Left Flank

David Brooks, talking on the PBS Online Newshour faults Alan Greenspan for his perspective.

Well, first of all, I admired him for saying that. We often are in a political culture where nobody admits a mistake, and he admitted a mistake. And the question is, why? What did he get wrong about the economy?

And I think what he got wrong is -- Paul Solman had a guy named Nassim Taleb on the show not long ago who got it right, who picked Fannie Mae, who talked about the banking collapse.

And the difference between the two worldviews is Greenspan relied on quantitative models of risk analysis, where Taleb is the product of behavioral economics, which talks about the psychology of perception and the perception of risks, and the biases we make in assuming the future will be basically like the past, and the way we look for evidence that confirms our prejudices.

And if you looked at the risk analysis through the frailty of human perception, as Taleb did, you can say this risk was out of control. People did not understand what was happening.

And all these bogus economic models that the quantifying people believed in just were bogus. And I think that's the two mental frameworks that allowed some people to understand what was going to happen and so many, so many experts not get it.

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The looming «deep recession» forming in the aftermath of the collapse of the American and European financial sectors is not a scythe, and its effect upon developing and newly-developed states will be complicated, according to Jeffrey Sachs. It's another illustration globally of how diverse political and economic conditions are. Some states could either be relatively unaffected, or benefit.

Other areas of the world are experiencing the crisis for lots of reasons—because their own banks did what U.S. banks did; because our monetary policy led to bubbles that spread; because their economies are dependent on imports. I don't think it will lead to a worldwide downturn everywhere. China, for example, will continue to experience good growth during this period.

(...)

I think the effects probably are ironically felt more in middle-income countries, because one of the attributes of the poorest countries is that they are more disconnected to the world system. Their banks are not connected and are very small relative to the economy. People don't own stock, so they don't lose their pensions. In middle-income countries like Brazil and India, there could be more substantial risks.

(...)

Of course Nigeria fluctuates with the oil prices, and that's also the case for Angola. Kenya is a lot more complicated because you have a more diversified economy. Its banks are not strong to begin with, and now the easy go-go days are [over]. But I don't see that as a major loss for the development of these countries. They will have their work cut out for them in attracting serious investment, but it can remain possible in this setting. Linkages that can be forged with the United States, China, India, will continue to go forward.

Yet, the danger for poorer, developing states comes at the tail of the crisis effect dogging developed donor states.

FP: At last weekend's meeting, Robert Zoellick noted that 100 million people have been driven into poverty so far this year. Do you think that number will go higher?

JS: That crisis is a result of commodity prices, especially rising energy prices and higher fertilizer prices. It is not the result of this crisis, and I don't think that the direct effects of this crisis will be significant.

The question of course is whether the crisis distracts [countries] from all of these [antipoverty] policy agendas, which is relevant and often a life-or-death issue. That's obviously a real concern. My general take is that in good times or bad, it's hard to get people to focus on these issues. I'm not sure [this crisis is] going to diminish from the low levels of focus we usually have.

Sachs sees an opportunity to reform the aid process, and for newly-developing states to step up.

I expect the whole attitude toward governance to change, especially if [U.S. Senator Barack] Obama becomes president. The days of laissez faire recklessness and greed are over, and the idea that government has responsibilities in the financial markets and to the poor and even to the world's poor will become more important.

(...)

FP: As president of the Millennium Promise Alliance, which aims to help countries reach the U.N.'s Millennium Development Goals by 2015, you have spent a great deal of time advocating for increased foreign aid. With hard economic times hitting big donors such as the United States, Europe, and others, how much do your efforts need to change?

JS: The main point I have been trying to make is that promises are for less than 1 percent of income—which is true whether we are in a good year or a bad year. Less than 1 percent is manageable. These are commitments that we can afford. It's important for the world, and I'll continue to argue that case.

Second, the idea of $25 billion for Africa suddenly doesn't sound like so much after a $700 billion bailout in the United States or $2 trillion in bank guarantees in Europe. We've just been making choices to ignore the poor rather than calculations based on real resources available. We made a choice to let millions of people die and not honor our commitments. The crisis doesn't change our quantitative ability to follow through. And now, I think everyone is more of a macroeconomist than they were before. They can evaluate for themselves that it's just not a lot of money compared to the amounts mobilized in recent weeks.

Third is that one of the core strategies is looking at multiple donors, not only traditional donors in the United States and Europe. The Middle East can and should put in more money; China can and should put in more money. We are going to see those connections grow, to the good of everyone.

This financial crisis could broaden the current leading from American hegemony to political and economic multipolarity.

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Are cheaper commodities bad for the economy?

Since the early summer the price of steel has fallen by 20-70% and the key rate for bulk shipping of commodities is down by more than four-fifths. There are even stories of grain cargoes piling up in ports in the Americas. Their buyers' letters of credit have not been honoured, because of a lack of confidence in the banks that underwrite them. At least one Australian producer has had the same problem with iron ore shipments to China. And shipowners are having trouble raising finance for new vessels.

The most spectacular reflection of falling activity has been the Baltic Dry Index (BDI), which traces prices for shipping bulk cargoes such as iron ore from producers such as Brazil and Australia to markets in America, Europe and China. The index has plunged by 85% after hitting a record high of 11,793 points in late May. It is a leading indicator of international trade and, by extension, of economic activity. In the past couple of years the index has been driven up by the boom in China, as that economy sucks in raw materials in bulk-carrying ships and pumps out finished products, which are exported in vessels.

The weakness is because of the slowing of world demand and the arrival of new capacity following the recent boom in shipbuilding. There are also signs of slowing demand for the container ships that take China's manufactured goods to Western markets. The latest forecasts show growth in container demand falling from 15% a year to barely 5%.

Steel prices have also been falling fast from record highs. In America the price of coil steel, used to make cars and white goods, has fallen by 20% since May. The price of steel billets, which are traded on the London Metal Exchange, has tumbled by 70% since May. Steelmakers, including ArcelorMittal, the industry leader, and Russian and Chinese firms, are moving to cut production.

Although China's iron ore imports in the first nine months of the year were up by 22% on 2007, there are fears among Australian mining firms that the cuts in Chinese steel production could presage a pause in China's boom. Mount Gibson, an Australian producer, has given warning that stockpiles of ore are piling up in China. Iron-ore prices on the spot market have fallen by roughly half this year, to $100 a tonne or less. The prices of copper, nickel and zinc have also fallen by half or more this year, and aluminium is down by a third. Those drops, in turn, have battered the share prices of mining companies.

Aside from the very effect upon employment, isn't this all cause for cautious optimism? Commodity-induced inflation might be its own bubble AND another cause of the current recession, along with the financial meltdown. But, would anyone argue that prices need to stay inflated, because everyone is bummed out by the spectacle of falling numbers?

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Oddly, instead of prepping myself for a dive off my roof, I'm taking cathartic relief from a consensus among smart talking heads and pundits, that humility is coursing through the media like a vaccination. No one knows if there is any precedent for this financial market crunch, and if so - or more likely, if not - what do we do? The big guy prayer - calling on the «leaders» to save us - took a swan dive now that consensus has it that allowing Lehman Brothers to tank was a bad plan.

That's because now - and blogging is a form of archiving - the plan is recapitalization.

American officials unveiled a three-part rescue programme on Tuesday October 14th. Under the first part, the Treasury will inject as much as $250 billion into American banks, with roughly half initially going to nine big institutions. The capital would come in the form of non-voting preferred stock. Under the second part, the Federal Deposit Insurance Corporation (FDIC) would guarantee unsecured borrowing by banks for maturities of up to three-and-a-half years, at a relatively modest cost of 75 basis points. That would include interbank loans. Under the third part, the FDIC would guarantee without limit small-business bank deposits that do not pay interest. Also on Tuesday the Federal Reserve gave more details of its previously-announced commercial paper backstop programme, which should ease borrowing for big nonbanks, such as GE Capital.

The plan is undoubtedly bold: it marks perhaps the largest foray by the American government into ownership of private enterprise since the second world war. But it would have looked much bolder a month ago. As it is, America has only caught up to where Germany, France and especially Britain (in that case, last week) had already reached. To a great extent, Hank Paulson, the treasury secretary and Ben Bernanke, the Federal Reserve chairman, are making up for what were, in retrospect, miscalculations in their earlier efforts.

The early evidence is reassuring. The historic stockmarket rally on Monday, though it petered out on Tuesday, will impress the retail audience of small investors and politicians. But the more important verdict is from the wholesale audience in the credit markets, which has been encouraging. Borrowing costs for big financial institutions plunged on Tuesday, as measured by credit-default swap spreads. Libor, the rate at which banks lend to each other, also dropped, although it remains stratospheric. «This is definitely the end as far as the systemic aspect to the credit system goes,» said Gregory Peters, head of fixed income at Morgan Stanley.

Even if true, that will not alleviate the downward pressure on the economy. Bank lending is still constrained by a lack of balance-sheet capacity: banks have been forced to boost loans to companies that are shut out of the commercial-paper market while setting aside more capital for future loan losses.

The new capital injections should help. In theory $250 billion of new capital leveraged by ten-to-one could support $2.5 trillion of assets in banking system, serious money when total loans to non-financial corporations, households and state and local governments in America stood at $27 trillion on June 30th. But it is unlikely to spur a big expansion in new loans. Much of the credit restraint comes from nonbanks such as the captive finance-arms of carmakers. Moreover, fewer householders can meet the stricter underwriting standards that now prevail because they have lost the equity in their home, or their jobs. «The combination of declining wealth and a sharp tightening of credit availability is likely to induce a substantial recession in consumer spending,» said Peter Hooper and Thomas Mayer of Deutsche Bank on Tuesday. They project zero growth for America in 2009 and outright contraction for every other G7 country apart from Canada.

The programme should overcome the errors that, with hindsight, hampered earlier efforts to tackle the crisis. The most prominent was the decision to let Lehman Brothers fail. That sparked a run on money-market funds which held Lehman paper, and forced deleveraging by customers and counterparties who had trading positions with Lehman. It dramatically raised in investors' minds the odds that other big banks could also fail, and those fears risked becoming self-fulfilling as their stock prices plunged, credit spreads exploded and lenders and depositors fled. The bank-loan guarantee and expanded deposit-insurance limits should eliminate that risk.

The authorities' second mistake was to treat the crisis as one principally of liquidity rather than solvency and thus to focus on solutions that did not directly rebuild capital in banks. The focus was understandable: in aggregate American banks are well capitalised and it is not clear how many would have voluntarily accepted public injections of equity. Fed officials had discussed ways the government could inject preferred equity into banks that also issued common stock as far back as June. But Mr Paulson worried that Congress would say no and in the process alarm markets more, according to some officials. A person close to the Treasury says that Mr Paulson and Mr Bernanke were in agreement on how to proceed. In any event, Mr Paulson made sure the bail-out law impliclity allowed such injections. But not until the law passed and panic ensued did he conclude it was necessary, and Britain's dramatic recapitalisation plan last week all but forced his hand.

Thirdly, the plan marks a move away from ad hoc interventions towards a comprehensive solution. In contrast to earlier rescues for AIG, Bear Stearns, Fannie Mae and Freddie Mac, the recapitalisations announced on Tuesday are designed to encourage new private capital infusions, rather than punish shareholders. Under the terms announced on Tuesday, the Treasury will receive preferred stock on the same terms as other preferred shareholders and warrants for common stock equal to 15% of the preferred stock, convertible at the trailing 20-day average stock price when the preferred stock is issued. The preferred stock will pay a 5% dividend for the first five years, and 9% thereafter. Those are hardly onerous: they are less than the 10% yield Morgan Stanley will pay Mitsubishi UFJ Financial Group and that Goldman Sachs will pay Warren Buffett for their preferred-stock investments. The banks can buy back the Treasury's stake after three years, sooner if they issue sufficient stock of their own.

Yet, even for all its customary optimism, The Economist is not immune to the bogeyman.

Aggressive as these actions are, they may not be the last. As the world falls into recession, loan losses will mount and banks may need yet more capital. Some emerging markets may be on the brink of another crisis on the scale of 1997-98. After 14 months, the defining characteristic of this financial crisis has been its tendency to change shape and return in ever more virulent form. But if the corner really has been turned, then attention in America will turn to the consequences of the bail-out, in particular: how will future administrations handle the responsibilities and temptations that come with being a big financial stakeholder?

Comparing the Japanese debacle in the 90s with the 2007-8 mutation, Joshua Kurlantzick rains further on the recapitalization prayer.

Koizumi's strategies were actually based on lessons learned after America's savings and loan crisis, when nearly half of the country's S&Ls went out of business and the rest were forced to adapt their business models. «A central lesson to remember from the U.S. [S&L] experience is that ... in the end, the principal use of public funds was to put institutions out of business,» notes economist Benjamin Friedman in a study comparing the S&L crisis to Japan in the '90s. Today, public funds are being used to do the opposite--to keep companies in business regardless of whether they change their practices, meaning that, as in Japan, the government might have to intervene again in a few years. Japan was able to afford repeated infusions of state cash in part because it was an export powerhouse. But, in the United States, which already boasts $10 trillion in public debt and regular trade deficits, another round of bailouts would be truly catastrophic. It could doom the entire U.S. economy throughout the next president's term. A «lost decade,» you might say.

Finally, Megan McArdle and Dan Drezner agree to remain skeptical and embrace their utter dearth of fortune-telling skills.

So, is there clear answer? Yes, according to Michael E. Lewitt, the dismal science is our savior.

...the stock market has the patience of a flea. The government's Herculean intervention into the markets will do what they are supposed to do--lead U.S. banks to start making loans again and reignite economic growth. But U.S. stock markets continue to be driven by «hot money»--failing to see money market rates plunge immediately, they conclude that these key lending rates won't drop at all. This is short-sighted and self-defeating. The government's actions will take some time to work, but they will work. The laws of economics were not repealed on the upside--that is why the markets crashed. But these laws were also not repealed on the downside, which is why these radical steps will work sooner rather than later.

Do less, but be firm and forceful when you do DO it? I'm very glad now I studied more political science than economics: it's axiomatic that the worst will happen, not, as the dismal science has it, that we can approach perfect equilibrium. At least I didn't waste my tuition money.

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Left and right, blogs are sighing with relief. Another «new-and-improved» bailout bill is on the way.

Chris Bowers is content the Paulson plan-cum tax breaks and an FDIC proposal, a progressive addition will squeak past the post (although the bar is higher because of the tax provision). The Weekly Standard has another list of possible House inclusions.

The message from the House is clear: sausage-making as usual. Don't reconsider the idea, just amend the bill to entice opponents. I hope there's the shock works, and that there's no need for further injection later.

But, will this bill please angry Independents?

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(Why is the MSM so lame?)

The stock market tanked on Monday, so why quibble with numbers? 777? 7%? So what?

But the most amazing misuse of this meaningless data point was on the front page of Rupert Murdoch's Wall Street Journal, where the sober six-column format has been replaced this morning with big headlines and a story on the bailout that takes up the entire top half of the front page. The second graph of the lede story reads: «The Dow Jones Industrial Average sustained its biggest point drop in history and its biggest closing decline since the day the markets reopened after the Sept.11, 2001 terrorist attacks. ...»

The New York Times, where I spent 13 years, got it right, though the tone--a two-deck, six-column wide headline--did not signal the kind of sober restraint to be expected in such uncertain times. The Times also relied on a broader and more useful gauge than the Dow, which has just 30 companies, to assess the market. The Times off-lede stated in its second paragraph, «The broad market as measured by the Standard & Poor's 500 stock index plunged almost nine percent, its third biggest decline since World War II.»

Pulitzer Prize-winning author David Cay Johnston concludes:

Stock indexes matter in terms of percentage changes, not point changes, because the base changes all the time. How many points an index like the Dow or the broader Standard and Poor's 500 went up or down compared to the day before, or over a week, or over another contracted time period is a legitimate measure when trying to figure out the short-term direction of the market. But when you are comparing it to trading from say 2001 or 1987 or 1929, counting points, instead of percentages, is absurd.

My first thought when scanning the nightly news programs was that this was just another example of how journalists, broadly speaking, are innumerate and so errors pop up when it comes to numbers. But the subsequent words in the ABC and NBC reports made it clear that someone on the writing and producing staff knew just what they were doing. This was not an error; this was fear mongering.

Have Americans learned anything from September 11, 2001?

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Now that readers can enjoy their panic, here are two opposite, and not exclusive, arguments, why rejecting the Paulson plan was both a sound political and economic decision.

Firstly, there will be no crisis.

President Bush and supporters of the recent massive Wall Street bailout plan still believe Wall Street to be the center of the entire economy.

Economic research over the last couple of decades rejects this belief. It has shown that the financial and non-financial sectors experience quite independent changes, especially over the short and medium term. Take for example the promised yield on the best commercial paper. Fluctuations in this yield are critically important to persons in the financial sector (such as money market traders), but have hardly anything to do with activity outside of that sector. Since World War II, the correlation between the inflation-adjusted commercial paper yield and subsequent inflation-adjusted growth of GDP per capita is zero. That is, GDP growth has been high following high yields just as often as it has been low. It is equally hard to detect a correlation between stock returns, long term bond returns, or commodity returns and subsequent GDP growth. Quite simply, history has shown that the non-financial sector can do well when the financial sector does poorly, and vice versa.

Secondly, prudence dictates, that if depression does ensue, the US government needs its $700 billion dollars to get the economy out of its funk.

People on 'main street' are even more concerned about the economy than economists and think a total financial meltdown is inevitable. Therefore, they think a 'bail out' will have no or very limited impact in the long run. They have already seen considerable govt interventions, while markets have just kept falling and firms continued going under. Hence they are afraid of spending another 700 bn on something that they don't think will fix the problem.

Maybe also Congress think a total meltdown is inevitable, and that is why it did not pass. On the one hand representatives would like to see something pass (to show action). On the other hand, representatives are afraid that when they stand for reelection there will have been a total financial collapse anyway, and the 700 bn bailout will be seen as 'wasted'. Hence, the majority of representatives would like to see a bill passed, but at the same time, they would like to show their vote record as having voted against it (in case the economy collapsed). It is unlikely that this bill will be known as the bill that 'saved the economy'. It is more likely to been known as the 700 bn bill with no or only temporary effect. Therefore, representatives may want to be on record as having voted against it.

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