Friday, October 3, 2008

A Couple Resources and One Hypothetical

I'll point you to the resources, first. In today's issue of The Wall Street Journal, George Mason University economics professor, Russell Roberts, has an excellent opinion piece on the role of government in providing the foundation for the current situation. If we take as a given that "people respond predictably to incentives", then the rules (institutions) of the market that collapsed were written some time ago by political leaders who were, themselves, responding to incentives - reelection being the most obvious. If you're into economic history with an institutional bent, this is a good piece to use to start a discussion.

Another interesting resource, particularly for those of you teaching American History, is in the forthcoming issue of The Chronicle of Higher Education. Scott Reynolds Nelson, a history professor at the College of William and Mary, writes that a good analogy for current times is not the Great Depression. Rather, he suggests the Panic of 1873. I especially enjoyed all the global parallels he sees.

Finally, here is an unrelated question for you. I've been thinking about the "buy local" movement and trying to imagine a debate between that idea and an old quote about the market. The quote states that through the miracle of the market, "every morning New York gets fed." (I think the original quote is by Frederick Bastiat and refers to Paris – but I may well be wrong on that.)

As I think about New York, I wonder how one could promote "buy local" and still feed the city. One would have to cast a wide net to do so – and by the time the net was cast widely enough – we’re still talking about traditional trade. How would you argue either side or both sides of this discussion with your classes?

I look forward to your comments. Have a good weekend.

10 comments:

rdan said...

Hi Tim,

I notice we are not on the link list anymore.

A look at policy by government is certainly necessary, and Fannie etc are part of the story, but to make the two agencies the cornerstone of our problems is a big stretch in my opinion.

I will be using the roller coaster item on housing prices.

Tim Schilling said...

I don't see where Roberts makes them the cornerstone. And I know I certainly didn't imply that they were. But it may be in how you read it.

rdan said...

Housing prices would never have risen so high without multiple Washington mistakes. Roberts


If one examines how the OCC and Thrift were handled, and that the market in derivatives was mainly in the shadow system, how does one examine the politics without noticing who is pushing the rules...are we not talking captured agencies to some extent, so the distinction between 'market' and 'government' is quite blurred.

Roberts spent half or more talking about Fannie and Freddie I believe. How is that not an implication?

rdan said...

As the Wachovia deal goes forward, and evidence of Paulson's intervention through changes in regulations over the last two weeks emerges even over FDIC objections, how do we explain what is going on? How do we explain where the money (yours and mine) goes and how it is being spent?

WSJ touts the Wells Fargo deal as triumph of markets, but there was again unprecedented intervention by gov using tax dollars to actually finance the deal.

Tim Schilling said...

"Roberts spent half or more talking about Fannie and Freddie I believe. How is that not an implication?"

As I read it, Roberts was merely using Fannie/Freddie as one detailed example. He also talked about HUD, CRA, the Fed and the Taxpayer Relief Act. Each one of them changing the rules...the institutional background for making decisions.

My point in recommending the Roberts piece is that the issue goes deeper than this administration, or the previous administration. The institutions (rules) that are in place have been built up over decades...decades in which there have been various mixes of administrative and legislative leadership. But all of them contributed to slight changes in the rules. The rules changed the incentives. And the incentives in place impact how we choose (or choose not to choose)...how we choose to live, how we choose to pay for what we live, how we choose to govern ourselves.

I've often told my students, "it's easy to point the finger when something goes wrong, but it's harder to accept that three of the fingers point back at you."

Tim Schilling said...

"As the Wachovia deal goes forward, and evidence of Paulson's intervention through changes in regulations over the last two weeks emerges even over FDIC objections, how do we explain what is going on? How do we explain where the money (yours and mine) goes and how it is being spent?

WSJ touts the Wells Fargo deal as triumph of markets, but there was again unprecedented intervention by gov using tax dollars to actually finance the deal.
"

I haven't read this yet, I'll have to comment later.

Tim Schilling said...

The way I read today's news (I know I'm not necessarily countering the information you brought up), the source of the problem is something that was inserted in the bailout bill at the behest of FDIC, not Paulson.

I do see where several pundits are suggesting the IRS ruling of last week may have played a role (Hmmm, institutions or rules affect our decision-making by changing our incentives. I've heard that somewhere.) And I have no doubt that it did. Again, my point is that the confusion in the marketplace is the result of government changing the rules, and changing the incentives. I defend nobody in this. I merely make the point.

To your last point about whether or not Wells Fargo is a an example of free-market rescue, I would agree that it is to the extent it doesn't put FDIC on the hook for some $200+ billion in losses. One can point to the bailout or the tax provision, but one must also point to fact that the Wells offer includes Wachovia Securities.

I would also disagree to the extent that there was an agreement already reached. To the extent that it was a FDIC-forced agreement, one could claim "duress" but I don't know how much more duress there is than a run on the institution. But if FDIC inserted the provision in the bailout package, it may be that the agency was looking to reduce the potential cost to taxpayer.

This internalizes the externalities, as it were.

Now one can say that via the tax break the taxpayer is on the hook. One could say the same about the tax breaks offered to mortgages and home equity loans - they just transfer the hook from loan-holders to those not holding that form of loan. Additionally, I suspect Wells Fargo's regulators will also be taking a positive view of losses incurred. That usually happens when a troubled financial institution is absorbed by another. Part of the incentive to the absorber is the treatment received by regulators as the bad assets are unwound.

rdan said...

Good points to make Tim. If it takes twenty years to make changes, we hardly notice in main street.

rdan said...

Fannie and Freddie played a significant role in the explosion of subprime mortgages and subprime mortgage-backed securities. Without Fannie and Freddie's implicit guarantee of government support (which turned out to be all too real), would the mortgage-backed securities market and the subprime part of it have expanded the way they did?....Roberts

How does one separate out cause and effect without bringing in other ideas?

Tim Schilling said...

I don't know. What ideas are you talking about?

The Fannie/Freddie issue is relevant to the extent that their mission and goals create incentives. Those incentives lead to choices. And all choices have costs and many of those costs are in the future.

If you go back to when Freddie/Fannie were founded, and the various periods of concern about their activity...this is that future.

Again, the point is that we need to be aware that making rules will change incentives. Chaning incentives will result in choices. Those choices may or may not be what we originally intend.