Economic Assumptions

Cross-posted to Mike's Blog!

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.

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.

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.

Tags: economics, epistemology (all tags)



Re: Economic Assumptions

Right now, many of the banks have performing assets that they value at .80 cents on the dollar while the market is only willing to pay .30-40 cents.

If private investors are willing to bid up these assets to the .70-75 level because of the low risk involved, then the banks will do great.

If they get less than .50, they are probably screwed.

But what's stopping a bank (or an indirect partner), from bidding on its own assets? Why not bid them up to .75 on the dollar and when they go bad, they only take a small loss and stick the rest with the taxpayer?

I don't see how these assets improve for a long time, because without jobs, even lower interest rates aren't going to keep people in their homes.

In the end, we're trying to solve the problem of too much debt, with even more debt and it will not solve the problem.

by tpeichel 2009-03-23 03:32PM | 0 recs
Postwar Prosperity colored our assumptions

After WWII we had a period when working people in the USA had a very high level of prosperity due to the GI Bill and the destruction of the industrial base in much of the rest of the industrialized world.

We attribute that success to inherent strengths in our democratic system and indeed, there is a good amount of truth to that. But it would be foolhardy to discount the reality that the US was lucky to largely escape the worst of WWII because of our location in the New World and that gave us a boost.

There have been several waves of increased productivity due to technological progress. The most recent one has been due to huge world-changing improvements in information technology.

Ultimately, what IT does is allow technology to manage all scriptable things. Anything that follows rules is scriptable.

We assume that industry needs us, workers, humans, and that is true.

It will always need us as consumers.

But to do X amount of work, it needs less and less. That is putting downward pressure on wages to do a given job worldwide. It also creates new jobs, at higher skill levels, but fewer than it replaces.

I don't see anybody discussing THAT.

Why not?

You know why.

by architek 2009-03-23 05:14PM | 0 recs
Re: Economic Assumptions

housing is called a bubble for a reason, the prices zoomed up, and investors got in and turned properties, and the lenders got in and made commissions and had 'assets' to claim on their books, but it wasn't sustainable because the middle class was losing ground while housing costs and energy costs and medical costs and education costs soared.  So, it was obvious to Krugman two years ago that this was a bubble and bubble's burst, that's why they're bubbles.  and it was obvious to Hillary a year ago January when she said we needed to help homeowners stay in their homes if we didn't want a bunch of foreclosed homes on the market that would drive down prices. now it's cheaper by far to buy a home than to build one, which is why builders are in trouble, materials costs have not yet gone down, nor labor, nor fees, and certainly not property taxes.

So, to claim you know the real value of a mortgage on a house that is in foreclosure makes no sense at all.  And to think that we can stop a world wide depression on our own is equally false, Krugman is being harder on Europe than on Barack's administration.

There is a philosophy behind these decisions, and I think it's a form of secular or capitalistic or whatever ideology, that is faith based, not fact based.  It's time to be conservative in our assumptions not optimistic.  There is a way to do what Barack wants to do without sticking future generations with a bad bet if it doesn't pay off.  Why won't he just nationalize the banks and clean up the mess?  I'm not against a financial plan, just against a stupid financial plan.  

by anna shane 2009-03-23 05:13PM | 0 recs
It's really not that easy

nationalizing the banks is easier said than done and it really won't make it any easier to clean up the's more expensive, takes just as long, and will almost certainly sink the stock market, which is the indicator people are going to use to judge the economy nowadays.  

by DTOzone 2009-03-23 06:10PM | 0 recs
Re: It's really not that easy

Banks are nationalized every week. It's called receivership. It's done when a bank goes insolvent all the time. You are throwing out another one of those talking points put out there that people believe simply because politicans repeat it ad nauseum.

by bruh3 2009-03-23 07:18PM | 0 recs
Re: It's really not that easy

i'd settle for an explanation, why is this better when it seems only riskier.  Why do we need investors in the middle who we guarantee but who'll take profits, if there are any.

The only explanation I can think up would be there are no government regulators who know how to take banks into receivership anymore.

But i think the real reason is that the insiders all know each other and value each other at the expense of common sense and the need for results.

by anna shane 2009-03-24 08:50AM | 0 recs
Re: Economic Assumptions

I think this is one of the concise and clear headed diaries on the subject I've seen on this site.

You are absolutely right. This is about assumptions. The core problem is whether one should make liberal or conservative assumptions about the state of both the assets and liabilities. I would add the question is whether we should make liberal or conservative assumptions about banking management? Whether they are going to act as good faith or bad faith actors?

My argument is that we should make conservative assumptions. There are many reasons why. 1) It was liberal economic assumptions that got us into this mess; 2) We have no idea what value these assets are; 3) Even if we determine the asset value- it still may not help with liability values on the balance sheets and 4) we have been given no proof that bank management will act in good faith.

There is a 5th one, but I want to separate that one out. This is that all of this requires a vigilant federal component and transparency. So far, the record has not been good on this. That's a concern that can not be solved by planning alone. It's a question of whether idealogical faith (in the private sector) will trump reality.

I think your example of Iraq is probably the best I've heard. A lot of us, including me, thought Iraq was wrong, but ultimately wanted to trust that our government would not lie to us.

People taut Obama's numbers about why we should trust his policy judgment here. But, Bush had high numbers in 2003 too. In fact, it was up to 80 percent as I remember. It took years to realize that the policies were ill concieved by most of the American public. This was the despite the fact that much of the criticism and signs were there early on.

My concern with Obama's team is that there are signs already that are not good signs. To me, AIG was not about outrage. i expected it. But I did hope that oversight would be there to prevent it. It wasn't. That's the real lesson of AIG for the Obama team. Taking them at their word, they didn't do enough oversight. 160 mil is small potatos. 1 tril is not.

Geithner's statement about his idealogical bent, and how important that bent is to him. His misdirections regarding nationalization even today- my distorting what nationalization would mean. The fact that Obama relies on these men rather than a broader section of economic thought.  His inherit sense of loyalty (a great trait but dangerous). All these things worry me given the question of : If this plan is going wrong- will they know fairly quickly given proper oversight and will they react quickly.

I am not certain about any of thing. Add to this my concern over the overzealous supporters who refuse to view poltiicans with skepticism, doubt and require accountability. This is the picture that I see.

I dont' know the out comes. I just know the factors involved so far have not been particularlly good.

by bruh3 2009-03-23 07:29PM | 0 recs
Those assets are not fixed in value.

That's the key--their value changes with other macro factors--unemployment, property values, and federal homeowner assistance policy.

The key is not what they are worth today, but what will they be worth in six months or a year?

by Geekesque 2009-03-24 05:24AM | 0 recs


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