Riding the Waves of Culture Understanding Diversity in Global Business 3E_14 pdf

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Conclusion

stocks rather than the price of items that dominate the consumer price index Depressions were thought a thing of the past, and Robert Lucas pronounced the end of depression economics and urged macro- economists to shift their attention to issues of eco- nomic growth

Economists were strongly influenced by Milton Friedman’s argument that the Great Depression had been the result of the Federal Reserve’s shrink- ing the money supply when prices and output fell in the wake of the stock market crash of October 1929 — that had the Fed kept up the money supply the nation would have experienced nothing worse than a recession Insufficient weight was given to the fact that the Federal Reserve’s creation of money is mediated by the banking industry The Fed in effect licenses the banks to create money by mak- ing loans, and if they are afraid to lend (more pre- cisely, if they set stringent criteria for lending, be- cause the risk of default is so great) and if overindebted people are afraid to borrow lest they have to repay their loans in more valuable dollars, the money supply may shrink despite the Fed’s ef- forts, causing deflation to accelerate as prices fall and firms and individuals hoard cash At that point, the efforts that the Federal Reserve would have to

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A FAILURE OF CAPITALISM

exert in order to arrest the deflationary spiral might plant the seeds of a terrible post-depression infla- tion And in anticipation of the inflation, interest rates might rise rather than fall, choking off recov- ery from the depression

The failure of the economics profession to have

grasped the dangers that have now produced the

first U.S depression since the 1930s is excusable Ideology has played a role in this professional

blindness, but that is unavoidable because of the

difficulty of empirically testing rival theories of de- pression and the political significance of depres- sions and responses to them The fact that finance and macroeconomics have become separate fields with some difficulties of intercommunication may have been the inevitable result of the relentless

pressure for ever-greater specialization in academic

disciplines Even the failure of officials and of most academic economists to heed the abundant warn- ing signs of the coming crash is, if not excusable, at least readily understandable; Cassandras rarely re- ceive a fair hearing, and for reasons that only in hindsight can be seen to be mistaken

What is inexcusable is the failure of the Federal Reserve and other economic agencies within the federal government to have prepared contingency

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Conclusion

plans for the possibility, remote as it seemed, that a crumbling of the banking industry would set the stage for a depression When the financial crisis hit in mid-September 2008, the government was unprepared and responded with a series of impro- visations that did avert the most catastrophic imagi- nable consequences of the crisis but could not avert a depression The improvisations were bum-

bling, incoherent, poorly explained; the President

seemed absent, so far as attending to the economy was concerned, during the critical period Even

now, four and a half months after the crisis hit, the

government has no coherent plan of recovery In the absence of such a plan, it is, or soon will be, try- ing everything at once—flooding the economy with money, which may not work, as I argued in chapter 5; trying to restore output and employment by massive deficit spending, which may not work either; bailing out the banking industry—or per- haps confiscating much of it (“nationalization”) (odd how saving the industry and swallowing it are discussed in the same breath); reforming the regulatory framework and as part of the reform per- haps consolidating the myriad agencies that have a piece of the financial regulatory pie; and relieving mortgagors of some of the burden of their mort-

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A FAILURE OF CAPITALISM

gages All are measures with strengths and weak- nesses that cannot be gauged in advance; all suffer from having to be adopted without having been thought out in advance; some, such as regulatory reform, are overly ambitious And doubtless there is more to come The atmosphere is electric with proposals for economic recovery —so many that the government may lack the intellectual resources to evaluate them

I am not a forecaster I do not know when the recovery from this depression will begin But if it

begins tomorrow, the trillions of dollars that the

government has spent to speed recovery, and the restructuring of banking and its reform that will bring in their train untold problems and uncertain- ties, will overhang the economy for years to come, as when an expensive treatment cures a deadly ill- ness but leaves the patient debilitated

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Further Readings

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Further Readings

The following is a list of books and articles that readers of this book may find interesting The views expressed in them are diverse, and I do not mean by suggesting them to imply that I agree with all of them

Tobias Adrian and Hyun Song Shin, “Financial In-

termediaries, Financial Stability, and Monetary Policy” (forthcoming in Journal of Economic Perspectives)

Dean Baker, Plunder and Blunder: The Rise and Fall

of the Bubble Economy (2009)

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FURTHER READINGS and Appropriate Policies” (Dec 2008), http:// papers.ssrn.com/sol3/papers.cfm?abstract_id= 13242808

Markus K Brunnermeier, “Deciphering the Liquid- ity and Credit Crunch 2007-08” (forthcoming

in Journal of Economic Perspectives)

Richard C K Burdekin and Pierre L Siklos, eds., Deflation: Current and Historical Perspectives

(2004)

George Cooper, The Origin of Financial Crises: Cen- tral Banks, Credit Bubbles and the Efficient Market Failure (2008)

Brady Dennis and Robert O’Harrow Jr., “A Crack in

the System,” Washington Post, Dec 29-31, 2008

Chris Farrell, Deflation: What Happens When Prices Fall (2004)

Niall Ferguson, The Ascent of Money: A Financial

History of the World (2008)

Stanley Fischer and Rudiger Dornbusch, Introduc-

tion to Macroeconomics (1983)

Irving Fisher, “The Debt-Deflation Theory of Great

Depressions,” 1 Econometrica 337 (1933) W Scott Frame and Lawrence J White, “Fussing

and Fuming over Fannie and Freddie: How

Much Smoke, How Much Fire?” Journal of Economic Perspectives (Spring 2005): 159

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FURTHER READINGS

Peter M Garber, “Famous First Bubbles,” Journal of Economic Perspectives (Spring 1990): 35:

James D Gwartney et al., Macroeconomics: Private and Public Choice, pt 3 (12th ed., 2008) Takeo Hoshi and Anil K Kashyap, “Will the U.S

Bank Recapitalization Succeed? Lessons from Japan” (Dec 2008), http://faculty.chicagogsb

.edu/anil.kashyap/research/will_us_bank _recapitalization_ succeedz.pdf

William C Hunter, George G Kaufman, and Mi-

chael Pamerleano, eds., Asset Price Bubbles: The Implications for Monetary, Regulatory, and In-

ternational Policies (2003)

John Maynard Keynes, The General Theory of Em-

ployment, Interest and Money (1936)

Charles P Kindleberger and Robert Z Aliber, Ma-

nias, Panics, and Crashes: A History of Financial

Crises (sth ed., 2005)

Paul Krugman, The Return of Depression Economics and the Crisis of 2008 (2008)

Christopher Mayer, Edward Morrison, and Tomasz

Piskorski, “A New Proposal for Loan Modificat-

ions” (Columbia Business School and Colum-

bia Law School, Jan 7, 2009)

Randall E Parker, The Economics of the Great De-

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FuRTHER READINGS

pression: A Twenty-First Century Look Back at

the Economics of the Interwar Era (2007) Lubos P4stor and Pietro Veronesi, “Was There a

NASDAQ Bubble in the Late 1990s?” Journal of

Financial Economics 81 (2006): 61

Raghuram G Rajan, “Has Financial Development Made the World Riskier?” in The Greenspan Era: Lessons for the Future: A Symposium Spon- sored by the Federal Reserve Bank of Kansas City

(2005), 313

Robert J Shiller, The Subprime Solution: How To- day’s Financial Crisis Happened, and What to Do about It (2008)

Andrei Shleifer, Inefficient Markets: An Introduction

to Behavioral Finance (2000)

Mark Zandi, Financial Shock: A 360° Look at the

Subprime Mortgage Implosion, and How to

Avoid the Next Financial Crisis (2008)

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[ndex Agency costs, 222-223 See also Compensation Agricultural Adjustment Act, 210 Aliber, Robert, 335 American Economic Associa- tion, 286 American Hoine Mortgage Corporation, viii American International Group, vill, 56-58, 62, 145, 209 American Recovery and Rein-

vestment Act of 2009, xvi— xvii, 164, 176, 179-184, 193

Aronson, Michael, xviii

Automatic stabilizers, 170-171

Automobile industry, 71; bub-

ble in, 35-36 See also under Bailouts Bailouts, 41, 63-70, 149-153, 238; for automobile industry, 153-164, 190, 277 Baird, Douglas, xviii Baker, Dean, 125, 333 Bank for International Settle- ments, 126 Bank of America, 236 Banking, 18-34, 41-74, 316-317; “bad bank” plan, 151-152; bank reserves, 22, 35, 43, 121, 128-129, 195, 197, 206; de-

fined, xvi; intrafirm conflicts

of interest, 79-82; and real estate, 13-14, 321-322; regula- tion of, 43-44, 317; solvency problems, 13-14, 67-68, 149- 150, 321-322 See also Banks; Demand deposits; Deregula-

tion; Regulation; Treasury

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INDEX Banks (continued) nationalizing of, 152; nonbank banks, 45 See also Banking Bayesian decision theory, 135- 136, 309-310 Bear Stearns, collapse of, viii, 98, 126, 133, 137, 146, 221, 248-256 passim, 274, 282 Becker, Gary, xviii

Becker-Posner Blog, The, xviii, 141 Bernanke, Ben, go, 117-122 pas- si, 132-133, 161, 203-207 passim, 211-212, 228, 239-240, 253-259 passim, 266-293 pas- SIM, 320, 322, 333 Bernstein, Larry, xix Blinder, Alan, 252 BNP Paribas, viii, 126 Bonds, 51, 71-72 Born, Brooksley, 127 Boudin, Michael, xix Bubble, 75-90 passim, 97, 137; defined, 10-11; dot-com, 12, 137, 281; housing, 13-14, 60— 61, 67, 75-105 passim, 118- 122, 145-146, 199-200, 287, 320; “new era” theory of, 85— 87; 1920s stock market bub- ble, 11; psychology of, 75-77,

82, 85-86; stock, 1, 82-83;

warnings of, 77-78, 118— 120

Budget deficits, Bush Adminis- tration’s responsibility for, 190-191, 273, 306 Buffett, Warren, 63, 221 Bush Administration, 160, 161, 338 164, 190, 238-25) passim, 271-274, 293, 301-308 passim Business cycle See Depression California, 53, 104, ng Capital, global surplus, 38-40 Capitalism: Darwinian charac-

ter of, 284-285; laissez-faire,

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INDEX 97-98; suggestions for regu- lating, 297 Competition in banking indus- try, 8, 40, 44-45, 107, 130-131, 323-324 See also Deregula- tion

Conflicts of interest, within banking firms, 79 See also Agency costs; Compensation

Congress, ix, xi, 9, 121, 127, 136, 140, 148~149, 160-168 pas- sim, 179, 207, 208, 215-225 passim, 239-240, 254, 277, 280, 292 Conservatism, 113-114, 224, 280, 304-314 See also Ideology: free-market; Republican Party Consumer price index, 16-17, 121, 283 Consumption: conspicuous, 108; versus savings, 29-36, 107-110, 229-230, 323-324 Corporations: attitudes of exec-

utives toward risk, 97-98; chief executive officers of, 98—99; time horizon of exec- utives of, g8-gg See also Compensation; Limited lia- bility Cost-benefit analysis, 138~139 Countrywide Financial Corpo- ration, viii, 282 Cox, Christopher, 248, 250, 259, 274, 293

Credit: credit crunch, 62-63;

effect of, on consumption,

29-30 See also Banking; Credit-default swaps; Credit-

rating agencies; Interest rates Credit ratings, 52, 62, 66-67, 70, 103-104, 290 Credit-default swaps, 52, 56-58, 62, 144-145, 270-271, 275- 276, 319-320 Credit-rating agencies, 55-62 passim, 78, 290 Dam, Kenneth, xix Davies, Jamison, 141-142 Deficit spending: as Keynesian anti-depression measure, 8— 9, 12, 164-194, 209-212, 266— 267; optimal, 188-189; poli- tics of, 189, 209-211 See also Public-works projects for fighting depression; ‘Taxa- tion; Transfer-payments ap- proach to fighting depres- sion Deflation, 6-7, 1-12, 15-18, 70, 106, 141, 150, 185-186, 193- 203 passim, 212, 325; limita- tions of monetarist measures against, 201-208; Milton Friedman’s proposal, 233; re- covery from, 201-203 Demand deposits, 22, 31, 41, 44, 129-130, 317; federal deposit insurance, 43-46, 146-147, 236, 317 See also Sweeps Democratic Party, 162, 207, 224-225, 240

Depression, 28; automatic sta-

bilizers as weapons against, 170-171; Bush Adminis-

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[NDEX Depression (continued) 140-141, 160-164, 261-263, 274-280, 308, 329; commis- sion to evaluate response to, 228; conservatives’ analysis of, 112-114; cost of fighting

current, x1, 189-190; costs of, 116; current, 14-15, 315-325; defined, ix—x; failure to an- ticipate, 122-147, 251-258, 328; lack of confidence as impediment to recovery, 203, 212~213; Obama Administra- tion's response to, 312-313; political consequences of,

220; versus recession, Vii—Vilil,

139-140, 231; simple eco- nomics of, 1-8; types of, g- 11 See also Bailouts; Deficit spending; Great Depression; Money supply Deregulation: of banks, 23, 4s— 46, 130-131, 292-296, 306, 317-319; meaning of, 292; movement, 115, 317-318, 326 Derivatives, 126-127, 144 See

also Credit-default swaps Diversification See under Risk Domestic Economic Council, 280 Dow Jones Industrial Average, ix East Asia, 118 Economic rent, 230-231 Economics, pragmatic, 313-

315 See also Economics pro- fession; Finance, theory of; Macroeconomics

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175, 192-212 passim, 233-239 passim, 253-293 passim, 302, 326-328; political constraints ON, 236-237, 256-257 See also Deflation; Federal funds rate; Inflation; Interest rates; Money supply

Feldstein, Martin, 189, 252, 265 Finance, theory of, 231-232

See also Kconomics profes- sion: finance theorists Financial intermediation, 19,

23; mechanics of, 41-44 See also Banking

Financial Times, 75

Fiscal measures for fighting de- pression See Deficit spend- ng Fisher, Irving, xvii, 6-7, 11-12, 131, 334 Ford Motor Co., 157 Foster, Dean, 95 Freddie Mac, viii, 49, 125, 209, 241-242, 334 Friedman, Benjamin, xix Friedman, Milton, 211, 233 264-265, 267, 327 Friedman, Stephen, 272 Funds of funds See under Hedge funds Geithner, Timothy, 239, 322 General Motors Corp., 153, 157-159, 190 Germany, 39, 232, 273, 290; Nazi era, 16, 123, 193, 220, 262-263 Glass-Steagall Act, 270 Gold standard, 12, 193 INDEX Goldiman Sachs, 63, 320 Government: absence of con-

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INDEX

Housing (continued)

243, 396-397; “ownership society,” 113 See also Mort- gages; and under Bubble Hubbard, Allan, 272 Hurricane Katrina, xv Ideology, 84; free-market, 134- 135, 243, 248, 259-267, 274; ideological voters, 305; sources of, 135-136 See also Conservatism; Liberalism; and under Economics pro- fession Income, permanent versus temporary, 166-167, 179 Inflation, xi—xii, xvii, 121-122, 137, 184-187, 198-199, 208, 237; in 1970s, 10; as predict- able response to extreme monetarist measures, 204— 207; in presence of low inter- est rates, 87, 282-283, 326— 327 Interest rates, xi—xii; in early 20008, 30, 38-40, 46, 105- 106, 128-130; relation of, to money supply, 195-196;

short-term versus long-term,

41-44, 317 See also Banking; Federal Reserve; Inflation

International Monetary Fund, 258 Inventory, 15, 325 Japan, 39, no, n8, 163, 184-185, 191, 212, 232, 262, 273, 323, 335; in World War II era, 122-123, 141-142, 193, 262-263

Keller, Ashley, xix

Keynes, John Maynard, xvii, 83, 92, 110, 167, 193, 203~211 pas- sim, 263-267 passim, 313, 335 Kindleberger, Charles, 335 Knight, Frank, 60, 110 Krugman, Paul, 235, 252, 285, 322, 335

Landes, William, xix Layoffs See Unemployment Lazear, Edward, 272 Lehman Brothers, collapse of, vill, 45, 61, 98, 126, 133, 138, 161, 209, 255, 274-277 Letters of credit, 276 Leverage, 46-48, 87, 129-130, 319; and bankruptcy risk, 88; defined, 26-27 Lewinsohn, Jonathan, xix Liberalism, 308-309 Limited liability, 86, 93 Lindsey, Lawrence, 272 Liquidity, 41, 63-70, 128, 149, 201-203, 205 Lockwood, Lee, xviii Long-Term Capital Manage-

ment, collapse of, 126-127, 131, 281 Lucas, Robert, xviii, 16, 254, 261, 267, 286-287, 327 Luxury goods See Consump- tion: conspicuous Macroeconomics, 231-232, 328;

schools of, 265 See also De- pression: simple economics of

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[NDEX Madoff, Bernard, 221-222, 243- 247, 250 Madrick, Jeff, 285 Mark to market, 68 Marketing, role of in consump- tion, 109-110 Markopolos, Henry, 245, 247 McCain, John, 304, 308 Media, coverage of depression by, xiii, 235-236, 267-268, 285 Meltzer, Allan, 122, 254-255 Merrill Lynch, viii, 45, 236 Mitsubishi, 63

Monetarism See Friedman, Milton; Money supply Monetary policy, 7-8, 192-209;

limitations of, in fighting de-

pression, 201-208, 211, 327— 328; socialistic aspect of, 207-208 See also Federal Reserve; Money supply Money market funds, 22-23,

45, 130, 146-147, 236-237

Money supply: expansion of, as anti-depression measure, 153, 192-209; velocity, 201- 203 See also Federal Re- serve; Gold standard Moral hazard, 236-238 Morgan Stanley, 63, 239 Morrison, Edward, 335 Mortgage-backed securities, 48-74, 91-93, 214-215; short selling of, 147 Mortgages, 13, 20, 44-60, 321; Alt-A, 25-26, 49, 54; de- ficiency judgments, 104; due process issue presented by

proposals for mortgage relief, 218-219; mortgage relief, 194-195, 214-219; mortgage- service companies, 60, 215; mortgagor behavior, 100- 104; subprime, 23-26, 100- 104 See also Mortgage- backed securities NASDAQ, 245, 336 National Association of Busi- ness Economists, 258 National Credit Union Admin- istration, 289

National debt, xi, 184, 190-192,

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INDEX Opp, Christian, xviii Opportunity cost, 178, 222, 227, 264 Organization economics, 7Q—

82, 237 See also Agency

costs; Conflicts of interest,

within banking firms; Cor- porations Paulson, Henry, 41, 69, 133, 161, 228, 239-240, 259, 271, 277- 280 passim Pearl Harbor, xv, 122 Persaud, Avinash, 77 Politics, 165-170 passim, 177, 179, 189, 311-312; of bailouts, 209; effect of, on Federal Re- serve, 236-237, 256-257; in- fluence of ideology on, 136 See also Democratic Party; Ideology; Republican Party Ponzi scheme, 221, 244, 245-

247

Posner, Eric, xix Posner, Kenneth, xix

Prediction by naive extrapola- tion, 17-18

President's Council of Kco-

nomic Advisers, go, 144, 256,

265, 272, 280 Private equity funds, 99 Private virtue versus public

vice, 107-108

Psychology: of emotion, 82; of investing, 75-77, 82-83; of mortgagors, 100-104; precon- ceptions, 134-136; and pre- diction, 117 See also 344 Bayesian decision theory; Ideology; Rationality Public-works projects for fight- ing depression, 165, 171-185, 193, 263-264; crowding-out problem, 182-183; domestic

versus foreign inputs, 183; evaluation of, 177-178; infra- structure and other construc- tion projects, 169, 171-172, 179-184, 188; Japanese expe- rience, 184-185; military ex- penditures, 176-177, 188, 262; multiplier effect, 172-173 Pyramid scheme, 246-247 Rajan, Raghuram, xix, 26-27, 252, 336 Rationality, 75-77, 82, 84-85, 100-104, 112-113, 235, 320 Real estate See also Housing;

Mortgages; and under Banking

Recession, 270; as depression

aftershock, xi, 207; role of Federal Reserve in prevent- ing or mitigating, 137; types of, g-11 See also Depression Regulation: bank regulatory

agencies, 143-144, 148-149, 290; of banks, 43-44, 317; ex

ante versus ex post, 30-31;

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De-[NDEX

regulation; Reorganization

of bank regulatory agencies Reorganization of bank regula- tory agencies, 250-251, 289— 291 Republican Party, 160-161, 240, 304-310 Reserve currency, 63 Reserves See Banking: bank reserves; Credit-default swaps Risk: of collapse of banking in- dustry, 79; diversification or distribution of, 50, 52-53, 55, 91; management of, 50, 80— 82, 110-111, 321; portfolio di- versification, 91; quantitative

models of, 110—111; risk man-

agers, 80-82, 96; versus un- certainty, 60, 83-84, 131 Romer, Christina, 273 Roosevelt Administration, 12, 148, 189, 220, 302 Rosenfield, Andrew, xix Roubini, Nouriel, 124-125, 132, 138, 143, 252 Rubin, Robert, 81, 135, 208— 209, 255-259) 271 Savings: market value versus

portfolio risk, 32-33; per- sonal savings rate, 32-35, 38, 232-233; precautionary, 5, 325; regulatory reforms de- signed to boost, 290 See also Consumption: versus savings Savings and loan associations, 44-45, 151 Scholes, Myron, xviii Securities: derivatives, 126-127; - portfolio diversification, 91; preferred stock, 68, 71, 149- 150, 190 See also Securities and Exchange Commission; Securitization; Short selling Securities and Exchange Com- Mission, 237, 239-250 pas- sim, 274, 289, 293 Securities Investor Protection Corporation, 289 Securitization: collateralized- debt obligations, 87; of debt, 49-50, 53-57, 98, 151-152,

204, 319-321 See also Credit- default swaps; Mortgage- backed securities Shiller, Robert, 77, 252, 336 Shleifer, Andrei, xix, 336 Shopping, recreational, 38 See

also Christmas shopping sea- son Short selling, 91-92, 147, 239 Snow, John, 271 Social security, 228-229 Special investment vehicle, 87 Stagflation, 282 States, fiscal problems of in de- pression, 169, 171 Stiglitz, Joseph, 235

Stimulus See Deficit spending Stock market, 11, 82-83; margin purchases, 11 See also Secu- rities; and under Bubble Summers, Lawrence, 127, 135,

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[NDEX Swaps See Credit-default swaps Sweeps, 22, 130-131 ‘Taxation, 9, 190-191, 300-301; tax burden of anti- depression measures, 186;

tax rates, 226-227; tax rebates

or other tax cuts as anti- depression measures, 121, 148, 164-169, 172, 211 See also Homeownership Taylor, John, 254 Terrones, Marco, 77 Thain, John, 236 Toyota, 160 Trade imbalances, 38-40 Tranche, 50 ‘Transfer-payments approach to hghting depression, 164-165, 169-170, 172, 174 Treasury bills (and other gov- ernment securities), 7-8, 42, 44, 65, 192, 195, 197 See also Federal Reserve Treasury Department, ix, xi, 41, 69, 127, 137-151 passim, 161, 207, 239, 255-256, 271, 278— 290 passim Troubled Asset Relief Program (TARP), ix, 72-73, 149-153 See also Bailouts 346 UBS, 221 Uncertainty See Risk: versus uncertainty Unemployment, 2-7, 172, 187;

effect of deflation on, 200-

201; opportunity costs of un- employed workers, 178; ver- sus underutilization of work- ers, 15, 187; unemployment benefits, 166, 170 See also Public-works projects for fighting depression Unions, 156, 162, 164, 21O, 224—

226, 262; adversarial

unionism, 224, 309 See also United Auto Workers United Air Lines, 155, 160

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ee sự nợ “HP Pa Vy Ney Se ee

Posner analyzes the two basic remedial approaches to the crisis, which correspond to the two theories of the cause of the

Great Depression: the monetarist— that

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FROM THE BOOK

Last fall the world’s banking svstem collapsed, was placed

on life support at a cost of some trillions of dollars, and now it remains comatose We may be too close to the event to grasp its cnormity An impoverished vocabulary, rich only in cuphemisms, calls what has happened to the cconomy

in consequence of the collapse a “recession.”

We are well bevond that

ISBN 978-0-b?74-03514-0

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