Reply to Comments--May 4 to May 8

I respond here to a number of the substantive comments received in the first week of my Atlantic blogging. I have not attempted to respond to all of them; to some I do not have a good reply!

Gabriel Sanchez's comment (follow link for full comment): I take it that you are not arguing that deregulation per se is bad or necessarily prompted by ideological commitments which may, in fact, be out of touch with reality. Even so, there appears to be a general suspicion now of deregulation which goes far beyond the financial sector. The "public utility" view of airlines has crept back in and one wonders if it couldn't lead to elements of reregulation on the general (and I believe faulty) assumption that deregulation as a whole has been a mass failure.

My response: My concern about deregulation of financial markets has not spilled over to other deregulated industries, such as airline, train, and truck transportation, telecommunications, oil pipelines, natural-gas production, and wholesale electric power. My concerns about deregulation of financial markets focuses on conditions peculiar to those markets, and in particular the potential of a crash in banking (in a broad sense, to encompass financial intermediation in general) to trigger a severe recession, or even (as I believe we are in now) a depression. Compare the airline industry. Like banking, it is inherently risky; the reason is that it has very heavy fixed costs, that is, costs that do not vary with output. And therefore when demand falls and the airlines have to reduce their output, they cannot reduce their costs proportionately to the fall in revenue. And so because air traffic fluctuates they are constantly teetering on the edge of bankruptcy. The unexpected and very sharp fall in demand caused by the 9/11 terrorist attacks brought the industry to its knees; it was saved by a modest federal bailout; but in subsequent years, there were bankruptcies, most notably the bankruptcy of United Air Lines in 2002. Yet because the airline industry is relatively small, and, more important, because it does not have the same centrality to the entire economy that banking does, airline bankruptcies, even when widespread, can at worst spark a very mild recession. To put it differently, the airline industry has little macroeconomic significance, and this is also true I believe of the other deregulated (in some cases, such as telecommunications, partially deregulated) industries. If they are being underregulated, it is for reasons distinct from those that persuade me that the banking industry is underregulated, although to repeat what I have said in the blog I do not think this is a good time to try to reregulate the industry, because the task of reregulation is immensely complex and sensitive.

jsc224's comment: I believe that utility deregulation is a failure because there is insufficient customer choice to restrain utilities. For example, a car customer can chose not to buy a new car if prices are raised too much. An electricity customer must buy new electricity every time he turns on a switch. Utility deregulation has not led to any "innovations" which benefit consumers. Similarly, deregulation of the financial industry has resulted only in "innovations" which have benefited only the financial industry. Shouldn't both industries be strictly regulated for the benefit of the entire economy and society as a whole?

My response: A "natural" monopoly, that is, a market in which competition is infeasible and thus unavailable to protect consumers, presents a traditional case for regulation of the public-utility or common-carrier type. But banking is not a natural monopoly. It is naturally competitive--in fact that is part of the problem. Competition in banking can be, as we have seen in the last year, "ruinous" in the sense of leading to a near collapse of the industry with resultant severe damage to the economy as a whole.

Kurt's comment: Which sectors of the economy will have the potential for a surge that will pull the economy out of this depression? The engine of the past US economic triumph, the manufacturing sector, has been systematically shipped abroad for cheap labor, while the housing bubble was deliberately created to provide temporary employment opportunities to fill the gap. Now that it has run its course and came to grounding halt, where do you expect we would create well paying jobs producing tangible goods?

My response: This comment points to the decline of manufacturing and notes correctly that heavy borrowing enabled at least an illusion of continued prosperity, although I do not agree that the housing bubble was "deliberately created." The comment is very pessimistic about the nation's economic future. I am neither optimistic nor pessimistic, but merely very concerned.

Calvin Jones's comment: Cramdown won't happen because the banks don't want it. Second, the rest of it is all well and good for those who still have their jobs. What about those that lost their jobs or who remain unemployed because of the upcoming jobless recovery (of the lame recovery there will be)?

My response: This comment expresses concern about the plight of the unemployed "because of the upcoming jobless recovery." There is indeed, as I discuss in a later blog entry, the risk of a "jobless recovery" in the sense that many jobs may disappear permanently, meaning that those who have lost those jobs will have to find a different line of work. I attribute this possibility to the fact that people have reacted to the depression by changing their consumption patterns. Even after an economic recovery is well under way, they may decide they like their new pattern of consumption and so will adhere to it.

JP22's comment: I don't wish to put words into your mouth, but it seems to follow from your discussion of the auto bailouts that we're no longer in the sort of emergency situation that could (arguably) justify the administration's alleged efforts to intimidate Chrysler's hold-out secured creditors.

My response: I share this commenter's concern with the Administration's effort (apparently successful) to subordinate Chrysler's secured creditors to their unsecured creditors. I agree that there is no longer an emergency justification for the government's attempting to save Chrysler outside the normal bounds of a bankruptcy, which gives priority to secured creditors. Had GM and Chrysler declared bankruptcy last December, the shock to the economy would have been profound. Since then, however, not only has the economy begun to stabilize--enough at least to reduce the anxiety level considerably--but the two companies, Chrysler especially, have shrunk to the point at which they are no longer vital components of the economy.

ottoubus's comment: There were four basic causes of the financial crisis: cheap money, lax regulation, deficit spending and reckless banking practices. The first three were the responsibility of govt but they didn't act in a vacuum free from pressure or manipulation from the financial industry. I'm afraid the bankers are every bit as culpable as govt.

My response: Well, I'm afraid I'm not omniscient, and I don't know when will be the right time to reregulate the banking industry, but surely not now. This is not only because it will make the economic environment of the industry more uncertain, which will retard lending and other investing by banks, but also because careful study will be necessary for the formulation of intelligent measures of regulatory reform. I think that what in hindsight appears to have been "reckless" behavior by bankers were in the main reasonable responses to the economic incentives created by government policy. Maybe I'm wrong, but it will take further study to determine that, and until that study is conducted we won't know what direction regulatory reform should take.

Richard Tompkins's comment: Everyone talks about "recovery" but no one defines it. The last time this country had an economy worth recovering to was forty years ago and the world has moved beyond that point. We can become a healthy economy again but not by trying to restart the one that broke down. We have to be able to compete as a manufacturing nation again and that requires fundamental changes in our whole social and economic structure.

My response: The United States is still of course a major manufacturing nation--think of passenger and military aircraft, other weaponry, pharmaceuticals, agricultural equipment, scientific instruments, computer chips. Moreover, there are many great industries in the United States that are neither manufacturing nor banking, such as university education, agriculture, medical and other scientific research, tourism, and the production of intellectual property such as popular music, movies, and television. I don't think our prosperity is dependent on our increasing our manufacturing, where the comparative advantage lies with nations that have lower wage rates. But I do agree that we have to produce to our capacity, rather than live on money borrowed from foreign investors public or private.

KEW's comment: What I do not understand is why "an efficient banking industry" is absolutely necessary. Possibly inefficiencies -- slower, more reasoned expansion and contraction of credit for example based on a market with edges clearly defined by regulations -- are needed. The industry we have had to this point seems to have placed us in a pretty lousy position quite "efficiently."

My response: Yes, trying to cap the size of banks or other firms can induce inefficiency, quite apart from the problem of deciding how big is too big. But I think efficiency in banking as in other industries is important, perhaps especially because finance is global. Unless we try to prevent foreign banks from operating in the United States (which would have the effect of driving many of our businesss abroad, so they could take advantage of access to a more efficient financial system), we would lose much business to less highly regulated foreign banks.

Vermando's comment: I like your post a great deal, Professor, but on the whole I think that you need to deal more not only with the costs of regulating, but the costs of not regulating. No system will be perfect, but as KEW notes, any imposition of inefficiency or regulatory cost seems to be a reason not to take a specific action. That is not right - the actions should be compared with the alternative, inaction, or another financial crisis. The only reason not to evaluate in this way would be that you don't believe the regulation would work.

My response: I do not oppose regulating the banking industry more tightly. On the contrary, I attribute our present economic calamity in significant part to deregulation, and so I would like to see more regulation--in principle. The problem is that I have trouble thinking of regulations that would pass the kind of cost-benefit test that you illustrate with your examples. We lack the information that we would need to conduct such a test with real rather than conjectural numbers. The first step, as I have suggested, is for some study group modeled on the 9/11 commission (though that was far from a complete success--indeed its recommendations were largely unsound) to conduct a thorough inquest of the events leading up to our present dire situation. Armed with the results of such an inquest, the government and the economics profession may be able to formulate sensible measures of regulatory reform.

I'm not sure that capping the size of banks would actually reduce the risk of a banking collapse of the sort that triggered the current depression. The banking industry as a whole would still I think have been as heavily invested in home mortgages. Billion-dollar plus mortgage-backed securities would be beyond the capacity of small banks to create, but consortiums of small banks could create such securities and certainly could buy slices of such securities created by hedge funds or other nonbank financial enterprises.