Time to delete mark-to-market?

There were rumors on Friday that the mark-to-market rules might be relaxed, and those rumors were credited with the rise in bank stocks.

Which leads to the question, why are those rules still in place? There have been suggestions throughout the financial panic that the mark-to-market rules were one of the things that was accentuating the fall. And if we look at how the Federal Reserve has responded, we can see that this financial panic is like no other. What is different this time? Could it be that the mark-to-market rules have introduced amplifying feedback, making the financial crisis a self-feeding process?

When FDR became president, his administration was a lot like the character in a comedy reacting to a crisis by pushing buttons. FDR pushed a lot of wrong buttons, but he did push one correct button by severing the tie to gold and eliminating the Fed from monetary policy, which had established an amplifying feedback loop in monetary policy. Maybe the mark-to-market button is the right one this time. Certainly it is worth trying. If the U.S. is willing to spend nearly two trillion dollars, the amount of the TARP and the so-called stimulus plan, why would it not also be willing to junk a rule that costs virtually nothing at all to junk? I wonder why the Bush administration was never willing to take this simple step given that they were willing other steps that were far more drastic.

Economics lacks a consensus framework in which to view macroeconomics. A framework of shocks and feedback, in which shocks knock the economy off path and the feedback accentuates the effect of the shock, leads one to focus on items like mark-to-market. The equilibrium approach of Keynesian economics leads to a focus on stimulus packages. If we get both a stimulus package and an elimination of mark-to-market, it may be very difficult to distinguish the effects of each.

Update Feb 16, 2009: Brian Wesbury, chief economist at First Trust Portfolios L.P., argues in a National Review piece, "Untouchable Accounting Rules? Really?", that mark-to-market has been a major contributor to the current crisis because of its procyclical feedback properties, and needs to be eliminated. He points to some history:

Fair-value accounting as we know it today is based on rule FAS 157, which was implemented by the FASB in 2007. But it has a longer history than that. Fair-value accounting existed in the 1930s, which was when we had the Great Depression. In 1938, President Roosevelt suspended those rules, and between then and 2007 the economy had no panics or depressions. Maybe its time we put fair value through the shredder once again.

Abandoned cars

Marginal Revolution points to an article on a Financial Times blog that discusses reports of car abandonment in Dubai, where the construction boom is ending. It reminds me of what has happened in Las Vegas, where there have been large auctions of construction equipment.

Update: There are people questioning the original report that there has been a large increase in car abandonment. The police say that only 11 cars have been abandoned at the airport in the last year, not 3000. Also, a reader leaves this comment in the marginalrevolution.com post:

About the abandoned cars in Dubai bit. there is a salient fact that is not mentioned. In 2008 the UAE government instituted a new law designed to get old cars off the road, whereby any car older than ten years cannot be re-registered by a new owner. That is, if you own an old car, you can continue to drive and register it, but a new owner cannot. Thus, cars over 10 years old suddently have a resale value of near zero - the only people you can sell them to are dealers who specialize in exporting them to places like Iraq or Uzbekistan.

So, if your stint in Dubai is up, and you have an older car (and a lot of the Indian and Pakistani expats did have cars this old), leaving it at the airport is the sensible thing to do, because going through the process of selling it for next to nothing and then renting a car for your last few days is a bigger PITA.

Update 2: The New York Times now has an article that says that conditions are deteriorating in Dubai.

No one knows how bad things have become, though it is clear that tens of thousands have left, real estate prices have crashed and scores of Dubai’s major construction projects have been suspended or canceled. But with the government unwilling to provide data, rumors are bound to flourish, damaging confidence and further undermining the economy.

The cultural divide

In Commentary Yuval Levin reflects on the what the reactions to Sarah Palin show us about American.

The answer has much to do with the age-old tension between populism and elitism in our public life, which is to say, between the notion that we are best governed by the views, needs, and interests of the many and the conviction that power can only be managed wisely by a select few.

The whole piece is worth reading.

Reasonable stock market price

Greg Mankiw has a link to a graph that I wish I had seen several years ago. It suggests that stocks are not presently undervalued. They have been overvalued for the past ten years.

Reforestation in the third world

As happened in the U.S., land in the tropics once stripped of forest for agriculture is now reverting back to forest.

U.S. sneezes, China get pneumonia

The economic downturn that the U.S. is experiencing is also being experienced in other parts of the world, and in some of that world the effects are more dramatic than in the U.S. The Wall Street Journal reports that 10 million Chinese workers may be returning to the farm because of a lack of factory and other urban jobs.

The Financial Times says it is 20 million.

Working for Walmart

Charles Platt, a senior writer at Wired magazine, spent two weeks working at Walmart and reported his impressions at Boing Boing. Why do this? He explains:

It started when I read Nickel and Dimed, in which Atlantic contributor Barbara Ehrenreich denounces the exploitation of minimum-wage workers in America. Somehow her book didn’t ring true to me, and I wondered to what extent a preconceived agenda might have biased her reporting. Hence my application for a job at the nearest Wal-Mart.

Platt finds that the workers were treated well and liked working for Walmart. The sentence that caught my eye was this:

Most of all, my coworkers wanted to avoid those “mom-and-pop” stores beloved by social commentators where, I was told, employees had to deal with quixotic management policies, while lacking the opportunities for promotion that exist in a large corporation.

When my father folded up his retail business and went to work for a family owned store, he found little good about it. After a few years, he sought and found greener pastures at a chain in St. Paul. He made more money and was treated better.

Update: A longer version of his impressions is here.

Innovation at google

Google has found a new way to use Google Earth--to explore paintings. It has taken a technology used for one thing and found another thing that it can do. Right now it has a number of famous painting from the Prado, including Bosch's Garden of Earthly Delights. Check out google.com/prado

If Google follows its usual course, it will soon have a great many famous pictures available, and will make museums as obsolete as it has made libraries.

Stimulus and the Great Depression

The Huffington Post has an article about the two views of the Great Depression,

The dominant story in the public mind is of President Franklin Delano Roosevelt's success. It goes like this. Like Obama, FDR comes to power with the American economy haemorrhaging jobs. He believed that, if private industry is withering, the government has to take up the slack by large public spending programmes. He set millions to work preserving green spaces and rebuilding the country's infrastructure.

The other view is attributed to a small number of right-wing economists in the 1980s.

They argued that the American people had been wrong: the New Deal actually made the Depression worse. By borrowing and spending so much, the government created a climate of uncertainty. This made investors hold on to their money - prolonging the despair. It didn't restore private investment, it "crowded it out".

The author, Johann Hari. then argues the first is correct for two reasons. First, when FDR cut back spending and raised taxes in 1936, we had relapse. Second, it was the spending of WWII that finally ended the Depression.

The article skips the interesting questions that are needed to frame the whole debate. We have had recessions every few years for the past two centuries. Most of them have been mild. Nothing else was close to being as severe or as long-lasting as the Great Depression. Why was it so deep? At the time, many thought it revealed an inherent flaw in capitalism, that it showed that Marx was correct. A large part of the intellectual class that grew up in that era accepted this explanation and became Marxist. But when there was no depression after World War II, despite the predictions of people such as Paul Samuelson, an ardent Keynesian, people had to start looking for other explanations. The most convincing explanation that has emerged is a monetary interpretation, arguing that the Great Depression was special because government policy set up an amplifying feedback loop. As things became worse, government (monetary) policy changed to make it even worse, etc. That loop was not broken until FDR neutered the Federal Reserve by abandoning gold. There remains disagreement among economists as to the importance of the real-bills doctrine and the gold standard in contributing to that feedback loop, but most economists who have looked at the episode with any care now see Federal Reserve policy as key to understanding the decline from 1929 to 1933, and also the sharp recession in 1936-7 when the Fed raised reserve requirements. This explanation was developed and popularized by Milton Friedman and Anna Schwarz, but it can be found far earlier, in, for example, a book by Lauchlin Currie.

Compared with other recoveries, the recovery after 1933 was slow. Why was this recovery so slow? One answer, favored by the left, is that because the fall was so deep, normal resiliency of markets was impaired, and government policy was needed. The New Deal was doing the right thing, but just not enough of it. On the other side, the conservative answer focuses not only on expectations and uncertainty (though not primarily caused by borrowing and spending), but also on interference with markets. When a market has a surplus, either a fall in price or an increase in demand will restore market clearing. If there is no increase in demand, then an attempt to keep price from falling will stop that market from finding an equilibrium. In a system of markets, preventing some markets from adjusting can keep the entire system from re-adjusting. The New Deal interfered with price adjustment in many ways--various programs attacked a symptom of recession (deflation), not the cause (insufficient demand). Hence, it is only natural for economists to argue that some New Deal policies made the problems worse rather than better.

The first rule of medicine is, "First, do no harm." It should also be the first rule of economic policy making. Economists have made a convincing case that government policies during the Great Depression did harm. Hari does not seem to take seriously the possibility that the stimulus package being discussed in Washington could do more harm than good.

(If Johann Hari is correct on what got us out of the Depression, shouldn't he be advocating a massive expansion of the military?)

Update: The Wall Street Journal has an piece dated Feb 2, 2006 by economists Harold Cole and Lee Ohanian that emphasizes the negative role of the New Deal's attempts to micromanage markets.

The Dark Knight

I finally got around to watching the movie The Dark Knight last night. I had read that it could be seen as political allegory, and I could see that in the movie. Like the movie Hero, it also poses interesting questions about how we select those we put on pedestals.

However, what struck me as an economist was the comic-book way in which it treated banks. The mob used the banks as a storage place for huge stacks of currency. I suspect that if the movie actually tried to show how modern finance works, it would have made the movie less understandable. Also, I wonder how many people noticed that the Joker was tremendously patriotic when he burned a huge pile of money. Since currency is indirectly debt of the U.S. government, its destruction reduced government debt. Burning money is an alternative to paying taxes, just as, for the government, printing money is an alternative to collecting taxes.