Monday, March 23, 2009

Brad deLong joins me!

He posts that he thinks Paul Krugman is wrong.

And his nervousness about that statement matches mine...

He notes that if the past decade has taught [him] anything, it has taught [him] that mistakes are avoided if you follow two rules:
  1. Remember that Paul Krugman is right.
  2. If your analysis leads you to conclude that Paul Krugman is wrong, refer to rule #1.
I have a similar view of the quality of Paul Krugman - and I am equally nervous saying he is wrong.

Nonetheless I formed the view that he was mistaken about five or six weeks ago...  and posted it here and here and here and here and here and here and in a few other places.  

I asked Paul Krugman for an email - because I am sure we could identify where we differ very accurately with an email exchange.  No such luck.  

Please Paul...



babar ganesh said...

JH - the fact that private capital only has to put up 3% as first loss capital is part (though not all) of what is angering people. do you think that is adequate?

lewy14 said...

John, isn't it possible that Krugman is simply being disingenuous?

Consider this snippet of his:

But the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt.

Parsed very closely, the point about "walk away from their debt" is accurate - but doesn't Krugman here intend to deliberately mislead people into thinking that the investors can't lose money in this scheme? Doesn't he mean to give the impression that the investors can walk away from their debt with their equity... which is, you know... factually challenged?

I mean, I know you hold him in high regard, but do you expect Krugman to point out that investors who misprice their asset purchases in fact risk 100% of their principle?

Isn't it possible that Krugman is being somewhat, well, political here?

Check out Felix Salmon for some context:

While the talking heads in New York and Washington throw around their millions and billions and trillions before commuting home to their comfortable middle-class-and-better lifestyles, the rest of the country is mad as hell, and ain't gonna take it any more. They're not interested in constructive solutions or in leveraging private capital or in the sanctity of contracts: f*** that s***. Those days are over. They want to see jail time, confiscatory policies, and worse.

I know plenty of people in my neighborhood who feel this way. A lawyer friend, my doctor, tech people, etc... not the usual class war suspects. In fact, I don't know many who have the patience any more to sit and review the issue with any sobriety.

Political risk is the ultimate tail risk. This is the rage that Krugman is looking to get in front of. He may concede that Geithner's plan is sane, but that the polity may remain insane longer than Geithner can remain (politically) solvent.

So Krugman is short Geithner, and Obama gets a negative ratings warning.

Nate said...

I don't think Krugman is being disingenuous. I think he sincerely thinks the Geithner plan won't work. I would guess that within about 6 months we should have a pretty idea of who was right, Krugman or Hempton/DeLong. Hempton and DeLong are both wise to hedge their bets, by saying that this plan is a step in the right direction but not necessarily the solution. Krugman doesn't think it's a step in the right direction, but rather just more fiddling while Rome burns.

I do like Hempton's suggestion of forcing the banks to sell a bit of their toxic assets to establish a mark, which could be a better stress test than the one currently envisioned.

It's not necessarily unwise of Geithner/Obama to be more wary of nationalization than Krugman is. There are many ways that such an unprecedented move could fail spectacularly. The temptation to stall and try half-measures must be intense, but that doesn't mean that a gradualist solution might not eventually work. Is it unreasonable to hope that the business cycle will turn around of its own momentum, and that if we can just keep the financial system on life-support long enough, we'll make it through? Krugman seems to think the only way out of the economic crisis is to take the financial bull by the horns, so to speak, but actions of that scale could have significant downside and possible repercussions that could last for a very long time.

babar ganesh said...

another way of putting this:

if you believe that Citigroup has a government guarantee (implied by 'no more lehmans') then the US treasury has effectively written a large put on C. the strike of that put is the equity value of C (ie small and maybe negative) and the volatility is high.

given that, every asset on Citigroup's books is protected by this put. So assets in general, especially high vol assets, are worth more to C than to other people. that is probably one reason why nobody else wants to pay C what C thinks they are worth.

this program tries to give other players a govt guarantee that is roughly the same terms that C implicitly has. ie it sells some of C's put to private capital.

if it reduces the volatility/uncertainty of C's asset base then the put is worth less, and that is the 'magic' part of the plan.

given that, it might possibly work, but i think it is rooted in the same bullshit soil that we are currently planted in.

this is the kind of crap that you get when your starting point is 'too big to fail' / 'no more lehmans'.

Nate said...

I just re-read the Treasury fact sheet, and it seems to me that the big question mark still hanging over this plan is this: what is the banks' motivation to sell? The fact sheet is kind of fuzzy on the details. Step 1 of the plan is the banks deciding a priori which assets they don't want, and offering them to the highest bidder. It seems more likely to me that they would circulate a "bid list" with many toxic assets, and only sell the ones (if any) that attracted a high enough bid. But what if none attract a bid high enough, especially considering BG's point above that these assets have little downside for a bank that enjoys a no-more-Lehmans guarantee? I think that may be the Achilles heel of the plan. There may need to be some gentle persuasion from regulators to get banks to unload these things (and simultaneously raise capital if necessary).

RN said...

I think Geithner/Delong et al. are nuts.

It seems pretty simple to me. How much are these assets worth?

These assets are principally based on home mortgages. They're largely valued on the income streams expected in the housing bubble. Their value is directly related to the number of defaults, which is related to the home prices, resets, and the economy. But home prices have fallen (and have a fair amount further to go to restore historical mean vaue to rent ratios, resets are coming (the option-ARMs are about to hit), and the economy (and people's ability to keep paying their mortgages) has fallen drastically, and probably has a lot further to go.

So how in the world can Geithner think these assets are simply "unappreciated"? The fundamentals backing these assets are pure and simple a disaster. How in the world can anyone think these assets are worth anything CLOSE to what Geithner/Delong/Hempton think and that if we just "appreciated" them they'll magically revert to their "true" value?

That's just insanity!

gz said...

I read your blog daily, excellent stuff, but what makes you think Krugman is right when for istance he advised the Japanese in the '90s and they did take his advice and it was quite wrong (see Richard Duncan book for instance)

Besides, he is a political leftist above all, he really and sincerely does not like free markets to succed

Anonymous said...

So if I'm a hedge fund, what stops me from going long on a bank, massively overbidding on the auction, and walking away from my 3% with a massive profit on the long bank with the FDIC left holding the bag?

Anonymous said...

To all those weighing in on Krugman, a humble suggestion: before concluding you know his thinking well enough to sterotype him or predict him, read his books in addition to his columns. Sometimes you'll get the feeling you're reading a different author entirely. I'm hoping he's wrong in this case but not putting money on it.

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