Re: [Pen-l] An Economy You Can Bank On

["Jim Devine" <jdevine03@xxxxxxxxx>]

the whole article:

The New York Times / October 10, 2008

Op-Ed Contributor
An Economy You Can Bank On
By CASEY B. MULLIGAN

Chicago

THE Treasury Department is now thinking about using some of the $700
billion it has been given to rescue Wall Street to buy ownership
stakes in American banks. The idea is that banking is so central to
the American economy that the government is justified in virtually
nationalizing much of the industry in order to save us from a
potential depression.

There are two faulty assumptions here. First, saving America's banks
won't save the economy. And second, the economy doesn't really need
saving. It's stronger than we think.

Bear with me. I know that most everyone has been saying for a couple
of weeks that something has to be done; a banking crisis could quickly
become a wider crisis, pulling the rest of us down. For this reason,
the Wall Street bailout is supposed to be better than no plan at all.

Too bad this line of thinking is seriously flawed. The non-financial
sectors of our economy will not suffer much from even a prolonged
banking crisis, because the general economic importance of banks has
been highly exaggerated.

Although banks perform an essential economic function — bringing
together investors and savers — they are not the only institutions
that can do this. Pension funds, university endowments, venture
capitalists and corporations all bring money to new investment
projects without banks playing any essential role. The average
corporation gets about a quarter of its investment funds from the
profits it has after paying dividends — and could double or even
triple that amount by cutting its dividend, if necessary.

>>this guy misses the fact that the financial crisis is hitting _all_ financial intermediaries, not just banks along with way in which slower growth hurts profits (and negative growth kills them).

What's more, it's not as if banking services are about to vanish. When
a bank or a group of banks go under, the economywide demand for their
services creates a strong profit motive for new banks to enter the
marketplace and for existing banks to expand their operations. (Bank
of America and J. P. Morgan Chase are already doing this.)

>>wow! this guy forgets that despite the "new banks" entering the financial marketplace, they are stuck with a large amount of toxic assets which keep the credit crisis going.

It's important to keep in mind, too, that the financial sector has had
a long history of fluctuating without any correlated fluctuations in
the rest of the economy. The stock market crashed in 1987 — in 1929
proportions — but there was no decade-long Depression that followed.
Economic research has repeatedly demonstrated that financial-sector
gyrations like these are hardly connected to non-financial sector
performance. Studies have shown that economic growth cannot be
forecast by the expected rates of return on government bonds, stocks
or savings deposits.

>> the Fed worked hard to prevent the 1987 crash from sinking the "real" economy. On top of that, we have deposit insurance and a fiscal deficit to stimulate the economy. The US economy has changed a lot since 1987, going heavily in the deregulated direction, making crises more likely and more effective in screwing up the real economy.

It turns out that John McCain, who was widely mocked for saying that
"the fundamentals of our economy are strong," was actually right.
We're in a financial crisis, not an economic crisis. We're not
entering a second Great Depression.

How do we know? Well, the economy outside the financial sector is
healthier than it seems.

One important indicator is the profitability of non-financial capital,
what economists call the marginal product of capital. It's a measure
of how much profit that each dollar of capital invested in the economy
is producing during, say, a year. Some investments earn more than
others, of course, but the marginal product of capital is a composite
of all of them — a macroeconomic version of the price-to-earnings
ratio followed in the financial markets.

When the profit per dollar of capital invested in the economy is
higher than average, future rates of economic growth also tend to be
above average. The same cannot be said about rates of return on the
S.& P. 500, or any another measurement that commands attention on Wall
Street.

Since World War II, the marginal product of capital, after taxes, has
averaged 7 percent to 8 percent per year. (In other words, each dollar
of capital invested in the economy earns, on average, 7 cents to 8
cents annually.) And what happened during 2007 and the first half of
2008, when the financial markets were already spooked by oil price
spikes and housing price crashes? The marginal product was more than
10 percent per year, far above the historical average. The
third-quarter earnings reports from some companies already suggest
that America's non-financial companies are still making plenty of
money.

The marginal product has accurately reflected hard economic times in
the past. From 1930 to 1933, for instance, the marginal product of
capital averaged 0.5 percentage points per year less than the postwar
average. The profit per dollar of capital was also below average in
the year before the 1982 recession and the year before the 2001
recession. Sure, the financial industry has taken a hit, and so have
cities like New York that depend on that industry. But the financial
system is more resilient today than it has been in the past, because
it's a much easier industry for companies to enter than it was in the
1930s.

When banks failed during the Great Depression, there were not so many
foreign investors that were cash-rich (or these days, oil-rich) and
appreciative of how some of the bank assets, personnel and brand names
in the United States could be used to earn profits in the future. And
don't worry about foreign ownership: Americans would benefit if
foreigners brought money into our economy to enable banks to continue
to lend.

And if it takes a while for banks and lenders to get up and running
again, what's the big deal? Saving and investment are themselves not
essential to the economy in the short term. Businesses could postpone
their investments for a few quarters with a fairly small effect on
Americans' living standards. How harmful would it be to wait nine more
months for a new car or an addition to your house?

>> how harmful would it be to wait nine more months to invest in that appendectomy you need?

We can largely make up for this delay by extra investment when the
banking sector reorganizes itself. Americans waited years during World
War II to begin private-sector investment projects (when wartime
production displaced private investment), and quickly brought the
capital stock (housing and big-ticket consumer items) back to normal
levels when the war ended.

So, if you are not employed by the financial industry (94 percent of
you are not), don't worry. The current unemployment rate of 6.1
percent is not alarming, and we should reconsider whether it is worth
it to spend $700 billion to bring it down to 5.9 percent.

Casey B. Mulligan is a professor of economics at the University of Chicago.

Copyright 2008 The New York Times Company

>> I've never heard of this fellow. Likely there's a good reason: his rampant ideology.
-- 
Jim Devine /  "Nobody told me there'd be days like these / Strange
days indeed -- most peculiar, mama." -- JL.
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