TheMoneyIllusion

  A slightly off-center perspective on monetary problems.

39 Responses to “Big Think part 3: John Allison”

1. Declan Trott
   17. December 2009 at 19:48
   

   Re the Calomiris talk: Carmen Reinhart was on EconTalk more recently and said (politely) that Calomiris was completely wrong about the late 19th century being a period of stability. Don’t know who is right, but Reinhart has just written a book about it so she should know!

   http://www.econtalk.org/archives/2009/11/reinhart_on_fin.html

   41:08 Calomiris podcast: Different story: look at the 1874-1913 period, increased capital flows, globalization, and compare it to the last 30 or 40 years, which had a similar flavor, there was a much larger number of banking crises in the more recent period…Two parts: first factual, document the crises for 66 countries in the book; incidence in the earlier period was huge. The only reason the number is higher for the more recent period is that we now have more countries–shouldn’t say the only reason–a reason. They were colonies back then; and some countries that didn’t have a banking sector have more developed banking now. The denominator is bigger.

2. Doc Merlin
   17. December 2009 at 19:54
   

   Very good point, Scott. We need to get rid of the FDIC (or at least tone it down) before we get rid of rest of the nationalization.

3. rob
   17. December 2009 at 21:32
   

   I am bothered when people describe themselves as libertarians, including you, and of course you know I am a big fan. Because what the hell do you mean by libertarian exactly? I’ve been reading your blog for about 9 months and I can’t think of any major issue I disagree with you on, except the label of libertarian. Isn’t it a meaningless label? I tell my co-workers I am a liberal. Mainly because I get offended when they use words like nigger or don’t like immigration or believe the poor are poor because they get what they deserve. I don’t like those ideas, which are considered “conservative” so a take a stance against it which I consider “liberal”.

   I suppose I am a pragmatic libertarian like you, but I would never call myself that because nobody I run into in regular life would have any understanding of what that means. So I simplify and describe myself as liberal. Of course I believe in free trade and free enterprise and all of that — because I am an American — but the everyday political values most of us non-academics have have nothing to do with economics. Most of us, even bleeding liberals, take the benefits of capitalism as a given. At least that is my premise. I would hate to have to become a right-winger merely to defend free trade.

4. rob
   17. December 2009 at 22:00
   

   Admittedly, a lot of these ideas I am describing as conservative are older generation ideas: I don’t hear many people under forty use the word nigger. But there is an emerging neo-con movement. Those who read Roissy, for example. Modern-day eugenicists. This group is very intellectual, often identify themselves as libertarians, and growing. Because of this movement I will still throw my hat in as a liberal, even if I am a Sumnerian regarding economics. (I’m all in favor of more prediction markets.)

   Anyway, isn’t it about time we do away with the old right-wing left-wing political axis? In my opinion, economics should shrug off political science — possibly by completely swallowing it within any general theory.

5. rob
   17. December 2009 at 22:34
   

   Sorry for the serial posting, but I guess the latest Bernanke comments have discouraged me from believing in the value of intellectual discourse. It seems all politicians, including the “independent” fed merely take their cues from the stupidity of crowds, which means CNN, Fox News, WSF, NYT, CNBC, Pacifica Radio, AM Radio, and whatever the fuck their friends or teachers tell them. Only a tiny, irrelevant minority considers issues thoughtfully, and this blog and those like it and economic academic papers are nothing more than intellectual masturbation, which only has status-seeking value for its authors. Nothing more. Bernanke’s comments make this clear.

   To paraphrase Keynes: Politicians and central bankers are merely slaves to some defunct populist political pundit idiot asshole.

6. Doc Merlin
   17. December 2009 at 23:13
   

   @Rob
   I call myself a libertarian, so I take exception to some of what you said.

   1. Libertarianism is very, very broad. You have anarchists like Rothbard, and David D. Friedman. You have right winged miniarchists like Ron Paul. You have economic right wingers, like Megan Mecardle. And you also have people like Scott here.
   The core of libertarianism says that people shouldn’t be able to do what they want so long as they aren’t actively harming anyone else. This leaves a REALLY big tent for behavior. It is purely a political ideology, not, a broader philosophical one.

   2. The Roissy crowd aren’t eugenicists at all. A eugenicist actually believes that people should be killed, and or forcibly kept from breeding. This is inherently an un-libertarian position. The Roissy crowd is sexist and very rude, but they aren’t even close to eugenicists.

   3. I don’t think you understand what the world neo-con means. A neocon believes in some of the welfare state and believes in spreading democracy by war. Libertarians usually don’t believe in either. Bush for example was a neo-con, the Clinton administration triangulating with congress after ’94 was vaguely neo-con.

   4. Using words like “nigger” and such isn’t a conservative thing to do, at least not where I grew up in the Texas. The conservatives here (even the older ones) would be horrified if someone said that in front of them.

   5. Some of the best economists can’t get into econ department nor do they publish in econ journals, the last nobel prize winners in econ for example worked in a poli-sci department and published in political science journals.

   6. If you want to know what the libertarian mainstream actually believes, I suggest you check out reason.com, reason.tv, and cato.org
   For the extreme libertarian, I suggest writings by David D. Friedman, particularly “The Machinery of Freedom.”

7. Doc Merlin
   17. December 2009 at 23:14
   

   Sorry, um, that should read “should be able to do what they want”

8. rob
   18. December 2009 at 00:24
   

   @Doc

   I think all your points are valid, but my point is that the tent of Libertarianism has grown so big that the ideology has lost its ideology. I’m sure most all of my political views could easily fit inside the Libertarian tent somewhere, but then what is the point of the descriptor?

   The Roissy crowd may not be orthodox eugenicists, but they are clearly slouching towards it. For instance, Mussolini, I mean, Burlusconi, is hoisted high as a hero among them. I was using neo-con in a more neo sense, not the Wolfowitz sense. I am speaking of the true new conservatives, who have freed themselves from the baggage of history by claiming ev-bio science is on their side. (Sound familiar?) And they are compelling.

   I live and work in the corporate oil world in Texas and the word nigger is in resurgence. It is used more frequently at a bar than in the office — and it is clearly a test by a dominant conservative meant to see if anyone is foolish enough to out themselves as a liberal. I usually fail this test, which is especially foolish on my part since I work in sales. I agree that most people are horrified when the word is used — and that fact demonstrates progress — but most of the horrified ones keep their mouths shut at the time and only say they were horrified in private after the fact. Only fools like me pick a fight, which I never win considering the environment. Good thing I’m not married to my career.

   I’m not saying that most conservatives are racist. I do not believe they are, particularly in America, which I believe is now the least racist country on earth. Even those white people who use the word nigger these days are more often than not just baiting other white people, to see if anyone calls them on it. It isn’t so much racism per se as it is a test of group allegiance. But my point is that politics comes down to these tests of group allegiances, not intellectual debate. I suppose there is nothing new in this. But sometimes I hope against hope that there could be some sphere in which good arguments matter more than group think.

   I give up. Long live Burlusconi! Our hero alpha male! Only a mentally deranged loser would think of punching that guy. Whatever happened to the idea that “everyone killed Kennedy”? Why has no one yet written that “Everyone Punched Burlusconi”?

   I’m not interested in what mainstream libertarianism is. I give up having a stance. Assholes and cowards will continue to run the world. Bernanke will be reappointed because he is the perfect coward. Nobody with both good intentions and balls would get that job.

9. bill woolsey
   18. December 2009 at 04:55
   

   Rob:

   I have never read a more superficial account of political philosophy before.

   I am a liberal because conservatives have bad attitudes. Actual public policy? What does that have to do with anything?

   Of course, I have been a libertarian for decades. Unlike Scott, I never describe myself as any kind of right winger.

10. ssumner
    18. December 2009 at 05:39
    

    Declan, My guess is that Reinhart is correct.

    Thanks Doc.

    rob, Labels are very tricky, but I think most people have a general idea of what libertarian means. ‘Classical liberal’ is another term I see tossed around.

    I use terms ‘right wing liberal’ and ‘left wing liberal’ to distinguish between liberals who favor socialism and liberals who favor capitalism. But no term is perfect, because we don’t all lie along a one dimensional left right continuum.

    Doc Merlin, Those are good points about libertarianism. There are many different types and I agree that neo-cons are not libertarians.

11. StatsGuy
    18. December 2009 at 05:58
    

    Scott, you do realize the arguments about the source of this latest cycle will never be resolved? Partly, this is because discourse in this country (and, perhaps, by all humans) is conducted in a way in which people defend their positions with facts as available, rather than seeking an answer with an open mind.

    Combine this with the fact that both camps are probably correct. Failure on the magnitude we saw required several systemic failures to happen simultaneously. It’s like a nuclear reactor accident – there are multiple “causes” – except the system is vastly more complex. One can point to a cause, and say (accurately) “but for that failure, things wouldn’t have been so bad”, but someone else can do the exact same thing.

    In this light, your comments about social construction of truth are accurate, even though objectivists would like to think that they own the one and absolute truth. I certainly appreciate that this is one of the most civil of the blogs I comment on, and that you yourself (and many whom you link to) make a good faith effort to approach questions without bias. Not so most of the blogosphere – left and right.

    Which suggests, of course, that given a plethora of causes to choose from, the answer to “the” cause will depend on which faction is louder and better funded.

12. Joe
    18. December 2009 at 06:09
    

    Would would dropping the FDIC do to banking deposits? Very few people understand that money in the bank is a loan to other people; they feel it is safe and secure. Would eliminating the FDIC move money under mattresses or into other liquid asset classes like gold? The deposit insurance is nice..it lets me sleep at night not needing a gun to protect my savings so I can feed my family in the future. Is the level of societal angst that a removal of the FDIC could cause worth it? Or would second best policies really be better for society as a whole?

13. StatsGuy
    18. December 2009 at 06:28
    

    Regarding libertarianism and government action – I think the fundamental difference between pragmatic and dogmatic libertarianism is this:

    Pragmatic libertarians consider the counterfactual. Dogmatic libertarians do not.

    Let us presume that government interference is in most cases bad. Pragmatic libertarians will, on a case by case situation, consider what the alternative would be – whether it is worse. The debate then becomes an empirical question, guided by normative thinking.

    (Under this definition, most comments on this site come from pragmatic libertarians…)

    I personally tend to favor more government action than many libertarians (but less than most progressives) because I observe the following – in the absence of power, the outcome is not always free exchange. And in the absence of free exchange, the organizations that fill the power vacuum (gangs, mafias, cults, paramilitary groups, KGB run oil conglomerates, etc.) often have fewer checks on their power than government. Often, the competing sources of power are worse than power wielded by the existing regime. (This was Burke’s fundamental observation, and the root of conservative thought – before conservatism became what it is today.) Jeffrey Sach’s massive miscalculation on Russia is a rather powerful example – one of the world’s greatest social engineering experiments. (Believing that a free market could create the institutions of freedom, rather than vice versa – or, more accurately, the co-evolution of markets and institutions, which is probably what really happens.) Observe Russia’s growth curve compared to Sach’s projected growth curve.

    Dogmatic libertarians – even if they accept that there are empirical examples of the failure of “pure” markets – will counter that markets are more moral in an “objective” sense. Again, hokey, in that it relies on a myth.

    In a modern world, where the myth that all individuals could theoretically be simultaneously self reliant (with a world pop > 6 billion) as in a “state of nature” (the Lockeian kind, not the Hobbesian kind) is simply bunk, the choice between government and not-government is not a choice between bad government and something not-so-bad. The absence of government is BAD. Simply look at Iraq, or the French Revolution… or any number of other similar cases.

    In other words, the pragmatic libertarian considers the empirical track record of government failure, and considers this his counterfactual. The dogmatic libertarian invents a fairy tale and considers this his counterfactual.

    Yet dogmatic libertarians are very loud, and the siren song of a worldview unobstructed by the mess of reality is too alluring for many intellectuals to resist.

    Arguing with them is ugly, because from time to time they raise good points and any good pragmatist will concede some points. But when pragmatists raise a good point, a dogmatic libertarian does not concede, but retreats into high minded dogma.

    Meanwhile, the general public (and media) do not weigh evidence; that is too costly. They weigh opinions, and if a reasonable group gives ground and an unreasonable group does not, the consensus shifts to the unreasonable group. That is our current state of affairs – and both the Dems and Reps have realized this. There is no gain, today, from moving to the center except late in an election when attention is high.

    I still don’t know how you remain so optimistic…

14. q
    18. December 2009 at 06:47
    

    it would be interesting to do a correlation plot which shows the terms people use (or even the positions they take) versus their putative ideology.

    in any case, this kind of blathering about how the GSEs were a major cause of the crisis shows ideology at work, not a reading of the facts.

    (of course it’s possible to think the GSEs are problematic even if you don’t believe they were a big cause of this crisis — lots of things could fall into that category. but ideologues don’t make distinctions.)

15. David Pearson
    18. December 2009 at 07:18
    

    I know of no definition of “libertarian” that encompasses the desire for Central Planning of the economy by the central bank. Scott has argued passionately on this blog that the Fed can and should direct the path of the economy — at least the nominal path, with the implicit assumption that the real economy will follow.

    Scott will doubtless argue that a rules-based system is not discretionary and therefore does not rise to the level of central planning. I disagree. Underlying this “non-discretionary” approach is the assumption that the economy must not be allowed to make adjustments in prices, wages, etc. without government intervention. It assumes that capitalism needs a “visible hand” to function.

    If I were a believer in constant Fed intervention and free markets, I might call myself a “conservative”. I might even call myself “right wing”. I would definitely not call myself “libertarian”.

16. OGT
    18. December 2009 at 07:29
    

    Declan- I just started Reinhart’s book, its fascinating and well written. The central theme seems to be that financial crisis are ubiquitous in history, government and private, with little regard to regulatory structure. The major common thread is a massive unsustainable credit expansion leading to almost inevitably to default.

17. StatsGuy
    18. December 2009 at 07:32
    

    David:

    “If I were a believer in constant Fed intervention and free markets, I might call myself a “conservative”. I might even call myself “right wing”. I would definitely not call myself “libertarian”.”

    I actually find Scott’s argument perfectly internally consistent, and libertarian.

    The question he tries to answer – indeed, Milton Friedman’s question (on his good days, when he wasn’t making pithy comments to appeal to his less-thinking fans) – is this:

    “What system, given the constraints of reality, maximizes individual liberty?”

    The dogmatic libertarian will ask:

    “What system, assuming reality looks like our theories say it _should_ look, maximizes individual liberty?”

    If you take the word “liberty” in the dogmatic objective and substitute “utility”, then you might well be a Marxist… Marxists, too, considered themselves to be objectivists. In this, Ayn Rand and Karl Marx were soul mates. Perhaps there is a little place in Dante’s prison where they share a cell, contemplating the lives they have each destroyed.

18. David Pearson
    18. December 2009 at 07:55
    

    I agree that Friedman’s question is the right one, and I also don’t think it “dogmatic” to point out that nominal GDP targeting doesn’t fit the bill. The assumption targeters are making is that there is a net increase in welfare from intervention across time, and that it does not take too much away from an individual’s latitude to decide his own fate. I think both premises are highly suspect.

    First, give the Central Bank discretion to set the rules, and you give them the power to change them when it suits a particularly powerful group. To think that a government agency can shield itself from pressure is to be dogmatic and blindly unrealistic. Where is there room in a rules-based Fed for its participation in the AIG bail out? And yet, it happened. That fact cannot be denied. The Fed is a giant balance sheet waiting to be filled with the trash from government’s collective mistakes. To think it won’t be used for that is to ignore the facts.

    Second, the discretion in setting rules leaves ample room for miscalculation. When individuals miscalculate and lose money, libertarians call it liberty. When governments miscalculate and cause individuals to lose money, libertarians call it stealing.

19. rob
    18. December 2009 at 08:03
    

    @Bill

    I think the rambling drunken superficial point i was trying to make is this: what difference does it make if i describe myself as a liberal or conservative or libertarian? My policy views are what they are despite the label.

20. David Pearson
    18. December 2009 at 08:10
    

    Statsguy,

    Let me give you a concrete example. I am an elderly widow, and I need a return on my savings to live out my life.

    Its early 2008, and NGDP is raging as oil prices and inflation rise. Sure we’re already in recession, but the markets do not care — NGDP futures trade at 7%, 2% above target. The Fed drains reserves, but the impact is small given speculative fervor. It tries even harder, raising rates. I earn 5% on my bank CD.

    Now, a few months later, NGDP is crashing. The Fed lowers rates. I earn 1% on my bank CD.

    If I am the elderly widow, how much can I expect the CD to return over 10yrs? How much should I spend every month? How can I possible predict this and make decisions when the Fed is jacking interest rates around like that? I have lost my economic liberty to the goal of maintaining NGDP. A goal which might benefit some — even most! — but certainly at my expense. This is libertarianism?

21. StatsGuy
    18. December 2009 at 09:09
    

    David:

    What a great example of economic relativism…

    Treating money as an asset class (which, in an international context, it most certainly is), any effort to stabilize the value of that asset class against inflation (and so, insure the risk of the the elderly woman), is purchased at considerable expense. If the currency should depreciate (raising inflation fears through commodity-push, which James Hamilton has recently been discussing, and which I believe triggered the August 08 tight money policy) then by raising rates the Fed is doing two things:

    – Shifting wealth from the elderly lady onto the 25 year old with college debt, a mortgage, and 2 children, who has less accumulated capital, more debt, and more future-earnings…

    – Subsidizing the risk-reduction for the elderly lady (by stabilizing the value of the asset class she holds her savings in relative to a basket of goods/services that she consumes).

    One of the reasons your example is so wonderful is because it coincides with a demographic/political shift – as our society ages, politically entrenched interests have moved aggressively to preserve the value (and reduce the risk) of their savings even at the expense of macroecomic stability and growth. They are buying this security with government debt; if they were not able to lean on government fiscal deficits (which they abused to fund low taxes and high services for 25 years), this strategy would not even be feasible – and we would be forced to confront either deflation or inflation directly (rather than delaying and worsening the decision by indebting future generations).

    Ultimately, this is self-defeating, as deficits (to fund transfers – far larger than the discretionary budgets that the Republicans harp on) will destroy credit-worthiness… But, perhaps, the old lady hopes to be dead by the time that happens.

    For you to describe the government’s role as preserving the “economic liberty” of the elderly lady by insuring the risk (at no cost) of the value of her nominal savings requires an interpretation of liberty that borders on “positive liberty”. Not liberty “from”, but liberty “to”. Vis a vis Rousseau.

    How is that consistent with Libertarianism?

22. q
    18. December 2009 at 09:55
    

    StatsGuy, thanks for that.

    Most of the libertarians I have casually read (except for the economists) believe that ‘savings’ are a first class concept. I don’t know where that comes from.

23. Doc Merlin
    18. December 2009 at 09:55
    

    To add to your point, StatsGuy
    Well, the vast majority of social welfare spending is on the richest age bracket. This is expected from, public choice theory, but goes against progressive rhetoric.

24. Doc Merlin
    18. December 2009 at 09:58
    

    @q
    Savings IS a great thing, q. The problem is more redistribution. Both monetary deflation and monetary inflation (I am distinguishing here from productivity deflation, and demographic caused inflation) are extremely harmful. They move savings around as a result of government fiat instead of mutual benefit maximizing choices.

25. Doc Merlin
    18. December 2009 at 09:59
    

    Oh, yah, forgot to add.

    If by saving you mean hoarding wealth in a box, thats mostly (not entirely) useless, but if by savings you mean investment (even a savings account counts as investment) it can be extremely beneficial for everyone involved.

26. Russell
    18. December 2009 at 10:40
    

    Scott’s idea of “pragmatic libertarian” greatly resonates with me, and I typically refer to myself as such in the rare cases it comes up in conversation (I’m a nobody). To distinguish pragmatic from dogmatic libertarianism I think of the work of Tetlock and Taleb:

    1. Pragmatists are foxes, dogmatists are hedgehogs in their cognitive styles (Tetlock) – pragmatists understand the importance of context and that real people’s values change when the underlying context changes (there is an epistemological humility at work); and

    2. Dogmatists are “Fooled by Randomness” – they think we live in a neat, deterministic, linear world (“make your own luck”, “true meritocracy”); pragmatists understand that the world is very complex and dynamic (and never perfectible).

    That’s my two cents, anyways.

27. Philo
    18. December 2009 at 11:43
    

    Some scattered comments:

    1) You move awfully swiftly from *gold standard* to *tight money*. Of course, it is supremely easy to adjust the supply of a fiat currency, but aren’t there monetary systems that might justifiably be considered versions of “the gold standard” in which the supply of some sort of M is pretty flexible?

    2) “[L]ibertarians often overlook the fact that policies must be judged in the context of the world we live in, not the world we wish we lived in.” This seems to mean that in judging a policy we should determine whether replacing it with a different policy *leaving everything else, including all other policies, as is* would make things go better. I’ll buy that, even though it produces what, to the uninitiated, *looks like* inconsistency. Suppose the policies now in place are {A, B, C, . . ., Z}. I am a supporter of A, because I think {A, B, C, . . ., Z} is better than {x, B, C, . . ., Z}, for any alternative x. And I support B, because I favor {A, B, C, . . ., Z} over {A, x, C, . . ., Z}, for any alternative x. But I am also a supporter of A’&B’, where A’ ≠ A and B’ ≠ B, because I think {A’, B’, C, . . ., Z} better than {A, B, C, . . ., Z}. There’s no help for this; things are complicated.

    When you ask someone for his policy views, it won’t always be clear to him whether you’re asking about A, or about A&B. I think that’s what happened when you asked Allison about requiring a 20% down payment to get a mortgage. He replied that he wouldn’t favor that if government encouragement of subprime lending were dropped as a policy. You were asking about A vs. A’, he was telling you about A&B vs. A&B’ vs. A’&B vs. A’&B’. I don’t think the difference is that he is “dogmatic” (bad) while you are “pragmatic” (good).

    3) People very often behave suboptimally, but that is not usually enough to justify a reaction of *outrage*. In my opinion, few of the individuals who contributed to the current recession did anything *outrageous*; even “disappointing” might be an overreaction to what was, for the most part, normal human weakness.

    4) “If that’s a ‘free market’, my response is ‘no thanks’.” Why this sentence? *Of course* that isn’t a free market. Allison never suggested otherwise.

28. Ash
    18. December 2009 at 13:58
    

    Scott and Statsguy have both discussed the fundamental problem in the debate about the causes of the crisis. The left and right are both so wedded to their respective dogmas that they refuse to consider any explanation to the contrary. As a result, neither side accepts the basic reality that we are living in a “second-best” world.

    In a world that is far from a textbook “free market”, any move towards the theoretical free market optimum does not necessarily increase welfare. As Scott has noted, this is essentially the argument for regulation, given that we have a explicit/implicit creditor guarantee in place in the banking system via deposit insurance and the TBTF doctrine. By extension, this is also the argument for how deregulation could have caused the current crisis. The Fed itself knew of and warned of the dangers of deregulation as early as 1983 – As John Kareken noted, “Deregulation Is the Cart, Not the Horse”. ( http://www.minneapolisfed.org/research/QR/QR721.pdf )

    The second-best nature of our financial system also means that any discussion of the crisis must be strongly empirical in nature. Deductive logic is useful but a logical argument with incomplete facts can be made to fit almost any conclusion. So the Keynesians blame the free market and greedy bankers, the libertarians blame government action, the behavioural economists blame irrationality and no one stops to consider any facts that don’t fit their preferred thesis.

    Coming to John Allison’s arguments, I think he is exactly right when he identifies deposit insurance as a key cause. I would just add that the implicit guarantee of the TBTF doctrine may have been even more important than the explicit guarantee of deposit insurance in the current crisis. If I had to choose just one reform that would improve our current system, it would be the removal of this explicit and implicit guarantee to bank creditors.

    I’m not sure that co-insurance is the answer though – in fact, I’m reasonably certain that it would not arise as the preferred solution in a free market. Curiously for a hard-core libertarian, Allison does not question the need for deposit insurance.

    The combination of increasing the insurance limits to $100,000 in 1980 from the initial $5,000 and the development of CDARS (essentially a system where a deposit of upto $ 50 million can be fully insured by splitting it up) has meant that almost all deposits are now insured. The paper by John Kareken that I’ve linked above has an excellent discussion of how we could live without deposit insurance. If the only argument is the need to give people a “fail-safe” bank to deposit their money with, then we could just resurrect the postal savings system.

    If re-regulation could achieve the same objective, then I’d be in favour of it. But i don’t think it can. Almost any regulation you can think of will be arbitraged away by the banks – call it Goodhart’s Law applied to financial regulation. The only regulations that have a chance have to be blunt and draconian regulations which will kill the efficiency of the system and even then the odds of arbitrage are not low enough. Daniel Tarullo for example has a great quote in his book on the Basel accords that illustrates the futility of regulating securitisation:
    “securitization appears to present a case in which efforts to plug gaps in regulatory coverage are quickly and repeatedly overtaken by innovative arbitraging measures.”
    ( http://books.google.co.uk/books?id=OUpYnjyKk34C&lpg=PP1&client=firefox-a&pg=PA81#v=onepage&q=&f=false )
    I fear the same could be said for minimum down-payment regulations – the banks will figure out a way to nullify the effect of the rule.

29. Ash
    18. December 2009 at 14:23
    

    Scott – you’ve also hit the nail on the head by identifying the hypocrisy of right-wing commentators who mistake favouring corporates with favouring free markets. The real problem here is not governments or the free market but the rent-seeking nexus between big financial institutions and the government. The best account of corporatism and its dangers is Rajan and Zingales’ “Saving Capitalism from the Capitalists” http://www.savingcapitalism.com/ . Corporatism is an ever-present danger to our system but it’s even more of a problem given the free taxpayer guarantee that the banking system enjoys. Maintaining and maximising the value of this guarantee is the priority for any bank so it is logical that rent-seeking will be the primary focus of the banking system rather than genuine economic value-added.

30. Bill Stepp
    18. December 2009 at 20:09
    

    Scott,

    James Grant has pointed out for years in his Interest Rate Observer that the government nationalized bank liabilities long ago.
    The solution is the separate government from money and banking, indeed from the economy, just as we try to separate church and state. That means free banking and whatever monetary anchor (e.g. a gold standard) evolves to support it.

31. Scott Sumner
    18. December 2009 at 21:04
    

    Statsguy, You said;

    “Scott, you do realize the arguments about the source of this latest cycle will never be resolved? Partly, this is because discourse in this country (and, perhaps, by all humans) is conducted in a way in which people defend their positions with facts as available, rather than seeking an answer with an open mind.”

    I agree with both points. But I’d remind you that originally there was great confusion about what caused the Great Depression. There is still a lot of debate but I think we have a better idea of the mistakes made by the Fed and the flaws in the interwar gold standard. So I think there can be some movement toward an improved understanding of these complex episodes, even if it falls short of consensus.

    Regarding your nuclear analogy, I agree. I think most great problems have represented a sort of perfect storm of bad luck and bad policy decisions. Indeed from a certain perspective that must be true. Suppose it didn’t take much going wrong to produce a Great Depression. Then there would have been lots of Great Depressions. Ditto for the 2006 housing bubble. How many such fiascos have their been in the US housing market? As far as I know it’s the first. So more than one thing must have gone wrong. My comment about coming to believe in the moral hazard being a key issue, is that we also saw a big S&L fiasco in the 1980s, which was driven by S&Ls abusing deposit insurance. So there is a pattern beginning to develop, even if this was the worst case, and many other factors played a role this time.

    Joe, I believe the Canadians didn’t have deposit insurance until 1967, and I think they slept OK in 1966. Here’s my suggestion, if you can’t stand the risk, just keep your money in MMMFs and government savings bonds, that’s what they’re for. If the banks saw lots of people pulling out, they’d institute the private deposit insurance scheme that John Allison mentions. And this private insurance company would have an incentive to rein in the banks behaving recklessly.

    Many people are scared about losing deposit insurance because of memories of the Great Depression. But those failures were due to NGDP falling in half, which isn’t going to happen. And if it does, I’d lose 10 times as much from my 401k going down that I would from the relatively small amount of money I keep in checking accounts.

    Statsguy, I mostly agree with your comments on pragmatic libertarians. One reason I am a bit more pessimistic about government than you are, is that I think those bad guys you mention would not only be a problem under laissez-faire, but they would also corrupt a big government as well. Indeed they do in many areas of the world. Thus Putin has a more interventionist government than Yeltsin did, but both were corrupted by special interests.

    I think many libertarians overestimate what can be achieved by political change alone, and in that case you and I probably agree. You may have read some of my earlier posts on Denmark, where I argued that liberal values were essential for good governance (where liberal is defined not as left-leaning, but merely idealistic.) You are right that if you simply impose capitalism in non-liberal societies, bad things often happen. My response is that those societies also have trouble getting effective statist policies as well. France might be the strongest counterargument to the point I am making (it is much less liberal than Scandinavia), whereas Singapore, HongKong and Chile are much less liberal than Denmark, and have pretty good economic policy. So I don’t claim my model is perfect, but in general I think good cultural values are the single most important factor in good governance.

    q, I don’t follow your argument. I recall that early on Krugman argued that the GSEs weren’t a big factor, but I don’t think anyone is making that argument today. The GSEs may end up needing a bigger bailout than the commercial banks (who are at least repaying those TARP loans) Can anyone confirm what I am saying? How much did we give the GSEs and how much are we likely to end up giving the commercial banks after the money is repaid by those banks that are able to? Does anyone have figures? BTW, I am not defending the commercial banks, who also behaved very recklessly.

    David Pearson, I don’t care what people call me, but I strongly take issue with the following:

    “I know of no definition of “libertarian” that encompasses the desire for Central Planning of the economy by the central bank. Scott has argued passionately on this blog that the Fed can and should direct the path of the economy “” at least the nominal path, with the implicit assumption that the real economy will follow.

    Scott will doubtless argue that a rules-based system is not discretionary and therefore does not rise to the level of central planning. I disagree. Underlying this “non-discretionary” approach is the assumption that the economy must not be allowed to make adjustments in prices, wages, etc. without government intervention. It assumes that capitalism needs a “visible hand” to function.”

    This confuses two completely separate issues, nominal prices and real prices. When we have things like rent controls the government is controlling real prices. The same for minimum wages. But a stable monetary policy merely steers nominal prices, and lets real prices freely adjust. Or you might think of it as controlling the value of a single good in the economy, the medium of account. I have never seen a convincing argument of how a free market could provide a stable medium of account. Libertarians make that assertion, but with weak arguments. A stable price level is a public good, why should an individual firm have an incentive to do things that make the overall price level stable? I’m not convinced. (And yes I’ve read books on free banking.)

    As far as whether I am a libertarian, I’d like to increase the role of government in a couple areas, like forced saving, and remove the US government from a couple million areas, including 95% of the regulations, taxes, and alphabet soup of agencies, etc. I’ll let others decide whether someone like me should be characterized as a libertarian. I’m fine if they want to kick me out, but if even I can’t qualify, what are the chances the libertarians will ever have any real influence?

    BTW, as far as I know, most of the top economists who are regarded as libertarians also favor having a central bank. Friedman was one obvious example, but there are many others.

    OGT, You said;

    “I just started Reinhart’s book, its fascinating and well written. The central theme seems to be that financial crisis are ubiquitous in history, government and private, with little regard to regulatory structure. The major common thread is a massive unsustainable credit expansion leading to almost inevitably to default.”

    I haven’t read the book, but if he argues that that happened in the late 1920s and early 1930s he is completely wrong. Excess lending played no role in the financial crisis of the early 1930s.

    I’ll respond to the other posts tomorrow. Hopefully the blog won’t crash again.

32. StatsGuy
    19. December 2009 at 06:43
    

    “One reason I am a bit more pessimistic about government than you are, is that I think those bad guys you mention would not only be a problem under laissez-faire, but they would also corrupt a big government as well.”

    That is true; statism is vulnerable to capture. It needs to rely on a tightly overseen state apparatus with a strong meritocratic corps – France, perhaps Singapore. We don’t know how stable such a design is over time (how many cases do we really have?).

    That is why the theory of crosscutting interest group liberalism (which is, some would argue, the basis of Madisonian Democracy, as opposed to Jeffersonian “yeoman” Democracy) contends that reducing society to atomistic individuals who can engage in “free contracting” is impossible in large scale nations – attempts to do so merely remove some of the groups and clear the road to power for the remaining groups.

    The best we can do once we move beyond the scale of Swiss Cantons and New England Town Meetings (so Madisonians might claim) is keep a number and diversity of groups that are well balanced with crosscutting/overlapping memberships so no single group can become dominant. Thus, a Madisonian liberal might agree that labor unions are bad, but would note that busting unions without busting the groups they oppose can create harmful asymmetries.

    It’s important to note that groups must be crosscutting – if they become excessively aligned, then it’s possible for dominant coalitions to form. Which raises the question – has group membership in the past 30 years in the US become more correlated/segmented? (Certainly media consumption has.) I wonder if Pew has a good measure of this…

    The downside, is that getting major change is nearly impossible…

33. Scott Sumner
    19. December 2009 at 07:57
    

    David Pearson, You said;

    “Its early 2008, and NGDP is raging as oil prices and inflation rise. Sure we’re already in recession, but the markets do not care “” NGDP futures trade at 7%, 2% above target. The Fed drains reserves, but the impact is small given speculative fervor. It tries even harder, raising rates. I earn 5% on my bank CD.

    Now, a few months later, NGDP is crashing. The Fed lowers rates. I earn 1% on my bank CD.”

    In my view these wild gyrations better describe what occurs when you don’t have NGDP targeting. In early 2008 an NGDP futures market would not have shown that we need to tighten policy. NGDP was only rising at a 3% rate, and so the market would have if anything expected an undershoot. But the key point is this; under NGDP targeting you always keep the future expected NGDP rate on target, say along a 5% growth trajectory. As long as future expected NGDP growth is on target, asset markets should be much more stable than when NGDP growth expectations are unstable. The asset markets crashed in late 2008 at precisely the moment when NGDP expectations were falling fast.

    The wild fluctuations in interest rates you describe are what happened when NGDP growth expectations are unstable. Nominal interest rates are strongly correlated with NGDP growth relative to target. If you always have on-target NGDP growth, then nominal rates would be far more stable than they are today.

    If my ideal policy had been adopted, nominal interest rates would have been HIGHER at the end of 2008 than they actually were, because of what are called the “income effect” and the “expected inflation effect.”

    q and Doc Merlin, The reason I see saving as a good thing, is that saving is the enemy of high taxes and socialism. What is the argument the socialists always use? We “need” unemployment comp., government health care, social security programs, because people don’t have enough money when they lose jobs, get sick, or retire. Maybe so, but why is that? The US is the richest major country in the world, so why are American’s so poor they must rely on the government for everything? That’s why I like saving. Of course there are some people too poor to save, and I support government subsidies (or private charity, whichever works better) for that group.

    Russell, Those are very good analogies.

    Philo, You asked:

    “1) You move awfully swiftly from *gold standard* to *tight money*. Of course, it is supremely easy to adjust the supply of a fiat currency, but aren’t there monetary systems that might justifiably be considered versions of “the gold standard” in which the supply of some sort of M is pretty flexible?”

    I was addressing free market gold standards. In that decentralized system there is no central authority to adjust the money supply to a level consistent with macroeconomic stability. That’s why many knowledgeable free banking types, like Bill Woolsey, suggest that money should be convertible into NGDP futures–it pushes the money supply to its equilibrium level.

    I agree with your point 2, and think this makes politics more an art than a science. You are always having to juggle the issues of what combinations of policies are politically feasible, and also desirable. That is very hard, and explains why a skilled politician has to have a nose for the way things are moving, and then harness the zeitgeist to his own policy goals. Hopefully they are libertarian goals.

    But the path may not always be straight. For instance, I think forced saving reduces our freedom in the short run, but in the long run allows for the dismantling of much of the high tax welfare state.

    Sorry if that final line was a cheap shot. I was responding to Alloson’s comment that he didn’t like mandatory downpayments because he favored free choice, or something to that effect. My response was meant to remind people that those mortgages are made with money lent by the Treasury, (even before this crisis), and hence maybe we should tell banks not to be reckless with our funds. Perhaps the intent did not come across well. You are right it isn’t a free market, but I thought he answered my downpayment question as if it was.

    Ash, Those were excellent comments, in many ways better than my post. Ironically in other posts I have also made the “Goodhart’s Law” arguments about regulation. I agree that they will find ways around new regs, until we address the root causes of excessive risk taking.

    On deposit insurance, I would point to the fact that savers can always put money in government bonds, (or government bond funds for small savers.) Indeed you can write checks against MMMFs. So withdrawing deposit insurance doesn’t mean that people would be forced to have sleepless nights. I’m not sure what these observations say about the likelihood of private deposit insurance developing, but I just throw them out there for people to think about.

    BTW, In other posts I have argued that forced saving is also a second best policy response to the massive disincentives to save in our tax/subsidy fiscal regime. So that was in the back of my mind when thinking about the 20% down regulation.

    Again, great comments.

    Bill, I didn’t know that about James Grant, but I’m not surprised others already had made the same observation.

    statsguy, Those observations about crosscutting groups are very interesting. I am afraid that I am woefully ignorant of the literature in many areas of political science. All I really know is what I pick up in journalistic summaries, and a handful of books I read.

34. mansoor h khan
    19. December 2009 at 11:33
    

    Here is a way to deal with Moral Hazard of Deposit Insurance:

    Safe Storage of Electronic Money — 100% Reserve Digital Cash
    The (usually) transparent process of inter-bank lending works so well that most of the time we don’t even think about it. This process has largely weaned the public away from physical paper money. Note that most money (about 90%) now exists only as entries on bank ledgers, backed by loans (debt). Also, note that possessing physical paper dollars is like having equity in the economic output of the United States of America, and has no credit risk associated to it. Physical paper money is not anyone’s liability.
    Bank deposit money, on the other hand, does have credit risk associated to it. That risk consists of the liability of the bank in which the deposit resides. Strangely enough, most of the time the credit risk of bank deposit money is lower than the theft and physical-loss risk of physical paper money.
    That is why we use bank deposit money more than physical money. Through this (normally) transparent process of inter-bank lending, the banking system acts like a huge clearinghouse (essentially a giant ledger) which clears payments between its customers without the physical transfer of cash, and keeps track of who has how much money. Most money in the world economy is not physical (paper cash or gold) but logical (ledger entries).
    To summarize: physical paper money is equity. Bank deposit money is backed by debt (actually that’s not 100% true–reserves at the federal reserve system are also equity, essentially an electronic version of physical paper cash).
    That difference — that physical paper money = equity in the nation’s economy, and that a bank deposit = debt (a bank obligation) causes great confusion.
    We have become very comfortable with bank deposit money, without thinking much about the credit risk we are taking. Bank failures, when they happen, create confusion and chaos because the vast majority of businesses and individuals use checking accounts for convenience (they can write checks rather than handling physical paper cash) and they don’t really think much about the credit risk that is normally associated with keeping their money (their most liquid capital) in a bank in a checking account. In fact, in most cases users of checking accounts do not want to take a credit risk. But in the current banking system there are no alternatives.
    Is There a Better Way?
    Consider the banking industry’s contribution to society. The banking industry provides three major services to the public:
    1. It provides a “safe” place to hold the public’s most liquid assets (cash).
    2. It acts like a giant clearinghouse (settling checks without physical paper cash transfer).
    3. It is a source of loan money (banks evaluate the credit worthiness of borrowers). Think of “credit worthiness evaluation” as a service to society. If bankers do a poor job at evaluating credit worthiness they will end up mis-allocating economic resources.
    What I am asserting is that it is possible to have a banking system where a customer would get benefits 1 and 2 described above without taking a credit risk, if banks gave people a choice between a regular account and a special “100% reserve account.”
    These special accounts, which are not available to the public today, would have no credit risk. The money in such accounts would not be lendable. There would still be fraud risk, of course. A bank desperate for cash might be tempted to “dip” into the reserves allocated to their 100% reserve accounts. Of course we would make such “dipping” illegal. The 100% accounts would be the electronic equivalent of storing physical paper bills in a safe deposit box at the bank. The total reserves of a bank would be “safely electronically stored” at a central bank (much like reserves at the FED).
    I know that Misesians and libertarians and ZH readers don’t like central banks and are very suspicious of them. But I wanted to write this blog and start a discussion. It seems to me that electronic version of physical paper cash (i.e., digital cash) is the next natural step. Much like airline tickets are now mostly issued as e-tickets and not as negotiable paper tickets. By its nature “digital cash” would have to be stored on some central bank on a computer hard-disk (i.e, an electronic ledger) and it would also contain the owner’s identifying information (i.e., the bank account number). Such “digitial cash” would NOT be debt money (as are bank deposits today) but would be “equity” money (like physical paper cash). Ofcourse we could go a step further and back-up the “digital cash” with gold reserves in the vault (but I am NOT proposing that we do this). I am trying to understand the Misesian and libertrarian distaste for a central bank. By the way I want a central bank as a safe repository of electronic money only and nothing more. I don’t think a central bank should try to influence interest rates or lend money like the current FED.
    Such accounts would have no credit risk (like physical paper cash) but would have the benefit of being used in electronic transactions and be accessible by personal checks. Of course, a 100% reserve account would not earn interest but would most likely have monthly maintenance fees associated to it (similar to a safe deposit box; it would also be very much like the reserve accounts that banks have with the Fed).
    Such accounts, if widely used, would lessen the impact of bank failures on the economy in terms of a contraction of the money supply, chaos and confusion–but would not completely eliminate them.
    Lending involves business risks (credit risks). If a customer were to choose a non-100% reserve account then he would be subject to losing his money. This would force the public to do some homework before handing money over to a bank (in essence, customers would need to consider banks’ credit ratings, quality of management, etc.).
    Of course, in this type of setup, a non-100% reserve account would probably have to pay a higher interest rate than the fractional reserve accounts do today. In fact if the public had a choice of 100% reserve accounts, there would be no need to impose legal reserve requirements on non-100% reserve accounts. There would be a clear separation between accounts that have a credit risk and accounts that don’t. The accounts with credit risk would need to set their interest rates high enough to attract depositors.
    If our banking system were set up this way, we would avoid huge systemic risks in the future, since a major part of the money supply would likely be sitting in non-lendable accounts. Many enterprises probably should not take any credit risk with their liquid capital (utility companies, municipalities, states, hospitals, etc.). In any insolvency or bankruptcy the 100% reserve accounts would receive priority, and unless the bank was fraudulently “using” these reserves the deposit owners of such accounts would never lose their money. If an electronic deposit account with no credit risk were available, then any individual or business choosing not to use such an account would be subject to losing their at-risk deposit. If such an alternative were available, then the depositor who chose the lendable money account would be warned that he or she could lose money if the bank became insolvent.
    Once this choice is given to the public, the banks can then be allowed to fail without severely impacting the payment system which is needed to conduct day-to-day commerce. The only job of the FDIC would then be to insure smooth transfer of 100% reserve accounts to another bank.
    I will go a step further and state that the availability of such accounts (non-lendable, 100% reserve accounts) should be mandated by Congress through force of law. Each business and individual should be able to choose whether they want to take a credit risk or not.

35. Larry
    19. December 2009 at 15:49
    

    Scott

    I noticed that on one day this week, you got mentioned by Cowen, Avent, McArdle, and Yglesias, while Kling still had an older post on his home page. You must be doing something right. Please continue!

36. Recomendaciones « intelib
    21. December 2009 at 09:22
    

    […] Recomendaciones Scott Sumner on John Allison […]

37. ssumner
    21. December 2009 at 13:36
    

    mansoor, That is an interesting post. Years ago people like Irving Fisher and Milton Friedman proposed 100% banking, which is similar to what you propose. But you also discuss the trend toward electronic money, and how that might allow even a central bank to handle these duties. You are right, it would be like having reserve accounts at the Fed. And you are right that this money would be equity not debt. (Although if Mike Sproul sees this he will disagree with me.)

    I still wonder about monetary policy however. What anchors the price level in your model, if the Fed isn’t doing monetary policy any more? Do you just control the total amount of this “equity” money in the system? I.e. use a monetarist approach?

    Larry, Thanks, but that caused so much attention that the blog crashed twice. We still hoope to move the blog to a commercial system in early Janauary, and I am told it will then stop crashing. I have already paid several hundred dollars to this company, so the intention to move is pretty definite now.

38. Simon K
    21. December 2009 at 21:41
    

    Allison is awfully dogmatic. This is far from the best “blame the government” account of the crisis I’ve read – it falls into two many libertarian shibboleths. The best blame-the-government account I’ve read is actually Arnold Kling’s – he has some awfully wacky views about money, but he does understand the housing market. The best blame-the-banks account I’ve heard was actually NPR’s “giant pool of money” episode of This American Life.

    Anyway, the worst thing about Allison’s account is the ignorance of the international situation in the mortgage and housing markets. I find this to be the biggest weakness in the blame-the-government story – many other countries had housing booms and busts on the same scale as that in the US, but in none of them do the precise criticisms made by the dogmatic libertarian right apply.

    To take the example I know best – the UK had no equivalent of the FDIC until 2007, has no role for the government clearing or guaranteeing mortgage bonds, no tax relief on mortgage interest. Essentially none of the regulatory issues nailed in the US (with some reason) apply, but the UK had a similarly sized housing boom and bust, and a far greater weakening of its banking system.

    And interestingly, in spite of the lack of morale sapping government guarantees, and greater regulation of what can be sold to consumers and what you have to disclose, many of the most criticized mortgage products in the US during the boom have existed in the UK since much earlier dates. ARMs? Yup, actually in the UK its fixed rates that are the innovation. Interest only? Yup – way back in the 1980s. Low down payments? 10% is standard. 0% or less existed during the boom. Neg-am? Yup, although more recently – the Virgin One account, which is actually more complex than US neg-am mortgages, is the most popular mortgage in the UK.

    Yes, these products are risky. They clearly expose borrowers to more price risk and interest rate risk than a 20% down fixed rate loan. But they have legitimate uses and I actually agree with Alison that they should be sold. But you know the one mortgage product that definitely is a product of government regulation and exists in no other mortgage market (at least that I know of) in the world, but has been appparently completely immune from libertarian criticism? The 30 year fixed rate mortgage.

    But it doesn’t fit the moralizing tendency of libertarians like Alison and even Kling to point this out forcefully to people. After all 20% down fixed rate loans are the responsible thing to do, and if we had zero or negative inflation they’d have reasonable real yield for the lender. But we don’t, so they don’t (after 7-10 years), so they exist only due to government intervention – without that lenders would fix rates only for the 7-10 years they can price reasonably. But funnily enough because they fit well into magic deflationary libertarian pixie land they don’t get criticised. Hmm.

39. George Selgin
    29. November 2016 at 16:44
    

    I don’t think it at all obvious that the gold standard would have produced serious deflation in the sort of banking system John Allison considers ideal. Treating what happened in the U.S in the 30s as the inevitable outcome of a gold standard is no more sensible than treating the events of 2008-9 as an inevitable result of fiat money. Banking arrangements and regulations matter; so does the type of gold standard.

    As for opposition to deposit insurance and TBTF being unrealistic, good luck coming up with regulations that achieve financial stability with those guarantees still in place, without strangling development-enhancing financial intermediation altogether.

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