Showing posts with label Economic Policy. Show all posts
Showing posts with label Economic Policy. Show all posts

Wednesday, March 13, 2013

UK Guardian: Policy response to financial crisis wrong

In a column by its editors discussing why the Funding for Lending Scheme has failed, the Guardian exposes why the entire policy response to the financial crisis has been wrong since the very beginning of the crisis.
The problem with the government's funding for lending scheme – and indeed its entire strategy for growth – can best be expressed in an old cliche: you can lead a horse to water, but you cannot make it drink. 
With its policy of monetary activism, the coalition has concentrated on laying on the H2O of credit.
Please re-read the highlighted text as the justification used by each of the western governments and Japan for bailing out its banks was to preserve their ability to extend credit.

Regular readers know that this justification was built on a number of false assumptions.

One false assumption was that banks had to have capacity on their balance sheets if they were to be able to extend the credit that the real economy needs for growth.  Your humble blogger has documented why this is assumption is wrong.  The simple fact is that lending and funding for loans are completely separate as for at least the last 4 decades banks have had the alternative of selling the loans that it originates to buyers like insurance companies and pension funds.

The Guardian editorial focuses on a different false assumption.  It focuses on the assumption that there is a great unmet need for credit in the presence of an economy facing a major shortfall in demand.
Ministers have exhorted banks to lend, the Treasury has signed up to the Merlin agreement with financiers – as well as encouraging the provision of £375bn of quantitative easing and the £80bn scheme of funding for lending. 
These wheezes have cost hundreds of billions of pounds and taken up months of policymakers' time – and the net result has been sorely disappointing....
They have been good for banker bonuses though as they have enhanced bank profitability.
Faced with a major shortfall in domestic demand, he has depressed demand still further by laying out the biggest programme of spending cuts ever seen in peacetime Britain. 
And to spur growth, he has relied instead on trying to offer as much credit as possible. Put another way, an unthirsty horse has been offered gallons of surplus water.
Please re-read the highlighted text as it nicely summarizes why the response to the financial crisis has not worked to date (even when there was some stimulus as in the US).
Going by reports this week, Mr Osborne will next week announce yet more policies to boost lending to small and medium-sized businesses; perhaps by more closely targeting the funding for lending scheme administered by the Bank of England. 
This could once be chalked up as foolishness, but now it surely goes beyond that – it is wilful, damaging blindness on the chancellor's part....
Willful, damaging blindness about the ineffectiveness of the policy responses to the financial crisis that began on August 9, 2007 are not limited to the UK's chancellor.  This extends across countries and central banks.

As a group, they choose to implement the Japanese Model that Japan deployed for handling its bank solvency led financial crisis.  As a group, they apparently believed they would get a different result than  a Japan-style economic slump.

As a group, they are unwilling to admit that their experience parallels the Japanese experience and they have pushed their economies into a Japan-style economic slump.  A result predicted by your humble blogger.

One of the reasons that your humble blogger has advocated for adopting the Swedish Model for handling a bank solvency led financial crisis is that it avoids the Japan-style economic slump.  It does this by requiring the banks to recognize upfront all the losses on the excess debt in the financial system.

As a result, the burden of servicing the excess debt is not placed on the real economy where it would divert capital needed for growth and reinvestment.
But it must surely be evident by now that the main problem is not the lack of loans available to firms; it is that businesses do not see the growing markets or buoyant economy that would justify them spending and borrowing to invest.
The chief executives and managing directors can hardly be blamed for this: as Tuesday's industrial production figures and bleak forecasts from the National Institute of Economic and Social Research indicate, the economy is still stuck in the doldrums. 
While this remains the case, the government's focus on credit is misplaced.
The Guardian editors have eloquently summarized the current state of the global economy and why the policy response to the bank solvency led financial crisis was and still is wrong.

Saturday, March 2, 2013

Is slow growth America's and western economies' new normal?

In his very interesting Washington Post blog post, Jim Tankersley asks the question of whether slow growth is the new normal?

Your humble blogger has said since the beginning of the financial crisis that based on the policies pursued by the global policymakers the answer is "yes".

In fact, I predicted in 2007 that the policies being pursued would leave the global economy at best in a Japan-style economic slump, more likely in a downward spiral and at worse in a depression.

Perhaps more importantly, your humble blogger has discussed at length what policies have to be adopted to end this period of slow growth and restore a higher level of growth across the global economy.
Good economists are great storytellers. They sculpt narratives .... Like a novel, a good economic forecast has action and characters and, in the end, helps you make a little better sense of the world. 
Unless it turns out to be wrong.
Fortunately for my regular readers, I have been right about both what is happening to the global economy and why it is happening.
Consider the dominant story that economic forecasters have been telling you for years now: The U.S. economy just can’t catch a break. 
It has been poised time and again to rocket back to a growth rate that would recapture all the ground lost in the Great Recession, while delivering big job gains. But every time, some outside event scuttles things. 
The euro crisis flares up. A Japanese tsunami scrambles global supply chains. Lawmakers play chicken with the federal debt limit....
This is the dominant story of economic forecasters who failed to predict our current financial crisis and/or have a vested interest in promoting the current mix of policies.
Now consider the possibility that the can’t-catch-a-break story gets it backward. What if the economy isn’t particularly unlucky? 
Actually, the real economy is horribly unlucky.

It is horribly unlucky in that it has economists who failed to predict the financial crisis offering opinions on what it will take to recover from the financial crisis.  Opinions that policymakers for better or worse appear to rely on in setting policy.

Having a Nobel Prize in Economics does not convey the right to open one's mouth in absolute ignorance.

In fact, having a Nobel Prize in Economics conveys the responsibility for truthfully answering the Queen of England when she asked the economics profession if everything was going so wonderfully, how did the economics profession miss seeing the crisis coming.

The answer is that the economics is known as the dismal science because of its track record in forecasting financial crises.

As a result, any suggestion that an economist makes based on a model that missed the financial crisis is highly unlikely to actually positively address the problem that caused the financial crisis in the first place.
What if it’s basically doing what we should expect it to?
It is performing as I predicted.
What if something has changed, thanks to fallout from the recession, or a string of bad policy choices, or both, and growth has shifted into a lower gear?
It is a string of bad policy choices that has caused growth to shift into a lower gear.

You don't need to be an economist to predict that if the burden of the excess debt in the financial system was placed on the real economy it would negatively impact growth.

Placing the burden on the real economy means that capital that is needed for growth, reinvestment and support of the social programs is diverted to debt service payments.

This diversion of how capital generated by the real economy is used guarantees a negative impact on economic growth.
What if this slow and fragile expansion is as good as we’re likely to get for a while? 
Until policymakers abandon the current policies that are damaging the real economy (think zero interest rate policies and austerity for example), this slow growth is as good as it will get.
This is an alternative story that economists across the ideological spectrum have begun to explore. If it’s correct, the implications for economic policy are big....
It has taken five years to realize that maybe we should examine the policies that were adopted in response to the financial crisis to see if maybe they were fundamentally flawed.

Your humble blogger could save economists a great deal of time.  They can simply read my earlier posts and see why the policies were fundamentally flawed.

More importantly, by reading the earlier posts, they can see what policies need to be adopted.
Where our stories diverge is on the reasons those forecasts were wrong.
Please note, your humble blogger's forecasts weren't wrong and I got the financial crisis.
Here’s the standard explanation, from a sharp economist named David E. Altig, the executive vice president and director of research at the Federal Reserve Bank of Atlanta. 
Altig says the economy would have grown faster if a bunch of unanticipated problems — most notably the European financial crisis, in all its iterations, and the now-frequent instances of fiscal brinkmanship in Washington — hadn’t popped up to rattle consumers and business executives. 
This is how many Fed and CBO economists view the past few years, and why they remain so optimistic that faster growth is just around the corner..... 
History explains their thinking: In past recessions, the economy has lost ground, only to roar ahead in later years to return to its historical growth trends. ...
“It’s still the story of the unlucky shocks” and of growth eventually bouncing back to make up its lost output, Altig says. He adds: “We’re keeping hope alive with our forecast.”
Even though the models didn't predict the financial crisis, the Fed is following policies that the models say should work.  And the reason that the models are still not predicting what is going on is a series of unlucky breaks.

Excuse me, but maybe the Fed's models don't work because the assumptions that go into the models are fatally flawed.  Oops.
For the gloomy story, meet Kevin Warsh, a former Fed governor .... 
It goes like this: U.S. policymakers have tried for several years to splash gasoline on the flames of growth in hopes of stoking a bonfire. They’ve thrown in the $800 billion of tax cuts and spending increases contained in the 2009 economic stimulus bill, as well as the extraordinary measures the Fed has taken in an attempt to boost employment: holding short-term interest rates near zero for years and buying an unprecedented amount of long-term securities such as Treasury bonds in order to push down long-term interest rates. 
Warsh’s story is that those efforts didn’t work, and to make matters worse, they dampened the economy’s longer-run growth prospects.... 
The reason the economy has been underperforming, Warsh says, is that policymakers responded poorly to the financial crisis.
Yes they did and Mr. Warsh was one of the policymakers involved in the response.
They focused on short-term growth boosts and neglected what you might call basic economic infrastructure investments. 
They didn’t open big new markets for international trade in order to expand exports, and they didn’t streamline the tax code to promote investment.
I guess Mr. Warsh needs to publicly reaffirm that he is a card carrying Republican and confirm that economists truly bring little to the table when it comes to discussing policies for recovering from a bank solvency led financial crisis.

Mr. Warsh would like to expand exports so that the real economy could generate more capital to be used to pay off the existing debts.  However, this policy choice assumes that paying off the existing debts is the right choice.

There is another better choice that was made by Iceland.  Rather than try to pay off the existing debts, Iceland made its banks recognize upfront the losses on the excess debt in the financial system.  As a result, its real economy was protected and has continued to grow.

Meanwhile, Mr. Warsh's policy has burdened the US real economy with the debt service payments on the excess debt in the financial system.  In addition, his policy has the US chasing after exports when every other country, like the UK and EU, that adopted similar policies is chasing after exports.  It is simply not likely that the US will prevail in the chase for exports.

So let's see, we could make the banks recognize losses and the real economy could return to its normal growth path or we could put the debt service burden of the excess debt on the real economy and hope we can win the chase for exports.
Meanwhile, Warsh said, lawmakers added new regulations to the financial system that solidified an oligopoly at the top of the banking industry, one that has served to restrict the flow of credit to small businesses and entrepreneurs....
I agree with Mr. Warsh's summary of what the policymakers have achieved in "reforming" the financial system.

Regular readers know that I would repeal all of the Dodd-Frank Act except for the Consumer Financial Protection Bureau and the Volcker Rule.  In place of all those complex rules and regulatory oversight contained in Dodd-Frank, I would put transparency and market discipline.

Specifically, I would require the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  This information allows market participants to independently assess each bank, link a bank's cost of funds to the risk it takes and to exert discipline on the banks.

I would require all structured finance securities provide observable event based reporting on all activities like a payment or delinquency involving the underlying collateral and report these activities to all market participants before the beginning of the next business day.  This lets market participants know what they are buying and know what they own.
Slow growth is the consequence of those policies, Warsh says. 
He fears the consequence of prolonged slow growth is a drop in the economy’s potential to grow. ... Executives have lost confidence in the economy’s ability to expand and willingness to invest in it. 
“We’ve been in this period of the new malaise for so long that workers and companies have lowered their expectations for what the U.S. economy can do,” Warsh says. 
If that’s the case, it’s as if our fireball pitcher has undergone arm surgery, and instead of throwing 95-mph fastballs, he’s stuck at 85 mph. Warsh says an infusion of better, long-run-focused policies is the only way to bring that velocity back — a second surgery of sorts. 
Warsh concedes that there isn’t a lot of data to back up his case. ... To this, Warsh likes to quote one of his mentors, the great free-market economist Milton Friedman: “Milton used to say, ‘everything we know in economics we teach in Econ 1, and everything else is made up.’ ”...
Great quote.

I have written a number of posts on how the economics profession doesn't understand the most basic principle of Econ 1:  the necessary condition for the invisible hand to operate properly is that market participants have access to all the useful, relevant information in an appropriate, timely manner so they can independently assess this information and make a fully informed decision.

It was the opacity in the financial system that lead to the financial crisis and it is the opacity in the financial system that prevents a recovery.

Until this opacity is addressed, we are going to continue muddling along.
This brings us to a third story... Two ideas are central to this story. 
First is that the recession didn’t just dig a big hole for the economy to climb out of, it also messed with the ladder. This is the basic theory set forth by the economists Carmen Reinhart and Kenneth Rogoff in their book “This Time is Different”: Financial crises weaken the financial system, slowing growth for years until the system heals....
I realize this post is overly long, but it is necessary to once again debunk the work of Reinhart and Rogoff.

Their work ignores what I call the learning curve.  Specifically, there is a chance that we have learned over the centuries how to deal with a bank solvency led financial crisis.  So in fact, this time could be different.

This bank solvency led financial crisis has two elements present that allow for a quick recovery (see Iceland).

First is the notion of deposit insurance.  With deposit insurance, depositors no longer care about a bank's book capital level (depositors are taught this as kids when they open up an account and are reassured that the government guarantees they will get their money back).

As a result, banks are fully capable of operating with low or even negative book capital levels.  At these levels, the taxpayers are effectively their silent equity partners.

Second is the notion of central banks providing access to funds as a lender of last resort.  This assures that the banks have liquidity even when they have low or even negative book capital levels.

Together, deposit insurance and lender of last resort, position the banks to protect the real economy from the burden of the excess debt in the financial system.  Specifically, the banks can recognize upfront the losses on the excess debt.

Then, over the next several years, the banks can retain their earnings to rebuild their book capital levels.

I realize that this might be bad for banker bonuses, but it is very good for the real economy as it keeps the real economy on a higher growth path (diverting capital from the real economy to debt service on the excess debt is what puts the real economy on a lower growth path).
This has prompted some wondering aloud, and it has given rise to perhaps the most interesting new story you hear from economists: Um, there’s a lot we don’t know about the economy. ... 
When you miss so regularly on your forecasts, Altig says, “it’s easy to think we have to rethink everything we think we know.” But, he adds, “You can be wrong for a very long period of time and still have the underlying structure and story about the economy correct. That’s not crazy. I guess that’s where I would be right now. It’s not like you have to throw out how you think about these things. You just have to have the same humility you always have.”
Economists and humility are not two words that go together.

Humility would imply that economists state clearly that they don't know what is going on and missing regularly on their forecasts confirms this.  Humility would further imply that economists then say that they will refrain from offering any policy recommendations until such time as they can demonstrate through their forecasts that they do have some insight into what is going on.

Thursday, January 24, 2013

Defending the indefensible, Merkel insists on more austerity

In her remarks at Davos, Angela Merkel insisted that austerity must continue to be imposed despite the simple fact that more than 50% of the youth in Greece and Spain are long-term unemployed.

Why does she push austerity?

To defend German bank book capital levels and German banker bonuses.

As regular readers know since August 9, 2007, policymakers have faced a choice everyday as to how to respond to a bank solvency led financial crisis.  They can adopt the Japanese Model and protect bank book capital levels and banker bonuses at all costs or they can adopt the Swedish Model and require the banks to recognize upfront the losses on the excess public and private debt in the financial system.

If policymakers adopt the Japanese Model, they place the burden of servicing the excess debt on the real economy.  At best, this diverts capital that is needed for growth and reinvestment to debt service and produces a stagnate economy (think the 2+ decade Japan-style economic slump).  At worst, this diversion of capital produces a depression (think current economic conditions in Greece and Spain).

If policymakers adopt the Swedish Model, they protect the real economy and the social contract as capital continues to be available for growth and reinvestment in the real economy.

So who loses based on the choice policymakers must make everyday?

If policymakers choose the Japanese Model, the losers are their country's citizens.

If policymakers choose the Swedish Model, the losers are the bankers.

So who wins based on the choice policymakers must make everyday?

If policymakers choose the Japanese Model, the winners are the bankers and no one else.

If policymakers choose the Swedish Model, the winners are their country's citizens.

Clearly Angela Merkel and the German policymakers have chosen the Japanese Model, is there any reason this choice is indefensible besides the incredibly negative impact on society for the benefit of the bankers?

Yes, modern banking systems are designed to support the Swedish Model.  Because of the combination of deposit insurance and access to central bank funding, banks can operate with low or negative book capital levels.

When banks have low or negative book capital levels, deposit insurance effectively makes the taxpayers the silent equity partner of the banks.  As a result, banks can continue to operate and there is absolutely no reason for countries to bailout the banks by injecting funds or protect the banks' book capital levels by engaging in regulatory forbearance or suspending mark-to-market accounting.

Is there any proof that pursuing the Japanese Model results in ending a bank solvency led financial crisis?

No.  Japan is still struggling to end its financial crisis 2+ decades after it started.  In the US, the Japanese Model was pursued at the time of the savings and loan crisis.  It failed and ultimately the vast majority of savings and loans were closed.  However, by pursuing the Japanese Model to handle the crisis, the US financial regulators did succeed in dramatically increasing the cost of dealing with the insolvent savings and loans.

The Swedish Model sounds too good to be true, is there any proof that it works?

Yes.  The first example of the Swedish Model being used was by the FDR Administration during the Great Depression.  According to the NY Fed, adopting the Swedish Model (it wasn't called that in the 1930s, it was called a bank holiday where only the "solvent" banks were allowed to reopen) broke the back of the Great Depression.

There have been other examples including Sweden and most recently Iceland.  Despite some mistakes in implementation, each of these examples showed just how effective making the banks recognize the losses upfront on the excess debt in the financial system is at ending the financial crisis.

Why do policymakers have to make this choice everyday?

Because adopting the Swedish Model is always an option.

Angela Merkel has insisted there can be no let-up in the painful economic reforms being driven across Europe, despite union leaders warning that the risk of social unrest in southern European countries is increasing. 
In a keynote speech at the World Economic Forum's annual meeting, Merkel insisted it was vital to keep driving down labour costs to make Europe more competitive. 
"Were we to meet halfway, we would have accepted that Europe will not be competitive globally," said Merkel, adding that this would cause unacceptable damage to Germany's exporters.
Perhaps I missed something, but it appears that Germany's economy is slowing down as its exports are declining as the austerity it imposes on the rest of the EU closes one of its major markets.

As mentioned above, choosing the Japanese Model is bad for the citizens of the country whose politicians make the choice.
She argued that growth and fiscal consolidation are "two sides of the same coin", disappointing Davos attendees who hoped for a thawing on Europe's austerity drive....
I must really be missing something, but the countries that are pursuing austerity all seem to be in either a recession or depression.  Support for this observation comes from the IMF which after admitting that it underestimated how devastating austerity is to countries in a recession is now urging the UK to end its austerity obsession.
But labour officials in Davos are deeply concerned that political leaders are still failing to address the issue of unemployment
The easing of the financial crisis has lulled many into a false sense of security, warned Guy Ryder, director general of the International Labour Organisation. "I am often asked whether the levels of unemployment in southern Europe threaten social stability. Yes, it does. But you don't have to wait for a revolution to do something about it," said Ryder. 
He was speaking as new data showed that 60% of young Spaniards are now out of work.
Your humble blogger admits to really missing something as zero interest rate policies, unlimited quantitative easing, promises to buy unlimited amounts of bonds for eurozone countries that agreed to be in a permanently depressed state and 60% youth unemployment do not suggest that the financial crisis is easing in the slightest bit.

What the claim the financial crisis is easing suggests is that bankers are once again lined up at the trough to take outsized bonuses that they would not be entitled to if Angela Merkel and the German policymakers were not protecting bank book capital levels.
Merkel insisted current unemployment levels were a price Europe had to pay to become more competitive, and pointed out that Germany had been on the same path, with unemployment hitting 5 million before the public accepted structural reforms.
What her story misses is that the global economy was expanding briskly at that time.  The situation is dramatically different today.
Sharan Burrow, general secretary of the International Trade Union Confederation, said there was "a real lack of political will" to address the unemployment crisis. "Leaders feel the pressure, but there is only a commitment to a jobs plan in a very few countries," said Burrow. 
"They are waking up and worrying about stock markets and rating agencies, rather than things people really care about – such as education, growth and jobs."
The concern with stock markets and rating agencies over the things people really care about is one of the surreal aspects of the ongoing pursuit of the Japanese Model.

The policymakers are so trapped in manipulating the financial system that they lose sight of the fact that their primary concern should be the well-being of their citizens and not the banks and bankers.
Merkel ended her Davos appearance with a plea to global international companies to employ more young people in Europe, to bring them "jobs, peace and hope". She added: "I welcome anyone who will give a helping hand to young people."
She should start the process of giving a helping hand to young people by adopting the Swedish Model and requiring the German banks to recognize upfront the losses on their on and off-balance sheet exposures to the excess public and private debt.

This would be a major step to restoring growth to the eurozone economies and the hiring of young people.

Friday, January 11, 2013

Tim Geithner and the myth of avoiding a second Great Depression

One of the arguments that Mr. Geithner likes to trot out to say the Obama Administration's policies worked is that the global economy was spared a second Great Depression.

Economic pundits tend to say you cannot disagree with this assertion because it is impossible to show what would have happened if these policies had not been followed.

Wait a second, but this argument has a couple of major assumptions that are actually false.

First, it assumes that there was something that the Obama Administration did that prevented the second Great Depression.  Perhaps I missed something, but there was a response to the first Great Depression that played a major role in how the global economy responded to the Great Recession and that by itself virtually eliminated the possibility of a second Great Depression.

Specifically, as a result of the first Great Depression, we have automatic economic stabilizing programs like unemployment benefits throughout the western economies.  In addition, we have programs like Social Security and Medicare.

The point is that by definition we had economic programs in place to prevent the Great Recession from turning into a Great Depression.

To date, I will give the Obama Administration credit for not ending these programs and throwing us into a Great Depression.  However, that doesn't mean the Obama Administration won't cut back on these programs in pursuit of lowering the fiscal deficit and that we will in fact find ourselves in a second Great Depression.

We have seen in the eurozone's southern peripheral countries what happens when these economic stabilization programs are ended.  Countries like Greece and Spain are suffering a second Great Depression.

Second, the argument assumes that the financial crisis has passed.

A reasonable definition of a financial crisis that has passed is that all the emergency programs that were put in place as temporary measures at the start of the financial crisis have ended.

Zero interest rate policies were put in place as a temporary response and until such time as they are ended the Fed is loudly proclaiming that the financial crisis is still with us.  Please note, Japan's central bank has been saying the same thing for 2+ decades.

Tuesday, January 8, 2013

Can economics be re-established as a relevant social science?

In an interesting post, Lars Syll, a Swedish economist, looks at what it would take to re-establish economics as a realist and relevant social science.
Economics – and especially mainstream neoclassical economics – has as a science lost immensely in terms of status and prestige during the last years. Not the least because of its manifest inability to foresee the latest financial and economic crisis – and its lack of constructive and sustainable policies to take us out of the crisis....
Please re-read the highlighted text as Professor Syll has nicely summarized both the failure of economics to foresee the crisis and, much more importantly, the failure of economics to present constructive and sustainable policies to get us out of the crisis.
Neoclassical economists, however, have wanted to use their hammer, and so decided to pretend that the world looks like a nail. Pretending that uncertainty can be reduced to risk and construct models on that assumption have only contributed to financial crises and economic havoc....
Please  re-read the highlighted text as Professor Syll has nicely made the critically important point that the economics profession has contributed greatly to the financial crisis.
How do we re-establish credence and trust in economics? Five changes are absolutely decisive.  
(1) Stop pretending that we have exact and rigorous answers on everything. Because we don’t. We build models and theories and tell people that we can calculate and foresee the future. But we do this based on mathematical and statistical assumptions that often have little or nothing to do with reality. By pretending that there is no really important difference between model and reality we lull people into thinking that we have things under control. We haven’t! This false feeling of security was one of the factors that contributed to the financial crisis of 2008.
Your humble blogger has frequently said that the every economist who offers their opinion about how to respond to the financial crisis should first say whether they publicly predicted the crisis or not.

Everyone knows that if you didn't see the crisis coming it is highly doubtful that your analysis of the crisis will be accurate.  After all, leading up to the financial crisis you had no insight into what was wrong with either your models or the financial system.
(2) Stop the childish and exaggerated belief in mathematics giving answers to important economic questions. Mathematics gives exact answers to exact questions. But the relevant and interesting questions we face in the economic realm are rarely of that kind. Questions like “Is 2 + 2 = 4?” are never posed in real economies. Instead of a fundamentally misplaced reliance on abstract mathematical-deductive-axiomatic models having anything of substance to contribute to our knowledge of real economies, it would be far better if we pursued “thicker” models and relevant empirical studies and observations.
A classic example of where the models haven't worked is the Fed's models of the economy.  The Fed models neither predicted the financial crisis nor have they predicted the subsequent economic performance that has occurred.

I have previously noted on this blog how economists get upset that consumers and savers are not responding in the way that their mathematical models suggest.  Perhaps the consumer or saver is not wrong, but rather the mathematical model is wrong.
(3) Stop pretending that there are laws in economics. There are no universal laws in economics. Economies are not like planetary systems or physics labs. The most we can aspire to in real economies is establishing possible tendencies with varying degrees of generalizability....
Actually, there is one law in economics.  For the invisible hand to operate properly, buyers must have all the useful, relevant information in an appropriate, timely manner so they can assess and make a fully informed decision.

Where this isn't true is an example of an imperfect market.
(5) Stop building models and making forecasts of the future based on totally unreal micro-founded macromodels with intertemporally optimizing robot-like representative actors equipped with rational expectations. This is pure nonsense. We have to build our models on assumptions that are not so blatantly in contradiction to reality. Assuming that people are green and come from Mars is not a good – not even as a “successive approximation” – modeling strategy.

From the IMF.

A session at the annual American Economic Association conference in San Diego January 4–6 heard that debt levels have exploded across the advanced economies since the financial crisis, and are now at unprecedentedly high levels. High debt levels are a potential drag on growth, the session was told. 
At the conference, economists from the IMF, academia, and a broad range of other institutions acknowledged that, five years after the start of the Great Recession, economists are still struggling to find solutions to the mounting debt and high unemployment the crisis has triggered....
“The past few years have highlighted how little we actually know,” stressed Donald Kohn, a former Vice Chair of the U.S. Federal Reserve who is currently at the Brookings Institution. 

Monday, October 15, 2012

Branches of economics do create more value than the ATM

This year's Nobel Prize winning economists confirm that there are branches of economics that actually create more value than Paul Volcker's famous standard of the automated teller machine.

Alvin Roth and Lloyd Shapley did research into how to efficiently and most beneficially match different actors in a given market to areas like organ donation and transplant.  The result of their research has been improved market performance.

Some readers might be shocked by your humble blogger having anything nice to say about the economics profession.  They shouldn't be.  I actually think that all branches of the economics profession could create a lot of value.

Unfortunately, there are some very prominent branches of the economics profession that not only do not create value, but actually promote destructive behavior.

It is no surprise that the branches of economics I think promote destructive behavior focus on the financial system and monetary policy.  I have been documenting this fact on this blog.

Monday, June 25, 2012

Central bankers 'shocked' that prospect of Japanese-like lost decades looms over developed economies

Bloomberg reports that
Central bankers are finding it easier to support their economies than to spur expansion as the prospect of Japanese-like lost decades looms across the developed world.
Please re-read the highlighted text as the central bankers are confirming what your humble blogger predicted would be the result of adopting the Japanese model for handling a bank solvency led financial crisis.

Under the Japanese model, bank book capital levels are preserved at all costs.  The result is the pursuit of policies that cause incredible amounts of harm to the real economy.

Examples of these policies range from regulatory forbearance (under which the banks use 'extend and pretend' techniques to keep zombie borrowers alive - it easier for zombies to get loans than creditworthy borrowers) to quantitative easing (under which central bank intervention distorts pricing of risk assets and investors react by focusing on return of their capital and not return on their capital) to zero interest rate policies (under which individuals in or approaching retirement cut back on their consumption so as to preserve their savings).

Another round of loosely correlated global stimulus has begun after the Federal Reserve extended its Operation Twist program and counterparts from Japan to Europe consider more monetary easing of their own. The Bank of Israel today joined those injecting stimulus by reducing its benchmark interest rate for the first time in five months, in part to insulate its economy from “potential negative consequences” elsewhere. 
The rub is that even as they renew their rescue efforts, policy makers are postponing forecasts for fuller recoveries and run the risk that their latest actions pack a smaller punch. 
This raises the prospect of longer-term anemic expansion akin to the doldrums Japan has suffered since the early 1990s. 
“Japan’s experience shows central banks can mitigate the worst effects of the current environment, but it’s going to be very hard for them to stimulate demand,” said Peter Dixon, global equities economist at Commerzbank AG in London. He predicts a lengthy period of “sluggish growth and high unemployment” in the debt-ridden industrial nations.
Japan's experience shows that if the losses hidden on and off bank balance sheets are not recognized, the burden this places on the real economy requires extraordinary fiscal and monetary policy efforts to offset.  Whenever there is a let up in these efforts to stimulate the economy, the burden causes the economy to contract.

The worry for international policy makers is that Japan’s recent past reflects their future. 
Its economy stagnated in the early 1990s after the BOJ boosted borrowing costs to rein in a surge in inflation, real-estate and equity prices. With banks hobbled by bad debt from the bursting of the asset bubble, the BOJ lowered its main rate to near zero in 1999. 
After flooding the banking system with cash from 2001 to 2006, the central bank now has deployed its second round of QE. The moves haven’t ignited growth, with GDP rising at an average rate of 0.75 percent in the past 20 years, according to IMF data. 
Consumer prices fell in eight of the past 13 years, and inflation hasn’t exceeded 1 percent since 1997. Unadjusted for price changes, the size of the economy last year was the smallest since 1990 and had contracted 10 percent from its peak in 1997.
Please re-read the highlighted text as it nicely summarizes what happens from pursuing the Japanese model for handling a bank solvency led financial crisis.
ECB economists say the U.S. and euro-area are “rather unlikely to tread the same path of Japan” because they had different pre-crisis debt imbalances, according to their May monthly bulletin.
So far, the experience has been very similar.

This is not surprising because it is not the pre-crisis debt imbalances that shape the recovery.  It is the fact that the banking systems are hiding and not recognizing their losses that shapes the recovery.
Japan’s experience nevertheless demonstrates the importance of repairing financial sectors before trying to generate a sustainable recovery and shows that delaying reforms may mean fragile economic growth, they wrote.
The only way to repair the financial sector is by adopting the Swedish model with ultra transparency.

Under the Swedish model, the banks recognize all the losses on the excesses in the financial sector today.  This takes the burden off the real economy to carry the excess debt and results in growth.

Subsequently, the banks rebuild their bank book capital levels through retention of 100% of pre-banker bonus earnings.

Under ultra transparency, banks disclose on an ongoing basis their current asset, liability and off-balance sheet exposure details.  With this information, market participants can confirm that all the losses have been realized and exert discipline to restrain future risk taking by the banks.

Tuesday, May 15, 2012

Run on the Greek banks begins in earnest

The Telegraph reports that the run on the Greek banks has accelerated.

Karolos Papoulias, the Greek president, warned party leaders that their continued failure to agree was risking “fatal consequences”. 
Citing a secret government document, he said Greeks were already pulling £80 million a day out of the country’s banks. Almost €1 billion (£795 million) has been withdrawn since the last elections on May 6. 
“The extension of political instability will lead to fatal consequences. The absence of government is a serious risk to the financial security of the Greek people and our national existence,” the president was reported as saying. 
Mr Papoulias said he had been warned by the central bank and finance ministry that the country faced “the risk of a collapse of the banking system if withdrawals of deposits from banks continue due to the insecurity of the citizens generated by the political situation”. 
Some economists have suggested that a euro exit could be done in an orderly way by closing Greek banks while the country prepares to reissue the drachma. Costas Simitis, a former prime minister, said that would spark panic, warning that Greeks would rush to withdraw money from banks. “If they close more than three days there will be a bank run,” he said. 
This reaction by Greek depositors is completely predictable.  Deposits stay put so long as the depositor thinks that the government will ensure the depositor can get their money back.  Depositors run to the bank to withdraw their money if they think they might only get 50% of their money back.
A report in Germany’s Wirtschaft Woche magazine forecast that a Greek bankruptcy and exit from the euro would cost the governments of the single currency’s 17 members £240 billion, pushing the eurozone and European economy into a crisis not seen since the 1930s.
My question is why anyone believes that the run on the Greek banks will stop in Greece and not spread immediately to say Spain, Italy, Portugal and Ireland?  There is no chance that those countries economies will not be seriously hurt if the collapse of the Greek economy results in a recession in the EU.

Sunday, May 6, 2012

How to restore growth to Europe

Now that the voters have rejected austerity and protecting bank book capital levels, the question is how to restore growth in Europe.

The key is to make use of the unlimited amount of capital that banks can provide to protect the real economy.  For example, banks can absorb the losses on the excess in the financial system and reduce the outstanding debt to what the borrowers can afford to pay.  This applies whether it is sovereign debt or consumer debt.

This is critical as it eliminates the distortion in asset prices currently going on as a result of regulatory policies like 'extend and pretend'.

This is critical because it supports the internal devaluation that is needed to make countries like France and Spain cost competitive with Germany.

This is critical because it quickly brings to an end the downward pressures on the real economy from the housing bust and sets the stage for economic expansion.

Clearly this will result in banks with significant negative book capital positions.  However, as discussed previously, this is not problematic for a modern banking system where deposits are guaranteed and the banks have access to central bank funding.  The banks can continue to operate while they rebuild their book capital levels and support the real economy with loans.

Using bank capital to set the stage for growth, it is up to the governments to adopt fiscal policies to jumpstart growth.

Monday, April 16, 2012

Is rescuing banks a prerequisite for rescuing economies?

According to a Guardian column, US Treasury Secretary Tim Geithner for years has lectured Europe on the need for rescuing the banks as a prerequisite for rescuing their economies.

While clearly an argument for adopting the Japanese model for handling a bank solvency led financial crisis, is this statement true?

The experience of Iceland and Sweden before it would appear to show the statement is false.  As discussed by Iceland's president in a must read previous post, saving the economy, democracy and society in fact required that the banks not be rescued.

The Guardian column looks at what has happened to the US as a result of rescuing the banks.

America's banks are bigger than ever. 
JP Morgan Chase, Bank of America, Citigroup, Wells Fargo and Goldman Sachs have emerged with more firepower than before the financial crisis following Hank Paulson's generous bailouts and the freedom to swallow rivals on the cheap....
For several years the US treasury secretary, Tim Geithner, lectured Europe on the need to rescue banks as a prerequisite for rescuing economies. Without a massive injection of cash, a co-ordinated guarantee scheme and a monster dumping ground for the bank's most toxic assets, foreign investors would look elsewhere. Worse, a constrained banking sector would discourage domestic companies from investing.
Where did the US banks' most toxic assets go?  While TARP was originally seen as a monster dumping ground for these assets, it morphed into a vehicle for making massive injections of cash.

Instead, the banks were allowed to hide these assets on and off their balance sheet through the suspension of mark-to-market accounting and adoption of mark-to-management's preferred valuation accounting.

Banks in the EU and UK have been allowed to do the same thing.

Apparently, Mr. Geithner's argument also includes the idea that a constrained banking sector would discourage domestic companies from investing.  What discourages domestic companies from investing is their perception of investment opportunities.  How an investment is financed is a trivial consideration compared to issues like how much revenue will the investment generate or cost will the investment save.

Look at the US economy now. While it may be cooling a little, the figures for growth and employment are streets ahead of anything the UK and Brussels can claim...
Comparing three areas that rescued their banking system tells nothing about whether rescuing the banks is a prerequisite for rescuing economies.

To answer that question, you have to compare these three areas against Iceland that did not rescue its banking system.

When this comparison is done, it is clear that rescuing the banks is not a prerequisite for rescuing economies.  In fact, it appears that rescuing the banks, slows down if not makes it impossible to rescue the economies.
Geithner says they should look no further than the pathetic self-flagellating treatment of the banks, which remain hamstrung by excessive regulation and poorly designed and generally puny rescue packages....
Compared to the US banks which effectively have no regulation?
The only route to growth is sorting out the finances of the banks and letting them lend again.
Not true as shown by Iceland.
Taxpayers are the only source of funds and should, like their US counterparts, bite the bullet....
Again, not true as shown by Iceland.
But Geithner has also created a monster that after only three years of recovery is already too big to fail. 
Without subsequent reforms, JP Morgan and the others will sow the seeds of the next crash. 
Their assets will be found again to be toxic and while the accounting may be clearer, there will still be lots of toxic loans to deal with. 
It is a dilemma that is hard to escape.
Actually, Iceland showed how easy it is to escape the dilemma.  First, realize that rescuing banks is not a prerequisite for economic growth.  Second, let the banks go.  Third, focus fiscal spending on supporting economic growth.
Barack Obama vowed to eliminate the possibility of the financial sector being too big to fail. 
Rightly he put growth first, but there is no doubting that restraining banks is harder once they have recovered their powers and legitimacy. It will be a severe test for the next administration.
Actually, it appears that he listened to Tim Geithner and as a result has managed to achieve a miraculous outcome.  He has managed to squander his opportunity and gotten the worst of all worlds - limited growth and a financial sector with firms that are too big to fail.

Friday, November 25, 2011

Despite low interest rates, Irish house prices continue falling...83% in one case

The Independent reports that Irish house prices are now down 45% from their 2007 peak and continuing to fall despite a very low interest rate policy.

What makes this statistic particular worrying is that like the banks in the US, the Irish banks have not dealt with the losses in their mortgage book.  Despite the fact that the Irish banks received a significant equity infusion from the government, they have not modified these mortgages so that the borrowers can service them.

The result of not modifying the mortgages is that there continues to be downward pressure on house prices.
HOUSE prices fell last month at their fastest rate for two-and-a-half years, official figures have revealed. 
In further signs that the crash has yet to bottom out, average property prices are down 15.1pc in the last year, the largest annual decline since March 2010. 
The housing index from the Central Statistics Office (CSO) also showed the cost of a home is now 45pc cheaper than the peak in early 2007. 
A breakdown of the property market revealed that average prices in Dublin are down 51pc while outside the capital the fall is much lower at 42pc. 
The collapse has hit apartments much harder, with values down 60pc in the last four-and-a-half years. 
The fall of 2.2pc in average property prices in October is the largest monthly drop since April 2009. 
It emerged last week that more than 100,000 people are now struggling to repay their mortgages. 
This is made up of around 62,000 homeowners in arrears of three months, or more, and just less than 40,000 who have restructured their repayments, Central Bank figures revealed.... 
It equates to four out of 10 households in mortgage arrears with the four domestic banks who have now been behind on their repayments for a year or more. 
These families have missed so many of their monthly payments that they have run up an average of €27,000 each in arrears, according to the Central Bank. 
The Central Bank study of mortgages at AIB, Bank of Ireland, EBS and Permanent TSB also found that troubled home loans at these lenders represented 56pc of all the mortgages in arrears.

A separate Independent article reports how one Irish house sold at auction for 17% of what its peak price was in 2007.

IF you ever needed proof that the property market had collapsed, here it is. 
A Dublin father yesterday bought his ideal family home for €65,000 -- three years after walking away from the three-bed house when the asking price was €380,000. 
"We looked at that exact house three years ago and it was €380,000," the man -- who didn't want to be identified -- told the Irish Independent as he left the Merlin Property auction in Dublin. 
"It's unbelievable; I thought that when I went in I wouldn't get it. It is the best value I have ever seen.... 
The attractive, three-bed terraced home in East Wall, Dublin, sold for €65,000. 
But the previous owner was happy enough to sell the house he had grown up in with his parents. 
Noel Langrell (55) said that while it had been on the market for a number of years, he was unable to sell it and decided to go to auction when Merlin advertised. 
"If you have a property sitting there and it's going nowhere, this is the way to go," he said afterwards. 
"What can I say? What's the point of holding on to it? It was a family home since the 1920s, my mam died and I was on my own by then." 
Just four of nine properties at the small auction were sold by last night, with three remaining under auction and two withdrawn. 
Their collective earnings were €305,500 compared to a peak market value of €1.03m....
"It's frightening; it's scary," observed a bidder who asked to be identified only as Dermot from Kildare. "And it reflects your own house; if you can pay your mortgage or if you don't have one that's okay but if you have to sell then that's when the issue comes in."

Monday, October 3, 2011

UK Chancellor looking to by-pass the banks to get credit to small businesses

According to a Telegraph article, George Osborne, the UK's Chancellor, has directed the UK's Treasury to look into how the government could directly lend money to small businesses and then package these loans so they could be sold in the capital markets.

The UK government would not need to do this if the securitization markets were functioning.  If they were, there would be private firms that would make the loans and sell them into the capital markets.

Regular readers know that the securitization market is not functioning because the buyers are on strike.  They went on strike at the beginning of the credit crisis and are not coming back until they have access to current performance information on the underlying assets.

The UK government could restart loans flowing to small business simply by requiring current performance disclosure on the underlying assets.

Of course, the UK government could also elect to retain the credit risk of the loans as an enticement to attract buyers.  But by doing so, it is no longer really "selling" the loans.  Instead, it is setting up the equivalent of Fannie Mae and Freddie Mac in the US - an agency where private investors do well and taxpayers are stuck with the losses.
George Osborne used his speech at the Conservative Party Conference to announce plans for "credit easing" - which is a form of quantitative easing for businesses. 
The Chancellor said: "I have set the Treasury to work on ways to inject money directly into parts of the economy that need it such as small business. It is known as credit easing. It is another form of monetary activism," he said. "It is similar to the national loan guarantee scheme we talked about in opposition." ...
However the Government could deploy public to buy corporate bonds either directly through the Treasury or via the Bank of England's asset purchase facility. This facility was set up in 2009 during the apex of the financial crisis but has hardly been used since. 
The Treasury wants to create packages of small business loans that could then be traded. 
In this way the Government support would not add to the national debt for accounting purposes because they would be a tradable asset. 
The plans also include setting up a Small Business Bank that could handle the new policy. At the Liberal Democrat Conference two weeks ago, Vince Cable used his speech to back plans for a new state-backed bank as a way of tackling the failure of banks to lend to small firms.... 
The chancellor also repeated that he would give the Bank of England the green light to engage in further quantitative easing if it decided to go for more asset purchases. 
John walker, National Chairman, Federation of Small Businesses, said: We also welcome steps to help inject money into small firms, but need to see more detail so look forward to working with the Government on this."

Monday, September 12, 2011

The Queen's Question part II: Paul Krugman defends the economics profession

According to a Financial Times column, in the fall of 2008, the Queen of England put the economics profession and global financial policy makers and regulators on the spot with a simple question.  At the London School of Economics she asked, "if things were so large, how come everyone missed them?"

In Part I of this series of posts, your humble blogger noted that he had in fact publicly predicted the financial crisis, but more importantly had offered a solution that would have moderated the impact of what occurred and prevented future financial crises.  This prediction and proposed solution were based on the FDR Framework.

The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

In Part II of this series of posts, Paul Krugman defends the economic profession's performance prior to and during the financial crisis.  

Based on what he said in this defense, Professor Krugman should be a very vocal supporter of the FDR Framework.     

There is a real sense in which times like these are what economists are for, just as wars are what career military officers are for .... But macroeconomics is, above all, about understanding and preventing or at least mitigating economic downturns. This crisis was the time for the economics profession to justify its existence....

We have not, to put it mildly, delivered.

What do I mean by that? As I see it, there are three main complaints one can make about economists and their role in the current crisis. First is the complaint that economists fell down on the job by not seeing the crisis coming. Second is the complaint that economists failed even to see the possibility of this kind of crisis — and that by pointing out the possibility, they could have helped head the crisis off. Third is the complaint that they have either failed to offer useful advice on what to do after the crisis struck, or that they have offered such a cacophony of voices as to provide no useful guidance for policy....
Under Professor Krugman's criteria, your humble blogger has delivered.  This includes publicly seeing the crisis coming, attempting to head off the crisis and, through development of the FDR Framework, providing useful advice on what to do after the crisis struck. 
What should economists have known about the impending crisis, and when should they have known it?
Ask any one economist that question, and by and large the answer is that they should have known what he or she knew, and can be excused for not knowing more. Me too!
Clearly, it's not fair to demand that economists have known that Lehman would go bust on September 15, 2008; in fact, I think most people would agree that it's unrealistic to have expected economists to get either the year of the crisis or the firms that fell first right. But should they have seen a crisis building several years before it happened? Should they have had at least a rough idea of how bad it would be?
Well, from my point of view — which, because I’m like everyone else, is that what I saw and no more is what everyone should have seen — it still seems bizarre how many economists failed to see that we were experiencing a monstrous housing bubble.
As Robert Shiller has documented — and, crucially, was documenting in real time circa 2004–5–6 [Shiller 2005] — the rise in real housing prices after 2002 or so took them into completely unprecedented territory. It was the clearest market mispricing I’ve seen in my professional life, even more obviously out of line than the dot-com bubble, which at least had the excuse that it involved novel technologies with unknown potential; houses have been with us for 7,000 years or so, and we should have a reasonable idea of what they’re worth.
So why were so relatively few economists willing to call the bubble? I suspect that efficient market theory, in a loose sense — the belief that markets couldn’t possibly be getting things that wrong — played a major role. And in that sense there was a structural flaw in the profession.
If a belief in the efficient market hypothesis is really why few economists were willing to call the bubble, then Professor Krugman and the economics profession should race to embrace the FDR Framework.

An important assumption underpinning the efficient market hypothesis is that market participants have access to all useful, relevant information in an appropriate, timely manner.  This was and is not the case for structured finance securities and financial institutions.
For structured finance securities, Wall Street intentionally preserved its informational advantage on the current performance of the underlying loans.  By doing so, Wall Street knew it could easily profit on the mis-pricing of risk by the other market participants.
 For financial institutions, regulators were given an information monopoly during the Great Depression.  As a result of this monopoly, all the other market participants are dependent on the regulators properly assessing the risk of the financial institutions.
The FDR Framework brings structured finance securities and financial institutions back into compliance with the assumptions underlying the efficient market hypothesis.
What about what would happen when the bubble burst? I personally failed to realize how big the “knock-on” effects would be; and according to the self-justifying principle, I’m tempted to say that nobody could reasonably have been expected to get that right. But actually, we should have seen that coming too — maybe not in full detail, but even a casual walk through historical crises should have indicated that a housing bust was likely to bring large financial and balance-sheet problems in its wake. I kick myself every once in a while for failing to think that part through. In particular, those of us who had worked on the Asian financial crisis of the 1990s had placed large weight on balance-sheet effects [Krugman 1999]. Why didn’t I think of applying the same logic to the coming bust in US home prices?
Beyond that, surely experts in banking and finance should have been aware of rising leverage, of the growing reliance on unregulated shadow banking, and so on. It's quite remarkable how few warnings we had that the system might be dangerously fragile. By all means, let's give credit to people like Rajan [2005] who saw some of it; but the very fact that such people were given a hard time for their analysis is telling about the profession.
Perhaps not surprisingly, the very people that give me a hard time are economists - OK, Wall Street does too, but that is to be expected because I trying to eliminate the profits they make from opacity.
Still, as Yogi Berra said, it's tough to make predictions, especially about the future. There are so many things going on in the world, many of them off any modeler's radar, that the profession's failure to see this crisis coming is not, in my mind, anything close to its biggest sin....
Regular readers know that the predictions made on this blog have in fact come to pass.
One can make excuses for the failure of the economics profession to foresee that the 2008 financial crisis would happen. It's much harder to make such excuses for much of the profession's failure to realize that such a thing could happen.
Banking crises are, after all, a theme running through much of modern economic history. Nobody should be able to call himself a macroeconomist unless he has a working knowledge of what went down in 1931, both in the United States and in Europe.

 And you don’t have to go back to the 1930s, either, as long as you’re willing to step outside the United States and core Europe. With the Scandinavian crises of the early 1990s, the Asian crises of the late 1990s, Argentina, and so on, there should have been ample reason to at least consider whether it might happen here....

The overall point should be clear: economists had good enough intellectual frameworks to have seen the risk of something like the banking and balance sheet crisis that burst upon us in 2008. But they ignored that risk.

My best answer is that they were caught up in the spirit of the times, with its faith in the wisdom of markets and of the financial industry. Nobody could deny the possibility of runs on conventional banks, which have happened so often in history. Few could deny that debt deflation had happened in the past.

But to argue, or even to think about, the possibility that the old evils could manifest themselves in new forms would have been to question the whole basis of decades of policy, not to mention the foundations of a very lucrative industry. You don’t have to invoke raw corruption (although there may have been some of that) to see why this was a line of thought few were willing to pursue. And by not pursuing that line of thought, the profession fell down badly on the job.
I wonder what economists who studied the Great Depression looked at if not how the financial system was designed to prevent the old evils from manifesting themselves.

The FDR Framework has its roots in the financial system designed in the 1930s.  Specifically, it includes the philosophy of disclosure.  The FDR Framework takes this philosophy and applies it using 21st century information technology.

21st century information technology allows the FDR Framework to bring the disinfectant of sunlight to those areas of the capital markets that are currently hidden from view.  This includes the performance of the loans underlying structured finance securities as well as what is happening on and off bank balance sheets.

The FDR Framework also has its roots in earlier financial systems and the practice of caveat emptor (buyer beware).  Under caveat emptor, buyers are responsible for all gains and losses.

Being responsible for all gains and losses provides plenty of incentive to use the information provided under the FDR Framework to assess the riskiness of an investment prior to investing and while an investor in a specific security.
Yet the profession's worst failure wasn’t what it failed to see before the crisis. It was what happened after crisis struck....

We’ve entered a Dark Age of macroeconomics, in which much of the profession has lost its former knowledge, just as barbarian Europe had lost the knowledge of the Greeks and Romans.

As long as monetary policy could bear the burden of macroeconomic stabilization, this didn’t seem to matter too much: even as equilibrium business cycle theory became increasingly dominant in graduate study, central banks, like medieval monasteries, kept the old learning alive. But once we were hit with such a severe banking and balance sheet crisis that monetary policy hit the zero lower bound, it was crucial that the economics profession be able to weigh in knowledgeably and coherently on other possible actions. And it turned out that it couldn’t....
And the result was that faced with a severe economic crisis, the profession spoke with a cacophony of voices. Or maybe a better way to put it is that the policy debate of 2009–2010 was virtually indistinguishable from the policy debate of 1931–1932.
Long-refuted doctrines that should have been consigned to the dustbin of history were stated as if they were fresh new ideas — and they were fresh and new to many economists, because our profession had lost so much of its heritage.
In short, in responding to the crisis, the profession presented a sorry spectacle of unnecessary ignorance that didn’t even recognize itself as ignorance, of bitter debate over issues that were resolved many decades earlier. And all of this, of course, made the profession mostly useless at a time when it could and should have been of great service. Put it this way: we would have responded better to this crisis if macroeconomics had been frozen at the level of knowledge it had in 1948, when Paul Samuelson published the first edition of his famous textbook. ... 
I’m sorry if I have painted a bleak picture of the role of economists in the crisis. Unfortunately, that's the way it looks to me. So what can be done to improve that picture?
Some economists are pushing forward with new macroeconomic models that incorporate the lessons of the crisis. Me too! And by all means, let's do that. But as I’ve said, our big problem was not lack of models.
There are also many calls for new economic thinking; there's even an institute dedicated to that project. Again, fine — but the biggest problem we had as a profession wasn’t failure to keep up with a changing world, it was failure to remember what our fathers learned.
 And what our fathers learned was that disclosure is the key to restoring confidence in the financial system.  The FDR Framework updates disclosure for the realities of the 21st century.