Economic Dreams - Economic Nightmares

Capitalism's Fatal Flaws

In The Worldly Philosophers, Robert Heilbroner tells us that all the great economists foresaw a time when capitalism would come to an end. In Stabilizing an Unstable Economy (1986), Hyman Minsky outlines an agenda for ending capitalism as we've know it (what Heilbroner called "Capitalism as a Regime" in Behind the Veil of Economics). Minsky suggests that we replace laissez-faire capitalism (Wiki link) with a less-flawed version of Capitalism that allows for much better automatic stabilizers than found in our current system.

Minsky, following his reading of Keynes, tells us that modern financial institutions (with inherent tendencies toward monopoly) inevitably will turn into predators on other economic subsystems. Minsky also tells us that most economic theories, with emphasis on "equilibrium" while allowing only for occasional shocks to the system, are ill-equipped to deal with the systemic problems stemming from stability that breeds instability. Minsky (p.280):

In a world with capitalistic finance it is simply not true that the pursuit by each unit of its own self-interest will lead an economy to equilibrium. The self-interest of bankers, levered investors, and investment producers can lead the economy to inflationary expansions [including asset inflation] and unemployment-creating contractions. Supply and demand analysis—in which market processes lead to an equilibrium—does not explain the behavior of a capitalist economy, for capitalist financial processes mean that the economy has endogenous destabilizing forces. Financial fragility, which is a prerequisite for financial instability is, fundamentally, a result of internal market processes. …

Institutions such as the Federal Reserve, which were introduced in an effort to control and contain disorderly conditions in banking and financial markets, are now slaves of an economic theory that denies the existence of such conditions.

The "stability breeds instability" process is now well-know to complex systems theorists. As systems age, newly emergent systems first gain, then lose redundancy and therefore resilience—they become fragile, brittle, or tightly-coupled. At some point a shock to the system will cause catastrophic failure (if the system just doesn't get stuck in a "poverty trap"), setting the stage for rebirth of that system or newly emergent systems that arise in the wake of the old. (See, e.g. adaptive cycle, or more generally: Resilience Alliance.)

Minksy's dream is a hard sell in the American culture, with our new-found American values. Minsky's agenda is to relegate market mechanisms to relatively minor roles. Minsky's "solutions" which he offered up humbly, are for bigger government, smaller banking institutions, and an elimination of "welfare" via a government-sponsored "employment strategy". It is an agenda that is still being pitched by some of Minsky's disciples, although there is dissension among the disciples as is always the case with economists. Minsky also advocated for a "balanced budget" — balanced not every year, but over a reasonable time-frame so as to avoid hyper-inflationary possibilities.

Time will tell whether Capitalism will survive (and if it does, In what form?). In the meantime we all watch and wait, cuss and discuss.

For more on Minsky and more on the bankster crisis, see:
Economic Perspectives from Kansas City.
For more on monetary complex systems thought, see:
Macroeconomic Resilience

The Politics of Future Promises

Over at Econbrowser, James Hamilton has been detailing his concerns about meeting future pension and health care obligations, interrelating them with the subprime meltdown, the derivatives/hedge fund 'problematic', etc. Today, Hamilton points to several contemporary examples — in California, Tenessee, New Jersey — and concludes:

If there were just one or two such stories, one might regard it as a mistake here or a miscalculation there. But the phenomenon is too widespread to be dismissed as accidental. I am forced to conclude that a pervasive feature of modern American politics is for elected officials to lavish benefits on their current power base, promising or in many cases legally obligating the government to make future payments that will prove to be extraordinarily costly to deliver. I conclude that the reason elected officials keep doing this is because that is what voters want.

I have not read Bryan Caplan's new book, but I must say the cover does a nice job of conveying what the issue may be.

US Headed Toward Bankruptcy?

A recent British news headline says US 'could be going bankrupt'. The storyline might be summed up: "A ballooning budget deficit and a pensions and welfare timebomb could send the economic superpower into insolvency, according to research by Professor Laurence Kotlikoff for the Federal Reserve Bank of St Louis…."

Bill Moyers asked Peter Peterson that question in the fall of 2003 (9/6/03) {Peterson is president of the Concord Coalition}. Peterson's answer was, in part:

… There's 77 million Boomers we're talking about. A doubling of the elderly. Half of the people getting Social Security make less than $20,000 and they depend enormously on Social Security as part of that. ... Unfortunately, our country has staggering amounts of elderly that have no savings at all, about 20 percent.

Imagine politically 77 million Boomers. They don't have savings. They depend on Social Security and somebody's saying to them, "Sorry, folks, we're out of money. You're not going to get your benefits."

And they've been told -- they've been misled by politicians all their lives -- that this Trust Fund is going to take care of them. My father went to his deathbed thinking that there was real money there. And he said, "My son, I don't know what you're talking about because it's like a savings account."

And I kept saying, "Dad, there's nothing in there. It's just liabilities." So I think that political ... implications would be devastating. But more than that, the social implications. It's the richest nation in the world. And you're going to sit there and tell me we're going to throw tens of millions of Americans into a destitute situation without advanced notice? I don't think so. …

I'll give you several possible suggestions. A menu. Very gradually increasing the retirement age, because we're living much longer. If we had indexed retirement to the way life spans have gone up, we'd be getting Social Security now at 73, not at 65.

A second thing is what I call an affluence test. I don't like the word "means test," because it sounds mean. And Bill Moyers and Pete Peterson would lose some of their benefits, because we don't need them.

A thing Lady Thatcher did that I find very promising, she said, "How do we be fairer to the current retirees and to our children? How do we do that?" And she came up with the idea of indexing benefits only to inflation. And that meant that my kids would get the same benefits in dollar-- real dollar terms, but they wouldn't grow.

Now those are the kinds of things we're going to have to seriously look at. …

Laurence Kotlikoff has his own list of remedies, including a national sales tax (with rebates some), Social Security Reform, Healthcare reform, and more. See his recent Federal Reserve article Is the United States Bankrupt? [PDF] , Federal Reserve Bank of St. Lewis Review, July/August 206.

I'm not sure whether or not Kotlikoff's proposals are workable and affordable even in the unlikely event that our politicians were to seriously address the issue of our current-path insolvency. But at least they ought to be given their due. Kotlikoff's proposals, ike Peterson's can be stacked up alongside others for future historians as they ponder our fate from the other side of destiny. At best, but not likely, our politicans might do something about this mess.

Note finally that Arnold Kling is likely typical of libertarian critics, not liking Kotlikoff's proposals in the main because they come from government:

… The fundamental problem, which Kotlikoff expresses in somewhat different terms, is that there is no consumer protection agency for phony government marketing. If a private company tried something as unsound as Social Security or Medicare, it would be shut down and its officers put on trial. But the voting public is ignorant of government scams, and I see nothing that will change that. …

And as to Bankruptcy, Kling doesn't buy it:

…Calling the U.S. bankrupt depends on calling future Social Security and Medicare recipients "creditors." But the government's extravagant promises can be taken away as well as given. The question is when and how. The government can wipe out its "bankruptcy" at the stroke of a pen by raising future retirement ages, although Kotlikoff probably would argue that for his tastes this does not shift enough of the burden onto the current wealthy elderly. …

The problem is, of course, politics. Yes promises can be "taken away" but not without paying a "political" price.

Note to myself: I ought to read Kotlikoff's and Scott Burns' book, The Coming Generational Storm, but who knows when. So many books, so little time!

'Fiscal Hurricane' on the Horizon

Richard Wolf's 'Fiscal Hurricane' on the Horizon, USA Today (Nov 15), explains "how the nation's finances are going to hell. … [B]udget experts say the nation could soon face its worst fiscal crisis since at least 1983, when social security bordered on bankruptcy." Wolf captures the views from an impressive group gathered together in Washington D.C. to alert the American people, the media, and the Congress that we face a "demographic tsunami," with baby boomers feeling entitled to much more than they can reasonably expect. The fallout from over-promised entitlements will spill over well beyond baby boomers.

The group includes David Walker, Comptroller General of the United States, Douglas Holtz-Eakin, Director of the Congressional Budget Office, Maya MacGuineas, President of the Committee for a Responsible Federal Budget, Kent Conrad, Democratic Senator from North Dakota, Stuart Butler from the Heritage Foundation, Alice Rivlin and Isabel Sawhill from the Brookings Institution. They are traveling the country—hoping to ward off impending disaster "by writing and speaking out on the need to cut spending, raise taxes, or both. They emphasize (using MacGuineas as their voice) that they "want to see a presidential election where the candidates are talking about what taxes they'll raise and what spending they'll cut."

Pension Funds or Unfunded Promises?

Brad Delong calls Delphi Auto Parts' pension fund losses a big problem, building his arguments from a recent Dean Baker post at MaxSpeak, You listen! I like to think of DeLong’s big problem as a domino—lined up with other dominos yet to fall. How far behind is GM, Ford? What about recent misadventures at United Air, Delta? Who will be next? What other games are afoot? How much more looting? Do any of us have pension funds that are not at risk?

On the government ledger, add US domino-effect government underfunded liabilities in the Pension Benefit Guarantee Corporation to underfunded mandates in health care, and to underfunded social security 'trust fund' obligations, etc. Add these underfunded liabilities to other big problems including asset bubbles and systemic risks derived from complex-derivatives adventures that may go awry. Now and ask youself a simple question: How resilient is the much-lauded American economy?

DeLong's conclusion:

...At the corporate-structure level, the big problem is that retirees (like workers, stockholders, and bondholders) have claims on corporate cash flows. Workers' claims at a company like Delphi are secured by the fact that if they don't show up, nothing gets made and there are no cash flows: Delphi's jobs are very highly-skilled indeed, and replacing any significant chunk of the workforce with people off the street is not a realistic option. Stockholders' claims are secured by the fact that they vote for the executives of the company--and can throw out the executives if they don't like what the executives do. Bondholders' claims are secured by their ability to throw the company into bankruptcy if they are not satisfied and by bankruptcy judges' mandate to protect their interests.

Retirees have claims on cash flows but no institutional mechanisms to secure their power if things go south--save for the fact that the PBGC will step in and cover some of their pension costs.

This is a big problem.

11/02/2005 Update: Brad DeLong weighs in again with The End of Pensions

Will Housing Bubble Bust Trigger Massive Pension Fund Crisis?

If Henry CK Liu’s Sept. 13 Asia Times commentary proves correct, many beyond Delta and Northwest Air employees can say goodbye to their pension plans. Liu believes that a housing bubble bust is inevitable and any Fed “slowing” of interest rate hikes will just prolong and intensify the agony later-on. Liu argues that massive pension fund liabilities are tied to the GSEs, and the banks that have serve as middle-men in associated GSE credit swaps. Such liabilities are largely unknown to owners of pension funds. Some homeowner/pension fund entitled folks may get a double whammy, and get to watch their homeowner “wealth effect” disappear along with much of their pension. Here are Liu’s concluding paragraphs, with an earlier snippet:

… On Greenspan's 18-year watch, GSE (government-sponsored enterprises) assets ballooned 830%, from $346 billion to $2.872 trillion. GSEs are financing entities created by the US Congress to fund subsidized loans to certain groups of borrowers such as middle- and low-income homeowners, farmers and students. Agency MBSs (mortgage-backed securities) surged 670% to $3.55 trillion. Outstanding ABSs (asset-backed securities) exploded from $75 billion to more than $2.7 trillion. Greenspan presided over the greatest expansion of speculative finance in history, including a trillion-dollar hedge-fund industry, bloated Wall Street firm balance sheets approaching $2 trillion, a $3.3 trillion repo (repurchase agreement) market, and a global derivatives market with notional values surpassing an unfathomable $220 trillion. Granted, notional values are not true risk exposures. But a swing of 1% in interest rate on a notional value of $220 trillion is $2.2 trillion, approximately 20% of US gross domestic product (GDP). ...

…[T]he Fed is engaging in self-delusion when it relies on a measured-paced interest-rate policy to deal with a runaway debt bubble sourced globally. For the Fed, the debt bubble is already too big to burst. The only option is to keep feeding it, albeit at a slower pace. The measured-pace interest-rate policy is merely an attempt to slow the bubble's rate of expansion, not to stop it, much less to burst it. But a measured-paced interest-rate policy will not slow the economy enough for a soft landing. It will only prolong the bubble for a bigger bang at the end. What Greenspan did at Jackson Hole was to give warning that the end is at hand.

Through mortgage-backed securitization, banks now are mere loan intermediaries that assume no long-term risk on the risky loans they make, which are sold as securitized debt of unbundled levels of risk to institutional investors with varying risk appetite commensurate with their varying need for higher returns. But who are institutional investors? They are mostly pension funds that manage the money the US working public depends on for retirement. In other words, the aggregate retirement assets of the working public are exposed to the risk of the same working public defaulting on their house mortgages. When a homeowner loses his or her home through default of its mortgage, the homeowner will also lose his or her retirement nest egg invested in the securitized mortgage pool, while the banks stay technically solvent. That is the hidden network of linked financial landmines in a housing bubble financed by mortgage-backed securitization to which no one is paying attention. The bursting of the housing bubble will act as a detonator for a massive pension crisis.