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Since 2008 – Progress Through Politics

Economic Assumptions

I’m really curious to see what happens with today’s new plan to fix the banks. Among people to whom I listen about the economy, opinions are sharply divided; here’s a strong argument in favor from Brad DeLong and a strong argument against from Paul Krugman. I don’t know enough to have a defensible opinion, although my instincts are with Krugman and against the banksters, so I don’t have much confidence in today’s plan.


The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.

Obviously for the sake of alleviating economic suffering I hope it works out, but I also think this is an intellectually critical moment, much like the Iraq war debate.

Cross-posted to Mike’s Blog!

Krugman and DeLong (and Calculated Risk, and Yves Smith and others) have all staked out clear positions on the issue based on their different assumptions about reality. The success or failure of the plan will serve as some sort of test of these assumptions, and will therefore tell us something about reality. It’s not as rigorous (or even controlled) as a scientific experiment, but clear debates like this are the closest approximation to science that real life offers.

For example, in 2003 I supported the Iraq war based on the assumption that the Bush Administration possessed actionable WMD intelligence they weren’t sharing with the public. This was partially because they were saying they possessed such intelligence, but mostly because I couldn’t imagine a case for offensive war without it. When Saddam proved not to have a nuclear or biological arsenal, my assumption of the Bush Administration’s good faith and basic competence was falsified, and I started paying attention to this whole “politics” thing.

So for future reference I think it would be a good idea to state clearly the assumptions that I think will be tested by implementation of Geithner’s new bank plan. Foremost is the assumption that mortgage-based assets are currently undervalued, and so if the government buys them from troubled banks and holds on for a while, they’ll regain their value and we taxpayers will get our money back. In other words, “there are no bad assets. Only misunderstood assets.” What a progressive, tolerant attitude!

Everyone seems to agree that if this is correct the banks will be fixed and if this is wrong the banks will not be fixed, so it should be pretty clear in a few weeks or months what these assets are worth. Or, more accurately, it will be clear whether “it’s the bad state of the economy that’s making them so worthless and [whether] if you solve the bank capitalization problem the asset values will rise.” Either way, this is a straightforward, testable assumption.

Adding a level of abstraction, we can also explore how people decide what to believe about these assets. In 2002, nobody knew for sure whether Saddam had a huge secret WMD program, and there was conflicting evidence (e..g. Colin Powell and the CIA vs. Hans Blix and the UN), so everyone with strong opinions about it formed their opinions based on their own models of the world and, especially on which information sources they trusted. People who got it right tended to distrust the mainstream media, the military-industrial complex, and especially the Republican Party and the Bush Administration.

In this case, my (entirely subjective, open to debate) understanding is that people who oppose the Geithner plan tend to distrust pretty much the entire finance sector and to discount the value of expertise in this sector. People who support the Geithner plan don’t necessarily believe in the banksters, but they seem more cautious and deliberative, uncomfortable with the current populism in Congress and the breathtaking scale required by the alternatives such as temporarily nationalizing American banks. (As usual for this blog, I’m ignoring the crank conservatives who argue instead for spending freezes and deregulation and just letting the banks fail.)

So, depending on how the banks fare in the next few months, we can test a few assumptions. I’m slightly interested in how the value of mortgage-based assets changes in the future, but mostly as a curiosity and as an indicator of the direction of the housing market over the next five to ten years. I am very curious about which group of economists will be proven right about the plan, however, since I think it will tell a fair amount about which worldview (i.e. the shrill one or the stately one) makes better predictions.


Categories: Uncategorized.

/ 18 Comments

18 comments

  2. John Allen

    As you say, it should become obvious fairly soon whether the assumptions behind this plan are valid. The one thing I would like to see is a reverse or dutch auction. Let the banks put up their assets with a price on them. If the hedge funds think those are valid prices then they will buy them. If not, the banks will be forced to reduce their asking price.

    In the end, it won’t really matter whether they use an auction or not. You can rest assured that if there is money to be made the hedge funds and other investors will be all over this. Today’s stock market surge suggests they think this is a good idea.

    Krugman is a very smart guy. He was shouting from the rooftops a year ago about the problems we were facing. However, as smart as he is, he can have blinders just like anyone else. It seems that lately he is vehemently opposed to any plan other than his own, which he hasn’t laid out in detail.  

  3. ragekage

    It does about as well as explaining the ordeal as anything I’ve seen. And your analysis is bang on. Me, I wish we could let the banks fail. It goes against my very nature to want to throw this much money at… anything, really. But I don’t know we have much of another choice.

  4. rfahey22

    is that it can’t be tested in a lab.  I just hope that Geithner has a better handle on the state of the markets and the parties’ motivations through his experience in the field than do his critics.  

  5. HappyinVT

    I watched part of Countdown and David Shuster (subbing for Keith) was talking to Craig Crawford of CQ Politics about the Geithner plan and, specifically if nationalization, should it happen, may happen too late politically.  Crawford’s response was that Obama is a change agent but not a radical change agent.  It made me pause for a moment.  Not to overly parse a sentence but it really could be taken one of two ways.  Either Obama isn’t going to radically redo how Washington/Wall St works or he isn’t going to change how Washington/Wall St works quickly or both, I guess.

    If we know nothing else about the man, we know President Obama will not be rushed.  He has said that change will take time.  What we don’t know is how much change and how much time.  I’m willing to wait a bit on both counts.

  6. Neef

    Personally, I’m struggling with my ignorance on the situation. I just figured out what the crisis itself was, much less trying to decide which global macroeconomic policy is “right”. Oy.

    I would echo DeLong’s thought that Krug isn’t seeing the politics (or even the logistics). Even in my job, there’s a huge difference between the right solution, and the solution you can sell to the client, finish under budget, and complete on time.

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