Two Lingering Questions for Krugman

[ProSense]

Two Lingering Questions for Krugman

By Bernard Avishai - March 31, 2009

Nobody has earned the the right to say "I told you so" as honestly as Paul Krugman. Like many others, I have not hidden my gratitude. Yet I wonder about two of his claims against Geithner's plan that seem to me both crucial and not sufficiently answered, at least not in Krugman's writings and public appearances I have seen. If we are going to put major banks into receivership--in effect, nationalize them--the answer to both had better be "no." (I have some working hypotheses, but l am prepared to be enlightened.)

1. The first has to do with the meaning of insolvency, or its flip, the recoverable value of mortgage-backed securities on banks' balance sheets. Krugman (supported by terrific bloggers on this site) insists that Geithner is not acknowledging the size of the housing bubble, that is, the very low actual values of these assets, as compared with the values they were booked at. But these values, much like the price of oil, depend almost entirely on the pace of recovery. What, if anything, can be said about that?

The value of housing will almost certainly not get back to what it was at the height of the bubble--probably not even close. Still, obviously, mortgage-backed securities are worth something very different in an economy that is contracting as opposed to one that is growing at just 2% a year. In that economy, many fewer households are defaulting on their mortgages, fewer loans are "under-water," and so forth.

Krugman attributes to Geithner a Wall Streetish view that "the bad assets on banks' books are really worth much, much more than anyone is currently willing to pay for them." But might they be worth only "much" more? The issue at hand is how fast do we get to reasonable levels of growth and does the nationalizing of major banks hinder or accelerate recovery.

Krugman, looking at the U.S. in the 1930s, or Japan in the 1990s, has concluded that we will not get back to more normal levels of growth for some time. But what exactly does that mean? If our growth is flat for a decade, as in Japan, then these assets are very, very bad indeed, and tax-payers are suckers for leveraging private equity purchases of them. But if the economy starts turning around in, say, 18 months (partly, but not only, as a result of this temporary leveraging), then the assets are merely bad, and Geithner's plan must be seen as the best under the circumstances.

So the first question is this: Given how much faster financial capital and entrepreneurial information move today than they did in the 1930s, or even in Japan in the 1990s, can we not assume that the pace, not only of decline, but recovery, too, will be much faster than any historical precedent? The president implied that he thought so in his "Sixty Minutes" interview last week, when he spoke of how "wired" the world has become.

2. Krugman suggests that Geithner (Summers, etc.) is a creature of Wall Street. But this begs the question of whether personal loyalty to bankers, or grudging professional respect for them, motivates him and, in any case, should concern us.

Krugman is right (and Geithner agrees) that managers of banks, investment banks, hedge-funds, etc., cashed in on government largesse and incompetence in the past. But in spite of their demonstrable greed, and even herd behavior, is replacing hundreds, perhaps thousands, of senior bank executives with public servants a little like disbanding and de-Ba'athifying Sadaam's army, a morally satisfying but systemically catastrophic thing?

So the second question is this: Do bankers, for all their faults and grotesque enrichment, know some important, subtle things about managing risk, assessing business plans, providing financial services, and so forth that we dare not lose during the process of recovery? Is there not real know-how here, not just know-about (that is, insider stuff, like ways of betting against "AIG's book")?

This is not a completely rhetorical question. I have not spent nearly as much time with the managers of banks and funds as I have with managers of technology companies. I really cannot say whether senior bank executives at Citigroup or Bank of America should be compared with executives at Google or IBM; whether they are really creative and talented people or just glorified salespeople with stunning commissions thanks to the sheer size of deals they have been rolling. And I can see the point of forcing the resignation of some banking CEOs, for the same reason GM's Rick Wagoner had to go.

Still, is running a bank like running, well, Phillip Morris, a job with its own challenges, to be sure, but nothing that smart, experienced managers can't pick up after a few months, and with trivial impact on the economy as a whole? Krugman wants bankers to be "boring" again? But in this same "wired" world, can they ever be boring again? Geithner seems to want to keep the management of banks more or less intact, even as he contemplates regulations that may make them more boring. Is this moderation not more prudent?

Avishai's Bio.

[MarjorieG]

1. Thanks, as usual, for really helpful posts. This global crisis requires finesse and contacts.

[asjr]

2. I just had a good laugh at myself. When I

first read "lingering", I read it as "lingerie." I must get new glasses.

[Forkboy]

3. One of the more rational pieces I've read on the subject.

Thanks for posting it.

[EVDebs]

4. Two articles by Steve Pizzo answer your questions

First, the banks are insolvent. Read Pizzo's

Failed Banks Wants MORE Porridge?
http://newsforreal.com/newsdesk/?p=403

( the Treasury chart link doesn't show, but it's here http://www.occ.treas.gov/ftp/release/2008-152a.pdf
go to page 22 of 33 at Table 1)

Second, Geithner's and Summer's support for banks holding derivatives is really what's in question here. There's no way to pay off the derivative chits. It's banker's gambling debts and it is far too huge to pay off, at $1.14 QUADRILLION dollars !

Follow The Numbers
http://www.opednews.com/articles/Follow-The-Numbers-by-Stephen-Pizzo-090302-530.html

Obama needs to face this reality and stop listening to his Wall St team.

[MarjorieG]

5. So what do we do publicly with a quadrillion dollar debt, and still function.

The world blames the catastrophe on us, rightfully.

[EVDebs]

12. The world can publicly outlaw derivatives

This is what Nassim Taleb has recommended in Mr Taleb Goes To Washington on page 2

http://tbm.thebigmoney.com/articles/judgments/2009/03/26/mr-taleb-goes-washington

"With complex derivatives unmasked and, in Taleb's vision of the future, outlawed, the next step is to create a more robust version of capitalism. Taleb calls it Capitalism 2.0."

Ironically, Capitalism 2.0 will supercede Thomas Friedman's Capitalism 2.uhoh.

[FrenchieCat]

6. I'm glad that someone else is echoing my concern with this Nationalization plan of Krugman.....

And start asking the questions beyond the cry of action, and start looking at the unintended consequences!

I'm speaking of this:

in spite of their demonstrable greed, and even herd behavior, is replacing hundreds, perhaps thousands, of senior bank executives with public servants a little like disbanding and de-Ba'athifying Sadaam's army, a morally satisfying but systemically catastrophic thing?

I used this as just one of many examples as to the difficulties and how it could make things worse, not better for both this administration, and by extension, the American people.

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=132x8282342

[girl gone mad]

7. This part isn't accurate:

"But these values, much like the price of oil, depend almost entirely on the pace of recovery".

CDOs and CMOs are often time dependent and cash flow dependent, etc.

[ProSense]

8. It would be really cool

if Krugman responds.

[Telly Savalas]

9. It would be.

By the way, thanks for all your posts on this forum.

I know I've gotten into it with you before, but I really appreciate what you're bringing to the discussion here. With the exception of Brad DeLong, pretty much all of the economic bloggers I read tend to be critical of Geithner, so it's good to get other well thought out opinions on these issues.

[ProSense]

10. Thanks, and

thanks for reading.

:hi:

[Cha]

11. Rec'd~ For

more thoughtful opinions.

[firefox28]

13. Stigltiz

I would rather listen to Stiglitz.