July 4, 2016

Mark Blyth

Green Army: Persons of Interest

(Terry Hillman, The Complete Idiot's Guide to Economics, Penguin, 2014, p 254)

John Galbraith (1908–2006):
The market will not go on [another] speculative rampage without some rationalization.
[And, needless to say,] during the next boom some newly rediscovered virtuosity of the free enterprise system will be cited. …
Among the first to accept these rationalizations will be some of those responsible for invoking the controls. …
They will say firmly that controls are not needed.
The newspapers, some of them, will agree and speak harshly of those who think action might be in order.
(p 206-7)

The Wall Street Journal [11 September 1929]:
[The] main body of stocks [continues] to display the characteristics of a major advance temporarily halted for technical readjustment.
(p 110)

Irving Fisher (1867–1947) [15 October 1929]:
Stock prices have reach what looks like a permanently high plateau. …
I expect to see the stock market a good deal higher than it is today within a few months.
(p 95)

Harvard Economic Society [10 November 1929]:
[A] severe depression like that of 1920-1 is outside the range of probability.
We are not facing protracted liquidation.
(The Great Crash 1929, Penguin, 1975, p 163)

Joseph Schumpeter (1883–1950)
[Recurrent] 'recessions' that are due to the disequilibrating impact of new products or methods. …
Economic progress, in capitalist society, means turmoil. …
[Capitalism's performance can, therefore, only be judged] over time, as it unfolds through decades and even centuries.
(Capitalism, Socialism and Democracy, 2nd Ed, 1942)

Robert Lucas (1937):
[The] central problem of depression-prevention has … for all practical purposes … been solved for many decades.
(Presidential Address, American Economic Association, 2003)

Gregory Clark (1957) [Professor of Economics, University of California, Davis]:
The debate about the bank bailout, and the stimulus package, has … been conducted in terms that would be quite familiar to economists in the 1920s and 1930s.
There has essentially been no advance in our knowledge in 80 years.
(Dismal scientists: how the crash is reshaping economics, The Atlantic, 16 February 2009)

George Megalogenis (1964):
[During the 1980's blue] collar workers had delivered their end of the bargain under the wages accord.
Yet their restraint in the boom, could not protect their jobs in the bust.
Ken Henry (1957) [Australian Treasury Secretary, 2001-2011]:
[More than half of the] people aged over 45 who lost their jobs in the early 1990's recession, [when unemployment peaked at 11.1%,] never worked a day again in their lives …
(Making Australia Great — Inside Our Longest Boom, Episode 2: Growing Pains, ABC Television, March 2015)

Joseph Stiglitz (1943):
In order to bail out the German banks [the Greeks have] had to accept [economic depression:
  • 25% unemployment (including 50% youth unemployment) and
  • a 25% decline in GDP. …]
[Historically,] Germany has been among the biggest defaulters and one of the biggest recipients of debt write downs after WWII and in other instances …
(Stiglitz on Greece and climate change, RN Drive, 10 July 2015)

Niall Ferguson (1964):
[Subprime mortgage refinancing deals] allowed borrowers to treat their [over-priced] homes as cash machines, converting their existing equity into cash. …
Between 1997 and 2006, US consumers withdrew an estimated $9 trillion in cash from the equity in their homes.
(p 265)

The final cost of the Savings and Loans crisis between 1986 and 1995 was $153 billion (around 3% of GDP), of which taxpayers had to pay $124 billion, making it the most expensive financial crisis since the Depression.
(The Ascent of Money, 2008, Penguin, p 259)

William Crawford [Commissioner, California Department of Savings and Loans]:
The best way to rob a bank is to own one.
(Henry Pontell and Kitty Calavita, 'White-Collar Crime in the Savings and Loan Scandal', Annals of the American Academy of Political and Social Science, 525, January 1993, p 37)

Mark Blyth:
[The 2007 global financial crisis has cost,] once lost output is included, as much as $13 trillion and, on average, a 40-50% increase in the debt of states hit by the crisis. …
(p 45)

Lost output from 2008 through 2011 alone [averaged] nearly 8% of GDP across the major economies.
(p 46)

Since the 2008 crisis, [US banks] have awarded themselves $2.2 trillion in compensation.
(p 50, emphasis added)

[When] those at the bottom are expected to pay disproportionately for a problem created by those at the top, and when those at the top actively eschew any responsibility or that problem by blaming the state for their mistakes, not only will squeezing the bottom not produce enough revenue to fix things, it will produce an even more polarized … society in which the conditions for sustainable politics of dealing with more debt and less growth are undermined. …
In such an unequal and austere world, those who start at the bottom of the income distribution will stay at the bottom, and without [hope of advancement,] the only possible movement is a violent one.
(p 15)

[The] true price of saving the banks [may not] just the end of the euro, but the end of the European political project itself, which would be perhaps the ultimate tragedy for Europe.
(Austerity, p 92)

Freeman Dyson (1923):
The gap between technology and needs is wide and growing wider.
If technology continues along its present course, ignoring the [basic] needs of the poor and showering benefits upon the rich, the poor will sooner or later rebel against the tyranny of technology and turn to irrational and violent remedies.
(Imagined Worlds, Harvard University Press, 1998, p 201)

Alexis ClĂ©rel (1805–1859) [Viscount of Tocqueville]:
Almost all the revolutions which have changed the aspect of nations have been made to consolidate, or to destroy, social inequality. …
Either the poor have attempted to plunder the rich, or the rich to enslave the poor.
(Democracy in America, 1835, Bantam, 2011, p 789)

Frederick Douglass (1818–1895):
  • Where justice is denied,
  • where poverty is enforced,
  • where ignorance prevails and
  • where any one class is made to feel that society is in an organized conspiracy to oppress, rob and degrade them:
neither persons nor property will be safe.

Karl Marx (1818–1883)
William Wood, 9 years old, was 7 years and 10 months when he began to work …
He came to work every day in the week at 6 am, and left off about 9 pm …
Mary Anne Walkley had worked without pause 26½ hours, together with sixty other girls, thirty of them in one room …
[She] died of apoplexy, but there is reason to fear that her death had been accelerated by overwork in an overcrowded workroom.
(Capital, Vol 1 Ch 8, 1867)

Terry Hillman:
In the eighteenth century, factory owners chained children to the machines.
They fought the government's attempt to [make the] shackling children illegal.
(The Complete Idiot's Guide to Economics, 2014, pp 20 & 23)

The Mills and Factory Act (1833):
  • No child workers under nine years of age.
  • Children of 9 to 13 years to work no more than 9 hours a day.
  • Children of 13 to 18 years to work no more than 12 hours a day.
  • Children are not to work at night.
  • Two hours of schooling each day for children.

Milton Friedman (1912–2006):
[The workers of 19th century Britain] were not exploited.
The studies that have been done recently have shown over and over again that the 19th century was a period in which the ordinary English worker experienced a very rapid and very substantial rise in his standard of life.
(The Tyranny of Control, Free to Choose, Episode 2, PBS, 1980)

Adam Smith (1723–1790)

The Wealth of Nations (1776)

[Wherever] there is property there is great inequality [consequently,] the acquisition of valuable and extensive property … necessarily requires the establishment of civil government. …

In spite of their natural selfishness and rapacity, though they mean only their own convenience, though the sole end which they propose from the labours of all the thousands whom they employ be the gratification of their own vain and insatiable desires, the rich divide with the poor the produce of all their improvements.
They are led by an invisible hand to make nearly the same distribution of the necessities of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus, without intending it, without knowing it, advance the interest of society, and afford means to the multiplication of the species. …

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.
We address ourselves, not to their humanity but to their self-love.
(Book 1, Chapter 2)

[The individual] is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. …
I have never known much good done by those who affected to trade for the public good.
It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.
(Book 4, Chapter 2)

The man whose whole life is spent in performing a few simple operations … generally becomes as stupid and ignorant as it it is possible for a human creature to become.
The torpor of his mind renders him not only incapable of relishing or bearing a part in any rational conversation, but of conceiving any generous, noble, or tender sentiment …
Of the great and extensive interests of his own country he is altogether incapable of judging …

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in conspiracy against the public, or in some contrivance to raise prices. …
It is impossible to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice.
But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.
(Book 1, Chapter 10, Part 2)

The proposal of any new law or regulation of commerce which comes from [the business elite] ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention.
[For it] comes from an order of men,
  • whose interest is never exactly the same with that of the public,
  • who have generally an interest to deceive and even to oppress the public, and
  • who accordingly have, upon many occasions, both deceived and oppressed it.

The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.
(Book 5, Chapter 2, Part 2, 1779)

The Theory of Moral Sentiments (1759)

[The illusion that the accumulation of possessions brings real satisfaction is the] deception which rouses and keeps in continual motion the industry of mankind. …

The great source of both the misery and disorders and disorders of human life, seems to arise from over-rating the difference between one permanent situation and another …
Some of those situations may, no doubt, deserve to be preferred to others …
[But] none of them can deserve to be pursued with that passionate ardour which drives us
  • to violate the rules either
    • of prudence or
    • of justice; or
  • to corrupt the future tranquillity of our minds, either
    • by shame from the remembrance of our own folly, or
    • by remorse from the horror of our own injustice.

(Charles Ferguson, Inside Job, 2010)

Mark Blyth

  • Democracy is Asset Insurance for the Rich
  • Redistribution and Debt is Reinsurance for Democracy
  • Austerity is Anorexia for the Economy

The Liberal Antistatist Neuralgia

Can't live without the state

The problem is, when you allow markets do what markets do, they create incredible inequality. …
[So] you have to have a state that can police [those inequalities;] otherwise, the people who are on the bad end [of the income distribution are going to come] and burn your house down.

Can't live with it

So you have a problem right away, which is: the liberal distrust of the state.
[Since] any state powerful enough to defend your property rights might [itself] come after you — hence the second amendment

Don't want to pay for it

[Finally, any state strong enough to] defend your property rights, is going to be expensive …
Adam Smith [initially] comes out in [favor] of proportional taxation [but then] backs away from it because, of course, rich people would [end up paying] most of the taxes, and he's one of the rich people …
[So he] goes for a very modern solution, [one] which modern day Republicans are fond of: a consumption tax …

(Austerity: The history of a dangerous idea, Big Ideas, ABC Radio National, 14 May 2013)

[Democracy,] and the redistributions it makes possible, is a form of asset insurance for the rich, and yet, through austerity, we find that those with the most assets are skipping on the insurance payments.
(p 14)

[In Europe and in the United States} top marginal incomes are estimated to be no less than 20%age points below those that would maximize tax revenue to the government.

Peter Diamond of the Massachusetts Institute of Technology and Emanuel Saez of the University of California, Berkeley, [argue] that taxing the top 1% at [a marginal rate of] over 80% would raise, not lower, revenue. …
According to their calculations, raising the average income tax for the top income%ile to 43.5% from 22.4%, the level of 2007, would raise revenue by 3% of GDP. which is enough to close the US structural deficit while still leaving very high earners with more after-tax income than they would have had under Nixon.
(p 243)

[The] Tax Justice Network estimates that there is as much as 32 trillion dollars, which is over twice the entire US national debt, hidden away offshore not paying taxes …
(p 244)

A Fallacy of Composition
Adam Smith (1723–1790):
What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.
(The Wealth of Nations, Book 4, Chapter 2, 1776)
[What] is true of the parts … is not true of the [whole:] we cannot all be austere at once.
All that does is shrink the economy for everyone. …
[If everyone is saving (ie paying back debt) at the same time, then no one is spending; hence, no consumption to stimulate investment.
Likewise, every country cannot pursue export-led growth at the same time because there is no import demand to drive it.]
We cannot all cut our way to growth, just as we cannot all export without any concern for who is importing.
This fallacy of composition problem rather completely undermines the idea of austerity as growth enhancing. …

Austerity is a zombie economic idea because it has been disproven time and again, but it just keeps coming. …
[It] a dangerous idea for three reasons:
  • it doesn't work in practice,
  • it relies on the poor paying for the mistakes of the rich, and
  • it rests upon the absence of a rather large fallacy of composition that is all too present in the modern world.
(p 10)

No Bailouts

[We] may have impoverished a few million people to save an industry of dubious social utility that is now on its last legs. …

[Between] 1994 and 2007 Irish GDP grew much more rapidly than in the 1980s and 1990s.
During this boom period, when cheap money was abundant in global markets, Ireland's banking sector also grew rapidly, and on the back of the credit bubble grew a housing bubble.
When the bubble popped in 2008, the Irish government issued a blanket guarantee to its banks and soon after gave five and a half billion euros to three banks:
  • Anglo Irish bank,
  • Allied Irish Bank, and
  • Bank of Ireland.
Unfortunately, since the assets of these banks were little more than dead real-estate loans, this was just throwing good money after bad.
It kept the banks going [until January 2009] when Anglo-Irish was nationalized — at the same time that 2 billion euros in savings were chopped off the public budget.
[Eventually,] to stop the complete collapse of the economy, the government set up a bad bank, the National Asset Management Agency (NAMA), to take the toxic assets off the banks' books. …

Since then, over 70 billion euros have been injected into [the Irish] banking system [or almost €1,500 for every man, woman and child.]
Some 47 billion euros disappeared into Anglo-Irish alone, never to be seen again.
The cost of bailing out the banks amounts to 45% of GDP, and that figure does not include the cost of the NAMA program, which is over 70 billion euros.
(pp 234-5)

Irish debt to GDP was 32% in 2007.
Today it stands at 108.2% after three years of austerity. …
The Irish government, which has implemented 24 billion euros in cuts since 2008, plans another 8.3 billion in taxes and another 3.5 billion in cuts for 2013. …

[By contrast,] Iceland
  • let its banks go bankrupt,
  • devalued its currency,
  • put up capital controls, and
  • bolstered welfare measures. …
(p 237)

The [Icelandic] banks were to be allowed to go bankrupt and be taken into receivership.
Their debts were not socialized; instead bondholders and foreign creditors bore the brunt of adjustment.
(p 238)

Everyone tightened their belts as the cuts were accompanied by a shift to a more progressive tax code that included
  • substantial tax hikes for top earners and
  • measures to help low- and middle-income families. …

[In] 2011 growth returned at 3% [— compared to 0.71% in Ireland; and, by 2012 Iceland was] near the top of OECD growth performance.
With higher marginal rates of taxation, returning growth, capital control, and equal fiscal tightening, Iceland is on target to eliminate its budget deficit in 2014 and have a budget surplus of 5% in 2016.
[And, unlike in Ireland,] employment growth in Iceland has been strong.
Even at its height [9% in 2009,] unemployment in Iceland was lower than the European average …
Unemployment stands at just under 6% in October 2012 [— compared to 14.8% in Ireland.]
(p 239)

[Real] wages have been rising at a brisk pace.
This has helped reverse the trend of growing inequality witnessed between 1995 and 2007 … mostly because of the high incomes of top earners — a phenomenon seen in all highly financialized societies. …
Iceland not only survived letting its banks go bust, it became a healthier and more equal society in doing so.
(p 240)

Thank You For Your Sacrifice

To: The [Citizens of Portugal, Italy, Ireland, Greece and Spain]

From: [The Political Classes of Europe]

We have been telling you for the past four years that the reason you are out of work and that the next decade will be miserable is that states have spent too much.
So now we all need to be austere and return to something called "sustainable public finances."
It is, however, time to tell the truth.
The explosion of sovereign debt is a symptom, not a cause, of the crisis we find ourselves in today.

What actually happened was that the biggest banks in the core countries of Europe bought lots of sovereign debt from their periphery neighbors, the PIIGS.
This flooded the PIIGS with cheap money to buy core country products, hence the current account imbalances in the Eurozone that we hear so much about and the consequent loss of competitiveness in these periphery economies.
After all, why make a car to compete with BMW if the French will lend you the money to buy one?
This was all going well until the markets panicked over Greece and figured out via our "kick the can down the road" responses that the institutions we designed to run the EU couldn't deal with any of this.
The money greasing the wheels suddenly stopped, and our bond payments went through the roof.

The problem was that we had given up our money presses and independent exchange rates — our economic shock absorbers — to adopt the euro.
Meanwhile, the European Central Bank, the institution that was supposed to stabilize the system, turned out to be a bit of fake central bank.
It exercises no real lender-of-last-resort function.
It exists to fight an inflation that died in 1923, regardless of actual economic conditions.
Whereas the Fed and the Bank of England can accept whatever assets they want in exchange for however much cash they want to give out, the ECB is both constitutionally and intellectually limited in what it can accept.
  • It cannot monetize or mutualize debt,
  • it cannot bail out countries,
  • it cannot lend directly to banks in sufficient quantity.
It's really good at fighting inflation, but when there is a banking crisis, it's kind of useless.
It's been developing new powers bit-by-bit throughout the crisis to help us survive, but its capacities are still quite limited.
(p 88)

Now, add to this the fact that the European banking system as a whole is three times the size and nearly twice as levered up as the US banking system; accept that it is filled with crappy assets the ECB can't take off its books, and you can see we have a problem.
We have had over twenty summits and countless more meetings, promised each other fiscal treaties and bailout mechanisms, and even replaced a democratically elected government or two to solve this crisis, and yet have not managed to do so.
It's time to come clean about why we have not succeeded.
The short answer is, we can't fix it.
All we can do is kick the can down the road, which takes the form of you suffering a lost decade of growth and employment.

You see, the banks we bailed in 2008 caused us to take on a whole load of new sovereign debt to pay for their losses and ensure their solvency.
But the banks never really recovered, and in 2010 and 2011 they began to run out of money.
So the ECB had to act against its instincts and flood the banks with a billion euros of very cheap money, the [Long Term Refinancing Operations,] when European banks were no longer able to borrow money in the United States.
The money that the ECB gave the banks was used to buy some short-term government debt (to get our bond yields down a little), but most of it stayed at the ECB as catastrophe insurance rather than circulate into the real economy and help you get back to work.
After all, we are in the middle of a recession that is being turbocharged by austerity policies.
Who would borrow and invest in the midst of that mess?
The entire economy is in recession, people are paying back debts, and no one is borrowing.
This causes prices to fall, thus making the banks ever more impaired and the economy ever more sclerotic.
There is literally nothing we can do about this.
We need to keep the banks solvent or they collapse, and they are so big and interconnected that even one of them going down could blow up the whole system.
As awful as austerity is, it's nothing compared to a general collapse of the financial system, really.

  • we can't inflate and pass the cost on to savers,
  • we can't devalue and pass the cost on to foreigners, and
  • we can't default without killing ourselves …
[All we can do is] deflate, for as long as it takes to get the balance sheets of these banks into some kind of sustainable shape.
(p 89, emphasis added)

This is why we can't let anyone out of the euro.
If the Greeks, for example, left the euro we might be able to weather it, since most banks have managed to sell on their Greek assets.
But you can't sell on Italy.
There's too much of it.
The contagion risk would destroy everyone's banks.
So the only policy tool we have to stabilize the system is for everyone to deflate against Germany, which is a really hard thing to do even in the best of times.
It's horrible, but there it is.
Your unemployment will save the banks, and in the process save the sovereigns who cannot save the banks themselves, and thus save the euro.
We, the political classes of Europe, would like to thank you for your sacrifice.
(p 89)

Austerity and the Fall of France

Although [the Bank of France] was the fiscal agent for the French Treasury, it was also a private institution with 40,000 shareholders whose 200 largest shareholders, often called "the 200 families," determined both personnel and policy.
They paid the governor's (large) salary in return for the usual diet of gold, cuts, and budget balance, all of which benefited the rentier class at the expense of everyone else.
(p 201)

[During the interwar years] the Bank of France continually vetoed budget increases that would have allowed the French military to modernize, and even mobilize, to meet the German threat.
As a result, French defense spending between 1934 and 1938 was one-tenth that of Germany.
(p 203)

[The] French financial elites were so afraid of inflation, and were so determined to maintain the value of the franc, that they paralyzed the French military's ability to mobilize against Hitler.
(p 204)

Milton's Great Vacation

[Milton Friedman] assumed that unemployment was voluntary and was not due to a deficiency [in the demand for labor.]
People [voluntarily trade off leisure against labor according to] the prevailing wage.
There is no [such thing as Keynesian] demand-deficient unemployment in Milton's world.
In other words, the 25% of Spaniards who are presently without work [have simply made a rational decision not to] work at the prevailing wage [— opting, instead, to go] on vacation.
(p 153)

[By this logic, the Great Depression was] a giant, unexpected, and astonishingly long unpaid vacation for millions of people …
(p 159)

[Joseph Schumpeter also] argued that the Great Depression was neither great nor depressing.
Rather, it was just a particularly marked transitional period of technological and organizational change …
(p 129)

(Austerity, 2013)

John Quiggin (1956)

Professor of Economics, Queensland University

An Epidemic of Laziness

[Real Business Cycle Theory interprets] fluctuations in aggregate demand and employment [as the] socially optimal equilibrium response to exogenous shocks such as:
  • changes in productivity,
  • the terms of trade, or
  • workers' preference for leisure.
(p 99)

[This analysis implies that,] at the outset was the Great Depression, [either:]
  • the state of scientific knowledge had suddenly gone backward by 30%, or …
  • workers throughout the world had suddenly succumbed to an epidemic of laziness …
(p 100)

(Zombie Economics, Princeton University Press, 2012)

Crisis? What Crisis?

The Efficient Markets Hypothesis implies that there can be no such thing as a bubble in the prices of assets such as stocks or houses.
(p 45)

The Efficient Markets Hypothesis, which enshrines the market price of assets as the summary of all relevant information, is inconsistent with any idea that managers should pursue the long-term interests of corporations, disregarding short-term fluctuations in share prices.
According to the Efficient Markets Hypothesis, the current share price is the best possible estimate of the long-term share price and therefore of the long-term value of the corporation to shareholders.

If the Efficient Markets Hypothesis is accepted, public investment decisions may be improved through the use of formal evaluation procedures like benefit-cost analysis, but the only really satisfactory solution is to turn [delivery of public services] over to the private sector. …
The Efficient Markets Hypothesis implies that governments can never outperform well-informed financial markets.
(p 49)

Privatization is bad for unions, which tend to be stronger and more effective in the public sector.
It is usually good for the incumbent senior managers of privatized firms, who move from being rather modestly paid public sector employees, constrained by bureaucratic rules and accountability, to doing much the same job but with greatly increased pay and privileges, and far fewer constraints.
(pp 185-6)

[In 2007 all] of the checks and balances in the system failed comprehensively.
The ratings agencies offered AAA ratings to assets that turned out to be worthless, on the basis of models that assumed that house prices could never fall. …
The entire ratings agency model, in which issuers pay for ratings, proved to be fundamentally unsound.
But, these very ratings were embedded in official systems of regulation.
Thanks to the Efficient Markets Hypothesis, crucial public policy decisions were, in effect, outsourced to for-profit firms that had a strong incentive to get the answers wrong.
(p 64)

The failure of the Efficient Markets Hypothesis does not imply the converse claim that governments will always do better.
Rather, the evidence suggests that markets will do
  • better than governments in planning investments in some cases (those where a good judgment of consumer demand is important, for example) and
  • worse in others (those requiring long-term planning, for example).
(p 76)

The experience of the twentieth century suggests that a mixed economy will outperform both
  • central planning and
  • laissez-faire.
(p 78)

The financial markets that were supposed to replace governments showed themselves incapable of managing their own businesses, let alone the world economy. …
[During the crisis everyone] in the financial sector was happy to be bailed out.
But of course, as soon as the crisis was over, they insisted that everything had been under control and that no rescue was necessary.
(p 225)

Throughout the [global financial] crisis, the economics profession carried on, for the most part, as if nothing had changed.
And now that the immediate crisis has passed, market liberals are trying to pretend … it never happened.
(p 231)

(Zombie Economics, Princeton University Press, 2012)

John Kenneth Galbraith (1908–2006)

The values of a society totally preoccupied with making money are not altogether reassuring.
(p 101)

[From June 1929,] free at last from all threat of government reaction or retribution, the market sailed off into the wild blue yonder. …
Never before or since have so many become so wondrously, so effortlessly, and so quickly rich. …
Perhaps it was worth being poor for a long time to be so rich for just a little while.
(p 68)

Those who employed rational, objective, and scientific methods … failed to foretell the crash.
(p 109)

Many things were wrong [in the lead up to the Great Depression,] but five weaknesses seem to have had an especially intimate bearing on the ensuing disaster. …

  1. The bad distribution of income. …
  2. [The] 5% of the population with the highest incomes in that year received approximately one-third of all personal income.

(p 194)
  1. The bad corporate structure. …
(p 195)
  1. The bad banking structure. …
(p 196)
  1. The dubious state of the foreign balance. …
(p 197)
  1. The poor state of economic intelligence. …
    [The] economists and those who offered economic counsel in the late twenties and early thirties were almost uniquely perverse.
(p 199)
    In the months and years following the stock market crash, the burden of reputable economic advice was invariably on the side of measures that would make things worse. …

    The Democratic platform in 1932 called for … at least a 25% decrease in the cost of government.
(p 200, emphasis added)
    The fear of inflation reinforced the demand for the balanced budget [— flying in the face of] the most violent deflation in the nation's history.
(p 201)

The economic advisers of the day had both the unanimity and the authority to force the leaders of both parties to disavow all the available steps to check deflation and depression.
(p 202)

[The] chances for a recurrence of a speculative orgy are rather good.
No one can doubt that the American people remain susceptible to the speculative mood — to the conviction that enterprise can be attended by unlimited rewards in which they, individually, were meant to share.
A rising market can still bring the reality of riches.
This, in turn, can draw more and more people to participate.
The government preventatives and controls are ready.
In the hands of a determined government their efficacy cannot be doubted.

There are, however, a hundred reasons why a government will determine not to use them. …
Action to break up a boom must always be weighed against the chance that it will cause unemployment at a politically inopportune moment.
(p 206)

[Now,] as throughout history, financial capacity and political perspicacity are inversely correlated.
Long-run salvation by men of business has never been highly regarded if it means disturbance of orderly life and convenience in the present.
So inaction will be advocated in the present even though it means deep trouble in the future.
Here, at least equally with communism, lies the threat to capitalism.
It is what causes men who know that things are going quite wrong to say that things are fundamentally sound.

(The Great Crash 1929, Penguin, 1975, p 210)

A self-serving branch of moral philosophy has been devised to defend the right of the affluent to freedom of choice [which neglects to mention] the way bad public services (like the absence of income itself) abridge the freedom of the poor.
(p xxiv)

[For] Herbert Spencer and his American disciples in the last century, the Social Darwinists, poverty is the socially therapeutic tendency that eliminates the unfit.
[This secular] instinct for Social Darwinism still lurks in our time [accompanied by a] fundamentalist theology that holds that property is God's natural reward for the worthy.
The poor, meanwhile, have the comfort of knowing they … will pass [more] easily into the next world to enjoy, along with the meek, full compensation for the miseries of this existence.
The relevant and supporting texts and sermons are amply available from the religious broadcasters and the Moral Majority.
(p xxvi)

The line which divides our area of wealth from our area of poverty is roughly that which divides privately produced and marketed goods and services from publicly rendered services.
[Our] wealth in privately produced goods is, to a marked degree, the cause of crisis in the supply of public services.
For we have failed to see the [the urgent need to] maintaining a balance between the two.
(p 190)

(The Affluent Society, 4th Ed, Penguin, 1984)


The Mother Of All Moral Hazard Trades

Would you like to know more?


Professor of International Political Economy, Brown University.

  • Global Trumpism, Foreign Affairs, 15 November 2016.
  • Austerity: The history of a dangerous idea, Big Ideas, ABC Radio National, 14 May 2013.
  • Austerity: The History of a Dangerous Idea, Oxford University Press, 2013.

    What actually happened in Europe was that over the decade of the introduction of the euro, very large core-country European banks
    • bought lots of peripheral sovereign debt (which is now worth much less) and
    • levered up (reduced their equity and increased their debt to make more profits) far more than their American cousins.
    Being levered up, in some cases forty to one or more, means that a turn of a few percentage points against their assets can leave them insolvent. …
    (p 6)

    Having already bailed out the banks [in 2008,] we have to make sure that there is room on the public balance sheet to backstop them.
    That's why we have austerity.
    It's still all about saving the banks. …

    This is a banking crisis first and a sovereign debt crisis second. …
    There was no orgy of government spending to get us there. …
    Austerity is not just the price of saving the banks.
    It's the price that the banks want someone else to pay.
    (p 7)

    [We] have turned the politics of debt into a morality play, one that has shifted the blame from the banks to the state.
    Austerity is the penance — the virtuous pain after the immoral party …
    [A party] few of us were invited [but which] we are all being asked to pay the bill [for.]
    (p 13)

    [A Credit Default Swap is a tradable] insurance policy [that] insures the purchaser of the CDS against the default of the bond upon which it is written [eg a mortgage backed security like a Collateralised Debt Obligation.]
    In return, the issuer of the CDS, the writer of the insurance policy, receives a regular income stream from the purchaser, just as an insurance company receives customers' insurance premiums.
    (p 28)

    A CDS is called a swap [rather than an insurance contract] mostly to avoid regulations that would kick in if it were named what it really is …
    Insurance requires reserves to be set aside, but swaps don't …
    (Note 13, p 248)

    With a decade of house-price increases telling everyone that house prices only go up … you could almost begin to believe that you had what bankers call a "free option": an asset with zero downside and a potentially unlimited upside, and one that is rated AAA by the ratings agencies.
    The fact that many investment funds are legally required to hold a specific proportion of their assets as AAA securities pumped demand still further.

    By the mid-2000s … the issuers of [sub-prime mortgage backed CDOs and their associated unbacked CDS insurance contracts] increasingly didn't want to hold any of this dubious risk on their own books and wanted them moved off-book.
    To get them off their books, CDO issuers set up a system in which their issuance and funding was moved to so-called [Structured Investment Vehicles.]
    These were separately created companies, isolated from the parent company's balance sheet, whose sole activity was to collect the income streams from these mortgages and CDS contracts and pay them out to the different investors holding them.
    (p 29)

    [So,] with an attractive yield, bond insurance, a quasi-governmental AAA stamp of approval, and rising prices, what could go wrong?

    Well, everything, really.
    When already tight credit markets froze in September 2008, prices for these securities collapsed. …
    With each bank holding similar assets and liabilities, and as each attempted to rid itself of these assets all at once, prices fell through the floor.
    But the real surprise, the amplifier, was that the design of these securities, rather than lessening [risk,] actually boosted it.
    (p 30)

    [If Value at Risk] thinking made the [global financial] crisis statistically impossible, [neoliberal] ideas about how markets work made it theoretically impossible — until it happened. …
    (p 39, emphasis added)

    [Assuming the Efficient Market Hypothesis and the Rational Expectations Hypothesis are correct,] while we can expect random individuals … to make mistakes, systematic mistakes by markets are impossible because the market is simply the reflection of individual optimal choices that together produce "the right price."
    Agents' expectations of the future … will be rational, not random, and the price given by the market under such conditions [necessarily] corresponds to the true value of the [underlying asset.]
    Markets are efficient in aggregate if their individual components are efficient, which they are, by definition. …

    [Financial operators] like these ideas because they justified letting the financial system do whatever it liked …
    If you [believe] markets work this way, the very notion of regulating finance becomes [a] nonsense.
    Self-interested actors, whether individuals or financial firms, acting in an efficient market will make optimal trading decisions, and these outcomes will improve everyone's welfare. …

    The only real policy problem becomes how to avoid moral hazard.
    That is, if individual institutions make bad bets and go bust, bailing them out simply encourages other firms to assume that they will be bailed out too, so don't bail out anyone.
    In short, [all] risk is individual [not systemic] and regulation is best left to the banks themselves (since they are the ones with “skin in the game,” anything they get into is good for everyone), and so long as you don't start bailing them out, [everything will] be fine.
    (p 42)

    There is no public sector, only the the private sector, and it is always in equilibrium. …

    [From the neoliberal perspective, the] shadow banks served the real banks by augmenting liquidity and assisting risk transfer.
    Derivatives made the system safe by making it possible for individuals to sell risk to those willing to buy it, who were presumed to be best suited to hold it by virtue of wanting to purchase it.
    And the banks themselves, those [supposedly] with skin in the game, were assumed to be the best people to judge the risks they were taking using models they designed themselves, even it it turned out [later that they, in fact,] didn't have skin in the game since they were moving everything they could off book into SIVs.
    (p 43, emphasis added)

    [The] crisis had nothing to do with either personal morality or state profligacy. …
    [Fundamentally, it] was the failure of a set of ideas that justified finance doing whatever it liked because whatever it did was by definition the most efficient thing that could be done. …
    (p 44)

    [Iceland] let its banks fail and is now doing really quite well, especially when compared to Eurozone Europe.
    [Ireland] bailed them out and has condemned itself to a generation of misery because of it.
    (p 231)

    [There] are two other ways out of the crisis in addition to the usual choices of

    1. inflation [— bad for capital and creditors;]
    2. devaluation [— bad for workers in the longer term;]
    3. endless austerity [/ deflation — bad for workers and debtors;] and
    4. default [— bad for everyone. …]

    Those alternative choices are …

    1. financial repression, and …
    2. a renewed effort to seriously collect taxes on a global scale.

    (p 232)

    [We] are going to deal with our debts … through taxes and not through austerity.
    • Not because austerity is unfair, which it is,
    • not because there are more debtors than creditors, which there are, and
    • not because democracy has an inflationary bias, which it doesn't,
    but because austerity simply doesn't work.
    (p 244)

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