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Sunday, January 11, 2009

What makes this recession long and bad?

Economist and popular blogger Tyler Cowen has this to say. I don't like to use the "D" word yet, but Tyler does and I do think his reasons are worth thinking about. In italics, I've made some comments.

Tyler Cowen's
Eight reasons why we are in a depression

1. We have zombie banks.

In other words, we have banks that are probably dead (or, at least, not helping provide liquidity to the economy). They chew up resources (including lots of bailout money) without improving things.

Despite the fact that the best and the brightest in America have gone into finance for a generation (due to the high salaries and the expansion of employment in this sector) it's clear that this intellectual capital has been squandered, and we were better off with the less intellectually superior bankers of a generation ago.

2. There is considerable regulatory uncertainty in banking and finance.

That's an understatement. We know the past didn't work. But the Madoff case shows the SEC doesn't help much even when they do multiple investigations of a firm. How can effective regulation be done without putting things in a straightjacket? As a result, it's likely lobbying efforts will increase. An increase in lobbyists and a dependence on Congress and the courts to sort things out is not a quick way to resolve uncertainty.

3. There is a negative wealth effect from lower home and asset prices.

I love the euphemism "negative wealth effect".

4. There is a big sectoral shift out of real estate, luxury goods, and debt-financed consumption.

This disrupts a lot. If people stop buying at Tiffany's, Tiffany lays off employees. But we don't really know what people will be buying and what people will be making, so it's unclear what to invest in. I thought alternative energy would be a good bet, but wasn't sure how I wanted to invest. The drop in oil prices means that alternative energy investments are really tanking -- good thing I was slow in figuring out what to get in there.

5. Some of the automakers are finally meeting their end, or would meet their end without government aid.

6. Fear and uncertainty are high, in part because they should be high and in part because Bush and Paulson spooked everyone.

It's sort of hard to blame W, because he was as clueless as he was on every other issue for 8 years. Who really expected him to help? It's hard to trust Paulson as having the welfare of the US in mind, since he was so clearly a part of the Wall Street mindset as former head of Goldman Sachs. I don't think Paulson is either corrupt or incompetent, I just think he looks at things from a point of view which values the financial sector above anything else.

7. International factors are strongly negative.

8. There is a decline in aggregate demand, resulting from some mix of 1-7.

I have two simple points, First, a large fiscal stimulus addresses factor #8 but fares poorly in alleviating the other problems.... Second, forecasting will prove very difficult.

And if forecasting is difficult investments become riskier. It's important for the incoming administration to set relatively clear ground rules. They should be good rules, but if we wait for great rules we will just prolong the uncertainty.