Welcome Menzie Chinn, (Econbrowser.com), and Jeffry Frieden, and Host Mike Konczal (Rortybomb.com)

[As a courtesy to our guests, please keep comments to the book. Please take other conversations to a previous thread. - bev]

Lost Decades: The Making of America’s Debt Crisis and the Long Recovery

Host, Mike Konczal:

What caused the housing bubble?

This is a different, though related, question from what caused the collapse of the financial sector or why unemployment is sky-high right now. Why did housing values skyrocket and then collapse? More broadly, why did all kinds of consumer debt expand so greatly over the past decade?

There are plenty of arguments out there, each with their proponents and their books. There’s the argument that the bubble is primarily the result of an out-of-control Wall Street, which was capable of getting money into housing by convincing investors that it was safe (while betting against it). There’s an argument it was the result of government policy and activism, of Community Reinvestment Acts and mortgage subsidies. There’s another approach which thinks it was the result of “irrational exuberance” on the part of homeowners, who all chased rising home prices which kept blowing air into the housing bubble.

But there’s another argument, which looks at the explosion of international lending and the indebtedness of the United States by foreign investors. Normally capital runs from rich countries to poor countries, but something changed where it reversed as capital went rushing to the United States. This exposed the United States to the same kind of risks developing nations usually face. And the new book Lost Decades by Menzie D. Chinn and Jeffry A. Frieden, economists at the University of Wisconsin, Madison and Harvard, is the best book-length treatment of this argument.

Lost Decades looks at why the explosion of debt happened through the traditional lens of supply-and-demand. It examines the motivations and situations of people on both side of this debt. Why did demand for debt increase in the United States? The first reason Chinn and Frieden identify is the huge deficits run during the George W. Bush years. These are the trillions spent on the Bush tax cuts, the expansion of Medicare part D and wars in Iraq and Afghanistan that weren’t paid for.

The second is the massive expansion of debt among private households. This was the result of “debt fever spread[ing] to the private sector.” “Americans began borrowing to supplement their incomes, in expectation of future economic growth.” This led to “debt-financed” consumption” which helped to deal with the problem of “working-class and middle-class Americans [seeing] their incomes stagnate.”

This led to an explosion in the measure for a country’s foreign borrowing, the current account deficit. What was around $100 billion a year in the 1990s averaged $600 billion a year during 2001-2008. Nearly one-third of all the country’s home mortgage debt was owed to foreigners.

On the flip side of demand is supply. Where did all this money come from? Lost Decades looks at three major culprits on the supply side. The first is the traditional kind, wealthy individuals in an age of rocketing inequality. The second are the oil-exporting Middle East countries and their “sovereign wealth funds.” And the third are East Asian countries holding huge currency reserves, particularly China which maintained a weak currency to keep a manufacturing edge.

Why is this bad? The first reason was that the debt wasn’t going to productive uses. As the IMF pointed out, a huge rise in federal deficits, housing debt and residential construction “does not raise US productive capacity.” Second, and more importantly, this exposure to foreign debt puts the United States at risk of debt crisis that were familiar to people studying developing countries. The comparisons the authors draw are between the United States and 1970s-80s Latin America or 1990s East Asia. Or 1990s Russia. Or Turkey. Or Mexico. Money flows into the region rapidly, which then leads to spectacular rises in housing prices, stock prices and the financial sector which stands in the center. When it stops, it all comes crashing down.

The book lays out how the financial sector reacted to this newfound debt situation, low interest rates from Alan Greenspan and a flattening of the yield curve. All these situations were ones where the “search for yield” caused Wall Street to go to further lengths to pack in leverage in order to try and amplify profits. This all came crashing down when the music stopped, giving us the alphabet soup of Wall Street bailout programs that characterized 2008 financial policymaking.

The story about CDOs, subprime mortgages and TARP will be familiar to those who have read other books about the financial crash. This book is unique for putting the situation in a similar situation to England and Ireland, both countries that also increased their debts massively throughout the 200s and now have to deal with the consequences. Their solutions are also broader than most other treatments. Though they understand and acknowledge the need for larger short-term federal deficits to deal with the current weak economy, getting the long-term fiscal picture into health, through raising revenues and restraining spending, is front and center in their solutions. So are re-regulating the financial system to combat Too Big To Fail and keeping self-interested agents from hiding leverage to unsuspecting customers. In addition to this, increasing exports, a smaller trade deficit, reducing oil imports and dealing with China’s trade policies are also on their policy agenda.

Economic blogosphere readers will recognize Chinn as one of the brilliant masterminds of the must-read blog Econbrowser, and the rigor yet accessibility of the that blog is on display in this book. The book is capable of dealing with some of the most complicated economic arguments about the crisis in a way that is straightforward and capable of being understood by its audience.

And it is important to emphasis how much this is not on the radar of most discussions of the crisis. The crisis discussion usually creates stories out of the greed of the deregulated financial sector, the implicit and explicit goals of government, the Federal Reserve for a host of reasons, without even touching on the issues of international capital flows. That this book gets this topic onto the agenda makes it a worthwhile enterprise.

I want to kick out some critical questions to begin the discussion:

1. The general consensus among elite thinking is a neoclassical model where trade in goods shouldn’t be inhibited as self-interest will allocate resources to-and-from people and countries will take the best, comparable, advantage of them. This is the basis of international trade, and this presumably includes the international trade of capital that concerns you. Sometimes there’s a role for the government handling externalities, like pollution, and public goods, like defense, but in general markets give us the best allocation possible.

How does your book work within and against this theory of how markets work?

There’s so much more I want to ask, but let’s open it up to the audience’s questions.

130 Responses to “FDL Book Salon Welcomes Menzie Chinn and Jeffry Frieden, Lost Decades: The Making of America’s Debt Crisis and the Long Recovery”

BevW October 1st, 2011 at 1:57 pm

Menzie, Jeff, Welcome to the Lake.

Mike, Thank you for Hosting today’s Book Salon.

Mike Konczal October 1st, 2011 at 1:59 pm

BevW and the firedoglake community, thanks for hosting this great opportunity, and Menzie and Jeff, welcome to the discussion. The first question is right above.

Jeffry A. Frieden October 1st, 2011 at 2:02 pm

Thank you all! It’s a pleasure to be (virtually) here.

Menzie D. Chinn October 1st, 2011 at 2:03 pm

Thanks to everyone as well — it’s great to have this opportunity to exchange views here.

Jeffry A. Frieden October 1st, 2011 at 2:03 pm

Markets are wonderful allocative mechanisms. But, as you suggest, there are also circumstances in which market actors create costs (negative externalities) for others. We don’t allow firms to pollute at will. And the financial system supplies plenty of standard examples of such externalities. For example, the failure of one bank can – due to the interconnectedness of the financial system – lead to a run on many, or all, banks. This could create a financial panic where none was really warranted. The recognition of this fact is what led Walter Bagehot, 140 years ago, to point out that the central bank has an obligation to act as a lender of last resort in such times of potential panic. But if the monetary authorities are going to bail out troubled banks – for the greater good of society – then they have the right, and duty, to monitor what the banks are doing, and keep them from gambling with an implicit taxpayer guarantee.

Jeffry A. Frieden October 1st, 2011 at 2:05 pm

This is a widely recognized principle in the foreign borrowing realm, especially with respect to developing countries. It is a commonplace to point out that uncoordinated borrowing by individual firms or banks in, say, Chile, can lead to an unsustainable burden on the country as a whole. This is why many developing countries either control foreign borrowing or tax it – to get the borrowers to internalize the externalities, that is, to be forced to think about not only the costs of borrowing to them but the potential costs to society at large.

Mike Konczal October 1st, 2011 at 2:06 pm

I’d be curious to hear your thoughts on the summary of the above I tried to provide above.

And here’s second question to get things going: A meta-metaphor for your book is that the United States went through an event like the East Asian crisis in the 1990s. There was a boom but then there was also a crash. But in that crisis, interest rates rose very steeply and exchange rate plummeted in the relevant countries. This forced the governments to curtail domestic expenditures – our favorite word “austerity” – causing even more havoc.

We are experiencing the opposite of that in the United States – the econoblogosphere has contests to see who can find the most creative way of describing to a general audience how low interest rates actually are (Karl Smith is winning with pointing out negative reals rates on 5-years). Has the current account deficit actually imposed a macroeconomic problem in the United States and are things like the East Asian crisis the best model?

BevW October 1st, 2011 at 2:08 pm

As a technical note:
There is a “Reply” button in the lower right hand of each comment. Pressing the “Reply” will pre-fill the commenter name and number you are replying to and helps for everyone in following the conversation.

Menzie D. Chinn October 1st, 2011 at 2:09 pm

It’s true that interest rates have not risen for the US… yet. And it’s important to recall for the East Asian countries, financing was easy until it wasn’t. So what we want to avoid is a path of undisciplined over-borrowing now, when the world is eager to lend and there is little private sector demand for credit, and then finding we have overborrowed when sentiment shifts, as it can (and has) in the past (Argentina, East Asia, and so forth).

That being said, it is important to stress that our borrowing problem is imbedded in the future path of deficits –- that is entitlements and deficient tax revenue in the out years. As we make clear in our book, “fixing” entitlements, not by eliminating them, but by way of moderate adjustments taking effect in the next decades, in addition to restoring tax rates and closing loopholes, is the only realistic way of addressing this challenge of debt accumulation.

Jeffry A. Frieden October 1st, 2011 at 2:09 pm
In response to BevW @ 8

I think I’ll let Menzie pick up the East Asian comparison. But in answer to your question, your summary is outstanding. And of course I endorse your characterization of Menzie as “one of the brilliant masterminds of the must-read blog Econbrowser.” I always wanted to work with a mastermind…..

Menzie D. Chinn October 1st, 2011 at 2:13 pm

Well, before my head gets too big, thanks for the compliment — I must say that I’ve learned a tremendous amount in writing the book with Jeffry, who has a masterful grasp of the history of crises. And it emphasizes the point economists must remember the past, in order to really understand real world economic phenomena.

Mike Konczal October 1st, 2011 at 2:13 pm
In response to Menzie D. Chinn @ 9

It might be useful here to explain the mechanisms on how the current account balance lead to the housing bubble? The most obvious mechanism is by driving down the interest rate. But wouldn’t the major benefit of cutting the Federal deficit during the 2000s have also been causing lower interest rates? And how much of the capital from countries we had an current account balance with went towards mortgage securitization, as opposed to treasuries?

This would lead to the idea that the Federal deficit wasn’t large enough in the 2000s…..

Menzie D. Chinn October 1st, 2011 at 2:14 pm

Less Federal borrowing would have lowered the risk free rate. However, that’s not the real problem during the Bush years. Rather, it was interest rates on the risky activities were too low. That occurred because of financial innovation, and because the regulators allowed higher leverage which increased the funds available. In other words, the credit spreads were too narrow. We also note that non-regulation of credit default swaps (CDS’s) allowed the risk to be “hidden”.

Mike Konczal October 1st, 2011 at 2:15 pm

Speaking of masterminds….let’s chat about Wall Street. Right now there’s some 18000+ people watching the arrests of the Occupy Wall Street marchers on the Brooklyn Bridge.

As opposed to most narratives on the crash, Wall Street doesn’t take on an incredibly important or interesting role in the generation of the housing bubble in your book. They aren’t greedy banksters finding ways to rig the game or noble John Galts pushed around by community organizers. They are largely middle-men, intermediaries in the battles of international capital flows.

To use a blunt, but fun, analogy you do not, Wall Street functions sort of like drug dealers in this model. Drug dealers can be immoral and shady, yet they don’t fundamentally create the supply of drugs – that’s the result of factors in South America and Afghanistan and run by higher-ups like “The Greek” from the show The Wire – or the demand for drugs, which comes from consumers. They can be bad human beings but, unless you are a neocon drug warrior, attacking drug dealers can only make a temporary dent in the ultimate trade of drugs.

Two things to complicate that. (i) As I read your argument, it is at least partially predicated on the idea that the marginal unit of foreign capital that came into the United States couldn’t find productive uses – implying that the financial sector is a massive allocative failure. And (ii) there are many stories coming out about how Wall Street was able to create instruments simply to bet against them, stories like the hedge-fund Magnetar, which kept much of the securitization market working post 2005. Thoughts on these?

Kelly Canfield October 1st, 2011 at 2:16 pm
In response to Menzie D. Chinn @ 9

Greetings:

Exactly what “moderate adjustments taking effect in the next decades” do you suggest?

Jeffry A. Frieden October 1st, 2011 at 2:19 pm

I suppose there are several components to your question. I’ll address the first point for now, about the culpability of Wall Street. A lot of the treatments of the crisis have pointed out the greediness of bankers, their incessant search for higher profit, their willingness to make money from the misfortune of others, their attempts to devise new exotic financial instruments — even, in the case of “Inside Job,” their use of cocaine. But we have a saying in the social sciences: You cannot explain a variable with a constant. I think some bankers have probably always been characterized by these features.
Their principal characteristic, in my view, is that they are extraordinarily quick to respond to incentives. And that’s what they did. So instead of blaming bankers for responding to incentives, I think we need to ask why the incentives were as they were.

Mike Konczal October 1st, 2011 at 2:20 pm

But as I read your book, the current account balance – driven by the supply and demand of credit that I mentioned in the book summary – is playing some major in the lead-up to the crash. Hiding leverage is a major problem, but there’s a sense in which Wall Street does it in this narrative to create instruments that get AAA-ratings – which is to say meet the demands and supply mechanisms of global trade balances.

Jeffry A. Frieden October 1st, 2011 at 2:21 pm

By this I don’t mean to let bankers off the hook. There were completely indefensible practices at work, as the gradual expansion of criminal investigations makes clear. But I don’t think these explain the broad outlines of a truly global phenomenon — with very similar processes taking place in the UK, Spain, Latvia, and other countries with very different financial institutions and traditions.

GlenJo October 1st, 2011 at 2:21 pm

Menzie Chinn, and Jeffry Frieden, thanks for being here, and and Mike Konczal, thanks for hosting.

I have not read your book, but have another question – why did Greenspan providing cheap money for so long? Was this politically motivated to provide the Bush Presidency with an uptick in the economy when the reality was the economy was an empty shell? Because he seemed to clamp down on the economy during the Clinton years in similar circumstances (debt and slow growth).

bigbrother October 1st, 2011 at 2:21 pm

The bubble was fed by Alan Greespan’s cheap money policy. Paul Krugman might call it a liquidity trap.
The fees the banksters gained on each transaction also drove the process. The Rating agencies giving junk AAA status. And the packaging of crap loans with better ones into tranches that were securitized and sold to investors in a major swindle that dropped pension funds, retirement funds and local government investment funds into the “tank”. It was a money making mill for the banksters and the regulators were on board as they were from the bank culture. SEC Cox oversaw that nothing was done.
Then the huge Swaps market of $50 trillion dollars was part of the destabilization of the financial industry as leveraging bad investments was risk on steroids. Main street ended up paying for it all in unemployment and recession.

Menzie D. Chinn October 1st, 2011 at 2:21 pm
In response to Mike Konczal @ 14

I think there are elements of truth in what you argue. But I think that the lack of regulation during the Bush years in particular led to a situation where funds were diverted into activities which provided higher returns to certain actors, while imposing hidden costs on the rest of society (taxpayers, for instance). So it’s not that the returns were so low in the US; deregulation and non-regulation (which critically allowed high leverage) distorted the rewards facing financiers. By the way, the speculation you write of wouldn’t have been so enticing if leverage had been constrained. That is why the reforms — both domestic and international via Basel III — impose higher capital requirements.

It’s a puzzle why Republicans are against such measures since they would stop exactly the speculation they argue is pernicious.

Scarecrow October 1st, 2011 at 2:22 pm

Welcome, Profs Chinn and Frieden, and thanks for the introduction, Mike Konczal — just a reminder, there is a Reply button at the bottom right of each comment. If you hit that first when you reply we can track your responses better to the question. thanks.

Menzie D. Chinn October 1st, 2011 at 2:24 pm
In response to Kelly Canfield @ 15

In our book, we lay out options; for Social Security, a revision to retirement age, or (my preference) removing the cap on Social Security taxes. The change in the cost of living formula (using Chained CPI) recently suggested by the Obama Administration is another. Medicare is a much more difficult issue; I think only the tough slog of determining cost effective treatments, and reducing the tax incentive toward health plans, will have a substantial impact. But I don’t believe “voucher-izing” Medicare will solve the problem.

eCAHNomics October 1st, 2011 at 2:25 pm

Starting in the 1980s, it became clear that the world was awash in a sea of excess savings/investment. Many causes, prominent among which was development of Asia Tigers, then China, India, Brazil, etc., along the traditional mercantilist lines of promoting exports & protecting imports. Worked like it always has for every country now with “first world” economies. But under those circumstances, the developing countries needed customers for their exports and the U.S. became the consumer of last resort. U.S. monetary policy, thru successive lower & lower interest rates, facilitated consumer borrowing when cheap imports were drying up more robust underpinnings of U.S. consumer spending.

Comments?

Jeffry A. Frieden October 1st, 2011 at 2:25 pm

Let me jump in on this issue, which raises a broader question: whether the supply of foreign funds drove the American borrowing boom, or America’s demand for foreign funds drove the process. It’s a great question, but I think we can only think of supply and demand as interrelated. Certainly many foreigners want to invest in the US, for all sorts of reasons, good and bad. When this investment goes into productive activities – such as, to some extent, during the hi-tech boom of 1996-1999 – the impact can be positive. However, in this case it was channelled – by Americans – into far less defensible investments.

And it might be pointed out the consumption boom in the US fed the supply of capital from abroad: the more Americans consumed, the bigger the East Asian, Northern European, and OPEC surpluses became, the the more these surpluses looked for investment outlets. So supply and demand are jointly determined – and nobody could have forced us to borrow what we did.

This point is strikingly clear in many other cases that are not complicated by America’s safe-haven and key-currency role: don’t borrow unless the money is going to increase your productive capacity. But the general rule applies, even to us.

Jeffry A. Frieden October 1st, 2011 at 2:28 pm
In response to GlenJo @ 19

It’s something of a puzzle why Greenspan held interest rates so low, so long. There was some justification in the early period, due to the recession of 2000 and then 9/11. But our view is that Fed Funds were effectively kept in the negative real interest rate zone for too long.

One theory is that Greenspan was eager to ensure his re-appointment in 2004. Another is that he was also eager to ensure Bush’s re-election later in 2004. Of course, both things happened. But correlation is not causation, and my guess is that we are unlikely to know the truth unless and until memoir some out. After all, the truth about Nixon’s pressures on Arthur Burns at the Fed in the runup to the 1972 election is only know becoming fully documented.

Menzie D. Chinn October 1st, 2011 at 2:28 pm
In response to GlenJo @ 19

Good question, GlenJo. It’s important to realize that at the time, the US economy was experiencing a particularly slow recovery; in fact unemployment kept on rising for a couple years *after* the recession ended. With the benefit of hindsight, we know the economy was a little better than it looked at the time. In addition, the Fed knew that in the wake of the collapse of asset bubbles (remember this is after the dot.com bust), monetary policy needed to be particularly stimulative. Hence, from my perspective, they were a bit too expansionary, but that wasn’t the key problem. The key issue is that Greenspan, due to his libertarian tendencies, refused to let the Fed use its *regulatory* powers to limit to overlending. That is the Fed’s key failing, in my view, during the run-up to the crisis.

Alex Gourevitch October 1st, 2011 at 2:28 pm

Professor Chinn, I have not read your book, so perhaps you also mention defense spending. But why would entitlements, as opposed to defense spending, be selected for selective trimming? Even just cutting defense spending back to the (quite high) 2001 levels would save something like $1.5 trillion over the next 10 years. A much quicker and more equitable way of cutting debt than chipping away at entitlements, it seems to me.

DWBartoo October 1st, 2011 at 2:31 pm

Testing … testing, my comments are being blocked.

Jeffry A. Frieden October 1st, 2011 at 2:32 pm

I suppose one could suggest a more political — perhaps nefarious — set of reasons. Greenspan may have been thinking about his reappointment, which came up in 2004; and about Bush’s reelection, also in 2004.

Of course, we are unlikely to know the full truth until the memoirs come out. After all, it is only know that we’re getting the full story about Nixon’s pressure on Arthur Burns in the runup to the 1972 election

bigbrother October 1st, 2011 at 2:32 pm

Cut the private profit out and you increase medical treatment affordability as in Northern Europe systems. That means eliminating the private sector and using a model like the VA. And allowing buying medicare drugs cheaper from Canada and other countries. Give carrots for healthy lifestyles.

Mike Konczal October 1st, 2011 at 2:32 pm

Jeffry and Menzie,

The audience here is likely going to be engaged, both in trying to figure out what has happened with Wall Street and how to prevent it in the future, and in terms of getting our budget to better reflect our values in the long run (table how to do it for this question). I’d be curious as to what you’d encourage people to take away from your book, something you believe it adds to the conservations, for those who pay attention and participate in these debates.

Scarecrow October 1st, 2011 at 2:34 pm

Can you discuss the role of trade deficits and exchange rates, please? If our trading partners maintain an artificially high dollar relative to their currency, that allows them to sell more of their product to us and we sell less to them, no? And so it just follows they’ll park their reserves in US Treasuries. Where does this play a role in your story about high US debts?

Menzie D. Chinn October 1st, 2011 at 2:34 pm
In response to eCAHNomics @ 24

I think that many countries have pursued export led development. China was the biggest economy to do so, and it came on the scene fairly suddenly as it integrated into the world economy. The large addition of lots of labor into the global economy forced a re-allocation of resources, and a drop in the cost of producing manufactured goods that all of us have benefited from. On the other hand, some of us (those in the industries that compete with imported goods) have suffered. It’s not useful to wish that times were like they were back in the 1970s. But it is useful to recognize that there are costs as well as benefits to international trade, and we should try to compensate the losers using some of the gains to the overall society — that’s what Trade Adjustment Assistance (which the Republicans wish to cut) is for.

In addition, now that China has developed, it’s time for them to move away from such a relentlessly export oriented growth model, and for the sake of its own people, look more toward domestic demand.

Elliott October 1st, 2011 at 2:34 pm
In response to DWBartoo @ 29

DB your comments are not being blocked
please be on topic here

but extraneous number counts on a 415 comment thread are being trimmed.

Peterr October 1st, 2011 at 2:34 pm

Does your book get into the failure of regulators at the Fed (especially FRBNY), OCC, OTS, and elsewhere? To what extent did regulatory capture — regulators captured by the industry they are supposed to be watching — play into the housing bubble?

Kelly Canfield October 1st, 2011 at 2:35 pm

Especially considering that Social Security, by law and design, hasn’t contributed one penny to the deficit, where as the wars certainly have.

Paul Rosenberg October 1st, 2011 at 2:35 pm

Sorry to post & run, but I’m on deadline today. I posted this to Mike’s announcement on his blog. It may be too far afield, but if not…

I do have two observations to make, that might be turned into questions somehow:

(1) The contributing factors noted, such as “the oil-exporting Middle East countries and their “sovereign wealth funds.” And the third are East Asian countries holding huge currency reserves” were obviously problematic in a long-term sense decades before they were recognized as such. They created inherintly unsustainable relationships that free-market ideology simply disappeared, because its worldview/models (to the extent there are any) simply did not let the problems be seen.

(2) Also decades ahead of the crash–going back to the 1980s, at least–was the creation of the narrative that consumer debt was a form of liberation. In a sense, back in the 1950s, when there was a lot less of it, this was actually true. But that’s because people had actual real rising incomes, so the debt burdens really were manageable. In the 1980s, this was clearly no longer the case, but it’s precisely at that point where the narrative expanded wildly, as the reality shrank in inverse relationship.

DWBartoo October 1st, 2011 at 2:36 pm
In response to Elliott @ 35

Thank you, I did not realize I was being extraneous, Elliott, my apologies to all.

DW

Jeffry A. Frieden October 1st, 2011 at 2:36 pm
In response to bigbrother @ 20

Certainly all the forces you mention were at work. We attempt to put them, and others, together in a narrative that also helps explain what a dozen other deficit (borrowing) countries got into the same trouble

alicewolf October 1st, 2011 at 2:37 pm
In response to BevW @ 1

Whatever the theory of how and what and where the markets do or don’t work is beside the point. When the sex and drugs and rock and roll where fashioned into something that people could buy into as a life style, many fell for it hook line and sinker. In fact it was so enticing and seductive that millions succumbed to the notion that a cominations of these elements would be like going to heaven without dying. So while the epidemic of self destruction was raging, the process of deregulation was carried out, and Greenspan et al quietly dismantled the firewall that

Menzie D. Chinn October 1st, 2011 at 2:38 pm

We do definitely believe that defense spending should be considered for cuts. however, if you look at the Congressional Budget Office’s long term budget outlook, you see that the combination of aging population and health care cost inflation (above the general CPI inflation rate) is going to impose incredibly high burdens on the government. So, to solve the *long term* budget problem (and the debt and deficit problem is primarily a *long term* problem), it’s got to be addressed via entitlements (and tax revenue enhancement). In the shorter term, you are right — defense can be a quicker fix.

bigbrother October 1st, 2011 at 2:38 pm
In response to Scarecrow @ 33

Yes and getting off of big carbon onto sustainable energy changes the balance of payments in our favor dramatically.

Jeffry A. Frieden October 1st, 2011 at 2:40 pm
In response to Scarecrow @ 33

The role of the currency policies of major East Asian exporters (such as China) is crucial. One of the sources of the flow of funds into the US was in fact, as you say, the parking of currency reserves in the American (especially Treasuries) market.

But keep in mind that the process feeds on itself — as Americans borrow and consume more, the Chinese surplus grows and they lend us more, and so on until the merry go round stops.

So currency policies are very important to the process — they help explain why the world was effectively divided into surplus (lending) and deficit (borrowing) countries over the course of the last decade. But they’re not everything. A similar process characterized Northern and Southern Europe within the eurozone, and of course they share a common currency (or perhaps, as Churchill might have said, they are divided by a common currency).

JW Mason October 1st, 2011 at 2:41 pm

Three questions:

1. Any increase in net saving will tend to push down interest rates, whether that saving comes from domestic sectors or from the rest of the world (in the form of inward foreign investment). What is special about foreign saving that makes its macroeconomic impact different from other forms of saving? Or it your view that low interest rates in the past decade would have led to a housing bubble regardless of their underlying cause?

2. If low interest rates tend to produce bubbles rather than higher investment, isn’t that the same as saying that the financial system is unable to channel additional saving to productive uses, but only to value-destroying speculation? If that is true, why would we want to increase national saving by, for instance, reducing government deficits? For that matter, if the financial system is unable to channel additional saving into productive investment, why do we have a private financial system at all?

3. Given that the debt crises in Mexico, Brazil, Russia, Turkey and various Asian countries all took the form of large outflows of portfolio investment, sharp falls in the exchange rates and spikes in interest rates, and the experience of the US has been the exact opposite on all three dimensions, why do you think it is useful to compare the US crisis to the crises in those countries?

Looking forward to your response.

GlenJo October 1st, 2011 at 2:42 pm

Thanks, I have also heard his cheap money policy was a “response” to 911 (I think it was in Adam’s Curtis’s BBC show – All Watched Over by Machines of Loving Grace), but your answer really hits the nail on the head – to this day we don’t seem to have a Fed which is willing to regulate. Right now, we have a Sec of the Treasury that didn’t think he was a regulator (as he testified to Congress) when he ran the NY Fed from 2003 to 2009. Why we had to make this guy who so spectacularly failed at the Fed, our Sec of Treasury is beyond me.

Alex Gourevitch October 1st, 2011 at 2:44 pm

Thank you for that response, Professor Chinn. I wonder, though, if that position too readily accepts that health care costs must rise that quickly, and slow rate of growth. I’ll leave the health care costs discussion to one side, since it’s tangential, but on the growth issue, I wonder if you could say a bit more about the point Mike made regarding the unproductive investment during the bubble. While I agree that higher capital requirements might have reduced the supply of money there was to speculate with, I don’t think inadequate capital requirements (and similar lacking regulation) explains why so much money ended up going into unproductive investment in housing. Can you say a bit more why you think that was the asset around which the bubble emerged? And is there a model, in your mind, for a better way of allocating resources productively?

Menzie D. Chinn October 1st, 2011 at 2:44 pm
In response to Mike Konczal @ 32

I believe in addressing the problem that Wall Street poses, I think it’s important to think of this in terms of how we can align incentives correctly. That is, while it might be satisfying to chastise or indict some individuals, what we need to do is to harness the energies of those in the financial sector so that they do what they are supposed to do — channel savings from those who have them to those households and firms that need them, to build new factories, conduct research and development, to educate themselves.

There never has been a financial sector that could self-regulate itself — so we need citizens to stand up, and demand that their representatives put in place tough rules that regulate financial institutions, and prevent them from over-leveraging, and taking on excessively risky investments. And to make sure those rules are effectively implemented, we need the agencies (the Securities and Exchange Commission, the Consumer Financial Regulatory Board, and so forth) to be adequately financed — and not defunded as certain representatives are trying to do now (allowing the Administration to get someone confirmed to head the consumer finance regulator agency would be a good first step…)

Jeffry A. Frieden October 1st, 2011 at 2:45 pm
In response to Peterr @ 36

We do certainly regard the regulatory laxity — indeed failure — of the period as an important part of the story. The principal Federal regulators made a series of very bad decisions in 2003-2004 that allowed financial institutions to engage in far riskier behavior than was appropriate to institutions that had an implicit government backstop, and to do so in far greater quantities than was prudent.

And we do think that a major reason was “regulatory capture,” the idea that the regulators were too closely aligned with the regulated industries. This is often a problem in finance, whether due to the very technical nature of the industry (regulators often know far less than the regulated) or to the revolving door between agencies and financial institutions.

Jeffry A. Frieden October 1st, 2011 at 2:46 pm

But here too there’s a *demand* side of the story of regulatory laxity. As the country’s financial system was faced with trillions in new loanable funds, the “search for yield” let bankers to look for new instruments, new outlets, new borrowers. And they put lots of pressure on regulators to make this possible.

Scarecrow October 1st, 2011 at 2:46 pm

It’s an interesting analogy: Greece is to Germany in the Euro system, as the US is to China in the international system when the Chinese — just to use an example — refuse to allow currency depreciation and rebalance trade. It’s like the Greeks being locked into the Euro, and the German’s refusing to boost their own internal spending to lift others. We’re locked into a fixed exchange rate by the Chinese — so naturally capital $$ flow into the US.

Doesn’t this suggest that the exchange rates problem is very critical in the short term? And if we can’t fix that, then what’s the analogy to the Greeks getting out of the Euro?

Peterr October 1st, 2011 at 2:51 pm

Bill Black repeatedly expresses disgust that no substantive criminal charges have been filed against anyone in this matter, which compares very, very poorly with the S&L mess for which he oversaw the cleanup.

The only penalties that anyone seems to talk about are corporate fines, which has the effect of turning any penalties for the criminal behavior of excessive risk-taking into just another cost of doing business. Basic game theory tells you that the absence of meaningful personal penalties against senior management increases the likelihood of bad behavior.

Does your book examine the lack of DOJ and SEC actions?

Jeffry A. Frieden October 1st, 2011 at 2:52 pm

There are many reasons, I think, why housing was the central locus of the capital inflow. But one observation I would make — in keeping with our insistence that the American experience followed a well-worn path trod by many other borrowers. When a country experiences a capital inflow, two things almost always happen. The money has to be spent on something, so some of it is spent on hard goods that are easily traded across countries — cars, computers, stereos. So you get a big increase in imports (which we got — from about 1.4 to 2.4 trillion). But most of it is spent on things that don’t get traded, non-tradable goods and services — and the biggest entry in this category is housing, which accounts for one-third of the average household’s spending in the US.

So as in hundreds of cases before, a capital inflow stimulated spending and drove up the price of housing. This then provided opportunities for new lending, and so on.

In addition, it is certainly the case that the Administration was enthusiastic about the “Ownership Society” idea, and encouraged an expansion of home ownership.

And Wall Street was more than happy to accommodate with a whole host of financial instruments that made housing finance that much easier

Menzie D. Chinn October 1st, 2011 at 2:53 pm
In response to JW Mason @ 45

Responses in turn:
1. Foreign saving is different in that flows of that saving can reverse, fairly quickly. That sort of event is sometimes called a “sudden stop”, and as you might imagine, it’s not a pleasant event to experience. In addition, foreign saving is sometimes acquired by issuing debt in a foreign currency — so that when the saving inflow stops, a currency crisis results, and one can have the country’s balance sheet go out of whack (foreign currency denominated debt goes up in value, domestic currency denominated assets go down…). Fortunately, the US doesn’t have that problem.
2. It’s not clear to me that bubbles always occur in the presence of low interest rates. Rather, that can help; but what you really need is the expectation that asset prices are going to keep on rising, perhaps being driven on by excessive leveraging. So…a properly regulated financial system is key, and key to a modern economy. Just don’t bet your economy on self-regulation (which was the buzzphrase of the 1990′s and 2000′s).
3. I answered this in my response to Mike Konczal’s 2:06 question. As Bob Blustein characterized the Argentine experience, “the money kept on rolling in”…until it stopped. And if we let entitlements explode and don’t raise revenues (both of those things are required), at some point, the money will stop rolling in.

Jeffry A. Frieden October 1st, 2011 at 2:54 pm
In response to Peterr @ 52

We certainly wish we could have anticipated everything that has happened (or not happened) in the past few months, since we finished the book. We don’t talk much about the absence of post-crisis activity; we do talk a lot about regulatory behavior before and during the crisis; and about Dodd-Frank.

Perhaps for an online update, or an updated new edition!

bigbrother October 1st, 2011 at 2:55 pm

The financial sector found a way to grow itself to a larger slice of the economy. They produce nothing in real terms and siphon off huge sums of capital.
The “Globalization” of the American economy impacted us in ways that were not anticipated or ignored as manufacturing of real goods was off shored and more recently service industries are also off shored. As paychecks go offshore USA consumption is reduced reducing government revenues.
The pie slice for “Main street” grows smaller. Those ops need to bear a larger share of the deficit burden.

doc_faustroll October 1st, 2011 at 2:55 pm

Indeed Jeffry,

Part of the problem has to be and has been since the 80′s and 90′s, the rise of the “shadow banking system” and the move to markets for the creation of credit. In my reading of the history, it looks clear that the FED was somewhat aghast at the fact that they had little control over that very “shadow banking system” and the systemic risks and concomitant leverage. Minsky’s work came to the fore in the late 90′s as a way to make sense of the instability that this form of financial innovation was adding. In addition the BHCs were tied to this new innovation.

To what extent are you working with the Minsky conversations? They seem to be having a big effect on internal FED debates and on actual operations. In many ways the FED lost control in the 2000′s as the bubble got extremely frothy, and post-bubble their only power seems to be one of ameliorating the pace of deleveraging?

Menzie D. Chinn October 1st, 2011 at 2:56 pm
In response to GlenJo @ 46

I disagree with you regarding SecTreas Geithner. He wasn’t at the Fed when Greenspan was holding back on regulation. He was head of NY Fed, and of all the people in the government, he was the one I recall most anxious about derivatives (including credit default swaps, CDS’s). You might still fault him for not being as tough as you would like on the banks, but of all the people to criticize in the run-up to the crisis, I don’t think he’s the one you should point to (I’d say, President Bush, Senator Phil Gramm, the head of the Treasury Office of Thrift Supervision, etc. are *much* better candidates).

Scarecrow October 1st, 2011 at 2:57 pm

If the main source of the long-run debt problem is not trade but rather rising health care costs flowing through “entitlements,” e.g., Medicare, etc, then shouldn’t the focus of remedies be on those costs we pay to private providers, and not on government programs that incur them? after all, those programs deliver care at less cost than the private system alone.

E.g., suppose we eliminated Medicare and had only private insurance. The long-term budget problem immediately vanishes, but the economy tanks because the private economy now has to pay the rising health care costs, no?

So I’m wondering whether it’s helpful to characterize this an an “entitlements” problem — or is that an oversimplication of what you’re saying.

And if this is correct, then the cost problem is one of massive market failure in the private health care sector, not uncontrolled spending by government. That suggests Congress is looking at the wrong problem, and will likely make the economic problem worse. Comments?

Jeffry A. Frieden October 1st, 2011 at 2:58 pm

I might add that it is in fact important to see some of the differences between the US experience and that of, say Turkey, or Greece today. As Menzie has said, we did not experience a “sudden stop” nor did we see a collapse of the exchange rate. And the former is definitely a good thing (imagine where we, and the world, would be if in October 2008 the US government had found itself unable to borrow).

But the general position the US finds itself in post-crisis is not all that different. In fact, as we point out and many others have indicated, the fact that the dollar has not weakened can be seen as a problem. A weaker dollar would reduce our levels of consumption, stimulate demand for our tradable products, and help in ways familiar to other crisis cases.

Menzie D. Chinn October 1st, 2011 at 2:59 pm
In response to Scarecrow @ 51

China quasi-pegs to the dollar, but is allowing the RMB to appreciate against the dollar. Over time, their ability to maintain their quasi-peg against the dollar is eroding in real terms, as Chinese inflation edges up (this is the monetary approach to the balance of payments at (slow) work).

Jeffry A. Frieden October 1st, 2011 at 2:59 pm

The broader point is that there are great similarities among crises of this type — a point made statistically by Reinhart and Rogoff in their book, “This Time is Different” and related articles. We think there is a tremendous amount to learn by looking both at the similarities and at the differences.

GlenJo October 1st, 2011 at 3:00 pm

I think a couple other factors:

Housing is very “low tech”. No technology “push” by government was required.

It’s plays on people’s “greed gene” as “money for nothing”. It was perhaps the only way an average guy could have a significant investment which “made money” when peoples real income was flat, and real cost of living was going up.

eCAHNomics October 1st, 2011 at 3:00 pm

Back in the NATFA daze, I read a stat that only 10,000 had ever applied (or per annum, I forget which) for Trade Adjustment Assistant, i.e. it was insignificant compared to the problem. TAA was tangential to the project I was working on, so I never pursued the ins & outs of the data. Is what I cited the rough order of magnitude? In which case, it doesn’t matter much if the Rs zero it out.

On my first comment (24) you misunderstand its intent. It is not nostalgia for an earlier period of more balanced trade, nor is it scapegoating any economy for imbalances. Instead, it is meant to diagnose the problem, so that appropriate policies might be devised. (LOL that should ever happen!)

So, for example, developing countries with high saving rates should be encouraged to stress domestic consumer spending, not just job creating biz. After all, why should all those workers in developing countries not enjoy higher standards of consumption as the fruits of their labors.

GlenJo October 1st, 2011 at 3:01 pm

Well, that’s good to know. Thanks.

Peterr October 1st, 2011 at 3:02 pm

Sooner or later, either you or the publisher says “enough for one book!”

But let’s look back then . . .

I look at the repeal of Glass-Steagall as a watershed in regulatory capture, where the banks used their influence in Congress to remove what they saw as shackles on their ability to make money — consequences to anyone else be damned.

And damned if we didn’t pay the consequences.

Jeffry A. Frieden October 1st, 2011 at 3:02 pm

There is a sense — part economic, part political — in which these global/EU parallels are instructive. Global surplus countries lent to the US and UK so that they could consume the surplus countries’ exports; EU surplus countries (largely N. European) lent to the S. Europeans so that they could consume the N. European exports.

My view is that neither process is sustainable over the medium run. In Europe I think this is clear — the S. European countries have experienced something like the sudden stop we were talking about above. In the US case, I believe both that foreigners’ appetite for American assets is not limitless, and that Americans’ appetite for further borrowing is waning.

Menzie D. Chinn October 1st, 2011 at 3:03 pm
In response to bigbrother @ 56

Yes, I agree that finance had too large an economic and political influence. I outline the share in this post on Econbrowser: http://www.econbrowser.com/archives/2010/05/tales_from_the.html

JW Mason October 1st, 2011 at 3:03 pm

Foreign saving is different in that flows of that saving can reverse, fairly quickly. That sort of event is sometimes called a “sudden stop”… In addition, foreign saving is sometimes acquired by issuing debt in a foreign currency

I agree with all this, but it’s not really responsive. In your book, you specifically argue that financial inflows to the US was responsible for the housing bubble. But the US did not experience a sudden stop of financial inflows (the opposite in fact) and of course did not issue debt in foreign currencies. So if I may ask again, how did foreign lending to the US cause the bubble? Was it simply that it contributed to low interest rates, or was there some other mechanism?

2. It’s not clear to me that bubbles always occur in the presence of low interest rates. Rather, that can help; but what you really need is the expectation that asset prices are going to keep on rising, perhaps being driven on by excessive leveraging. So…a properly regulated financial system is key, and key to a modern economy. Just don’t bet your economy on self-regulation.

Again, I agree, but this has nothing to do with current account imbalances, which your book specifically identifies as *the* cause of the bubble and crisis.

If we let entitlements explode and don’t raise revenues (both of those things are required), at some point, the money will stop rolling in.

Is there ever a point where the fact that the crisis hasn’t occurred, leads us to revise our theories that say it must occur? Or do we just keep saying it’ll come along any day now?

Peterr October 1st, 2011 at 3:06 pm

*Geithner* was the one most concerned about derivatives?

Does the name Brooksley Born ring any bells?

JW Mason October 1st, 2011 at 3:06 pm

The broader point is that there are great similarities among crises of this type

The three key features of foreign-debt crises in developing countries are a sudden stop in financial inflows; rapid and disorderly fall in the exchange rate (often but not always due to the abandonment of a peg); and a sharp rise in domestic interest rates. The US experienced the exact opposite of all this. So in what sense is it a crisis of this type? Where’s the similarity?

Jeffry A. Frieden October 1st, 2011 at 3:07 pm
In response to eCAHNomics @ 64

On the first point, it is true that the take-up of Trade Adjustment Assistance is well below what might be expected. I don’t know the actual numbers (10,000 seems low) but it’s only a fraction of eligible workers, I believe. I have heard that this may be because of difficulties in meeting criteria, or applying; but more generally, it is something of a puzzle. Of course, if the government were aggressive about searching out those who are eligible, the take-up would undoubtedly be higher.

On the second point (export orientation) there are two reasonable arguments. One is that export promotion is an effective way for a very poor country to get its producers used to world-class quality, technology, marketing channels, and the like. This is almost certainly true. The other is that export promotion — and especially an artificially weak currency — benefits exporters at the expense of local consumers. This is a domestic distributional issue, and a very important one for China today.

Peterr October 1st, 2011 at 3:08 pm
In response to Peterr @ 70

From Glenn Greenwald in April 2009:

Last night, former Reagan-era S&L regulator and current University of Missouri Professor Bill Black was on Bill Moyers’ Journal and detailed the magnitude of what he called the on-going massive fraud, the role Tim Geithner played in it before being promoted to Treasury Secretary (where he continues to abet it), and — most amazingly of all — the crusade led by Alan Greenspan, former Goldman CEO Robert Rubin (Geithner’s mentor) and Larry Summers in the late 1990s to block the efforts of top regulators (especially Brooksley Born, head of the Commodities Futures Trading Commission) to regulate the exact financial derivatives market that became the principal cause of the global financial crisis. To get a sense for how deep and massive is the on-going fraud and the key role played in it by key Obama officials, I highly recommend watching that Black interview (it can be seen here and the transcript is here).

eCAHNomics October 1st, 2011 at 3:09 pm
In response to JW Mason @ 69

If my diagnosis were accurate, namely that the world is awash in a sea of excess saving, then one of the “solutions” is to destroy those excess savings by bubbles bursting with assets becoming worthless.

Not a very smart “solution,” mind you, but the one that Bubbles Greenspan & Bernanke clearly prefer. Ditto Bank of Japan in 1980s.

Menzie D. Chinn October 1st, 2011 at 3:10 pm
In response to eCAHNomics @ 64

Sorry — didn’t mean to imply you were waxing nostalgically for those days.
Trade is a big issue; the tools we have are weak, and I wish they were stronger. Fortunately, in recent years, TAA has been extended to those in the service industry, which makes sense since more and more services are now import competing (think call centers).

In our book, we observe that in order to rebalance the global economy, China will need to re-orient its economy to depend on domestic sources of demand. That will in turn require spurring consumption by establishing a social safety net, among other things. But in the shorter term, exchange rate adjustment will be key. We can get some of that by expansionary monetary policy in the US, but clearly we need cooperation from the Chinese (well, adjustment along these lines is in their interests as well). For more on this, see my post on my talk at the IMF last year:
http://www.econbrowser.com/archives/2010/10/transforming_ch.html

alicewolf October 1st, 2011 at 3:10 pm

Meanwhile, back to the 60′s. Since Woodrow Wilson sold the US back out to the oligarchs there has been a problem. FDR erected a firewall, the Glass Steagall standard between speculative and commercial banking activity, and together with the fixed exchange rate between sovreign nations, worked tirelessly to bring about the end of empire. The empirical monetary system of the oligarchs to be clear what that means in this context. The reason the war of Independence had been fought, to evade the monetary system of empire. The original intention of the Treasury Secretary, Alexander Hamilton, at the time of the construction of the US Constitution, was for Congress to utter credit, Article 1 Section 8.
for projects that were big, bold and bad enough to create higher and higher potential for decent civilised living standards throughout the world and deconstruct empire’s colonialization of the planet. The oligarchs were furious and decided to promote sex drugs and rock n roll.
This was a great success, and millions fell for the idea. So entranced by the new so called freedom, their society started to erode, and while this was going on the puppets of empire, placed in high positions in the US government and the military, CIA et al, started deregulation and brought down Glass Steagal and the fixed exchange rate and the markets were allowed to go crazy. The digitization of the markets speeded the madness up and here we are, Ben Bernanke literally doing the impossible, by leveraging the FED funds at 53 to 1 or thereabouts to keep this un merry go round going round. Obama is push push pushing for the EU to dance to the melody of the FED printing press as well as selling democracy to the Arab Spring demonstrators who like the Wall Street protesters and the indignados have no leaders and no agenda and are therefore ripe for hijacking into the hands of George Soros or someone of his ilk, to use them as political pawns for the next major coup. So, the markets we talk about today are about a virtual economy, not a physical economy. Economy is human, not fiscal. Productivity per head per square kilometer is what counts. History repeats itself, and the Dark Age that may soon be upon us will be more severe than the last Dark Age. The recession that is looming on the horizon is global, and therefore much worse than the Great Depression ever was. It is time to revert to FDR and JFK, they were patriots. They were followers of the US Constitution. People want to go to heaven but they don’t want to die. We have to die to “consumerizionism” and go back to the US Constitution otherwise the unique character of this amazing creative work and our wonderful sovreign republic will not entirely go to waste, because contained in it all is many the natural law, the principle of LIFE, which will continue on without us.
Just as the dinosaurs were unable to survive the ever rising standards of the universe, so we may not survive. If you listened to Obama’s address to the UN he described the UN as the moral compass of the world. I would be wary of that compass ……………………. We are facing other challenges such as increased incidents that are a result of galactic radiation etc. earthquakes, tornadoes, floods, hurricanes,drought etc etc which need to be taken seriously, and yes, there is another market emerging. A market for sane things to be undertaken. For NASA to reopen so we can do more research in space about the weather. We need to get NAWAPA project going. JFK had signed onto it, the North American Water and Power Alliance, when he was assassinated, so that the oligarchs could force the next war on the US and the world, and the wars have not stopped.
The market is about wars, and death and everything grim you can imagine.
We need to ressurect the spirit of FDR and JFK and start being creative and joyful again. Looking forward to tomorrow and tomorrow and tomorrow.

GlenJo October 1st, 2011 at 3:10 pm
In response to Scarecrow @ 59

I agree. It’s not an entitlements problems, it’s a American health care system problem. We are way more expensive than the rest of the world, and our current system dumps much of these costs onto the companies making products in the US, which worsens our trade issues. This is going to nail our economy in the future.

Germany thrives on exports, yet still has a good healthcare system, along with well paid and well educated workers.

Any country which wants to excel in the high technology trade area (export) will need to figure this out. You cannot perform in this sector without educated and motivated workers. And you’re not going to create that by smashing worker pay, removing healthcare and raising cost barriers to higher education.

Jeffry A. Frieden October 1st, 2011 at 3:10 pm
In response to JW Mason @ 71

The comparison we are drawing is not solely to the process once the crisis hits (although I would point out that your three features would do a pretty good job of describing the experience of a phalanx of European countries — minus, of course, the exchange rate collapse, so far). It is more broadly to the capital-flow cycle as a broader phenomenon.

And on this I’ll refer to a prior post (not sure this is kosher, but anyway):

“one observation I would make — in keeping with our insistence that the American experience followed a well-worn path trod by many other borrowers. When a country experiences a capital inflow, two things almost always happen. The money has to be spent on something, so some of it is spent on hard goods that are easily traded across countries — cars, computers, stereos. So you get a big increase in imports (which we got — from about 1.4 to 2.4 trillion). But most of it is spent on things that don’t get traded, non-tradable goods and services — and the biggest entry in this category is housing, which accounts for one-third of the average household’s spending in the US.

“So as in hundreds of cases before, a capital inflow stimulated spending and drove up the price of housing. This then provided opportunities for new lending, and so on.”

Menzie D. Chinn October 1st, 2011 at 3:11 pm
In response to Peterr @ 70

Yes, it does. I’d say she’d be *the* most concerned. But I was referring in the years after the Commodity Futures Modernization Act.

Jeffry A. Frieden October 1st, 2011 at 3:13 pm

The American experience — during the runup and especially after the crisis hit — is powerfully affected by the key-currency status of the dollar and the safe-haven status of the US. There is no doubt that this strongly differentiates the US from, say, Chile. But we are not immune to the basic principles of macroeconomics, and basic accounting relationships. When a country runs a current account deficit of 6 or 7 percent of GDP, it’s consuming more than it produces, investing more than it saves, its government is spending more than it takes in (or some combination). At some point, one assumes even in the case of the US, that level of borrowing is unsustainable. And if something is unsustainable it will come to an end. I think it is coming to an end.

eCAHNomics October 1st, 2011 at 3:15 pm

Underuse of TAA for whatever reason, and yours that it is difficult to take advantage of, is a feature, not a bug. Devised so that it is a propaganda sop to get sweetheart deals for pols’ corp sponsors while looking like workers’ interests are being looked after, what we refer to here as kabuki…

WRT Chinese qua consumers, when I was there a decade ago (a useless U.S. Eisenhower program peeps-to-peeps, with mainly U.S. academic economists on the trip; I’m a retired Wall St economist), I made casual mention of Chinese economy becoming more domestic consumer oriented, and both Chinese economists (like Chinese political leaders, engineering trained/oriented) and U.S. economists looked at me like I had 3 eyes.

Menzie D. Chinn October 1st, 2011 at 3:17 pm
In response to JW Mason @ 69

I would say in order to have the asset boom of the magnitude we saw, one needed the inflows. It’s conceivable that it could’ve all been done with domestic saving, where heightened leverage is allowed (often in financial “reform”), but our reading of economic history is that inflows are part of the mixture. See also this post:
http://www.econbrowser.com/archives/2011/09/what_predicts_a.html

GlenJo October 1st, 2011 at 3:17 pm

I think you’re right, I just cannot see how this plays out. Do you think this will be caused by coordinated action of the BRICs?

Jeffry A. Frieden October 1st, 2011 at 3:17 pm
In response to Peterr @ 66

It may well be that the repeal of Glass-Steagall was driven by bank influence. But we don’t think it was central. To a large extent, the separation of commercial and investment banking had long since been eroded, in part by regulatory permissiveness, in part by new financial techniques. It may well have been a bad idea, but I don’t think it was central to the regulatory story.

The more important decisions were largely, we believe, about the shadow banking system and about risk management, and they were made by the SEC and the Federal regulators in 2003 and 2004.

eCAHNomics October 1st, 2011 at 3:19 pm

China will need to re-orient its economy to depend on domestic sources of demand.

Ding. see my 81.

But in the shorter term, exchange rate adjustment will be key.

Profoundly abysmal idea. That merely further impoverishes the already stretched U.S. consumer of last resort, while creating NO new U.S. jobs for at least a year and likely longer, aka J-curve. I ran so many J-curve regressions on U.S. trade in the day that I ran out of personal degrees of freedom. :-)

JW Mason October 1st, 2011 at 3:20 pm

The comparison we are drawing is not solely to the process once the crisis hits (although I would point out that your three features would do a pretty good job of describing the experience of a phalanx of European countries

Oh absolutely. I’m not disputing your approach in general, I think it’s very useful in a lot of contexts. I’m just questioning its applicability to the United States. To say that the US has experienced a capital-flow cycle except without the outflow part is the same as saying that we experienced a debt crisis without the crisis. It means you need some other explanation for the crisis we actually did experience.

So as in hundreds of cases before, a capital inflow stimulated spending and drove up the price of housing. This then provided opportunities for new lending, and so on.

Sure, but the mechanism by which this happens is simply a fall in interest rates. Any other source of greater savings — for instance a lower government deficit — would be expected to have the exact same effect. Money that the government ceases to borrow also “has to be spent somewhere.” From a macroeconomic standpoint, a decrease of government borrowing by one dollar, and an increase in foreign purchases of government debt by one dollar, should be exactly equivalent.

Jeffry A. Frieden October 1st, 2011 at 3:20 pm
In response to eCAHNomics @ 81

I am no China expert (Menzie, any thoughts?) but those who know more tell me that the Chinese leadership is painfully aware that their policies are seen by many Chinese as artificially constraining their purchasing power. I know that large swaths of the country seem to think that they have not participated as much as they deserved in the country’s economic growth. Part of this is regional, part industry-specific, part class, I suppose. But I do think that the Chinese leadership understands. Whether they can change course — which means disturbing existing political, social, and economic relationships that have governed the country since the late 1970s — is another matter.

alicewolf October 1st, 2011 at 3:22 pm

The concept of money has to change completely. The monetary system of the oligarchs is preventing us from doing anything except adopt austerity and that is for the birds. We need the US CREDIT SYSTEM. Credit equals life. Debt equals death. Credit has to be uttered for projects that will show a good return, not in the cash matrix, but in PRODUCTIVITY.
Human productivity. We are being asked to go into debt to save the banks?
Sovreign debt is not even being mentioned any more as a coverup mechanism.
The banks want us to go into deeper and deepter debt so they can take everything from us at the lowest possible price, and better yet for nothing.
They want a free pass. Are we nuts……..how could we have ever fallen for this garbage. The market, they are marketing death. I say we turn the table on them and pass THE RETURN TO PRUDENT BANKING ACT introduced by Marcy Kaptur D Ohio which will effectively shut the present day derivative and toxic asset market right down.

Menzie D. Chinn October 1st, 2011 at 3:24 pm
In response to eCAHNomics @ 85

The empirical evidence for the J-curve is surprisingly weak (a paper by Andy Rose and Janet Yellen, Journal of Monetary Economics, 1989).

The pass through of exchange rate changes into import and export prices is better documented.
http://www.econbrowser.com/archives/2011/01/chinese_exchang.html

Jeffry A. Frieden October 1st, 2011 at 3:25 pm
In response to JW Mason @ 86

Also relevant to GlenJo at 83: We’re not trying to predict the exact nature of the adjustment process that the country faces. But we are, I think, confident that there *will* be an adjustment. Just to fix ideas, think of two (extreme) alternatives:

1. We continue to run current account deficits in the 3-6 percent of GDP range ad infinitum, which allows us to maintain previous patterns of consumption, production, savings, government spending/revenue.

2. Either due to a supply response (foreigners have enough American assets in their portfolio) or a demand response (Americans are worried enough about the liabilities) the current account moves toward balance. Probably not to real balance, because the reserve currency status probably means we can run a 1.5 percent of GDP CA deficit for a long time.

I believe in scenario 2. And this scenario involves more or less precisely the kinds of measures faced by countries that have overborrowed and must now adjust.

JW Mason October 1st, 2011 at 3:26 pm

we are not immune to the basic principles of macroeconomics, and basic accounting relationships. When a country runs a current account deficit of 6 or 7 percent of GDP, it’s consuming more than it produces, investing more than it saves, its government is spending more than it takes in (or some combination). At some point, one assumes even in the case of the US, that level of borrowing is unsustainable. And if something is unsustainable it will come to an end. I think it is coming to an end.

Well maybe. Altho I would note that something that is sustainable, will also come to an end sooner or later. (Such is the way of all flesh.) And something that is unsustainable, can still go on for a very long time. Not only the US, but Australia and various other countries have run substantial current account deficits year after year for 20, 30 and 40 years with none of the bad consequences that are supposed to follow. Why can’t we do it another 20, 30, 50 or 100? (Especially since the large, persistent differential between the return on US assets abroad and foreign assets here means that current account deficits don’t give rise to negative income flows.)

But let’s say you’re right. You’re still *predicting a crisis that may occur in the future.* Your book, however, is supposed to explain the crisis we actually had. How were current account imbalances responsible for that?

Jeffry A. Frieden October 1st, 2011 at 3:27 pm

And the aftermath of every debt crisis I know of is political conflict over how the burden of adjustment will be distributed. On one dimension it’s between countries (cf. Germany vs. Greece) — which could be the case in the US, to very dangerous effect in my view. On another dimension it’s within countries. Who will pay the price of the necessary adjustments — public sector workers, taxpayers, recipients of government services, workers, managers? I think this battle has already been joined in the U.S.

eCAHNomics October 1st, 2011 at 3:27 pm

I prolly know less about Chinese economy than you do. When I was there, we were told China needed to create 20 million new jobs/year to prevent social unrest: school leavers, ag workers leaving farm & SOE workers coming into “market” economy. My perception of Chinese leadership was that it was obsessed with job creation. Social unrest in China (Taiping Rebellion being a representative example) is viewed in a Confucianism hierarchical society are being profoundly destabilizing.

Menzie D. Chinn October 1st, 2011 at 3:29 pm

Jeff is right — Chinese policymakers well recognize they are reaching the limits of what they can achieve by way of export oriented development. But realizing there’s a problem is different than effecting change. That is, the technocrats understand the problem, but vested interests (including export oriented industries, well-represented in the Communist Party) will fight against more rapid RMB adjustment.

eCAHNomics October 1st, 2011 at 3:29 pm

Well, if ya don’t mind, I’ll stick to the work I did, which was incredibly convincing. Any academic economists connected to any pol figures, like Yellen, are automatically suspect.

On edit: If it is not the price mechanism that makes exports cheaper & imports more expensive, the classic J-curve rationale, what else might it possibly be? Magical thinking?

Jeffry A. Frieden October 1st, 2011 at 3:31 pm
In response to JW Mason @ 91

I think we’re going around in circles a bit (perhaps, ironically, given the linear nature of the chat!). We see the capital inflow as central to the boom in consumption after 2001, which fed the housing boom and financial expansion, which turned into a bubble, and which eventually burst. Bubble have their own dynamic, but we look to the capital flow cycle as the underlying cause of the relationship.

We do *not* argue that specific aspects of the eruption of the crisis (Lehman, AEG, whatever) could have been forecast. But the fact that the US was borrowing very heavily for purposes that were highly questionable was, we believe, the root cause (along with others we’ve mentioned).

You say the crisis has not happened. But it has. What has not happened exactly as in Greece, or Brazil, or Turkey, is a rapid adjustment to the new macroeconomic reality. The special position (exorbitant privilege) of the US dollar buys us time. But the need for adjustment is, I believe, still there.

Scarecrow October 1st, 2011 at 3:32 pm
In response to Mike Konczal @ 14

Mike and authors — I think it’s worth returning to your observation at the end of that question, that the financial sector fundamentally failed in it’s assumed duty to allocate capital efficientlyy — it basically allocated a large share to itself — and ask, what’s to be done? I suspect the folks participating in #occupyWallStreet don’t exactly have that worked out yet, and neither, seems to me, does anyone else who are looking down on them.

Can you and our authors expand on what you each think needs to be done to Wall Street and the financial sector generally, to have thm perform some useful instead of destructive function?

Can we reduce it to a few demands, a few signs for our folks to carry? (only slightly facetious). We really need a good, simple way to explain this.

Menzie D. Chinn October 1st, 2011 at 3:32 pm
In response to JW Mason @ 91

If the net international investment position of the United States hadn’t gone from positive to -20% of GDP, I’d be, like you, more sanguine.

We analyzed one crisis, and found imbalances (plus deregulation and government borrowing) important; doesn’t mean we can’t have another one. Argentina has had many, many, many over the past 250 years.

JW Mason October 1st, 2011 at 3:35 pm

exchange rate adjustment will be key

Menzie, I’m curious: How large a dollar depreciation do you think is feasible? And how large an improvement in the US current account balance do you think it could deliver?

In the past, you’ve published papers that estimate exchange rate elasticities that don’t even satisfy the Marshall-Lerner-Robinson condition, implying that a dollar depreciation would actually make the current account deficit larger. Obviously you don’t believe this now. So what are your preferred values for the long-run exchange-rate elasticities of US trade flows?

Menzie D. Chinn October 1st, 2011 at 3:35 pm
In response to eCAHNomics @ 93

As Feenstra and Hong ( http://www.nber.org/~confer/2007/cwt07/feenstra.pdf ) point out, export oriented industries are relative capital intensive. Hence, a switch to satisfying domestic demand could achieve the target level of labor absorption with lower growth.

In any case, we know that the coastal sources of cheap labor have been largely exhausted, and labor costs are rising (as in the standard Fei-Ranis/W.A. Lewis model). So there are forces moving toward greater consumption share, and policy could help that trend move along.

Jeffry A. Frieden October 1st, 2011 at 3:37 pm
In response to Scarecrow @ 97

I’m not sure about the signs — I’m an academic, after all, used to speaking in 50-minute segments. But the very broad point I would make is that the principal responsibility rests with the government. The idea — which I hear a lot — that the crisis is due to all of us because we enjoyed consuming seems misguided. The average person does not study open-economy macroeconomics, or finance, nor should he (well, maybe a little).

It’s the government’s job, in principle, to watch out for the general well-being. This may be pie in the sky, but there are plenty of instances of good government policies being adopted in the aftermath of serious crises.

Let me make clear that borrowing in and of itself is not bad, so long as the funds are put to productive use, and so long as the financial activities do not create risks for the broader society. The first point is a basic canon of foreign borrowing, or any borrowing, one which American economists have been insisting on for decades in preaching to developing nations: do not borrow for purposes that do not increase the productive capacity of your society. Tax cuts and housing speculation are unlikely to qualify as productive uses of foreign funds.

So how might the government have had an impact here? First, it seems clear that the tax cuts of 2001 and 2003, which initiated the most recent borrowing spree, were unjustified. Second, monetary policy between 2002 and 2004 was almost certainly too loose, leading to real interest rates that were close to negative and giving households a great incentive to borrow. Third, just when the financial regulators should have become more vigilant, to deal with the huge increase in funds flooding into the financial system, they disarmed themselves – allowing large financial institutions to determine the riskiness of their own investments, and relaxing requirements on capital charges to “off-book” subsidiaries.

To be sure, when five trillion dollars flooded into the American financial system in the space of six years, it was inevitable that the average quality of loans and investments made would decline. But regulatory and macroeconomic policy can, and should, mitigate the effect of this process. Otherwise we would have no grounds for criticizing the Mexican government for using its foreign loans to build obsolete steel mills, or for criticizing Mobutu for using his foreign loans to pad his overseas bank account.

And that provides some cautionary notes for the future.

bigbrother October 1st, 2011 at 3:39 pm

Please exclude Social Security from the entitlement discussion..it is an insuranace fund recipients paid into. If it is not solvent then the funds were taken illegslly.

Menzie D. Chinn October 1st, 2011 at 3:40 pm
In response to JW Mason @ 99

I don’t know how much real depreciation is feasible on a broad-trade-weighted dollar basis, especially given recent movements in exchange rates, but my most recent work indicates that the Marshall-Lerner conditions are more than satisfied. See this paper for the gruesome details:
http://www.ssc.wisc.edu/~mchinn/Trade_supply_vertspec_tariffs.pdf

Jeffry A. Frieden October 1st, 2011 at 3:40 pm

One very specific issue is the implementation of Dodd-Frank. Most of the action with respect to financial re-regulation will have to do with how the bill is put into practice by the regulators. And the interest-group action on this has been very intense. I think it’s important that consumers, and broader economic concerns, be more fully reflected in this process.

Scarecrow October 1st, 2011 at 3:40 pm

That description of adjustment sounds right. What’s striking to me about the adjustment occurring in the US is how closely it matches what the creditor — Germans/French, et al — are forcing on the Greeks. We’re imposing it on ourselves, when we don’t have to; we have other choices, we have our own currency, and our debt is in our own currency but our political conversation pretends these key differences don’t exist.

That suggests the way we talk about the problem, how we describe it and how we describe possible remedies is absolutely critical. Do you agree, and if so, how would you like to change the conversation to make it more constructive and to open up other possibilities?

econobuzz October 1st, 2011 at 3:41 pm

It’s the government’s job, in principle, to watch out for the general well-being. This may be pie in the sky, but there are plenty of instances of good government policies being adopted in the aftermath of serious crises.

With all due respect, it is “pie in the sky.” We just learned that — the hard way.

Jeffry A. Frieden October 1st, 2011 at 3:44 pm
In response to bigbrother @ 102

Well, unfortunately, that’s the general perception but it’s not the case. Social Security is a pay-as-you-go system whereby current contributors are paying for current recipients — on the presumption that future generations will return the favor. This may be a small distinction, but it should be clear that Social Security is *not* like a retirement savings account and that people are just drawing down their earnings.

One could say that current generations of contributors *deserve* to be paid as much as the current generation of beneficiaries, but that is a different matter.

That said, the necessary “fixes” to Social Security are relatively easy (tax SS income above a certain amount, change the retirement ages a bit, and so on). Medicare is much harder — and, as others have noted above, also raises very difficult questions about the costs of health care more generally.

econobuzz October 1st, 2011 at 3:45 pm

I think it’s important that consumers, and broader economic concerns, be more fully reflected in this process.

There is absolutely no mechanism in our system to provide for this.

Menzie D. Chinn October 1st, 2011 at 3:47 pm

Housing is especially sensitive to interest rates given the long-lived nature of the asset. However, in addition we had the expansion of mortgage backed securities, and development of collateralized debt obligations (CDOs) which, given the regulations of the time, allowed circumvention of capital requirements. Low risk free rates, and the disappearance of spreads due in part to the aforementioned developments, made housing particularly susceptible to a boom. Hence, regulation (or nonregulation) was key to making the boom particularly exaggerated.

The global and widespread nature of the crisis was in part due to the way the MBS’s and CDO’s were distributed throughout the financial system, sowing uncertainty about solvency everywhere.

Jeffry A. Frieden October 1st, 2011 at 3:47 pm
In response to Scarecrow @ 105

I certainly agree that the way we think about the crisis is crucial to a resolution. If we think of it as just a typical cyclical crisis, that would imply one set of measures; if we think of it as a debt crisis, that implies a different universe in which terms like debt overhang, debt deflation, and de-leveraging play a major role.

The way I think about the US-European comparison is that the creditor-debtor divide in Europe is largely North-South. In the US it is much more along income/wealth lines, with the net creditors wanting the burden to be borne primarily by the net debtors (and vice versa).

Jeffry A. Frieden October 1st, 2011 at 3:49 pm
In response to econobuzz @ 108

Well, I’m not quite so cynical. We do have elections, and some hand-waving about consumer protection still goes on. I certainly agree that the public interest is often trumped by special interests — but I don’t agree that this is inevitable, or that it has always been thus.

Menzie D. Chinn October 1st, 2011 at 3:49 pm
In response to econobuzz @ 106

We agree it’s hard to regulate. But at various times in history (i.e., when prudence trumped free-market ideology), we have regulated (think post-war America). We’re not asking for comprehensive regulation of every aspect of finance; however, quantitatively oriented measures like capital requirements should be implementable. Doesn’t seem particularly pie-in-the-sky to me.

Jeffry A. Frieden October 1st, 2011 at 3:51 pm

And that’s why we worked together so well as co-authors.

Scarecrow October 1st, 2011 at 3:52 pm

“Second, monetary policy between 2002 and 2004 was almost certainly too loose, leading to real interest rates that were close to negative and giving households a great incentive to borrow.”

I read counter views — e.g. Dean Baker? — that note we were still experiencing a near “jobless” recovery from the previous bubble-induced recession in those years, so the low interest rates were justified for that reason. The analogy might be watching the ECB prematurely (according to some) raise interest rates in Europe and surprise, surprise, growth in Europe almost halts and it’s harder to solve unemployment. Does that view seem valid, and if so, how should the Fed have balanced those concerns? And if the concern is excessive borrowing for housing, well, we’re supposed to have regulators watching over lending standards, lender fraud, etc.

Jeffry A. Frieden October 1st, 2011 at 3:53 pm

I would note that the global nature of the crisis should not be misinterpreted. There has been a big difference between how the crisis hit the deficit countries (debtors) and how it hit the surplus countries (creditors). The former, especially those that experienced something like a sudden stop, were driven into massive adjustment and austerity (cf. Latvia with a 20% drop in GDP). The latter were hit with an effective collapse of their financial system, because so many of their loans had proven to be worth less.

econobuzz October 1st, 2011 at 3:53 pm

With all due respect again, imho, effective regulation when hundreds of billions of dollars — trillions — are at stake is impossible. We are now going through a perfect case study. Unless we’re willing to learn that lesson, we are doomed.

BevW October 1st, 2011 at 3:53 pm

As we come to the end of this lively Book Salon discussion,

Menzie, Jeff, Thank you for stopping by the Lake and spending the afternoon with us discussing your new book and the debt crisis / Wall Street.

Mike, Thank you very much for Hosting this great Book Salon.

Everyone, if you would like more information:

Their book

Menzie’s website and blog

Jeff’s website

Mike’s website / blog

Thanks all,
Have a great evening.

Sunday:
Christopher Phillips /Constitution Cafe: Jefferson’s Brew for a True Revolution; Hosted by Steven Schwinn

Mike Konczal October 1st, 2011 at 3:54 pm

Huh. It appears to have eaten my comments.

Trying again, my workplace, the Roosevelt Institute, has put out both a blueprint on a better financial market (Make Markets Be Markets) pre-Dodd Frank and has put out an implementation map on what a successful Dodd-Frank would look like – Will It Work and How Will We Know? As opposed to Health Care Reform, with coverage targets and bent cost curves, there is little on how Dodd-Frank should look after implementation. We have tried to make a difference there.

It is a tough battle. What has surprised me most is how much the various parts of industry and the real economy all lined up to be against the toughest parts of regulation – especially when it came to derivatives. Right now I think focus should be on foreclosures and housing debt, which is holding back the economy and devastating lives – so I am interested in work that links foreclosures to the real economy and investigations into the fraud and broken channels within the servicing of mortgage debt.

Jeffry A. Frieden October 1st, 2011 at 3:55 pm
In response to BevW @ 117

Bev, Mike, and all those who participated,

This was a great experience and I hope that we were able to address some of the issues in ways that help us move toward a constructive resolution of this crisis. Thank you all for participating!

Jeff

econobuzz October 1st, 2011 at 3:56 pm

Great discussion. Thanks all.

gigi3 October 1st, 2011 at 3:56 pm

“We do have elections”

That may be, BUT:

The likelihood of an honest election becomes more remote (pun intended) with each passing day. Here is Brad Friedman (Bradblog) discussing “the man in the middle” on KPFK:

http://www.bradblog.com/?p=8790

More on the subject:

http://www.bradblog.com/?p=8785

Menzie D. Chinn October 1st, 2011 at 3:57 pm
In response to Scarecrow @ 59

Because we promise health care, rising health care costs are an “entitlements” problem. I agree that we could certainly get more for the resources we are devoting to health care. Without the apparatus of the private health insurance firms, care could probably be delivered much more cheaply. But the capital and labor devoted to the health care system has arisen over decades, and squeezing out the rents will take lots of time.

For sure, however, implementing something like the Ryan plan (voucherizing) would take the direct costs off the government’s books, but not solve the health care cost problem at all (according to CBO), and the costs would probably shift back onto the government’s books somehow, via emergency room costs (unless we were able to credibly precommit to following the reaction at one of the Republican debates, and let those without health insurance follow nature’s course).

Scarecrow October 1st, 2011 at 3:58 pm

Thanks much to our authors and to Mike for responding to all our questions. Really appreciate it. Excellent discussion.

eCAHNomics October 1st, 2011 at 3:58 pm

Capital intensity is a second order condition. Can’t be dispositive.

When I visited China a decade ago, we went to Chonquing, the first inland center of govt-graced econ development. In fact, I’m wearing my Stillman Museum Flying Tigers T-shirt right now. The WWWI capitol with U.S. supporting the incredibly corrupt & inept Chaing Kai Shek, what else is new! Don’t know how many more Congquing’s have been fiscally favored in the intervening decade, but must be quite a few. Days of cheap Chinese labor are far from over.

Menzie D. Chinn October 1st, 2011 at 3:59 pm
In response to BevW @ 117

Thank you Bev, for having Jeff and me on, and thanks to Mike for the great questions to start off the debate.

JW Mason October 1st, 2011 at 3:59 pm

my most recent work indicates that the Marshall-Lerner conditions are more than satisfied.

Do you mean the final column of Table 1? With due respect, I think you are mistaken. The reported coefficients (0.95 for exports, 0.16 for imports) do (barely) satisfy the MLR condition *for a country with balanced trade.* But for a country that starts from the current US position of exports of 14% of GDP and imports of 18% of GDP, they do not satisfy the MLR condition, and imply that depreciation will worsen the current account. Just do the math…

JW Mason October 1st, 2011 at 4:10 pm

I don’t know how much real depreciation is feasible

I don’t mean to sound snarky, but I don’t see how it’s possible to believe that “exchange rate adjustment will be key” if you don’t have any idea how much exchange rates can actually adjust.

bigbrother October 1st, 2011 at 4:16 pm

When is the “Level Playing Field” coming?
G)

Menzie D. Chinn October 1st, 2011 at 4:56 pm
In response to JW Mason @ 127

OK, 10% implies 1.6 ppts of GDP.

darms October 1st, 2011 at 10:43 pm

Hi, here at the end of the world no one’s gonna see this but I will go out on a limb and say the cause of of the US debt crisis was the rating agencies rating crap securities AAA so they could be purchased by pension funds and other institutional investors. Had they not been able to abuse the AAA rating the securitization boom would not have occurred and the bubble would have been a great deal smaller. Those are the folks who need to go down…

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