Economist's View

Making Fannie and Freddie Pay for Their Free Lunch

Joseph Stiglitz says just say no to free lunches:

Fannie’s and Freddie’s free lunch, by Joseph Stiglitz, Commentary, Financial Times: ...The US government is about to embark on ... a partnership, in which the private sector takes the profits and the public sector bears the risk. The proposed bail-out of Fannie Mae and Freddie Mac entails the socialisation of risk – with all the long-term adverse implications for moral hazard – from an administration supposedly committed to free-market principles.

Defenders of the bail-out argue that these institutions are too big to be allowed to fail. If that is the case, the government had a responsibility to regulate them so that they would not fail. No insurance company would provide fire insurance without demanding adequate sprinklers; none would leave it to “self-regulation”. But that is what we have done with the financial system.

Even if they are too big to fail, they are not too big to be reorganised ...[to] meet the basic tenets of what should constitute such a publicly sponsored scheme.

First, it should be fully transparent, with taxpayers knowing the risks they have assumed...

Second, there should be full accountability. Those who are responsible for the mistakes – management, shareholders and bondholders – should all bear the consequences. Taxpayers should not be asked to pony up a penny while shareholders are being protected.

Finally, taxpayers should be compensated for the risks they face. ...

All of these principles were violated in the Bear Stearns bail-out. ... The same administration that failed to regulate, then seemed enthusiastic about the Bear Stearns bail-out, is now asking the American people to write a blank cheque. They say: “Trust us.” Yes, we can trust the administration – to give the taxpayers another raw deal.

Something has to be done; on that everyone is agreed. We should begin with the core of the problem, the fact that millions of Americans were made loans beyond their ability to pay. We need to help them stay in their homes.... This will bring clarity to the capital markets – reducing uncertainty about the size of the hole in Fannie Mae’s and Freddie Mac’s balance sheets. ...

We should not be worried about shareholders losing their investments. In earlier years, they were amply rewarded. The management remuneration packages that they approved were designed to encourage excessive risk-taking. They got what they asked for. Nor should we be worried about creditors losing their money. Their lack of supervision fuelled the housing bubble and we are now all paying the price. We should worry about whether there is a supply of liquidity to the housing market, so that those who wish to buy a home can get a loan. This proposal provides the necessary liquidity.

A basic law of economics holds that there is no such thing as a free lunch. Those in the financial market have had a sumptuous feast and the administration is now asking the taxpayer to pick up a part of the tab. We should simply say No. [...much more here...]

Why Is Airline Service So Bad?

Chris Hayes wants to know why air travel is so lousy. A source inside the industry responds:

Why Airline Travel Sux: Big Air Responds!, by Christopher Hayes: So I’ve been on a bit of a jag about how awful flying is. I’ve flown four of the last eight weeks and every single return trip has had some very significant problems: three cancellations and one flight delayed long enough we would have missed our connection. What gives?

Megan McArdle made some good points on the general topic of complaints about air travel, which Matt added to here.

I decided to email my super secret source inside a major air carrier, and I’m pasting in his response below, which I found pretty fascinating. The subject of my email to him was “Why does flying suck so hard?” His response:

Actually, people have been asking me this question for the entirety of the ten years I have worked in this business. I think the best thing I can do is to basically give you the answer I gave ten years ago, and then take you through the ways in which that answer has changed (or, really, gained additional layers and nuance) as 1) the tech bubble burst, 2) 911 and aftermath 3) the current fuel crisis happened. First off, flying today *doesn't* suck so hard. There, I said it. Flying today, however, is often racked with numerous small frustrations and irritations, and on occasion is a complete pain in the ass. What is the difference?

"Financial Crisis Resolution"

How should policymakers respond to a financial crisis?:

Financial crisis resolution: It’s all about burden-sharing, by Charles Wyplosz, Vox EU: An old and familiar debate is back. Should taxpayers bail out the US banking system, quite possibly the British and European ones as well?

There are two standard views on the multi-trillion dollar question of who pays for getting us out of the financial crisis.

• One view is that the situation has become so desperate that ordinary citizens will in any case be paying a high price for the crisis; throwing money at banks right now might lower the overall burden by preventing a deep, protracted recession.
• The other view is that banks ought to be left hanging to pay for their sins. Governments ought to be worried about their taxpayers, not bank shareholders.

In fact, we don’t have that much choice.

Should William Poole Say "I Told You So"?

Questions for William Poole:

Seven Questions: How Bad Will It Get?, Foreign Policy: When William Poole warned in 2003 that Fannie Mae and Freddie Mac lacked the capital to weather a financial storm, his advice went unheeded. Five years later, the outspoken former president of the Federal Reserve Bank of St. Louis is far too polite to say “I told you so,” but he does have a message for the Fed: Wait too long to tackle inflation, and you’ll face an even worse recession in the years to come.

Foreign Policy: What’s your diagnosis of what happened to Fannie Mae and Freddie Mac?

William Poole: First of all, they had too little capital to withstand adverse circumstances. And the adverse circumstances were the severe downturn in housing, the decline in house prices, and the rising default rate on mortgages. I don’t know of anyone who early enough was saying that there would be a major national decline in house prices, so I can’t hold them to that standard, but I can hold them to a standard of holding adequate capital to be able to withstand unforeseen circumstances. That’s what capital is for. ...

FP: Now, there has obviously been some turmoil in the banking sector. ... Analysts are wondering where the line is in terms of what banks are considered “too big to fail.” Where would you draw that line?

WP: I like the way that Greenspan used to put it and probably still does put it, that no firm should be too big to fail. Some might be too big to liquidate quickly and may require some support until they can be wound down, but there should be no firm too big to fail. We don’t know yet what the nature of the bailout of Fannie and Freddie is going to be, but I believe the plan would be to pay off at par all of the regular obligations. They are being turned into full faith and credit obligations of the United States government. ...

FP: NYU economist Nouriel Roubini, who has been sounding the alarm for quite a while, told Bloomberg News that we’re seeing the worst U.S. financial crisis since the Great Depression.

WP: I think that’s right, but let’s go back and revisit the Great Depression for a moment. ... There was a total and complete collapse of the banking system, and the economy that had functioned on credit and deposits was suddenly left to function on hand-to-hand currency. We aren’t anywhere close to that and we won’t get close to that because of ample Federal Reserve resources and also intellectual understanding that would not permit that to happen.

FP: How bad will it get, then?

WP: We are going to have failures of large numbers of firms, financial firms in particular..., failures of smaller commercial banks ... that were the most heavily involved in real estate are the ones at the greatest risk. ...

FP: Meanwhile, consumer prices are rising at their fastest rate in 17 years. Does that mean the Fed is running out of tools to keep growth going?

WP: All the financial turmoil that we’ve just been talking about—the tightening of credit...—that’s putting downward pressure on the economy, and the big increase in fuel prices is also putting downward pressure on real activity. ... There is a growing amount of unemployment in those sectors, and the Federal Reserve is trying to support economic activity by holding the federal funds rate ... at its current level. If the downturn in employment becomes much more severe, the Fed might even cut rates.

Now, to me, the inflation problem is actually part of what is depressing economic activity, because the generalized inflation that I think we have underway—although it’s not showing up in core inflation and wages just yet—is showing up in the depreciating dollar, and the depreciating dollar directly feeds through to increased energy prices and food prices. So, the depreciation itself is leading to depressed economic activity.

Moreover, if the inflation really starts to go into wages and into the core ... price indices—it will probably develop a fair amount of momentum and the Federal Reserve is not going to be able to reverse it even with a tighter monetary policy for probably a year or two, maybe even three. If the policy is too expansionary too long and we end up with a real inflation problem, all we’re doing is trading a bigger recession later for a smaller recession now.

On the too big to fail issue, I don't think it is the size of firms alone that is the problem. For example, suppose that we take a firm too big to fail and break into two smaller firms of one half the original size. If the factors that would have caused the one large firm to fail would have also caused the two smaller firms to fail, then we really haven't accomplished much, the size of the banking disaster will be the same. The problems that affected the GSEs came from factors they did not anticipate, factors that were out of their control. In such a situation, it's not clear to me that having more firms specializing in the same business is any safer than one combined firm. Maybe if there are 100 firms a few will pursue safer strategies and survive, but if we then have 97 smaller banks in trouble rather than just one large bank having problems, the scale of the problem is essentially the same and it would be harder, not easier, to take action to shore up the system since it would take 97 separate arrangements rather than just one.

For that reason, I think regulators should consider the overall size of certain classes of risky activity in addition to the size of individual firms. If a risky activity is too large a component of the financial system, and there isn't adequate backup in the event of widespread default, it doesn't matter whether problems bring down a large number of small firms or one large one, the result will be the same.

I don't mean to say that large firms shouldn't be broken up. Even with a (seemingly) well diversified portfolio, i.e. one that avoids over exposure to any particular type of risky asset, size alone could be a risk should a very large firm fail, though hopefully diversification would make failure less likely. I'm saying that breaking firms up into smaller pieces isn't enough in and of itself to reduce the risk of massive financial meltdown. We also need to worry about the overall magnitude of particular classes of risk and how concentrated those risks are within particular sectors of financial markets. If x is a big part of overall financial activity, i.e. if a bad outcome involving x could cause a financial meltdown, one firm doing nothing but risky activity x isn't much (or any) safer than ten firms doing nothing but risky activity x (scale effects could even increase the likelihood of failure).

So I think three things should come under consideration. First, the size of individual banks. Unless scale effects justify it (a natural monopoly argument, in which case it would be heavily regulated), no firm should to large enough to bring down the economy by itself in the event it fails. Second, no particular class of risky assets should be large enough to pose a threat to the financial system. Either the overall size of the asset class should be constrained, or the degree of risk should be limited. Third, the risk from particular classes of asset should not be concentrated in a small number of firms or concentrated within a particular sector if that group of firms or that sector is, collectively, too big to fail.

Paul Krugman: Fannie, Freddie and You

Paul Krugman says Fannie and Freddie won't bring down the economy, and they did not cause the difficulties they are experiencing, but that doesn't mean they don't have problems such as under-capitalization:

Fannie, Freddie and You, by Paul Krugman, Commentary, NY Times: And now we’ve reached the next stage of our seemingly never-ending financial crisis. This time Fannie Mae and Freddie Mac are in the headlines, with dire warnings of imminent collapse. How worried should we be?

Well, I’m going to take a contrarian position: the storm ... is overblown. Fannie and Freddie probably will need a government rescue. But since it’s already clear that that rescue will take place, their problems won’t take down the economy.

Furthermore, while Fannie and Freddie are problematic institutions, they aren’t responsible for the mess we’re in.

Here’s the background: Fannie Mae — the Federal National Mortgage Association — was created in the 1930s to facilitate homeownership by buying mortgages from banks, freeing up cash that could be used to make new loans. Fannie and Freddie Mac, which does pretty much the same thing, now finance most ... home loans...

The case against Fannie and Freddie begins with their peculiar status: although they’re private companies with stockholders and profits, they’re “government-sponsored enterprises” established by federal law, which means that they receive special privileges.

The most important of these privileges is implicit: it’s the belief of investors that if ... threatened with failure, the federal government will come to their rescue.

This implicit guarantee means that profits are privatized but losses are socialized. ... Heads they win, tails we lose. Such one-way bets can encourage the taking of bad risks, because the downside is someone else’s problem. ...

But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending... In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.

Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t ... by law...

So whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.

In that case, however, how did they end up in trouble?

Part of the answer is the sheer scale of the housing bubble, and the size of the price declines taking place... The result is a rising rate of delinquency even on loans that meet Fannie-Freddie guidelines.

Also, Fannie and Freddie, while tightly regulated in terms of their lending, haven’t been required to put up enough capital — that is, money raised by selling stock rather than borrowing. This means that even a small decline in the value of their assets can leave them underwater, owing more than they own.

And yes, there is a real political scandal here: there have been repeated warnings that Fannie’s and Freddie’s thin capitalization posed risks to taxpayers, but the companies’ management bought off the political process, systematically hiring influential figures from both parties. While they were ugly, however, Fannie’s and Freddie’s political machinations didn’t play a significant role in causing our current problems.

Still, isn’t it shocking that taxpayers may end up having to rescue these institutions? Not really ..., major financial crisis ... almost always end with some kind of taxpayer bailout for the banking system.

And let’s be clear: Fannie and Freddie can’t be allowed to fail. With the collapse of subprime lending, they’re now more central than ever to the housing market, and the economy as a whole.

"I am Not Paid Enough to Deal with This Lying Bullshit"

Brad DeLong gets Bush-whackoed:

Every Time I Try to Crawl Out, They Pull Me Back in!, by Brad DeLong:

You know something?

I hate yelling shows.

No, that is not right:

I HATE YELLING SHOWS!

No, that is still not right:

I HATE YELLING SHOWS!!

Maybe this will do it:

I HATE YELLING SHOWS!!!!

Called on forty minutes' notice, I trot over to the J-School studio to be a talking head on BBC/Newsnight about Fannie and Freddie. I have my talking points ready:

...[extensive list of points]...

In short, I trot over to the J-School TV studio as part of the sober, sensible, bipartisan consensus, intending to carry water for Ben Bernanke and Hank Paulson.

And what do I find also on BBC/Newsnight when I get there?

I FIND THAT I AM ON WITH GROVER-FRACKING-NORQUIST!! I FIND THAT I AM ON WITH GROVER-FRACKING-NORQUIST!!! WHO HAS THREE POINTS HE WANTS TO MAKE:

• Barack Obama wants to take your money by raising your taxes and pay it to the Communist Chinese.
• Oil prices are high today and the economy is in a near recession because of Nancy Pelosi: before Nancy Pelosi became speaker economic growth was fine--and she is responsible for high oil prices too.
• Economic growth is stalling because congress has not extended the Bush tax cuts. Congress needs to extend the Bush tax cuts, and if it does then that will fix the economy, and if it doesn't then the economy cannot recover.

I am not paid enough to deal with this lying bullshit. I am not paid enough to deal with Grover Norquist and his willful stream of defecation into the global information pool.

It is as Paul Krugman says somewhere: Grover Norquist's M.O.--George W. Bush's M.O.--the entire Republican Party's M.O. these days is (a) find a problem (i.e., financial crisis and threatening recession), (b) find something you want to do for other reasons unrelated to the problem (i.e., extend the Bush tax cuts), (c) claim without explanation that (b) will solve (a), and so (d) profit--because Peter Cardwell of BBC/Newsnight is too busy being the objective journalist referee of the yelling match to do his proper job and say:

Come, come, Mr. Norquist, are you serious? Your claim to believe that Nancy Pelosi's actions are responsible for the rise in oil prices is risible!

OK. Calm down. Adjust my meds...

Mr. Paulson? Ben? Are you there?

I have been carrying water for the two of you for a year now, as you have tried to do your jobs and contain the ongoing slow-motion financial crisis. Lots of us have been carrying water for you. Now you owe us a favor.

Will you please call John McCain Saturday morning. Call him jointly. Tell him that there is serious public business that needs to be done, and that pseudo-ideologues like Grover Norquist are not helping.

Tell him that unless he can control the swine like Grover Norquist and his ilk who work for him, that both of you are going to, Monday morning:

• announce your support for Barack Obama for president
• announce your change of affiliation from the Republican to the Democratic Party

You owe it. You owe it to me after that TV appearance. You owe it to all of us in the sober, sensible, bipartisan consensus. You owe it to your country. You owe it to the world.

Fannie and Freddie

Robert Reich says Fannie and Freddie are too big to be allowed to fail:

Fannie, Freddie, and the Pending Taxpayer Bailout, by Robert Reich: Fannie Mae and Freddie Mac, the two giant quasi-public housing lenders that together own or guarantee about half the $12 trillion in home loans outstanding, are heading into insolvency. No surprise. As housing prices continue to drop, more and more middle-class homeowners who got their loans from Fannie or Freddie are under water... And as the economy continues to go south, more and more of them can't meet their loan payments.

While it's true that most of their home loans were made before 2006 when lending standards were tighter, that doesn't really matter because the rip-tide of this sinking economy is now hitting a much broader group of home owners.

Fannie and Freddie may not be technically insolvent yet, but I'm betting that if their lending portfolios reflected the true market prices of their loans they would be. That's why their own investors are bailing out.

So who gets stuck with the tab? Investors in Fannie and Freddie have always believed that the loans issued by the two giants were guaranteed by the federal government but technically they aren't. The guarantee has always been assumed but has never been put into law explicitly... Yes, the companies' charters give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default, and the two companies have access to the Fed's so-called Fedwire payments system allowing them to access funding if needed. But these won't keep the two afloat for long.

As a practical matter, we're facing a Bear Stearns squared. Fannie and Freddie are way too big to fail -- especially now. There's no question the government will have to take over the companies, which means taxpayers will get stuck with the tab yet again.

Here we have another example of socialized capitalism. The executives of Fannie and Freddie have been among the best paid in all of corporate America. We're talking tens of millions a year in CEO pay alone. Fannie and Freddie are treated like giant investor-driven entities as long as they're healthy and their investors and executives are doing well. But when they start to go down the tubes they become public entities with public responsibilities, and the rest of us have to bail them out.

On the too big to fail issue, my view hasn't changed. If failure of these firms endangers the broader economy, and hence threatens to impose large costs on people who had nothing to do with creating the problems, then policymakers need to step in and do what they can to prevent a downward economic economic spiral. In addition, they need to change the rules and regulations that allowed the problem to emerge in the first place, and add new rules and regulations as needed to lower the moral hazard worries going forward.

What would you do?

Update: Big Picture adds:

Risk Mis-Assessment Agencies

No real surprises here. One of the reasons financial markets faltered is that ratings agencies fell down on the job, in large part due to the presence of incentives that worked against issuing low ratings:

Study Finds Flawed Practices at Ratings Firms, by Michael M. Grynbaum, Commentary, NY Times: The analyst at the credit ratings agency was blunt: “Let’s hope we are all wealthy and retired by the time this house of cards falters.”

That candid assessment, sent by e-mail to a colleague in December 2006, referred to the market for certain investments linked to subprime mortgages — investments that were assigned top AAA ratings from major agencies, only to later plummet in value.

That e-mail message and dozens like it were disclosed Tuesday in a blistering 37-page report issued by the Securities and Exchange Commission, which confirmed what many on Wall Street had long suspected: the major ratings firms, including Fitch, Moody’s and Standard & Poor’s, flouted conflict of interest guidelines and considered their own profits when rating securities, among other suspect practices.

The report represented a definitive dent in the aura of objectivity that has been cultivated for decades by ratings firms... The assumption was that the firms’ analysts — ostensibly disinterested types who assess the financial health of everything from states and cities to complex mortgages — offered a bias-free view of potential investments.

Instead, the S.E.C. found that the agencies had become overwhelmed by an increase in the volume and sophistication of the securities... Analysts ... began to cut corners. ...

The report also turned up evidence that ratings firms had run afoul of basic guidelines intended to avoid conflicts of interest. It is common practice for investment banks and other financial outfits to pay agencies to rate assets they will later sell. Agency regulations often require analysts ... to remain unaware of any business interests involved with the products whose safety they are gauging.

The S.E.C. found that this was not always the case. ... For example, in an e-mail message from November 2004, an analyst wrote that he was unsure of providing a particular rating because it could hurt revenue. ...

The agencies also considered changing their ratings criteria to better compete with their rivals. ...

The S.E.C. also found that the agencies did not sufficiently disclose or document changes to their ratings criteria. ...

It was unclear whether the findings would lead to criminal charges against the agencies. ... The findings from Tuesday’s report would have to be referred to the enforcement arm of the S.E.C. before any charges can be filed, a spokesman said.

Some states have already opened investigations into the agencies’ conduct. Last week, Moody’s acknowledged that some employees had gone astray of internal conduct codes. ...

"The Blame for High Gas prices"

Richard Serlin:

The blame for high gas prices rests on simple-minded Republican ideology not speculators, by Richard Serlin: In Paul Krugman's June 27th column he writes:

Why are politicians so eager to pin the blame for oil prices on speculators? Because it lets them believe that we don’t have to adapt to a world of expensive gas.

A perhaps even bigger reason why Republicans want to blame speculators for sky high gas costs is that they don't want the public to put the blame where it's really due – on them.

For decades Republicans have constantly blocked Democratic attempts to increase fuel mileage and many other efficiency and conservation measures. They've also constantly blocked or cut spending on alternative energy, all the while mindlessly chanting "Free market". The economics community had proven long ago that there are many situations and ways where a government role can add greatly to efficiency, wealth, and welfare, but this is a party that long ago refused to think beyond slogans. They acted as though not being simple-minded was a vice, liberal and un-American, when in fact, thinking, and believing in science, evidence, and logic is one of the things that made this country great, and the richest and strongest in the world.

Now we're paying a big price for Republican ideology in energy and so many other things. Had the Democrats not been outvoted, filibustered, and vetoed from enacting their "big government" mileage, conservation, research, and other energy measures over the last almost three decades, gasoline might be less than half its price today...

And, of course, it wouldn't hurt that this would have starved the terrorists, and some of the worst authoritarian regimes in the world, of money, and greatly decreased the momentous risks of global warming,... benefits that aren't taken into account by the magical free markets. ...

Is a Financial Transactions Tax the Answer?

Dean Baker says a financial transactions tax has attractive properties:

Bloodletting on Wall Street, by Dean Baker: There were two noteworthy episodes last week in the ... the housing market meltdown. First, the New York Times ... found that the Wall Street banks had already written down ... almost half of their profits in their boom years from 2004 through the first half of 2007.

The other big item was that two Bear Stearns hedge fund managers were marched off to jail, charged with fraud and other related offences. ...

This raises many questions...

The "Enron Loophole"

From Marketplace:

Deflating the oil bubble, by Michael Greenberger: ...Host Kai Ryssdal talks with former commodity regulator Michael Greenberger about ways to keep tabs on speculation.

Kai Ryssdal: ...The [Commodity Futures Trading Commission is] in charge of regulating oil markets in this country and Congress has been after the agency to do something -- to do anything -- about oil and gas prices, what lawmakers perceive to be speculation, in particular.

Michael Greenberger used to run the ... [Division of Trading and Markets for the Commodities Futures Trading Commission. He now teaches law at the University of Maryland.]

Ryssdal: Why is it so hard to figure out what's going on in commodities markets -- oil specifically?

Greenberger: Well, the reason it's hard to figure out is about 30 percent of our crude oil energy futures are traded in what is called a dark market -- that is a market that was deregulated in December of 2000 at the behest of Enron. Prior to that legislation..., all energy futures traded in the United States or affecting the United States in a significant fashion were regulated ... under a very careful regime that had been perfected over about 78 years and many observers believe that because those markets are not being policed, malpractices are being committed and traders are able to boost the price virtually at their will.

Ryssdal: You're not really telling me that seven years on, we're still paying the price for Enron, are you?

Greenberger: Well, this has been called the "Enron Loophole" and there are many legislators working very hard to close that loophole ...[and] bring the speculation under the kind of time-tested controls that were used until Enron had its way and amended the law...

Ryssdal: So what's Congress going to do?...

Greenberger: Well, there are several proposals..., but the bottom line is the speculators will, in the end, be policed. We will know who they are, what they're doing, what their controls are, what effect they're having on the market. Maybe we'll find out that there's nothing there.

Ryssdal: So just to be clear, you do think that we're in a bubble, then?

Greenberger: I believe it and I'm certainly not alone in my belief. If you talk to anybody who trades in these markets on a regular basis, they will tell you that the markets are completely dysfunctional and out of control because of speculative activity.

Ryssdal: How long is it going to take then if we are, as you say, in a bubble, for it to work its way through and us to get back to something more realistic for the price of a barrel of oil, whether its 50 bucks or 80 bucks?

Greenberger: From my own experience as a commodity regulator, I believe that if the Bush Administration were serious about its regulation, we could begin seeing prices drop within a month. If we don't get the kind of regulation that has been done for decades and the market proceeds along the pace its proceeding, we will have to go through a very, very serious recession. The question is do you want to deflate the bubble by that kind of suffering or do you want to deflate the bubble by applying tight U.S. regulatory controls? ...

Regulation and Foodborne Disease Outbreaks

As noted below, in response to this column by Paul Krugman on the failure of food safety regulation in recent years, questions have been raised about whether food borne disease outbreaks have been increasing or decreasing. Here's Alex Tabarrok at Marginal Revolution:

Krugman gets a Rotten Tomato, by Alex Tabarrok: Paul Krugman is attacking Milton Friedman (again) for rotten tomatoes...:

Lately, however, there always seems to be at least one food-safety crisis in the headlines — tainted spinach, poisonous peanut butter and, currently, the attack of the killer tomatoes.

How did America find itself back in The Jungle?

I was curious so I collected data from the Center for Disease Control on Foodborne Disease Outbreaks from 1998-2006. The data only go back to 1998 because in that year the CDC changed its surveillance system creating a discontinuity but note that we are covering a chunk of the Clinton years and are well within the time frame over which Krugman says the safety system has degenerated. Here's the result:

What we see is a lot of variability from year to year but a net downward trend. You can also look at cases per year which are more variable but also show a net downward trend. No evidence whatsoever that we are back "in The Jungle."

Mathew Yglesias says:

...isn't the pattern of spiking in even years and declining in odd years sort of strange...

I am going to turn this over to a food economist the the U.S. Food Policy Blog:

Marginal Revolution covers food safety, by Parke Wilde: Alex Tabarrok at Marginal Revolution gives Paul Krugman a hard rap on the knuckles for criticizing federal food safety regulators without noting the relevant data. Krugman's recent column describes a crisis of foodborne illness outbreaks, while Tabarrok points out CDC statistics showing that at least some kinds of outbreaks haven't increased. Still, the CDC data aren't the whole story. Here is my comment:

...I try to ignore the ideologues. On the one hand, Grover Norquist and Milton Friedman have hopes for market incentives that are not only unrealistic, they are very far from the current state of good contemporary economic thought on food safety.

On the other hand, I give little weight to critics who hold out unrealistic expectations for government prevention of all food safety risks, not so much because they care about food safety, but because they just have large ambitions for government interventions in the economy.

Current economic thought draws on a fairly specific diagnosis of different kinds of imperfect information, each of which calls for a different policy response, which can range from laissez faire to labeling to testing to regulation.

A standard mainstream -- or even somewhat conservative -- text on the economics of food safety is John Antle's book on food safety. It acknowledges market failures in food safety, and particularly recognizes the need for strong government regulation of food-borne pathogens, because in many cases consumers cannot recognize the safety of the food even after purchase, and hence cannot defend their own interests in the marketplace. In my reading, ... on foodborne disease [Antle] seems to me closer to Krugman than Friedman.

There are some exciting private market innovations in food safety recently. For example, the buyers for major supermarket chains are getting more sophisticated in demanding safety from their suppliers, which allows the market to achieve good outcomes that individual consumers could not command on their own.

At the same time, it is fair to say USDA and FDA oversight of food safety have fallen far short of a balanced position. The CDC stats on outbreaks have a number of shortcomings, and don't suffice to make me think otherwise. Take something like the USDA's refusal to let Creekstone beef voluntarily test its own product for BSE. ... The so-called "regulators" are way out of step with the public interest position of economists, even market economists who appreciate the market's accomplishments on its good days.

Let me take this a step further. Here are the actual data from the individual reports from the CDC (the totals are shown in the graph from Alex's post):

	1998	1999	2000	2001	2002	2003	2004	2005	2006
Bacterial	257	222	226	235	226	196	208	188	223
Chemical	48	32	37	52	46	54	47	40	53
Multiple		2	3	7	12	7	5	6
Parasitic	4	3	6	5	5	3	8	6	9
Viral	59	109	176	156	205	149	251	170	337
Confirmed	368	368	448	455	494	409	519	410	623
Suspected									275
Unknown	946	976	969	783	838	663	800	572	349
Total	1314	1344	1417	1238	1332	1072	1319	982	1247

When I look at these data, it's hard to find any consistent trends. The increase in confirmed cases appears, for the most part, to be due to an increase in confirmed viral outbreaks, but it's hard to know whether the increase is more actual cases, which would be worrisome, or just better technology at identifying them. For the rest of the confirmed cases, there is not that much of a pattern. But no matter what the trends in confirmed cases say, with more than half the cases due to unknown causes and so much variation in the number of unknown etiologies, it's hard to know how to interpret the overall figures shown in the graph above as a rebuttal to Krugman.

Stepping away from the data for a moment, and given their quality that may be wise, the larger issue is whether the government should intervene and regulate food markets to promote safety, or follow Friedman's advice and let the private sector take care of the problem. The market failure due to asymmetric information identified above, and the advice of experts in the area make a compelling case for regulation.

Update: Tyler Cowen, Alex Tabarrok, and others have asked in comments that I update the post to say that these data do not support Krugman. Yes, that's true, but it's because these data are too noisy to support anything (they suffer from a huge errors in variable problem that appears to be time-varying, and also appear to be heteroskedastic). These data are of such poor quality that you can't conclude anything. The trend could be rising, it could be flling, it could be constant, but these data can't tell us the answer. So, the rebuttal  argument seems to be as follows. Someone (Krugman) makes a claim. To check the claim, I go get really, really noisy data, run a regression, and say, "see - the hypothesis doesn't stand up to the data!" That doesn't seem very compelling to me.

FRBSF: Did Large Recalls of Chinese Consumer Goods Lower U.S. Imports from China?

When products imported from China were recalled, e.g. due to excessive lead in toys, how large of an impact did it have on the volume of imports?:

Did Large Recalls of Chinese Consumer Goods Lower U.S. Imports from China?, by Christopher Candelaria and Galina Hale, FRBSF Economic Letter: In the latter half of 2007, the media were full of stories about recalls of consumer goods produced in China, with the majority related to high concentrations of lead used in the paint for toys. The volumes and the values of the affected goods were large; for example, the value of toy industry recalls totaled almost 20% of the overall monthly import of toys and related products from China. Some of the multinational manufacturers involved stated that they were not aware of the violation of consumer safety laws in the production process. This raises the question of whether the recalls led such manufacturers to shift production from China to other countries and whether they unleashed a general backlash against the "Made in China" label. This Economic Letter analyzes the extent to which the recalls have led to fewer imports from China in the affected industries.

Paul Krugman: Bad Cow Disease

"Back in The Jungle":

Bad Cow Disease, by Paul Krugman, Commentary, NY Times: "Mary had a little lamb / And when she saw it sicken / She shipped it off to Packingtown / And now it’s labeled chicken."

That little ditty famously summarized the message of "The Jungle," Upton Sinclair’s 1906 exposé of conditions in America’s meat-packing industry. Sinclair’s muckraking helped Theodore Roosevelt pass the Pure Food and Drug Act and the Meat Inspection Act — and for most of the next century, Americans trusted government inspectors to keep their food safe.

Lately, however, there always seems to be at least one food-safety crisis in the headlines — tainted spinach, poisonous peanut butter and, currently, the attack of the killer tomatoes. The declining credibility of U.S. food regulation has even led to ... mass demonstrations in South Korea protesting the ... decision to allow imports of U.S. beef, banned after mad cow disease was detected in 2003.

How did America find itself back in The Jungle?

It started with ideology. Hard-core American conservatives have long ... wanted a restoration of the way America was “up until Teddy Roosevelt, when the socialists took over. The income tax, the death tax, regulation, all that.”

The late Milton Friedman ... call[ed] for the abolition of the Food and Drug Administration. It was unnecessary, he argued: private companies would avoid taking risks with public health to safeguard their reputations and to avoid damaging class-action lawsuits. (Friedman, unlike almost every other conservative I can think of, viewed lawyers as the guardians of free-market capitalism.)

Such hard-core opponents of regulation were once part of the political fringe, but with the rise of modern movement conservatism they moved into the corridors of power. They never had enough votes to abolish the F.D.A..., but they ... did ... deny... these agencies enough resources to do the job. For example,... the F.D.A. has ... a substantially smaller work force now than ... in 1994, the year Republicans took over Congress.

Perhaps even more important, however, was the systematic appointment of foxes to guard henhouses.

Thus, when mad cow disease was detected in the U.S. in 2003, the Department of Agriculture was headed by Ann M. Veneman, a former food-industry lobbyist. And the department’s response to the crisis —... downplaying the threat and rejecting calls for more extensive testing — seemed driven by the industry’s agenda.

One amazing decision came in 2004, when a Kansas producer asked for permission to test its own cows, so that it could resume exports to Japan. You might have expected the Bush administration to applaud this example of self-regulation. But permission was denied, because other beef producers feared consumer demands that they follow suit.

When push comes to shove, it seems, the imperatives of crony capitalism trump professed faith in free markets.

Eventually, the department did expand its testing, and ... most countries ... have allowed [US beef] back into their markets. But the South Koreans still don’t trust us...

The ironic thing is that the Agriculture Department’s deference to the beef industry actually ended up backfiring: because potential foreign buyers didn’t trust our safety measures, beef producers spent years excluded from their most important overseas markets. ...

The moral of this story is that failure to regulate effectively isn’t just bad for consumers, it’s bad for business.

And in the case of food, what we need to do now — for the sake of both our health and our export markets — is to go back to the way it was after Teddy Roosevelt, when the Socialists took over. It’s time to get back to the business of ensuring that American food is safe.

Is Austan Goolsbee Betraying the Chicago Tradition? If So, is That Bad?

Greg Mankiw has a question for Austan Goolsbee:

George Stigler rolls over in his grave, by Greg Mankiw: Remember when the University of Chicago used to be the intellectual center of the deregulation movement? No more. A reader alerts me to this news:

Investment banks that obtain Federal Reserve Bank loans during a financial crisis should face much closer regulatory scrutiny, a key economic adviser to Democratic presidential candidate Sen. Barack Obama said.

Austan Goolsbee, an economics professor at the University of Chicago and one of Sen. Obama's closest advisers on economic issues, said the senator believed strongly in enhanced regulation of any financial institution that has access to the Fed's discount window.

"If you can borrow money from the U.S. taxpayer at a moment of crisis, that is a very sacred insurance policy underwritten by the U.S. taxpayer," said Mr. Goolsbee in an interview last week with Dow Jones Newswires. "We have the right to oversee anyone who is accessing that insurance policy."...

Mr. Goolsbee said that an Obama presidency would ensure that investment banks are regulated as closely as commercial banks.

Here's a question for Austan: Can an investment bank avoid such regulation if it promises never to use the discount window? Or is this insurance-regulation combo a mandate?

This story seems to confirm the fears of Vince Reinhart.

I agree that access to the Fed's lending facilities should come with regulatory restrictions. The question is whether banks should be allowed to move outside the regulatory umbrella if they voluntarily give up access to the discount window.

Isn't the problem credible commitment? A bank would also have to promise that it would not become "too big to fail" for the commitment from the Fed to prohibit access to the discount window to be credible. If a bank does become too big to fail, and if it runs into trouble and asks the Fed for help, then the Fed will be forced to bail them out if it wants to act in the best interest of the overall economy no matter what the prior agreement had been. Sending the economy into a tailspin and deep recession simply to honor a past promise to prohibit access to the window would not be the best policy at that point.

So, if banks can grow large enough to threaten the overall economy in the event of failure, I don't see how you avoid a regulatory solution. We either have to regulate the size of banks to make sure the threat to the overall economy does not exist, and then intervene if a bank grows too large. Or we need to allow banks to grow large enough to threaten the economy should they get into trouble, perhaps because large banks have desirable efficiency properties, but impose regulations to reduce the chances that they will need to be helped, and to limit their ability to damage the overall economy in the event that the help we can provide to a bank that is in trouble is not enough to prevent it from failing.

Update: Brad DeLong has a follow-up discussion.

What Should We Do with the Revenues from Cap-and-Trade?

More on cap-and-trade from Robert Reich:

Why Revenues from Cap-and-Trade Should Be Returned to Us As Dividends, by Robert Reich [originally here] ...[To address global warming,] Barack Obama is on record in favor of cap and trade. And so, significantly, is John McCain.

So it's a certainty that we'll have a president next year who wants to address global warming by imposing an overall cap on U.S. carbon emissions, which will drop annually. The "trade" part ... would allow companies finding efficient ways to cut emissions to sell the unused portions of their permits to others. Obama’s proposal is more ambitious than McCain’s in terms of how fast the overall cap would drop.

But the biggest difference between McCain and Obama is how the permits would be allocated. McCain’s proposal would initially give out most of them for free to the nation’s biggest emitters of greenhouse gases. This does have some logic to it: after all, as the overall cap tightens each year, the biggest polluters will face the largest challenges in cutting emissions.

By contrast, Senator Obama has proposed allocating the permits through an auction. Under his proposal, every company ... would have to buy the rights to emit greenhouse gases. As a result, the biggest emitters would have to pay the most - thereby providing them with the greatest incentive to cut emissions right from the start. In economic terms, such a carbon auction is the equivalent of a carbon tax, and it make more sense than a system that allocates permits on the basis of how much greenhouse gas a company or industry already emits. Companies and industries that impose the largest social costs in terms of such emissions should be given the greatest incentives to cut costs right from the start.

Moreover, carbon auctions invite far less political maneuvering. Setting initial allocations by emissions, as McCain wants to do, invites every big corporation and industry to fight for the biggest possible allocation and claim the largest emissions. Despite John McCain’s avowed determination to reduce the influence of lobbyists in Washington, the resulting free-for-all would be a bonanza for K Street. And there’s no reason to suppose the outcome would bear any resemblance to the public interest. ... This is one reason why cap-and-trade hasn't worked very well in Europe so far. ...

But carbon auctions raise another problem when it comes to Washington. ... Lieberman estimates that the market value of all permits under his bill would be about $7 trillion by 2050. That sum would go into what Lieberman calls a Climate Change Credit Corporation, which, operating outside the budget process, would invest in various plans for developing alternative energy. You can bet that lobbyists for ethanol, nuclear, and so-called “clean” coal are already salivating...

That's why it's important that all revenues from carbon auctions be cycled back to citizens. And rather than launch another endless debate over how and to whom – a payroll tax cut for people earning under the median wage? a cut in capital gains? – it would be well to agree to the simplest possible formula: Every adult citizen should receive an equal share. If the carbon auction yields $150 billion in the first year, for example, each of America’s 150 million adult citizens should receive a Treasury check of $1000.

Such direct and simple repayments – what analyst Peter Barnes, who has been pushing this idea, wisely calls “dividends” – deal with another problem. Although the balance of economic studies suggest that the cost of a cap and trade system will be modest, ... inevitably some costs will be involved and be passed along to consumers. The cost of doing nothing about climate change will be far higher. But consumers who are already walloped by high fuel and food costs will be in no mood to accept even modest additional price increases. Hence, ... dividend checks will be a welcome offset. ... Our atmosphere belongs to all of us. It seems only reasonable that corporations should have to pay to use it. ...

Insuring against Insurance Risk

Robert Shiller says we need to move to long-term home owners' insurance:

Insuring Against Insurance, by Robert J. Shiller, Project Syndicate: ...Almost universally in the world today, homeowners’ insurance is short term. Typically, it is renewed annually, which means that it does not cover the risk that insurance companies will raise rates at any future renewal date.

Yet we have seen major changes recently in homeowners’ insurance rates. For example, the average homeowner premium in Florida soared from $723 at the start of 2002 to $1,465 in the first quarter of 2007. Such rapid increases represent a risk that is on the same order of magnitude as many of the damage risks that the policies are supposed to address.

In a study..., the economists Dwight Jaffee, Howard Kunreuther, and Erwann Michel-Kerjan called for a fundamental change in policy aimed at developing true long-term insurance (LTI) that set insurance premiums for many years. Unless we do that, homeowners are unsure from year to year whether their insurance policies will be canceled or that their premiums will skyrocket unexpectedly as they have ... where there is hurricane and flood risk. As the authors point out, for insurers to even consider a long term policy they must have the freedom to charge premiums that reflects risk.

"Change is in the Air for Financial Superclass"

Is the financial superclass about to have its wings clipped?

Change is in the air for financial superclass, by David Rothkopf, Commentary, Financial Times: ...The re-engineering of international finance has been one of the transformational trends of our times – in just a quarter-century, capital flows became massive, instantaneous and controlled by a new breed of traders representing a handful of major financial institutions from a few countries. Their rewards have transcended any in history as shown by an estimate ... that the top hedge fund manager last year made $3bn.

The concentration of power has also steadily grown..., the key executives are in the US and Europe, underscoring the transatlantic nature of this elite. Change, however, is in the air. The history of elites is one of their rising up, over-reaching, being reined in and supplanted by a new elite. Several recent developments suggest that the financial crisis could signal the high-water mark of power for this group.

First, the crisis is prompting a re-regulatory drive. The power of financial elites had been evident in their ability to argue that global financial markets and markets in new securities should remain “self-regulating” (how many of them would hop into a self-regulating taxicab?), then when crisis comes ... these champions of less government involvement have then persuaded governments to cauterise their wounds.

Now, however, there are encouraging, if preliminary, signs of a push towards more effective collaboration between governments – the first steps towards creating the much needed checks on global markets... This could erode the agility of financial elites to play governments off against each other, with the weakest regulator setting the rules.

Second, the credit crisis is exacerbating the emerging backlash against corporate excess. Elites make billions on markets whether they go up or down and their institutions win government support while the little guy loses his home. ... The crisis has focused attention on the obscene inequities of this era – the world’s 1,100 richest people have almost twice the assets of the poorest 2.5bn. There are signs of open and growing anger at this, as we have seen this week in the Netherlands with calls to address bonuses, and the attack on the world’s financial markets as “a monster that must be tamed” from Horst Köhler, the German president.

Third, the accumulation of financial reserves in the Persian Gulf, Russia and China underscores that the centre of gravity in global finance is also shifting. ... The top creators of great new personal fortunes are in China, India and Russia. It seems unavoidable that the transatlantic elite ... will be rivalled in influence by the Asian contingent – a group that has as little appetite for the ... the values and priorities of the western financial superclass.

So, are we at the beginning of the end of a golden era for transatlantic financial elites? Perhaps, but elites cede power reluctantly and there are signs of an effort to stave off decline. There is now a recognition of the need to accept some global market reforms to avoid more invasive legislation. ... Institutional investors could play a role by demanding more sensible pay packages from money managers. The rise of Asia probably cannot be resisted. But by recognising that there are public interests to which they must respond, the financial superclass can stall the fate of previous elites. To succeed at that they must shun their arrogant “leave-it-to-the-market” explanations for the inequality they have helped foster.

Is it different this time? [See also Fed Chariman Bernanke's speech today, Risk Management in Financial Institutions. Update: See also How Should We Respond to Asset Price Bubbles? by Fed Governor Mishkin. There's been a lot written about how the Fed's recent communication on bubbles represents a change in policy for the Fed where bubbles will be attacked more aggressively, but they've always said regulatory and supervisory steps were needed to moderate financial markets, the big change would be for the Fed to use interest rate policy to manage bubbles, and I don't see much change in the way the Fed intends to conduct monetary policy.]

"Another Tool for the Fed?"

Barry Ritholtz notes:

Another Tool for the Fed?, by Barry Ritholtz: Have you ever even thought about this?

"The Federal Reserve is formally asking Congress for authority -- starting this year -- to pay interest on commercial-bank reserves, in an effort to gain better control over interest rates and more leverage to battle the credit crunch...

In 2006, Congress gave the Fed permission to pay interest on reserves -- the sums banks keep on deposit at the Fed -- but it delayed the effective date of the legislation until 2011 to postpone the cost to the Treasury.

Banks are required by law to hold a certain fraction of their deposits in reserve accounts at the Fed, but receive no interest on these deposits. Having the authority to pay interest would solve two technical headaches for the Fed.

If they earned interest from the Fed, banks would have no incentive to lend out excess reserves for less. That would make the Fed's benchmark federal-funds rate, which banks charge on overnight loans to each other, less likely to plunge below the Fed's official target -- now 2% -- on days when the banking system was awash in cash.

I'll bet this sort of stuff never even entered your thinking . . .

I don't think he is talking to me, but if he's willing, I'll take that bet. It's interesting how much attitudes toward regulation have changed in the two years since that post, "Regulatory Relief for Banking Organizations," was written.

Also, given our recent financial market troubles, the second "technical headache" that is solved is worth noting:

In addition, the Fed could theoretically combat the credit crunch by buying securities or extending loans without limit without causing the federal-funds rate to fall to zero, something that could fuel inflation or distort markets. ...

To combat the credit crunch, the Fed has replaced half the roughly $800 billion of Treasurys it held last July with loans to banks and securities dealers.

If the Fed used up all those Treasurys, it could purchase more, but in the process it would create large quantities of excess reserves. As banks lent out those excess reserves, the federal-funds rate would fall to zero. By paying interest on reserves, the Fed could put a floor under the funds rate and expand its balance sheet to deal with the credit crunch. The Fed, however, has not cited that as the immediate objective of its request.

Paul Krugman: Success Breeds Failure

When duct tape won't do the job, it's time to break out the baling wire. But eventually, if real repairs aren't made, the whole system can come apart at the seams:

Success Breeds Failure, by Paul Krugman, Commentary, NY Times: Cross your fingers, knock on wood: it’s possible, though by no means certain, that the worst of the financial crisis is over. That’s the good news.

The bad news is that as markets stabilize, chances for fundamental financial reform may be slipping away. As a result, the next crisis will probably be worse than this one.

Let’s look at the story so far.

After the financial crisis that ushered in the Great Depression, New Deal reformers regulated the banking system, with the goal of protecting the economy from future crises. The new system worked well for half a century.

Eventually, however, Wall Street did an end run around regulation, using complex financial arrangements to put most of the business of banking outside the regulators’ reach. Washington could have revised the rules to cover this new “shadow banking system” — but that would have run counter to the market-worshiping ideology of the times.

Instead, key officials, from Alan Greenspan on down, sang the praises of financial innovation and pooh-poohed warnings about the growing risks.

And then the crisis came. Last August, as investors began to realize the scope of the mortgage mess, confidence in the financial system collapsed. ...

The Fed’s efforts these past nine months remind me of the old TV series “MacGyver,” whose ingenious hero would always get out of difficult situations by assembling clever devices out of household objects and duct tape.

Because the institutions in trouble weren’t called banks, the Fed’s usual tools for dealing with financial trouble, designed for a system centered on traditional banks, were largely useless. So the Fed has cobbled together makeshift arrangements to save the day. There was the TAF and the TSLF..., there were credit lines to investment banks, and the ... barely legal ... rescue not of Bear itself, but of its “counterparties,” those who were on the other side of its financial bets.

It’s still far from certain whether all this improvisation has resolved the crisis. But it was the right thing to do, and for the moment things seem to be calming down. ...

We now know that things that aren’t called banks can nonetheless generate banking crises, and that the Fed needs to carry out bank-type rescues on their behalf. It follows that hedge funds, special investment vehicles and so on need bank-type regulation. In particular, they need to be required to have adequate capital.

But while our out-of-control financial system has been bad for the country, it has been very good for wheeler-dealers... They don’t want regulations that would stabilize the economy but cramp their style.

And now that the financial clouds have lifted a bit, the pushback against sensible regulation is in full swing. ... Maybe a Democratic sweep in November can revive the cause of financial reform, but right now it looks as if we’ll soon return to business as usual.

The parallel that worries me is what happened a decade ago, after the hedge fund Long-Term Capital Management failed, temporarily causing the whole financial system to freeze up.

Through luck and skill, that crisis was contained — but rather than serving as a warning, the episode nurtured the false belief that the Fed had all the tools it needed to deal with financial shocks. So nothing was done to remedy the vulnerabilities the L.T.C.M. crisis revealed — the same vulnerabilities that are at the heart of today’s much bigger crisis.

And if we don’t fix the system now, there’s every reason to believe that the next crisis will be bigger still — and that the Fed won’t have enough duct tape to hold things together.

"A Strategy to Promote Healthy Globalisation"

Larry Summers continues his conversation on how to promote broad based support for globalization:

A strategy to promote healthy globalisation, by Lawrence Summers, Commentary, Financial Times: Last week, in this column,... I suggested that opposition to ... economic internationalism ... reflected a growing recognition by workers that what is good for the global economy and its business champions was not necessarily good for them, and that there were reasonable grounds for this belief. ...

This ... was ... emphasised years ago by Robert Reich... The normal argument is that a more rapidly growing global economy benefits workers and companies in an individual country by expanding the market for exports. This is a valid consideration. But it is also true that the success of other countries, and greater global integration, places more competitive pressure on an individual economy. Workers are likely disproportionately to bear the brunt of this pressure. ...

In ... an open economy where investments in innovation, brands, a strong corporate culture or even in certain kinds of equipment can be combined with labour from anywhere in the world. Workers no longer have the same stake in productive investment by companies as it becomes easier for corporations to combine their capital with lower priced labour overseas. Companies, in turn, come to have less of a stake in the quality of the workforce and infrastructure in their home country... Moreover businesses can use the threat of relocating as a lever to extract concessions regarding tax policy, regulations and specific subsidies. Inevitably the cost of these concessions is borne by labour.

The public policy response of withdrawing from the global economy, or reducing the pace of integration,is ultimately untenable. It would generate resentment abroad on a dangerous scale, hurt the economy as other countries retaliated, and make us less competitive as companies in rival countries continue to integrate ... with developing countries. ...

The domestic component of a strategy to promote healthy globalisation must rely on strengthening efforts to reduce inequality and insecurity. The international component must focus on the interests of working people in all countries, in addition to the current emphasis on the priorities of global ­corporations.

First, the US should take the lead in promoting global co-operation in the international tax arena. There has been a race to the bottom in the taxation of corporate income as nations lower their rates to entice business to ... invest in their jurisdictions. Closely related is the problem of tax havens that seek to lure wealthy citizens... It might be inevitable that globalisation leads to some increases in inequality; it is not necessary that it also compromise the possibility of progressive taxation.

Second,... prevent harmful regulatory competition. ... Financial regulation is only one example of where the mantra of needing to be “internationally competitive” has been invoked too often as a reason to cut back on regulation. There has not been enough serious consideration of the alternative – global co-operation to raise standards. While labour standards arguments have at times been invoked as a cover for protectionism, and this must be avoided, it is entirely appropriate that US policymakers seek to ensure that greater global integration does not become an excuse for eroding labour rights.

To benefit the interests of US citizens and command broad political support, US international economic policy will need to focus on the issues in which the largest number of Americans have the greatest stake. A decoupling of the interests of businesses and nations may be inevitable; a decoupling of international economic policies and the interests of American workers is not.

"The Dreaded 'R' Word"

Alan Blinder outlines the regulatory changes he would like to see enacted in financial markets:

The Case for a Newer Deal, by Alan S. Blinder, Economic View, NY Times:  Part of the New Deal was a new financial deal. The shameful shenanigans leading up to the 1929 stock market crash and the frightening wave of bank failures during the Depression led directly to the creation of the Securities and Exchange Commission and the Federal Deposit Insurance Corporation.

As we emerge from this, the worst financial crisis since the 1930s, a New Financial Deal may follow. If so, what should some of the reforms be?

A warning to laissez-faire-minded readers: The following is mostly about the dreaded “R” word — regulation. But I’m afraid that we need more of that...

An inordinate share of the dodgiest mortgages granted in recent years originated outside the banking system. They were marketed aggressively, sometimes unscrupulously, by mortgage brokers who were effectively unregulated... The need for a federal mortgage regulator — including a suitability standard for mortgage brokers — is painfully obvious.

Next, we should resist calls to scrap the “originate to distribute” model, wherein banks originate mortgages, which are then ... turned into mortgage-backed securities that are sold to investors around the world. This ... model has given the United States the world’s broadest, deepest, most liquid mortgage markets. And that, in turn, has meant lower mortgage interest rates and more homeownership. These are gains worth preserving.

But the model needs some nips and tucks. A far less radical, though still regulatory, approach would require both originating banks and securitizers to retain some fractional ownership of each mortgage pool. ...

And while we’re on the subject of M.B.S., we must end the regulatory fiction that off-balance-sheet entities like conduits and S.I.V.’s are unrelated to their parent banks. ... Since last summer, we have seen one financial giant after another brought to its knees by losses that originated off balance sheet.

What’s the solution? ... The remedy here is simple: Apply appropriate capital charges to off-balance-sheet assets.

That brings us to leverage. After all, high leverage means owning a lot of assets with only a little capital. This is where something fundamental changed on March 16. Before that day, only banks had access to the Fed’s discount window; broker-dealers took large risks without a safety net. But... Because securities firms are now under the Fed’s protective umbrella, they must start operating as safely and soundly as banks. That means both closer supervision and less leverage.

How much less? You may recall that Bear Stearns ended its life with leverage of around 33 to 1, meaning that just 3 cents of capital stood behind each dollar of assets. That won’t do any longer. Leverage of 10 or 12 to 1 is more typical for a bank. ...

Next come ratings agencies, whose recent performance has drawn criticism. The good news is that they are making good-faith efforts at change. ... The bad news is that they face an acute incentive problem when they get paid by the issuers of the very securities they rate.

What to do? The third-party reviews should help. ...Dilip Abreu suggests paying ratings agencies with some of the securities they rate, which they would then have to hold for a while. Robert Pozen ... wants independent investors in the conduits to hire the agencies instead. Another idea would have a public body, like the S.E.C., hire the agencies, paying the bills with fees levied on issuers. ...

Last, but certainly not least... Everyone knows we live in a world of giant multinational financial institutions... Such an environment demands ever closer international cooperation and coordination among the world’s major financial regulators. But today’s level of international cooperation is wholly inadequate...

Finally, let’s be clear about the purposes of all these New Financial Deal reforms. They would not banish speculative bubbles from the planet. After all, there have been bubbles for as long as there have been speculative markets. But with each bursting bubble, new flaws in the system are exposed. Like a good roofer after a soaking rainstorm, we should patch the leaks we see now, knowing full well that more leaks will spring up in the future.

Sometimes, it's best not to wait for more leaks if you know full well they will reoccur. You may not catch them all when you try to repair them in a piecemeal fashion, and with each new set of leaks the dry rot spreads further into the supporting structure, and if nothing is done, at some point the rot will cause the entire roof to collapse leading to very costly repairs.

Sticking with the dreaded "R" word analogy - roofs - when there is a danger of this happening, then the shingles, supporting plywood, and sometimes part of the frame need to be replaced, i.e. much more is required than simply plugging holes as they occur, the roof needs to be fully repaired. So the question for financial markets is how deep the repair needs to go. Do we plug a few holes, or do the repairs need to go deeper, into the supporting structure? With roofs, what is it, three sets of shingles before they all need to be scraped off and redone? Financial markets might be similar - at some point, as we layer on new regulation after each crisis, it might be best to scrape it all off and replace it with a thinner, more effective shield before it is too much for the underlying structure to support.

For financial markets, I'm not sure plugging a few holes is enough, and minimally I want us to strip the shingles off and examine the plywood and deeper supporting structure closely to see if it needs attention, then make the repairs as needed to prevent leaks for a good number of years. There are no guarantees that this will prevent all troubles, there's always the danger that a raccoon or something will dig a hole in your roof, a tree could fall on it, etc., but I do think we need to scrape the shingles off the regulatory structure that is currently in place, examine the underlying structure closely, and do what we can to prevent more leaks in the future.

Paul Krugman: Party of Denial

The party of pragmatic solutions versus the party of denial, obfuscation, and stalling:

Party of Denial, by paul Krugman, Commentary, NY Times: During Barack Obama’s Sunday appearance on Fox News, the interviewer asked him for an example of “a hot-button issue where you would be willing to buck the Democratic Party line” and say that Republicans have the better idea.

Mr. Obama’s answer was puzzling because he gave credit where it isn’t due — and thereby undermined what could be a very effective Democratic line of argument.

In particular, Mr. Obama attributed to Republicans the idea that regulation can be flexible rather than a matter of “top-down command and control,” and in particular for the idea of controlling pollution with ... tradable emission permits rather than rigid regulations.

Well, that’s not at all what actually happened... It’s true that the first President Bush established a market-based system for controlling ... acid rain. But by then the idea of markets in emission permits had long been accepted by ... leading Democrats. The Environmental Protection Agency began letting cities meet air-quality standards using emissions-trading systems during the Carter administration — which also led the way on deregulation of airlines and trucking.

Furthermore, the ... scheme actually marked a sharp change in policy from the Reagan administration, which — committed to the belief that government is always the problem... — spent eight years opposing any effort to control acid rain. ...[E]ven as the consequences of acid rain became ever more alarming... — the Reaganites insisted that there was no problem at all. They denied the evidence, questioned the science, called for more research and did nothing. Sound familiar?

And that, surely, is the line the Democrats should be pushing in this election: Republicans have become the party of denial. If a problem can’t be solved with deregulation and tax cuts, they pretend it doesn’t exist.

Climate change is the obvious contemporary parallel with acid rain. But if the Democrats really want to pin the denialist label on John McCain, health care is the place to focus.

The health care situation, in case you haven’t noticed, is going from bad to worse. ... The Democrats have been offering real plans in response; they’re not perfect, but they are serious.

The G.O.P., by contrast ... hasn’t even tried to address concerns about coverage.  ... Until a few days ago, the only answer the McCain campaign offered to those worried about lack of coverage was the vague, implausible assertion that the magic of the marketplace would make health care cheap enough for everyone to afford.

Now Mr. McCain has admitted that maybe a government program is needed.... This appears to be a response to criticism from Elizabeth Edwards, who has been pointing out that deregulated insurers would deny coverage to anyone with, say, a history of cancer — a category that includes both her and Mr. McCain himself. But the way Mrs. Edwards has rattled the McCain campaign is evidence of just how vulnerable he is on the issue.

The point is that the health care issue could be Exhibit A for a Democratic campaign based on the argument that they are the party of pragmatic solutions, while modern Republicans won’t even acknowledge problems that don’t fit into their rigid ideological framework.

But are Democrats ready to make that case?

To be clear, both Democratic candidates have been saying things they shouldn’t; Hillary Clinton shouldn’t have endorsed the bad idea of a gas tax holiday.

But I think Mr. Obama is doing much more harm to the Democratic cause by echoing Republican attack lines on such issues as insurance mandates and Social Security. And now he’s demonstrating his post-partisanship by giving Republicans credit for good ideas they never had.

"Don't Blame All Borrowers"

Robert Frank argues that as we decide who is responsible for the housing crisis, we shouldn't place too much blame on families who overextended themselves. They were, for the most part, trying to avoid sending their children to inferior schools:

Don't Blame All Borrowers, by Robert H. Frank, Commentary, Washington Post: ...Over 9 million mortgages are "under water," meaning that more is owed on them than the home is worth. As foreclosures mount, ... Congress is debating loan guarantees that would help homeowners renegotiate mortgages in default. In his initial response to the proposed legislation, Sen. John McCain argued that "it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers."

Many share McCain's concern. But while Congress clearly should not rescue borrowers who lied about their incomes or tried to get rich by fl