because it means that the greater the delinquency on the borrower's part, the bigger the government subsidy will be.
If you bought a house for $200,000 and it is now worth $100,000, but you still have your job and make your mortgage payments, you get nothing from the government. But if you bought a house for $400,000 that you could never possibly afford to pay off and it is now worth $200,000, you get the government to wipe off half your debt and you keep the house. In other words, the government gives you a huge gift of $200,000.
It's one thing to guarantee bank deposits: that is, to say people with positive bank balances won't lose their money if the bank goes bust. It's another and altogether bizarre thing to guarantee people's extravagant borrowing by abolishing their debts.
Indeed, it is so wacky, it is the first thing I've heard McCain say that seriously makes me doubt whether he should be president. (Of course, Obama also supports relief for people facing mortgage foreclosure.)
This is the vicious circle that could get us: economic problem => bad ideas => economic problems get worse. The threat of a new Great Depression doesn't come from economics, but politics.
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