I agree with Atrios and David Dayen, this is an absolute must read to clearly understand the basis for the current jobs and economics crises.
We believe that the relative absence of proposals to deal with mass unemployment is a case of “self-induced paralysis”-a phrase that Federal Reserve Chairman Ben Bernanke used a decade ago, when he was a researcher criticizing policymakers from the outside. There is room for action, both monetary and fiscal. But politicians, government officials, and economists alike have suffered a failure of nerve-a failure for which millions of workers will pay a heavy price.
Our guess is that the bubble got started largely thanks to the global savings glut, but that it developed a momentum of its own-which is what bubbles do. Financial innovations such as the securitization of mortgages may have made it easier for the bubble to inflate-but European banks managed to extend too much credit without such frills. However, it is clear that there were major failures in oversight. In particular, Ben Bernanke has admitted that the Fed failed to use its regulatory powers to rein in the excesses of the mortgage lenders-a tragic oversight. Greenspan disregarded the clear warning by a member of the Fed board that mortgage lending had become dangerously excessive. And the widespread securitizing of mortgage loans has made the mess much harder to clean up.
In a housing market that is now depressed throughout the economy, mortgage holders and troubled borrowers would both be better off if they were able to renegotiate their loans and avoid foreclosure. But when mortgages have been sliced and diced into pools and then sold off internationally so that no investor holds more than a fraction of any one mortgage, such negotiations are impossible. And because of the financial industry lobbying that prevented mortgages from being covered by personal bankruptcy proceedings, no judge can impose a solution. The phenomenon of securitization, created in the belief that a large-scale housing crash would never happen, has trapped investors and troubled borrowers in a mutually destructive downward spiral.
Richard) Koo is the chief economist at the Nomura Research Institute. Much of his book (The Holy Grail of Macroeconomics) is devoted to Japan’s long era of stagnation from the early 1990s onward. This stagnation, he argues, mainly reflected the balance sheet problems of nonfinancial corporations, which were stranded with high levels of debt after the Japanese real estate bubble of the 1980s burst. He argues that the United States now faces a similar problem, with debt problems concentrated not among corporations but among home owners, who ran up large debts both in the course of buying houses and through using them as ATMs-that is, using refinancing to extract cash from rising home values, and spending that cash on higher consumption.
In Koo’s analysis, simultaneous attempts by many private players to pay down their debts lead to a “fallacy of composition” that’s closely related to the famous (but too often overlooked) “paradox of thrift.” Each individual corporation or household cuts back on spending in an effort to reduce debt; but these spending cuts reduce everyone’s income and keep the economy persistently depressed.
These broader problems of debt and deleveraging arguably explain why the successful stabilization of the financial industry has done no more than pull the economy back from the brink, without producing a strong recovery. The economy is hamstrung-still crippled by a debt overhang. That is, the simultaneous efforts of so many people to pay down debt at the same time are keeping the economy depressed.
Tanks to David Dayen for his excellent choice of excerpts from the article and this comment at the end
It’s pretty obvious that Krugman and Wells are suggesting that government borrow, to sop up the paying down of debt from everyone else in the economy and cancel it out. Only this will create the kind of demand needed; in fact, Krugman and Wells assert that global budget deficits had more to do with averting a Depression than any financial bailout. But these mainly came from a crash in revenues through taxes and automatic stabilizers, not fiscal stimulus, which was too small. The writers put off their solutions for economic recovery until a future article, but you can pretty well figure out what they are.
I am looking forward to the article on their solutions, as should Obama and his economics team.
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