Paul Krugman, Nobel Prize winning economist, knows what he is talkng about!

[iceaura]

SUMMARY: It doesn't work. At best it makes temporary jobs at great expense per job created.

It worked in the US for fifty years - but that was in avoiding trouble, not handling it.

The points you make might apply more to emergency response to disaster, and are more applicable to mistaken or inadequately wise government on the pitch of chaos?

I would go one further, saying it is a vicious cycle by which the fiscal and monetary stimulation used during the downturn merely plant the seeds for the next bubble and subsequent burst, necessitating another round of stimulation, which causes another bubble, and so on. My opinion is that if you cut out the stimulus altogether, then you won't have the bubbles and subsequent crashes,

Bubbles and crashes have been common features of capitalistic enterprise under all kinds of governmental policy. The last couple of bubbles and crashes in the US were not consequences of governmental stimulus. They were consequences of deregulated and privately funded capitalistic enterprise.

 

[Jeff 152]

I have a broader definition of stimulus. As far as I'm concerned, we've had economic "stimulus" since the Fed was created, especially after going off the gold standard, racking up deficits through borrowing, running a huge current account deficit, etc. Fractional reserve banking and the unprecedented expansion of the money supply. All of it has helped us live beyond our means without having to suffer the consequences due to the US reputation and the reserve currency status. That's the stimulus.

 

[iceaura]

I have a broader definition of stimulus. As far as I'm concerned, we've had economic "stimulus" since the Fed was created, especially after going off the gold standard, racking up deficits through borrowing, running a huge current account deficit, etc

Which worked pretty well for fifty years, until Reagan - and was not the cause of the S&L bubble, or the tech bubble, or the derivatives bubble, all of which followed deregulation of key industry finance rather than "stimulus".

 

[Jeff 152]

Well I would argue that our loose monetary policy helped to fuel a lot those booms, but you are right, it did not play a direct role the way it did (in my opinion) in this most recent bubble. I think that is why there has been a resurgence in austrian school thought since the crash, since this is exactly the kind of scenario that austrians have been worried about for years.

 

[iceaura]

it did not play a direct role the way it did (in my opinion) in this most recent bubble. I think that is why there has been a resurgence in austrian school thought since the crash, since this is exactly the kind of scenario that austrians have been worried about for years.

It entered the arena only as an expression of hard core "free market" capitalism - the key events were the deregulations of the banking and finance institutions. Greenspan was no Keynesian, in his reliance on "the market" to discipline greedy bankers and enforce prudence and self-denial in the face of a commons of incredible wealth. He was removing government curb, not injecting government money.

The recent surge in Austrian references seems more like a last resort; a fallback after the more obvious explanations have led to the conclusion that bankers need close regulation, free markets are like aquariums in need of constant maintenance rather than wild oceans self-balancing in the tides of reality, and capitalism is not the end all be all of economic creation; a last ditch effort to find a way to blame government for the behavior of the rich and powerful when not governed.

 

[Jeff 152]

a last ditch effort to find a way to blame government for the behavior of the rich and powerful when not governed.

How about the behavior of the rich and powerful when governed by a system which creates perverse incentives?

 

[iceaura]

How about the behavior of the rich and powerful when governed by a system which creates perverse incentives?

Greenspan relied on the invisible hand of the free market. He should have relied more on Keynesian policy, perhaps as discussed by JK Galbraith.

Capitalism creates perverse incentives, especially in bankers and financiers. Part of governing a modern industrial state is recognizing and curbing them. Failure to do so creates all too familiar situations, invites all too common troubles.

 

[Billy T]

they Greenspan relied on the invisible hand of the free market. ...

That is correct but less than half the story: He thought banks, etc. would make prudent loans - after all it was their money at risk he reasoned.

He greatly underestimated the bankers. They not only wrote no-money down home loans so street living drunks could buy a big house, as soon as a few cups of coffee got them sober enough to sign documents (OK, that is a SLIGHT exaggeration) but then they swapped these loans with other banks from different regions (for "risk diversification"). Then they packaged them into complex, mulit-tiered, mortgage backed securities, MBS, which only a few well versed in math could understand, so they got at least an AA rating. Then the banks could quickly:

(1) Shove these high-risk complex loan packages off onto others. (Who are now called the holders of "toxic trash" being bailed out by tax-payers.)
(2) Do it all over again with the money they got from selling the MBSs.

That how they got to more than 30 fold leverage. I.e. they had very little or no "skin in the game" so did not need to be prudent in writing loans as Greenspan had expected. On the "up-front" loan writing commission alone, they would net a bundle even if no loan was ever repaid!

Greenspan was either very naive or ignorant of how clever bankers could be. - Probably due to many hours sitting in Anne Rand's living room listening to right wing nonsense.

 

[iceaura]

Greenspan was either very naive or ignorant of how clever bankers could be

Pay me what they paid him, I could be naive too.

There's a quote close to this: It is almost impossible to make a man understand something when his livelihood depends on his not understanding it.

 

[Jeff 152]

(1) Shove these high-risk complex loan packages off onto others. (Who are now called the holders of "toxic trash" being bailed out by tax-payers.)
(2) Do it all over again with the money they got from selling the MBSs.

Do you fault Fannie and Freddie as a government sponsored perverse incentive since they effectively put the government guarantee on all the MBSs? Or all of the policies pushing for home ownership?

 

[Billy T]

Do you fault Fannie and Freddie as a government sponsored perverse incentive since they effectively put the government guarantee on all the MBSs? Or all of the policies pushing for home ownership?

That the tax-payers should eat the losses is a sad result of the banks (and other writers of high risk mortgages) creating a problem.

There was a very general lack of adequate regulation under GWB.* It was the philosophy of his administration (and of Ayn Rand taught Greenspan too) that the government which in interferes least with the private market place is the best government. Unfortunately, this POV is common among many Republicans and nearly all tea-party people. If anything that "small government is best" POV seems too be growing. For example, many are happy that the new Congress will be unable to act to solve problems.

Greed can be a good thing but unregulated it leads to economic disasters such as we have now.

*During the Congressional investigation of the Madoff mess, the former head of the SEC explained that part of the reason why they did nothing even when provide with very detailed evidence that Maddoff was running a Ponzi scheme, said "The administration keep us on a very tight leash."

To more directly answer you:
Yes there has been for decades the idea that home ownership should be encouraged. That renters are less responsible citizens, etc. It is built into the tax laws that you can deduct the interest on your home mortgages. These complex tax laws are really an economic distortion force of a central planning government - but few understand that. The USA has about the same, but hidden, central planning via the tax laws as the old USSR had openly, IMHO. I.e. practically every economic decision in the US is strongly influenced by the tax consequences of it vs. its alternative (renting vs owning being an obvious example. SUV gas hog vs European style cars is another important example of US's low taxes on gasoline. Oil depletion allowance tax breaks another, etc. the list is endless.)

Fanny May & Freddy Mac (or some thing like them) is essential to keep mortgage money available. The banks (and other writers of mortgages) must have some way to sell the mortgage they write or soon they would just shut down their lending departments. What is wrong is that they need not keep any "skin in the game" so don't need to be prudent about what loans they write. Furthermore, the sold mortgage were resold many times, to other buyers paying with mainly borrowed money. (They had little of their own skin in the game too.) Packages of packages were created, for more diversification This multiple reselling and re packaging built the leverage to 30 fold or more. Thus even a 4% reduction in home values wiped out 100% of their value. Made the MBS packages into toxic trash. Most falsely assumed that home prices could only go up so high leverage was wise and profitable.

The Bush administration's SEC, etc. and Greenspan simply and falsely assumed that the free market would self regulate and be prudent. Part of the reason why I could predict, and post here, that a run on the dollar (and subsequent depression), coming before Halloween 2014 was inevitable while GWB still had more than a year remaining as POTUS.

 

[Jeff 152]

I largely agree with your post. I think there needs to be a distinction between believing in the free market and being an anarcho-capitalist. The free market isn't truly free unless regulations are in place to prevent fraud and other dishonesty. Now there of course are regulations which are overly bureaucratic and create too much red tape and are prohibitive to the market. But regulations which protect property rights and punish fraud - absolutely.

A note on Greenspan - he was criticized heavily by many in the objectivist school due to abandoning many free market principles in his role in inflating the housing bubble via extreme rate cuts and other central bank activity. Objectivists being against a central banks in general of course, it is surprising that greenspan was ever a part of that group.

And I still contend that Fannie and Freddie create a moral hazard as a guaranteed buyer of whatever crap the banks throw at them.

 

[iceaura]

And I still contend that Fannie and Freddie create a moral hazard as a guaranteed buyer of whatever crap the banks throw at them.

They aren't. They are not guaranteed buyers of crap - only loans that meet standards.

As long as those standards are enforced, there is no moral hazard in their operations. Failure to enforce rules creates moral hazards, of course - but in any system.

And they weren't the major cause of the bubble and crash anyway. The bad loans themselves were only a small part of the disaster.