Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

13 October 2008

The Right Kind of Decoupling


[For a handy chart comparing John McCain and Barack Obama, click here. For comment on Paul Krugman’s Nobel Prize, click here.]

Up to now, the term “decoupling” has meant isolating foreign economies from the “American contagion” of toxic mortgage-related assets. As the G7 ministers just recognized in their extraordinary meeting, that kind of decoupling is a fool’s errand. Our global economy exposed every nation’s financial institutions to the disease. If world leaders do nothing and wait for the incubation period to end, the whole globe will get very sick. That end is coming nigh.

But an entirely different kind of “decoupling” may be possible. Toxic mortgage disease directly threatens only financial institutions, not other businesses, far less industrial companies. There is nothing fundamentally wrong with Apple Computer, Boeing, Caterpillar, Cisco, General Electric, Google, Hewlett Packard, Procter & Gamble, or 3M—to name just a few. (If I thought for a while, I could probably come up with dozens of similar names.)

The current financial crisis need not take down these healthy giants. It threatens them only if it deprives them of the capital they need to operate, or if it causes such a severe depression that it kills off their customers and suppliers. A key goal of government “rescue” efforts therefore should be to “decouple” these and other healthy businesses from the financial crisis as much as possible.

For big businesses like the companies named, the government’s entry into the commercial paper market can serve this purpose. As I’ve outlined in another post, the government can recycle money fleeing the stock market for the safety of Treasury bills. By diverting that flow of funds into the commercial paper market, it can keep big business afloat. The stock market’s collapse can provide literally trillions of dollars for this purpose. The government can even make a small profit for the taxpayers, since these companies are sound and the fleeing capital is available at rock-bottom interest rates.

But what about small business? One of our nation’s great strengths is its vast diversity of small business. As I’ve outlined in another post, the corporation is one of the greatest social inventions in human history because it diversifies and decentralizes industrial activity, economic power, and economic decision making. In our nation, small business is where that theory meets real life. Yet small business doesn’t get its working capital from the commercial paper market. Can we decouple it, too?

There may be a way. Our financial system is incredibly diverse, with over 5,000 separate banking entities. Not all of them are in trouble, and many have not been exposed to toxic mortgage disease. The federal government knows (or should know) which of these banks are healthy, because it regulates commercial banks heavily (unlike investment banks) and regularly examines them. What if the federal government set up a website, organized by community, revealing which banks in each community have the soundest capital structure, the biggest reserves, and the least toxic mortgage contagion?

Individuals’ money probably wouldn’t move much. Inertia and the new FDIC guarantee of $250,000 per account would probably keep most individuals’ money in place. But many small businesses have larger accounts. Many would move their accounts from shaky institutions to sounder ones. The new money would be available, under sound, local management, for small businesses in the sounder institutions’ communities. (The Washington Post recently published a heart-warming article about just such a local bank.)

One thing about the current crisis that sticks in everyone’s craw is moral hazard. The solutions suggested so far don’t force stupid and greedy people to suffer the consequences of their poor character and bad decisions. Nor do they reward folks who acted soundly and prudently while enduring the scorn of the know-it-all Masters of the Universe for earning much less money. Indiscriminately guaranteeing bank loans and buying up financial institutions’ stock are in that category. Unless managed extremely carefully (mostly with information about toxic assets and credit-default swaps that doesn’t yet exist) these “solutions” won’t reward prudence or punish stupidity.

“Decoupling” shaky financial institutions (temporarily) from the healthy business community that depends on them would. For big business, the government could bypass the big banks and investment houses by taking over (temporarily) the commercial paper market, using the vast hoard of wealth freed up by the stock-market collapse. In the process, it would force the Masters of the Universe to begin cleaning up their mess, privately and on their own initiative, lest they have no business to do and no way to survive. Some of them might even consent voluntarily to sell their toxic mortgages (and related assets) at what I call the “prudent” value, based on payments of one-third the homeowner’s gross income, with a retroactive 10% down payment and equity sharing on sale.

As for small business, decoupling also would serve it well. Strengthening prudent local banks would strengthen communities, provide locally controlled, non-government capital for small business, and help restore the diversification and decentralization that the last wave of financial-industry mergers reduced. It would also help replace arrogant and remote Masters of the Universe with prudent local lenders who know their communities and are there for the long haul.

As these solutions began to work, the Masters of the Universe would become isolated (temporarily) in their ivory office towers and cut off from the day to day operation of the American economy. There they would have time to reflect upon their sins, start cleaning up the mess they made, and get real about the value of their toxic assets.

In the process, they might reconsider how to make themselves useful to society, besides dreaming up “innovative” toxic assets that no one, including they, can keep tabs on or understand. They might begin to think about supporting real, i.e., industrial, innovation. Venture capital for good batteries, anyone?

P.S. Paul Krugman’s Nobel Prize

Today economist and New York Times columnist Paul Krugman won the Nobel Prize for economics. Along with millions of Americans who crave rational economic policy and rational government, I congratulate him. The Nobel Committee made a good choice, especially at this turning point in our history.

Last year I criticized Krugman harshly for his over-the-top partisanship for Hillary Clinton on the issue of health care. This year I dinged him for his unwillingness to appreciate the presence and promise of a new generation of leadership in the Democratic party.

But no one is perfect. Those faults are peccadillo compared to Krugman’s contributions. When he sticks to his field of economics, he has no peer in explaining the practical side of that complex science to policy makers and general readers, who desperately need the insight he provides.

Krugman has a virtue rare among economists. He never loses sight of the fact that economic science is not primarily about mathematical or social abstractions, but about people. He sees economists’ role as more than creating the world’s prettiest abstract theory. He wants them to make life better and more predictable for the average Joe and Mary. As we emerge from a disastrous era of simplistic ideology, his path of people-centered pragmatism is the one to follow.

I read every column that Krugman writes. As our economic crisis deepened, he wrote some wonderful pieces, explaining complex ideas with good writing and insightful simplicity. Among his recent best are “Health Care Destruction” (10/6), about Republicans’ multi-generational assault on government-assisted health care, “The 3 A.M. Call” (9/29), comparing Barack Obama’s economic prowess with John McCain’s, and “Cash for Trash” (9/22), brilliantly explaining the origins of the mortgage meltdown and criticizing Secretary Paulson’s initial plan to resolve it.

I’d been meaning to write a separate post about these columns and congratulate Krugman for them. But I got sidetracked by the presidential campaign and the crisis. Now is a good time to join the general admiration for a man who has worked hard to promote rational government based on economic science.

I hope and expect that he will play an important role in any Obama Administration. With the extra credibility that his Nobel Prize now gives him, the independence that his former Hillary partisanship suggests, and his unusual ability to explain complex ideas simply to a general audience, he would make a good addition to the Dream Team.

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