links for 2008-03-25

• Reforming to attract foreign investors - Vox EU
• The Price of Dithering - TierneyLab
• McCain adviser abandons misguided tax plan - Think Progress
• Debut of South Park Online - Andrew Sullivan
• Exit, pursued by Bear Stearns - Dean Baker
• McCain versus McCain - The Democratic Party
• Why we should fear a McCain presidency - FT
• Death Toll for Iraq War Reaches 4,000 - New York Times
• Counterparty of last resort? - Interfluidity
• The Fed and Crony Capitalism - Thomas Palley
• Too much information? Study shows how ignorance can be influential - EurekAlert
• An Explanation for Soaring Commodity Prices - Jeff Frankel

Comments

[FDI]

"...foreign investors highly value a host country’s financial system that is able to allocate capital efficiently, monitor firms, ameliorate, diversify and share risk, and ultimately mobilize savings..."

A fact that we have recently found out from first hand experience. FDI is apparently very important for nations with domestic savings that are inadequate to meet domestic demand, whether those nations are less developed or developed. Curiously, we now need to make many of the same reforms that the researchers found important for less developed nations to make. The sound financial principles necessary for attracting foreign savings are similar for all nations.

[Soaring Commodities]

When real interest rates are very low, or negative, commodity appreciation is (temporarily) expected to be greater than the cost of carrying the commodities. The same principle appears to apply to certain durable consumer goods (e.g., homes). When home appreciation is (temporarily) expected to be greater than the cost of servicing the interest, home prices rise until:

"Until commodities are widely considered “overvalued” — so overvalued that there is an expectation of future depreciation..."

[Soaring Commodities]

"In the long run, the general price level adjusts to the change in the money supply. As a result, the real money supply, real interest rate, and real commodity price eventually return to where they were."

Eventually return to where they were. If this parallel to homes hold, prices must eventually fall back to where they were. The bigger the upward spike into over valued territory, the bigger the eventual correction. Taking extra steps to limit leverage (in sensitive areas) during times of dropping real rates might help to avert a subsequent credit crises.

[wjd123]

This is from Thomas Palley's "The Fed and Crony Capitalism."

The Fed’s new Primary Dealer Credit Facility (PDCF) effectively gives Wall Street’s primary government securities dealers, which includes all the large investment banks, access to discount window borrowing. That means access to funding at the bargain basement interest rate of 2.5 percent, and all that is asked is borrowers post some form of investment grade collateral.

This arrangement constitutes a massive subsidy, which would be large in normal times. However, it is especially large at a time of market uncertainty and liquidity shortage. While other market participants are being forced to de-lever at fire-sale prices, the Fed’s friends are being given near-free government money to snap up assets....

This means the Fed is providing risk capital to the likes of Goldman Sachs at paltry interest rates that confer a significant subsidy. Moreover, the mere right of access enables them to borrow more cheaply from other lenders because of the back-stop reassurance provided by discount window access. It also establishes incentives for future excessive risk-taking.

These subsidies are a travesty. Goldman Sachs, Lehman Brothers, and Morgan Stanley are extraordinarily profitable companies. They have also been the drivers of the worst trends in the American economy over the past generation, pushing excessive CEO pay that has spread like a cancer throughout corporate America, even reaching into universities and non-profits. Additionally, they have pedaled the shareholder value paradigm, that has pushed companies to emphasize short-term gain over long-term investment, and contributed to ripping up America’s social contract. Meanwhile, their business model has promoted speculation that is behind repeated asset and commodity price bubbles.

Subsidizing these firms is an insult to Main Street. Many families are losing their homes as part of the mortgage crisis. If they had access to 2.5 percent financing that would not be happening. Likewise, manufacturing firms are being forced to close because of lack of affordable capital, which is destroying jobs and the economic foundation of communities.....

[Inequality]

"Goldman Sachs, Lehman Brothers, and Morgan Stanley are extraordinarily profitable companies."

The Fed directly subsidizes short rates at low levels, but has not attempted to "directly" control long rates since the disastrous stagflation of the 1970's. Investment banks, hedge funds, etc... borrow lots of money at subsidized short rates to place their highly leveraged bets in the various markets. Thus the primary private sector beneficiaries of Fed short rate subsidies have always been high rolling financial organizations. Since the ultimate source of Fed funds is inflation that regressively affects the less well to do, subsidized short rates increase inequality in the US.

Sparingly applied, lower short rates can shorten recessions. However, if rates are held low too long, they can create imbalances in the economy, and steadily reduce the standard of living of the median person.

[anne]

http://www.nytimes.com/2008/03/25/washington/25policy.html

March 25, 2008

Bush Given Iraq War Plan With a Steady Troop Level
By STEVEN LEE MYERS and THOM SHANKER

Troop levels in Iraq would remain nearly the same through 2008 as at any time during five years of war, senior officials said.

[Tragedy continued; to no surprise, only sadness.]

[anne]

http://krugman.blogs.nytimes.com/2008/03/25/the-age-of-the-anti-cassandra/

March 25, 2008

The Age of the Anti-Cassandra
By Paul Krugman

Reading some of today’s news, it suddenly struck me: we’re living in the age of the anti-Cassandra.

Cassandra had the gift of prophecy — she saw, correctly, what was coming — but was under a curse: nobody would believe her.

Today, our public discourse is dominated by people who have been wrong about everything — but are still, mysteriously, treated as men of wisdom, whose judgments should be believed. Those who were actually right about the major issues of the day can’t get a word in edgewise.

What set me off was the matter of Alan Greenspan; as Dean Baker like to remind us, news analyses of the housing and financial crisis almost always draw exclusively on “experts” who first insisted that there wasn’t a housing bubble, then insisted that the financial consequences of the bubble’s bursting would remain “contained.”

It’s even worse, of course, on the matter of Iraq: just about every one of the panels convened to discuss the lessons of five disastrous years consisted solely of men and women who cheered the idiocy on.

Now, none of this is entirely new. Consider what Keynes said in 1931:

"A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him."

Still, it seems especially extreme now. And think of the incentive effects. What’s the point of taking the risk of challenging conventional wisdom if, even after you’re proved right, only the guys who were wrong get invited to opine on Charlie Rose?

[kthomas]

Thanks for the Palley article, Mark.

Ouch. How the winds have changed direction...

[anne]

http://krugman.blogs.nytimes.com/2008/03/25/malthus-was-right/

March 25, 2008

Malthus Was Right!
By Paul Krugman

The Wall Street Journal has an article titled “New Limits to Growth Revive Malthusian Fears”, which begins:

"Now and then across the centuries, powerful voices have warned that human activity would overwhelm the earth’s resources. The Cassandras always proved wrong. Each time, there were new resources to discover, new technologies to propel growth.

"Today the old fears are back."

Leave on one side the typical misreading of the Cassandra legend: Cassandra’s problem wasn’t that she was wrong. On the contrary, she was always right; her curse was that nobody would believe her. Statements like this are deeply unfair to Parson Malthus. The fact is that Malthus was right about the whole of human history up until his own era.

Sumerian peasants in the 30th century BC lived on the edge of subsistence; so did French peasants in the 18th century AD. Throughout history population growth had always managed to cancel out any sustained gains in the standard of living, just as Malthus said.

It was only with the industrial revolution that we finally escaped from the trap (if we did — for all we know, 35th-century historians will view the period 1800-2020 or so as a temporary aberration).

Was Malthus just unlucky? No. The same forces that made the industrial revolution possible — above all, the spirit of inquiry and rationality — also led to the birth of analytical economics. There probably couldn’t have been a Malthus until the world was on the verge of becoming non-Malthusian.

* http://online.wsj.com/article/SB120613138379155707.html

[Spectator]

The Palley article lays out the reality that most economists are unable to grasp. The intellectual architects of this travesty are the mainstream economists.

Subsidizing these firms is an insult to Main Street. Many families are losing their homes as part of the mortgage crisis. If they had access to 2.5 percent financing that would not be happening. Likewise, manufacturing firms are being forced to close because of lack of affordable capital, which is destroying jobs and the economic foundation of communities.

The Fed will claim it had to institute these measures to calm Wall Street. That is nonsense...

The hidden theft from the public is unmeasurable. Someday these misguided economists will hopefully be taken to task.

[anne]

http://krugman.blogs.nytimes.com/2008/03/25/look-and-feel-15-years-younger/

March 25, 2008

Look and Feel 15 Years Younger!
By Paul Krugman

The latest report of the Social Security Trustees * is out. I think the key message is what has happened to the estimate of actuarial balance ** — the difference between projected outlays and projected revenues over the next 75 years. This is the thing that’s supposed to get steadily worse as time goes by, as the 75-year window contains ever fewer years in which the baby boomers are in the work force, paying payroll taxes, and ever more years when the boomers are out of the work force and collecting benefits.

In fact, however, the actuarial balance has been improving rather than worsening. It’s now better than it’s been since 1993. What this tells us is that projections made in the mid-to-late 1990s were, in the light of subsequent revisions, way too pessimistic.

Moral: Social Security’s financial problem is relatively minor. It doesn’t deserve the emphasis it receives from most pundits.

* http://www.ssa.gov/OACT/TR/TR08/trTOC.html

** http://www.ssa.gov/OACT/TR/TR08/VI_LRact_bal.html#102806

[anne]

Prepare for the spate of dire warnings on Social Security, coming our way; be afraid, be somewhat afraid.