Friday, September 19, 2008

Moral hazard? What moral hazard?

It seems to me that the response of the stock market to the creation of a Resolution Trust agency -- 450 rise yesterday, and a similar rise so far today -- is the very essence of 'moral hazard.'

"Sonny. You wrecked the house last weekend while we were gone. You broke all the furniture, threw up all over the carpets, tore down the curtains.

"But don't worry, we've hired some cleaners to fix it all up.

"Please don't do it again.

"And, oh by the way, your mother and I are going on vacation next week. We want you to be good, O.K?"


RDC said...

Again your analogy is a little off base. The actions taken by the Fed todate are more along the line of because you messed up the house you now have to stay in the garage, sign over your paycheck to pay for fixing the damage, and once it is all paid off we might give a mattress for the garage floor.

Duncan McGeary said...


I'm sure Daddy punished Jr. severely. Took away his car privileges and cut his allowance.

But since Jr. sold Daddy's big screen T.V., he doesn't care much. And he can always 'borrow' the car, cause Daddy will no doubt forgive him.

Besides, he can always move over the Mary's house which hasn't been wrecked yet.

Party On!

RDC said...

Ok Duncan,

Lets talk specifics who do thing think is getting off easy in the actions taken by the FED todate?

I can think of two people, but lets see who you come up with.

Duncan McGeary said...

Got to work, and this is exactly what they're talking about on NPR.

Accountability and responsibility.

And then Regulation.

Get the bad managers out: ban them from being C.E.O.'s for a period of time.

RDC said...

Uh, in each of the agreements so far the management teams have been removed. In most of the cases the CEO's, at least on the commercial firms have lost hundreds of millions, in some cases billions. In one example Hank Greenberg who created AIG, but was removed as CEO a number of years ago lost 6 billion in one week.

The two that made out the best just happens to be the two that had the closest ties to Congress. The two CEO's of Freddie and Fannie. They lost their positions, but they did get consulting contracts to help in the transition and it is uncertain what if anything they lost directly through stock ownership.

So what exactly would you do differently?

The Lady with a Cuppa said...

Look at the tent cities springing up outside every major US city Duncan and ask yourself what alternative the government had. If you can present an alternative I'd be interested to hear it . . .

Duncan McGeary said...

I kind of doubt any kind of bailout is going to reach those people in the tent cities.

Take one/tenth of the money they've pledged to AIG, and we could really do something for them.

I'm for that.

Duncan McGeary said...

As long as we're going back to the New Deal playbook, why not a public works program?

blackdog said...

It's amusing to see everybody blaming the crisis on "the greed of Wall Street." Greed is good. Greed makes the world go 'round -- the world of business, anyway. You can put some restraints on greed but you can't legislate it out of existence -- nor should you want to.

Nor will regulation -- although certainly needed -- cure the fundamental sickness of the American economy, which is the loss of purchasing power of the middle class and working class. America's period of greatest economic prosperity and strength was in the post-WWII era from 1945 to 1970. It was not a coincidence that it was also the era of the highest union membership and the most progressive income tax structure.

RDC said...

For one reason unemployment is not anywhere close to what is was durng the great depression.

For another there are some elements we certainly do not want to repeat.

FDR's Policies Prolonged Depression by 7 Years, UCLA Economists Calculate

Two UCLA economists say they have figured out why the Great Depression dragged on for almost 15 years, and they blame a suspect previously thought to be beyond reproach: President Franklin D. Roosevelt.

After scrutinizing Roosevelt's record for four years, Harold L. Cole and Lee E. Ohanian conclude in a new study that New Deal policies signed into law 71 years ago thwarted economic recovery for seven long years.

"Why the Great Depression lasted so long has always been a great mystery, and because we never really knew the reason, we have always worried whether we would have another 10- to 15-year economic slump," said Ohanian, vice chair of UCLA's Department of Economics. "We found that a relapse isn't likely unless lawmakers gum up a recovery with ill-conceived stimulus policies."

In an article in the August issue of the Journal of Political Economy, Ohanian and Cole blame specific anti-competition and pro-labor measures that Roosevelt promoted and signed into law June 16, 1933.

"President Roosevelt believed that excessive competition was responsible for the Depression by reducing prices and wages, and by extension reducing employment and demand for goods and services," said Cole, also a UCLA professor of economics. "So he came up with a recovery package that would be unimaginable today, allowing businesses in every industry to collude without the threat of antitrust prosecution and workers to demand salaries about 25 percent above where they ought to have been, given market forces. The economy was poised for a beautiful recovery, but that recovery was stalled by these misguided policies."

Using data collected in 1929 by the Conference Board and the Bureau of Labor Statistics, Cole and Ohanian were able to establish average wages and prices across a range of industries just prior to the Depression. By adjusting for annual increases in productivity, they were able to use the 1929 benchmark to figure out what prices and wages would have been during every year of the Depression had Roosevelt's policies not gone into effect. They then compared those figures with actual prices and wages as reflected in the Conference Board data....

"This is exciting and valuable research," said Robert E. Lucas Jr., the 1995 Nobel Laureate in economics, and the John Dewey Distinguished Service Professor of Economics at the University of Chicago. "The prevention and cure of depressions is a central mission of macroeconomics, and if we can't understand what happened in the 1930s, how can we be sure it won't happen again?"

Jeff said...

"So [FDR] came up with a recovery package that allowed businesses in every industry to collude without the threat of antitrust prosecution"

Collusion means that businesses were less likely to compete on price, and were more likely to survive. When so many businesses were failing, is this the end of the world?

My Grandmother told us stories of farmers who committed suicide during the Depression because they could only get 5 cents per pound for their hogs. I bet they would have enjoyed some market power.

"workers to demand salaries about 25 percent above where they ought to have been, given market forces"

It's a BAD thing that laborers were getting paid "too much"? This is the type of thing that tenured profs earning more than $120,000 per year so easily say.

OK, OK, I get the point that collusion and unions are bad for productivity.

But I ask, RDC, is diminished productivity that big lesson to take away from the Great Depression era?

For example, U.S. farmers became heavily subsidized during the 1930s. But yet their productivity remains among the very highest in the world.

If FDR did wrong in these 2 things, they are NOTHING compared to all the good that he DID do.

The right-wing doesn't have anyone like FDR to look up to ... there best is Hoover!

(Please hold any mention of the fairy tale that cutting taxes will ultimately increase tax revenues.)

The argument that FDR's anti-trust policies / pro-labor policies were harmful in some way is HARDLY the central policy lesson to come out of the Great Depression.

Thank goodness for us that Ben B. has a more realistic view of what's important than these 2 guys. At least they got a nice paper out of it.

RDC said...

Black Dog,

Now where exactly do you get the loss of earning power from the 70's.

I think you have been drinking a bit too much cool aid not doing enough independent checking of the numbers.

RDC said...

If you really really want to talk about erosion, then what you really need to think about are not so much changes in the US, but what has been occuring in the rest of the world. To put it simply the third world countries have developed enough education and enough infrastructure to make it easy to set up and run competing factories and other businesses. A couple of decades ago that was not the case but today it is. That means that workers in the US are not just competing with other workers in the US or in Europe, but with the third world countries. Countries such as China where the median income is $2000 per year. If a worker wants to compete and make 40,000 per year they and the company they work for need to figure out how to make them 20 times a productive. Plus you have all kinds of people that make very low wages coming into the US and bringing down wages for jobs in the service area that cannot be easily relocated.

Now so far most in the US has been fat dumb and happy because it has meant that they have been able to buy all kinds of inported garbage cheap and support their apparent standard of living on credit.

well that is coming to an end.

The only way to prevent or slow down the impact is by making the US more competitive. That mean weaning the people from credit cards, improving academic standards,
supporting research in those areas where we still have a technical advantage such as biomed and pharmaceutical, etc.

Unfortunately the things you seem to advocate are exactly what will accelerate the pace of the demise not slow it down. We need to rebuild the work ethic, not expand handouts. We need to expand research, not penalize the companies that have been sucessful in creating new technologies.

If we don't there are billions making less than $2000 per year that are perfectly willing to do so because they want it and they are willing to work and compete for it.

The Lady with a Cuppa said...

Hmm, I shouldn't comment on the fly from work. It makes for an incomplete thought/sentence/paragraph.

You are correct, the bail out won't help ppl already in the tent cities. But it just may prevent more from ending up in them.

Regardless of the press/government's outlook on this we are in a depression that has the potential to be more devestating than the Great D. How horrifying it is to me that not just 'hobos' are homeless but entire families?

Will McCain or Obama create a TVA for these folks? Dunno. During the Great D we weren't the world wide economic power that we are today. The wide ranging effects of our markets slipping into the cesspool haven't begun to seep into the brains of the everyday Joe, when it does will paranoia and fear take a jump into extreme behaviors? That's pretty typical of humanity.

Great Depression + 1950's fears = ?

Thoughts that come to me when I listen to the Beeb and how very concerned the rest of the world is as they watch us cannabalize ourselves.

RDC said...


The point is that the great depression lasted far longer than it needed to because of actions taken by the Government. Were there some programs that did some good in that time frame> The answer to that is yes. However, there are also substantial cautions to be learned from that time frame as well. Those cautions are to only do what is absolutely necessary. Another is that competition and the ability to profit from that is a major driver in growth.

If you take a look at history the greatest periods of economic growth occur when you have two conditions. The first is a period which stresses the population. The second is when that is followed by a period where one can advance themselves on their own merit.

In the case of the US there have been two periods of "stress". THe first is the settling of the country. A period in which people willing to work hard and take risks came to this country. The second was the great depression and World War II. What happens during a time of stress is that a very strong work ethic is created. There is a realization that if one is going to survive and prosper it must be because of their efforts. Couple this with a period in which people can advance through those efforts and dramtic growth can occur. In each place where you see such growth those two conditions exist. In Europe you have the devastation of WWII. In the third world growth areas the stress was rampant poverty which has now been coupled with free enterprise where people willing to take risks get rewarded.

There are other lessons from the great depression. It was brought on primarily by a trade war, where tariffs went through the ceiling and trade between countries came to a halt, more so then a stock bubble. Along with the over whelming war debts owed by Germany after WWI. The tariffs brought trade to a halt, Germany's inability to make its debt payments, the collapse of the market bubble, and finally a collapse of commodity prices.

One question - Why does it seem that people these days tend to resort to falling back on labels instead of discussing issues? Anybody that has studied communications knows that throwing up labels tends to block effective communications, not enhance it. They also really do not help one make a point either.

RDC said...

Oh there is also one other key lesson from the Great Depression that the US clearly did not learn, or rather the great depression generation learned, but generations after have forgotten is wise us of debt or basically it is not very smart to go excessively into debt. The Great Depression as in the Japanese decade in the 80's both had excessive leverage at both the corporate and individual level. To the degree that deflation became reality.

If one really wants to put the country back on a fiscally sound footing it needs to get away from this retail consumption mania. The best way to do that would be to bring back the usury laws. THe ones that limit the amount of interest that can be charged to some reasonable comparison to prime or Libor. Now what that would do is to prevent credit card and other companies from extending credit to those with bad credit or without the means to pay it back and then making up for it by charging excessive interest rates and fees. Basically to return credit to reasonable cost and improved loan quality. You also then make sure that fiscal education is a prime component of education. Make sure that people realize just how much of their personal wealth is being destroyed by excessive use of credit. Make sure that they realize the true cost of something when credit is used, instead of just the impact on cash flow.

Just one item. You really need to differentiate between tax reductions, tax rate, and deficit spending.

It is very clear that increased tax rates have a negative effect on economic growth. It is also very clear that money spent by the government has less impact on growth than money which is invested in growth by commercial enterprises. Now the problem occurs if the government is deficit spending and creating an increasing level of debt. This has the same negative impact on the government as excessive spending does by the individual.

Now I think (correct me if I interpreted your comment about tax reductions incorrectly) that you were referring to the concept that reducing taxes would generate enough growth that enough increased revenue would occur to make up for the tax reduction. That is a concept which as far as I can find is not substantiated by data.

However, there is substantial proof that a lower tax rate does result in increased growth over that which would be generated by a higher tax rate during the same time. That is pretty much proven.

The debate is more about is the negative impact of a deficit more or less of an effect than the positive impact of a lower tax rate.