Paul Krugman talks about the Ireland financial problems  in the oped piece Eating the Irish.

I was going assign to you, dear reader, the task of reconciling Krugman with my posts about Blustein, Roubini, and Taleb. However, I realized that he did his own reconciling.

He asked the question about Ireland’s bailout “Does it really have to be this way?”. I quote his answer comparing Iceland’s economic recovery to Ireland’s lack thereof as follows:

Part of the answer is that Iceland let foreign lenders to its runaway banks pay the price of their poor judgment, rather than putting its own taxpayers on the line to guarantee bad private debts. As the International Monetary Fund notes — approvingly! — “private sector bankruptcies have led to a marked decline in external debt.” Meanwhile, Iceland helped avoid a financial panic in part by imposing temporary capital controls — that is, by limiting the ability of residents to pull funds out of the country.

And Iceland has also benefited from the fact that, unlike Ireland, it still has its own currency; devaluation of the krona, which has made Iceland’s exports more competitive, has been an important factor in limiting the depth of Iceland’s slump.

Nassim Nicholas Taleb has some very useful information for us about how to invest.  The trouble is that he has such a hard time sticking to the point and putting it in terms that we can understand, that I have not figured out how to put into practice what he is telling me.  However, I seem to pick up something on the edge of usefulness each time I read something he has written or listen to him speak.

I was going to post this on my blog when I noticed that RichardH had posted Bill Sharpe ( of CAPM fame) on ‘The Wrong Financial Advisor’.  In my stumbling across the videos below, I read an item `Black Swan’ Author Says Investors Should Sue Nobel for Crisis that quotes remarks by Taleb.

Taleb singled out the Nobel award to Harry Markowitz, Merton Miller and William Sharpe in 1990 for their work on portfolio theory and asset-pricing models.

“People are using Sharpe theory that vastly underestimates the risks they’re taking and overexposes them to equities,” Taleb said. “I’m not blaming them for coming up with the idea, but I’m blaming the Nobel for giving them legitimacy. No one would have taken Markowitz seriously without the Nobel stamp.”

Now for the videos I originally intended to post here

26 Nov 2010

I realized that parts of his message are really simple

1. We need to have a robust system that can withstand the shock of unpredictable events
2. Have safety margins so that your survival doesn’t depends on the accuracy of your forecasts
3. Debt means leverage means more risk. Decrease debt levels.
4. Concentration increases risk, so diversify
5. Pay systems that are no bonus without malice – means if you get extra pay (a bonus) when you do well, you should lose pay (malice) if you do poorly
6. Don’t transform private debt into public debt (i.e. bank bailouts without equity)

Having just read two books on the economic crises by journalists, I am feeling the need to find out what some actual economists think about these crises.

One economist this leads me to is Nouriel Roubini.  I have found that he, along with Stephen Mihm, has written the book Crisis Economics: A Crash Course in the Future of Finance. The interview with Roubini at the above link gives some idea of what may be in the book. Here is just one set of questions and answers from that interview.

Bremmer: In the book you propose radical reforms of the system of regulation and supervision of banks and other financial institutions and criticize the more cosmetic reforms now considered by the US Congress and in other countries. Why the need for radical reform?

Roubini: If reforms will be cosmetic we will not prevent future asset and credit bubbles and we will experience new and more virulent crises. The currently proposed reforms of “too-big-to-fail” financial institutions are not sufficient: imposing higher capital levies on these firms and have a resolution regime for an orderly shutdown of large systemically important insolvent firms will not work. If a financial firm is too-big-to-fail it is just too big: it should be broken up to make it less systemically important. And in the heat of the next crisis using a resolution regime to close down too-big-to-fail firms will be very hard; thus, the temptation to bail them out again will be dominant.

Also, the modest Volcker Rule – that may not even be passed by Congress because of the banking lobbies power – does not go far enough. It correctly points out that banking institutions that have access to insured deposits and to the lender of last resort support of the Fed should not be allowed to engage into risky activities such as prop trading, hedge funds and private investments. But more needs to be done: we need to go back to the more radical separation between commercial and investment banking that the Glass Steagall Act had imposed. Repealing this Act was a mistake that led to excessive risk taking and leverage by both banks and non-bank financial institutions.

Finally, the government should regulate much more tightly toxic and dangerous over-the-counter derivative instruments; and compensation of bankers and traders should be subject to radical “clawbacks”: bonuses should not be paid outright but go into a fund and clawed back if the initial investments/trades turned out to be risky and money losing over time.

I think I’ll have to put this book on my reading list.

The original version of my post Obama Vows To Veto Tax Cut For The Wealthy, brought out howls of complaint from one reader.

The reader wrote “When I read the last line, I got pissed at the post.  I felt betrayed.”  That’s the part of his email that I can safely quote on this family oriented blog.

Warning! Spoiler Alert, for those reading And The Money Kept Rolling In (And Out): The World Bank, Wall-Street, The IMF, and the Bankrupting of Argentina.

Paul Blustein, the author of the book, ends Chapter 9

These concerns would be less pressing, of course, if Argentina were sui generis, its crash a unique “perfect storm” reflecting a confluence of events unlikely to occur anywhere else in the world for decades, Was it?

He answers that question in Chapter 10.

REST EASY, because Argentine-type bubbles are not about to materialize elsewhere. Markets have a marvelous capacity to self-correct, and Argentina’s default chastened international investors and lenders so severely that they have demonstrated a new level of sobriety in their approach to emerging-market countries. This caution on the part of global-market players should reassure the world that there is no longer much reason to worry about global markets pumping up the economies of developing nations to the point of intemperance.

Unfortunately, the preceding paragraph is a laughable fantasy. By late 2003, investors’ eagerness to roll the dice in emerging markets was reaching levels not seen since the Asian crises of 1997, causing much unease among policymakers and expert observers. “Is this another bubble?” the Financial Times fretted in an editorial January 16, 2004. The newspaper’s use of the B-word was justified, and was being echoed elsewhere.

This book was first published in 2005. Obviously the author was unaware of what would happen in 2008 and 2009 that would make his description of the laughable fantasy even more true that when he wrote it.

Notice the use of the literary device that my reader felt was a betrayal when I used it.  This is the book recommended to me by said offended reader.

I found the link to Roll Back the Reagan Tax Cuts on the Facebook page of my friend MardyS.

Consider all the “tax cuts” working people have gotten over the past 30 years, from Reagan, Clinton, and Bush Jr. In each case, within a year or two working people’s wages were the same or lower. On the other hand, when working-class people’s taxes went up, during the Truman, Eisenhower, Johnson, and Nixon administrations, their wages went up in the following years, too.

We’ve seen both happen over the past 80 years, over and over again.

Interesting premise.  You have to read the article for the explanation of why this is. The article was so long, that I haven’t read it all. I have read more than enough to understand the quote that I have highlighted above.

I think it was Nassim Nicholas Taleb who pointed out that it is one thing to note some historical behavior, but quite another to postulate that you know the reason why it happened. The first can be a pretty safe thing to do. The second is fraught with the danger of fooling yourself. I can think of a few other explanations for the change in wages with respect to taxes than the author of the article comes up with. Normally taxes are cut when the economy is struggling and wages are falling.  Taxes are raised when the economy is booming and wages are rising.  If you take a snapshot of wages when the tax policy is changed and then look again at wages two years later, then you will see the results described in Roll Back the Reagan Tax Cuts. However, given my scenario, the cause and effect is the exact reverse of what Thom Hartmann describes.

Also refer to RichardH’s blog post Diversion–Highway Fatalities and Lemons.

Despite its possible flaws, the Roll Back the Reagan Tax Cuts article makes a nice complement to my post A Way Out Of Economic Mess.  That is, if you can believe other things in the article despite the flaw in one of his major arguments.

I have toyed with a few ideas for solving our economic mess in the posts Obama Vows To Veto Tax Cut For The Wealthy, Time For A Wealth Tax?, and Redeploy the Tax Cut That Was For The Wealthy To The Middle Class.

I have also been reading And The Money Kept Rolling In (And Out): The World Bank, Wall-Street, The IMF, and the Bankrupting of Argentina by Paul Blustein. I have just been reading the part where Argentina spiraled into a crisis because it did not balance its budget when the economy was healthy.  What Reagan, Bush, and Bush did to our economy seems to be mimicking what Argentina did.  I worry that they have set us on the road to the same outcome.  By blocking Obama’s attempts to save us, the Republicans may have assured our following the same path until we reach destruction.

I think I have a way out of the economic mess that will not involve the bankruptcy of the United States.  In a way, it is a variation on Keynesian economics that the experts don’t seem to be thinking about.  If the experts are thinking about this, I have not read about it in the current context.

The typical prescription for a recession/depression that you hear from proponents of Keynesian economics is to have the government spend more money to stimulate the economy by replacing the missing private sector demand.  The trouble as seen by Keynesians is that when everyone tries to increase their saving of money, demand dries up, businesses shrink, and unemployment rises. Only the government can spend to get money circulation going again instead of the money resting idle in savings type accounts with the banks not making loans against those savings. Usually, at least in the case of the U.S. for the last 80 years, the increased government spending occurs in a period of deficit spending thus adding to the deficit.

If the problem is that money is being squirreled away instead of being spent and deficit spending puts nations at risk of default, then nations ought to tax the money being saved and put it to work as a stimulus.  This is more of an idle wealth tax than an income tax. It ought to kick in for idle wealth above a fairly large threshold, $1 million or $10 million might be in the neighborhood of the right threshold. With these thresholds, you wouldn’t be having an impact on the middle class who are valiantly and correctly trying to deleverage from the recent refinancing bubble. With these taxes, the economy could be stimulated without running a deficit. I leave it up to the implementers to figure out how to tax idle (and I emphasize idle) wealth in a way that doesn’t just cause it to be hidden in foreign accounts.

The stimulus money should be spent on the investments we fail to make when the economy is booming. (I am searching for some kind of  spending that can be turned off when the economy rebounds.  I don’t think I have found it yet.) With the income tax rates already restored to pre-Bush levels during the downturn, the surpluses will grow as the economy recovers.  The surpluses can be invested in long term problems such as Social Security, Medicare, and general health care cost reduction.  Also government debt can be retired as a way of deleveraging an economy that becomes over-stimulated and threatens to have rampant inflation and over speculation.

There need to be specific advance plans for shifting spending and taxing for different phases of the economic cycle. For instance, an idle wealth tax could come into play when the unemployment level rose above a certain threshold and would end when the unemployment level fell below the threshold again.

If we can think of tax deductions for business investment that creates jobs in this country, we can think of applying taxes to corporate cash holdings that are not so invested.  Not every incentive has to be a tax expenditure. If this tax had a slight discouraging effect on amassing cash to buy out competitors, then this could be a nice side-effect.  The concentration of business in larger and fewer entities is probably not a good long-term pattern that we would want to continue.

If the Republicans can think that tax cuts are a solution to every ill, perhaps they just have it backwards.  Could it be that tax increases are the solution to every problem?  No, there are times when taxes should be decreased.

Perhaps Obama really ought to veto any extension of the Bush tax cuts for anyone. If we cannot afford those tax cuts, we cannot afford them for anyone.  Of course, Obama would be letting income taxes rise instead of the idle wealth tax I am proposing.  However, the action would be better than making the Bush tax cuts permanent.  In fact this action might be a necessary adjunct to the temporary idle wealth tax.

Despite the perceived wisdom from on high that you will wreck the economy if you raise tax rates during a recession/depression, that may only be true if you fail to recirculate the money collected by the increased tax rates.

If this is the only long-term viable solution to our problem, but it is not politically possible, then I am afraid that the country will just suffer the consequences of inaction in the face of an impending disaster.  There are many examples of countries that were unable to face up to the action that was necessary.  There is nothing that says that the US cannot fall victim to this internal failure of its citizens.

22 November 2010, I updated this piece based on comments from RichardH.

22 November 2010, I found an article along the same vein on BuzzFlash, Raise Taxes on Wealthy Bond Holders, Global Corporations, and the Rich to Avoid Cutting Safety Net Programs.

You might find a remarkable similarity to how these authors describe what happened to what I have been saying on this blog for quite a long time.

My only quibble is their contention that Democrats don’t want to admit that the government screwed up. Their description of how Fannie Mae and Freddie Mac got involved in the mess is exactly what I have said on this blog and on many discussion boards.

The Democrats and I were complaining about the laxity of the regulatory agencies in the executive branch run by George Bush. The description of how politics got in the way of regulators who wanted to put a stop to this is described quite well for the S & L fiasco in the book The Best Way To Rob A Bank Is To Own One. A book that I have featured on this blog.

Let me give credit to RichardH for making me look for something to post about these two authors and their new book All the Devils Are Here: The Hidden History of the Financial Crisis. I have been touting Naomi Klein’s book, but RichardH thought that Bethany McLean was prettier. Actually, my suspicion is that RichardH is just trying to avoid admitting that he won’t read Naomi Klein’s book because I recommended it to him.