Obama The Empiricist

Barack Obama has talked himself into a comfortable position on the issue of nationalization - that Japan did too little and Sweden did too much, and we're going to settle in a nice middle ground, and anyway Sweden has five banks and seven customers and we have a bank in every Starbucks so it would just be too messy. This is a decent soundbite but isn't necessarily going to help credit get flowing anytime soon, and so I'm happy that this interview quote shows Obama more willing to step out of the ideological box and toward an empirical reality.

When pressed on whether he was ruling out the Swedish approach, he declined to do so:

"My absolute goal is to make sure that our financial system is set and that we get credit flowing again, that homeowners, small businesses and large businesses will get -- invest and create jobs and get this economy going again. I’m going to be very practical in terms of how to approach it. What we want to do is to make sure that we get this right on the front end. What Tim Geithner did was to provide a framework. He is presenting then a timeline of how this is going to roll out over the next several months: When do we start applying these stress tests to the banks; opening up their books; making sure that everybody knows for sure exactly what’s going on in there; structuring plans to attract private capital to help deal with some of these weaker institutions. Some of the smaller institutions that don’t pose systemic risks, if it turns out that they’re in really, really bad shape, then we may have to reevaluate how we approach some of those institutions.

"He’s also working the Federal Reserve Bank and the FDIC to open up lines of credit that immediately provide some relief to small businesses and consumers. There are a whole bunch of credit markets, like student loans or credit cards, that are locked up right now, but actually the underlying assets in these securitized markets are not that bad, so we may just have to use a variety of different tools to give private investors some confidence on that front.

"But here’s the bottom line: We will do what works. It is going to take time to lay out every aspect of this plan and there are going to be certain aspects of any plan that was designed which will require reevaluation and then have some experimentation -- if that doesn’t work then you do something else. What I’m confident about is that the basic framework that we have put forward is the right one, and that it balances a whole host of issues, including, by the way, the issue of making sure the taxpayers aren’t just carrying the whole freight on this thing, and that we’re sharing -- that institutions on Wall Street are sharing the burden of cleaning up this mess.

"We want to help because -- not because I’m particularly happy about how Wall Street has been running its businesses, but because if we don’t fix the banking system and the credit markets, then businesses can’t make payroll and we continue to see pain among ordinary Americans. On the other hand, I think that folks on Wall Street have to understand that these burdens have to be shared, and so restrictions on executive compensation, transparency, making sure that shareholders are more effectively involved, all those things we’re taking into account. And by the way, the market is not always going to like some of those decisions, because ideally what they’d like to do, they’d like to continue business as usual and not pay a price for a whole bunch of really big mistakes that were made."

We pressed him again on his meaning, and he said:

"I will not allow our financial system to collapse. And we are going to do whatever is required to get credit flowing again so that companies and consumers can do their business and we can get this economy back on track."

That is a flexible enough approach, and I appreciate the candor. As long as there's the recognition that we need a functioning banking system rather than one that hoards capital because it can't admit defeat and wants to spare a few bondholders, we can live with it. And this does reflect Obama's general approach. The details are subservient to the main goal - creating or saving 3-4 million jobs, getting credit moving again. If he is truly willing to do what it takes to reach those goals, then we may finally see the inventiveness we've needed from government over the past several decades. Josh Marshall has more.

Stress Test Then Nationalization?

I'm a little late to this party, but here's President Obama on nationalization.

There are two countries who have gone through some big financial crises over the last decade or two. One was Japan, which never really acknowledged the scale and magnitude of the problems in their banking system and that resulted in what’s called “The Lost Decade.” They kept on trying to paper over the problems. The markets sort of stayed up because the Japanese government kept on pumping money in. But, eventually, nothing happened and they didn’t see any growth whatsoever.

Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you’d think looking at it, Sweden looks like a good model. Here’s the problem; Sweden had like five banks. [LAUGHS] We’ve got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would — our assessment was that it wouldn’t make sense. And we also have different traditions in this country.

Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America’s different. And we want to retain a strong sense of that private capital fulfilling the core — core investment needs of this country.

And so, what we’ve tried to do is to apply some of the tough love that’s going to be necessary, but do it in a way that’s also recognizing we’ve got big private capital markets and ultimately that’s going to be the key to getting credit flowing again.

I appreciate that he's thought through the scenario and is aware of the Swedish solution. I think the "cultural differences" is a cop-out. First of all, for the last 70 years the FDIC has been able and willing to take over banks all the time, and nobosy has really raised their voices in alarm. In fact, they appreciate it. In addition, there's a market-based case for nationalization - banks that are insolvent and have failed shouldn't get propped up but should be subject to the vicissitudes of the market. We don't want consumers to be wiped out in the process, and that's why we have a system of temporarily taking over the banks and selling them back to investors once they get on their feet. If we have to call it "preprivatization" to remove the stigma, fine, but "cultural differences" should never get in the way of sound policy.

The "Sweden had like five banks" isn't really a legitimate claim, either. Nobody's talking about the thousands of community banks and lending concerns; there is a problem with half-a-dozen very large banks and financial companies. The scale in terms of numbers is not so different.

Now, if Obama wanted to make a technical point, he could make this one:

My bottom line: Visit the Nordic countries and you’ll be impressed that their civilian public agencies are much more effective than ours. Arguments which observe that things their institutions can do, our institutions might well screw up are valid. At the same time, there are things that require effective public agencies to do that need to be done. In fields like educating poor children, we’re simply not doing them, and a price is paid. But it’s a price that most middle class Americans don’t see or pay personally. If it turns out that we can’t manage a financial panic adequately, we’ll all be paying the price. I don’t think assuming failure in advance and therefore adopting unlikely-to-work policies makes sense. Abraham Lincoln and FDR both asked the government to do things it didn’t have the ability to do; that meant they had to build the institutions.

Exactly. Cultural or technocratic barriers aren't an option when the clearly preferable policy is a temporary nationalization. We don't have the luxury of messing this part up. If the banks aren't lending properly because they are hording capital, all of the economic multiplier effects of the stimulus are lost. Banks will suck up money from consumers and it will fall into this black hole. We will not have solved the core economic problems. And if the Fed is planning this massive community lending for cars, students, credit cards, small business and nonresidential mortgages, um, why do you need the banks at all? Not to mention that such lending just re-inflates the securitization bubble by guaranteeing the secondary market, which isn't wise.

The case for nationalization is pretty clear. Robert Kuttner and Simon Johnson say it well, but Martin Wolf is perhaps saying it best:

All along two contrasting views have been held on what ails the financial system. The first is that this is essentially a panic. The second is that this is a problem of insolvency.

Under the first view, the prices of a defined set of “toxic assets” have been driven below their long-run value and in some cases have become impossible to sell. The solution, many suggest, is for governments to make a market, buy assets or insure banks against losses. This was the rationale for the original Tarp and the “super-SIV (special investment vehicle)” proposed by Henry (Hank) Paulson, the previous Treasury secretary, in 2007.

Under the second view, a sizeable proportion of financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities. The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad – on sovereign, housing and corporate debt – will surely fall on US institutions, with dire effects.

Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. But this is not the heart of the matter. That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst. If this proved pessimistic, they would end up with an over-capitalised financial system. If the optimistic choice turned out to be wrong, they would have zombie banks and a discredited government. This choice is surely a “no brainer”.

The "stress test" portion of the plan holds out some hope. If there is a legitimate independent audit of the books, and the top banks are all seen to be insolvent, the case for nationalization becomes much more clear. That's privileged information and it makes sense to go through a process to find it out. But in the interim, handing over a bunch of money that isn't going to do much of anything is ridiculous.

Obama and his team may think there is no political possibility of nationalization without the data. But there's probably no possibility WITH the data - Republicans won't go for it. Sometimes you just have to rip the band-aid off.

The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once. It is an important, but secondary, question whether the right answer is to create new “good banks”, leaving old bad banks to perish, as my colleague, Willem Buiter, recommends, or new “bad banks”, leaving cleansed old banks to survive. I also am inclined to the former, because the culture of the old banks seems so toxic.

By asking the wrong question, Mr Obama is taking a huge gamble. He should have resolved to cleanse these Augean banking stables. He needs to rethink, if it is not already too late.

Amen.

Obama And The Energy Future

Friends of the Earth, the newest and most forward-thinking environmental group, endorsed Barack Obama today, mainly because of his stance on the gas tax suspension.

“We endorse Senator Obama because we believe he is the best candidate for the environment,” said Friends of the Earth Action President Brent Blackwelder. “The ‘gas tax holiday’ debate is a defining moment in the presidential race. The two other candidates responded with sham solutions that won’t ease pain at the pump, but Senator Obama refused to play that typical Washington game. Instead, Obama called for real solutions that would make transportation more affordable and curb global warming. He showed the courage and candor we expect from a president.”

Experts agree that gas prices are likely to decline only slightly under a Clinton-McCain “gas tax holiday”—if they decline all. Instead of signing onto this gimmick, Obama has called for long-term solutions that would limit oil consumption by requiring cars to be more fuel efficient and expanding transportation options including passenger rail.

So Hillary Clinton is not only content to call for pointless proposals that would potentially eliminate hundreds of thousands of highway construction jobs and do next to nothing for working people, she's happy to lose all of her allies in the environmental movement over it. Obama is right - this is a function of status quo political thinking:

He used the tax holiday — an idea that Sen. John McCain, the presumptive Republican nominee, also supports — to illustrate the Democratic Party's need to set itself apart. "When we're offering the same things that John McCain is offering on the cheap, that means we are not presenting a truthful response to the challenges we face in America," Obama said. "We can do better than that this time."

Now, Clinton's team is countering with the fact that Obama voted to suspend the gas tax in Illinois a few years ago. Right, and he LEARNED from it that the oil companies do not pass that relief on to the customer. He also knows that George Bush isn't going to impose any tax burden on oil companies.

"At best, this is a plan that would save you pennies a day for the summer months - that is, unless gas prices are raised to fill in the gap, which is just what happened in Illinois when we tried this a few years ago," Obama said.

"Meanwhile, unless you can magically impose a windfall-profits tax on oil companies overnight to pay for the holiday, it could imperil federal highway funding and cost Indiana more than 6,000 jobs," Obama said.

In the short-term gas prices are going to be high; it's a fact of life in a country where the fuel efficiency is too low and the driving distance is too long. There are plenty of things you can do in the long-term to reduce people's expenses, help save the planet from the ravages of global warming, kickstart the economy and enhance quality of life. It's steps like investing in high-speed rail and mass transit, improving the fuel economy of the national fleet of cars (which was in last year's energy bill, much to the dismay of lawmakers who like their SUVs), eliminating coal-burning power plants (good for Kathleen Sebelius) and investing in wind, solar and biomass, and eventually spurring those investments with money from a tax on carbon that will actually be an economic engine:

If there's a paradise for environmentalists, this Nordic nation of 9.2 million people must be it. In 2007 Sweden topped the list of countries that did the most to save the planet - for the second year running - according to German environmental group, Germanwatch. Between 1990 and 2006 Sweden cut its carbon emissions by 9%, largely exceeding the target set by the Kyoto Protocol, while enjoying economic growth of 44% in fixed prices [...]

The main reason for this success, say experts, is the introduction of a carbon tax in 1991. Swedes today pay an extra 2.34 kronor (20p) per litre when they fill the tank (although many key industries receive tax relief or are exempted). "Our carbon emissions would have been 20% higher without the carbon tax," says the Swedish environment minister, Andreas Carlgren.

"It was the one major reason that steered society towards climate-friendly solutions," reckons Lindberg. "It made polluting more expensive and focused people on finding energy-efficient solutions."

"It increased the use of bioenergy," concurs Professor Thomas B Johansson from the University of Lund, a former director of energy and climate at the UN Development Programme. "It had a major impact in particular on heating. Every city in Sweden uses district heating [where steam and hot water are piped to a building in a particular area]. Before, coal or oil were used for district heating. Now biomass is used, usually waste from forests and forest industries." [...]

Today, environmental measures are common throughout the country. Take Linköping, Sweden's fifth biggest city, which is running its fleet of buses and rubbish lorries, a train line and some private taxis on biogas, from methane produced from the entrails of slaughtered cows.

Similarly, Stockholm's central station is planning to harness the body warmth of 250,000 daily commuters to produce heating for a nearby office block. The body heat would warm up water that would in turn be pumped through pipes over to a new office block. And King Carl Gustaf XVI last month had all the lights at royal castles turned off for an hour to back an energy efficiency campaign.

While our gas tax pays for highway construction, it's structured essentially the same way as the carbon tax. This is what Hillary Clinton wants to eliminate for the sake of a few votes in Indiana.

I believe that Obama's base of support among young people will spur him to fiercely confront climate change in his first term, for environmental, economic and national security reasons. We aren't going to get off fossil fuels overnight but we can make a difference. But not if conventional Washington thinking rules the day.