On looting

A good read: Graeme Wood's Atlantic essay covering Vicky Osterweil, her popular book In Defense of Looting, and NPR interview. (HT Niall Ferguson) 

NPR summarizes the book as an argument that “looting is a powerful tool to bring about real, lasting change in society.” If the real, lasting change you wish to effect is burning society to cinders and crippling for a generation its ability to serve its poorest citizens, then I suppose I am forced to agree. 

That's as nice a topic sentence as you could ask for.  

Looting is good, she [Osterweil] says, because it exposes a deep truth about the great American confidence game, which is that “without police and without state oppression, we can have things for free.” 

Just who is going to produce those things and work hard to sell them in a looting society? Wood essentially asks that gaping question. 

Osterweil’s argument is simple. The “so-called” United States was founded in “cisheteropatriarchal racial capitalist” violence. That violence produced our current system, particularly its property relations, and looting is a remedy for that sickness. “Looting rejects the legitimacy of ownership rights and property, the moral injunction to work for a living, and the ‘justice’ of law and order,” she writes. Ownership of things—not just people—is “innately, structurally white supremacist.”

This quote, I think, provides a deep understanding of our current far left. 

What if the private sector were responsible for California wildfires?

So we enter another week enveloped in smoke, here in California.

My thought for the day: Can you imagine the public and political reaction if this were caused by a private-sector activity?

Imagine for a minute that Jeff Bezos and Mark Zuckerberg had a many thousand acre ranch in Northern California, but for decades they refused to do any proper management and let kindling pile up. Suppose that when massive fires erupted every year, they relied on heroic volunteers and prisoners being paid a few dollars a day to go try to put out the flames. Suppose this happened every year, covering the state in smoke that make the bad old days of 1960s air pollution. Or, worse than Beijing

Suppose when questioned that Bezos and Zuckerberg said, well, there is nothing to be done about it because the climate is getting warmer. Or supposed they offered to build a high speed train and subsidize electric cars to reduce California's 0.1% contribution to carbon, so the climate will only get warmer 2.999 degrees rather than 3.00 degrees in the next century. Which you will pay for.

Imagine if any of this came from the private sector. Suppose one of the few remaining oil refineries were covering the state in smoke for a month at a time every year. Or if it were automobile exhaust.

I think the guillotine set up in front of Bezos' home recently is mild compared to what would happen. The state government would be launching lawsuits, draconian regulations, and long prison terms. Politicians and activists would be issuing daily denunciations of capitalism gone amok.  Bad air  hits poor, sick, and minorities harder, which they'd be screaming about.

This is the state that pioneered clean air after all. We have had our own special smog restrictions on cars for a half a century. Commenters on nextdoor go apoplectic if anyone turns on a gas leaf blower.

Yet the response so far is an amazing silence. If indeed it is climate change, dear fellow citizens, then that is ever more reason to do something about it. Climate change is a slow-moving predictable problem that will get worse. Even if the whole world takes up the whole green new deal, and even if that turns out to work, it only limits how much the climate gets warmer. If it's climate change, the only rational answer is to spend a lot more money to fix the problem, now. There are a lot of unemployed people in this state. They could be cleaning forests 11 months of the year. There is a huge amount of money in the state budget. It could be hiring firefighters, buying airplanes, and stopping this in its tracks.

Underlying it is the moralistic attitude. This is the price we must pay for our carbon sins, so we must pray to the carbon gods with useless virtue signals and endure, as our ancestors prayed to keep plague away. Even though we know the cause and effect here. To do anything about climate-induced problems is dreaded "adaptation," which does not involve the necessary self-flagellation.

But that attitude would change fast if the government were not completely responsible for this avoidable disaster. Hence my thought for the day.

Goodfellows RNC commentary

The latest Goodfellows podcast, with guest Lanhee Chen. We discuss the Republican convention, the implosion of cities,  and related matters.

Direct link here.

The main message of each convention, perhaps: Joe Biden is not Donald Trump. Donald Trump is not a progressive Democrat.

Sowell review

Coleman Hughes writes a wonderful review of Thomas Sowell's life and work in City Journal. Savor it.

My first Sowell book was Knowledge and Decisions, and I am heartened to see Hughes put that foremost as well. Sowell takes up where Hayek left off, how the price system is the network like our neurons communicating information across a complex economy. This remains a verbal part of the economics tradition, resisting formal modeling so far, and is thereby too often glossed over in graduate training. Read it. 

Sowell of course has written masterpieces on race, a collection of impeccably documented uncomfortable truths to the progressive left. My first, The Economics and Politics of Race is just one of nearly a dozen meticulous books, from Black Education: Myths and Tragedies (1972) to Discrimination and Disparities, second edition (2019). Hughes reviews important points in Conquests and Cultures, Migrations and Cultures, and Race and Culture.

The filibuster and partisanship

The Wall Street Journal reports that the movement among Senate Democrats to get rid of the filibuster entirely is gaining steam. I think this is a bad idea and will lead to more polarized politics.

Why are our politics so polarized? One answer is that elections are more and more winner take all. The more it is winner take all, the more incentive there is for scorched-earth tactics to win, or to keep from losing.

Imagine a not so distant future in which winning an administration and both houses of Congress by 50.5% means a party can pass any legislation it likes, pack the Supreme Court or better yet impeach the lot and replace them, take control of the Department of Justice and FBI, swiftly jail anyone involved with the previous administration, take control of voting law and regulation, further hand out money to political organizations on its side, and by regulation and high taxes force businesses and wealthy individuals to its side. One person, one vote, one time.

That's extreme, but our political system has headed a lot in this direction already. As the stakes in each election get higher, do not be surprised that the scorched-earth partisanship and polarization of politics gets stronger.

The first function of a democracy is a peaceful transition of power. That requires losers to accept their fate, acknowledge the legitimacy of the outcome, regroup and try again. And they have to be able to do that.  We are not a pure democracy. We are set up as a republic, with elaborate protections for electoral minorities. The point is to keep those electoral minorities from rebelling. Union first, "progress" second.

The filibuster is a small and imperfect part of this protection. It evolved by tradition, not design. It has a sordid racial history, being used for decades by southern democrats to block civil rights legislation. To work, both sides had to accept certain rules of the game. You use it only to block core issues of great importance. You do not use it as willy-nilly obstructionism. It has to be costly to those who use it.  It, and other protections could be improved for sure. But we need somehow the space that a narrow election loss does not mean utter defeat and devastation.

Like the other protections for electoral minorities, it has already been mostly torn down, as the WSJ reports. But if, say, Republicans can shove guns, immigrant deportation, and abortion prohibition down Democratic throats with a tiny majority, or Democrats can shove unions, wealth taxes, and national health insurance down Republican throats with a tiny majority; if, more importantly, either party can take a tiny majority to entrench their hold on power and disenfranchise the other, we have not seen anything yet in the partisanship and polarization department.

Magical monetary theory full review

I read Stephanie Kelton's book, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy,” and wrote this review for the Wall Street Journal. Now that 30 days have passed I can post the whole thing. 

I approached this task with an open mind. What I had heard of MMT has some overlap with fiscal theory of the price level, on which I work, and I hoped to see some commonality.

I was disappointed.

The review:

Modern monetary theory, known as MMT, erupted suddenly into the public consciousness when it won the attention of high-profile politicians including Bernie Sanders and Alexandria Ocasio-Cortez and their media admirers. Its central proposition states that the U.S. federal government can and should freely print money to finance a massive spending agenda, with no concern about debt and deficits.

What is MMT? Its advocates have told us in essays, blog posts, videos and tweets what MMT says about this and that, but what is its logic and evidence? As a monetary theorist who is also skeptical of conventional wisdom, I looked forward to a definitive exposition from Stephanie Kelton’s “The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy.”

Ms. Kelton, a professor of economics at Stony Brook University and senior economic adviser to Bernie Sanders’s presidential campaign, starts with a few correct observations. But when the implications don’t lead to her desired conclusions, her logic, facts and language turn into pretzels.

True, the federal government can spend any amount by simply printing up the needed money (in reality, creating bank reserves). True, our government need never default since it can always print dollars to repay Treasury bonds. But if the government prints up and spends, say, $10 trillion, will that not lead to inflation? Ms. Kelton acknowledges the possibility: “If the government tries to spend too much in an economy that’s already running at full speed, inflation will accelerate.”

So how do we determine if the economy is running at full speed, or full of “slack,” with unemployed people and idle businesses that extra money might put to work without inflation? Ms. Kelton disdains the Federal Reserve’s noninflationary or “natural” unemployment rate measure of slack as a “doctrine that relies on human suffering to fight inflation.” Even the recent 3.5% unemployment is heartlessly too high for her.

“MMT urges us to think of slack more broadly.” OK, but how? She offers only one vaguely concrete suggestion: When evaluating spending bills, “careful analysis of the economy’s . . . slack would guide lawmakers. . . . If the CBO [Congressional Budget Office] and other independent analysts concluded it would risk pushing inflation above some desired inflation rate, then lawmakers could begin to assemble a venue of options to identify the most effective ways to mitigate that risk.” She doesn’t otherwise define slack or even offer a conceptual basis for its measurement. She just supposes that the CBO will somehow figure it out. She doesn't mention that the CBO now calculates a measure, potential GDP, which does not reveal perpetual slack. And she later excoriates the CBO for its deficit hawkishness.

Really her answer is: Don’t worry about it. She simply asserts that “there is always slack in the form of unemployed resources, including labor.”

We’re not talking about a little slack either. Ms. Kelton’s “people’s economy” starts with the full Green New Deal and moves on to a federal job for anyone, free health care, free child care, the immediate cancelation of student debt, free college, “affordable housing for all our people,” national high-speed rail, “expanded Social Security,” “a more robust public retirement system,” “middle-class tax cuts,” and more. How much does this add up to? $20 trillion? $50 trillion? She offers no numbers. How is it vaguely plausible that the U.S. has this much productive capacity lying around going to waste?

In a book about money, the inflation of the 1970s and its defeat are astonishingly absent. History starts with Franklin Roosevelt—a hero for enacting the New Deal but a villain for paying for it with payroll taxes rather than fresh dollars. Ms. Kelton praises John F. Kennedy, too. He “pressured unions and private industry, urging them to keep wage and price increases to a minimum to avoid driving inflation higher. It worked. The economy grew, unemployment fell sharply and inflation remained below 1.5 percent for the first half of the decade.”

The second half of that decade—Lyndon Johnson’s Great Society and Vietnam War spending, inflation’s breakout, Richard Nixon’s [1971] disastrous price controls—is AWOL. Did we not try MMT once and see the inflation? Did not every committee of worthies always see slack in the economy? Did not the 1970s see stagflation, refuting Ms. Kelton’s assertion that inflation comes only when there is no “slack”? Don’t look for answers in “The Deficit Myth.”

Victory over inflation under Ronald Reagan and Margaret Thatcher goes likewise unmentioned. History starts up again when Ms. Kelton excoriates Thatcher for saying that government spending has to be paid for with taxes. She insinuates, outrageously, that Thatcher deliberately lied on this point in order to “discourage the British people from demanding more from their government.”

If spending can be financed by printing money, “why not eliminate taxes altogether?” Ms. Kelton begins consistently. She criticizes Sens. Bernie Sanders and Elizabeth Warren for claiming that they need to raise taxes to pay for spending programs. But then why raise taxes? Taxes exist to decapitate the wealthy, not to fund spending or transfers: “We should tax billionaires to rebalance the distribution of wealth and income and to protect the health of our democracy.”

She offers a second answer, more subtle, and revealingly wrong. She starts well: “Taxes are there to create a demand for government currency.” This is a deep truth, which goes back to Adam Smith. Soaking up extra money with fiscal surpluses [higher taxes or less spending] is, in fact, the ultimate control over inflation. But then arithmetic fails her. To avoid inflation, all the new money must eventually be soaked up in taxes. The new spending, then, is ultimately paid for with those taxes.

What about the debt? Ms. Kelton asserts the government can wipe it out. Again, she starts correctly: The Fed could purchase all of the debt in return for newly created reserves. She continues correctly: The Fed could stop paying interest on reserves. But in conventional thinking, these steps would result in a swift inflation that is equivalent to default. Ms. Kelton asserts instead that these steps “would tend to push prices lower, not higher.” She reasons that not paying interest would reduce bondholders’ income and hence their spending.

 The mistake is easy to spot: People value government debt and reserves as an asset, in a portfolio. If the government stops paying interest, people try to dump the debt in favor of assets that pay a return and to buy goods and services, driving up prices.

What about all the countries that have suffered inflation, devaluation and debt crises even though they print their own currencies? To Ms. Kelton, developing nations suffer a “deficit” of “monetary sovereignty” because they “rely on imports to meet vital social needs,” which requires foreign currency. Why not earn that currency by exporting other goods and services? “Export-led growth . . . rarely succeeds.” China? Japan? Taiwan? South Korea? Her goal posts for “success” must lie far down field.

The problem is that “the rest of the world refuses to accept the currencies of developing countries in payment for crucial imports.” Darn right we do. Her solution: more printed money from Uncle Sam—a “global job guarantee.”

She also advises small and poor countries to cut themselves off from international commerce. They should develop “efficient hydroponic and aquaponics food production” and install “solar and wind farms” rather than import cheap food and oil. They should refuse international investment, with the “classical form of capital controls” under Bretton Woods as an ideal. “We share only one planet,” she writes, yet apparently that planet must have hard national borders.

By weight, however, most of the book is not about monetary theory. It’s rather a recitation of every perceived problem in America: the “good jobs deficit,” the “savings deficit,” the “health-care deficit,” the “infrastructure deficit,” the “democracy deficit” and—of course —the “climate deficit.” None of this is original or relevant. The desire to spend is not evidence of its feasibility.

Much of “The Deficit Myth” is a memoir of Ms. Kelton’s conversion to MMT beliefs and of her time in the hallways of power. She criticizes Democrats, including President Obama and his all-star economic team, for their thick skulls or their timidity to state her truth in public. Republicans, such as former House Speaker Paul Ryan, are just motivated by dark desires to keep the people down and enrich big corporations and wealthy fat cats. President Trump’s tax cuts are a “crime.” How insightful.

In a revealing moment, Ms. Kelton admits that “MMT can be used to defend policies that are traditionally more liberal . . . or more conservative (e.g., military spending or corporate tax cuts).” Well, if so, why fill a book on monetary theory with far-left wish lists? Why insult and annoy any reader to the right of Bernie Sanders’s left pinkie?

Writing the book to “defend” an immense left-wing spending agenda destroys her argument. If you could only feel her singular empathy for the downtrodden, if you could, as she does, view the federal budget as a “moral document,” if you could just close your eyes and need it to be true as much as she does, your “Copernican moment” will arrive, and logic and evidence will no longer trouble you.

That effect is compounded by her refusal to abide by the conventional norms of economic and public-policy discourse. She cites no articles in major peer-reviewed journals, monographs with explicit models and evidence, or any of the other trappings of economic discourse. The rest of us read and compare ideas. Ms. Kelton does not grapple with the vast and deep economic thinking since the 1940s on money, inflation, debts, stimulus and slack measurement. Each item on Ms. Kelton’s well-worn spending wish list has raised many obvious objections. She mentions none.

Skeptics have called it “magical monetary theory.” They’re right.

****

Update. To "jabmorris" and "rob." How could you possibly know if I have or have not read the book? As a matter of fact, I read every word of it. You offer a false accusation of impropriety, that you could not possibly know anything about, instead of a shred of fact or logic. This seems about par for the course in MMT land.

The cancel culture twitter mob comes to economics

Last week we learned  the twitter mob has taken over economics too.

In case you aren't following, here is the short version of the story. Harald Uhlig, a distingushed macroeconomist at the University of Chicago,  sent out a few tweets questioning the wisdom of quickly "defunding the police." The twitter mob, led by Paul Krugman and Justin Wolfers, swiftly attacked. A petition circulated, reportedly gaining 500 signatories, demanding his removal as editor of the Journal of Political Economy.  I saw an astonishing number of tweets from economists that I formerly respected and considered to be level headed, fact-and-logic, cause-and-effect analysts of public policies pile on.   The media piled on, with coverage at  New York Times, Wall Street Journal Chicago Tribune and a bit of a counterpoint at Fox News, Breitbart National Review and others. By Friday, the University of Chicago caved in and threw Harald under the bus.

Start by actually reading Harald's tweets.

Good Fellows -- International Man of History

A new lively Good Fellows discussion video

and podcast





Direct links here if the above embed codes don't work.

School of sustainability

In a few recent posts, I was critical of university endowment practices. Why build up a stock of investment, rather than invest in faculty, research, or other core activities? Why wall that pile of assets from being spent, especially when budgets are cratering in a pandemic? When we see businesses with piles of cash, we infer they don't have any good investment projects, and the piles are ripe for diversion to bad ideas.

But universities are non-profits, and one major piece of being a non-profit is that the business is protected from the market for corporate control. If you see a business wasting money on bad investments, buy up the stock, fire management, and run it right. Repurchases were part of an earlier reform effort, to stop management from wasting money on aggrandizing projects.

Perhaps restrictions on endowment spending serve a somewhat parallel function for universities. Perhaps I was wrong to criticize so harshly.

These thoughts are brought to mind by Stanford's announcement of a new school "focused on climate and sustainability." A "school" is bigger than a center, an institute, a department, a division. Stanford has seven "schools," Business, Education, Engineering, Humanities & Sciences, Law, Medicine, and, yes, Earth, Energy & Environmental Sciences.

Why a new school? It will

"amplify our contributions in education, research and impact further by aligning people and resources more effectively.

Says university President Tessier-Lavigne. Vice Provost Kathryn Moller will

"lead an inclusive process designing the school’s structure....consult with key internal and external stakeholders to develop a school organization that amplifies faculty and student contributions to address the most urgent climate and sustainability challenges." 

creating an

"impact-focused community, with new opportunities to enhance the impact of their work on the issues they deeply care about,” 

"Impact" and "amplify" repeat quite a few times.

Strategies for Monetary Policy

Strategies for Monetary Policy is a new book from the Hoover Press based on the conference by that name John Taylor and I ran last May. (John Taylor gets most of the credit.) This year's conference is sadly postponed due to Covid-19. We'll have lots to talk about May 2021.

At that link, you can see the table of contents and read Chapter pdfs for free. You can buy the book for $14.95 or get a free ebook.

The conference program and videos are still up.

Much of the conference was about the question, what will the Fed do during the next downturn? Here we are, and I think it is a valuable snapshot. Of course I have some self interest in that view.

As long as I'm shamelessly promoting, I'll put in another plug for my related Homer Jones Lecture at the St. Louis Fed, video here and the article Strategic Review and Beyond: Rethinking Monetary Policy and Independence here. That was written and delivered in early March, about 5 minutes before the lookouts said "Iceberg ahead." John and I don't put a lot of our own work into the conference books, but it sparked a lot of thoughts.  I am grateful to Jim Bullard and the St. Louis Fed for the chance to put those together.

Monetary policy is back to "forget about moral hazard, rules, strategies and the rest, the world is ending." This is a philosophy that happens quite regularly and now has become the rule and strategy. So strategic thinking about monetary policy is more important than ever.  This is a philosophy very much due to John Taylor.

The last part of my Homer Jones paper delves into just what risks the big thinkers of central banking were worried about on the eve of the pandemic. Pandemic was not in any stress test.  BIS, BoE, FSB and IMF  wanted everyone to start stress testing ... climate change and inequality. This is a story that needs more telling.    

Markets work even in crisis

A lovely result of the corona virus outbreak has been how we see stifling aspects of regulations. Right left and center are figuring out that the regulations need reform. Now, the forces for regulatory stagnation are always strong, so the insight may fade with the virus. Still, let us enjoy it while it lasts.

The trouble with regulations is that, unlike "stimulus," the action is all in minute detail not grand sweeping plan.

John Goodman writes in Forbes

The Americans for Tax Reform calculates that 397 regulations have been waived in order to fight COVID-19. That count is probably way too low. The federal Food and Drug Administration (FDA) has eliminated so many restrictions it would be hard to count them all. ... 

Consider that, up until a few months ago: 

·     The only tests for the coronavirus that were approved for use in the United States were produced by the Centers for Disease Control (CDC) and half of those tests turned out to be defective. 

·     It was illegal to produce, sell and distribute ventilators, respirators, and other  medical equipment without complicated and burdensome government regulatory permission. 

Heckman Haiku

Jim Heckman's interview with Gonazlo Schwartz at the Archbridge Institute is making the rounds of economists. I admire it for how much the interviewer and Heckman pack in so little space, so pithy, well expressed, and so happy to trounce on today's pieties. (As blog readers will have noticed, short does not come easily to me.) It's hard to summarize a Haiku -- go read the whole thing. But I'll try.

Gonzalo Schwarz: Many commentators have said that it is not possible to achieve the American Dream any more in the United States. Do you think the American Dream is alive and well?

Dr. James Heckman: Ask any immigrant. They are grateful for the chances that America has given them. Many came with nothing. They live in decent neighborhoods and their families have better lives than they could have before coming here. Their children go to college and integrate into American society. The progress of African Americans over the past century is staggering. Many have shaken off the legacies of poverty and discrimination....

Social mobility:

G: ...what do you think are the main barriers to income or social mobility?...

H: The main barriers to developing effective policies for income and social mobility is fear of honest engagement in the changes in the American family and the consequences it has wrought. It is politically incorrect to express the truth and go to the source of problems.... Powerful censorship is at play across the entire society....The family is the source of life and growth. Families build values, encourage (or discourage) their children in school and out. Families — far more than schools — create or inhibit life opportunities. A huge body of evidence shows the powerful role of families in shaping the lives of their children. Dysfunctional families produce dysfunctional children. Schools can only partially compensate for the damage done to the children by dysfunctional families.

He is right on the fact, how blissfully it is ignored by those wishing more "policies" to address inequality and other social programs, and censorship against those who say it.

On "current academic and policy discussion on income mobility and inequality, "

GoodFellows: Cold War 2

The latest GoodFellows, on just how much we need to ramp up Cold War 2 against China.

Since it was two against one, and I didn't get a response in, I'll add one unfair late hit. In discussing Huawei, and whether Chinese state planning would allow them "economic dominance" in the next decades, my colleagues jumped to the charge that Huawei equipment would include nasty backdoors that the Chinese government would use to spy on us.

I think here they confused "economic competition" with security competition. The topic was whether state planning could give a nation "economic domination" of anything important. The reply that we need to worry about security implications does not answer the question.

The charge I think has also been overstated. Huawei has every interest to assure people its equipment does not have back doors, and my impression is they convinced the UK pretty well on that. Moreover, the US government is explicit in its desire that Apple and other US companies give the NSA back doors. I would welcome more knowledgeable commentary on this issue before next week.

We were prepared

A lovely compilation from Judge Glock. Some excerpts

six months before the current outbreak, Congress passed the Pandemic and All-Hazards Preparedness and Advancing Innovation Act of 2019, which offered funds and planning authority for just such a crisis as we now face.[2] This act was a reauthorization and an extension of half a dozen similar acts passed over the previous two decades, which acts were themselves extended in countless congressional spending bills, all of which resulted in countless plans....

Pervasive Pandemic Preparedness Planning

After the avian influenza scare of 2005, Congress did the thing it does best, demand that somebody else come up with a plan. With the help of some of the best known names is Congress, Congress passed the Pandemic Preparedness and Response Act in December of the following year.[3] The act ordered the administration to convene a Pandemic Influenza Preparedness Policy Coordinating Committee, with most of the Cabinet in attendance, to write a plan for a biological catastrophe.[4] The result was, first, a White House Homeland Security Council National Strategy for Pandemic Influenza, followed the next year by National Strategy for Pandemic Influenza Implementation Plan. The latter plan contained 233 pages of nebulous suggestions, such as recommending that, in a crisis, the government should be “providing anticipatory guidance and dispelling unrealistic expectations about the delivery of health and medical care.”[5] These general plans in turn birthed numerous individual departments plan, such as the Department of Defense Implementation Plan for Pandemic Influenza.[6] To supplement these federal plans, the Preparedness Act, and its subsequent iterations, also mandated that states create their own Pandemic Preparedness Plans, which have to be submitted regularly to the Centers for Disease Control and Prevention for approval. These plans total thousands of pages.[7]

Kocherlakota on moral hazard

I found a kindred spirit. Narayana Kocherlakota, ex president of the Minneapolis Fed, shares my concerns over the current lending and bailout spree, in particular propping up the prices of corporate bonds.

In its last financial stability report of 2019, the Fed highlighted how many nonfinancial corporations were making use of highly risky debt. The report pointed out that “a number of contacts expressed concern that a U.S. recession would expose highly leveraged sectors … concerns related to nonfinancial corporate debt were cited most frequently, with a focus on the growth in leveraged loans, private credit, and triple-B-rated bonds.” 

The financial stability report, of course, made no mention of pandemics or social distancing. It didn't need to — the risk to the financial system and the economy is posed by any recessionary shock. The coronavirus just happened to be the first one that come along.

Bailout redux

The greatest financial bailout of all time is underway. It’s 2008 on steroids. Yet where is the outrage? The silence is deafening. Remember the Tea Party and occupy Wall Street? “Never again” they said in 2008. Now everyone just wants the Fed to print more money, faster. (Well, there are some free market economists left. But we're a small voice!)

Maybe the Fed is right that if any bondholder loses money, if bond prices fall, if companies reorganize in bankruptcy, the financial system and the economy will implode. I am not here today to criticize that judgement. But if so, we must ask ourselves how we got to this situation, again, so soon. Once is an expedient. Twice is a habit.  It is clear that going forward any serious shock will be met by bailouts, and the Fed printing reserves to buy vast quantities of any fixed-income asset whose price starts to fall.

Why does the Fed feel the need to jump in? Because once again America is loaded up with debt, because bankruptcy is messy, and because the Fed fears that debt holders losing money will stop the financial system from providing, well, more debt.

This crisis is a huge wealth shock. The income lost during shutdown is simply gone. The question is, who is going to take that loss? Borrowing to keep paying bills, the current solution, posits  that future profits will soak up today's losses. We'll see about that. The CARES act puts future taxpayers squarely on the hook to pay today's bills. But where do those bills go? To creditors -- property owners, bond holders, and so forth. If we're looking around for pots of wealth to absorb today's losses, why are bondholders not chipping in? The biggest wealth transfer in history is underway, from tomorrow's taxpayers to today's bondholders, on the theory that if they lose money the economy falls apart?

OK, but why did America load up with debt again, apparently all "systemically important?" Could the expectation of a bailout any time there is an economy wide shock happens have had something to do with it? Will we do anything when this is over to stop companies from once again loading up with debt -- especially short term debt -- and forcing the Fed's hand again?

Meantime, anyone who hoarded some savings in the hope of profiting from fire sales, in the hope of providing liquidity to "distressed markets" has once again been revealed as a chump. Will we do anything to encourage them? Will lots of debt, private gain, taxpayers take the losses,  be the perpetual character of our financial system.

"You can't worry about moral hazard in a crisis," they said, and they didn't. At least last time there was some recognition of moral hazard, and a promise to clean up the moral hazard with reform. Will there be any such effort this time? Is anyone even thinking about the enormous moral hazard we are creating with these precedents? Will  the financial system perpetually a four-year-old on a bicycle, a parent running closely behind with one hand on the seat? Will the "Powell put" on fixed income grow ever larger? Or will we, this time, finally cure the financial system so it can survive the next shock?

A bailout 

Small but symbolic: The federal government just bailed out the airlines -- or more precisely airline stockholders, bondholders, unions, airplane leaseholders and other creditors who would lose in bankruptcy.

 "big airlines will receive 70% of the money as grants—which won’t be paid back—and 30% as loans. The cash comes with strings attached: Airlines must give the government warrants amounting to 10% of a given loan’s value that can be swapped for stocks; they cannot lay off staff until September; and they face restrictions on dividends, buybacks and executive compensation."

Oh, and as the article makes clear, this only gets us maybe through the summer. Anyone want to take a bet that planes are full again by September?

The big banks got bailed out in 2008 — or more precisely, the stockholders, bondholders and creditors of the big banks got bailed out.  Never again, they said. Again.

Now, one can make a case that big banks are “systemic,” that if their bondholders lose money the financial system collapses. Just how are airline bondholders “systemic?” What calamity falls if airline bondholders don’t get paid in full?  Just why is a swift pre-packaged bankruptcy not the right answer for airlines? This seems like a great time to renegotiate airplane and gate leases, union contracts (some require the airlines to keep flying empty planes!) fixed-price fuel contracts and more.

If taxpayers have to give airlines cash grants don't we get some reassurance this doesn't have to happen again? Even I would say, no more debt financing. You can see the instinct in "restrictions on dividends, buybacks and executive compensation." Democrats in Congress wanted "stakeholder" board seats, carbon reporting, and more. Why not go full Dodd-Frank on them? Detailed regulation of their financial affairs, stress tests to make sure they can survive the next time? Like banks, the existing airlines might not end up minding so much a return to the 1970s status as regulated utilities. Or, more likely, like GM, we just forget about it, let them load up on debt again, and pretend there won't be a 2030 bailout?

The Fed's big artillery

The real action is at the Fed. The Fed is buying commercial paper, corporate bonds, municipal bonds. The Fed is explicitly propping up asset prices. The Fed is also lending directly to companies. The current guesstimate is $4 trillion, with $2 trillion already accomplished. More is coming.

It started "small" On March 17, the Fed bailed out money market fund investors, buying the “illiquid” assets of those funds so that the funds could continue to pay out dollar for dollar.  Recall that in 2008, the Fed and Treasury bailed out money market fund investors, buying assets to stop a run on money-market funds' promise that you can always cash out at $1. Never again, they said. Fixed dollar promises must be backed by Treasuries, other funds must let asset values float. Again.

On March 17 the Fed also announced it will buy commercial paper.  “Directly from eligible companies.” Yes, the Fed prints reserves to lend directly to companies that can issue A1/P1 commercial paper.

"By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. " 

Why are companies borrowing long term by rolling over commercial paper? Didn't we learn anything about rolling over short term debt in 2008? Are we going to follow up by putting a stop to that? Why don't companies have more equity financing, on which they can just stop paying dividends?

"Investors" you say, it's not all the Fed. Read carefully. "By eliminating much of the risk..." The Fed props up prices, and removes risk. Then private investors will come in. The markets won't ride that bike without the Fed's hand on the saddle, apparently. Why do we bother to have private markets?

On March 17 the Fed started to lend again to primary dealers. These are the traders, much maligned by the Volcker rule.

The PDCF will offer overnight and term funding with maturities up to 90 days...Credit extended to primary dealers under this facility may be collateralized by a broad range of investment grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities. 

Let's translate. You're the trading desk at, say Goldman Sachs. You want to buy stocks, as you think people are dumping in a hurry. Great, that's what traders are supposed to do: "provide liquidity." But, sadly, you're in the habit of of funding trading activity by borrowing money, short term. And you can't do that right now. So the Fed will now lend you the money to buy stocks, and will take the stocks as collateral! It's almost as if the Fed is buying stocks -- except you get the gains, and if you go under, the Fed gets the stocks! (A friend in the securities industry say nobody is bothering to investigate and price high grade corporates. The Fed is setting the prices.)

Again, the Fed is between a rock and hard place. Yes "balance sheets are constrained." Trading firms don't have enough equity to take on additional risk. The natural buyers at asset fire sales are constrained out of the market. Bail the Fed feels it must. But this is exactly what happened when the Fed first lent to broker/dealers in 2008! Why in the world are we in this position, 12 years after that crisis?

On March 20, the Fed expanded into state and municipal markets. The mechanism is the same: Fed lends to a financial institution, which buys the assets, and then gives the Fed the assets as collateral for the loan. Once again the point is  "enhance the liquidity and functioning of crucial state and municipal money markets."

On March 23, the Fed rolled out real artillery. Ominously, Treasury markets appeared "illiquid," so the Fed has stepped in buying $1.3 trillion in the first month -- more than the Treasury issued.  The Fed is funding Treasury borrowing with newly printed reserves.  The Fed now buys mortgage backed securities.

And now.. corporate bonds. This is well past 2008.

the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.

Translation: The Fed will buy new corporate bonds, thus directly lending to corporations. And it will buy  outstanding bonds.

Why would it do that? Well, to "provide liquidity." This is a word that ought to set off BS detectors. Yes, there is such a thing as an "illiquid" market. There is also such a thing as a market whose prices are dropping like a stone. Sell all you want but at 50 cents on the dollar. "I wish I had sold at yesterday's prices" is not illiquidity. You have to pay people a lot to take risk right now. Which is it? Hard to tell. There are ways to tell, of course. For example, illiquid markets have negative price autocorrelation -- a low price today bounces back. I am not aware of the Fed having applied this or any other test. (Research topic suggestion.)

Again, I don't want to criticize, but there sure is a danger of propping up prices under the guise of "illiquidity." The Fed's view that if the Fed takes all risk off the table "liquidity" will reappear is also pretty close to taking risk off the table so prices will rise.

The Fed is already buying new bonds from companies to finance their new expenditures. Propping up prices of existing bonds is a way to let old bondholders cash out at high prices, now before the deluge. Just why can't old bondholders even take mark-to-market losses?

And, if corporate bondholders need to be bailed out in this way, are we going to do anything about it going forward? Do you get to buy junk bonds, high interest municipal debt, and the Fed will let you out if anything bad happens?

Wrap up

OK, I haven't even gotten through March and the Fed is just getting going. Let's wrap up.

The Fed has felt the need to take over essentially all new lending in the economy. The Fed is also propping up most fixed-income prices. The Fed is deliberately removing risk from holding these assets.

Once again, I will be told, "this isn't the time to think about moral hazard." But having done this twice, the first time with huge protest, the second time as if it is perfectly normal, this is the pattern, and the moral hazard is there. The economy will load up on debt, especially short term debt. People will not keep stashes of savings around to provide liquidity or jump on buying opportunities. And the need for bailouts will be larger in the next crisis.

"But the Fed made money in 2008" you may retort. And it has a half chance of making money again. If the recession wraps up in September and these "loans" get paid back, it will do nicely. If the recession goes on a year and all these "loans" go sour, it will not look so pretty.

Yes, in 2008 the Fed and treasury successfully operated the world's largest hedge fund, printing money to buy low-price assets. But is this really the function of the Federal Reserve? Do we want it driving private hedge funds out of the liquidity provision business, by its ability to print rather than borrow money, and by the off-balance-sheet put that the US taxpayer will in the end take losses if this massively leveraged portfolio doesn't work out?

Where is the outrage? Where are the financial economists? Where is the reform plan so we don't do this again? At a minimum, can we say tha  the government could stop subsidizing debt, via tax deduction and regulatory preference for "safe" (ha!) debt as an asset?

Hello out there? In 2008, everyone was writing financial crisis papers. Now everyone is playing amateur epidemiologist.

Finance colleagues, you have a bigger crisis and intervention to study, and a deeper set of regulatory conundrums. Is everyone just too scared of sounding critical of the Fed? Get to work!

The Fed and Treasury's actions are telling us we are on the verge of financial apocalypse. Let's wake up and look at what's coming, especially if it doesn't all get better by September.

Some links 

This post continues from Financial Pandemic.

I had planned a longer post on the details of many of these programs, but this is long enough.


A great explanation by Robert McCauley in FT. Section heads include  1) Acting as a lender of last resort to securities firms, 2) acting as a lender of last resort to investment funds, 3) acting as a securities dealer of last resort, 4) acting as a securities underwriter of last resort and finally 5) acting as a securities buyer of last resort.

A simple tweet storm by Victoria Guida

Via the indefatigable Torsten Slok,

Financial Policy During the COVID-19 Crisis MIT opeds on financial affairs

A great list of policy trackers.

Financing Firms in Hibernation During the COVID-19 Pandemic

The Yale Financial Stability Tracker and especially the Finance Response Tracker are very useful list of what's going on.

Fed Intervention in the To-Be-Announced Market for Mortgage-Backed Securities
by Bruce Mizrach and Christopher J. Neely is a very nice description of what's going on there

The United States as a Global Financial Intermediary and Insurer by Alexander Monge-Naranjo. More contingent liabilities waiting for Uncle Sam bailouts.

A data set of international fiscal responses

Financial pandemic

The headlines are on the disease, the shutdown, and the hoped-for safe reopening. It's time to pay some attention to the financial side of the current situation, and the Federal Reserve's immense reaction to it.

Disclaimer: do not read in this post criticism of the Fed. Maybe the world would have ended if they had done things differently. But it is important for us who study such things to understand what they did, what beneficial and adverse consequences there are, and how the system might be set up better in  the future.

Big picture: We face an extremely severe economic downturn, of unknown duration -- it could be a V,  U, or L. If it is not a V shaped in months, there will be a wave of bankruptcies from personal to corporate, and huge losses all over the financial system. Well, earn returns in good times and take losses in bad times, you may say, and I do, more often than the Fed does, but for now this is simply a fact.

Our government's basic economic plan to confront this situation is simple: The Federal Reserve will print money to pay every bill, and guarantee every debt, for the duration. And, to a somewhat lesser approximation, to ensure that no fixed-income investor loses money. 

I reiterate, the point of this post is not to criticize. If you are reading economics blogs, you like me probably have a nice work-from-home job that still pays some money. This is not what's going on. From a combination of voluntary and imposed social distancing, the economy is collapsing. As I detailed in an earlier post  20 million people, more than 1 in 10 US workers, lost their jobs in the first month of this shutdown. That's more than the entire 2008 recession. In 3 weeks. 1/3 of US apartment renters didn't pay April rent. Run that up through the financial system. Most guesses say that companies have one to three months of cash on hand, and then fail. We'll look at signs of financial collapse in a bit, that the Fed reacted to. If you want to know why the Fed hit the panic button, it's because every alarm went off.

Pay every bill? Yes, pretty much. This is not "stimulus." It is get-through-it-us. People who lost jobs and businesses that have no income can't pay their bills. When people run out of cash they stop paying rent, mortgages, utilities, and consumer debts. In turn the people who lent them money are in trouble. Businesses with zero income can't pay debts (just why debts are so large is a good question to keep track of), employees, rent, mortgages, utilities. When they stop, paying they go through bankruptcy and their creditors get in to trouble. If you want to stop a financial crisis, you have to pay all the bills, not just some extra spending cash.

And that's pretty much the plan. There will be unemployment insurance, with 100% replacement of wages, for people who lose jobs, so they can pay rent, mortgages, utilities, and consumer debts. The Small Business Administration will make forgivable loans to businesses. Bailout plans are in place to make sure industrial companies like Arlines do not file for bankruptcy. (Much of this money is stuck in snafu, but that's the plan if not the execution.) And, where the big money is, the Fed is propping up corporate bond, municipal bond, treasury, money market funds, and other markets. I'll survey the programs below, this is big picture for now.

Printed money? Yes. Start with the Treasury. The Treasury wants to spend $2 trillion in the first stimulus bill. Where is that money coming from? In normal times, that would mean selling $2 trillion of treasury bond and bills. But who has $2 trillion of extra income lying around that they want to use to buy treasury debt right now? Yes, the new treasury debt has to come from a new flow of savings. Well, you can argue if that's there or not, but you don't have to. The Fed is buying more debt than the Treasury is selling. 

When the Fed buys Treasury debt, it prints up new money, and gives it to the holder of the Treasury debt. (I will say "printing money" as that is clearer. The Fed actually creates new reserves, accounts banks have at the Fed, by flip of an electronic switch. Banks can convert reserves to cash and back at will.)  On net, if the Treasury borrows and spends the money, and the Fed buys the Treasury debt, the government as a whole has printed up new money to spend. That's what's going on now. 

From the March 4 and April 8 Fed H.1 data, we learn that the Fed held $2,502 billion and $3,634 billion Treasury securities on those dates, an increase of $1,132 billion.  From the Treasury debt to the minute page, we learn that debt held by the public (including the Fed) rose from $17,469 billion to $18,231 billion -- a (huge) rise of $762 billion. $9 trillion at an annual rate. The Fed bought all the Treasury debt, printing new money to do it, and then some. On net, the government financed the entire $762 billion by printing new money and printed up another $370 billion to buy back that much existing treasury debt. 

The UK is abandoning pretenses. Bank of England to directly finance UK government’s extra spending writes the FT. Rather than have the government sell to the market, and then the bank buy it, the bank will now print money for the government to spend, and the government will print treasury debt to give to the bank in return.

(Who cares you may ask? The US Fed is not legally allowed to buy from the Treasury. The Treasury must sell in private markets to establish the interest rate, i.e. the price of the debt. If not, there is an inevitable temptation to say that markets are "impaired" or "illiquid" requiring too high rates, and thus the Fed buys at artificially low rates and high prices. The laws against inflationary finance are pretty thoughtful.)

The new lending programs are explicitly financed by the Fed printing up new money to do so.

The Fed and Treasury are teaming up to provide trillions to lend money to businesses and banks, and to buy assets including  money market funds, corporate bonds, municipal bonds, mortgages,

Now where do these trillions come from? Answer, in short, the Fed simply prints them up. It prints up the new money, and gives it to a business or bank or uses it to buy assets. 

A bit longer explanation 

In normal times, the Fed creates money (reserves) by buying Treasury bills. It has an asset -- the Treasury -- and a liability -- the money. The money is backed by Treasurys, a good principle of non-inflationary policy. That's the simple version of which  the Fed just did a trillion. 

When the Fed lends money to a bank or a company, the Fed likewise prints up money, gives it to a company, and counts the company's promise to pay back the loan as the corresponding asset. You can see the danger. The Fed is supposed to make only safe loans, to guard against inflationary finance, and to keep the Fed politically independent. Printing money to hand gifts to well connected firms and politically powerful interest groups is dynamite, and an independent agency will not stay independent long if it does so. 

For this reason the Fed and Treasury work together. The Treasury agrees to take the first tranche of losses, so the Fed can say this is a safe loan. Jay Powell was, as usual, clear on this. 

I would stress that these are lending powers, not spending powers. The Fed is not authorized to grant money to particular beneficiaries. The Fed can only make secured loans to solvent entities with the expectation that the loans will be fully repaid

What happens if the loans are not paid back? Well, in the first 5 to 10%, the Treasury takes the loss.  But right now, the Treasury gets its money from the Fed. So it really comes back to printed money anyway. If losses are so severe that the Fed loses a lot of money, the Treasury will have to recapitalize the Fed with a gift of Treasury bills. 

So, if the loans are not paid back, one way or another, we end up with that much more outstanding Treasury debt, either owned by the Fed and money outstanding, or owned by people. 

But this Fed vs treasury business, while important inside baseball for Fed independence and a bunch of issues on how the plumbing works, is really beside the point. The Fed and Treasury right now are, together, printing up trillions of dollars -- $4 -$6 trillion is the current guesstimate, which assumes a short sharp recession -- and handing them out. Most of it is "loans" which the Fed and Treasury hope to recoup. Then they can reduce the amount of money left outstanding. 

Is this really lending? 

As Jay Powell emphasized, the current vision is that most of the current support is lending, not spending. The Treasury kicks in something like $400 billion which really is spending, the anticipated loan losses (companies that don't survive) and forgiveness (programs that promise to forgive the loan if the company meets employment or other goals). The Fed lends $4 trillion on top of that, and gets its money back. The government as a whole has only spent $400 billion when its over, and the new debt (money) is soaked up again by repayment. 

But is this really lending or just spending?  Well, in the short run it's lending, but if the recession lasts more than a few months it will turn in to spending.

Companies have no income but must pay rent, debts, (interest on their corporate bonds and bank loans used to purchase now idle plant and equipment), utilities, skeleton staff, etc. Local governments are in a similar bind. They borrow to cover this cost. What's wrong with that? 

Well, borrowing usually corresponds to a productive asset, to an increase in value. If a bakery borrows to buy an oven, the bakery will make more bread, and use the additional profits on the extra bread to pay off the loan. If it doesn't work out, the oven is a real asset, collateral that the bank can sell to get some of its money back. A city borrowing to build a highway gets more tax revenue from greater activity to pay off the loan. 

But there is no economic value to these loans. These are consumption loans, stay-afloat loans, preserve-the-business loans. They are loans against future profits, but not additional future profits. They are a transfer of the franchise value of the firm to the lender. 

So, first, the firm clearly at some point is better off shutting down than promising its entire profit stream to a lender just for the right to reopen someday. Second, the government, already inclined to forgive, say, student debt, has every reason to forgive these "loans" as well. The business "loans" explicitly promise forgiveness if the government keeps workers on board. When we are in a sluggish recovery, and businesses are saying "well, I would hire more people, but we have all this extra debt because we took Fed loans to keep our employees fed while we were shut down," let's see just how tough the government is going to be on repayment. 

So, in a matter of months, these loans turn to gifts. The $4 trillion Fed lending package winds up as $4 trillion permanently added to Treasury debt. 

Does this mean inflation? 

You would think that, if the Fed and Treasury are going to print up something like $1 trillion a month of money to pay everyone's bills and prop up markets for the duration, we would be heading for inflation, soon. 

No, or at least not immediately. Reserves pay interest. Reserves are just another form of Treasury debt. (Reserves that pay interest is one of the best innovations of recent decades, and Kudos to Ben Bernanke and everyone else involved.) 

So why does it matter? Couldn't the Treasury just print up Treasury bills, sell them for reserves, hand out the reserves, collect loans in due time and retire the Treasurys? In the short run it does matter, which should send a few shivers up our spine. Apparently the Treasury had a hard time finding willing buyers. So printing up the reserves directly made a difference. So, the Fed ends up with a loan "asset" on its balance sheet against reserves, rather than the Treasury with that loan as an asset on its balance sheet against Treasury bills. Conveniently, also, reserves though equivalent to Treasury debt are not counted in the debt limit along with many other contingent liabilities. 

In the long run it does not matter. The Fed and Treasury print up reserves, lend it to Joe's Laundry; Joe pays his mortgage; the mortgage company pays its investors. If those investors are happy sitting on reserves (bank accounts backed 1:1 with reserves on the margin), it sits. If they are not, which would be the beginning of the inflationary process, the Fed can just raise the interest rate on reserves until they are, really really transforming reserves to Treasury debt. Or the Fed can give them some of its stock of Treasurys and so on up the reserves. 

With abundant interest-paying reserves, reserves and Treasury debt are almost exactly the same thing, and in roughly functional markets, what matters is their total supply, not reserves alone. Inflation is a danger, but from the total quantity of government debt, not its split between reserves and  bills. Inflation comes basically if the US hits a debt crisis. 

(That is, so long as the Fed pays market interest on reserves, and lets the market basically have as much or as few reserves as it wants. If the Fed, and Treasury, start worrying about interest costs of the debt, and do not pay interest on reserves and do not allow people to convert to Treasurys, then inflation comes sooner. )

But we're looking for sure at raising US debt from $22 trillion to $27 trillion, likely hitting 150% of GDP if this is a short and swift recession. It could be much larger if the recession goes on a year or more. Is there a demand for that much more treasury debt in the long run? Is there a flow of that much new saving that people are willing to park with Uncle Sam? How much more can markets take? So the chance of a global sovereign debt crisis and inflation is not zero -- but not centrally from the fact that it's currently financed by printing money. I'll come back to this issue in detail later. 

Questions. 

First, how long can this go on?

As you can see, the viability of this whole plan depends on a short recession. The Fed is printing up something like $1 trillion per month. If the recession ends up being L shaped, those numbers will ramp up as reservoirs of private cash dry up. A few large company bailouts, a few more "dysfunctional" markets turn to the Fed to buy everything, and so on. The  IMF wants  $1.2 trillion to bail out emerging market economies. After 3 weeks. That will get worse. State and local governments, already facing pension crises, are gong to be toast when sales and income tax receipts collapse. Bear Stearns, Fannie and Freddy, AIG...

Where is the limit? Perhaps the peasants with pitchforks, remarkably absent so far, will revolt. Perhaps the willingness to hold interest-bearing reserves or US Treasury debt will find its limit after $10 trillion. Or $20 trillion.

At some point, people who bought risky, high return debt, and earned nice returns on the way up, will have to bear some of the genuine economic losses. There is no magic. Government debt is paid back by taxes. (If you think that law has been repealed by MMT or r<g, I'll disabuse you of that in an upcoming post.) Trillions will be spent. Either taxpayers pay it, or creditors pay it. 

Second, isn't there a bit of moral hazard here? Now, you may say, nobody asks about moral hazard in a foxhole. But at some point we have to address the moral hazard. Half of these interventions were things done in 2008, and we said no, never again, we'll pass a mountain of regulations to control moral hazard. Remember "no more bailouts?" Especially money market funds? And here were are, one week into it and airlines are too big to fail and money market funds need the Fed to stop from breaking the buck. At a minimum we can look at what the Fed has done, remark on how the post 2008 controls on moral hazard failed, and at least think about how we might avoid being in exactly the same  pickle in 2032.  We can also once again Monday morning quarterback and suggest how things might be done in a way to diminish the moral hazard. At least we can get a better playbook for next time.

I will look at both these issues in detail in upcoming blog posts.

Strategic Review and Beyond: Rethinking Monetary Policy and Independence

March 4, I was honored to give the Homer Jones lecture at the St. Louis Federal Reserve. Link here

Strategic Review and Beyond: Rethinking Monetary Policy and Independence.

I used the opportunity to put lots of thoughts together in condensed form, on how the Fed and other central banks should approach monetary policy, financial regulation, and ever-expanding mandates.  The link is to the html version. It will appear in prettier form in the April St. Louis Fed Review.

The conclusion

Should, and can, the Fed stimulate with strongly negative rates, immense QE asset purchases, and an arsenal of forward guidance speeches? I think not. What sort of target should it follow? A price-level target. The Fed should get out of the business of setting the level of nominal rates and target the price level directly. Price-level control will be much more effective with fiscal policy coordination. The Fed should offer a flat supply curve of interest-paying reserves, open basically to anyone, though the Treasury should take up much of that role directly. 

Going forward, the Fed and its international counterparts should disavow the temptation toward ever-expanding mandates and economic and financial dirigisme that would take them to "macroprudential" policy, discretionary credit cycle management, asset price targeting, and exploiting regulatory power to embrace social and political goals… today on climate change and inequality, perhaps tomorrow on immigration, trade restriction, China-isolation, or whatever the smart set at Davos wants to see. Only limited scope of action to areas of agreed technocratic competence will salvage the Fed's, other central banks', and international institutions' useful independence.

Of course this effort arrives with spectacularly bad timing, as nobody is talking about anything but the Covid-19 virus. Still, life does go on, and I don't see anything that is directly contradicted by current events. And perhaps you want to read and think about something other than virus crisis, and issues we will go back to thinking about when it's all over.

In the final section (see the footnotes too) I discovered that our international institutions, BIS, IMF, FSB, and so forth were busy dragging banks into the partisan warfare over green new deal style climate policy and forced redistribution. I took a dim view of that. First of all, the idea that climate and inequality present financial risks is just fanciful. Most importantly these are political minefields that will doom independence.

I think this section holds up well. That the worthies who look in to the future and spot risks to the financial system, and drag banks into accounting for them via stress tests and regulatory accounting, found climate change and inequality the biggest run-provoking risks they could think of, not even mentioning pandemic, tells you volumes about the whole technocratic project.

If you like to watch videos, here is the actual lecture somewhat shorter than the written version.

Groundhog Day virus plan.

Via Marginal Revolution, a very clever idea from Scott Ellison:

I propose temporarily stopping time. This means that today’s date, Tuesday, March 17th, 2020, will remain the current date until further notice. This also means that everything that happens in time (e.g. mortgage due dates, payrolls, travel bookings, stock market trading, contractor gigs, concerts, sporting events) will be paused. It also means that all of these events remain on the books, and will continue as planned once time is resumed.

I mentioned "the debt clock keeps ticking when the economy shuts down" as the central problem, but didn't go as far as to advocate this simple solution. (Which I still don't, read on.)

The central problem is really a coordination problem. A owes B money. A is shut down so can't pay. B understands and would be happy to wait until the crisis is over. But B owes C money, so can't wait. And on down the line it goes. It's like daylight savings time. We could individually decide to move things an hour earlier in spring, but mostly A wants to show up at work when B will be there. There are lots of coordination problems like this, and a useful function of government is to solve them.

But the economy is not completely shut down. Food and medicine need to keep going, and need to be paid! If we literally stop all payments, shutting down the ATM machines, credit card machines, and salaries of the 80% or so who will keep their jobs, we create an insane mess. So some clocks shut down and some others don't and now you have a mess on your hands.

So while this is a useful metaphor and guide to a central problem now, it's not a practical solution.   An economy is much like a human. We can sleep, but we can't freeze the clock, shut down totally and  restart again.

Airline bailouts and capital regulation

The airlines are about to get a huge bailout. Why are they in such trouble? Well, yes, nobody is flying so their revenues are cratering. But why not just stop flying for a while? The answer is, they have loads and loads of debt.

U.S. Airlines Spent 96% of Free Cash Flow on Buybacks writes Brandon Kochkodin on Bloomberg

American Airlines Group Inc...led the pack, with negative cumulative free cash flow during the decade while it repurchased more than $12.5 billion of its shares. United Airlines Holdings Inc. used 80% of its free cash flow on buybacks, while the S&P 500 Index as a whole allocated about 50% for the purpose. As the industry reels under the weight of the coronavirus outbreak corporate leaders are seeking federal assistance to ease the burden.

Let's be clear. It is a myth that buybacks are bad because they reduce investment. And free cash flow isn't a very interesting divisor. But buybacks do have a downside: they reduce equity and increase debt. Fine if you and the creditors are willing to take a bath in bad times. Not good if debt means taxpayers have to bail out in bad times. Too big to fail is spreading like a virus.

If airlines were financed by equity, they would have a natural shock absorber. They could just shut down, stop paying dividends, and then wake up on the other side. But they have debts to pay, and if they don't pay creditors will take them to bankruptcy court, seize assets, break them up and there won't be airlines when the virus is over.

Enter the federal bailout, as always really a bailout of the creditors.

Does this all sound like banks 2008? It is.

If we are going to bail out airlines then there needs to be subsequent capital regulation. Once bailed out you cannot finance yourself on a mountain of debt next time around.  Issue equity, retain earnings.

Everyone is watching. If debts lead to bailouts with no consequences, there will be more debts and more bailouts. Yes, even now we have to watch moral hazard. We are setting precedents for the next larger pandemic.

The only reason the economy is in trouble is that not enough people and businesses kept cash reserves or plans to weather a shut down. If the ants bail out the grasshoppers without consequences, we will enter the next crisis with nothing but grasshoppers.

If there is going to be a bailout this consideration makes it ever more important that the government lends money, or invests, and is paid back first before any current creditors or stockholders. Don't just send a check.