Irish Economist Responds To Krugman

Constantin Gurdgiev has written a post called Replying to Prof Krugman at his "True Economics" blog. You may have read that Krugman said "Ireland had none of the American right’s favorite villains: there was no Community Reinvestment Act, no Fannie Mae or Freddie Mac." Professor Gurdgiev shows that there were many more similarities than Krugman suggested. The government did encourage risk taking that led to the credit crisis.

Why Financial Reform Is Stalled

That is the title of a 3-1-2010 WSJ article by PETER J. WALLISON (p. A 25). You can read it by clicking here. The brief synopsis is:

"Partisan gridlock is not the reason. The administration's plans are flawed, and they're encountering resistance from both sides of the aisle in Congress."

Here are the key exerpts:

"The administration appears to have begun its regulatory reform effort with the idea propagated by candidate Barack Obama that the financial crisis was caused by deregulation. There was never any evidence for this. The banks, which were in the most trouble, are the most heavily regulated sector of the economy and their regulation has only gotten tighter since the 1930s."

"So we have the spectacle of Paul Volcker, having recently persuaded Mr. Obama to back the idea of restricting proprietary trading by banks or bank holding companies, telling a puzzled Senate Banking Committee he can't really define proprietary trading but knows it when he sees it."

"The Fed had been regulating the largest banks and bank holding companies for over 50 years—among the very companies that would be considered systemically important—yet it failed to see the risks they were taking or the impending danger.'

"Wouldn't designating particular companies as "systemically important," and subjecting them to special Fed regulation, signal to the markets that these companies were too big to fail?"

"..."the administration says all large and "interconnected" financial firms in crisis should be dealt with by a government agency, rather than by a judge in bankruptcy proceedings.

The term "interconnected" is important here. It implies that when one large firm fails it will carry others down with it, causing a systemic crisis. But that is clearly not the lesson of Lehman. Although the company went suddenly and shockingly into bankruptcy, none of its large financial counterparties failed."

"To be sure, there was a freeze-up in lending after Lehman. But that episode demonstrated the power of moral hazard—the tendency of government action to distort private decision-making. After Bear Stearns was rescued by the Fed in March 2008, market participants assumed that all companies larger than Bear would be rescued in the future. As a result, they did not take the steps to protect themselves against counterparty failure that would have been prudent in a panicky market. When Lehman was not rescued, all market participants immediately had to review the credit standing of their counterparties. No wonder lending temporarily froze."

"And it is clear creditors will be treated far more favorably in a government resolution process than in a bankruptcy.

To understand why this is true, consider the administration's reasons for preferring a government resolution process. The claim is that large, interconnected firms will drag down others when they fail. The remedy for this is to make sure their creditors and counterparties are fully paid when the takeover occurs."

"Creditors will realize that by lending to large companies that might be taken over and resolved by the government, their chances of being fully paid are better than if they lend to others that might not."

"...as creditors increasingly assume that large firms will be rescued, the too-big-to-fail phenomenon will grow, not decline."

Did The February 2009 Stimulus Do Any Good?

Read The Stimulus Evidence One Year On: Over five years, my research shows an extra $600 billion of public spending at the cost of $900 billion in private expenditure. That's a bad deal by Robert Barro in the WSJ, 2-23-2010, page A19. Keynesian models usually show that a $1 increase in government spendng leads to a more than $1 increase in GDP. Barro disagrees, The key exerpts are:

"I estimate a spending multiplier of around 0.4 within the same year and about 0.6 over two years. Thus, if the government spends an extra $300 billion in each of 2009 and 2010, GDP would be higher than otherwise by $120 billion in 2009 and $180 billion in 2010. These results apply for given taxes and, therefore, when spending is deficit-financed, as in 2009 and 2010. Since the multipliers are less than one, the heightened government outlays reduce other parts of GDP such as personal consumer expenditure, private domestic investment and net exports."

"I estimate that an increase in marginal tax rates reduces GDP, particularly in the next year. When one factors in the typical relationship between tax rates and tax revenue, the multiplier is around minus 1.1. Hence, an increase in taxes by $300 billion lowers GDP the next year by about $330 billion."

"I suppose that the government collects an additional $300 billion of taxes in each of 2011 and 2012. The timing of the future taxes does not matter for the main calculations—the key point is that the government has no free lunch and must collect the extra taxes eventually. Since I assume a tax multiplier of minus 1.1, applying with a one-year lag, the higher taxes reduce GDP by $330 billion in each of 2012 and 2013.

We can now put the elements together to form a "five-year plan" from 2009 to 2013. The path of incremental government outlays over the five years in billions of dollars is +300, +300, 0, 0, 0, which adds up to +600. The path for GDP is +120, +180, +60, minus 330, minus 330, adding up to minus 300. GDP falls overall because the famous "balanced-budget multiplier"—the response of GDP when government spending and taxes rise together—is negative. This result accords with the familiar pattern whereby countries with larger public sectors tend to grow slower over the long term.

The projected effect on other parts of GDP (consumer expenditure, private investment, net exports) is minus 180, minus 120, +60, minus 330, minus 330, which adds up to minus 900. Thus, viewed over five years, the fiscal stimulus package is a way to get an extra $600 billion of public spending at the cost of $900 billion in private expenditure. This is a bad deal.

The fiscal stimulus package of 2009 was a mistake. It follows that an additional stimulus package in 2010 would be another mistake."

Mr. Barro is a professor of economics at Harvard University and a senior fellow at Stanford University's Hoover Institution.

Speculation Can Be A Good Thing

So says Darrell Duffie, a professor of finance at Stanford University's Graduate School of Business. See In Defense of Financial Speculation: It is not the same thing as market manipulation from the WSJ, page 2-24-2010, page A15. The key exerpt is:

"Speculators earn a profit by absorbing risk that others don't want. Without speculators, investors would find it difficult to quickly hedge or sell their positions.

Speculators also provide us with information about the fundamental values of investments. When the fundamentals appear favorable, they buy. Otherwise, they sell. If their forecasts are correct, they profit. This causes prices to more accurately forecast an investment's value, spreading useful information."

Creative Destruction Works As Blockbuster Loses Market Share

It seems like not that long ago Blockbuster was seen as the capitalist bully on the block or the evil empire. But market forces and competition are serving consumer needs. Read Blockbuster Plots a Remake form the WSJ, 2-24-2010, page B1. The key exerpt is:

"Blockbuster's plight comes amid major shifts in how people rent and watch movies. Consumers are now getting movies through Redbox, a unit of Coinstar Inc. that operates $1-a-night movie-vending machines in grocery stores and McDonald's Corp. outlets. Netflix Inc., a mail-order and online rental service, has also stolen Blockbuster customers. Consumers are also watching movies and TV shows through on-demand cable services and electronic gadgets such as Apple Inc.'s iPod."

In trying to eye-ball the numbers from the chart they provide, it looks to me that from 2004-7 then number of stores fell about 10%, even befor the recession started.

Some Good Ideas On Health Care

Go to A Better Way to Reform Health Care: The critical problem is rising costs. The solution is more competition and greater individual control over health spending. Here's how. From the WSJ, 2-25-2010, page A13. The key exerpts are:

"Right now, $5 out of every $6 of health-care spending is paid for by someone other than the person receiving care..."

"To reduce the growth of costs, individuals must take greater responsibility for their health care, and health insurers and health-care providers must face the competitive forces of the market. Three policy changes will go a long way to achieving these objectives: (1) eliminate the tax code's bias that favors health insurance over out-of-pocket spending; (2) remove state-government barriers to purchasing and providing health services; and (3) reform medical malpractice laws."

"...for most families, buying health care through an employer is 30%-40% cheaper than buying it directly. The best way to address this clear bias is by making all health spending—including out-of-pocket payments, purchases of individual insurance, and purchases of COBRA coverage—tax-deductible."

"First, individuals must be allowed to buy health insurance offered in states other than those in which they live. The current approach of state-by-state regulation has raised costs by reducing competition among insurance companies. It has also allowed state legislatures to impose insurance mandates that raise prices, while preventing residents from getting policies more suitable for their needs.

Second, reasonable caps on damages for pain and suffering need to be established in medical malpractice cases. Caps on these kind of damages reduce costs and decrease unnecessary, defensive medicine."

"Taken together, the policy changes outlined here will produce a substantial decline in health-insurance premiums."

"It is also important to increase access to health care—but this should not be confused with increasing access to health insurance, and it cannot be achieved without getting costs under control. There are several ideas for improving access worth considering: removing artificial barriers to entry for physicians and within specialty groups, allowing states greater flexibility with Medicaid, providing tax credits for health spending, and expanding programs that provide services directly, such as Community Health Centers."

The authors were JOHN F. COGAN, GLENN HUBBARD, AND DANIEL KESSLER. Mr. Cogan, a senior fellow at Sanford University's Hoover Institution, was deputy director of the Office of Management and Budget under President Ronald Reagan. Mr. Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush. Mr. Kessler is a professor of business and law at Stanford University and a senior fellow at the Hoover Institution.

Short Selling Might Be Good

See Selling Investors Short: The SEC refutes its own short-sale ban from the Wall Street Journal, -26-2010, page A14. The key excerpt is:

"In fact, short-sellers make for a more efficient market by allowing all points of view to be expressed in a company's stock price. The SEC came to this conclusion several years ago when it abandoned the so-called uptick rule that had prevented a short-sale unless the last movement in the stock price had been up. The idea was that the rule would serve as a brake on market panics, preventing sharp declines in stock prices, while also preventing short-sellers from manipulating the market.

After years of study and a long pilot test, the SEC staff found no evidence that the uptick rule did any of these things. Studying the 2008 crisis, when the SEC enacted outright bans on short-selling many financial stocks, the SEC staff still hasn't found evidence that such limits benefit investors."