Tag Archives: financial crisis

The slow demise of a company town

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Amy Goldstein’s Janesville: An American Story is one of the books on the Financial Times business book of the year shortlist & I have quite enjoyed reading it. It consists of reportage over several years (2008-2013) of a small Wisconsin town whose prosperity had long depended on the well-paying jobs provided by a General Motors plant and its suppliers. When the GM plant is mothballed and later permanently closed, the economic fortunes of the town and its families spiral down. As people use up their unemployment benefits and savings, or scrape by with low-paid service sector jobs, families that were solidly middle class find they need to rely on charitable food handouts, or supplies a teacher at school collects for the kids – shampoo, jeans.

The portraits of the individuals are mainly sympathetic – perhaps least so the Republican-supporting bank manager, although the results of her role as a cheerleader for Janesville’s economic future without GM are acknowledged. It is always a shock to a Briton to be reminded that people in the US with no job have no access to healthcare, and that private philanthropy has to fulfil (inadequately) the role the welfare state plays here. The American healthcare debate is, like the gun control debate, absolutely unfathomable to Europeans. There are some interesting insights into the reasons what support there is for retraining fails to achieve its aims – bureaucratic constraints on access to funding and how it’s used. It was also a surprise to learn that the ex-auto workers who had opted for retraining were doing less well, five years later, than those who had just taken the first job they could find and stayed in the labour market. All in all, it’s a sobering tale of the heart being wrenched out of a company town.

Having said all this, I thought the book was less compelling than George Packer’s The Unwinding. The Janesville tales are not set in a wider context of progressive deindustrialisation and the prospects of automation. Janesville is also silent on race, and I can’t decode the names. Unless it’s an all-white town – surely not? – this must be one of the relevant aspects of how families cope after an economic shock? Or subsequent American politics? There was also less insight into family finance than in the recent detailed study of income uncertainty and its corrosive effects in The Financial Diaries: How Americans Cope in a World of Uncertainty, or in Lisa Servon’s The Unbanking of America: How the New Middle Class Survives. (I haven’t read Hillbilly Elegy – should I?)

This shouldn’t put off readers as Janesville is worthwhile, but I’d be slightly surprised if it emerges the winner of the FT prize.

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Global gloom and community currencies

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I’m late to Mervyn King’s The End of Alchemy, which as all the reviewers have noted is a very well written and interesting book. It isn’t exactly cheering. On the contrary, it cast me into gloom.

As the final chapter puts it, “Without reform of the financial system, as proposed in Chapter 7 [a set of reforms with approximately zero chance of happening…..] another crisis is certain, and the failure to tackle the disequilibrium in the world economy makes it likely it will come sooner rather than later.” The chapter goes on to say not to worry, there’s something that can be done: forgive Greek debt and break up the Euro (or go for a full political union). Globally, stop struggling with Dani Rodrik’s trilemma of democracy, national sovereignity and economic intergration – King seems prepared to give up on the third leg. Change policies in China, Japan and Germany. In short, just tackle the underlying global imbalances and all the other problems or symptoms – debt overhangs, zero interest rates etc – will resolve themselves. No problem then.

To be fair, King does speak of “the audacity of pessimism”. Trouble is, you need a lot of people to get a lot more pessimistic before such policy changes would come about. As the book also points out, the last time there was such a big re-ordering was after the 1930s and 2nd world war.

More cheering is Dave Birch’s wonderful forthcoming book Before Babylon, Beyond Bitcoin, the latest in the Perspectives series (and the first full-length one). It surveys the history and the future of money. In this blog post, Dave suggests an e-currency for Manchester (and other cities). As in his previous work, Identity is the New Money, Dave points out the close link between money and trust – indeed, Mervyn King makes this point too. So financial stability is a question of communities of trust. It’s more comforting to think about trust from the ground up rather than global imbalances and crises….

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Financial crises, past, recent and future

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Very late in the day, I’ve finally read Barry Eichengreen’s Hall of Mirrors: The Great Depression, The Great Recession and the Uses – and Misuses – of History. The subtitle is a concise capsule summary. The book does a neat job weaving between the 1920s/30s and the 2000s, underlining the similarities and the significant differences. There is some nice storytelling as well, particularly in the Great Depression chapters, using colourful figures and their exploits to draw in the reader, starting with the notorious Charles Ponzi but with many others too. In fact, there’s a 20 page Dramatis Personae, so this is no abstract text but a story of actual people doing actual (bad/stupid/short-sighted) things.

Given the number of books already available about both episodes, the added value of this one needs to be in the compare and contrast, and I think it succeeds in this. The common features (apart from human frailty) lie in the dynamics of bubbles, and their roots in periods of stability and optimism; in the global character of financial market reactions and the way decisions that seem either sensible or politically necessary in one country can have immense negative externalities for others; and in the interplay between politics and economics or between democracy and technocracy. Perhaps the most important difference emphasised here is the greater scale and complexity of financial markets now. Even when people are not trying to hide misdeeds, it is not easy to identify dangerous flows or accumulations of risk.

But the book also points to the difference in policy responses: in the Great Depression the answer was more government. Given the way politics has moved, it was not the answer to the Great Financial Crisis. Eichengreen – relatively gently – points to the under-regulation of big banks and other financial institutions in key dimensions, such as the only modestly higher capital ratios and lower leverage; or the failure to reform credit ratings agencies. This gently touch, he argues, reflects the success of the monetary and fiscal policy action to avert another Great Depression: “Thus the very success with which policy makers limited the damage from the worst financial crisis in eighty years means we are likely to see another such crisis in less than eighty years.

Much less, I’d say, given how little has changed.

Anyway, I enjoyed Hall of Mirrors. I think it helps to have read other books on both episodes, as in effect half a book on each of the Great Depression and the Financial Crisis is pretty compressed. A combination of Liaquat Ahamed’s Lords of Finance and John Lanchester’s Whoops! would be perfect preparation (the latter was IOU in the US).

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Mainstream macro and Minsky the maverick

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I was one of the many economists who had barely heard of Hyman Minsky, still less read any of his work, before the financial crisis. One of the many who, seeking to understand, quickly devoured his [amazon_link id=”0071592997″ target=”_blank” ]Stabilizing an Unstable Economy[/amazon_link]. And found it pretty sensible. Macro isn’t my field, but there didn’t seem to be anything in that book a sensible mainstream macro person should have objected to. Should being the operative word. Because of course everyday, mainstream DSGE models in use in 2008 ruled out the very possibility of a crisis, whereas Minsky believed in their inevitability in some shape.

[amazon_image id=”0071592997″ link=”true” target=”_blank” size=”medium” ]Stabilizing an Unstable Economy[/amazon_image]

This week I’ve been reading Randall Wray’s [amazon_link id=”0691159122″ target=”_blank” ]Why Minsky Matters[/amazon_link], which is a useful and accessible overview of both what Minsky said and – as the title puts it – why it matters. I recommend the book (perhaps particularly to mainstream macro people!).

[amazon_image id=”0691159122″ link=”true” target=”_blank” size=”medium” ]Why Minsky Matters: An Introduction to the Work of a Maverick Economist[/amazon_image]

The first chapter gives an overview of Minsky’s arguments. The second chapter was to me the most interesting. It’s called ‘The Road Not taken’ and sets out the broad mainstream approach against which Minsky developed his arguments. This is the neoclassical synthesis, whose foundations were laid by John Hicks and Alvin ‘Secular Stagnation’ Hansen in the early years after Keynes’s death, then by both ‘Keynesians’ like Patinkin and Tobin and ‘Monetarists’ such as Friedman. Wray argues that these camps disagreed largely over parameter values, and that they essentially bowdlerised Keynes by ignoring his emphasis on investment, finance and uncertainty.

Debates about what Keynes ‘really’ meant in [amazon_link id=”1502423588″ target=”_blank” ]The General Theory[/amazon_link] are not all that interesting – and by the by a good reason for emphasising the importance of maths as well as words in economics. The mathematical notation is a way of enforcing logical consistency and expressing arguments with precision; the words can then explain more clearly, and introduce reality while keeping it rooted in logica and clarity. Anyway, what’s interesting about the chapter is its brief account of how finance vanished from macro, to our great cost.

[amazon_image id=”1502423588″ link=”true” target=”_blank” size=”medium” ]The General Theory of Employment, Interest, and Money (Classic John Maynard Keynes)[/amazon_image]

The later chapters of Wray’s primer set out Minsky’s views on specific issues, starting with his now-famous financial instability hypothesis: that market forces must be constrained in finance to prevent instability, but the consequent stability is itself destabilizing. The final chapter ends with some thoughts about how to proceed in the face of this paradox – in Wray’s view, tougher regulation especially of the shadow banking sector, and a smaller financial sector overall focusing on industrial investment. I agree, not least because the [amazon_link id=”0691169853″ target=”_blank” ]contribution of the sector to GDP is overstated[/amazon_link] (as Sir Charles Bean also pointed out in his recent interim report on economic statistics), and its contribution to economic welfare might well be a net negative.

This seems like common sense. I don’t entirely understand the unwillingness of the political classes to address the finance problem (despite the lobbying and campaign contributions)  – will it really take another crisis? The reluctance of people who did pre-2008 macro to ditch their human capital is entirely understandable, and I’m constantly told that anyway there has nevertheless been a lot of change in macroeconomics. Still (and to repeat, this is not my field) I’d be interested to know what proper macroeconomists think about Minsky now. If Minsky is still, as the book jacket claims, a maverick shunned by the mainstream – why?

Debt, debt, debt, debt

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I’m rather late to [amazon_link id=”022627165X” target=”_blank” ]House of Debt[/amazon_link] by Atif Mian and Amir Sufi, which is recently out in paperback. It argues eloquently and persuasively that the Great Financial Crisis was not only a banking crisis but also a household debt crisis, and that the length and severity of the downturn can largely be explained by the private debt overhang. This is not the received wisdom, of course. All the policy attention has focused on the near-catastrophe of the banking meltdown, and it is terrifying even now to think how serious the economic consequences would have been if the payments systems had stopped working, as they almost did in the UK. The book acknowledges that the authorities were absolutely right to act swiftly to prevent banking meltdown, and argues that more would have been better – more in the sense of the famous ‘helicopter money’ drop advocated by Adair Turner, for one, in his recent [amazon_link id=”0691169640″ target=”_blank” ]Between Debt and the Devil.[/amazon_link]

[amazon_image id=”022627165X” link=”true” target=”_blank” size=”medium” ]House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again[/amazon_image]

However, Mian and Sufi also point out that while political campaign contributions can be shown to have led the US Congress to support bank bailouts, there was next to no household debt relief. The core of their argument is that the effects of household leverage spilled over to the whole US economy, and that writing off some of the debt owed by homeowners underwater (not because of idleness or irresponsibility but because of a macro shock) would have benefited everyone. I found their argument convincing, along with the corollary that you can not fix an excess debt problem by getting people to take on more debt. The book makes a strong case for reducing the attractiveness of debt, due in large part to the tax system. They write:

“Debt instruments lead investors to focus on a very small part of the potential set of outcomes …In a world of neglected risks, financial innovation should be viewed with some degree of scepticism. If investors systematically ignore certain outcomes, financial innovation may just be secret code for bankers trying to fool investors into buying securities that look safe but are actually extremely vulnerable.” They are also critical of the extent of the bailouts for the financial sector: “The fundamental business of a bank is lending, just as the fundamental business of a furniture company is to sell furniture. Few economist believe that the government should promote the sale of bad furniture by stepping in to protect the creditors and shareholders of a poorly performing furniture company.” This understates the externalities involved in a bank failure, of course, and – as I noted – Mian and Sufi do not condemn the authorities’ response in 2008/9.

Given where we are, they advocate instead a range of measures to reduce debt dependence in future, including levelling the tax code as between debt and equity, and encouraging the use of more equity-like financial instruments, including in lending for home purchase. They cite approvingly Bob Shiller’s suggestions for instruments to insure against macro risks (in his book [amazon_link id=”B00C791JJI” target=”_blank” ]Finance and the Good Society[/amazon_link]) and [amazon_link id=”B00HZ634AU” target=”_blank” ]Admati and Hellwig'[/amazon_link]s advocacy for far higher levels of equity as opposed to be debt to be required on banks’ balance sheets. These kinds of arguments are slowly making headway in both economics and in policy circles. But slowly. Meanwhile, what is terrifiying is the evidence of a re-inflating of the debt bubble in some economies, including the UK. Can we really be ready to risk going around the same hamster wheel again, just because the financial sector lobbies so effectively?