Baseline Scenario

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The Baseline Scenario
Mixed Messages
Bernanke And The Lobbies: Confidence Illusion
The Spam Filter
What Will Change?
S&P Revises Expectations for the Economy Downward
Mixed Messages
Posted: 23 Jul 2009 12:30 PM PDT
David Wessel seems to be doing the impossible: his book, In Fed We Trust, is getting mentions from all over the Internet, even before its publication, despite competition from what seem like dozens of other crisis books. That’s what a good PR campaign (and a good review from Michiko Kakutani) will do for you.
I obviously haven’t read the book yet, but I was interested in this description in Bloomberg:
None of the senior government policy makers anticipated the credit-market collapse that followed Lehman’s bankruptcy filing in the early hours of Sept. 15, according to Wessel’s book. . . .
On a conference call the previous week, Paulson, Bernanke, Securities and Exchange Commission Chairman Christopher Cox, and senior staff members from those agencies had agreed that companies and investors who did business with Lehman had learned from Bear Stearns and would have acted to protect themselves from a Lehman failure, Wessel wrote.
What were they supposed to learn from Bear Stearns? That they should be very, very afraid of a major bank failure and take steps to protect themselves? Or that the government would step in, so that even if shareholders were largely wiped out, counterparties would be protected? It seems like more of them drew the latter conclusion, even though Paulson, Bernanke, et al. wanted them to draw the former conclusion.
This seems to me an illustration of the fact that you can never be sure what message you are sending. Perversely, even letting Lehman fail ultimately convinced market participants that the government would step in the next time – because the damage done by Lehman’s collapse was so great. One-off intervention are a crude and risky way of communicating policy and creating incentives.
By James Kwak

Bernanke And The Lobbies: Confidence Illusion
Posted: 23 Jul 2009 04:18 AM PDT
Ben Bernanke is opposed to the creation of a new Consumer Financial Protection Agency. Disregarding his organization’s disappointing track record in this regard, he claims that the Fed can handle this issue perfectly well going forward.
He thus adds his voice to the cacophony of financial sector lobbyists favoring the status quo.
At the same time, Bernanke and the lobbyists talk about the importance of consumer confidence for the recovery. But how can you expect anyone to have confidence enough to spend and borrow when so many people have been so badly treated by the financial sector in recent years?
What happens when there is a scare regarding food contamination in the US or globally? People buy less of that kind of food until the government assures them that (1) we know understand the cause of the problem, and (2) it will not happen again.
Word has got around that many financial products are not safe – as well as the idea that the debt levels encouraged by the finance industry are not always healthy. Consumers are going to be more careful and, if there is no way to reassure them fully, they may be excessively careful.
In addition, we have learned that allowing financial firms to abuse consumers is very bad for our overall financial system health – leading directly to the current crisis, loss of jobs, and still rising unemployment; all of this further undermines confidence of all kinds. If the financial system can turn nasty or even nastier, we should all carry more “precautionary” savings.
There’s no question that some financial firms would like to return to abusive practices, figuring they can once again make money and then move on. Yet serious financial sector firms would prefer to clean up their acts and work with properly informed customers. These firms are making a bad mistake in opposing the CFPA.
If the CFPA does not make it through Congress – and right now it seems a toss-up – this will just feed the backlash against finance more generally, e.g., in the 2010 midterm elections and beyond. There is no way that is good for overall confidence. It just doesn’t make sense for well-run financial firms to go down this road.
Industry thought leaders, the American Bankers’ Association, the Financial Services Roundtable, and other interest groups should switch their positions and support the CFPA – if they really want consumer confidence in financial products and more generally to return.
The Fed, it seems, just wants to defend its turf. This is unfortunate, particularly given its ambition to become even more responsible for the safety and soundness of the entire financial system. How can our financial system ever be sound when so many elements prey on so many consumers’ confidence?
By Simon Johnson
(The material after the break is an excerpt from my Economix column on NYT.com this morning. )



The Spam Filter
Posted: 22 Jul 2009 07:14 PM PDT
The spam filter seems to be catching a few more legitimate comments than usual recently. I just rescued about nine comments (out of over one hundred messages flagged as spam) from the last several days. Some of those comments were from some of our most regular commenters. I know that if you put in a lot of links your comment is more likely to be flagged. Besides that I don’t really know what it is looking for.
If your comment does not appear, feel free to email me to look into it. I do get a lot of email, but if you are a regular commenter I will try to look into it as soon as I can.
By James Kwak

What Will Change?
Posted: 22 Jul 2009 07:08 PM PDT
Timothy Garton Ash is a prominent modern European historian, who became famous writing about the collapse of Communism and the transformation of Eastern Europe in the 1990s. It was something many people thought they would never live to see.
A friend asked me what I thought of Ash’s article a couple of months ago in The Guardian, where he asked what will come of modern capitalism in the wake of the financial and economic crisis.
An extreme “neoliberal” version of the free-market economy, characterised not just by far-reaching deregulation and privatisation but also by a Gordon Gekko greed-is-good ethos – and fully realised in practice only in some areas of Anglo-Saxon and post-communist economies – seems likely to find itself [left in ruins or at least very substantially transformed]. But how about a modernised, reformed version of what postwar German thinkers called the “social market economy”?
Ash goes even farther than what you might call the Continental European social-democratic model, and envisions a world with a better balance between production and consumption, between national and international governance, and between exploitation and protection of the environment.
Ash’s essay reflects the feeling that the financial crisis was so cataclysmic, and the behavior that precipitated it so indefensible, that it could not help but trigger a major change in economic organization and perhaps even in societal values. Today, it’s pretty easy to label it as hopelessly optimistic. Many emerging markets, with China in the lead, are determined to return to an economic boom as quickly as possible. In the United States, the official administration strategy is to reflate the banking system as a means of stimulating the economy. After a couple of months of uncertainty, the media has consolidated around reporting this as an ordinary recession, though more severe than most.
More fundamentally, people change only a little bit, and only very slowly. People may be a little less willing to buy flat-screen TVs on credit, but they will still aspire to own flat-screen TVs. Domestic political systems will still undercut attempts at international governance; “internationalism” is perhaps more a dirty word than ever in the United States, as evidenced by the shameful attempts to portray Harold Koh (until recently dean of the Yale Law School) as un-American during his confirmation hearings. As for the environment, I have yet to see compelling evidence that the human race will pull it together in time to meaningfully slow down global warming, and if anything the recession is being used as an argument against investing in alternative energy.
In the longer term, I think we can hope for a few silver linings from this crisis and recession. People may be less willing to take on debt, which will mean greater domestic savings and therefore greater domestic investment with less foreign debt. People may feel less secure economically, or maybe will at least remember feeling less secure during the dark days of 2008-2009, which may make them a little more concerned about the poor and a little more willing to pay for a better social safety net. Graduates of our top universities may want to do something other than become bankers and hedge fund managers, and may invent new technologies and teaching methods instead of new derivatives. Maybe the glorification of extreme wealth will be tempered a bit for a few decades, so the ultra-wealthy will flaunt it a little less and the rest of us will admire it a little less.
All of these things would be good, and they may still happen. But it will be within a capitalist system that remains pretty much the same as before – perhaps with a tiny bit more regulation.
By James Kwak

S&P Revises Expectations for the Economy Downward
Posted: 22 Jul 2009 07:00 PM PDT
Calculated Risk reports that S&P is increasing its forecasts for losses on subprime mortgages again. As I’ve said before, in principle this means that their expectations about the economy are worse today than they were yesterday. They’re not just saying that defaults will go up; they’re saying that they will go up by more than they thought before today.
I previously discussed why I think this is weird, and there are a number of good comments to that earlier post. My theory that they are trying to spread out the deterioration of their forecasts over several months to save face got some support. q and others explained that rating agencies lag the economy because they base their forecasts on published economic data. That may be true, and it may be the best explanation for what is going on, but if so it seems like a condemnation of the rating agencies, since their job is to estimate the likelihood of default, and one of the inputs to their models should be the economic situation. (Or maybe their job is to estimate default likelihood assuming “normal” economic conditions, and it’s up to the investor to adjust accordingly.)
Note that these are their macroeconomic forecasts, not revisions to ratings of specific bonds, so the bond-rating schedule isn’t the driving factor here.
By James Kwak