Wednesday, September 3, 2014

Keen, Hudson, Bezemer, Werner, Koo, Vague, and others


Recommended reading: At Business Spectator, Time for a Copernican revolution in economics by Steve Keen. Keen writes:
The global financial crisis took the vast majority of the economics profession by surprise... The OECD’s advice in its June 2007 Economic Outlook was typical:

"Indeed, the current economic situation is in many ways better than what we have experienced in years. Against that background, we have stuck to the rebalancing scenario. Our central forecast remains indeed quite benign..."

After being so disastrously wrong, one might expect that this modeling approach would now be subject to serious revision. But while New Keynesian DSGE model-builders are starting to add “financial frictions” to their repertoire of factors that prevent the economy from almost instantly attaining a competitive equilibrium (as in New Classical models), the core paradigm -- of an economy which, left to its own devices, will ultimately reach equilibrium, and in which money and financial institutions generally play non-essential roles -- has not been challenged.

Keen provides an extended analogy to astronomy. He explains:
I believe there are enormous parallels between the Ptolemaic-Copernican transformation of astronomy and the current state of economics.The alternative vision of capitalism -- as fundamentally unstable and monetary -- is as discordant with the Neoclassical vision of equilibrium in a barter economy as Copernicus’s Heliocentric vision was to Ptolemy’s Earth-centric model. It simply isn’t possible for one vision to incorporate the other -- which is why Neoclassical attempts to assimilate Hyman Minsky’s “Financial Instability Hypothesis” have been so lame...

Here Neoclassical economics shares another commonality with Ptolemaic astronomy. Just as it couldn’t explain comets, nor will Neoclassical theory be able to explain if another major financial crisis occurs in the relatively near future -- say the next three to seven years (bear in mind that the gap between the crisis of 2007/8 and the previous serious recession was about 18 years). On the other hand, the alternative private-debt-focused perspective that I share with Michael Hudson, Dirk Bezemer, Richard Werner, Richard Koo, Richard Vague, and many others, will have an explanation.

Well I see I didn't make the list :)

I do like that "vision of capitalism -- as fundamentally unstable and monetary". But I don't so much like the self-satisfying notion that Keen, Hudson, Bezemer, Werner, Koo, Vague, and others "will have an explanation" if "another major financial crisis occurs in the relatively near future".

I don't want an explanation. I want to prevent the problem. See the difference?

Keen provides this graph and text:
This recovery is starting from an unprecedented level of private debt: whereas the last post-recession recovery in America began from a debt level of 115 per cent of GDP, this one is commencing from 155 per cent (see Figure 2). If it only reaches the level of the previous peak (177 per cent) in the next five years, it will have fulfilled Richard Vague’s empirical rule of thumb for the cause of an economic crisis (a private debt to GDP ratio above 150 per cent, and an 18 per cent increase in that ratio over 5 or less years).

Yeah, I read that rule. I don't think you can calculate the future so precisely. So, grain-of-salt there. But this recovery is most assuredly starting with an unprecedented level of private debt, and that can't be good.

I don't see why this doesn't make sense to people: If we need credit for growth, and growth is, you know, maybe five percent each year, then I can easily see that we need an accumulated debt of five or ten percent of GDP. And, if it takes some years to pay off debt then I can see that we might have an accumulated debt equal to 50% or 100% of GDP. But there is no reasonable justification to ever have an accumulated debt of 300% or 350% of GDP or more. There is just no reason for it.

Of course, there is a reason. There is no justification for it. The reason we have such debt is that policy encourages the accumulation of debt, fails to discourage the accumulation of debt, and fails to encourage the accelerated repayment that could reduce debt to a sustainable level, a level that maximizes rather than hinders economic growth.

Oops! I let the cat out of the bag. I gave away the secret. I gave you my plan to prevent the problem.

9 comments:

nanute said...

Those bastards! They left you off the list? On the debt thing, and policy encouraging it: It's worse than encouragement in some cases. (mortgage debt and student loan debt, come readily to mind.)When financial crisis hits the consumer of debt, the policy is too bad, pay us back, and if you're late we'll just add more debt. When the lender has this problem, the policy is, oh, you made a mistake and almost blew up the economy? No problem, here's some money, see if you can try not to do it again. No equilibrium? Just a thought.

Auburn Parks said...

This brings to mind an INET interview between Marshall Auerback and Charles Goodhart.

At one point in the interview (at the 5:44 min mark), Marshall makes a point about how financial liberalization (code for allowing banks to create more debt)has generally not been beneficial. And that the "golden age of capitalism" (50's-70's)had tightly controlled financial markets (aka low private debt levels and growth).

Goodhart counters that those times were actually not very good because regular people had little access to credit. Only the biggest and most established firms\people could get bank financing.

And as a point of logic, Goodhart's point sounds reasonable. But I don't know the data well enough. I would just like to say that a counterpoint to this would be "but what about prices?"

If a normal person couldn't get a loan for 3x their yearly income in order to buy a home, then home prices couldn't be 3X your yearly income. Similar to the what we've seen in college costs. If the Govt didnt guarantee college debt, there would be very little student loan debt. Which would mean that people could only pay tuition out of income or savings. Which would in turn lower the prices that colleges could charge.

On the flip side of the benefits of cheaper housing, that would change the savings structure of normal people significantly. Instead of home equity being the largest stock of savings, people would instead have those savings elsewhere. Which would probably be a good thing.

But would we get as much home construction?

How would that impact construction input costs (lumber, concrete, PVC, copper, windows, etc) and the home construction labor market?

If the median house cost $100K instead of $200K, where is the profit going to come from for the title insurance companies, real estate agents, appraisers, inspectors, etc? As each of those costs would double on a % basis.

I'm not saying I know the answers to any of this, and I would most definitely like to run the experiment. Just throwing some thoughts out there.

here is the video link if anyone is interested:

http://ineteconomics.org/new-economic-thinking/charles-goodhart-state-global-economy-central-bankers-perspective

jim said...

It really saddens me to see you guys so thoroughly suckered in by Wall Street propaganda lies. This whole meme that it is all the government's fault is simply not supported by the facts.

The mortgage bubble was driven by $6 trillion in loans that were financed by private label securities. Before the bubble and after the bubble the amount of mortgages financed by private securitization was practically zero.
http://www.weebly.com/uploads/4/0/4/4/4044041/graph_2.png

Of the $6 trillion in mortgages financed by private securities only $2.2 trillion were still in force when the bubble collapse. That is because these were Ponzi loans that had to either default or be rolled over.

35% of the $2.2 tn remaining loans financed by private label securities ended in default. That means about 80% of the $6 tn in loan contracts are now kaput.
https://www.economy.com/mark-zandi/documents/2013-06-26-Resurrection-of-RMBS.pdf

Compare that to lending by Freddie and Fannie where 95% of the loans they made during the bubble are still performing. How anybody can put the blame on F&F is totally outside the realm of rational thinking.


The housing bubble was all about what happens when the market abandons federally subsidized mortgages and turns to private financing. And it will happen again if the propaganda campaign is successful at killing off federally subsidized mortgage lending. It is estimated that federal subsidies save the average homeowner $40K at today's prices. That is $40k/loan potential profits for Wall Street financiers.
Those trillions of hoped-for profits explains the avalanche of disinformation that Wall Street has flooded into the media.

The same holds true for student loans. Even if you get rid of federal loans to students, the students will continue to borrow from private sources because they can do the math and it will still be advantageous to borrow. But it will cost more. And that additional cost will flow to private investors and the financial sector.

The Arthurian said...

Jim, who do you think is saying "it is all the government's fault"? And what was said, exactly, that makes you so sad?

jim said...

Art you wrote
"The reason we have such debt is that policy encourages the accumulation of debt"

That story is fiction. People lend and borrow because they believe it is economically advantageous to do so. Government policy has very little influence in driving people to accumulate debt. In fact if it were not for govt policy the accumulation of debt would likely have been larger and the credit collapse that occurred in 2008 would have been a much bigger fiasco and far more painful to get out of.

Auburn wrote:
"Marshall makes a point about how financial liberalization (code for allowing banks to create more debt)has generally not been beneficial."

That is just another part of the "blame the govt" fiction.

Goodhart responds correctly that before financial liberation the credit was only available to the big, wealthy and well established. And he goes on to say that govt policy changes that has made credit available to others is not something that went wrong.

The Arthurian said...

Jim, you quoted me: "The reason we have such debt is that policy encourages the accumulation of debt".

And you replied:
That story is fiction. People lend and borrow because they believe it is economically advantageous to do so. Government policy has very little influence in driving people to accumulate debt.

Mmm. People lend and borrow because they believe it is economically advantageous to do so. Okay. Yeah.

So, if policy were to change so that people came to believe it was somewhat *less* economically advantageous to lend and borrow, they would lend and borrow somewhat less. Pursued over the long term, such a policy could have significant impact on debt accumulation.

Good grief Jim! Almost everything Congress does is one way or another related to tax incentives, making it economically advantageous to do some things and not to do other things.

And of course, "financial liberalization" was the method policymakers used to enhance the availability of credit, which added to the accumulation of debt.

jim said...

First of all "financial liberalization" was a policy change that occurred in UK and Europe after several decades of evidence that traditional policy in Europe was not working. In the US since the 1930's anybody who was white and willing to get a job and keep at it could own a house and a car by virtue of the fact that they had access to credit.
Minorities started to be included in the 1960's.
By 1970 Europe was economically way behind the US because that "financial liberalization" wasn't available there.

I see nothing good coming from policy that would be a reversion back to a period when credit is only available to the big, wealthy and well established.

The fundamental flaw in your thinking is that you treat all lending as equally bad. In reality there are destructive loan arrangements and constructive ones. The policy changes you seem to be hinting at look to me to be disproportionally restrictive on good lending while allowing bad lending to flourish. There may be
some reduction in total accumulated debt but the outcome won't be what you expect.

The Arthurian said...

So Jim, are you acknowledging that you were wrong to say "Government policy has very little influence" and I was right? Or are you just trying to change the topic.

I think I have a soup strainer here somewhere. You could borrow it and run your comments through it to take out the lumps. I mean, you say "anybody who was white ... had access to credit." and in the very next paragraph you refer to that same time period (i guess, the same time period) as "a period when credit [was] only available to the big, wealthy and well established."

Are you trying to say all the white guys were big, wealthy and well established? Or are there some lumps in your gravy?

Another thing. You wrote: "The policy changes you seem to be hinting at look to me to be disproportionally restrictive on good lending while allowing bad lending to flourish."

I don't know what that is based on. Maybe on your shortened version of my plan: "The reason we have such debt is that policy encourages the accumulation of debt"

But if you notice, even your shortened version of my plan does not say anything about lending. My plan is that after we have done our lending, we should pay it back a little quicker than we did, on average, during the 1947-2007 period.

jim said...

I stated government policy has had a definite influence, but there is no evidence that the influence has been what you claim it is.

The lumps you see are due to your misreading what was said about financial liberalization from the Goodhart video. I was making a comparison of the differences between Europe and the US. By 1970 it became evident that the huge disparity in wealth between average US households and average Euro households was largely due to those differences in availability of credit. Since financial liberalization in Europe that disparity has mostly disappeared.

As for what policy changes you advocate, you've only vaguely hinted at what they might be. However, your underlying assumption that policy was what was behind the 6 decade run up of debt is just that an assumption. You have given very little in support of that claim.