http://www.invisibleheart.com/ en-US Copyright 2011 Mon, 07 Feb 2011 09:38:36 -0500 http://www.sixapart.com/movabletype/ http://blogs.law.harvard.edu/tech/rss in the Wall Street Journal on June 28, 2010. He was born in the 19th century, wrote his most influential book more than 65 years ago, and he's not quite as well known or beloved as the sexy Mexican actress who shares his last name. Yet somehow, Friedrich Hayek is on the rise. When Glenn Beck recently explored Hayek's classic, "The Road to Serfdom," on his TV show, the book went to No. 1 on Amazon and remains in the top 10. Hayek's persona co-starred with his old sparring partner John Maynard Keynes in a rap video "Fear the Boom and Bust" that has been viewed over 1.4 million times on YouTube and subtitled in 10 languages. Why the sudden interest in the ideas of a Vienna-born, Nobel Prize-winning economist largely forgotten by mainstream economists?]]> http://www.invisibleheart.com/2011/02/why_friedrich_hayek_is_making.php http://www.invisibleheart.com/2011/02/why_friedrich_hayek_is_making.php Competition and Emergence Mon, 07 Feb 2011 09:38:36 -0500 This article originally appeared in the Wall Street Journal on February 26, 2010 For an economist, these are the best of times and the worst of times. We live in the best of times because everyone wants to understand what happened to the economy and what's going to happen next. Is the mess we're in a market failure or a government failure? Is the stimulus plan working? Would tax cuts for small business spur employment? When will the job market improve? Is inflation coming? Do deficits matter? So many questions and so little in the way of answers. And so it is the worst of times for economists. There is no consensus on the cause of the crisis or the best way forward. There were Nobel Laureates who thought the original stimulus package should have been twice as big. And there are those who blame it for keeping unemployment high. Some economists warn of hyperinflation while others tell us not to worry. It makes you wonder why people call it the Nobel Prize in Economic Science. After all, most sciences make progress. Nobody in medicine wants to bring back lead goblets. Sir Isaac Newton understood a lot about gravity. But Albert Einstein taught us more.]]> http://www.invisibleheart.com/2010/02/is_the_dismal_science_really_a.php http://www.invisibleheart.com/2010/02/is_the_dismal_science_really_a.php Crisis of '08 Sat, 27 Feb 2010 12:42:21 -0500 This is the text of my testimony before the Joint Economic Commitee on December 10, 2009. It differs from the text in the Congressional Record that was submitted in advance. This is the actual text I delivered. Video of my testimony (along with Joseph Stiglitz's testimony, opening statements by the committee members, and the Q and A) is available here. My testimony starts at 58:15. A man once asked his doctor how much weight he’d lose if he skipped his daily breakfast of a bagel with butter, about 350 calories. The doctor said if you can do that every day for a month, you’ll lose three pounds. After ten days of skipping breakfast, the man came in to see how he was doing. To the doctor’s surprise, the man’s weight was unchanged. The doctor said good thing you stopped eating breakfast. Otherwise you’d have gained a pound. When I made my prediction, I didn’t realize how bad your situation was. Unfortunately, the doctor’s analysis was flawed. He didn’t realize the man was eating a bigger lunch because he was hungry after skipping breakfast. I think about that doctor when I think about the CBO estimates of the impact of the American Recovery and Reinvestment Act of 2009, the stimulus package. The CBO estimates that there are between 600,000 and 1.6 million extra jobs in the economy compared to what would have happened in the absence of the stimulus. That’s an embarrassingly imprecise estimate. But it’s not really an estimate at all. It’s just a repeat of the forecast that the CBO made at the beginning of the process, like the doctor who predicts that skipping breakfast reduces your weight. We have no idea of how many jobs have been created or lost because of the stimulus. As the CBO admits, to know the real impact of the stimulus, we’d have to know the path of the economy in the absence of the stimulus. And that is unknown to the CBO just as the lunch habits and metabolism of the patient might be unknown to the doctor. What we do know is that since March, the economy has lost another 2.7 million jobs. When the stimulus was passed, we were told that without it, unemployment would reach 8.8%. Well, with the stimulus, unemployment went over 10%. ]]> http://www.invisibleheart.com/2009/12/congressional_testimony_decemb.php http://www.invisibleheart.com/2009/12/congressional_testimony_decemb.php The Great Recession Thu, 10 Dec 2009 17:50:38 -0500 What follows is my testimony before the House Committee on Oversight and Government Reform, delivered October 28, 2009. The topic was executive compensation and the Special Master for TARP Compensation, Kenneth Feinberg, who was determining compensation at the firms who had not repaid their TARP funds. Chairman Towns, Ranking Member Issa, and Distinguished Members of the Committee: Americans are angry about executive compensation. Rightfully so. The executives at General Motors and Chrysler don’t deserve to make a lot of money. They made bad products that people didn’t want to buy. The executives on Wall Street don’t deserve to make a lot of money. They were reckless. They borrowed huge sums to make bets that didn’t pay off. And they wasted trillions of dollars of precious capital, funneling it into housing instead of health innovation or high mileage cars or a thousand investments more productive than more and bigger houses. Everyday folks who are out of work through no fault of their own want to know why people who made bad decisions not only have a job but a big salary to go with it. No wonder they’re angry at Wall Street, But if we keep getting angry at Wall Street, we’ll miss the real source of the problem. It’s right here. In Washington. We are what we do. Not what we wish to be. Not what we say we are. But what we do. And what we do here in Washington is rescue big companies and rich people from the consequences of their mistakes. When mistakes don’t cost you anything, you do more of them. When your teenager drives drunk and wrecks the car, and you keep give him a do-over—repairing the car and handing him back the keys—he’s going to keep driving drunk. Washington keeps giving bad banks and Wall Street firms a do-over. Here are the keys. Keep driving. The story always ends with a crash. Capitalism is a profit and loss system. The profits encourage risk-taking. The losses encourage prudence. Is it a surprise that when the government takes the losses, instead of the investors, that investing gets less prudent? If you always bail out lenders, is it surprising that firms can borrow enormous amounts of money living on the edge of insolvency? I’m mad at Wall Street. But I’m a lot madder at the people who gave them the keys to drive our economy off a cliff. I’m mad at the people who have taken hundreds of billions of taxpayer money and given it to some of the richest people in human history. I’m mad at President Bush and President Obama and Secretary Paulson and Secretary Geithner and Chairman Bernanake. And I’m mad at Congress. You helped risk-takers continue to expect that the rules that apply to the rest of us don’t apply to people with the right connections. You have saved the system, but it’s not a system worth saving. It’s not capitalism but crony capitalism. Using a Special Master for Compensation to get our money back is too little, too late. Many people argue that because the government handed out the money, the government has a right to dictate how it is spent. It’s a reasonable thought in personal relations. If I offer you money, I have a right to attach strings to my generosity. But in a constitutional democracy like ours, it is not the government that has rights. We, the people, have rights. The Constitution exists to restrain government, not to empower it. Whether government has the right to limit pay isn’t the question. The question is whether it’s a good idea for the government to have the power to set compensation. Despite our anger, the answer is no. F. A. Hayek, the Nobel Laureate economist, said: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” The Special Master imagines he can design compensation packages that “align incentives” while “retaining key talent.” But it is impossible for any one person—no matter how wise—to anticipate the consequences of such decisions. Certainly the Special Master does not possess that knowledge. The Special Master doesn’t even know who is key and who is not. Some of that talent should leave and some of those firms need to disappear. But he does not know enough to decide correctly. Nor does he have any incentive to acquire that knowledge. He has no skin in the game. A single individual has been given enormous arbitrary power with insufficient accountability or transparency. This is not good for the rule of law, democracy or capitalism. By focusing on those who owe the government TARP money, the Special Master distracts us from other firms that benefited from government rescue such as Goldman Sachs and JP Morgan Chase. The comfort we receive from seeing compensation reduced distracts us from the policies that created the problem in the first place—the rescue of Wall Street from its own recklessness. It is a charade of political window dressing to make crony capitalism look respectable. I want my country back. Let’s get the government out of the auto business, out of the banking business and out of the compensation design business. We need explicit timetables to disengage from government ownership including a plan for how the Federal Reserve will draw down its balance sheet. Most of all, we need to stop trying to imagine we can design housing markets and mortgage markets and financial markets and compensation. I want my country back. I want a country where responsibility still means something. Where rich and poor, Main Street and Wall Street live by the same rules. We don’t need a Special Master to level the playing field. We just need to take the crony out of crony capitalism so we can get back to the real thing. ]]> http://www.invisibleheart.com/2009/11/congressional_testimony_octobe.php http://www.invisibleheart.com/2009/11/congressional_testimony_octobe.php Crisis of '08 Wed, 25 Nov 2009 15:44:50 -0500 Download file ]]> http://www.invisibleheart.com/2009/11/how_little_we_know.php http://www.invisibleheart.com/2009/11/how_little_we_know.php Crisis of '08 Tue, 24 Nov 2009 00:49:13 -0500 on NPR.org on 8/25/09) President Obama has reappointed Federal Reserve Chairman Ben Bernanke, praising his creativity in preventing another Great Depression. Talk about damning with faint praise. It's true that we appear to have avoided the worst-case scenarios of the last year, but at what price? Back in March of 2008, Bernanke and Treasury Secretary Henry Paulson engineered a rescue of Bear Stearns. A single suitor, JP Morgan Chase, was chosen to receive a sweetheart deal in the name of avoiding a credit freeze. The freeze came anyway. The Bear Stearns rescue was the beginning of an unprecedented expansion of power in the hands of the Fed and the Treasury with a level of opaque decision-making that is not appropriate for a democracy. Even today we have heard little justification for the expansion of the Fed's power and the Fed's balance sheet. Yes, we have avoided a depression. But let us count the costs. Financial firms that made irresponsible and imprudent decisions have been rescued, propped up and bailed out. AIG has received about $180 billion. That is almost $2,000 for every American household. That money has gone to sustain the bonuses of AIG and the financial health of its counterparties, such as Goldman Sachs. This is an obscene travesty. The Fed currently holds $600 billion worth of Fannie, Freddie and Ginnie mortgage-backed securities. I am not optimistic about how that will turn out. The Fed has injected hundreds of billions of reserves into member banks. This will fuel future inflation unless Bernanke is willing to raise interest rates when the recovery begins. There will be tremendous political pressure on him not to do so. So inflation is likely to come along with any recovery. Worst of all, Bernanke, Paulson and Timothy Geithner have continued the disastrous policy of sustaining bondholders and creditors of reckless financial institutions. Capitalism is a profit-and-loss system. The profits encourage risk-taking. The losses encourage prudence. The bondholders and creditors are the single most important check on imprudence. They care only about one thing: solvency. By making them whole, their incentive to restrain recklessness has been greatly weakened. This sows the seeds of the next financial crisis. I feel sorry for Bernanke. In one sense, as the world's greatest living authority on the Great Depression, he is the best man for the job. But because he is the world's greatest living authority on the Great Depression, another catastrophic economic debacle of a similar magnitude would be particularly embarrassing were it to occur on his watch. I believe he has gone too far in the other direction. The Great Depression was caused, or at least greatly worsened, by too little liquidity. Bernanke has avoided that mistake. He has instead committed the opposite mistake of too much liquidity and too few failures. Obama has praised him. How history judges him will be the real test.]]> http://www.invisibleheart.com/2009/08/will_time_prove_ben_bernanke_w.php http://www.invisibleheart.com/2009/08/will_time_prove_ben_bernanke_w.php Crisis of '08 Tue, 25 Aug 2009 09:57:09 -0500 on NPR.org on 2/25/09) In his first address to a joint session of Congress, President Obama pledged to cut the federal budget deficit in half in four years. Keeping that pledge won't be easy. The Congressional Budget Office is forecasting a deficit for this year of $1.2 trillion. That forecast does not include the spending package Congress just passed and Obama signed that will add hundreds of billions of dollars to the deficit over the next four years. And that doesn't include unforeseen spending increases in further bailouts for Fannie and Freddie or AIG or Bank of America or GM or the state of California or whoever else shows up in Washington with a hand out. So Obama probably needs to cut spending or raise taxes by at least $700 billion a year. To give you an idea of how much money that is, that's about the amount the payroll tax currently collects. The payroll tax is about 15 percent, shared between employer and employee. Doubling that rate to 30 percent would add an extra $700 billion if — and it's an impossible if — if a tax rate of 30 percent didn't lead employers to reduce their number of employees or force workers to reduce their hours.]]> http://www.invisibleheart.com/2009/03/halve_the_deficit_good_luck_ob.php http://www.invisibleheart.com/2009/03/halve_the_deficit_good_luck_ob.php Taxes Mon, 02 Mar 2009 17:52:28 -0500 on the Boston Globe website on 2/2/09) The House has passed an $819 billion spending package. Soon the Senate will vote. Will government spending get the economy going or slow it down? How long will it take to have an impact? How many jobs will it create? Can we afford it? You would think economists could answer these questions. Since at least the Great Depression, economists have theorized about what causes the economy to slow down or speed up. We've theorized about unemployment and inflation and whether they're connected. We've theorized about monetary policy, tax policy, and the role of government spending. And economists have tried to find evidence to settle these fundamental questions. And yet there is little or no consensus for what we should do right now to get the economy going and prevent it from getting worse. I wish it were otherwise. People expect us to know the answers. And plenty of economists claim to have the answers. Yet some of the finest economists in the country, including Nobel laureates, are on opposite sides of the current debate. And each side can cherry-pick data or historical anecdotes in support of its position. I think the real divide between economists isn't over different macroeconomic theories but over underlying differences in philosophy and ideology. So where does that leave you, the curious, intelligent, non-economist citizen?]]> http://www.invisibleheart.com/2009/03/what_economists_know_and_do_no.php http://www.invisibleheart.com/2009/03/what_economists_know_and_do_no.php Recession Mon, 02 Mar 2009 17:48:28 -0500 on Forbes.com on 1/23/09) President Obama is eager to attack the economic crisis. Here is the speech I'd like to hear from him. My fellow Americans, these are fearful times. Through a set of public and private mistakes, our financial system is in disarray. The problems of Wall Street have spread to Main Street. Unemployment is on the rise. Key sectors of our economy face unparalleled challenges. The auto industry is reeling. Housing and construction are in deep trouble. The financial sector has been hit with bankruptcy and layoffs. The retail sector is struggling. Workers, investors, managers and entrepreneurs face a fog of doubt and uncertainty. When will the economy rebound? Will I lose my job? Will my products sell as they once did and at what price? Investors and employers, consumers and entrepreneurs are sitting on the sidelines. Such caution is understandable. Until people are confident of the future, our economy is going to struggle. What can the federal government do to unleash the forces of recovery? Many are urging a massive increase in government spending coupled with tax rebates as a way to jump start the economy. But the economy is not stagnant because of a lack of spending. The economy is stagnant because of a lack of confidence in the future. Government spending on bridges, roads and new schools will stimulate the construction industry. But without confidence, the benefits will not spread to the rest of the economy. ]]> http://www.invisibleheart.com/2009/03/the_speech_i_wish_obama_had_gi.php http://www.invisibleheart.com/2009/03/the_speech_i_wish_obama_had_gi.php Recession Mon, 02 Mar 2009 17:24:41 -0500 Forbes.com on 11/20/08) President-elect Obama announced the other day that the government would do "whatever it takes" to revive the economy. I suppose that made some people feel good. After all, who wouldn't want tireless effort in the face of a crucial problem? Unfortunately, the problem with the economy isn't insufficient effort or focus. The problem is that no one knows what to do next. Hank Paulson already looks like a man who's not sleeping enough. His problem isn't insufficient effort. It's too much effort. If reviving the economy were like reviving a patient whose heart has stopped, then relentless effort would be the key. Get out those paddles and keep stimulating the guy until he comes back to life. Never give up. Whatever it takes.]]> http://www.invisibleheart.com/2008/11/how_to_move_the_economy_forwar.php http://www.invisibleheart.com/2008/11/how_to_move_the_economy_forwar.php Financial Meltdown Thu, 20 Nov 2008 00:12:10 -0500 NPR.org on 11/14/08) Secretary Paulson might be the only person in America who worries that consumers haven't borrowed enough money. He says the consumer credit market has "ground to a halt." He wants to get it going again — maybe if we all just buy enough cars and use our credit cards, the economy will come back to life. Paulson is also upset that banks aren't doing enough. He's given them all this money and they're sitting on it. He doesn't seem to realize that these two phenomena are really one and the same. He can inject all the money he wants into the consumer credit market and it isn't going to make us want to buy cars or use our credit cards.]]> http://www.invisibleheart.com/2008/11/paulsons_faulty_imagination.php http://www.invisibleheart.com/2008/11/paulsons_faulty_imagination.php Financial Meltdown Fri, 14 Nov 2008 10:00:00 -0500 Wall Street Journal on 10/31/08) People ask me if the current mess feels like 1929. But the right comparison is 1932, when Herbert Hoover was desperately trying anything, anything at all, to get the economy going. The stock market had crashed. The economy was starting to follow it down. So what did Hoover and his fellow policy makers do? In 1930, Congress passed a massive tariff increase, in hopes of protecting American jobs. Hoover signed it. But it simply accelerated the economy's slide. The Federal Reserve contracted the money supply, taking a recession and making it into a depression. By 1932, real GDP was 25% lower than three years earlier. Hoover increased federal spending steadily, including an increase in real terms of about 40% in 1932. At the same time, fearful that deficits were harmful, Hoover raised income taxes. Nothing worked. So Franklin Roosevelt came into office pledging stronger medicine. Enter even bigger increases in government spending. Government nationalization. Bigger deficits. Destruction of crops and livestock in the name of raising prices. Government-organized cartels. A greater empowerment of unions. It was a whirlwind of activity without any real plan. It worked for a while, but then, in 1938, the economy turned sour again. Unemployment, which had been falling, spiked again, reaching 19%. Consumption didn't recover to its prewar levels until 1945. Today, President George W. Bush plays the role of Hoover, the so-called free market ideologue who is trying anything to avert disaster. He signs a $700 billion bill putting Treasury in charge of buying troubled assets. A week later, the money is used to partially nationalize the banks. Some companies, like Bear Stearns, are bailed out. Others, like Lehman Brothers, are not. Some companies are sold. Some are allowed to fail. There is no plan, no rules, nothing to count on. ]]> http://www.invisibleheart.com/2008/10/dont_just_do_something_stand_t.php http://www.invisibleheart.com/2008/10/dont_just_do_something_stand_t.php Financial Meltdown Fri, 31 Oct 2008 09:57:19 -0500 Wall Street Journal on October 3, 2008) Many believe that wild greed and market failure led us into this sorry mess. According to that narrative, investors in search of higher yields bought novel securities that bundled loans made to high-risk borrowers. Banks issued these loans because they could sell them to hungry investors. It was a giant Ponzi scheme that only worked as long as housing prices were on the rise. But housing prices were the result of a speculative mania. Once the bubble burst, too many borrowers had negative equity, and the system collapsed. [How the Government Stoked the Mania] David Klein Part of this story is true. The fall in housing prices did lead to a sudden increase in defaults that reduced the value of mortgage-backed securities. What's missing is the role politicians and policy makers played in creating artificially high housing prices, and artificially reducing the danger of extremely risky assets.]]> http://www.invisibleheart.com/2008/10/how_government_stoked_the_mani.php http://www.invisibleheart.com/2008/10/how_government_stoked_the_mani.php Financial Meltdown Regulation Fri, 03 Oct 2008 09:49:42 -0500 Forbes.com on 9/18/08) The collapse of Bear Stearns and Lehman Brothers, and the bailouts of Fannie Mae, Freddie Mac and AIG, have led to an inevitable call for more regulation. Obama promises "real" regulation. McCain will "reform Wall Street." The consensus is that Something Must Be Done to rein in financial markets. This consensus is part of a general theme among some pundits and economists that it's time to give up the naïve faith that markets can solve every problem. We are told that markets have failed. Yet much of the current chaos is the result of attempts to steer or control markets rather than let them be. Much of the chaos is the result of political failure.]]> http://www.invisibleheart.com/2008/09/organic_market.php http://www.invisibleheart.com/2008/09/organic_market.php Financial Meltdown Thu, 18 Sep 2008 09:43:27 -0500 This commentary aired on National Public Radio's All Things Considered on March 25, 2008. Audio is here. Wall Street is all about profit. All about the bottom line. And profit does play a major role in making our world go round. Without profit, there's no point in taking risks. Without risk-taking, there's no investment. Without investment, there's no growth. Profits are the cornerstone of our economy and our way of life. But as Milton Friedman liked to point out, our economic system isn't just based on profit. It's a profit and loss system. It's the combination that sustains and enhances our standard of living. Yes, the potential for profit encourages people to take risks. But without the potential for loss, you have reckless risk-taking. You have risk-taking without prudence. Without the potential for loss, irresponsibility goes unpunished. The Federal Reserve and the Treasury Department have orchestrated the rescue of Bear Stearns. The defenders of that maneuver argue that if Bear Stearns had failed it would have created a lot of collateral damage, so much collateral damage, that you and I, normal folk who don't know anything about high-falutin' financial instruments like "collateralized debt obligations" would have been engulfed as well. If Bear Stearns had gone bankrupt, Lehman Brothers might have been next. Some say that if Bear Stearns had failed, the entire banking system was at risk. Maybe. It seems awfully hard to know for sure. But what I do know for sure is that by subsidizing the marriage of Bear Stearns and JP Morgan, the government has removed some of the loss from the profit and loss system. Oh, they tried to make Bear Stearns suffer by demanding a price of $2 a share. But now the deal has been renegotiated—ta-da!—to $10 a share, a mere five-fold readjustment. What's going on here? What's going on here is that we're in uncharted territory, a world where the Fed and the Treasury are making up the rules as they go along, where accountability is being ignored and a world where the government bails out Bear Stearns and its creditors rather than letting those who have been reckless learn a lesson for the next time. Yes, letting Bear Stearns go under would have been dangerous. But helping JP Morgan devour Bear Stearns is dangerous, too. Where does the government stop in protecting people from irresponsibility? Home owners and lenders are next. The political pressure is inexorable for some sort of bail out. And then comes more regulation of investment banks. In a world where people who make bad decisions are spared the full consequences, only one thing is certain. We've encouraged more people to make more bad decisions in the future. The real price to be paid isn't the dollar costs of any bail out, but the encouragement of recklessness and irresponsibility. That will make all of us poorer down the road. ]]> http://www.invisibleheart.com/2008/03/the_bear_stearns_debacle.php http://www.invisibleheart.com/2008/03/the_bear_stearns_debacle.php Financial Meltdown National Public Radio Regulation finance money moral hazard Wed, 26 Mar 2008 11:02:31 -0500