Thursday, September 24, 2009
Tomgram: Chalmers Johnson, How to Sink America
Tomgram: Chalmers Johnson, How to Sink America
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The world's top 10 military spenders and the approximate amounts each country currently budgets for its military establishment are:
1. United States (FY08 budget), $623 billion
2. China (2004), $65 billion
3. Russia, $50 billion
4. France (2005), $45 billion
5. United Kingdom, $42.8 billion
6. Japan (2007), $41.75 billion
7. Germany (2003), $35.1 billion
8. Italy (2003), $28.2 billion
9. South Korea (2003), $21.1 billion
10. India (2005 est.), $19 billion
World total military expenditures (2004 est.), $1,100 billion
World total (minus the United States), $500 billion
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The world's top 10 military spenders and the approximate amounts each country currently budgets for its military establishment are:
1. United States (FY08 budget), $623 billion
2. China (2004), $65 billion
3. Russia, $50 billion
4. France (2005), $45 billion
5. United Kingdom, $42.8 billion
6. Japan (2007), $41.75 billion
7. Germany (2003), $35.1 billion
8. Italy (2003), $28.2 billion
9. South Korea (2003), $21.1 billion
10. India (2005 est.), $19 billion
World total military expenditures (2004 est.), $1,100 billion
World total (minus the United States), $500 billion
U.S. Military Troops and Bases Around the World
U.S. Military Troops and Bases Around the World
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737 U.S. Military Bases = Global Empire | | AlterNet
737 U.S. Military Bases = Global Empire | | AlterNet
By Chalmers Johnson, Metropolitan Books. Posted February 19, 2007.
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With more than 2,500,000 U.S. personnel serving across the planet and military bases spread across each continent, it's time to face up to the fact that our American democracy has spawned a global empire.
By Chalmers Johnson, Metropolitan Books. Posted February 19, 2007.
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With more than 2,500,000 U.S. personnel serving across the planet and military bases spread across each continent, it's time to face up to the fact that our American democracy has spawned a global empire.
Monday, September 14, 2009
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Get Real on Health Care
NEW YORK — Some of my summer in France was spent listening to indignant outbursts about U.S. health care reform. The tone: “You must be kidding! What’s there to debate if 46.3 million Americans have no health insurance?”
I think the French are right. I don’t think there’s much to debate when France spends 11 percent of its gross domestic product on health care and insures everyone and the United States spends 16.5 percent of G.D.P. and leaves 20 percent of adults under 65 uninsured. The numbers don’t lie: The U.S. system is wasteful and unjust.
It’s not just the numbers. It’s the intangibles. Two of my children were born in Paris — a breeze. One of them got very sick on arrival in the United States — and my wife fainted in a doctor’s office from the anxiety of finding the appropriate care (when we did, at the eleventh hour, it was excellent). The American health system is an insidious stress-multiplier whose hassles, big and small, permeate already harried lives.
So I’m convinced there’s no real argument. As President Obama put it last week, “We spend one and half times more per person on health care than any other country, but we aren’t healthier for it.” Why would the United States cling to the dubious distinction of being the only wealthy nation that does not afford basic health insurance to all?
The answer can be found only in myths and misleading stereotypes, so let’s try to dispel a few in the interest of having a more fruitful discussion.
I’ve said I think the French are right. But the French are also wrong. To cement a land-of-capitalist-cruelty American stereotype, they tend to believe no elements of the European welfare state exist in the United States.
Most would be shocked to hear about American social security, let alone Medicare and Medicaid, the government-run health care systems for the elderly and the poor that together form one of the largest publicly financed health systems in the world.
Americans obsess less about France than vice-versa but when they do they tend to suffer from equally delusional ideas. The French — like many Europeans — loom as a feckless multitude coddled by a nanny state that’s so big it must be socialist.
In fact, ever since President Mitterrand tried broad nationalizations in the early 1980s with catastrophic results, France, like most of Europe, has been on a steady march toward freer markets, trade and competition. In its way, it has been Americanizing.
The French health system uses a mixture of public and private funding, guaranteeing basic coverage through national insurance funds to which employees and employers make contributions. Most French people supplement these benefits by buying private insurance. The distinctions from the single-payer British system are significant, the results better.
So beyond all the hectoring, the main French-American difference on health care is not ideological but a question of efficiency. Both countries use a mixture of public and private. France is at a very far remove from “socialism.” The United States has already “socialized” a significant portion of its medicine. (Nothing illustrates right-wing ideological madness in the United States better than calls from some to “keep the government out of my Medicare!”)
The real difference is that the French state mandates health coverage for everyone, picks up the tab where necessary (as for the unemployed), holds down costs through a national fee system, and uses mainly nonprofit mutual insurers even for supplemental private coverage. The profit motive is outweighed by the principle of universal health care, with a corresponding effect on doctors’ salaries.
These are real distinctions. But the “socialism sucks” Republican broadside on Obama’s reform plans — with its overtone that the “cosmopolitan” president wants to “Europeanize” American medicine — is nonsense. It’s nonsense because the free market is vigorous in France (and Europe), because there are all sorts of European approaches to health (within the compulsory coverage), and because the United States has already “socialized” aplenty without turning its capitalism pink.
As Peter Baldwin makes clear in an interesting new book called “The Narcissism of Minor Differences: How America and Europe are alike,” U.S.-European contrasts can often be more about playing politics by comforting old myths — individualist at the new frontier versus collectivist at the beach — than facts.
Still some facts of the trans-Atlantic health care contrast are disturbing and justify the incredulity of my French friends, none more so than the furor over President Obama’s support for a government insurance option (like Medicare) that would, among other things, keep private insurers honest. Its Republican critics have portrayed this idea as so dangerous it represents a fight for freedom over tyranny.
So Obama has retreated a little and portrayed this option as a “only a means to an end” that could be discarded. He should not retreat. The public option best enshrines the principle of the state’s commitment to insuring everyone.
It’s therefore essential. Without it, we’ll get tinkering at best. The commitment to that health-as-right principle is what distinguishes France from the United States far more than all the socialist-capitalist claptrap.
News Hounds: Why Do Fox Nation Moderators Keep Allowing Racist Comments?
News Hounds: Why Do Fox Nation Moderators Keep Allowing Racist Comments?
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Boy, Oh, Boy
WASHINGTON
The normally nonchalant Barack Obama looked nonplussed, as Nancy Pelosi glowered behind.
Surrounded by middle-aged white guys — a sepia snapshot of the days when such pols ran Washington like their own men’s club — Joe Wilson yelled “You lie!” at a president who didn’t.
But, fair or not, what I heard was an unspoken word in the air: You lie, boy!
The outburst was unexpected from a milquetoast Republican backbencher from South Carolina who had attracted little media attention. Now it has made him an overnight right-wing hero, inspiring “You lie!” bumper stickers and T-shirts.
The congressman, we learned, belonged to the Sons of Confederate Veterans, led a 2000 campaign to keep the Confederate flag waving above South Carolina’s state Capitol and denounced as a “smear” the true claim of a black woman that she was the daughter of Strom Thurmond, the ’48 segregationist candidate for president. Wilson clearly did not like being lectured and even rebuked by the brainy black president presiding over the majestic chamber.
I’ve been loath to admit that the shrieking lunacy of the summer — the frantic efforts to paint our first black president as the Other, a foreigner, socialist, fascist, Marxist, racist, Commie, Nazi; a cad who would snuff old people; a snake who would indoctrinate kids — had much to do with race.
I tended to agree with some Obama advisers that Democratic presidents typically have provoked a frothing response from paranoids — from Father Coughlin against F.D.R. to Joe McCarthy against Truman to the John Birchers against J.F.K. and the vast right-wing conspiracy against Bill Clinton.
But Wilson’s shocking disrespect for the office of the president — no Democrat ever shouted “liar” at W. when he was hawking a fake case for war in Iraq — convinced me: Some people just can’t believe a black man is president and will never accept it.
“A lot of these outbursts have to do with delegitimizing him as a president,” said Congressman Jim Clyburn, a senior member of the South Carolina delegation. Clyburn, the man who called out Bill Clinton on his racially tinged attacks on Obama in the primary, pushed Pelosi to pursue a formal resolution chastising Wilson.
“In South Carolina politics, I learned that the olive branch works very seldom,” he said. “You have to come at these things from a position of strength. My father used to say, ‘Son, always remember that silence gives consent.’ ”
Barry Obama of the post-’60s Hawaiian ’hood did not live through the major racial struggles in American history. Maybe he had a problem relating to his white basketball coach or catching a cab in New York, but he never got beaten up for being black.
Now he’s at the center of a period of racial turbulence sparked by his ascension. Even if he and the coterie of white male advisers around him don’t choose to openly acknowledge it, this president is the ultimate civil rights figure — a black man whose legitimacy is constantly challenged by a loco fringe.
For two centuries, the South has feared a takeover by blacks or the feds. In Obama, they have both.
The state that fired the first shot of the Civil War has now given us this: Senator Jim DeMint exhorted conservatives to “break” the president by upending his health care plan. Rusty DePass, a G.O.P. activist, said that a gorilla that escaped from a zoo was “just one of Michelle’s ancestors.” Lovelorn Mark Sanford tried to refuse the president’s stimulus money. And now Joe Wilson.
“A good many people in South Carolina really reject the notion that we’re part of the union,” said Don Fowler, the former Democratic Party chief who teaches politics at the University of South Carolina. He observed that when slavery was destroyed by outside forces and segregation was undone by civil rights leaders and Congress, it bred xenophobia.
“We have a lot of people who really think that the world’s against us,” Fowler said, “so when things don’t happen the way we like them to, we blame outsiders.” He said a state legislator not long ago tried to pass a bill to nullify any federal legislation with which South Carolinians didn’t agree. Shades of John C. Calhoun!
It may be President Obama’s very air of elegance and erudition that raises hackles in some. “My father used to say to me, ‘Boy, don’t get above your raising,’ ” Fowler said. “Some people are prejudiced anyway, and then they look at his education and mannerisms and get more angry at him.”
Clyburn had a warning for Obama advisers who want to forgive Wilson, ignore the ignorant outbursts and move on: “They’re going to have to develop ways in this White House to deal with things and not let them fester out there. Otherwise, they’ll see numbers moving in the wrong direction.”
Monday Sept. 14, 2009 09:15 EDT
Who are the undeserving "others" benefiting from expanded government actions?
The New York Times' Ross Douthat argues, uncontroversially, that the tea-party protests, townhall outbursts and related appendages aren't about specific health care proposals but, instead, are motivated by a more generalized anger over what is happening in Washington:
At the same time, [the health care protests have] become the vessel for a year’s worth of anxieties about bailouts, deficits and Beltway incompetence.
This August’s town-hall fury wasn’t just about the details of health care. Neither were the anti-Obama protests that crowded Washington over the weekend. They were about the Wall Street bailout, the G.M. takeover, the A.I.G. bonuses, and countless smaller examples of middle-income Americans’ "playing by the rules," as [GOP pollster Frank] Luntz puts it, "and having someone else benefit."
Notably, Douthat never specifies the identity of this so-called "someone else" who, as a result of government behavior, is unfairly benefiting from the hard work of middle-class Americans, but he gives a clue when he compares current anger over the health care bill to the anger over the 1994 crime bill, which he argues drove Democrats out of, and Newt Gingrich into, Beltway power:
Instead, the crime bill became a lightning rod for populist outrage. The price tag made it seem fiscally irresponsible. (Back then, $30 billion was real money.) The billions it lavished on crime prevention -- like the infamous funding of "midnight basketball" -- looked liked ineffective welfare spending. The gun-control provisions felt like liberalism-as-usual.
"Every day that the Republicans delayed the bill," Luntz remembers, "the public learned more about it -- and the more they learned, the angrier they got."
In other words, the 1994 fury over the crime bill was driven by the belief that the Clinton-led federal government would steal money from middle-class Americans and give it to "midnight basketball" programs, i.e., "welfare" recipients. The racial and class-war components of that fear-mongering campaign were manifest: Bill Clinton wanted to steal the money of "'middle-income Americans playing by the rules" and transfer it to the inner-city (see Ta-Nehisi Coates' examination of the racial, class and similar cultural appeals that fueled vitriolic right-wing attacks on Clinton).
In that sense, Douthat (and Luntz) are correct when they say: "That’s exactly what’s been happening now." Just as was true for the 1994 crime bill, the right-wing fury over health care reform is motivated by the fear that middle-class Americans will have their money taken away by Obama while -- all together now, euphemistically -- "having someone else benefit." And this "someone else" are, as always, the poor minorities and other undeserving deadbeats who, in right-wing lore, somehow (despite their sorry state) exert immensely powerful influence over the U.S. Government and are thus the beneficiaries of endless, undeserved largesse: people too lazy to work, illegal immigrants, those living below the poverty line. That's why Joe Wilson's outburst resonated so forcefully among the Right and why he became an immediate folk hero: he was voicing the core right-wing fear that their money was being stolen from them by Obama in order to lavish the Undeserving and the Others -- in this case illegal immigrants -- with ill-gotten gains ("having someone else benefit," as Douthat/Luntz put it).
* * * * *
This is the paradox of the tea-party movement and other right-wing protests fueled by genuine citizen anger and fear. It is true that the federal government embraces redistributive policies and that middle-class income is seized in order that "someone else benefits." But so obviously, that "someone else" who is benefiting is not the poor and lower classes -- who continue to get poorer as the numbers living below the poverty line expand and the rich-poor gap grows in the U.S. to unprecedented proportions. The "someone else" that is benefiting from Washington policies are -- as usual -- the super-rich, the tiny number of huge corporations which literally own and control the Government. The premise of these citizen protests is not wrong: Washington politicians are in thrall to special interests and are, in essence, corruptly stealing the country's economic security in order to provide increasing benefits to a small and undeserving minority. But the "minority" here isn't what Fox News means by that term, but is the tiny sliver of corporate power which literally writes our laws and, in every case, ends up benefiting.
It wasn't the poor or illegal immigrants who were the beneficiaries of the Wall St. bailout; it was the investment banks which, not even a year later, are wallowing in record profits and bonuses thanks to massive taxpayer-funded welfare. The endlessly expanding (and secret) balance sheet of the Federal Reserve isn't going to fund midnight basketball programs or health care for Mexican immigrants but is enabling extreme profiteering by the very people who, just a year ago, almost brought the global economic system to full-scale collapse. Our endless wars and always-expanding Surveillance State -- fueled by constant fear-mongering campaigns against the Latest Scary Enemy -- keep the National Security corporations drowning in profits, paid for by middle-class taxes. And even health-care reform -- which supposedly began with anger over extreme insurance company profiteering at the expense of people's health -- will be an enormous boon to that same industry, as tens of millions of people are forced by the Government to become their customers with the central mechanism to control costs (the public option) blocked by that same industry. That's why those industries are enthusiastically in favor of reform: because, as always, they will benefit massively from it.
This is what is so strange and remarkable about these tea-party protests. The people who win when government acts aren't the poor, minorities or illegal immigrants -- the prime targets of these protesters' resentment. Their plight only worsens by the day. In Washington, members of those groups are even more powerless than "middle-income Americans." That's so obvious. The people who win whenever the federal government expands its power are the ones who, through their massive resources and lobbyists armies, control what the government does: the richest and most powerful corporations. And yet -- in an extreme paradox -- those are the people who are venerated by the Right: they simultaneously spew rage at what's happening in Washington while revering and defending the interests of the oligarchs who are most responsible.
What's really happening with these protests is that the genuine rage and not unreasonable economic insecurity of these citizens is being stoked, exploited, distorted and manipulated by movement leaders for entirely different ends. The people who are leading them -- Rush Limbaugh, the Murdoch-owned Fox News, Glenn Beck, business-dominated organizations of the type led by Dick Armey -- are cultural warriors above everything else. They're all in a far different socioeconomic position than the "middle-income Americans" whose anger they're ostensibly representing. Their principal preoccupation is their cultural contempt for various groups (illegal immigrants, the "undeserving" poor, liberals) and their desire to preserve the status quo whereby the prime beneficiaries of government policies remain themselves: the super rich and the interests that control Washington. It's certainly true that many of these protesters are driven by the standard right-wing cultural issues which have long shaped that movement -- social issues, religious fears, cultural and racial divisions, and hatred for "liberals" as Communist-Muslim-Terrorist-lovers. For many, all of that is intensified by the humiliation of being completely thrown out of power, at the hands of the first black President. But much of it is fueled by the pillaging of the corporations and Wall St. interests which own their government.
That's what accounts for the gaping paradox of these protests movements: genuine anger (over the core corruption of Washington and the eroding economic security for virtually everyone other than a tiny minority) is being bizarrely directed at those who never benefit (the poorest and most downtrodden), while those who are most responsible (the wealthiest and largest corporations) are depicted as the victims who need defending (they want to seize Wall St. bonuses and soak the rich!!). Several months ago, Matt Taibbi perfectly described the bizarre contradiction driving these protests:
After all, the reason the winger crowd can’t find a way to be coherently angry right now is because this country has no healthy avenues for genuine populist outrage. It never has. The setup always goes the other way: when the excesses of business interests and their political proteges in Washington leave the regular guy broke and screwed, the response is always for the lower and middle classes to split down the middle and find reasons to get pissed off not at their greedy bosses but at each other. That’s why even people like [Glenn] Beck’s audience, who I’d wager are mostly lower-income people, can’t imagine themselves protesting against the Wall Street barons who in actuality are the ones who fucked them over. . . .
Actual rich people can’t ever be the target. It’s a classic peasant mentality: going into fits of groveling and bowing whenever the master’s carriage rides by, then fuming against the Turks in Crimea or the Jews in the Pale or whoever after spending fifteen hard hours in the fields. You know you’re a peasant when you worship the very people who are right now, this minute, conning you and taking your shit. Whatever the master does, you’re on board. When you get frisky, he sticks a big cross in the middle of your village, and you spend the rest of your life praying to it with big googly eyes. Or he puts out newspapers full of innuendo about this or that faraway group and you immediately salute and rush off to join the hate squad. A good peasant is loyal, simpleminded, and full of misdirected anger. And that’s what we’ve got now, a lot of misdirected anger searching around for a non-target to mis-punish . . . can’t be mad at AIG, can’t be mad at Citi or Goldman Sachs. The real villains have to be the anti-AIG protesters! After all, those people earned those bonuses! If ever there was a textbook case of peasant thinking, it’s struggling middle-class Americans burned up in defense of taxpayer-funded bonuses to millionaires. It’s really weird stuff.
A significant reason this has happened is that the Democratic Party has largely ridden to power based on its servitude to these corporate interests -- chief party-fundraiser Chuck Schumer is the Senator from Wall St. and the Blue Dogs are little more than corporate-owned subsidiaries -- and thus can't possibly pretend to be opponents of the status quo. They can't and don't want to tap into any populist anger because they're every bit as supportive of, servants to, the corporate agenda as the GOP establishment is. K Street support is what sustains their power. Super-rich corporations aren't benefiting from a free market, laissez faire approach. They're benefiting from the opposite: a constant merging of government and corporate power whereby the latter exploits the former for its own benefit. The right-wing theme that an expansion of federal government power means a contraction in corporate freedom is completely obsolete: government power is the means by which large corporations benefit themselves at the expense of everyone else.
Both parties -- but particularly the one in power at any given moment -- perpetuate that system because they benefit from it. That's what has left the gaping void into which Fox News, Glenn Beck, Limbaugh and the like have stepped: absurdly parading around as populist leaders while supporting policies designed to further crush the interests of the people who they are leading.
* * * * *
In a rational world, there ought to be citizen rage towards the government that transcends -- indeed, that has little to do with -- divisions between the so-called "Right" and "Left." One saw the incipient emergence of that sort of citizen anger during the rage over the Wall St. bailouts and AIG bonuses, where the divisions were defined not as "conservatives v. liberals" but as "outsiders" (citizens of all ideologies who were enraged by such blatant corruption and stealing) v. "insiders" (who defended it all as necessary and scorned the irresponsible dirty masses who were protesting). The real power dynamic in this country has little to do with the cable-generated "right v. left" drama and much more to do with "outsider/insider" divisions, since the same corporate interests control the Government regardless of which political party wins.
But these protests end up expressing themselves in dichotomies that are largely besides the point -- "right v. left" or "Democratic v. GOP" -- because that's how their leaders define it. These protests, at their leadership level, are little more than Fox-News-generated events. That is notable in itself: it's extremely unusual (if not unprecedented) for a political movement in the U.S. to be led and galvanized by a "news" media outlet; that's usually something that happens elsewhere ("opposition television or radio stations" sponsoring street protests in Italy, Venezuela, Rwanda). Fox News and Rush Limbaugh are part of the class that has long controlled and benefited from Washington, and thus promote a view of the world based in the Douthat/Luntz "having someone else benefit": the Democrats are socialists coming to steal your money and give it to the poor, the minorities and the immigrants. As a result, citizen rage is directed towards everyone except those who are actually responsible for their plight.
If Fox News, Glenn Beck and Rush Limbaugh were truly opposed to expanded government power, where were they when George Bush and Dick Cheney were expanding federal power in virtually every realm, driving up the national debt to unprecedented proportions, destroying middle-class economic security in order to benefit the wealthiest, and generally ensuring government intrusion into every aspect of people's lives? They were supporting it and cheering it on. That's what gives the lie to their pretense of "small-government" rhetoric. These citizen protests have a core of truth and validity to them -- it would be bizarre if citizens weren't enraged by what is taking place -- but that is all being misdirected and exploited for ends that have nothing to do with the interests (or even their claimed beliefs) of the protesters themselves.
Treasury: Billions still needed to backstop the economy - The Hill's Blog Briefing Room
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How Did Economists Get It So Wrong?
I. MISTAKING BEAUTY FOR TRUTH
It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession. On the theoretical side, they thought that they had resolved their internal disputes. Thus, in a 2008 paper titled “The State of Macro” (that is, macroeconomics, the study of big-picture issues like recessions), Olivier Blanchard of M.I.T., now the chief economist at the International Monetary Fund, declared that “the state of macro is good.” The battles of yesteryear, he said, were over, and there had been a “broad convergence of vision.” And in the real world, economists believed they had things under control: the “central problem of depression-prevention has been solved,” declared Robert Lucas of the University of Chicago in his 2003 presidential address to the American Economic Association. In 2004, Ben Bernanke, a former Princeton professor who is now the chairman of the Federal Reserve Board, celebrated the Great Moderation in economic performance over the previous two decades, which he attributed in part to improved economic policy making.
Last year, everything came apart.
Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy. During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year. Meanwhile, macroeconomists were divided in their views. But the main division was between those who insisted that free-market economies never go astray and those who believed that economies may stray now and then but that any major deviations from the path of prosperity could and would be corrected by the all-powerful Fed. Neither side was prepared to cope with an economy that went off the rails despite the Fed’s best efforts.
And in the wake of the crisis, the fault lines in the economics profession have yawned wider than ever. Lucas says the Obama administration’s stimulus plans are “schlock economics,” and his Chicago colleague John Cochrane says they’re based on discredited “fairy tales.” In response, Brad DeLong of the University of California, Berkeley, writes of the “intellectual collapse” of the Chicago School, and I myself have written that comments from Chicago economists are the product of a Dark Age of macroeconomics in which hard-won knowledge has been forgotten.
What happened to the economics profession? And where does it go from here?
As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.
Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.
It’s much harder to say where the economics profession goes from here. But what’s almost certain is that economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic “theory of everything” is a long way off. In practical terms, this will translate into more cautious policy advice — and a reduced willingness to dismantle economic safeguards in the faith that markets will solve all problems.
II. FROM SMITH TO KEYNES AND BACK
The birth of economics as a discipline is usually credited to Adam Smith, who published “The Wealth of Nations” in 1776. Over the next 160 years an extensive body of economic theory was developed, whose central message was: Trust the market. Yes, economists admitted that there were cases in which markets might fail, of which the most important was the case of “externalities” — costs that people impose on others without paying the price, like traffic congestion or pollution. But the basic presumption of “neoclassical” economics (named after the late-19th-century theorists who elaborated on the concepts of their “classical” predecessors) was that we should have faith in the market system.
This faith was, however, shattered by the Great Depression. Actually, even in the face of total collapse some economists insisted that whatever happens in a market economy must be right: “Depressions are not simply evils,” declared Joseph Schumpeter in 1934 — 1934! They are, he added, “forms of something which has to be done.” But many, and eventually most, economists turned to the insights of John Maynard Keynes for both an explanation of what had happened and a solution to future depressions.
Keynes did not, despite what you may have heard, want the government to run the economy. He described his analysis in his 1936 masterwork, “The General Theory of Employment, Interest and Money,” as “moderately conservative in its implications.” He wanted to fix capitalism, not replace it. But he did challenge the notion that free-market economies can function without a minder, expressing particular contempt for financial markets, which he viewed as being dominated by short-term speculation with little regard for fundamentals. And he called for active government intervention — printing more money and, if necessary, spending heavily on public works — to fight unemployment during slumps.
It’s important to understand that Keynes did much more than make bold assertions. “The General Theory” is a work of profound, deep analysis — analysis that persuaded the best young economists of the day. Yet the story of economics over the past half century is, to a large degree, the story of a retreat from Keynesianism and a return to neoclassicism. The neoclassical revival was initially led by Milton Friedman of the University of Chicago, who asserted as early as 1953 that neoclassical economics works well enough as a description of the way the economy actually functions to be “both extremely fruitful and deserving of much confidence.” But what about depressions?
Friedman’s counterattack against Keynes began with the doctrine known as monetarism. Monetarists didn’t disagree in principle with the idea that a market economy needs deliberate stabilization. “We are all Keynesians now,” Friedman once said, although he later claimed he was quoted out of context. Monetarists asserted, however, that a very limited, circumscribed form of government intervention — namely, instructing central banks to keep the nation’s money supply, the sum of cash in circulation and bank deposits, growing on a steady path — is all that’s required to prevent depressions. Famously, Friedman and his collaborator, Anna Schwartz, argued that if the Federal Reserve had done its job properly, the Great Depression would not have happened. Later, Friedman made a compelling case against any deliberate effort by government to push unemployment below its “natural” level (currently thought to be about 4.8 percent in the United States): excessively expansionary policies, he predicted, would lead to a combination of inflation and high unemployment — a prediction that was borne out by the stagflation of the 1970s, which greatly advanced the credibility of the anti-Keynesian movement.
Eventually, however, the anti-Keynesian counterrevolution went far beyond Friedman’s position, which came to seem relatively moderate compared with what his successors were saying. Among financial economists, Keynes’s disparaging vision of financial markets as a “casino” was replaced by “efficient market” theory, which asserted that financial markets always get asset prices right given the available information. Meanwhile, many macroeconomists completely rejected Keynes’s framework for understanding economic slumps. Some returned to the view of Schumpeter and other apologists for the Great Depression, viewing recessions as a good thing, part of the economy’s adjustment to change. And even those not willing to go that far argued that any attempt to fight an economic slump would do more harm than good.
Not all macroeconomists were willing to go down this road: many became self-described New Keynesians, who continued to believe in an active role for the government. Yet even they mostly accepted the notion that investors and consumers are rational and that markets generally get it right.
Of course, there were exceptions to these trends: a few economists challenged the assumption of rational behavior, questioned the belief that financial markets can be trusted and pointed to the long history of financial crises that had devastating economic consequences. But they were swimming against the tide, unable to make much headway against a pervasive and, in retrospect, foolish complacency.
III. PANGLOSSIAN FINANCE
In the 1930s, financial markets, for obvious reasons, didn’t get much respect. Keynes compared them to “those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those that he thinks likeliest to catch the fancy of the other competitors.”
And Keynes considered it a very bad idea to let such markets, in which speculators spent their time chasing one another’s tails, dictate important business decisions: “When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”
By 1970 or so, however, the study of financial markets seemed to have been taken over by Voltaire’s Dr. Pangloss, who insisted that we live in the best of all possible worlds. Discussion of investor irrationality, of bubbles, of destructive speculation had virtually disappeared from academic discourse. The field was dominated by the “efficient-market hypothesis,” promulgated by Eugene Fama of the University of Chicago, which claims that financial markets price assets precisely at their intrinsic worth given all publicly available information. (The price of a company’s stock, for example, always accurately reflects the company’s value given the information available on the company’s earnings, its business prospects and so on.) And by the 1980s, finance economists, notably Michael Jensen of the Harvard Business School, were arguing that because financial markets always get prices right, the best thing corporate chieftains can do, not just for themselves but for the sake of the economy, is to maximize their stock prices. In other words, finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a “casino.”
It’s hard to argue that this transformation in the profession was driven by events. True, the memory of 1929 was gradually receding, but there continued to be bull markets, with widespread tales of speculative excess, followed by bear markets. In 1973-4, for example, stocks lost 48 percent of their value. And the 1987 stock crash, in which the Dow plunged nearly 23 percent in a day for no clear reason, should have raised at least a few doubts about market rationality.
These events, however, which Keynes would have considered evidence of the unreliability of markets, did little to blunt the force of a beautiful idea. The theoretical model that finance economists developed by assuming that every investor rationally balances risk against reward — the so-called Capital Asset Pricing Model, or CAPM (pronounced cap-em) — is wonderfully elegant. And if you accept its premises it’s also extremely useful. CAPM not only tells you how to choose your portfolio — even more important from the financial industry’s point of view, it tells you how to put a price on financial derivatives, claims on claims. The elegance and apparent usefulness of the new theory led to a string of Nobel prizes for its creators, and many of the theory’s adepts also received more mundane rewards: Armed with their new models and formidable math skills — the more arcane uses of CAPM require physicist-level computations — mild-mannered business-school professors could and did become Wall Street rocket scientists, earning Wall Street paychecks.
To be fair, finance theorists didn’t accept the efficient-market hypothesis merely because it was elegant, convenient and lucrative. They also produced a great deal of statistical evidence, which at first seemed strongly supportive. But this evidence was of an oddly limited form. Finance economists rarely asked the seemingly obvious (though not easily answered) question of whether asset prices made sense given real-world fundamentals like earnings. Instead, they asked only whether asset prices made sense given other asset prices. Larry Summers, now the top economic adviser in the Obama administration, once mocked finance professors with a parable about “ketchup economists” who “have shown that two-quart bottles of ketchup invariably sell for exactly twice as much as one-quart bottles of ketchup,” and conclude from this that the ketchup market is perfectly efficient.
But neither this mockery nor more polite critiques from economists like Robert Shiller of Yale had much effect. Finance theorists continued to believe that their models were essentially right, and so did many people making real-world decisions. Not least among these was Alan Greenspan, who was then the Fed chairman and a long-time supporter of financial deregulation whose rejection of calls to rein in subprime lending or address the ever-inflating housing bubble rested in large part on the belief that modern financial economics had everything under control. There was a telling moment in 2005, at a conference held to honor Greenspan’s tenure at the Fed. One brave attendee, Raghuram Rajan (of the University of Chicago, surprisingly), presented a paper warning that the financial system was taking on potentially dangerous levels of risk. He was mocked by almost all present — including, by the way, Larry Summers, who dismissed his warnings as “misguided.”
By October of last year, however, Greenspan was admitting that he was in a state of “shocked disbelief,” because “the whole intellectual edifice” had “collapsed.” Since this collapse of the intellectual edifice was also a collapse of real-world markets, the result was a severe recession — the worst, by many measures, since the Great Depression. What should policy makers do? Unfortunately, macroeconomics, which should have been providing clear guidance about how to address the slumping economy, was in its own state of disarray.
IV. THE TROUBLE WITH MACRO
“We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time — perhaps for a long time.” So wrote John Maynard Keynes in an essay titled “The Great Slump of 1930,” in which he tried to explain the catastrophe then overtaking the world. And the world’s possibilities of wealth did indeed run to waste for a long time; it took World War II to bring the Great Depression to a definitive end.
Why was Keynes’s diagnosis of the Great Depression as a “colossal muddle” so compelling at first? And why did economics, circa 1975, divide into opposing camps over the value of Keynes’s views?
I like to explain the essence of Keynesian economics with a true story that also serves as a parable, a small-scale version of the messes that can afflict entire economies. Consider the travails of the Capitol Hill Baby-Sitting Co-op.
This co-op, whose problems were recounted in a 1977 article in The Journal of Money, Credit and Banking, was an association of about 150 young couples who agreed to help one another by baby-sitting for one another’s children when parents wanted a night out. To ensure that every couple did its fair share of baby-sitting, the co-op introduced a form of scrip: coupons made out of heavy pieces of paper, each entitling the bearer to one half-hour of sitting time. Initially, members received 20 coupons on joining and were required to return the same amount on departing the group.
Unfortunately, it turned out that the co-op’s members, on average, wanted to hold a reserve of more than 20 coupons, perhaps, in case they should want to go out several times in a row. As a result, relatively few people wanted to spend their scrip and go out, while many wanted to baby-sit so they could add to their hoard. But since baby-sitting opportunities arise only when someone goes out for the night, this meant that baby-sitting jobs were hard to find, which made members of the co-op even more reluctant to go out, making baby-sitting jobs even scarcer. . . .
In short, the co-op fell into a recession.
O.K., what do you think of this story? Don’t dismiss it as silly and trivial: economists have used small-scale examples to shed light on big questions ever since Adam Smith saw the roots of economic progress in a pin factory, and they’re right to do so. The question is whether this particular example, in which a recession is a problem of inadequate demand — there isn’t enough demand for baby-sitting to provide jobs for everyone who wants one — gets at the essence of what happens in a recession.
Forty years ago most economists would have agreed with this interpretation. But since then macroeconomics has divided into two great factions: “saltwater” economists (mainly in coastal U.S. universities), who have a more or less Keynesian vision of what recessions are all about; and “freshwater” economists (mainly at inland schools), who consider that vision nonsense.
Freshwater economists are, essentially, neoclassical purists. They believe that all worthwhile economic analysis starts from the premise that people are rational and markets work, a premise violated by the story of the baby-sitting co-op. As they see it, a general lack of sufficient demand isn’t possible, because prices always move to match supply with demand. If people want more baby-sitting coupons, the value of those coupons will rise, so that they’re worth, say, 40 minutes of baby-sitting rather than half an hour — or, equivalently, the cost of an hours’ baby-sitting would fall from 2 coupons to 1.5. And that would solve the problem: the purchasing power of the coupons in circulation would have risen, so that people would feel no need to hoard more, and there would be no recession.
But don’t recessions look like periods in which there just isn’t enough demand to employ everyone willing to work? Appearances can be deceiving, say the freshwater theorists. Sound economics, in their view, says that overall failures of demand can’t happen — and that means that they don’t. Keynesian economics has been “proved false,” Cochrane, of the University of Chicago, says.
Yet recessions do happen. Why? In the 1970s the leading freshwater macroeconomist, the Nobel laureate Robert Lucas, argued that recessions were caused by temporary confusion: workers and companies had trouble distinguishing overall changes in the level of prices because of inflation or deflation from changes in their own particular business situation. And Lucas warned that any attempt to fight the business cycle would be counterproductive: activist policies, he argued, would just add to the confusion.
By the 1980s, however, even this severely limited acceptance of the idea that recessions are bad things had been rejected by many freshwater economists. Instead, the new leaders of the movement, especially Edward Prescott, who was then at the University of Minnesota (you can see where the freshwater moniker comes from), argued that price fluctuations and changes in demand actually had nothing to do with the business cycle. Rather, the business cycle reflects fluctuations in the rate of technological progress, which are amplified by the rational response of workers, who voluntarily work more when the environment is favorable and less when it’s unfavorable. Unemployment is a deliberate decision by workers to take time off.
Put baldly like that, this theory sounds foolish — was the Great Depression really the Great Vacation? And to be honest, I think it really is silly. But the basic premise of Prescott’s “real business cycle” theory was embedded in ingeniously constructed mathematical models, which were mapped onto real data using sophisticated statistical techniques, and the theory came to dominate the teaching of macroeconomics in many university departments. In 2004, reflecting the theory’s influence, Prescott shared a Nobel with Finn Kydland of Carnegie Mellon University.
Meanwhile, saltwater economists balked. Where the freshwater economists were purists, saltwater economists were pragmatists. While economists like N. Gregory Mankiw at Harvard, Olivier Blanchard at M.I.T. and David Romer at the University of California, Berkeley, acknowledged that it was hard to reconcile a Keynesian demand-side view of recessions with neoclassical theory, they found the evidence that recessions are, in fact, demand-driven too compelling to reject. So they were willing to deviate from the assumption of perfect markets or perfect rationality, or both, adding enough imperfections to accommodate a more or less Keynesian view of recessions. And in the saltwater view, active policy to fight recessions remained desirable.
But the self-described New Keynesian economists weren’t immune to the charms of rational individuals and perfect markets. They tried to keep their deviations from neoclassical orthodoxy as limited as possible. This meant that there was no room in the prevailing models for such things as bubbles and banking-system collapse. The fact that such things continued to happen in the real world — there was a terrible financial and macroeconomic crisis in much of Asia in 1997-8 and a depression-level slump in Argentina in 2002 — wasn’t reflected in the mainstream of New Keynesian thinking.
Even so, you might have thought that the differing worldviews of freshwater and saltwater economists would have put them constantly at loggerheads over economic policy. Somewhat surprisingly, however, between around 1985 and 2007 the disputes between freshwater and saltwater economists were mainly about theory, not action. The reason, I believe, is that New Keynesians, unlike the original Keynesians, didn’t think fiscal policy — changes in government spending or taxes — was needed to fight recessions. They believed that monetary policy, administered by the technocrats at the Fed, could provide whatever remedies the economy needed. At a 90th birthday celebration for Milton Friedman, Ben Bernanke, formerly a more or less New Keynesian professor at Princeton, and by then a member of the Fed’s governing board, declared of the Great Depression: “You’re right. We did it. We’re very sorry. But thanks to you, it won’t happen again.” The clear message was that all you need to avoid depressions is a smarter Fed.
And as long as macroeconomic policy was left in the hands of the maestro Greenspan, without Keynesian-type stimulus programs, freshwater economists found little to complain about. (They didn’t believe that monetary policy did any good, but they didn’t believe it did any harm, either.)
It would take a crisis to reveal both how little common ground there was and how Panglossian even New Keynesian economics had become.
V. NOBODY COULD HAVE PREDICTED . . .
In recent, rueful economics discussions, an all-purpose punch line has become “nobody could have predicted. . . .” It’s what you say with regard to disasters that could have been predicted, should have been predicted and actually were predicted by a few economists who were scoffed at for their pains.
Take, for example, the precipitous rise and fall of housing prices. Some economists, notably Robert Shiller, did identify the bubble and warn of painful consequences if it were to burst. Yet key policy makers failed to see the obvious. In 2004, Alan Greenspan dismissed talk of a housing bubble: “a national severe price distortion,” he declared, was “most unlikely.” Home-price increases, Ben Bernanke said in 2005, “largely reflect strong economic fundamentals.”
How did they miss the bubble? To be fair, interest rates were unusually low, possibly explaining part of the price rise. It may be that Greenspan and Bernanke also wanted to celebrate the Fed’s success in pulling the economy out of the 2001 recession; conceding that much of that success rested on the creation of a monstrous bubble would have placed a damper on the festivities.
But there was something else going on: a general belief that bubbles just don’t happen. What’s striking, when you reread Greenspan’s assurances, is that they weren’t based on evidence — they were based on the a priori assertion that there simply can’t be a bubble in housing. And the finance theorists were even more adamant on this point. In a 2007 interview, Eugene Fama, the father of the efficient-market hypothesis, declared that “the word ‘bubble’ drives me nuts,” and went on to explain why we can trust the housing market: “Housing markets are less liquid, but people are very careful when they buy houses. It’s typically the biggest investment they’re going to make, so they look around very carefully and they compare prices. The bidding process is very detailed.”
Indeed, home buyers generally do carefully compare prices — that is, they compare the price of their potential purchase with the prices of other houses. But this says nothing about whether the overall price of houses is justified. It’s ketchup economics, again: because a two-quart bottle of ketchup costs twice as much as a one-quart bottle, finance theorists declare that the price of ketchup must be right.
In short, the belief in efficient financial markets blinded many if not most economists to the emergence of the biggest financial bubble in history. And efficient-market theory also played a significant role in inflating that bubble in the first place.
Now that the undiagnosed bubble has burst, the true riskiness of supposedly safe assets has been revealed and the financial system has demonstrated its fragility. U.S. households have seen $13 trillion in wealth evaporate. More than six million jobs have been lost, and the unemployment rate appears headed for its highest level since 1940. So what guidance does modern economics have to offer in our current predicament? And should we trust it?
VI. THE STIMULUS SQUABBLE
Between 1985 and 2007 a false peace settled over the field of macroeconomics. There hadn’t been any real convergence of views between the saltwater and freshwater factions. But these were the years of the Great Moderation — an extended period during which inflation was subdued and recessions were relatively mild. Saltwater economists believed that the Federal Reserve had everything under control. Freshwater economists didn’t think the Fed’s actions were actually beneficial, but they were willing to let matters lie.
But the crisis ended the phony peace. Suddenly the narrow, technocratic policies both sides were willing to accept were no longer sufficient — and the need for a broader policy response brought the old conflicts out into the open, fiercer than ever.
Why weren’t those narrow, technocratic policies sufficient? The answer, in a word, is zero.
During a normal recession, the Fed responds by buying Treasury bills — short-term government debt — from banks. This drives interest rates on government debt down; investors seeking a higher rate of return move into other assets, driving other interest rates down as well; and normally these lower interest rates eventually lead to an economic bounceback. The Fed dealt with the recession that began in 1990 by driving short-term interest rates from 9 percent down to 3 percent. It dealt with the recession that began in 2001 by driving rates from 6.5 percent to 1 percent. And it tried to deal with the current recession by driving rates down from 5.25 percent to zero.
But zero, it turned out, isn’t low enough to end this recession. And the Fed can’t push rates below zero, since at near-zero rates investors simply hoard cash rather than lending it out. So by late 2008, with interest rates basically at what macroeconomists call the “zero lower bound” even as the recession continued to deepen, conventional monetary policy had lost all traction.
Now what? This is the second time America has been up against the zero lower bound, the previous occasion being the Great Depression. And it was precisely the observation that there’s a lower bound to interest rates that led Keynes to advocate higher government spending: when monetary policy is ineffective and the private sector can’t be persuaded to spend more, the public sector must take its place in supporting the economy. Fiscal stimulus is the Keynesian answer to the kind of depression-type economic situation we’re currently in.
Such Keynesian thinking underlies the Obama administration’s economic policies — and the freshwater economists are furious. For 25 or so years they tolerated the Fed’s efforts to manage the economy, but a full-blown Keynesian resurgence was something entirely different. Back in 1980, Lucas, of the University of Chicago, wrote that Keynesian economics was so ludicrous that “at research seminars, people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another.” Admitting that Keynes was largely right, after all, would be too humiliating a comedown.
And so Chicago’s Cochrane, outraged at the idea that government spending could mitigate the latest recession, declared: “It’s not part of what anybody has taught graduate students since the 1960s. They [Keynesian ideas] are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children, but it doesn’t make them less false.” (It’s a mark of how deep the division between saltwater and freshwater runs that Cochrane doesn’t believe that “anybody” teaches ideas that are, in fact, taught in places like Princeton, M.I.T. and Harvard.)
Meanwhile, saltwater economists, who had comforted themselves with the belief that the great divide in macroeconomics was narrowing, were shocked to realize that freshwater economists hadn’t been listening at all. Freshwater economists who inveighed against the stimulus didn’t sound like scholars who had weighed Keynesian arguments and found them wanting. Rather, they sounded like people who had no idea what Keynesian economics was about, who were resurrecting pre-1930 fallacies in the belief that they were saying something new and profound.
And it wasn’t just Keynes whose ideas seemed to have been forgotten. As Brad DeLong of the University of California, Berkeley, has pointed out in his laments about the Chicago school’s “intellectual collapse,” the school’s current stance amounts to a wholesale rejection of Milton Friedman’s ideas, as well. Friedman believed that Fed policy rather than changes in government spending should be used to stabilize the economy, but he never asserted that an increase in government spending cannot, under any circumstances, increase employment. In fact, rereading Friedman’s 1970 summary of his ideas, “A Theoretical Framework for Monetary Analysis,” what’s striking is how Keynesian it seems.
And Friedman certainly never bought into the idea that mass unemployment represents a voluntary reduction in work effort or the idea that recessions are actually good for the economy. Yet the current generation of freshwater economists has been making both arguments. Thus Chicago’s Casey Mulligan suggests that unemployment is so high because many workers are choosing not to take jobs: “Employees face financial incentives that encourage them not to work . . . decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire).” Mulligan has suggested, in particular, that workers are choosing to remain unemployed because that improves their odds of receiving mortgage relief. And Cochrane declares that high unemployment is actually good: “We should have a recession. People who spend their lives pounding nails in Nevada need something else to do.”
Personally, I think this is crazy. Why should it take mass unemployment across the whole nation to get carpenters to move out of Nevada? Can anyone seriously claim that we’ve lost 6.7 million jobs because fewer Americans want to work? But it was inevitable that freshwater economists would find themselves trapped in this cul-de-sac: if you start from the assumption that people are perfectly rational and markets are perfectly efficient, you have to conclude that unemployment is voluntary and recessions are desirable.
Yet if the crisis has pushed freshwater economists into absurdity, it has also created a lot of soul-searching among saltwater economists. Their framework, unlike that of the Chicago School, both allows for the possibility of involuntary unemployment and considers it a bad thing. But the New Keynesian models that have come to dominate teaching and research assume that people are perfectly rational and financial markets are perfectly efficient. To get anything like the current slump into their models, New Keynesians are forced to introduce some kind of fudge factor that for reasons unspecified temporarily depresses private spending. (I’ve done exactly that in some of my own work.) And if the analysis of where we are now rests on this fudge factor, how much confidence can we have in the models’ predictions about where we are going?
The state of macro, in short, is not good. So where does the profession go from here?
VII. FLAWS AND FRICTIONS
Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system. If the profession is to redeem itself, it will have to reconcile itself to a less alluring vision — that of a market economy that has many virtues but that is also shot through with flaws and frictions. The good news is that we don’t have to start from scratch. Even during the heyday of perfect-market economics, there was a lot of work done on the ways in which the real economy deviated from the theoretical ideal. What’s probably going to happen now — in fact, it’s already happening — is that flaws-and-frictions economics will move from the periphery of economic analysis to its center.
There’s already a fairly well developed example of the kind of economics I have in mind: the school of thought known as behavioral finance. Practitioners of this approach emphasize two things. First, many real-world investors bear little resemblance to the cool calculators of efficient-market theory: they’re all too subject to herd behavior, to bouts of irrational exuberance and unwarranted panic. Second, even those who try to base their decisions on cool calculation often find that they can’t, that problems of trust, credibility and limited collateral force them to run with the herd.
On the first point: even during the heyday of the efficient-market hypothesis, it seemed obvious that many real-world investors aren’t as rational as the prevailing models assumed. Larry Summers once began a paper on finance by declaring: “THERE ARE IDIOTS. Look around.” But what kind of idiots (the preferred term in the academic literature, actually, is “noise traders”) are we talking about? Behavioral finance, drawing on the broader movement known as behavioral economics, tries to answer that question by relating the apparent irrationality of investors to known biases in human cognition, like the tendency to care more about small losses than small gains or the tendency to extrapolate too readily from small samples (e.g., assuming that because home prices rose in the past few years, they’ll keep on rising).
Until the crisis, efficient-market advocates like Eugene Fama dismissed the evidence produced on behalf of behavioral finance as a collection of “curiosity items” of no real importance. That’s a much harder position to maintain now that the collapse of a vast bubble — a bubble correctly diagnosed by behavioral economists like Robert Shiller of Yale, who related it to past episodes of “irrational exuberance” — has brought the world economy to its knees.
On the second point: suppose that there are, indeed, idiots. How much do they matter? Not much, argued Milton Friedman in an influential 1953 paper: smart investors will make money by buying when the idiots sell and selling when they buy and will stabilize markets in the process. But the second strand of behavioral finance says that Friedman was wrong, that financial markets are sometimes highly unstable, and right now that view seems hard to reject.
Probably the most influential paper in this vein was a 1997 publication by Andrei Shleifer of Harvard and Robert Vishny of Chicago, which amounted to a formalization of the old line that “the market can stay irrational longer than you can stay solvent.” As they pointed out, arbitrageurs — the people who are supposed to buy low and sell high — need capital to do their jobs. And a severe plunge in asset prices, even if it makes no sense in terms of fundamentals, tends to deplete that capital. As a result, the smart money is forced out of the market, and prices may go into a downward spiral.
The spread of the current financial crisis seemed almost like an object lesson in the perils of financial instability. And the general ideas underlying models of financial instability have proved highly relevant to economic policy: a focus on the depleted capital of financial institutions helped guide policy actions taken after the fall of Lehman, and it looks (cross your fingers) as if these actions successfully headed off an even bigger financial collapse.
Meanwhile, what about macroeconomics? Recent events have pretty decisively refuted the idea that recessions are an optimal response to fluctuations in the rate of technological progress; a more or less Keynesian view is the only plausible game in town. Yet standard New Keynesian models left no room for a crisis like the one we’re having, because those models generally accepted the efficient-market view of the financial sector.
There were some exceptions. One line of work, pioneered by none other than Ben Bernanke working with Mark Gertler of New York University, emphasized the way the lack of sufficient collateral can hinder the ability of businesses to raise funds and pursue investment opportunities. A related line of work, largely established by my Princeton colleague Nobuhiro Kiyotaki and John Moore of the London School of Economics, argued that prices of assets such as real estate can suffer self-reinforcing plunges that in turn depress the economy as a whole. But until now the impact of dysfunctional finance hasn’t been at the core even of Keynesian economics. Clearly, that has to change.
VIII. RE-EMBRACING KEYNES
So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.
Many economists will find these changes deeply disturbing. It will be a long time, if ever, before the new, more realistic approaches to finance and macroeconomics offer the same kind of clarity, completeness and sheer beauty that characterizes the full neoclassical approach. To some economists that will be a reason to cling to neoclassicism, despite its utter failure to make sense of the greatest economic crisis in three generations. This seems, however, like a good time to recall the words of H. L. Mencken: “There is always an easy solution to every human problem — neat, plausible and wrong.”
When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly. The vision that emerges as the profession rethinks its foundations may not be all that clear; it certainly won’t be neat; but we can hope that it will have the virtue of being at least partly right.
This article has been revised to reflect the following correction:
Correction: September 6, 2009
Because of an editing error, an article on Page 36 this weekend about the failure of economists to anticipate the latest recession misquotes the economist
Judge Rejects Settlement Over Merrill Bonuses
A Federal District judge on Monday overturned a settlement between the Bank of America and the Securities and Exchange Commission over bonuses paid to Merrill Lynch executives just before the bank took over Merrill last year.
The $33 million settlement “does not comport with the most elementary notions of justice and morality,” wrote Jed S. Rakoff, the judge assigned to the case in federal court in Lower Manhattan.
The ruling directed both the agency and the bank to prepare for a possible trial that would begin no later than Feb. 1. The case involved $3.6 billion in bonuses that were paid by Merrill Lynch late last year, just as that firm was about to be merged with Bank of America. Neither company provided details of the bonuses to their shareholders, who voted on Dec. 5 to approve the merger.
The judge focused much of his criticism on the fact that the fine in the case would be paid by the bank’s shareholders, who were the ones that were supposed to have been injured by the lack of disclosure.
“It is quite something else for the very management that is accused of having lied to its shareholders to determine how much of those victims’ money should be used to make the case against the management go away,” the judge wrote.
In a statement, the S.E.C. said on Monday: “As we said in our court filings, we believe the proposed settlement properly balanced all of the relevant considerations. We will carefully review the court’s most recent order.”
Bank of America has argued in its filings with the judge that it did nothing wrong in its disclosures.
The judge also criticized the S.E.C., which has been trying to step up the profile of its investigations unit. The judge quoted Oscar Wilde’s “Lady Windermere’s Fan” in the end of his ruling to say that a cynic is someone “who knows the price of everything and the value of nothing.”
The proposed settlement, the judge continued, “suggests a rather cynical relationship between the parties: the S.E.C. gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger; the bank’s management gets to claim that they have been coerced into an onerous settlement by overzealous regulators. And all this is done at the expense, not only of the shareholders, but also of the truth.”
The case before Judge Rakoff is just one of several investigations into the bank’s deal with Merrill. Andrew M. Cuomo, the attorney general of New York, is also investigating the bank’s disclosures of bonuses and of Merrill’s surprise losses late last year. The House Committee on Government Oversight and Reform is also looking into the merger.
It is not the first time Judge Rakoff has ruffled feathers in the business world. In 2003, for example, he refused to approve what he saw as a low settlement the S.E.C. had negotiated with WorldCom, the phone company that collapsed in an $11 billion accounting fraud.
Rewarding — and punishing — the right parties was at the fore of the judge’s thinking in that case. Shareholders of WorldCom had already lost out. So when the judge forced the S.E.C. to increase the $500 million fine it was levying against WorldCom to $750 million, he also demanded that the money be paid out to the company’s shareholders, rather than to the agency.
Friday, September 11, 2009
REUTERS/Jason ReedOn Saturday, President Obama will return to Target Center, the scene here of a February 2008 campaign rally that drew an overflow crowd.
By Doug Grow | Friday, Sept. 11, 2009
On June 29, 2007, Democratic presidential candidate Barack Obama came to Minnesota to kick off his campaign in the state. The event was held at the International Market Square.
"The cardinal rule in politics is always fill the space so it looks crowded on television," said Minneapolis Mayor R.T. Rybak, an early Obama supporter and one of many working to ensure a big turnout for the president's return visit Saturday to Target Center.
International Market Square is an ideal venue, the mayor explained, because there are many levels. If there's only a small crowd, organizers only allow people on the first floor to make it look crowded.
On that first Obama visit, the people kept coming and coming and tier after tier at the building was filled.
"It was electric," recalled Rybak.
Still, when candidate Obama scheduled a Minneapolis campaign event for February 2008, Rybak was nervous.
"I was concerned he couldn't fill it [the Target Center]," the mayor recalled. "I suggested the auditorium at Augsburg."
The Obama campaign apparently had loftier visions. Rybak said OK, but had a Plan B in mind.
"I knew that the Target Center had come up with a way to cut the building in half, you know for smaller concerts and things like that," Rybak said. "I thought that's what we might have to do. Well, of course, as the event got closer, you could just feel the buzz. It turned out to be a political Woodstock. I remember coming early and seeing the lines and lines of people waiting to get in."
Rybak also recalled a brief conversation with the candidate.
"Right before he went on, he turned to me and said, 'Are we going to win this thing?' I said, 'I think so. He heard that word 'think.' He said, 'We have to.' "
And, of course, Obama proclaimed his victory in the long campaign for the nomination to an overflow crowd at St. Paul's Xcel Energy Center on June 3, 2008.
Now, he returns, as part of another brutal campaign. The campaign for substantive health care reform.
Rybak confident about Saturday rally
Rybak has no concerns about the greeting President Obama will receive.
"We [Obama supporters] will show up," Rybak said. "We'll do it again. There will be a lot of people, a lot of noise. We outnumber the people who have fought change — and we have a chance to show that. We've had a very small group of people present a lot of misinformation and make a lot of noise. Anybody mad about this junk that's gone on this summer should show up."
Caleb Williams/Augsburg EchoAt the February 2008 rally, then presidential candidate Barack Obama warmly greets Minneapolis Mayor R.T. Rybak, one of his early supporters.
To ensure that he's doing his part, Rybak urged "my 6,000 Facebook friends" to attend. He's also buttonholing everyone he sees when he's walking down his city's streets to make sure they show up Saturday.
Rybak's not alone in pushing Obama supporters to attend. The DFL is contacting its loyalists, as is Organizing for America, the Obama-inspired post-election organization, which sent out emails urging people to show up very early. (The event is at 12:30 p.m., doors open at 9:30 a.m.)
"He's under attack by Washington insiders, insurance companies and well-financed special interests who don't go a day without spreading lies and stirring up fear," wrote Jenn Brown, the Organizing for America state director for that organization's volunteers. "We need to show that we're sick and tired of it and that we're ready for real change this year."
What will the mayor say if the president turns to him and asks, "Are we going to win this thing?''
"I will say, 'We will win this thing,' " said Rybak.
And he's convinced that the wildly enthusiastic reception the president will receive Saturday will help change the tone of the debate.
Obama critics ready, too
Of course, others beg to differ.
Toni Backdahl is the president of the Minnesota chapter of the Tea Party Patriots, a conservative group that opposes a "government takeover" of health insurance. Although many observers believe that the president chose Minnesota for this campaign-style event because of its relatively progressive health care system and because it always has embraced him, Backdahl sees it differently.
"We must be doing a good job in Minnesota to make him come all the way out here," Backdahl said.
Despite the fact that these are very busy times for the Tea Party people, she believes they will have a substantial number of people at the Target Center Saturday and will join with other groups that also oppose the president.
Backdahl won't be able to attend. She and at least 30 other Tea Party folks have chartered a bus for the big 9-12 Day bash in Washington, D.C. on Saturday.
Digression here: Unless you're on the political right, you may not know of the significance of 9-12. I didn't, so Backdahl patiently explained.
It seems that Glenn Beck, a conservative-talk media guy and author, decided that 9-12 should be significant because in his view (video clip below), there are nine conservative principles and 12 values, thus there should be a gathering in D.C. on 9-12. A number of conservative organizations are promoting this event and have hopes of attracting 500,000 people to the nation's capital.
Anyhow, 30 of those folks will be rolling in on a bus from Minnesota late tonight. Additionally, a number of Tea Party members — they claim to have about 3,000 members in Minnesota — and other groups opposing reform, will be at a Saturday town hall meeting cheering U.S. Rep. Michele Bachmann in St. Cloud.
Still, Backdahl believes that a substantial number will show up at Target Center to voice displeasure over the Obama plan.
"We all know there needs to be reform," Backdahl said. "Many of us have had awful situations with health care. But many of us feel we're being lied to."
So outside the Target Center, there's likely to be some debating going on among those who support the president and those who don't trust him.
Minneapolis police expect no logistical problems
Minneapolis police seem calm in the face of what seemingly could be a messy situation.
"Fortunately, we're used to this," said Sgt. Jesse Garcia, spokesman for the Minneapolis police department. "When Bill Clinton was president, he came here frequently. We have sort of a template for handling these situations."
Much has been made of the fact that the Obama program at the Target Center starts shortly after the Twins are to play the Oakland A's at the Metrodome and a few hours before the University of Minnesota football team is to open its brand-new stadium on campus.
That seems like a whole lot of people moving around in a fairly small area.
But Garcia said that traffic for all of these events pales in comparison to the typical rush hour traffic that the city deals with every weekday. When presidents make weekday appearances — as Clinton frequently did — then, there are headaches because routes from the airport to downtown have to be closed to make way for a presidential motorcade just when people are trying to get to, or leave, work.
"This shouldn't be any different than a Saturday afternoon concert," said Garcia, "except you won't have to deal with so many drunken people or indiscriminate drug use."
What will the reception for the president be like?
Pawlenty low-key, welcoming
Given the tone set by Gov. Tim Pawlenty at a Thursday afternoon media briefing on the wonders of health care in Minnesota, even the foes of reform may be quite civil. Pawlenty went out of his way to avoid any sort of inflammatory rhetoric.
"We welcome his visit," the governor said, adding that the president could learn a lot about reform by looking at the Pawlenty administration's work in that area.
"I'm very proud of my administration's record. … It's less government-centric and more consumer-centric," Pawlenty said.
MinnPost photo by Craig LassigGov. Tim Pawlenty
Over and over, Pawlenty seemed to go out of his way to be careful with his rhetoric.
"This is an important debate," he said. "The issues need to be addressed."
It almost seemed as if the "You lie!" outburst blurted out by South Carolina Rep. Joe Wilson in the midst of the president's speech Wednesday night — served to pour cold water on some of the hot rhetoric.
"Inappropriate and unfortunate," said Pawlenty of the Wilson outburst. "There has to be a degree of respect. Applause is appropriate, silence is appropriate. Heckling is not."
As if responding to complaints that the Republicans are merely saying "no" to reform, Pawlenty laid out 10 things that constitute Pawlenty's view of reform in Minnesota.
The gov's top 10 goes like this:
1. Recognize that the current publicly subsidized system can't be sustained no matter "how well intentioned."
2. Pay for outcomes, not quantity of tests.
3. Focus on costs more than access.
4. Set up a system of "401ks for health care [because] it puts consumers in charge."
5. Tort reform.
6. More information for consumers.
7. Use market principles to hold down costs. If a consumer chooses to go to high-cost facilities, that consumer pays more.
8. Engage the private sector as a partner, not an opponent.
9. Require reporting of medical errors and don't pay when errors are made.
10. Prohibit insurance companies from denying coverage to those with pre-existing conditions.
The point he kept coming back to was cost.
"We need to focus on cost and quality as much as expanding access," said Pawlenty, adding that most Americans are happy with their care but fearful of the ever-growing expense.
But through all of this, Pawlenty's voice was soft. There was little of the overt sarcasm that so often comes out when speaking of Democrats.
Pro-reform side ready to rally
Likely, the voices won't be so soft on Saturday at an event being billed as a rally. After an August filled with taking lumps, the pro-reform crowd is coming back swinging.
"When the president spoke [Wednesday] I could almost feel a collective stiffening of the spine," said Rybak. "I could just feel it."
Rybak was so pumped up Thursday that he was urging people to make a day of it in Minneapolis. Go to the rally, have a meal, go to the Gophers' game, come back to downtown to party.
"Our own federal stimulus," said Rybak, laughing.
Restaurant owners near the Target Center share the mayor's enthusiasm for the big event.
"We'll have a few extra people working," said John Stein, manager of The Loon.
Stein's not saying where he stands on reform. All are welcome at his establishment — even the president.
"I understand he's a fan of chili," said Stein. "We're known for our chili. It would be real good if he wants to stop."
Doug Grow writes about public affairs, state politics and other topics. He can be reached at dgrow [at] minnpost [dot] com.
President Obama | Fri, Sep 11 2009 9:52 am
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