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The Economists' Liberal Agenda, a review of: Roubini, Nouriel and Stephen Mihm, Crisis Economics: A Crash Course in the Future of Finance (NY: The Penguin Press, 2010.
Raymond Richman, 12/12/2011

One of Nouriel Roubini’s genuine claims to fame was his prediction on September 7, 2006 in a talk at the International Monetary Fund in Washington, D.C. that the nation’s economy would soon suffer a once-in-a-lifetime housing bust that would be followed  inevitably by a deep recession. Roubini was not alone. Distinguished Yale Professor Robert Shiller, whose name appears in the authors’ acknowledgements, called the stock market bubble in 2000 and the housing bubble in 2005. Roubini has developed a reputation as a contrarian and I was looking forward with great anticipation to this book which I expected to be full of new and creative ideas.

Unfortuinately, I found the book very disappointing. There is very little in the book that does not represent conventional liberal ideas. He exhibits little faith in the free market, ignores the huge costs of environmental policies, has no solution to the jobs lost to outsourcing abroad, etc

In their book, the authors could not bring themselves to blame the government or the FED for the housing bubble although the FED’s failure to contain the bubble before it became such a threat does come in for criticism. But they downplay the role of the Community Reinvestment Act of 1977, one of whose administrators was the FED itself. The FED should have rejected the appointment to maintain its freedom of action vis-a-vis the banks. We agree that it was not the act itself that caused the bubble; it was the actors who implemented the act over the decades of the bubble. Pres. George H.W. Bush, for example, made it possible for ACORN and other leftist neighborhood organizations to “blackmail” the major banks by requiring an annual open meeting at which consumers could complain about the inadequacy of the banks response. ACORN and other leftist organizations succeeded in actually gaining contracts with the banks to initiate and process mortgages, in the process earning millions of dollars and strengthening their political power. And the left in Congress, Barney Frank, et. al., pressed Fannie Mae and Freddie Mac to buy mortgages made to unqualified borrowers.

When does a boom become a bubble? The authors conclude, “When everyone from banks to consumers leveraged themselves to the hilt.”  The immediate causes of the housing bubble, the authors write, were the securitization of bad loans, changes in corporate governance and compensation schemes, inappropriate monetary policy, and decades of government policies favoring home ownership even for the financially disadvantaged. None of these things in our opinion caused the bubble or cause it to burst. Financial innovation – mortgage-backed securities -- spread risk around the world.  But spreading the risk does not cause a bubble. What causes a bubble is the purchase by too many institutions, investors, and speculators acting on a belief that there is nothing that will stop the trend. Indeed, economists who evaluated the effects of the Community Investment Act of 1977 concluded in the 1980s and 1990s that the collateral-less mortgages had done no harm. But they assumed that the annual rise in home values they observed   would never end, the very assumption that sustains a bubble. Traditional rules for qualifying for loans were abandoned and “liars’ and ninja (no income, no job, no assets) loans proliferated.

How does one affect a recovery? The authors basically take a conventional Keynesian approach. They write, “Japan triggered a recession in 1998 by ending zero rate of interest too soon.”  Really? Wasn’t it the bursting of the real estate  bubble in Japan that precipitated its financial crisis?  What lesson did Roubini take from it?  “By the same logic, the U.S., should it curtail stimulus spending or tighten the monetary reins while the recovery has barely started, risks repeating this mistake today.” In our opinion, this is Keynesian nonsense.Why was Pres. Obama’s Recovery Act of 2009 such a dismal failure, producing no Keynesian multiplier? It increased GDP by the amount of the deficit.  Would Japan have to keep a zero rate of interest forever and the U.S. keep increasing its debt indefinitely? If so, there is no Keynesian multiplier which we have been arguing on this site for a very long time. That appears to be the case but Roubini did not foresee that.  

Prof. Roubini is much more “politically correct” than his public image as a contrarian would indicate. The authors makes no mention of the harmful expenditures on restricting carbon emissions with fictitious benefit-cost analyses that put ridiculously high negative values on carbon emissions nor do they condemn the wasteful expenditures on so-called renewable energy which exert a powerful negative effect on economic growth.

What public policies do the authors advocate to recover from the recession?

They decry FED Chairman Greenspan’s failure to raise interest rates to prevent  the mortgage bubble. A correct but conventional criticism.  

They urge the resurrection of the Glass-Steagle Act which imposed restrictions on banks’ speculating with depositors’ money. Had the act not been repealed, banks would not have gotten so much in debt. But repeal did not cause the bubble.

End the enormous benefits paid to corporate CEOs. Managers want to maximize short-term benefits to shareholders to justify their bonuses while the real interest of shareholders is in long-term returns. We have long opposed corporate buy-backs of their own shares which corporate CEOs argue would benefit shareholders by raising share prices. Shareholders they believe prefer taking capital gains to receiving dividends.  It is the corporate managers who want an easy way to justify their huge bonuses. Buy-backs amount to disinvestment. They indicate that the CEOs have run out of good investment ideas. In our view, increasing dividends would be of much greater benefit to shareholders. Roubini argues, “Employees should be restricted from selling  .. until their retirement, or at the very least, for well over a decade.”  But this did not contribute to the financial crisis. Is it part of crisis economics? We do not believe so.

Another problem is the “securitization” e.g. the issuance of derivatives, and other CDOs (collateralized debt obligations). Banks and shadow banks that issue such securities should as proposed by the Credit Risk Retention Act, retain 5 or 10 percent of all securities they create. This may not be a bad suggestion but securitization did not cause the bursting of the housing bubble. It only ensured that the consequences would be widely felt.   

Roubini recommends standardization of structure and wants information provided periodically to some government agency. What would be the responsibilities of such an agency? We have much less trust in government as a regulator of private industry and practices than Roubini. Roubini seems to have no objection to an expanding government bureaucracy. We believe that a free market would create information disseminating institutions. We have a negative view of Czars.

Roubini observes that rating agencies like S&P and Moody’s have a conflict of interest. They rate institutions but also provide services to them. The two functions, he argues, should be separated. Not a bad idea but we doubt that their independence would solve the problem. Their ratings are frequently ignored.

The Basel I accords required large issuers of internationally distributed securities to keep a reserve of 8 percent.  It did not apply to securitized assets so it would not have averted the bursting of the housing bubble. It did not avert crisis. The authors suggest that far more radical reforms be implemented if the financial system is to achieve any semblance of stability in the coming years. We don’t believe this at all. It would only create an international bureaucracy. We generally favor the abolition of international agencies which have long outlived their usefulness, like the World Bank. None of these new regulations would have prevented the housing bubble which was caused by government encouraging the banks to make loans without adequate collateral in implementation of the Community Investment Act.

The authors quote Bernanke, “The lesson I take from this experience is not that final regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter.”  That requires perfect foresight of trends in the economy. Mr. Bernanke has on the FED Board at least one individual who was and continues to be supportive of low collateral loans. There is no way to ensure decision-makers will be “better and smarter.”

The authors write, “As of 2010, China and the United States remain locked in what economist Lawrence Summers has described as a “balance of financial terror.”  Neither side can make a move without upsetting that balance.”  That is nonsense. It  indicates why Lawrence Summers made a bad chief economist during the first two years of the Obama administration.  “To get out of this bind, both countries need to bring their current accounts into some semblance of equilibrium. The United states must tackle its twin saving deficits; its ballooning federal budget deficit and its low level of private savings. As its first step on the road to redemption, it will have to repeal the misguided tax cuts that the Bush administration pushed through earlier in the decade.” Yes, George W. Bush was wrong but his error was in not reigning in expenditures. To the contrary, he expanded entitlements without raising taxes or reducing other expenditures. “For their part, China and other emerging economies in Asia need to let their currencies appreciate.” Over the past few years, China has increased the exchange value of the yuan and they had no effect at all on the continuing increase in our trade deficits with China. We disagree that there is a balance of financial terror. Under WTO rules, countries which experience large chronic trade deficits with one or more of its trading partners are entitled to impose tariffs and other barriers to restore a trade balance. Taking such action does not constitute terror.

The Decline of the dollar appears to be ongoing although the problems of the euro have strengthened the dollar, at least temporarily.  Roubini quotes distinguished economist Robert Triffin that nations that issue reserve currencies generally maintain current account surpluses. Of course, any currency standard must be reliable. The continuing current account deficit of the U.S. is jeopardizing the dollar as the world’s reserve currency, leading to a further decline of the dollar. “That was precisely what happened in 1971, when President Nixon reneged on the pledge to convert dollars into gold.”  Roubini declares that China’s rapid growth means that the dollar’s days are numbered “in years rather than decades.” “ If [the U.S.] doesn’t get  its fiscal house in order and increase its private savings” the dollar will be replaced. The yuan? China looks much like the United States did when it came to power; it runs large current account surpluses, has become the world’s biggest exporter, has a relatively small budget deficit.” It already is permitting its financial institutions in Hong Kong to issue Chinese public debt denominated in the yuan, a crucial step in creating a regional market in the debt and, by extension, the currency.” We agree and we argue for a so-called scaled tariff on all imports from China, a tariff the rises as the trade deficit increases and disappears as it approaches balance. We believe such action is authorized under the rules of the WTO.

Roubini warns that "weaning the global economy off the kinds of imbalances that played a role in the recent crisis is important." And, “Will the world’s major economies truly cooperate for the common global good? Or will they keep on following their national interests, eventually destabilizing the global economy and the global financial system?”  He has no answer. We di, They will pursue their national interests and we should do so likewise.

“Crises, as we have seen, are as old and ubiquitous as capitalism itself.” And Communism in the Soviet Union was in crisis continually and killed millions of farmers because they refused to have their crops confiscated. And fascism was without crises? So much so that the military tried to kill him.

 “Almost all crises begin the same way: modestly, .. This scene setting can take years, even decades, as numerous forces create conditions hospitable to a boom-and-bust cycle.”  This is conventional wisdom. “For the past half century, academic economists, Wall Street traders, and every one in between have been led astray by fairy tales about the wonders of unregulated markets, and the limitless benefits of financial innovation. The crisis dealt a body blow to the belief system, but nothing has yet replaced it.”  “Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.” Not a few. A whole bubble! What fairy tales do free market economists believe in.

In our view, an economic system of widely regulated markets is aptly called fascism or to make it more palatable, social-democratic-fascism. The wonders of unregulated markets have given us the most productive economic system and the highest standard of living for more people in world history. Severe business downturns and mass unemployment are not the result of unregulated markets but of government mismanagement of the economy. The current crisis was the result of a phony claim that neighborhood banks were redlining disadvantaged neighborhoods. The government forced the banks to make mortgage loans to persons unqualified for such loans, and low interest rates fed speculation. The large number of mortgages needed new financial instruments and new institutions like Fannie Mae and Freddie Mac. The FED was an active promoter and Congress promoted the housing boom which turned into a bubble. It is not private industry that needs reforming. It is government that needs to interfere less in private business. It abused its control of the banks and is the principal institution responsible for the housing crisis and the subsequent financial crisis. One of the original sponsors of the Community Reinvestment Act was Sen. Proxmire. Two of the responsible Congressional actors were Rep. Barney Frank, Sen. Chris Dodd, and their ilk. Congress and the Obama administration and its predecessor the Bush administration have been wasting hundreds of billions of dollar and imposing trillions of dollars of burden on the private sector, reducing standards of living around the world on what appears increasingly to have been a hoax initiated by an anti-capitalist dominated UN bureaucracy promoting so-called anthropogenic (man-made) global warming . A government agency, the EPA, has arbitrarily issued regulations that have imposed enormous burdens on private firms, to their detriment, with no obvious benefits to the public. No mention of this by the authors.

Roubini believes large institutions become too big to fail. “Certain institutions considered too big to fail must be broken up, including Goldman Sachs and Citigroup.” We do not believe the large banks and shadow banks should be broken up. It would have no effect on business cycles and would actually increase the failure rate in our opinion. All they need to reform their practices is knowledge that the government does not believe they are too large to fail. When they fail they will be broken up as the parts of them are sold and the officers will lose their jobs and some may be prosecuted. Rescuing the banks kept the CEOs of large institutions, believed to be too large to fail, in their jobs and secured their bonuses.

There is a role for government to do the things that the private sector cannot do, won’t do, but needs to be done. One of those is to oversee the smooth transition of big bankrupt firms to their new owners. We do not believe that any institution is too big to fail. The courts are able to ensure that the bankrupt firm’s assets are transferred smoothly to its creditors.

Roubini wants “deadly derivatives”, like those that blew up in the bursting of the housing bubble,  to be registered in data-bases and their use appropriately restricted. We believe that investors should be more aware of the risks involved but we do not believe it is the government’s obligation to prescribe their administration. Investors will take care of that. 

One of our complaints against many macroeconomists, including Roubini, is their lack of understanding of how microeconomic institutions like the firm actually work. The authors are rightly critical of University of Chicago economists like Prof. Eugene Fama who argued that competitive markets worked efficiently. But that is not what distinguishes the Chicago school, whose faculty has won a large number of Nobel prizes none of which was for the efficient market hypothesis. Princeton university is not criticized although its Prof. Burton Malkiel espoused the efficient market hypothesis in his famous book,  A Random Walk Down Wall Street, now in its 10th edition.  It is the nature of science to progress by challenging hypotheses.  One of the most underrated economists of the past century was the late Prof. Edward Chamberlin, author of  The Theory of Monopolistic Competition, 1950, who was willing to challenge ideology masquerading as economic science. While Roubini is right to challenge the theory of perfect competition, no one at Chicago believes it is an accurate description of the real world. But they do believe that the theory makes better predictions than the Keynesian theories Roubini favors. Roubini’s Acknowledgments include in the order named such left-of- center thinkers as Jeff Sachs, Paul Krugman, Ken Rogoff, Carmen Reinhart, Joe Stiglitz, and Jeffrey Frankel.

The book is full of conventional wisdom. It is worth reading but its title is misleading. Most of the ideas in it have little or nothing to do with economic crises and when they do, many of the solutions simply call for expanding the federal bureaucracy, almost always a usseless enterprise. And its omissions are serious. It offers no solution to the trade deficit that has caused millions of unemployed workers in manufacturing. It ignores the wasted expenditures on subsidies to wind and solar power and to industries like Solyndra which have adversely affected the standard of living of Americans and millions around the world. It amounts to a crash course in goverment administered economy. 

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  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

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