Posted by: jamesthethickheaded | September 23, 2008

Random Gleanings from the Levy Economics Institute

The Levy Economics Institute has provided something of an edge these past few years. Their adherence to Keynes coupled with the insights of Minsky… well, since the 1998 Asian Crisis that ended the greatest bull market of all time… they have been 100% on the money. Yes, most folks continue to date the bursting of the Tech Bubble two years later as the end of the bull market, but for the average stock of the American economy, it was earlier. And yes, as The Street recognizes this as the long feared Minsky Moment… you’d think the Levy folks would get a few ears. You’d think.

Given that these folks have had both the right analysis and correct policy solutions, but not the public ear given the ascendancy until now of monetarism and central bank control, the recent implosions send me back to review some of their recent material. Understand that as Keynesians, these folks are decidedly in favor of fiscal policies over the longer term, and that’s not always the right prescription – even by their own admission. But surprising to many, their disagreement with the Bush Administration over the stimulating tax cuts of the first term lay primarily in their belief that the government should run larger deficits than Bush’s cuts contributed in order to restore balances upset by the Clinton economic program and mercantilist Asian development models. Go figure. I recall even hearing an AFL-CIO economist remarking that while he’d prefer a jobs program, but in the absence of that (Democrats at the time proposed tax increases) he’d take a stimulus so long as it was scaled up about 10 times. No kidding. Sometimes the Donkeys and Elephants run in surprising directions.

So here are thoughts worth pondering for those who must:

“Over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is a large weight to units engaged in speculative and Ponzi finance.” – Hyman P. Minsky (1992)

“To be exact, our economic leadership does not seem to be aware that the normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciations, unemployment, and poverty in the midst of what could be virtually universal affluence – in short, that financially complex capitalism is inherently flawed.” – Hyman P. Minsky (1986)

“Implicit in the legislation which I am suggesting to you is a declaration of national policy. This policy is that the broad interests of the Nation require that special safeguards should be thrown around home ownership as a guarantee of social and economic stability, and that to protect home owners from inequitable enforced liquidation in a time of general distress is a proper concern of the Government.” – President Franklin D. Roosevelt, Message to Congress on Small Home Mortgage Foreclosures (1933)

“This is an impressive crowd – the haves and the have-mores. Some people will call you the elite. I call you my base.” – President George H. W. Bush address to the Archdiocese of New York in December, 2000.

“The model is in trouble – and not just with respect to the mortgage mess, as the United States faces record inequality and destruction of the middle class, a health care crisis, an incarceration disaster, and other problems beyond the scope of this analysis. We must return to a more sensible model, with enhanced oversight of financial institutions and with a housing-finance structure that promotes stability rather than speculation. We need policy that promotes rising wages for the bottom half (or even three-quarters) of workers so that borrowing is less necessary to maintain middle-class living standards, and policy that promotes employment, rather than transfer payments – or worse, incarceration – for those left behind.” – L. Randall Wray, “Financial Markets Meltdown: What Can We Learn From Minsky?”, September, 2008.

Keynes is one of those great sources of wisdom and quotations, but I’ve left him out. And lest anyone get the wrong idea, both Keynes and Minsky were exceedingly successful investors. Minsky is often seen as a classic gloom-and-doomer, but in fact reportedly was very optimistic as well. In economics, the obvious limitations of the “knowns” always lead to “glass half-empty” forecasts… but the problem is not just that folks will do everything they possibly can to avoid such circumstances, but also that economies are inevitably led and dependent on exogenous variables… things as simple and at the same time obvious as human ingenuity. And these can’t possibly be quantified and modelled without sounding ludicrous. So they aren’t.

In closing, let me add that if we are fortunate to be led properly out of this crisis, the all-hallowed efficient markets theory will be unseated and replaced with the Minsky modification of the Keynesian valuation model in the opinion of this writer. Without this, it will be difficult to unseat the theories that got us into this mess. In addition, the capital requirements regulation of banking in force in recent years will also be replaced with traditional sound, counter-cyclical banking regulation on the basis of fractional reserves. I’d add that among some, there is a consensus broader than I would expect for changes along at least some of these line on the Buy-side of the Street. The Sell Side… I mean… seriously… the folks not in jail, not in bankruptcy, and not out of money… will fight this with every fiber of their being. They may even move to London… which according to the FT is equally hot to put them on trial. What’s next, Dubbai? So as Wray points out, we may find ourselves addressing an incomes policy – a traditional Keynsian concern – for the first time in the generation since average household income stalled out.

Maybe we’ll go in the right direction, or maybe we won’t. I think basically, we have a tendency to feel our way along in the dark for a while, and then stumble along in the right direction.  Sometimes we stub our toes, sometimes we fall down, sometimes we get stuck in a dark alley for a while… but inevitably, we manage to find our way out. Like I wrote earlier, I’m not sure I’m going to like it all… and please don’t misread some of these posts as political… I’m not.. and I don’t like any of the candidates. Fact is that I like some less than others… and no one is “my guy / girl / emu”.  But I think we’re at the big re-think that refocuses this nation in the right direction for the first time in a long time. And that’s good in itself.

Yeah.. if the Thickheaded Dude can figure this out… I mean… I am the last to know… who’s left to tell? Who indeed? Don’t turn out the lights.

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