Dean Baker -- Plunder and blunder: the rise and fall of the bubble economy
============================================================================


This is a good analysis of recent financial bubbles and a set of
recommendations for the preventing future ones.  It's especially
usable because it is concise.  (If you want to understand more of
the details and more of what went on before, underneath, and behind
these bubbles, then a good read is John Cassidy's "How markets
fail".)

Some of the analysis:

- Our government panders to consumers.  We spend now and worry
  about the future later, which leads us to neglect education,
  infrastructure, building businesses that provide jobs,
  fundamental research, etc.  Our political system privileges
  short-term benefits over long-term gains.

- The housing bubble was easy to recognize.  Some *did* recognize
  it and warn us about it.  But, we ignored those warnings,
  possibly because we were greedy or we did not want to get left
  behind by rising home prices etc.

- The housing bubble and the (paper) profits it generated and the
  cash we took out of it of our houses via home equity loans helped
  us get out of the recession caused by the 2000 stock market
  collapse.  But, that cure was unsustainable.

- There were a variety of enablers of the housing bubble: (1) home
  owner and consumer greed; (2) Fed policies, e.g.  pursuing low
  interest rates, promoting deregulation, encouraging the use of
  ARMs (adjustable rate mortgages); (3) securitization that enabled
  banks to continue making risky, bad loans while keeping those
  loans off their books; (4) the willingness, even eagerness of
  loan originators to grant Alt-A, sub-prime, liar, and NINJA
  loans; (5) collaboration of the rating agencies who were willing
  to rate packages of individually risky loans and not risky; (6)
  loans that were structured so as to enable home owners to delay
  payment of both principle and interest; (7) misguided incentives
  and compensation in financial industry; and (8) desire by the
  U.S.  Congress and the U.S.  President to please voters by
  extending home ownership and to enable home owners to spend more
  (through use of home equity loans).

- There were enough rationalizations, even by those inside the U.S. 
  government and by some in prestigious academic institutions so as
  to provide plausibility for the bubble deniers.

And, a few of Baker's recommendations:

- The Fed must have a stronger commitment to fighting asset
  bubbles.  But, we cannot control the Fed.  And, the Fed chairman,
  in particular, who is appointed by the U.S. President is likely
  to continue to promote policies that encourage bubbles.  The
  dream for a politically independent Fed, is a dream, really. That
  Baker does not take this proposal seriously is shown by the fact
  that he addresses it in a single sentence at the very end of a
  section and then with a conditional: "If the central bank lacks
  the necessary political independence from Wall Street to
  effectively manage the economy, then it must be reorganized to do
  so."  Good luck with that proposal.

- Price the dollar lower.  A high dollar makes imports cheap, but
  moves manufacturing and jobs out of the U.S.  Long-term, it hurts
  manufacturing workers and benefits professionals.  However, since
  the benefits of a higher dollar are short-term, our political
  system won't do it.

- In the financial sector, the following would help: (1) correct
  incentives; (2) do not allow firms to choose their auditors or
  the rating agency for the securitizations; (3) guarantee and
  save investment banks *only if* they agree to serious regulation
  and promise *not* to save them (but there is really no effective
  way to make and keep that promise); (4) impose a tax on gambling
  in financial assets.

- More support for renters; less support for home owners.  Do less
  to encourage those who speculate in home real estate.  But, the
  political forces are aligned in favor of more support.

- Punish incompetent people in the financial industry; punish the
  incompetent, gullible media and reporters; punish incompetent,
  ideological economists; punish the over-seers (e.g. Fed, the U.S.
  Treasury Department, and the Congressional oversight committees).

The most disappointing aspect of this book, and it's not Baker's
fault, is that his recommendations are not likely to be implemented
and are not even remotely viable politically.  That's not a reason
for ignoring this book, and it's true of most, if not all, other
books that have recommendations for fixing our financial markets,
too.  But, it is depressing, because it indicates that we have no
real, usable solutions.  It also suggests that the problems with
our financial markets and institutions are fundamental to the
system itself, and that they cannot be fixed without changing to an
entirely different system.  We'd have to switch to a different
financial system, e.g.  one that is not really a capitalist,
market-based system at all.  Or, we'd need a a different political
system, in particular, one that does not pander to constituencies,
and is, therefore, not a democracy at all.  But, neither of those
changes seem remotely acceptable.

12/06/2010

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