Sunday, March 29, 2009

Capitalist Fools

Recent Nobel laureates Joseph Stiglitz and Paul Krugman have long been known as left-liberal critics of conservative economic dogma. I offer here my own summary of Stiglitz's recent article in Vanity Fair , entitled "Capitalist Fools", both because it might benefit someone who doesn't have time to read the original article, and because it accords nicely with several of my own recent commentaries.

Stiglitz's column singles out five key mistakes by policy makers which contributed to our current malaise.

1. Firing the Chairman (Replacing Paul Volcker with Alan Greenspan)

In 1987, former president Ronald Reagan This meant replacing a noted pragmatist and believer in the need for financial regulation with an ideological follower of ultra-libertarian philosopher Ayn Rand. The timing of the appointment helped to obscure the fact that it was Volcker, not Greenspan, who had done most of the work in wringing inflation out of the economy.

No. 2: Tearing Down the Walls (The Deregulation Philosophy)

The deregulation philosophy would pay unwelcome dividends for years to come. In November 1999, Congress repealed the Glass-Steagall Act—the culmination of a $300 million lobbying effort by the banking and financial-services industries, and spearheaded in Congress by Senator Phil Gramm. Glass-Steagall had long separated commercial banks (which lend money) and investment banks (which organize the sale of bonds and equities); it had been enacted in the aftermath of the Great Depression and was meant to curb the excesses of that era, including grave conflicts of interest.

Stiglitz opposed the repeal of Glass-Steagall, for reasons that now seem obvious:

"The proponents said, in effect, Trust us: we will create Chinese walls to make sure that the problems of the past do not recur. As an economist, I certainly possessed a healthy degree of trust, trust in the power of economic incentives to bend human behavior toward self-interest—toward short-term self-interest, at any rate, rather than Tocqueville’s “self interest rightly understood.”

"The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking.

There were other important steps down the deregulatory path. One was the decision in April 2004 by the Securities and Exchange Commission, at a meeting attended by virtually no one and largely overlooked at the time, to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process. "

"In agreeing to this measure, the S.E.C. argued for the virtues of self-regulation: the peculiar notion that banks can effectively police themselves. Self-regulation is preposterous, as even Alan Greenspan now concedes, and as a practical matter it can’t, in any case, identify systemic risks—the kinds of risks that arise when, for instance, the models used by each of the banks to manage their portfolios tell all the banks to sell some security all at once. "...

"As we stripped back the old regulations, we did nothing to address the new challenges posed by 21st-century markets. The most important challenge was that posed by derivatives. In 1998 the head of the Commodity Futures Trading Commission, Brooksley Born, had called for such regulation—a concern that took on urgency after the Fed, in that same year, engineered the bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar-plus failure threatened global financial markets. But Secretary of the Treasury Robert Rubin, his deputy, Larry Summers, and Greenspan were adamant—and successful—in their opposition. Nothing was done."

No. 3: Applying the Leeches (The Bush Tax Cuts)

Then along came the Bush tax cuts, enacted first on June 7, 2001, with a follow-on installment two years later. The president and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches. The tax cuts played a pivotal role in shaping the background conditions of the current crisis. Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil—money that otherwise would have been spent on American goods. Normally this would have led to an economic slowdown, as it had in the 1970s. But the Fed met the challenge in the most myopic way imaginable. The flood of liquidity made money readily available in mortgage markets, even to those who would normally not be able to borrow. And, yes, this succeeded in forestalling an economic downturn; America’s household saving rate plummeted to zero. But it should have been clear that we were living on borrowed money and borrowed time.

No. 4: Faking the Numbers (Dishonest Accounting)

The Sarbanes-Oxley Act that followed on the heels of the Enron scandal failed to deal with stock options; it also failed to deal with a collateral problem with stock options: that they provide incentives for bad accounting. Top management has every incentive to provide distorted information in order to pump up share prices.

The incentive structure of the rating agencies also proved perverse. Agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of what college professors know as grade inflation. As Stiglitz puts it "the rating agencies, like the investment banks that were paying them, believed in financial alchemy—that F-rated toxic mortgages could be converted into products that were safe enough to be held by commercial banks and pension funds. "

NO. 5: Letting It Bleed (The Bush Bailout)

The crisis started when the US Treasury bailed out Bear Stearns--but then did not bail out Lehmann Brothers. "The original proposal by Treasury Secretary Henry Paulson, a three-page document that would have provided $700 billion for the secretary to spend at his sole discretion, without oversight or judicial review, was an act of extraordinary arrogance. " But while the purpose of this act was to "restore" confidence" , how could it do that without addressing the cause for the lossof confidence--that too many bad loans had happened and too many foreclosures were happening.

The initial bailout plan was a failure. As Stiglitz puts it, "When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks."

Stiglitz concludes by saying that the fundamental problem was an ideological one: a naive faith in the Self -Regulating Market:

"The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today."

Sunday, March 22, 2009

enough, already: STOP THE F***ING TAX CUTS!

Conservatives. They think that money grows on trees. And they think that all they need to do to make the money tree grow is prune it with tax cuts and sprinkle it with tax expenditures and tax incentives. And that is the part of their Economic Action Plan that they actually believe in. The rest is even worse: that just consists of reluctant scattergun spending on various political constituencies without any intellectual coherence. They give more money to culture ("after all we got burned by Quebecers in the last election for not doing so") but give less to social science research ("most of them are against us"); they say that they're on board with Barack Obama and the G-20 in providing economic stimulus, but then avoid investments in the green economy and wind and solar power that would keep Canada in the lead on climate change (guess where the research and development jobs in wind and solar and renewables will be?); they deal with child care and First Nations issues through more "targetted spending".
  • Remember when Gordon Campbell campaigned to reduce income taxes by 20% and reassured us that the cuts "would pay for themselves" and therefore would not impair social spending? Not only did he blow a huge hole in revenues and create the largest deficit in BC history, but within a few years he and Carole Taylor were claiming that "health care costs were getting out of control". Actually, international comparisons showing France spending 1.1% more of its GDP on health care than Canada and the US spending 5% more of its GDP on health care than Canada suggest that it is private and two-tier systems that are "out of control"; Canada at 10% and Britain at 8% are doing just fine (although they should spend more). So why all the bullshit? The Conservatives are leading us down the same path as the BC Campbell Liberals: cut, cut, cut, cut taxes and then complain that single-payer health care is "unsustainable".

  • Economists frequently make cogent arguments for shifting taxes away from income taxes (or taxes on productive activity) to expenditure taxes (in order to promote saving and investment) and Pigouvian taxes (to discourage pollution and other negative externalities). So why was the Conservative priority to have $12 billions in reduced GST instead? Because it was ideologically congenial, politically opportunistic, and the business lobby wanted it.
  • If most economists place less stress than the government does on tax cuts for stimulus (because tax cuts mean larger deficits, and spending on students, EI recipients and low-income households yield a larger multiplier effect), why did the government persist? Because it was ideologically congenial, politically opportunistic, and the business lobby wanted it.
  • If childrens' sports tax credit has been criticized because it disproportionately benefits middle-class suburbanites and doesn't help the most needy 1/3 of children; if the childcare tax credit has been criticized for not doing enough to either stimulate supply or guarantee high quality of universal early childcare learning; if 95-97% of those being subsidized by the public transit tax credit were riding public transit anyway and a consultant's report told them that the cost of the tax credit would be a wasteful $800 per tonne of greenhouse gas eliminated and would have little impact on transit usage, why did the government persist? Because it was ideologically congenial, politically opportunistic, and the business lobby wanted it.
  • If the Commissioner of the Environment and Sustainable Development has dismissed the $1.5 billion Clean Air and Climate Change Trust Fund as being little more than a transfer payment ot the provinces "conducted [with]almost no analysis", why did the government persist? Because it was ideologically congenial, politically opportunistic, and the business lobby wanted it.
  • If reliable analysis backed up by extensive international research suggests that every dollar spent on early childhood intervention can save 8 or 9 dollars down the road in improved productivity and reduced social costs; or that preventing a single fetal alcohol syndrome child can save society a million dollars in costs to health, education, and criminal justice systems; or that strategic investment in scientific research, universities, and alternative energy can make Canada a more competitive and productive country in the future, why didn't the government go for it? Because it wasn't ideologically congenial, wasn't politically opportunistic, and the business lobby didn't want it.

It's such a shame--all those years when we were light-years ahead of the conservatives in Washington and could have led the world in productive social investments. Pretty soon we'll be playing catch-up to the Americans, all because the Liberals didn't believe in half or what they were saying, and the Conservatives didn't believe in half of what they were doing.

Sunday, March 15, 2009

Billions for Carbon Sequestration?

From the ringside seat to the oil sands project that we have in Athabasca/Edmonton, it would be easy to take comfort in the $2billion plus committed by governments in Canada to finding improved cost-effective carbon sequestration ( or "carbon capture and storage", CSS). But, personally, I would find the announcement of two or three new nuclear reactors for northern Alberta and Saskatchewan to be more comforting. There is absolutely no guarantee that a cost-effective and sustainable CCS will ever come into being; the search for CCS also represents public resources diverted from the search for greener and more sustainable forms of alternative energy. Indeed, I am cynical enough to believe that this expenditure of money is as much about public relations as anything else.

On this subject, the recent leader in the Economist of March 7 (pp.22 and 74-75) put it quite well:

"With the private sector sitting on its hands, Western governments are lavishing subsidies on CCS. Some $3.4 billion earmarked for CCS found its way into America’s stimulus bill. The European Union, which already restricts greenhouse-gas emissions through a cap-and-trade scheme, unveiled further incentives for CCS last year. Britain, Australia and others have also vowed to help fund demonstration plants partly because they reckon the private sector is put off by the huge price-tag on a single CCS power plant, and also in the belief that the cost of CCS will fall with experience.

Burning cash
The private sector, however, is reluctant to fork out not just because of the upfront cost of power plants, but also because, tonne for tonne, CCS looks like an expensive way of cutting carbon. The cost of it may fall, but probably not by much, given the familiarity of the technologies it uses.

Politicians should indeed encourage investment in clean technologies, but direct subsidies are not the way to do it. A carbon price or tax, which raises the cost of emitting carbon dioxide while leaving it up to the private sector to pick technologies, is the better approach. CCS is not just a potential waste of money. It might also create a false sense of security about climate change, while depriving potentially cheaper methods of cutting emissions of cash and attention—all for the sake of placating the coal lobby."

Sunday, March 08, 2009

Alberta could teach BC a thing or two about Climate Change Policy

Using the selling and trading of carbon credits to develop viable alternative energy projects is already a reality in BC's greener neighbour to the east--Alberta.

Alberta? If you don't believe me, just visit . That is where Alberta companies can peruse offers of carbon credits that have been earned through the curtailment of Greenhouse Gas (GHG) emissions. As journalist Sheila Pratt has written in a couple of important articles in the Edmonton Journal in February , this carbon-trading system has made it easier for a company named Highmark Renewables to profitably turn almost any kind of organic waste -- slaughterhouse waste, sugar beet waste, municipal sewage -- into biogas. Not only can the energy be sold, but so can the carbon credits they earn for reducing GHGs. And--even better--Highmark's ethanol plants need not take land out of food production, since they are powered by manure from adjacent feedlots.

This is an idea that could be useful in the Cariboo, where the ranching industry could benefit from power generation by feedlots, or even elsewhere in British Columbia, by helping to make farmland more profitable, thereby reinforcing the viability of the Land Reserve. And that is no B.S.