Mass Unemployment is Not the Best Remedy for Moral Hazard

August 24th, 2011 at 11:00 am David Frum | 54 Comments |

| Print

Barry Eichengreen, the pre-eminent historian of the international monetary system, delivers a withering retort to those who urge inaction in the face of financial crisis:

inflicting intense pain upon innocent bystanders through a long period of high unemployment is not the best way of discouraging irrational exuberance in financial markets. Nor is precipitating a depression the most expeditious way of cleansing bank and corporate balance sheets. Better is to stabilize the level of economic activity and encourage the strong expansion of the economy. This enables banks and firms to grow out from under their bad debts. In this way, the mistaken investments of the past eventually become inconsequential. While there may indeed be a problem of moral hazard, it is best left for the future, when it can be addressed by imposing more rigorous regulatory restraints on the banking and financial systems.

Recent Posts by David Frum



54 Comments so far ↓

  • SSteamers

    While there may indeed be a problem of moral hazard, it is best left for the future, when it can be addressed by imposing more rigorous regulatory restraints on the banking and financial systems.

    Great idea that appears to be working splendidly in practice!

  • D Furlano

    The main problem with the economy is unemployment. And yet it is the least focused on.

    Ideology has become so instinctual that it dominates every conversation. People now are led by blind believe. Critical reading and thinking skills have been totally abandoned.

    Not sure what happened but I feel it has to do with the concept of winning and losing. All I can think about is Charlie Sheen claiming that he is winning. I was never really sure what he was winning. I have the same feeling about politics.

    • balconesfault

      Critical reading and thinking skills have been totally abandoned.

      Seriously. The other day I was having an internet exchange with a friend over how crazy the potential debt ceiling fight was … and suddenly they came back with how they knew where THEIR birth certificate was. And after I parried that, suddenly the attack was a link on how Michelle Obama had too many assistants.

      These people really want Obama to fail. That’s all there is to it. It’s purely tribal.

      • Steve D

        To resort to unsavory rhetoric from the Bad Old Days, he’s an “Uppity N*****” and that’s the whole issue. Not only is he black, but he’s smart and he knows it. And they can’t tolerate a black man being smarter than they are. Bubba Bill Clinton had to hide his Rhodes Scholarship under a mass of aww-shucks buffoonery. Americans have shown over and over again they will not elect candidates that demonstrate real excellence. JFK was the last candidate who could project real intelligence and get elected.

      • Houndentenor

        I heard the one about Michelle O having too many assistants about a month ago. It’s an outright lie, of course. She has roughly the same amount of staff that Laura Bush had. As always, snopes.com is your friend.

        http://www.snopes.com/politics/obama/firstlady.asp

        I always hear this crap from Christianists. I guess bearing false witness is no longer a sin?

      • laingirl

        An interesting factoid to give such people is to remind them that under Ronald Reagan, there were more nonmilitary government employees than under President Obama. The Office of Personnel keeps track of such numbers.
        http://www.opm.gov/feddata/HistoricalTables/TotalGovernmentSince1962.asp

  • rbottoms

    Republicans are hard-ass jerks.

    This is news?

  • FosterBoondoggle

    “Inflicting intense pain upon innocent bystanders” is an excellent strategy if you expect those bystanders to blame someone else. That is the essence of the GOP strategy for 2012. It worked pretty well in 2010, so why should they back off now?

  • MSheridan

    Great piece by Eichengreen. Thanks for pointing me toward it. I knew a lot of what he wrote already, but could not have explained it as well. Now perhaps I can.

  • JimBob

    Who says Barry Eichengreen, the pre-eminent historian international monetary system??

    In reality he’s just another in a long list of economist that blames the great depression on the gold standard. Milton Friedman destroyed that argument.

    Just another left wing economist.

    • Sinan

      He did? Where is your proof?

    • medinnus

      Hey JimStupidFuckBob – remember the great GOP promise of 2010?

      Jobs, jobs, jobs.

      What did we get? Social conservative political posturing, theatre, and threatened default.

      And cries from the GOP to screw the poor.

      “Republicans whine and Republicans bitch,
      The Rich are too poor!
      The Poor are too rich!”

      “Too bad that GWB was stopped from making Reparations to the slave-owners whose traitor-asses weree kicked in the Civil War for taking away their slaves, by taking more money away from the middle and poor and redistributing it towards the coward lazy White Christianists. ” -The Anti Smeggy

  • JimBob

    “Historically, societies attracted to using gold as legal tender have dealt with this problem by empowering their governments to fix its price in domestic-currency terms (in the U.S. case, in dollars). But the idea that government should legislate the price of a particular commodity, be it gold, milk or gasoline, sits uneasily with conservative Republicanism’s commitment to letting market forces work, much less with Tea Party–esque libertarianism. Surely a believer in the free market would argue that if there is an increase in the demand for gold, whatever the reason, then the price should be allowed to rise, giving the gold-mining industry an incentive to produce more, eventually bringing that price back down. Thus, the notion that the U.S. government should peg the price, as in gold standards past, is curious at the least. More curious still is the belief that putting the United States on a gold standard would somehow guarantee balanced budgets, low taxes, small government and a healthy economy. Most curious of all is the contention that under twenty-first-century circumstances going back to the gold standard is even possible.”

    Gold Standard Myths and Lies

    http://mises.org/daily/5379/The-Gold-Standard-Myths-and-Lies

    • DeathByIrony

      The sum of anecdote is not fact, nor is it analysis.
      You sell the article entirely too short. I do believe it might sway a few devout Krugmanites from their “Obvious” solutions. It makes a strong case for Hayek, something I’ve found increasingly difficult with the sort of arguments employed in his defense.
      If what wisdom Hayek espoused survives the Goldbug tribe, it will be nothing less than a miracle.

  • Frumplestiltskin

    yes, Jimboob knows the real pre-eminent historians, but doesn’t realize that History does not really come in Comic book form. Maybe his Astromonaut son and Brain sturgeon daughter tell him history. Or he learned it at Haryaleton, where he gradumacated with a Phd is knowing everything.

    • JimBob

      Kid, my son is not an Astronaut. He is getting his PhD in aerospace engineering. My daughter is an M.D. of internal medicine.

      You on the other hand are a loser. That’s all you’ve ever been and that’s all you ever will be.

      • Frumplestiltskin

        sure jimboob, sure. you know taking pictures of people out of magazines and putting them in your mobile home doesn’t fool anyone, you pig screwing hillbilly.

      • SteveT

        We’ve been down this road before with you. Is there anyway you can prove this?

        Bear in mind if you really, really wanted to there are ways.

    • Curiosity

      At best this post feeds trolling behavior, at worst it makes frumple look childish and petty.

  • valkayec

    Eichengreen’s article is indeed enlightening. Thanks, Mr. Frum, for pointing us to it. Since the lead up to this recession mimics in many ways that of the Great Depression, it would be beneficial to run an economics related series on the 1920′s as well as the decades previous.

  • armstp

    Barry Eichengreen sounds like Krugman and both of them are right.

    • JimBob

      So you think creating a housing bubble was the right thing to do?? Because Krugman sure did!!

      • armstp

        First of all Jimbooo we are not talking about housing bubbles in this post. Second, there is no evidence whatsoever to Krugman promoting a housing bubble. Now go a head and give me your BS link to your Mise comment on this…

  • Chris Balsz

    “Better is to stabilize the level of economic activity and encourage the strong expansion of the economy. This enables banks and firms to grow out from under their bad debts. In this way, the mistaken investments of the past eventually become inconsequential. While there may indeed be a problem of moral hazard, it is best left for the future, when it can be addressed by imposing more rigorous regulatory restraints on the banking and financial systems.”

    Once we confuse our national interest in a strong financial industry, with an imagined duty to preserve individual institutions, we will not only end up guaranteeing the bad actors who created this crisis, and refrain restraining their actions; we will called on to crush their innovative competitors who have no bad debt to overcome–in the national interest.

    America needs some entity to do what AIG does for the industry.

    That doesn’t mean America needs AIG.

  • Oldskool

    Ha, I didn’t realize this was even being debated. I thought Rs wanted to obstruct for the sake of obstructing. So they have an actual philosophy?

  • Michigan Outsider

    The current unemployment rate is a consequence for what has happened in the past. It’s a disease, not the treatment.

    Returning to the gold standard would be foolish, but, given Senate filibuster rules, there is no risk of that happening even if Ron Paul or Herman Cain somehow became President, which is not going to happen anyway. So, a few small states have passed some silly laws that really don’t matter given what really counts as legal tender and the fact that most transactions happen electronically. States pass silly laws that don’t do much of anything all the time.

    Bernacke’s finest hour was getting TARP done, which more or less did what it was supposed to do and prevented a complete breakdown of the banking system. Probably a greater accomplishment than Greenspan’s constant micromanagement of interest rates. But, there is no reason to believe that printing another trillion or two dollars is going to solve unemployment or any other economic problem. We will really come out of this recession when a lot more individuals believe that it makes sense to start spending a little more and saving a little less.

  • sinz54

    “…inflicting intense pain upon innocent bystanders through a long period of high unemployment is not the best way of discouraging irrational exuberance in financial markets.”

    NOBODY.IS.INNOCENT.

    All those homeowners who signed deals to buy homes with 5% (or less) down payment and ARMs with subprime financing didn’t know what they were doing? Of course they’re saying that now. But someone should go investigate their friends and neighbors. Did any of those homeowners say at the time that they had been bamboozled? I doubt it.

    I have no respect for such people. They wrecked not just their own finances, but the finances of honest Americans who bought homes with sizable down payments and tried to build up equity. Now they too are underwater, dragged down by the collapse in housing prices caused by the aforementioned defaults and foreclosures.

    We have to bail them out, just like we had to hold our noses and bail out the banks.

    But we don’t have to do it without strings attached, like we stupidly did with the banks.

    Here’s my deal: The Government can step in and negotiate with the banks to write down part of the mortgage balance, enabling those homeowners to refinance with a fixed-rate mortgage with a lower balance.

    In return, the credit rating of those homeowners will be destroyed for a period not less than 15 years. For 15 years, they won’t be able to get auto loans. They won’t get student loans. They won’t get any loans.

    And the Government will publish a database with the names of those homeowners, to be made publicly accessible on the Internet. Just like we register sex offenders, we are going to have a registry of National Deadbeats who wrecked the housing market.

    Let them live their lives in shame.

    • ottovbvs

      “Let them live their lives in shame.”

      I can safely assure you Sinz they won’t. Only someone as detached from reality as you could think this the remotest possibility.

    • SteveT

      It’s the responsibility of the lender to make sure the loan can be repaid. If I was offered a $10 million loan tomorrow I’d take it in a heartbeat. Enough to live out my life in comfort to the grave and the lender be dammed.

      The average person knows only enough that they could take out a loan and buy a home. That’s exactly as it has always been and exactly as it should be. You don’t go in and TELL them how much money you want, they tell you. This system (where the lenders were the responsible party) worked perfectly well for decades. You think we suddenly got different human beings?

      • Chris Balsz

        Many lenders did not care about the loan being repaid. Their business was originating loans that were sold to servicers. This generated immediate profit, and by creating transactions the executives could report increased market share to the Board.

        • SteveT

          Yes, Chris, this is well known. That’s what TARP was all about. Of course, by letting the banks off the hook completely, that’s where the moral hazard came into being from the first place. Looks like a second round of that by the way with banks now stuck with foreclosures they can’t sell.

          My argument still stands however, lenders are the party responsible for deciding how much to lend/or not to lend at all, not the borrower.

    • Xclamation

      “In return, the credit rating of those homeowners will be destroyed for a period not less than 15 years. For 15 years, they won’t be able to get auto loans. They won’t get student loans. They won’t get any loans.

      And the Government will publish a database with the names of those homeowners, to be made publicly accessible on the Internet. Just like we register sex offenders…”

      I’m just going to go ahead and assume that you haven’t really thought this out. I mean, do you really understand the consequences of what you’re proposing?

      If your idea of just punishment for defaulting on a mortgage is a big ol’ Scarlet D and no chance at getting a loan for a car, a house or an education then you’ve effectively condemned large chunks of this country to sink into third world status.

      Say goodbye to labor mobility. Say goodbye to wealth generation. Bid a bon voyage to the futures of millions of children. Don’t let the door hit those guilty, guilty store owners whose customers reside in Nevada on the way out. Toodle-oo to municipal tax bases and police forces and fire departments and public parks and libraries and parts of town that are relatively drug-free.

      Hell, why just say goodbye when you can get proactive about it and actually throw rocks at those dirty mortgage defaulters while their punishment spirals out from their (bank owned) back yards and consumes their neighbors and communities? I mean, if a person is willing to live near the kind of folks who make bad investments, then they can’t expect us to show them any empathy either. Honestly, they’re just lucky we don’t hunt them for sport and or prizes on a reality show.

      Of course, while that’s all very bad, at least you, the one innocent in all this, will be able to print off a government-endorsed list that proves that you > than people who can’t afford to live in their homes.

      Righteous.

      (Sorry if this is a double post, I tried to edit a typo and I think FF ate my original comment…)

      • Banty

        Amazing suggestion, how homeowners are supposed to get ‘D’s. Would he also go for employees of AIG going around with “CDO” emblazoned on their shirts? Or not.

        It perpetually amazes me how millions of individuals were all supposed to individually hold up the entire system with perfect prudence and perfect intelligence, and mortgage originators and those devising fancy securities were just Doing what they Do, in these narratives.

        Unless Sinz is so confident he can spot a bubble each time, but consider that many of these homeowners saw a rising home market, that had been rising for years, and decided they had to jump in at some point, that it’s now or never, even if they stretch a bit financially. Now I’m one of those preternaturally cautious people who didn’t buy until I was 39 years old and had 20% down, but I sure can tell the difference between people reaching for something, and people who, as Sinz portrays, knew that they were over-reaching and that things were not going to work out. After all, everyone had friends and acquaintances who had extended themselves to purchase a house say, five or six years earlier, and with pay raises now were dealing easily with the mortgage and the prices had consistently risen still further, and some of these had even sold, cashed in, and moved on.

        I don’t know what crystal balls people are supposed to have. And how those crystal balls are supposed to maintain a whole financial system, instead of good underwriting and conservative straight forward banking.

    • Banty

      “All those homeowners who signed deals to buy homes with 5% (or less) down payment and ARMs with subprime financing didn’t know what they were doing? Of course they’re saying that now. But someone should go investigate their friends and neighbors. Did any of those homeowners say at the time that they had been bamboozled? I doubt it.”

      This brings to mind those current-Tea Partiers that told me back in 2005 to take an ARM when I re-fi’ed, to leverage other investments. I thought that idea unworkable for myself at the time; they now think that those ‘other’ homeowners ruined the game. See, they think that, if all those ‘other’ homeowners did not take out too-too-much, unlike they, who knew what they could handle, the whole thing would not have collapsed, and their own dealings would have held up better.

      Now they’re in not too bad shape simply because around here we did not have quite the excesses that there have been in other places, and housing has dropped about 30% but not more. And I’m glad as I don’t wish ill on people. But it’s amazing the power people have to rationalize their actions and beliefs.

    • valkayec

      Chris, try this example of an underwater homeowner.

      House bought 7 years ago on a 7 yr ARM. Now, the owners who are current, a good credit rating, and have jobs want to refinance the mortgage to reduce the monthly payment. But the house is worth considerably less than the principle. As a result, the owners have been told they have to come up with ~ $50K to refinance – the difference between the principle and the current value.

      You’re saying that homeowners such as these should be punished because they bought a home that is now worth about 1/2 of what they bought it for? These homeowners did nothing wrong and have been responsible. It’s not their fault the RE market crashed. So why should they be punished in any way, shape or form?

      As Ezra Klein and Mike Konczal (economist at Roosevelt Inst. & Rortybomb website) wrote today, the debt overhang caused by the housing market is preventing the economic growth. Moreover, having Fannie & Freddie write down the underwater mortgages would cost next to nothing while at the same time freeing up a great deal of consumer cash.

      • Banty

        This far I agree with Sinz – an ARM is a bet, and it’s a bet that might be lost. What you described is exactly the downside risk of an ARM mortgage.

        Now with the siren song that anyone ‘smart’ would get an ARM to re-fi later (which I’m *still* hearing in places), it takes a good bit of fortitude, knowledge, and serenity to pass that up for plain ol’ fixed mortgage payments and tell Grandma you’ll only be visiting her every other year. It’s one thing to punish the foolish. It’s another to punish the herd for being, well, part of the herd.

  • Oldskool

    Off topic story that’s probably interesting in some way:

    I’ve been after my bank to lower one of my mortgage payments for more than a year now. It originally covered three houses but I sold one in April 2010 and of course a hefty chunk of the sale was applied to the balance but the payment remained the same. Yesterday I finally talked to the right person and he okayed a new 55% lower monthly payment over the phone without so much as a signature. I”m still not sure what to make of this, but I am ecstatic.

    • Chris Balsz

      I recommend you fax him a letter of memorandum to document those terms. Today. And keep that right with your deed. You don’t want to have to argue that a person who is no longer with the bank verbally promised you could pay less than the note states.

      • Oldskool

        You can be sure I’ll be sending a note with my next payment with his contact info. The surprising thing is that normally you have to prove you don’t need any help before a bank will give you any. I explained that they’ll have some new foreclosures in their inventory unless they did something.

        • Chris Balsz

          Actually I think you should push for an amended note to be recorded on title as the best protection. If the bank is sold or comes under FDIC receivership, the receiver or successors in interest may hold that you owe every penny due under the recorded note, and are therefore deficient (and technically delinquent) from Sept. 2011 forwards… Glad you found somebody with sense, I suspect it’s because you don’t have a straight 1 house 1 lot mortgage.

        • Oldskool

          They’ve paid back their $5 bn bailout money so they should be good to go. It’s a commercial loan. Their residential mortgage department is a hopeless nightmare to deal with.

  • Frumplestiltskin

    NOBODY.IS.INNOCENT

    Bullshit, I am innocent. Hell, I am not even living in the US so don’t blame me for its ills.
    Anyway, I bought my home in Shanghai for about 10% down with even easier terms and I have watched my house quintuple in value in the past 15 years.

    And Sinz, you are idea is beyond idiotic. I could solve the housing crisis tomorrow but you xenophobes would never allow it.

    I would allow all wealthy foreigners to get tourist visas on condition that they buy homes, if they violate their visas, they lose their homes. The overwhelming majority of wealthy chinese just want a safe place to park their money.

    I could sell out all California, New York, New Jersey and Florida real estate in a months time.

    • laingirl

      A lot of nice homes in San Antonio have been sold to Mexican Nationals and I understand they can get an E-2 visa if they invest at least $100,000 in a business here and employ 3 or 4 people. That was in the paper here, but according to the RWNJs it’s a commie, Kenyan newspaper written to attract Mao Maos, so maybe it was wrong. By the way your above post to Jimbob made me laugh so hard I’ll probably have to take my computer in for repairs tomorrow.

  • ottovbvs

    Conservatives be warned (Sinz please note). Prolonged spells of mass unemployment don’t tend to produce demands for more fiscal conservatism. They tend to produce socialism, communism and revolutions!

    • Banty

      Yeah I can’t figure out how they can think everyone will just sit with their hands folded, for months and years, during a deflationary cycle, while the economy moves debt quickly off the books the way they want.

      The economy is an organism. You have to keep it going as you fix it.

  • SpartacusIsNotDead

    Schizophrenic Sinz54 first wrote: “NOBODY.IS.INNOCENT.”

    But then, “They wrecked not just their own finances, but the finances of honest Americans who bought homes with sizable down payments and tried to build up equity.”

    So apparently, not even the “honest Americans” who bought with sizable down payments are innocent and they should suffer right along with those who bought with just 5% down?

    • Xclamation

      If you read those two lines out loud you’ll hear the sound of a loophole opening just big enough for Sinz to sneak through.

  • Graychin

    If you’re already a gazillionaire, mass unemployment isn’t so bad. It makes labor cheaper.

    • Banty

      If you’re already a gazillionaire, you’d like a little deflation to protect that money pile. “Don’t punish the savers” they say. As long as you can ensconce yourself somewhere away from the breadlines and civil unrest …

      But if you’re already a gazillionaire, you can do that, too.

      • balconesfault

        If you’re already a gazillionaire, a prolonged downturn in the economy that causes a lot of foreclosures and distressed sales is a wonderful buying opportunity.

        • Banty

          If you’re already a gazillionaire, you’d want a new prevailing economic theory put out to convince people to create economic conditions that foster high unemployment and deflation.

          If you’re a certain kind of gazillionaire…

          Like I’ve said before, the set of political statements we’re hearing from the right speak the interests of the well-heeled middled aged to older segment of the population. It’s all dressed up, of course, to be all about a return to prosperity for all. But when you look at the statements and tenets advocated, and ask yourself who would benefit, it’s the well-heeled middled aged to older. A deflationary cycle as some kind of resetting or cleansing of the economy, the trashing of education, teachers and their compensation; at the same time an ardent concern that physicians and financial fund managers be kept happy; the protection of gub’mint benefits for those 55 and older but an eager willingness to slash services and security net provisions for anyone younger.

        • Polifan

          Considering that this is a fictional scenario, would you be willing to give the government an interest free loan?

        • Banty

          Polifan:”Considering that this is a fictional scenario, would you be willing to give the government an interest free loan?”

          Meaning, if I were a gazillionaire? I wouldn’t do an individual interest free loan (a la that adolescent nothings-stopping-Buffett-from-sending-a-check-to-treasury retort), because I’d rather direct my checks to my chosen charities, but I would support a higher income bracket for me and my rich fellows.

          Think I’m just sayin’ this now and I wouldn’t be real? Well, I advocate SS payroll withholding above the $106,000 or so current limit, and I do earn above that.

          OK?

  • Bebe99

    “Let them live their lives in shame.”

    We currently have the long-term unemployed and a huge number of unemployable felons already taking up space in the “living their lives in shame” category. We really don’t need more hopeless and desperate people living under highways. We COULD use more compassion and forgiveness, lest we drive these people out into the streets demanding a lot of changes. On second thought that may not be a bad idea.