The Credit Crunch Story

at the very least, it's very difficult to tell who is and is not solvent during a liquidity crisis.

it goes without saying that forcing a large holding company liquidation during a liquidity crisis will deepen that crisis.

so what about the story of CIT? CIT was not a small bank. the US treasury refused to throw money at them, and restructured its debt privately, averting liquidation by hours.

Two reasons come to mind:
a) Outsourcing is much easier and quicker than generally imagined. Given the regulation of the past 10 years and the regulation on the horizon, and now that people are laid off, it's very easy to leave them laid off. For firms with established and solid import relationships, it is relatively painless to require previous work done domestically to become a value added function from the supplier. And it has the benefit of being less risky.
b) Small business is very scalable. So in periods of uncertainty, they can refuse to grow for awhile and sit it out. Marginal income for many small businesses is initially low and requires a great deal more work and worry. Why bother until things look better? In general, the street doesn't rely on data to tell them we're out of a recession. And on the street, at least 1 in 10 people they know are out of work.

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No data to back any of that up.

BTW, is there a formal inquiry of GDP numbers? I wonder if it is over-stated from imported raw and intermediate materials.

I don't think Cochrane's story has fallen apart at all, so long as his caveat about government intervention is taken to include the Fed. The large banks that suffered during the credit crunch will naturally seek out the most conservative investments out there. Normally, that would be taken to mean strict lending standards, but lending nonetheless. These banks aren't lending though. They're taking an arbitrage profit by borrowing from the Fed at next to nothing and investing in government securities. So long as Fed policy keeps interest rates so low, the banks don't have incentive to lend and the recovery will continue to be slow.

One thing I would like to see is much, much higher dividend payouts. Let management beg for capital. Ideally, we'd get rid of all corporate taxation, too. Our current tax code encourages leverage. Stock options also encourage it.

I know this is all idealistic, but too much capital just gets tossed into bad investments (both in finance in non-financials). Shareholders ought to be voting in higher dividends across the board: don't let the suits play with the money!

Sadly, I think we are slowing going the route of highly regulated financial institutions. As Greg Mankiw says, maybe this is optimal given that can't resist bailing them, so let's tax them. Maybe a fair trade-off is to adjust tax policy to encourage high dividend payments as well.

I find myself hoping that the recalculation story is true, at least in terms of unemployment.

Would it not be better to have high unemployment as long as it leads to new leaders and liberal reforms?

GDP will bounce back pretty quickly, if employment does too then we will be stuck with the current group of politicians for 6 more years. Imagine the long run cost of that in terms of unrealized jobs, technology, and GDP.

There are two different questions. First, how important has the credit crunch been as a cause of the recession? Second, is the end of the credit crunch a sufficient or a necessary condition for ensuring a rapid recovery? The answer to the second question is independent of the answer to the first one. Let me address two special cases.
Case 1: We agree that the credit crunch was an important cause of the recession, but too many other things happened in the past 18 months so now the end of the crunch is not a sufficient condition for ensuring a rapid recovery. It's a necessary condition (as it was in the credit crunch of 1966), but we cannot ignore the election of Obama and the many attempts to impose policies that are rejected by a majority of the population.
Case 2: We agree that the credit crunch was not an important cause, but somehow its end has become a sufficient condition for ensuring a rapid recovery. I cannot say under which circumstances this may be true, but we should be open to this possibility.

Arnold, I agree with a lot of your theory about the recession. But a note on marketing the theory, try not to capitalize "Recalculation" every time you refer to your ideas. Making it more subtle helps better relay your ideas to people.

Also, on the third explanation. What is to be decided as quick? I think this is the crux of most of the issues surrounding economics. People expect things so quickly. If it doesn't happen tomorrow morning, it's too late and everything is failing. That's the narrative most people seem to adhere to, anyways.