Martin Wolf presents a nuanced analysis of Lehmans’ debate. Now we are recoveri ng – just a year afterwards! – it’s tempting to conclude that ‘clean up afterwards’ works.
It seems that the strange combination of a) bully Bear into takeover, with support b) let Lehmans go hang c) support everything else after the politicians are scared sh1tless, was the right one. (Niall Ferguson seems to think so – and Economics Focus agrees that some other mess would have happened, had Lehmans not gone down) But they could have easily got it wrong. Furthermore, there is even a risk when policymakers getting it right in an emergency: it leads to overconfidence, moral hazard . . . and another bubble. He ends with a superb final paragraph:
Letting Lehman go was not our biggest mistake. That was letting the economy and financial system become so vulnerable. Equally, the past year has restored neither the financial system nor the economy to health. We have avoided the worst. That is good. It is not enough.
Liberal Conspiracy think there is another bubble. Their reasoning is fairly ropey, however:
As this astonishing interactive graph from the New York Times shows, big finance, after shrinking from $1.87 trillion dollars market capitalisation in the summer of 2007 to just $290 billion in March 2009, has now tripled in size from this low back to to $947 billion.
Equity prices get more volatile as they get lower: they start to resemble options, and options have highly volatility-sensitive returns. Banks even more so, because of their intrinsic gearing. So a bank with 1trillion of assets, and 990bn of liabilities, only needs a relatively small upswing in asset prices to see its equity price rocket. I don’t like it -but taking the bottom point of a volatile oversold market, measuring the upswing from there, and extrapolating to ‘bubble’, is too glib.
There are reasons to think banks are too leveraged (see many of my posts passim), reasons to think they are unfairly profitable (see this week’s Buttonwood), but you can’t just go straight from shareprices like this. Not during a year like 2009. Their judgement that house prices are back in a bubble is similarly nuts – given the low transaction levels, for example. House prices have stablised, if you take the long view. This may disappoint the Onion.
Liberal Conspiracy are clearly feeling full of fight right now: like Anthony Painter, they are (through a guest TUC writer Adam Lent) denying the need for cuts. No, they are ‘ineffective, unnecessary, and dangerous.’ What, no matter what the current debt? No matter what we are currently spending on? Dangerous? This sort of thing gives those of us who defend Labour’s crisis management a bad name.
Adam Lent’s economic history is badly out.
Margaret Thatcher’s attempts at cuts in the early 1980s created a deep recession which seriously damaged the public finances. The deficit only began to reduce in 1985 when the economy recovered.
The 1980-81 recession was created by tight money and a soaring pound, plus inflation so high that no sane business would invest. She did not cut spending till many years later (see A Balancing Act, Chart 9). Yes, there can be knock-on effects from firing staff – don’t do it when the economy is in deep recession and no private economy to replace the demand – but applying as a general rule, as Adam Dent does (he does not say ‘firing staff is bad now‘, but ‘is bad, full stop’), is nuts.
AL is right that the gilt markets are not on strike. But he is probably underestimating the dynamics of the situation. The causality is not:
Debt costs are fine, therefore borrow away, sailor.
It is probably:
We know you’re determined to deal with this fiscal deficit and take political pain, so we are not going to go on strike.
But if the TUC were elected to power, the bond market would tank. Because they would be confronted with a Chancellor who said ‘Cuts are unnecessary’.
Lent seems to row back at the end by qualifying his statements with ‘in the short term’. Perhaps with that qualification we are in closer agreement. Cutting right now like that Lunatic Policy Exchange paper called for would clearly be crazy. But the impression I don’t like is hat even discussing cuts is bad. I won’t repeat all of my last post about starting a debate. We need one, a mature, grown up debate, somewhere in the middle.