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Most of these are links in posts by Mark Thoma.

Richard Robb says that letting Lehman fail really did cause big problems. However, he concedes,


There is plenty of room to debate the larger counterfactual: if the government had never bailed out Bear Stearns and other too-big-to-fail firms that followed, would Lehman have mattered? If the government had never bailed out anyone at all, would we be better off?

Simon Johnson discusses the uses and abuses of economic models.

VaR doesn't kill banks; executives who don't recognize the limits of VaR kill banks. As Bookstaber put it, "one has to look beyond VaR, to culprits such as sheer stupidity or collective management failure: The risk managers missed the growing inventory [of risky assets], or did not have the courage of their conviction to insist on its reduction, or the senior management was not willing to heed their demands. Whichever the reason, VaR was not central to this crisis."

Let me hear you say, "Suits. vs. Geeks divide."

Brad DeLong writes,


The argument that more expansionary fiscal policies should not be tried because it is theoretically impossible for them to work fails. The argument that more expansionary fiscal policies should not be tried because the unstable nature of global imbalances and U.S. long-run fiscal deficits has us teetering on the edge of a Credit Anstalt-like currency crisis disaster fails. The argument that banking policies have been successful enough that we do not need more expansionary fiscal policy fails.

One argument that DeLong does not address is the challenge of a fiscal exit strategy. The problem of running big deficits in, say 2010 and 2011 is that it makes returning to lower deficits in 2012 contractionary (assuming you believe that deficit spending is expansionary in the first place). So now you have to keep running big deficits in 2012. That brings you to 2013. Do you want a contraction then? No, so...

DeLong is of course living in the macroeconomic world where we do not worry about Recalculation. Instead, we all work in one giant GDP industry, and for some mysterious reason many of our GDP factories have shut down, so that government must build and operate some GDP factories to keep us all employed.

From the Recalculation perspective, the economy needs to shift resources out of some sectors and into others. The government is either (a) permanently shifting resources from the private sector to government or (b) temporarily shifting resources from the private sector to government. If it is doing (a), then we are not facing mere temporary deficits but permanent increases in government spending, and eventually we will have to figure out how to pay for them. If it is doing (b), then the Recalculation problem isn't really being solved. Instead, at best the government is redistributing the pain from the reallocation process out of the present and into the future. People who otherwise would be unemployed can find temporary work on government projects, but when those projects expire they will go back to being unemployed. This is what makes the fiscal exit strategy so problematic.


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COMMENTS (14 to date)
fundamentalist writes:

Johnson: "The risk managers missed the growing inventory [of risky assets]..."

I don't know where people are getting this idea that risk managers or regulators were stupid, ignorant, greedy or any of their other favorite adjectives. It has been reported many times that all regulatory authorities viewed derivatives as means to reduce risk. They didn't miss that they were risky; they thought that they reduced risk and encouraged banks to use them even more. In fact, a recent article on the IMF chief has him advocating greater use of derivatives because the spread the risk.

And the regulators were right! Derivatives do reduce risk by spreading it around. Had the housing market not collapsed, none of those derivatives would have been risky.

Occupant writes:

"one giant GDP industry"

nicely put. props.

Thomas DeMeo writes:

fundamentalist - Derivatives do not reduce risk by spreading it around. They do the opposite. They take a whole instrument and separate into pieces it based on risk, leaving one piece with virtually all the risk and the rest all shiny and clean.

Don the libertarian Democrat writes:

The whole point about Moral Hazard is that it needs to be vigilantly applied over time, so that it is clear and credible. I would go back to at least the 1980s for the beginning of this crisis. The S & L crisis was a clear escalation in this problem. In fact, just look back to when TBTF was first used.

My view is that the primary cause of this crisis is govt guarantees. But it is not just govt's fault: it is a mutually beneficial arrangement between govt and the financial sector. The idea that the financial sector is anything but a full-fledged member of the Welfare State is wrong. We have a crony/special interest welfare state.

To put it simply: We had deregulation and govt guarantees working hand in hand. As the govt looked the other way, it also implicitly guaranteed the system. That's what investors thought, and their reactions to Lehman showed that.The question is how to break this arrangement up, when you have a LOLR. Even if it isn't the Fed, it will be the govt should we ever face financial crises. It's actually hard to believe that this arrangement wasn't obvious. Watch what people do. Don't just listen to what they say. The financial sector is great at pretending to be Cato Scholars, and acting like protected govt entities.

I'm for Narrow/Limited Banking. See Martin Wolf's post for a discussion of it.

Don the libertarian Democrat writes:

By the way, when I left a comment on your blog about Lehman earlier, I was so terrified that I didn't make any sense that I e-mailed my comment to Prof. Robb. He actually e-mailed me back and said that he agreed with my comment. I really appreciated his feedback. It was very decent of him.

fundamentalist writes:

Thomas, It's not my claim that derivatives spread risk. I couldn't care less what derivatives do. I'm saying that there are plenty of interviews of regulators in the media that prove that they did not see derivatives as risky but as risk reducing. That was the view of Greenspan, the IMF, and all of the regulatory agencies. So to suggest that regulators were asleep or that CEO's knowingly took excessive risks is just pure unadulterated fabrication. Everyone, CEO's included, thought they were reducing risks by using derivatives. Of course, they were wrong.

Lord writes:

No, the government is doing no such thing. It is employing idle private resources for production. The immediate production may be of limited value but any value is better than none and the secondary value of spending those incomes are the only thing that even permits recalculation to occur. The transfer between future and present is key to rebalancing the economy, producing when it is needed and trimming back when it is not. It quickens the recalculation process.

mars writes:

"Had the housing market not collapsed, none of those derivatives would have been risky."

Bwahahahahaha!! This is the funniest thing I've read all day!

Stan Kelley writes:

The question is "how much risk is being spread?" If the risk being spread is great enough then spreading it will be injurious to all. It was the failure to recognize the extent of the risks being taken in the mortgage market that was the regulatory problem. It was the kind of thinking that worships the market which was behind that failure.

RR writes:

"The government is either (a) permanently shifting resources from the private sector to government or (b) temporarily shifting resources from the private sector to government."

Are the resources really moved from the private sector to government, though, if they are for the time being completely unused? I'd say an unemployed worker is in no sector at all.

There is also the problem of deterioration of unused resources. Machines rust and unemployed people become destitute and develop mental problems. If the government doesn't take idle workers (or, say, expensive construction machinery) into temporary use in temporary infrastructure projects, there won't be much left for the private sector either when the recovery arrives.

The best is to use government orders in public projects, ordered from private construction companies, without adding a single government employee in the process.

John Papola writes:

GDP industry indeed. DeLong and Shiller clearly believe in GDP as a widget as well (as well as mass collective psychology as the answer for everything):

http://fora.tv/2009/02/18/Animal_Spirits_How_Psychology_Drives_the_Economy

Keynesian FAIL.

Roland Buck writes:

"The problem of running big deficits in, say 2010 and 2011 is that it makes returning to lower deficits in 2012 contractionary (assuming you believe that deficit spending is expansionary in the first place)."

Once the economomy reaches potential output, contractionary fiscal policy is EXACTLY WHAT YOU NEED to keep output from overshooting potential output and causing inflation. Once the economy is on a strong upward trajectory, it has a stong upward momentum that reinforces the upward movement and, if brakes are not applied, will result in overshooting. So the contrationary effects of eliminating the deficits and even running surpluses are to be welcomed.

Roland Buck writes:

"and for some mysterious reason many of our GDP factories have shut down"

The reason they have shut down is not mysterious at all. They have shut down because their products are not selling and if they were to keep producing they would suffer losses. The reason that the products are not selling is that aggregate demand has decreased. John Maynard Keynes explained this very well in the General Theory. The decrease in aggregate demand is that, due to the collapse of the housing bubble and the subsequent meltdown of the financial system, both firms and households have sharply reduced their expenditures.

Except for genuine supply shocks, which are clearly recognizable and rare, every recession is caused by a drop in aggregate demand. And these drops in aggregate demand are caused by shocks from the financial system, although the PARTICULAR type of financial system shock will vary from case to case. For example, in the present case it IS the collapse of a bubble and the resulting meltdown of the financial system. In the case of the early 1980s recession, on the other hand, it was the result of the Fed stepping on the monetary brakes in order to bring the rate of inflation down.

Roland Buck writes:

The chief empirical defect with the recalculation theory is that unemployment has not only increased in the sectors of the economy in which there was excess capacity before the recession began. Rather, the unemployment is widepread throughout the economy, involving many sectors in which there was no excess capacity. Deficient aggregate demand explains this, recalculation does not.

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