Who is Ron Bloom? (CZAR)

Ron Bloom, whom the Treasury Department is expected to bring in as a senior adviser to help handle the U.S. auto industry’s restructuring, is a special assistant to the president of United Steelworkers union and a former investment banker.

Ron Bloom

Mr. Bloom’s negotiating skills may play a key role in shaping the Obama administration’s policies toward the auto industry. It was reported Sunday that the administration won’t name a single “car czar” to help oversee the restructuring process as originally planned. Instead, President Barack Obama will support a new inter-agency task force to deal with the issue, according to senior administration officials. And Mr. Bloom, in his early fifties, is among the players in the administration’s new strategy.
Mr. Bloom attended Harvard Business School, where he gravitated to populist business cases and was keenly interested in employee buyouts. After 10 years at investment banks, among them Lazard, he became special assistant to the USW president in 1996.
Both inside and outside the USW, Mr. Bloom is known as a financially savvy negotiator — with a tendency to spout profanities. In a 2007 article depicting Mr. Bloom’s role in the Wheeling-Pittsburgh Corp. takeover battle, The Wall Street Journal wrote some USW members thought Mr. Bloom is “too cozy with the moneymen.”
The USW helped block Brazilian steel giant CSN’s attempt to merge with Wheeling-Pitt by finding a more union-friendly bidder in Esmark — a Chicago upstart that got bought by Russia’s OAO Severstal in 2008. In the Wheeling-Pitt case, Mr. Bloom dealt with entrepreneurs who run Esmark as well as with Franklin Mutual Advisers LLC, a big mutual-fund firm that owned 70% of Esmark’s shares. In return for Esmark’s no-layoff promise, the USW agreed not to oppose its wish to import steel slabs to Wheeling-Pitt mills. The union customarily opposes such imports.
In that article, Mr. Bloom was quoted as saying that dealing with financial buyers of steel assets “is just business.” Indeed, he said, in contrast to traditional steel executives, who sometimes want unions “in their place,” talking to private-equity types is refreshing: “They don’t take cultural offense to anything. They just deal with power.”

Daley: City Managers To Take Nearly Five Weeks Off

Thousands Of City Workers To Take 24 Unpaid Days In 2010

Faced with a $550 million budget deficit, Chicago Mayor Richard M. Daley on Monday said that all non-union city workers would take nearly five working weeks of unpaid leave next year to save the city money.

Daley announced plans Monday to save $114 million by requiring 3,600 non-union city workers to take 24 unpaid days off, eliminating 220 vacant jobs and cutting expenses like travel and supplies by $20 million.

It's about a nine percent pay cut next year for top city officials, administrators and middle managers at City Hall -- including the mayor himself. That will cost about $8,100 for a boss who usually makes $90,000.

Those furlough days would not affect frontline employees who actually deliver services to the public. But one analyst said the move would still affect city services.

"You won't have enough people on the management side of the ledger making sure that people, like I say, show up on time, do their job, are held accountable," said Ralph Martire, executive director of the Center for Tax and Budget Accountability.

 "For any business to function, for any service to be provided well, whether in the public sector or the private sector, you need adequate number of managers or administrators to go along with the front-line workers."

Unlike this year, when City Hall shut down on three regular work days, there will be none of that in 2010.

The city's non-union workers were set to take off one personal day a month, a total of 12 unpaid personal days for each worker. The 12 regular holidays, such as New Years Day and Thanksgiving Day, will also be unpaid.

Dozens of city labor unions previously cut a separate furlough-day agreement.
Daley has said he won't support tax increases in these tough financial times to raise more city revenue.

The mayor will present his proposed 2010 budget at Wednesday's City Council meeting.

The city will save $70 million through the union agreements and unpaid holidays and furloughs for nonunion workers.

CBS 2 Political Editor Mike Flannery and the Associated Press contributed to this report.

More Pa. State Government Layoffs Expected Soon

government will announce another round of layoffs soon.

Gov. Ed Rendell said Monday that he might make an announcement on layoffs by the end of the week. The state has laid off more than 300 employees since July because of spending cuts.

Rendell signed a state budget on Oct. 9 that cuts overall state spending by nearly 2 percent, and slashes the Department of Environmental Protection by about 27 percent.

Environmental Protection Secretary John Hanger says there'll be additional layoffs, but he isn't offering specifics. His agency currently has more than 2,770 employees.

Sen. Mary Jo White, who chairs the Senate Environmental Resources and Energy Committee, says the department's cuts will be partially offset by higher permitting fees.

Countdown to the next crisis is already under way

By Wolfgang Münchau
Published: October 18 2009 18:42 | Last updated: October 18 2009 18:42

We did not need to wait until the Dow Jones Industrial Average hit 10,000. It has been clear for some time that global equity markets are bubbling again. On the surface, this looks like 2003 and 2004 when the previous housing, credit, commodity and equity bubbles started to inflate, helped by low nominal interest rates and a lack of inflation. There is one big difference, though. This bubble will burst sooner.
So how do we know this is a bubble? My two favourite metrics of stock market valuation are Cape, which stands for the cyclically adjusted price/earnings ratio, and Q. Cape was invented by Robert Shiller, professor of economics and finance at Yale University. It measures the 10-year moving average of the inflation-adjusted p/e ratio. Q is a metric of market capitalisation divided by net worth. Andrew Smithers* has collected the data on Q, a concept invented by the economist James Tobin.
Cape and Q measure different things. Yet they both tend to agree on relative market mispricing most of the time. In mid-September both measures concluded that the US stock market was overvalued by some 35 to 40 per cent. The markets have since gone up a lot more than the moving average of earnings. You can do the maths.
The single reason for this renewed bubble is the extremely low level of nominal interest rates, which has induced people to move into all kinds of risky assets. Even house prices are rising again. They never fell to the levels consistent with long-term price-to-rent and price-to-income ratios, which are reliable metrics of the property markets’ relative under- or over-valuation.
But unlike five years ago, central banks now have the dual role of targeting monetary and financial stability. As has been pointed out time and again, those two objectives can easily come into conflict. In Europe, for example, the European Central Bank would under normal circumstances already have started to raise interest rates. The reason it sits tight is to prevent damage to Europe’s chronically under-capitalised banking system, which still depends on the ECB for life support. The same is true, more or less, elsewhere.
Now, I agree there is no prospect of a significant rise in inflation over the next 12 months, but the chances rise significantly after 2010.
Once perceptions of rising inflation return, central banks might be forced to switch towards a much more aggressive monetary policy relatively quickly – much quicker than during the previous cycle. A short inflationary boom could be followed by another recession, another banking crisis, and perhaps deflation. We should not see inflation and deflation as opposite scenarios, but as sequential ones. We could be in for a period of extreme price instability, in both directions, as central banks lose control.
This is exactly what the economist Hyman Minsky predicted in his financial instability hypothesis.** He postulated that a world with a large financial sector and an excessive emphasis on the production of investment goods creates instability both in terms of output and prices.
While, according to Minsky, these are the deep causes of instability, the mechanism through which instability comes about is the way governments and central banks respond to crises. The state has potent means to end a recession, but the policies it uses give rise to the next phase of instability. Minsky made that observation on the basis of data mostly from the 1970s and early 1980s, but his theory describes very well what has been happening to the global economy ever since, especially in the past decade. The world has witnessed a proliferation of financial bubbles and extreme economic instability that cannot be explained by any of the established macroeconomic models. Minsky is about all we have.
His policy conclusions are disturbing, especially if contrasted with what is actually happening. In their crisis response, world leaders have focused on bonuses and other irrelevant side-issues. But they have failed to address the financial sector’s overall size. So if Minsky is right, instability should continue and get worse.
Our present situation can give rise to two scenarios – or some combination of the two. The first is that central banks start exiting at some point in 2010, triggering another fall in the prices of risky assets. In the UK, for example, any return to a normal monetary policy will almost inevitably imply another fall in the housing market, which is currently propped up by ultra-cheap mortgages.
Alternatively, central banks might prioritise financial stability over price stability and keep the monetary floodgates open for as long as possible. This, I believe, would cause the mother of all financial market crises – a bond market crash – to be followed by depression and deflation.
In other words, there is danger no matter how the central banks react. Successful monetary policy could be like walking along a perilous ridge, on either side of which lies a precipice of instability.
For all we know, there may not be a safe way down.
*Wall Street Revalued: Imperfect Markets and Inept Central Bankers, Wiley 2009; ** Stabilising an Unstable Economy, McGraw-Hill, 2008
munchau@eurointelligence.com
More columns at www.ft.com/wolfgangmunchau

The Banking System Is Still Broken

Borrow from the Federal Reserve at zero and lend to Treasury for a profit. That's some racket.

 

By ANN LEE

Treasury Secretary Tim Geithner and Federal Reserve Chairman Ben Bernanke have announced that the recession is over. Now that the Dow Jones Industrial Average has broken the 10,000 mark, we'll surely be hearing assurances that economic growth is here to stay. But the credit markets are in much worse shape than some indicators suggest.
First of all, not all U.S. banks are created equal. A few multinational banks such as Citigroup are officially too big to fail. Credit spreads in the markets reflect the relatively risk-free nature of these large companies, which now have implicit government guarantees.
But this protection doesn't apply to smaller banks, some of which are being shut down by the FDIC without much media attention. These smaller banks have done most of the lending to the many small and medium-sized enterprises that do the bulk of the hiring in our economy. They've now had to cut off the flow of credit to their clients.
According to Automatic Data Processing Inc.'s August employment report, large businesses shed 60,000 jobs, and employment at medium-sized and small businesses declined by 116,000 and 122,000, respectively, in August alone. Small businesses, defined as employing anywhere from one to 49 people, account for 48 million jobs in the U.S., and medium-sized businesses, between 50 and 499 employees, account for 42 million jobs. Large businesses account for just 17 million. Without access to capital, these small and medium-sized businesses will continue to lay off their employees, creating a vicious cycle of shrinking consumer credit and demand.
The volume of overall bank lending has not returned to pre-crisis levels. While credit spreads have contracted, not much debt has been underwritten. In fact, banks that received government bailout money reduced their average loan balance by $54 billion in July, compared to the previous month, according to the Treasury's Capital Purchase Program Monthly Lending report.
The first reason for this slowdown in lending is that underwriting standards have risen across the board, making it much more difficult for businesses to obtain loans. Institutional investors no longer tolerate the easy loans so characteristic of this latest credit bubble. Banks are now also being asked to retain a portion of any loans they underwrite in order to align their interests with their investors. As a result, credit has scaled back dramatically. According to reports issued by the major rating agencies, in 2007 $700 billion of asset-backed securities were underwritten. Only $10 billion has been issued in 2009. This has a significant knock-on effect across every sector of the economy.
The banks have no incentive to lend. Most of them still have a significant amount of bad loans sitting on their books that they don't want to recognize as nonperforming. If the banks recognize these bad loans, all the write-offs may force them into bankruptcy. Instead, they hope that over time renegotiated loan terms will eventually allow the borrowers to make their payments. This ordeal could last at least a decade if this cycle is similar to other crises, like Japan's lost decade of the 1990s. As the fed funds rate goes to zero and existing loans in technical default continue to sit in bank portfolios, why should banks make new loans when they can make money for free with the government? There is no longer a stigma associated with borrowing from the Fed, so banks can earn a huge spread by borrowing virtually unlimited amounts for nothing and lending that same money back to the Treasury.
Wall Street will most definitely get richer again. But a return to easy credit for the average consumer and business is not likely in the near future. The only reason that credit spreads have tightened is because of the extraordinary interventions by the Fed and the Treasury.
Such unprecedented actions by the government have led to speculation over when inflation might get out of control. But why not question whether our current banking system actually makes any sense? Rather than giving capital to businesses with real products and services, Wall Street plays a government-backed shell game, enriching bankers' pockets at everyone else's expense.
If banks are being supported by taxpayer dollars as a public good, wouldn't it be logical to make Citigroup and Goldman part of the government so that they can serve the public like the Department of Motor Vehicles? The powerful banking lobby will likely prevent the nationalization of the entire banking system. But expect new challenges to our assumptions about the status quo if this recovery and the proposed regulatory reforms fail.
Ms. Lee, an adjunct professor at New York University, is a former investment banker and hedge-fund partner.

How did Paul Krugman get it so Wrong?

John H. Cochrane*

September 16 2009

Many friends and colleagues have asked me what I think of Paul Krugman’s New York Times Magazine article, “How did Economists get it so wrong?”

Most of all, it’s sad. Imagine this weren’t economics for a moment. Imagine this were a respected scientist turned popular writer, who says, most basically, that everything everyone has done in his field since the mid 1960s is a complete waste of time. Everything that fills its academic journals, is taught in its PhD programs, presented at its conferences, summarized in its graduate textbooks, and rewarded with the accolades a profession can bestow, including multiple Nobel prizes, is totally wrong.  Instead, he calls for a return to the eternal verities of a rather convoluted book written in the 1930s, as taught to our author in his undergraduate introductory courses.  If a scientist, he might be a global-warming skeptic, an AIDS-HIV disbeliever, a creationist, a stalwart that maybe continents don’t move after all.

It gets worse. Krugman hints at dark conspiracies, claiming “dissenters are marginalized.” Most of the article is just a calumnious personal attack on an ever-growing enemies list, which now includes “new Keyenesians” such as Olivier Blanchard and Greg Mankiw.  Rather than source professional writing, he plays gotcha with out-of-context second-hand quotes from media interviews. He makes stuff up, boldly putting words in people’s mouths that run contrary to their written opinions.  Even this isn’t enough: he adds cartoons to try to make his “enemies” look silly, and puts them in false and embarrassing situations.  He accuses us of adopting ideas for pay, selling out for “sabbaticals at the Hoover institution” and fat “Wall street paychecks.” It sounds a bit paranoid.

It’s annoying to the victims, but we’re big boys and girls. It’s a disservice to New York Times readers. They depend on Krugman to read real academic literature and digest it, and they get this attack instead. And it’s ineffective. Any astute reader knows that personal attacks and innuendo mean the author has run out of ideas.

That’s the biggest and saddest news of this piece: Paul Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. “Irrationality” and advice to spend like a drunken sailor are pretty superficial compared to all the fascinating things economists are writing about it these days.  

How sad.

That’s what I think, but I don’t expect you the reader to be convinced by my opinion or my reference to professional consensus.  Maybe he is right. Occasionally sciences, especially social sciences, do take a wrong turn for a decade or two. I thought Keynesian economics was such a wrong turn. So let’s take a quick look at the ideas. 

Krugman’s attack has two goals. First, he thinks financial markets are “inefficient,” fundamentally due to “irrational” investors, and thus prey to excessive volatility which needs government control. Second, he likes the huge “fiscal stimulus” provided by multi-trillion dollar deficits. 

Efficiency.

It’s fun to say we didn’t see the crisis coming, but the central empirical prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going – neither benevolent government bureaucrats, nor crafty hedge-fund managers, nor ivory-tower academics. This is probably the best-tested proposition in all the social sciences. Krugman knows this, so all he can do is huff and puff about his dislike for a theory whose central prediction is that nobody can be a reliable soothsayer. And of course it makes no sense whatsoever to try to discredit efficient-markets finance because its followers didn’t see the crash coming.

Krugman writes as if the volatility of stock prices alone disproves market efficiency, and efficient marketers just ignored it all these years. This is a canard that Paul knows better than to pass on, no matter how rhetorically convenient. (I can overlook his mixing up the CAPM and Black-Scholes model, but not this.)  There is nothing about “efficiency” that promises “stability.” “Stable” growth would in fact be a major violation of efficiency.  Efficient markets did not need to wait for “the memory of 1929 … gradually receding,” nor did we fail to read the newspapers in 1987.  Data from the great depression has been included in practically all the tests. In fact, the great “equity premium puzzle” is that if efficient, stock markets don’t seem risky enough to deter more people from investing! Gene Fama’s PhD thesis was on “fat tails” in stock returns.

It is true and very well documented that asset prices move more than reasonable expectations of future cashflows. This might be because people are prey to bursts of irrational optimism and pessimism. It might also be because people’s willingness to take on risk varies over time, and is lower in bad economic times.  As Gene Fama pointed out in 1970, these are observationally equivalent explanations. Unless you are willing to elaborate your theory to the point that it can quantitatively describe how much and when risk premiums, or waves of “optimism” and “pessimism,” can vary, you know nothing. No theory is particularly good at that right now.

Crying “bubble” is empty unless you have an operational procedure for identifying bubbles, distinguishing them from rationally low risk premiums, and not crying wolf too many years in a row. Krugman rightly praises Robert Shiller for his warnings over many years that house prices might fall. But advice that we should listen to Shiller, because he got the last one right, is no more useful than previous advice from many quarters to listen to Greenspan because he got several ones right.  Following the last mystic oracle until he gets one wrong, then casting him to the wolves, is not a good long-term strategy for identifying bubbles. Krugman likes Shiller because he advocates behavioral ideas, but that’s no help either. People who call themselves behavioral have just as wide a divergence of opinion as those who don’t. Are markets irrationally exuberant or irrationally depressed? It’s hard to tell.

This difficulty is no surprise. It’s the central prediction of free-market economics, as crystallized by Hayek, that no academic, bureaucrat or regulator will ever be able to fully explain market price movements. Nobody knows what “fundamental” value is. If anyone could tell what the price of tomatoes should be, let alone the price of Microsoft stock, communism would have worked.

More deeply, the economist’s job is not to “explain” market fluctuations after the fact, to give a pleasant story on the evening news about why markets went up or down. Markets up? “A wave of positive sentiment.” Markets went down? “Irrational pessimism.” ( “The risk premium must have increased” is just as empty.) Our ancestors could do that.  Really, is that an improvement on “Zeus had a fight with Apollo?” Good serious behavioral economists know this, and they are circumspect in their explanatory claims. 

But this argument takes us away from the main point. The case for free markets never was that markets are perfect. The case for free markets is that government control of markets, especially asset markets, has always been much worse.

Krugman at bottom is arguing that the government should massively intervene in financial markets, and take charge of the allocation of capital.  He can’t quite come out and say this, but he does say “Keynes considered it a very bad idea to let such markets…dictate important business decisions,” and “finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a `casino.’” Well, if markets can’t be trusted to allocate capital, we don’t have to connect too many dots to imagine who Paul has in mind.

To reach this conclusion, you need evidence, experience, or any realistic hope that the alternative will be better. Remember, the SEC couldn’t even find Bernie Madoff when he was handed to them on a silver platter. Think of the great job Fannie, Freddie, and Congress did in the mortgage market.  Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment?  As David Wessel’s excellent  In Fed We Trust makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming. And not from any lack of smarts. 

In fact, the behavioral view gives us a new and stronger argument against regulation and control. Regulators are just as human and irrational as market participants.  If bankers are, in Krugman’s words, “idiots,” then so must be the typical treasury secretary, fed chairman, and regulatory staff.  They act alone or in committees, where behavioral biases are much better documented than in market settings. They are still easily captured by industries, and face politically distorted incentives.

Careful  behavioralists know this, and do not quickly run from “the market got it wrong” to “the government can put it all right.” Even my most behavioral colleagues Richard Thaler and Cass Sunstein in their book “Nudge” go only so far as a light libertarian paternalism, suggesting good default options on our 401(k) accounts. (And even here they’re not very clear on how the Federal Nudging Agency is going to steer clear of industry capture.) They don’t even think of jumping from irrational markets, which they believe in deeply, to Federal control of stock and house prices and allocation of capital. 

Stimulus

Most of all, Krugman likes fiscal stimulus. In this quest, he accuses us and the rest of the economics profession of “mistaking beauty for truth.” He’s not clear on what the “beauty” is that we all fell in love with, and why one should shun it, for good reason.  The first siren of beauty is simple logical consistency. Paul’s Keynesian economics requires that people make logically inconsistent plans to consume more, invest more, and pay more taxes with the same income. The second siren is plausible assumptions about how people behave. Keynesian economics requires that the government is able to systematically fool people again and again.  It presumes that people don’t think about the future in making decisions today. Logical consistency and plausible foundations are indeed “beautiful” but to me they are also basic preconditions for “truth.”

In economics, stimulus spending ran aground on Robert Barro’s Ricardian equivalence theorem. This theorem says that debt-financed spending can’t have any effect because people, seeing the higher future taxes that must pay off the debt, will simply save more. They will buy the new government debt and leave all spending decisions unaltered. Is this theorem true? It’s a logical connection from a set of “if” to a set of “therefore.” Not even Paul can object to the connection.

Therefore, we have to examine the “ifs.” And those ifs are, as usual, obviously not true. For example, the theorem presumes lump-sum taxes, not proportional income taxes. Alas, when you take this into account we are all made poorer by deficit spending, so the multiplier is most likely negative. The theorem (like most Keynesian economics) ignores the composition of output; but surely spending money on roads rather than cars can affect the overall level.

Economists have spent a generation tossing and turning the Ricardian equivalence theorem, and assessing the likely effects of fiscal stimulus in its light, generalizing the “ifs” and figuring out the likely “therefores.”  This is exactly the right way to do things.  The impact of Ricardian equivalence is not that this simple abstract benchmark is literally true. The impact is that in its wake, if you want to understand the effects of government spending, you have to specify why it is false.  Doing so does not lead you anywhere near old-fashioned Keynesian economics. It leads you to consider distorting taxes, how much people care about their children, how many people would like to borrow more to finance today’s consumption and so on. And when you find “market failures” that might justify a multiplier, optimal-policy analysis suggests fixing the market failures, not their exploitation by fiscal  multiplier.  Most “New Keynesian” analyses that add frictions don’t produce big multipliers.

This is how real thinking about stimulus actually proceeds. Nobody ever “asserted that an increase in government spending cannot, under any circumstances, increase employment.” This is unsupportable by any serious review of professional writings, and Krugman knows it. (My own are perfectly clear on lots of possibilities for an answer that is not zero.) But thinking through this sort of thing and explaining it is much harder than just tarring your enemies with out-of-context quotes, ethical innuendo, or silly cartoons.

In fact, I propose that Krugman himself doesn’t really believe the Keynesian logic for that stimulus. I doubt he would follow that logic to its inevitable conclusions. Stimulus must have some other attraction to him.

If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it.  Each dollar so transferred, in Krugman’s world, generates an additional dollar and a half of national income.  The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt.

If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up. 

If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.

The crash.

Krugman’s article is supposedly about how the crash and recession changed our thinking, and what economics has to say about it. The most amazing news in the whole article is that Paul Krugman has absolutely no idea about what caused the crash, what policies might have prevented it, and what policies we should adopt going forward. He seems completely unaware of the large body of work by economists who actually do know something about the banking and financial system, and have been thinking about it productively for a generation.

Here’s all he has to say: “Irrationality” caused markets to go up and then down. “Spending” then declined, for unclear reasons, possibly “irrational” as well. The sum total of his policy recommendations is for the Federal Government to spend like a drunken sailor after the fact.

Paul, there was a financial crisis, a classic near-run on banks. The centerpiece of our crash was not the relatively free stock or real estate markets, it was the highly regulated commercial banks. A generation of economists has thought really hard about these kinds of events. Look up Diamond, Rajan, Gorton, Kashyap, Stein, and so on.  They’ve thought about why there is so much short term debt, why banks run, how deposit insurance and credit guarantees help, and how they give incentives for excessive risk taking.

If we want to think about events and policies, this seems like more than a minor detail. The hard and central policy debate over the last year was how to manage this financial crisis. Now it is how to set up the incentives of banks and other financial institutions so this mess doesn’t happen again. There’s lots of good and subtle economics here that New York Times readers might like to know about. What does Krugman have to say? Zero.

Krugman doesn’t even have anything to say about the Fed.  Ben Bernanke did a lot more last year than set the funds rate to zero and then go off on vacation and wait for fiscal policy to do its magic. Leaving aside the string of bailouts, the Fed started term lending to securities dealers. Then, rather than buy treasuries in exchange for reserves, it essentially sold treasuries in exchange for private debt. Though the funds rate was near zero, the Fed noticed huge commercial paper and securitized debt spreads, and intervened in those markets. There is no “the” interest rate anymore, the Fed is attempting to manage them all. Recently the Fed has started buying massive quantities of mortgage-backed securities and long-term treasury debt.

Monetary policy now has little to do with “money” vs. “bonds” with all the latter lumped together. Monetary policy has become wide-ranging financial policy.  Does any of this work? What are the dangers? Can the Fed stay independent in this new role? These are the questions of our time. What does Krugman have to say? Nothing.

Krugman is trying to say that a cabal of obvious crackpots bedazzled all of macroeconomics with the beauty of their mathematics, to the point of inducing policy paralysis.  Alas, that won’t stick. The sad fact is that few in Washington pay the slightest attention to modern macroeconomic research, in particular anything with a serious intertemporal dimension.  Paul’s simple Keynesianism has dominated policy analysis for decades and continues to do so. From the CEA to the Fed to the OMB and CBO, everyone just adds up consumer, investment and government “demand” to forecast output and uses simple Phillips curves to think about inflation.  If a failure of ideas caused bad policy, it’s a simpleminded Keynesianism that failed.  

The future of economics.

How should economics change? Krugman argues for three incompatible changes.

First, he argues for a future of economics that “recognizes flaws and frictions,” and incorporates alternative assumptions about behavior, especially towards risk-taking.  To which I say, “Hello, Paul, where have you been for the last 30 years?” Macroeconomists have not spent 30 years admiring the eternal verities of Kydland and Prescott’s 1982 paper. Pretty much all we have been doing for 30 years is introducing flaws, frictions and new behaviors, especially new models of attitudes to risk,  and comparing the resulting models, quantitatively, to data.  The long literature on financial crises and banking which Krugman does not mention has also been doing exactly the same. 

Second, Krugman argues that “a more or less Keynesian view is the only plausible game in town,” and “Keynesian economics remains the best framework we have for making sense of recessions and depressions.” One thing is pretty clear by now, that when economics incorporates flaws and frictions, the result will not be to rehabilitate an 80-year-old book. As Paul bemoans, the “new Keynesians” who did just what he asks, putting Keynes inspired price-stickiness into logically coherent models, ended up with something that looked a lot more like monetarism. (Actually, though this is the consensus, my own work finds that new-Keynesian economics ended up with something much different and more radical than monetarism.) A science that moves forward almost never ends up back where it started. Einstein revises Newton, but does not send you back to Aristotle.  At best you can play the fun game of hunting for inspirational quotes, but that doesn’t mean that you could have known the same thing by just reading Keynes once more.

Third, and most surprising, is Krugman’s Luddite attack on mathematics; “economists as a group, mistook beauty, clad in impressive-looking mathematics, for truth.” Models are “gussied up with fancy equations.” I’m old enough to remember when Krugman was young, working out the interactions of game theory and increasing returns in international trade for which he won the Nobel Prize, and the old guard tut-tutted “nice recreational mathematics, but not real-world at all.” He once wrote eloquently about how only math keeps your ideas straight in economics. How quickly time passes. 

Again, what is the alternative? Does Krugman really think we can make progress on his – and my – agenda for economic and financial research -- understanding frictions, imperfect markets, complex human behavior, institutional rigidities – by reverting to a literary style of exposition, and abandoning the attempt to compare theories quantitatively against data? Against the worldwide tide of quantification in all fields of human endeavor (read “Moneyball”) is there any real hope that this will work in economics?

No, the problem is that we don’t have enough math. Math in economics serves to keep the logic straight, to make sure that the “then” really does follow the “if,” which it so frequently does not if you just write prose. The challenge is how hard it is to write down explicit artificial economies with these ingredients, actually solve them, in order to see what makes them tick. Frictions are just bloody hard with the mathematical tools we have now.    

The insults.

The level of personal attack in this article, and fudging of the facts to achieve it, is simply amazing.

As one little example (ok, I’m a bit sensitive), take my quotation about carpenters in Nevada. I didn’t write this. It’s a quote, taken out of context, from a bloomberg.com article, written by a reporter who I spent about 10 hours with patiently trying to explain some basics, and who also turned out only to be on a hunt for embarrassing quotes.  (It’s the last time I’ll do that!)  I was trying to explain how sectoral shifts contribute to unemployment. Krugman follows it by a lie -- I never asserted that “it take mass unemployment across the whole nation to get carpenters to move out of Nevada.” You can’t even dredge up a quote for that monstrosity.

What’s the point?  I don’t think Paul disagrees that sectoral shifts result in some unemployment, so the quote actually makes sense as economics. The only point is to make me, personally, seem heartless -- a  pure, personal, calumnious attack, having nothing to do with economics.

Bob Lucas has written extensively on Keynesian and monetarist economics, sensibly and even-handedly.  Krugman chooses to quote a joke, made back in 1980 at a lunch talk to some business school alumni. Really, this is on the level of the picture of Barack Obama with Bill Ayres that Sean Hannity likes to show on Fox News.

It goes on. Krugman asserts that I and others “believe” “that an increase in government spending cannot, under any circumstances, increase employment,” or that we “argued that price fluctuations and shocks to demand actually had nothing to do with the business cycle.”  These are just gross distortions, unsupported by any documentation, let alone professional writing. And Krugman knows better. All economic models are simplified to exhibit one point; we all understand the real world is more complicated; and his job is supposed to be to explain that to lay readers. It would be no different than if someone were to look up Paul’s early work which assumed away transport costs and claim “Paul Krugman believes ocean shipping is free, how stupid” in the Wall Street Journal.  

The idea that any of us do what we do because we’re paid off by fancy Wall Street salaries or cushy sabbaticals at Hoover is just ridiculous. (If Krugman knew anything about hedge funds he’d know that believing in efficient markets disqualifies you for employment. Nobody wants a guy who thinks you can’t make any money trading!)  Given Krugman’s speaking fees, it’s a surprising first stone for him to cast.

Apparently, salacious prose, innuendo, calumny, and selective quotation from media aren’t enough: Krugman added cartoons to try to make opponents look silly. The Lucas-Blanchard-Bernanke conspiratorial cocktail party celebrating the end of recessions is a silly fiction. So is their despondent gloom on reading “recession” in the paper. Nobody at a conference looks like Dr. Pangloss with wild hair and a suit from the 1800s. (OK, Randy Wright has the hair, but not the suit.)  Keynes did not reappear at the NBER to be booed as an “outsider.”  Why are you allowed to make things up in pictures that wouldn’t pass even the Times’ weak fact-checking in words?

Most of all, Krugman isn’t doing his job.  He’s supposed to read, explain, and criticize things economists write, and real professional writing, not interviews, opeds and blog posts. At a minimum, this style leads to the unavoidable conclusion that Krugman isn’t reading real economics anymore.

How did Krugman get it so wrong?

So what is Krugman up to? Why become a denier, a skeptic, an apologist for 70 year old ideas, replete with well-known logical fallacies, a pariah? Why publish an essentially personal attack on an ever-growing enemies list that now includes practically every professional economist? Why publish an incoherent vision for the future of economics?

The only explanation that makes sense to me is that Krugman isn’t trying to be an economist, he is trying to be a partisan, political opinion writer. This is not an insult. I read George Will, Charles Krauthnammer and Frank Rich with equal pleasure even when I disagree with them.  Krugman wants to be Rush Limbaugh of the Left.

Alas, to Krugman, as to far too many ex-economists in partisan debates, economics is not a quest for understanding.  It is a set of debating points to argue for policies that one has adopted for partisan political purposes. “Stimulus” is just marketing to sell Congressmen and voters on a package of government spending priorities that you want for political reasons. It’s not a proposition to be explained, understood, taken seriously to its logical limits, or reflective of market failures that should be addressed directly.

Why argue for a nonsensical future for economics? Well, again, if you don’t regard economics as a science, a discipline that ought to result in quantitative matches to data, a discipline that requires crystal-clear logical connections between the “if” and the “then,” if the point of economics is merely to provide marketing and propaganda for politically-motivated policy, then his writing does make sense. It makes sense to appeal to some future economics – not yet worked out, even verbally – to disdain quantification and comparison to data, and to appeal to the authority of ancient books as interpreted you, their lone remaining apostle.

Most of all, this is the only reason I can come up with to understand why Krugman wants to write personal attacks on those who disagree with him. I like it when people disagree with me, and take time to read my work and criticize it. At worst I learn how to position it better. At best, I discover I was wrong and learn something. I send a polite thank you note.

Krugman wants people to swallow his arguments whole from his authority, without demanding logic, or evidence.  Those who disagree with him, alas, are pretty smart and have pretty good arguments if you bother to read them. So, he tries to discredit them with personal attacks.

This is the political sphere, not the intellectual one. Don’t argue with them, swift-boat them. Find some embarrassing quote from an old interview. Well, good luck, Paul. Let’s just not pretend this has anything to do with economics, or actual truth about how the world works or could be made a better place.

*University of Chicago Booth School of Business. Many colleagues and friends helped, but I don’t want to name them for obvious reasons. Krugman fans: Please don’t bother emailing me to tell me what a jerk I am. I will update this occasionally, so please pass on the link rather than the document,  http://faculty.chicagobooth.edu/john.cochrane/research/Papers/#news.

Paul Krugman Makes No Cents

How the economic guru of the Left went off the rails

By JOHN H. COCHRANE

Last Updated: 8:17 AM, October 4, 2009

Posted: 12:15 AM, October 4, 2009

In his weekly column and recent New York Times Magazine story, “How Did Economists Get It So Wrong?” Paul Krugman blasts economic theory, argues against free markets and says that the country needs more taxpayer-funded “stimulus,” not less. He also faults economists for not predicting the crisis. In an essay on his web site, John H. Cochrane, finance professor at the University of Chicago Booth School of Business, wonders “How did Paul Krugman get it so wrong?” An excerpt:<p> </p><br> It’s fun to say we didn’t see the crisis coming, but the central prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going — neither benevolent government bureaucrats, nor crafty hedge-fund managers, nor ivory-tower academics. This is probably the best-tested proposition in all the social sciences.<p> </p><br> Paul Krugman writes as if the volatility of stock prices alone disproves market efficiency, and efficient marketers just ignored it all these years. But there is nothing about “efficiency” that promises “stability.” “Stable” growth would in fact be a major violation of efficiency.<p> </p><br> Crying “bubble” is empty unless you have an operational procedure for identifying bubbles, distinguishing them from rationally low-risk premiums, and not crying wolf too many years in a row. Krugman rightly praises Robert Shiller for his warnings over many years that house prices might fall. But advice that we should listen to Shiller, because he got the last one right, is no more useful than previous advice from many quarters to listen to Alan Greenspan because he got several ones right. Following the last mystic oracle until he gets one wrong, then casting him aside, is not a good long-term strategy for identifying bubbles.<p> </p><br> This difficulty is no surprise. No academic, bureaucrat or regulator will ever be able to fully explain market price movements. Nobody knows what “fundamental” value is. If anyone could tell what the price of tomatoes should be, let alone the price of Microsoft stock, communism would have worked.<p> </p><br> More deeply, the economist’s job is not to “explain” market fluctuations after the fact, to give a pleasant story on the evening news about why markets went up or down. Markets up? “A wave of positive sentiment.” Markets went down? “Irrational pessimism.” (“The risk premium must have increased” is just as empty.) Our ancestors could do that. Really, is that an improvement on “Zeus had a fight with Apollo”? Good serious behavioral economists know this, and they are circumspect in their explanatory claims.<p> </p><br> But this argument takes us away from the main point. The case for free markets never was that markets are perfect. The case for free markets is that government control of markets, especially asset markets, has always been much worse.<p> </p><br> Krugman at bottom is arguing that the government should massively intervene in financial markets, and take charge of the allocation of capital. He can’t quite come out and say this, but he does say “[John Maynard] Keynes considered it a very bad idea to let such markets . . . dictate important business decisions,” and “finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a ‘casino.’ ”<p> </p><br> Well, if markets can’t be trusted to allocate capital, we don’t have to connect too many dots to imagine who Paul has in mind.<p> </p><br> To reach this conclusion, you need evidence, experience, or any realistic hope that the alternative will be better. Think of the great job Fannie, Freddie, and Congress did in the mortgage market. Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment? As David Wessel’s excellent “In Fed We Trust” makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming. And not from any lack of smarts.<p> </p><br> Regulators are just as human and irrational as market participants. If bankers are, in Krugman’s words, “idiots,” then so must be the typical treasury secretary, fed chairman, and regulatory staff.<p> </p><br> *<p> </p><br> Krugman calls for even more fiscal stimulus, and a return to Keynesian economics.<p> </p><br> But Keynesian economics requires that people make logically inconsistent plans to consume more, invest more, and pay more taxes with the same income. It requires that the government is able to systematically fool people again and again. It presumes that people don’t think about the future in making decisions today.<p> </p><br> If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it. Each dollar so transferred, in Krugman’s world, generates an additional dollar-and-a-half of national income. The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt.<p> </p><br> If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up.<p> </p><br> If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.<p> </p><br> The biggest and saddest news of this piece is that Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. “Irrationality” and advice to spend like a drunken sailor are pretty superficial compared to all the fascinating things economists are writing about it these days.<p> </p><br> *<p> </p><br> So what is Krugman up to? Why become a denier, a skeptic, an apologist for 70-year-old ideas, replete with well-known logical fallacies, a pariah? Why publish an incoherent vision for the future of economics?<p> </p><br> The only explanation that makes sense to me is that Krugman isn’t trying to be an economist, he is trying to be a partisan, political opinion writer.<p> </p><br> Alas, to Krugman, as to far too many ex-economists in partisan debates, economics is not a quest for understanding. It is a set of debating points to argue for policies that one has adopted for partisan political purposes. “Stimulus” is just marketing to sell Congressmen and voters on a package of government spending priorities that you want for political reasons. It’s not a proposition to be explained, understood, taken seriously to its logical limits, or reflective of market failures that should be addressed directly.<p> </p><br> Krugman wants people to swallow his arguments whole from his authority, without demanding logic, or evidence. Those who disagree with him, alas, are pretty smart and have pretty good arguments if you bother to read them. So, he tries to discredit them with personal attacks.<p> </p><br> This is the political sphere, not the intellectual one. Don’t argue with them, swift-boat them. Well, good luck, Paul. Let’s just not pretend this has anything to do with economics, or actual truth about how the world works or could be made a better place.<p> </p><br> Read the whole essay at:<p> </p><br>http://faculty.chicagobooth.edu/john.cochrane/research/Papers/krugman_response.htm<p> </p><br>

But this argument takes us away from the main point. The case for free markets never was that markets are perfect. The case for free markets is that government control of markets, especially asset markets, has always been much worse.
Krugman at bottom is arguing that the government should massively intervene in financial markets, and take charge of the allocation of capital. He can’t quite come out and say this, but he does say “[John Maynard] Keynes considered it a very bad idea to let such markets . . . dictate important business decisions,” and “finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a ‘casino.’ ”

P Anastasselis / Rex USA

"The saddest news is that Krugman has no interesting ideas about what caused our economic problems, or what might help us in the future."

Well, if markets can’t be trusted to allocate capital, we don’t have to connect too many dots to imagine who Paul has in mind.
To reach this conclusion, you need evidence, experience, or any realistic hope that the alternative will be better. Think of the great job Fannie, Freddie, and Congress did in the mortgage market. Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment? As David Wessel’s excellent “In Fed We Trust” makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming. And not from any lack of smarts.
Regulators are just as human and irrational as market participants. If bankers are, in Krugman’s words, “idiots,” then so must be the typical treasury secretary, fed chairman, and regulatory staff.
*
Krugman calls for even more fiscal stimulus, and a return to Keynesian economics.
But Keynesian economics requires that people make logically inconsistent plans to consume more, invest more, and pay more taxes with the same income. It requires that the government is able to systematically fool people again and again. It presumes that people don’t think about the future in making decisions today.
If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it. Each dollar so transferred, in Krugman’s world, generates an additional dollar-and-a-half of national income. The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt.
If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up.
If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.
The biggest and saddest news of this piece is that Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. “Irrationality” and advice to spend like a drunken sailor are pretty superficial compared to all the fascinating things economists are writing about it these days.
*
So what is Krugman up to? Why become a denier, a skeptic, an apologist for 70-year-old ideas, replete with well-known logical fallacies, a pariah? Why publish an incoherent vision for the future of economics?
The only explanation that makes sense to me is that Krugman isn’t trying to be an economist, he is trying to be a partisan, political opinion writer.
Alas, to Krugman, as to far too many ex-economists in partisan debates, economics is not a quest for understanding. It is a set of debating points to argue for policies that one has adopted for partisan political purposes. “Stimulus” is just marketing to sell Congressmen and voters on a package of government spending priorities that you want for political reasons. It’s not a proposition to be explained, understood, taken seriously to its logical limits, or reflective of market failures that should be addressed directly.
Krugman wants people to swallow his arguments whole from his authority, without demanding logic, or evidence. Those who disagree with him, alas, are pretty smart and have pretty good arguments if you bother to read them. So, he tries to discredit them with personal attacks.
This is the political sphere, not the intellectual one. Don’t argue with them, swift-boat them. Well, good luck, Paul. Let’s just not pretend this has anything to do with economics, or actual truth about how the world works or could be made a better place.