The quality of muddling

Ezra Klein, Karl Smith, and Ryan Avent today debate the merits and demerits of muddling though vs “grand bargains” and bold solutions. Here’s Smith, insightful as always:

The opportunity to muddle through is a gift. It allows one to make changes at the margin, to monitor their effects and to update accordingly. It allows us to avoid massive often useless sacrifice. It allows our knowledge, understanding and resources to race ahead opening up new ways to deal with our problems… We don’t always have that opportunity. Sometimes we are forced to deal with things in a big way. Indeed, this is much of what we mean by crisis. However, you don’t want to avoid an externally inflicted crisis by creating a self-inflicted one. If you have a chance to make your way with adjustments at the margin, take it.

I think this is right, and important. But even true words can lead us astray if we are not careful. To say that muddling through is a gift because it permits certain advantages can mutate into a case for incrementalism where there are clear disadvantages.

Further, which changes constitute “adjustment” and which would be disruptive are themselves contested. Consider Scott Sumner‘s view of the world. Sumner claims that the stance of monetary policy, when properly defined, turned sharply contractionary in 2008. However, what Sumner would have proposed in order to “stay the course” would have seemed bold and radical to status quo central bankers. Generally, what constitutes measured and incremental changes and what constitutes a sharp turn gets defined according the the conventions of dominant interests. Consider the TARP vs bank nationalization debate. The case against nationalization was often made on grounds of continuity and nondisruption, and that certainly reflects the perspectives of people inside the banking system and the Treasury department. And yet to me and many others like me, the no-accountability/no-more-Lehmans policy regime that was crystallized as TARP represents a wrenching and violent alteration of previously settled social arrangements.

Today’s conversation began with US fiscal policy. Klein tells us

The wish for a grand bargain that’ll take care of the deficit all at once is probably just that: a wish. The likelier outcome is a slew of deficit-reduction measures passed over the next decade or so. That’s even truer for health-care spending, which is both the biggest fiscal problem we face and the one that most requires a decades-long process of trial-and-error in which we test out new ways of delivering care, of paying for care, of separating useful treatments from useless ones and of modernizing the sector’s IT infrastructure.

Overall, this seems sensible. There is a problem, but we won’t hubristically predetermine a 30 year plan,. We’ll make small adjustments in real-time until the problem is solved. That sounds wise.

But is it true? Is that how US fiscal issues are likely to play out? I don’t think so. I’d bet on one of the following three scenarios:

  1. We will experience a boom and/or create technical efficiencies in health care delivery such that the US fiscal trajectory seems to stabilize on its own.
  2. The US fiscal situation will fail to durably stabilize at anywhere near the levels we now deem reasonable, but nothing catastrophic will happen. The MMT-ers will turn out to be right that any inflation or yield pressure associated with a growing stock of public debt will prove manageable in real time. It will feel like we are muddling through perpetually, but nothing bad will ever come of it.
  3. A crisis will force bold changes on the political system. This might take many forms — an inflation, a sharp spike in bond yields, a disruptive depreciation of the dollar, popular revolt against the distributional effects of fiscal largesse, etc.

At the moment, Klein’s scenario seems plausible. After all, despite elevated chronic unemployment — which in our society constitutes almost unthinkably severe human tragedy — we are making genuflections towards deficit reduction. Surely this means we are committed, and bit by bit we will adjust. Right?

No. For better or for worse, we are not adjusting. The small changes our political system proves capable of are promises of future chastity and cuts that disproportionately harm the disenfranchised. Historical experience suggests that even this degree of restraint depends upon an ephemeral configuration of political authority — a Democratic president, a Congress divided or Republican. There is little evidence that our government is capable of adjusting, incrementally but intelligently. It follows paths of least resistance and responds to crises. That might work out all right, or it might lead us to catastrophe.

So is it wise to muddle through? I think we all can agree that not all paths of least resistance end up in places one would wish to go. At the same time, Karl Smith is still wise. Sharp, bold changes are ipso facto crises, and there’s no sense creating pain willy-nilly to deal boldly with inexhaustible phantoms.

So what’s the right strategy? I’m not sure, but I’ll tell you what I used to think. I used to think that the right strategy was to muddle through in a context created by sophisticated financial markets. Human beings, as individuals and as policymakers, have limited information and are prone to flawed choices. Markets aggregate the information and foresight of millions, weighted by confidence expensively signaled via degrees of financial risk assumed. Such markets would always be current, would produces prices reflective of the best available information at any point in time, and would be forward looking. Markets would ensure that, on the path of least resistance, peoples’ incentives would be to make smart adjustments in real-time. Muddling through under these circumstances would leave us where Smith suggests: With “knowledge, understanding and resources…opening up new ways to deal with our problems…[we’d make our] way with adjustments at the margin.”

I think that this view, once my view, is now completely discredited. Financial markets, as they exist in the world we live in, have proven liable to catastrophic and foreseeable mistakes. The instruments we trade hide information and prevent adjustments as frequently as they reveal and promote them. Plausible mechanisms of self-correction have been weakened rather than strengthened during the crisis, so we can expect even poorer performance looking forward. Our financial institutions are best understood as means by which certain groups within our society protect and perpetuate themselves, and as mechanisms by which covert prerequisites of stability are maintained. Of course markets were never going to be perfect — no human institution is. But existing market institutions have fallen in my estimation from “good enough, the best we’ve got” to “incompetent and hopelessly corrupt”.

Absent some context that shapes incentives and links muddling through with intelligent adjustment, accepting muddling as a default position is unsatisfactory. It becomes a means of drifting towards hazards unknown and an excuse for attending to the interests of the powerful. The alternative of bold, flawed, improvisations is also unattractive. The choice between moldy bread and rancid stew is best made on a case-by-case basis, with a lot of unscientific sniffing.

The only way out is to recreate some context in which we’ve reason to expect our muddling will be smartly shaped. Our existing political and financial systems strike me as a poor place to start, but here we are. In the end, I’d like to agree with Karl Smith about the virtues of muddling through. But it all hangs on the quality of the muddling.

Update History:

  • 10-May-2011, 3:55 a.m. EDT: Fixed some typos and awkward sentence constructions. No substantive change.

39 Responses to “The quality of muddling”

  1. JKH writes:


    The current “fiscal crisis” is largely a construction of the technique of the present valuation of an uncertain future. This is the muddy stuff of multi-trillions of “insolvency”.

    So was the financial crisis. While one may argue and believe and be right to some degree that the banks virtually destroyed the real economy, they were also able to repay TARP – as a result of muddling through the dubious ravages of present valuation – although the dominant blogosphere take is that the US banking system remains “insolvent”, based on the same technique of present valuation.

    Muddling through may be less risky than betting the house on the abrupt volatility of present valuation and the potentially erratic responses to it.

    What you used to think turned out to be wrong because the US has an insanely dysfunctional and incompetent financial regulatory system – unless you also thought at the time that it shouldn’t have such regulation at all, as a complement to the “free market”.

    Nevertheless, it is still important for a more functional financial and political system not to overreact, based on spurious compressed measures that abruptly sum the future into the present.

  2. chrismealy writes:

    Historical experience suggests that even this degree of restraint depends upon an ephemeral configuration of political authority — a Democratic president, a Congress divided or Republican.

    Clinton’s 1993 budget, which set up the surpluses in the 1990s, received zero Republican votes in Congress. Same with the revenue-neutral PPACA. Contrast with Iraq and Medicare part D.

    Anyway, if our elite’s not doing a great job then let’s just take their money away from them. Bring back the 80% marginal tax rates and we’ll see just how elite they are.

  3. […] The quality of muddling Steve Waldman […]

  4. TY writes:

    “Consider the TARP vs bank nationalization debate. The case against nationalization was often made on grounds of continuity and nondisruption, and that certainly reflects the perspectives of people inside the banking system and the Treasury department. And yet to me and many others like me, the no-accountability/no-more-Lehmans policy regime that was crystallized as TARP represents a wrenching and violent alteration of previously settled social arrangements.”

    The case against nationalization was based on the fact that the US government lacked the legal authority to unilaterally nationalize the big banks. The so-called “nationalization debate” was a farce — not only was nationalization a stupid idea, it was also literally impossible to carry out. It’s amusing that the blogosphere still talks about “the nationalization debate” as if it was some great Clash of Ideas. It wasn’t. Nationalization advocates pretty much proved that they didn’t know what the hell they were talking about.

  5. liberal writes:

    Our financial institutions are best understood as means by which certain groups within our society protect and perpetuate themselves…

    Firstly, I’d say they’re means by which a privileged class extracts enormous economic rents.

  6. Klein’s views on health care are hardly “sensible.” No testing whatever is needed if the goal of health care reform is, well, health care; see the two charts for what distinguishes United States from other countries in terms of health care outcomes; single payer is the obvious and tested solution. Now, if you view “health care reform” as a gigantic experiment to see whether a system of health care for profit can produce, as a sort of side effects, better outcomes for some, an experiment performed on many without their informed consent, then Klein’s views may appear “sensible,” as indeed they do to the policy-making elite in Versailles. I’d call Klein’s views delusional at best, psychopathic at worst, but that’s par for the course these days, isn’t it?

  7. JKH writes:

    the US has an insanely dysfunctional and incompetent financial regulatory system

    Well, no. Not at all. The financial regulatory system was and is highly competent at enabling the largest upward transfer of wealth in world history (Jamie Galbraith), orchestrated at the CEO level by rentiers using all the techniques accounting control fraud (Bill Black), and entirely outside the rule of law (see under MERS). The financial regulatory system also was ad is highly competetne at shielding the CEOs from criminal responsibility. Seen any banksters in orange jump suits doing the perp walk lately? Thought not.

    So, function and dysfunction, competence and incomptence, are very much in the eye of the beholders, or, in this case, the masters and owners, the kleptocrats for whose benefit our current arrangements in political economy are made.

  8. Indy writes:

    If you like our current decade-old situation in Afghanistan, you’ll be a big fan of the results of a strategy of muddling through the measures needed to prevent a real debt crisis in our political system.

    The best part about trying for a grand bargain is that whether it succeeds or fails, there is an informational dividend. If it succeeds, we know more about the outlines of the future evolution new social understanding. And if it fails utterly – we know more about the impossibility of compromise, and about the lack of a Zone Of Possible Agreement. It’s futile to labor under a delusion and pursue and negotiate a “peace agreement” when one should instead be preparing for an inevitable and inescapable war.

  9. Joe Rebholz writes:

    “…recreate some context in which we’ve reason to expect our muddling will be smartly shaped.”

    It’s muddling when you don’t have a clear goal. Our current economic and financial system (and it is one system) sees itself as running on automatic, as the only way, as unchangable. The muddling is just small variations within what is seen as a very constrained system — neoliberalism or whatever it is we have been doing for the last 30 (?) years or so. We need to change the goal of the system from maximizing money for individuals to something like zero unemployment and assuring basic human necessities for each person in an environmentally sustainable way. Then with such a goal we work, not muddle, toward that goal.

  10. Nicholas Mycroft writes:

    TY, was it impossible for the FDIC to use its authority to take depositary subs of TBTF conglomerates (or the Fed & Treasury their ability to provide/withold capital and regulatory relief to TBTF conglomerates which were both insolvent and undergoing liquidity crises) to threaten said TBTF conglomerates and thereby force them to accept government control of their operations?

  11. RSJ writes:

    “muddling through” is an insipid characterization of what is happening. There is compromise, there is “doing nothing” and hoping for the best, and there is actively undermining the interest of the majority.

    About the vagaries of NPV, that argument would be a bit more believable if the FDIC wasn’t shutting down hundreds of banks across the country.

    There is a two-tiered system, in which the big banks can make colossally idiotic valuation choices such as purchasing Countrywide (BAC) or stuffing their balance sheet with helocs (WFC), but if they are big they can wave away valuation with some philosophical tripe, whereas if they are small they get shut down.

    I’m waiting for households to be immune from valuation concerns so that they, too, can repay their own debts by accessing effectively limitless cheap funding, instead of getting foreclosed upon and having their credit card rates hiked.

  12. […] The quality of muddling Steve Waldman […]

  13. K. Williams writes:

    “And yet to me and many others like me, the no-accountability/no-more-Lehmans policy regime that was crystallized as TARP represents a wrenching and violent alteration of previously settled social arrangements.”

    Steve, I don’t really understand how this assertion is reconcilable with the way the US government dealt with the banks during the Latin American debt crisis of 1982 or the way it dealt with Citibank,, in the early 1990s. In both of these previous periods, major banks were, by the standards used to judge banks in 2008, insolvent. Yet the government did not nationalize them or force them into receivership, nor did it clean house at these institutions. Instead, it exercised regulatory forbearance and gave the banks time to earn themselves out of trouble, which they did — and in the case of Latin American debt, it actually stepped in and brokered a deal (Brady bonds) to keep the banks’ borrowers from defaulting. There’s no fundamental difference between the government did during these periods and what it did during the financial crisis of 2008/2009, so whatever you think of Treasury’s actions, criticizing them as “a wrenching and violent alteration of previously settled social arrangements” seems way off base.

  14. JKH — I mostly agree with RSJ, who responds below, on this.

    All valuation criteria are imperfect and to some degree arbitrary. But we require valuation criteria.

    I invest and speculate on margin. In my opinion, I am always “hold-to-maturity” solvent. The positions I choose are positions I honestly believe will be far more valuable than they are at some point in the future.

    My brokerage doesn’t care. It sets a margin, and valuation criteria (typically but not always mark-to-market). When those imperfect valuation criteria signal that my equity level is below my required margin, I am margined out. I lose control of my assets on disadvantageous terms, and may bear large opportunity costs if my valuations eventually prove correct. Them’s the breaks.

    In a world of functional finance, the government could finance my positions indefinitely, despite a little thing like margin violations. I would appreciate that.

    But the government doesn’t do that, because it would pervert my incentives, entice me to invest in a manner that is not socially useful. Rather than selecting both assets and magnitudes carefully, with generous functional finance, I would invest very large magnitudes in assets that are likely to fluctuate upward for a time, regardless of whether they are long-term losers. The government could entirely afford in my case “not to overreact, based on spurious compressed measures that abruptly sum the future into the present”. Tim Geithner could guarantee my positions and see to it that my margin is waived. He does not. For exactly the reason I am expected to abide by somewhat arbitrary valuation margins, so too should the managers and shareholders and unguaranteed creditors of Citi. No assets need be destroyed.

    When I am margined out, my losses are somebody else’s gain. But they are still legitimately my losses, and they are necessary, to ensure my incentives ex ante. They are necessary for Citi — and BAC and JPM and GS — too. No one says anything disruptive of the larger economy needed to have happened. There needed to be a transfer of ownership of some financial and commercial assets that did not occur.

    MMT and functional finance are often criticized on the grounds that, if we disavow the conventional solvency constraint, we will permit ourselves foolish and unjust distributions of government money. If you are sympathetic to functional finance, quality and legitimacy of expenditures has to be an overriding concern. Asset guarantees that failed to hold accountable managers and shareholders and creditors who made foolish decisions and engaged in intentional “implicit guarantee” trades are precisely the sort of thing an enthusiast of functional finance ought to stand very firmly against.

    Surely there is some discretion. Neither God nor Government perfect each and every individual’s incentives and offer each and every just desserts. But there is a continuum, and the response to the 2008 crisis was at a very extreme end of the continuum. In my opinion, it is completely unsupportable. It has been devastating to me and to the polity in which I reside.

  15. Chris — It is not who votes that matters. My point here is that the US political system does not take deficit reduction measures absent a crisis, real or manufactured. Effective crises are almost never manufactured when a Republican is President, I’d argue both because the interests capable of ginning up such crises do so less when a Republican is in the White House and because Democrats act insecure and vulnerable and capitulate to perceptions of crisis. Democrats have never had a Dick Cheney whose overriding message (despite denials and qualifications over the years) was that deficits don’t matter, they’re at best a tertiary concern. (Dick Cheney should hang out with the functional finance crowd! My wouldn’t they get along.)

    1993-1994 was the era of the bond vigilantes, a moderate but real crisis in long-term rates. Clinton turned sharply right — ended welfare as we know it, became a globalizer — following his loss in 1994. Manufactured crises, concern about deficits despite little evidence of constraint, is something that really does come up almost always in Democratic administrations with a divided Congress. This may not be durable. The way the Democrats are behaving, they may retake Congress and still end all unemployment benefits in the face of zero interest rates just because they and their funders have internalized that “it’s the right thing to do”. But it has generally been true, I think, that Democratic spending priorities have overridden deficit concerns when both Congress and the White House were Democratic (and there was no external constraint or crisis), Republican tax cut and war priorities have overridden everything when a Republican has held the White House, and the main window during which relatively discretionary, considered deficit reduction has occurred has been with Democratic presidents and a divided Congress.

    There are exceptions. PAYGO rules was first enacted under Bush I. There was the Graham Rudman act in the 1980s. But these were not very effective. A case can be made that nothing is very effective at reducing deficit spending except the business cycle itself. If you were to argue that, ultimately, party doesn’t matter and it’s just the happenstance of booms and busts that explains fluctuations in the Federal deficit, I wouldn’t argue much. But it still seems true that only Democratic administrations are significantly constrained in their priorities by deficit concerns, and mostly when they are fighting ascendent Republicans. Neither party may be very good at (or from an MMT-ish perspective foolishly capable of) reducing deficits, but one party seems able even with a divided Congress to immunize its policy preferences from deficit concerns, while the other consistently subordinates its preferences.

    BTW, I am not, never have been, and probably never will be either a Democrat or Republican. There have been times in my life when I’ve sympathized more with Rs than Ds, although now is not one of those times. I mostly detest both parties, consider them collusive and destructive monopolists, am desperate for a more open political space.

    I’m with you, at least on an emotional level, on the 80% thing. Krugman writes about the unwisdom of the elites. It is the unaccountability of the elites that is killing us.

  16. TY — The Federal government had incredible leverage over the banks. They could formally nationalize the FDIC-regulated bits, but more importantly, they could dictate terms simply by threatening to withhold support. For legal niceties, Paulson post-Bear could have lobbied for resolution authority rather than developing proto-TARP.

    There’s no doubt there would have been conflicts and complexities had the government taken a tougher line. But there’s also no doubt that the easy, no-fault approach that was adopted was a matter of policymakers’ preferences more than any legalistic constraint. The legal form a tougher line would have taken is an open question. An obvious thing the government might have done is invested its TARP money in market-valued common shares with control rights, rather than in generously valued preferred shares. No receivership then would have been necessary. The government would simply have purchased the firms, and would have every right to kick out and then sue the bejeezus out of the old management. The government would also have found itself in possession of documentation that might have inspired some criminal indictments.

    Our government chose not to go there. It wasn’t merely constrained. It contorted itself absurdly to structure deals so that it would not, never nationalize any of the large banks.

  17. liberal — no argument there.

    lambert — I’m not inclined to say much re Ezra Klein’s views on health care. I was commenting on his views about deficit resolution. (I’d qualify the adjective “sensible” there, in that his views seem sensible from the conventional perspective that treats fiscal deficits as objects to be eliminated. The MMT-ers have not yet persuaded me this is wrong, but they’ve gotten me more agnostic about it.)

    You’ll think me a bit of a milquetoast, or worse, in that I’m sympathetic to your outrage, but I still consider Ezra Klein a net positive for the world, despite your accurate perception that his views have been infected the destructive “policy-making elite in Versailles”. I don’t think he’s been totally subsumed, and there are times he is a powerful and perceptive writer despite the blinders required of courtiers.

    I agree with your comment to JKH. Our policymakers did precisely what they were inclined to do, and they have been extremely competent. They were extremely competent, for example, at evading legal requirements of “prompt corrective action”, of finding creative ways to structure support and improvise guarantees for banks, etc. Before the crisis, they worked assiduously to eliminate prudential regulation. That was not a failure, but an objective successfully pursued. They are talented people, and they performed brilliantly. Their goals are simply not my goals.

  18. Indy — Great point about the information production that results from trying to work out grand bargains. There is a counterpoint, though, that the process of information production doesn’t just reveal positions, but may create and harden them. In that case, the information production may be counterproductive. Suppose immediately following the incident where a US military plane was shot down and its pilot taken custody, the US and China had tried to reach a grand bargain. Publics and politicians in both countries were inflamed at that time, and the positions elicited might have been less compatible than a similar exercise a few years later would have produced. Had the information been publicly elicited, though, the human compulsion for time consistency might have created severe barriers to a settlement that would in fact be advantageous and agreeable. In social affairs, sometimes muddling through is a way of cooling off, and I think a case can be made for that.

    Afghanistan is indeed a great counter argument to muddling. Muddling through is only a good strategy under certain circumstances, when time is on your side, when it is likely you will respond advantageously to information revealed over time. It all depends on the context, the “quality of the muddling”. The problem with Smith-ish arguments, and again Afghanistan is an example, is they tend to be applied sloppily, as though muddling through is always a good strategy. It is occasionally a good strategy, and we have to be discriminating.

  19. Joe — I think I’d put it a bit differently. Muddling is what human beings do, most of the time. Conscious, directed behavior is very demanding of attention and energy. Mostly we do follow paths of least resistance.

    A “grand bargain” is a way of trying to reset our position in a burst of careful attention. Of course, we will drift away over time, and eventually we’ll need another grand burst. The roof will leak too, and we will fix it.

    The neoliberal dream — and I have been one of its dreamers — is that we can design a world in which the path of least resistance is in fact to do the right thing. This is parallel to how capitalism flips greed from vice to virtue. Under the dream, the demanding, uncertain work of grand bargains can be eliminated, we can follow paths of least resistance, and the system will ensure those paths are goal-directed. This turns a kind of laziness from vice to virtue. It is better we not make up grand schemes, but outsource our decisionmaking to markets, which are wiser than we can ever be. Markets are said to adjust continuously in real time, so we capture option value that we would have lost in grand bargains, we have an easier, more pleasant experience as we go, and we end up in better places than any hubristic grand bargain would have taken us. It is a very compelling idea. Too bad it doesn’t work.

    As you say, we need goals. But once we adopt goals, we have to pursue them. That isn’t muddling through. The only way to simultaneously pursue goals and muddle through is to place yourself in some context, under some circumstance, where what you’d “naturally” do muddling through serves you adopted goals. Neoliberals thought they had that — the goals were growth and efficiency, the context was markets, and muddling could be treated as a positive virtue. If we want to adopt goals like zero employment, we’ll either have to forthrightly and energetically pursue them, or else try the neolib trick and create some political or institutional context in which muddling through will achieve our objectives.

    This, BTW, is what European elites tried to do re the European Union. The current crisis in Europe was foreseen. EU architects believed that the Eurozone would be a context in which muddling through would inevitably lead to greater integration, and a unified Europe was their long-term goal. The Eurozone is doing a lot of muddling right now. It’s an open question whether the confidence of EU leaders a decade ago was well-placed. Will each fudging crisis lead to greater integration, or will contradictions collect until the thing flies apart? We shall see.

  20. Nicholas — Here, here.

    RSJ — Here, here, here… See my comment above to JKH, where I say what you are saying less concisely and elegantly.

  21. K. Williams — You make a good point, but I stand behind my statement. Let me explain.

    You are right that, beginning even in the mid-1960s, we began to have banking and financial crises after a period of quiescence. Those crises have been handled in a wide variety of ways, from takeouvers with criminal prosecutions (e.g. the second S&L crisis), big receiverships like Penn Square, forbearance and public negotiation in the Latin American debt crisis, denial and covert taxation (Citi in the early 1990s), etc. You are absolutely right to point out that kid-glove bailouts and forebearance are not a new strategy, although it’s overstating things to call the approach a consistent norm. One way or another, the government does end up finanacing and/or forbearing and taking on private risk that sometimes results in overt losses. Typically even modest banking crises are associated with recessions during which the national debt spikes, which enables indirect government intermediation and finance of troubled balance sheets. These practices are not new under the sun.

    But something was new and terrible in 2008. That something has to do with the scale and overtness of the machinations. Formally, we did and do have strong overt norms about these things: Bank managers and shareholders enjoy bank profits in exchange for managing certain risks. When they fail to manage those risks, control of bank assets is expropriated in order to protect guaranteed creditors and the public interest.

    Now everybody interested in the subject knows that these norms have occasionally been breeched, sometimes in big ways. But they were still the norm, and when they were breeched, it was done as quietly as possible and revealed over time in ways people very attentive to the business press might understand. It has always been understood to be a kind of corruption.

    Americans generally believe their country to be relatively “clean”, but we all know that there is corruption. We know that sometimes local officials are on the take, that police occasionally abuse their authority and plant evidence, etc. But we are sophisticated enough to know that zero is not the standard by which we should judge the quality of our institutions. We think our country clean because we think these corruptions are the exception, not the rule. We take heart that if and when corruption reaches a certain level, when truly consequential corruption is exposed, we will energetically respond to punish it.

    What happened in 2008 was analogous to learning that a mob boss had half the Senate on his payroll and having the attorney general shrug it off. Nothing would be new in any of that. We understand that some Senators are and have been corrupt, and we even know that sometimes deals have been made to hush that up within law enforcement. But it is a different kind of shock when large-scale corruption is overt and the body politic fails to respond.

    Our overt norms were “prompt corrective action”. Small banks were in fact put into receivership. We did and do understand that sometimes things are quietly finessed, even though that is counter to our rules and principles. We tolerate that with greater or lesser degrees of discomfort. But we never did, and even those of us who follow these issues would not have expected, such a combination of heroic, overt interventions with so little accountability. We’ve seen the bits and pieces, a menagerie of interventions, widely varying degrees of accountability. But never before was the dial toward government risk-bearing turned so high and accountability turned so low, in plain sight before a polity that still has need of its principles. Nothing like that has ever happened. It was indeed wrenching and violent, and it has harmed us as a polity very badly.

    I spend a lot of time in Romania. In 2001, when I first went, I was in my neolib phase, about which I reminisced in this post. In Romania corruption is ubiquitous, and it frustrated the hell out of me. I did business there, and when it came up, I endured permitting delays and legal hassles to avoid paying bribes. But Romanians were very blasé about the whole thing. They all understood the country to be corrupt. It was a thing everybody knew, a public fact. Because it was a public fact, not any kind of an exception, an equilibrium took hold. They didn’t fight it, because it was a durable public fact. For the most part, they just paid the bribes. What’s the point of outrage?

    In 2001, I thought in a decade, Romania would be more like the US. They were working to join the EU, empowering commission after commission “impotriva corruptie” in order to approach Western European norms.

    In 2011, what I see is that the United States has approached Romania. When I talk to ordinary, non-financed-obsessed people, many of them now take for granted that our banks are above the law, that they always come out winners and are protected by the powerful, that the system is unfairly tilted. And in very Romanian style they shrug and get on with their lives. What’s the point of outrage?

    Legally finessed corruption has become a durable public fact in the United States of America. The cost of this is incalculable.

  22. JKH writes:

    Hundreds of banks have been shut down. But hundreds also received TARP funds.

    I wonder how many of the smaller ones who were shut down also received TARP funds and paid them back? Zero or close to it?

    I’d be interested of evidence pointing to different specific asset valuation criteria for big and small banks.

    Yes we require valuation criteria. But the reliability of those criteria is a function of the development of the markets for such valuation. Valuation for margining liquid stocks is more established than marks and capital charges for mortgage derivatives that don’t trade.

    Regarding competence, I wasn’t referring to the policy response in the crisis, but to the supervisory framework for capital and liquidity that preceded it.

  23. Ashwin writes:

    The paper by Paul Posner that Karl Smith’s post refers to highlights a theme that I have some sympathy with. Posner says: “Paradoxically, the global financial strength of the United States may ultimately constitute a weakness.”

    Stabilisation makes the system fragile. After a period of stability, the incumbent corporates and elite will adopt preserving the status quo i.e. stabilisation as their prime objective. Olsonian logic tells us that it’s not worth it for the masses to revolt against this situation unless faced with truly dire circumstances. In this situation, the position of being the issuer of the reserve fiat currency of the world allows the incumbent corporatist-statist nexus to finance the stabilisation of the system for far longer than they otherwise could, thus making the eventual collapse all that much more dramatic and painful (a point I made at the end of this post).

    Similar to your experience in Romania, my experience in India has influenced my thinking a lot. American crony capitalism reminds me of numerous emerging market parallels, except that the rent-seeking/corruption happens in a more “sophisticated” manner. It was examining these similarities and differences that led me to write my posts on crony capitalism.

    I also think the political left-wing in the West can learn from their contemporaries in developing countries. The radical left in places such as India have always understood that the enemy is corporate power AND state power. The idea that state power will countervail corporate power is ludicrous when a cosy coalition can allow them to feast on the masses.

  24. yankeefrank writes:

    The whole question of muddling versus some bolder action is moot devoid of context. It’s an angels and pinheads type debate best left to philosophy. We clearly need bold action on many fronts and will just as clearly not get it until its too late for many.

  25. RSJ writes:

    Pro-publica has a list of bailout recipients — including GM and the agencies — totaling 929 institutions, of which 9 failed, creating losses of of about 2.6B for Treasury. About 40% of the funds have been repaid.

    The only big bank to fail was CIT Group, that wiped out 2.3B. Everything else was small change. Of the 929 institutions, the top 2% received 80% of the capital.

  26. Detroit Dan writes:

    Whenever I get as gloomy as SRW in this post, I try to step back and look at the bigger picture without so many value judgments. Under the dismal circumstances so eloquently described above, we might take ironic comfort in the fact that the status quo keeps getting defeated in national elections. Perhaps the public is aware of the rampant corruption and is ripe for the same sort of new political presence that SRW craves.

    Clearly, the crisis we face has little to do with the national debt, and a lot to do with diminishing employment opportunities, stagnating wages, and crippling opposition to effective government regulation. Muddling through is no longer an option for many of the unemployed, and the shit will really hit the fan when the stock market takes another nosedive, imperiling the retirement savings of tens of millions middle class and upper middle class persons.

    But having a crisis is not enough, there must also be a coherent strategy for dealing with the crisis. That’s where MMT can be useful. We have the ability to deal with our problems, but it will require a strong national government focused on the real issues that face the majority of the people, and with a coherent idea of how the economy works.

  27. TY writes:

    “They could formally nationalize the FDIC-regulated bits”

    No, Steve, you’re wrong. First of all, the FDIC can’t just seize any bank it wants. The bank’s prudential regulator has to put it in receivership and then appoint the FDIC as receiver. But more importantly, this can’t even happen unless the capital position at the depository institution falls below a certain level. Neither BofA nor Citi allowed the capital positions at their FDIC-regulated depository institutions to fall anywhere near that level. So it’s simply a fact that the government had no authority to unilaterally seize Citi or BofA.

    “An obvious thing the government might have done is invested its TARP money in market-valued common shares with control rights, rather than in generously valued preferred shares. No receivership then would have been necessary. The government would simply have purchased the firms, and would have every right to kick out and then sue the bejeezus out of the old management.”

    1. I’m not sure what kind of rights you think common shareholders have, but they can’t just step in and fire management. At best, the government would have had to wait for the next board elections to name new board members, who would then fire management. Not the clean process that pro-nationalization pundits imagined.

    2. Good luck getting the banks’ executives and board to agree to anything like that. And yes, they would have to have voluntarily agreed to that arrangement, since as noted before, the government had no authority to step in unilaterally. It’s easy to sit on the sidelines and say, “If I was the Secretary of the Treasury, I would have forced the banks to sell themselves to the government.” It’s quite another thing to actually try to do it. (We got incredibly lucky when Paulson got all the big banks to accept at least some TARP money in October 2008 — and he barely even pulled it off. But the so-called “nationalization debate” was happening circa March 2009, which was a much different time. There’s a roughly 0% chance that Citi or BofA would have acquiesced in March 2009.)

    “For legal niceties, Paulson post-Bear could have lobbied for resolution authority”

    He did.

    “The legal form a tougher line would have taken is an open question.”

    When will bloggers learn: the “legal form” a nationalization would have taken wasn’t some secondary issue, to be dealt with later. It was paramount. Both BofA and Citi were vigorously opposed to nationalization, so unless and until you can identify a legal method to force a nationalization on an unwilling management and board of directors, the idea that nationalization was a viable alternative will remain a figment of the blogosphere’s imagination.

  28. TY — We’re not going to agree, but it is you who are wrong.

    Re: FDIC. You talk as though you are a lawyer, but you are wrong on the law. An FDIC insured financial institution may be put into receivership for a whole welter of criteria. From FDICIA:

    SUBSTANTIAL DISSIPATION (of assets or earnings, due to “any unsafe or unsound practice”
    CEASE AND DESIST ORDERS (violations of terms thereof)
    LOSSES (basically anticipated insolvency)

    Yes, ordinarily, the bank’s supervisor, not necessarily FDIC, would declare a bank insolvent prior to an FDIC receivership. This only means that it’s possible some internecine squabble between, say, OTC and FDIC could hold up the process. It doesn’t constrain the government as a consolidated entity, when there is consensus.

    Bank supervisors have a great deal of discretion, both in determining the criteria under which an institution is undercapitalized, and whether “other supervisory criteria” exacerbate. In the case of WaMu, for example, the primary evidence of undercapitalization, and the primary justification for its P&A with JPM, was a run on its liabilities. WaMu’s published level of capitalization was fine. Just prior to its demise, it had entered into a Memo of Understanding with OTC that explicitly acknowledged no need to raise capital. In public, Sheila Bair basically said WaMu faced a run, required funding, and the government exercised its option to take over a bank requiring government liquidity support. There is nothing in American law that requires any government agency or the Federal Reserve to provide liquidity-on-demand against opaque collateral, even to “long-term solvent” institutions. Banks must manage their own liquidity, or risk receivership, at its supervisor’s option.

    Nearly every major institution faced incipient runs on their liabilities over the course of the financial crisis. Had the government not intervened to forestall those runs, it would have certainly have found itself with legal authority to resolve FDIC insured subsidiaries.

    There was never any question that FDIC subs could be resolved. I have heard Sheila Bair state, in person, that the legal difficulty they faced was with non FDIC insured parent and sibling institutions. [Listen to the Sheila Bair Q&A here, specifically the response to Jamie Galbraith’s question.]

    But even that was not insurmountable.

    Under what legal authority did Treasury and the Fed do an effective P&A on Bear? Hard to find, but Bear’s merger with JPM was hardly voluntary. Bear executives had little choice but to accede to a merger that management described to its employees as “violence” that was done to them, because their funding dried up. Why did their funding dry up? Because the markets lost confidence, and their only option was to rely on a credit line from the Fed via JP Morgan, and the Fed/Treasury set terms.

    It would have taken nothing more than a mild statement of no confidence by the Secretary of the Treasury or the Chairman of the Fed to put any of several large financial institutions in Bear’s position. Under some circumstances that might be unjust, but in a situation where, say, a broadly insolvent bank holding company ensured that its FDIC-insured subs were highly capitalized in order to forestall regulatory action, it would not be at all unjust. And it would certainly be legal. No bank is entitled to good PR from the government. No bank is entitled to access the Fed’s discount window except by supplying collateral the Fed deems fully adequate. High quality collateral was scarce in 2008. Had the Fed withheld discount window support, and had FDIC not affirmatively financed these institutions via TGLP, they would have been precisely where Bear was.

    Of course, you can argue that bank executives might have played hardball and insisted on bankruptcy, rather than submitting to terms as Bear did. They might have.

    But again, Treasury might have pointed out that this would not be advisable, and that, following a disruptive bankruptcy, should evidence of any irregular or fraudulent activity at the bank surface, prosecutions against upper management would be pursued vigorously.

    Insolvent banks have no leverage. They must submit to terms, if the government upon whose confidence and finance they rely wish to offer them. The legal form of nationalization was entirely a secondary issue. Had regulators been determined to assume effective control of any highly leveraged financial institution that found itself in need of Federal support of any form, they most certainly could have.

    They did not wish to.

    BTW, I have seen no evidence that Paulson proposed, suggested, or even would have been open to resolution authority post-Bear. Do you have a cite? We know that he instructed Treasury staff to prepare and shelve “break the glass” plan like the original-TARP (i.e. an asset purchase, not capital provision, plan. see Philip Swagel’s account In Treasury’s post-Bear “blueprint“, there is no discussion of resolution authority or receivership for nonbank financials. One might or might not read hints of that between the lines of some of the Paulson’s proposals, but you’d have to squint hard, despite the fact that many of us recognized that uncertainty surrounding whether Bear might threaten a formal bankruptcy was the key danger during the Bear crisis.

    Regulators made choices, consistent with their history, allegiances, interests, and ideologies. Those choices shaped the handling of the financial crisis far more than any legal constraint. They chose a path of generous support and little accountability. They were not forced to make those choices. And while they deserve some measure of sympathy for the difficult situation in which they found themselves, and some measure of appreciation for hard work and sleepless nights during the crisis, ultimately they deserve our condemnation for choosing an approach that while “safer” and “easier to execute” than some alternatives, damaged the institutional quality of the United States of America severely.

  29. Detroit Dan — I appreciate your non-gloominess.

    But I’ll be a bastard and take issue.

    Suppose that MMT-ers are right, that the fiscal constraints of government are much looser than we conventionally think and its powers of regulation broader. You say, “We have the ability to deal with our problems, but it will require a strong national government focused on the real issues that face the majority of the people, and with a coherent idea of how the economy works.”

    How do you suppose we get that? We do have a strong national government, and it caters, often reflexively and unconsciously, to certain interests while ignoring others that you and I care about.

    When in the early 2000s, our government found itself running a surplus and therefore freed of ordinary fiscal constraint even on conventional terms, how did it respond? With tax breaks to the wealthy, of course. MMT-ers often presume a government that behaves well, but absent that, perhaps it is best that officials imagine their hands to be tied more than they are. (But that’s not even right — officials only imagine their hands to be tied when asked to do things for groups other than the interests they cater to.)

    Lifting constraints on government action is insufficient. We also have to change how government action is shaped.

    RSJ — Thanks for the info.

    yankeefrank — Very concise, and I pretty much agree. Muddling does make sense sometime, bold action is required other times, and rather than make blanket arguments we have to discriminate between circumstances.

    Ashwin — Not unusually, I agree with almost everything you have to say…

    JKH — I think you’ll find valuation criteria ad hoc, particularly at large banks due to sheer complexity and scale of books. Regulators are not able to independently value the position of a Lehman or JP Morgan. And that is a problem.

    You might call that an example of regulatory incompetence prior to the crisis. But I think that’s too benign a term. Regulators didn’t mean to independently value JPM’s assets and find themselves at a loss. They chose to cede valuation to bank-internal modelers. They made an intentional choice that independent valuation was only necessary at smaller banks.

    It is incompetent if you mean to do something and fail. It is something else if you do what you mean to, and others dislike the consequences. You might say that US regulators meant for there not to be a financial crisis but failed, so in that sense they were incompetent. But regulators had other objectives, such as to support a deep and sophisticated, globally competitive US financial industry. US regulators (cf Timothy Geithner) are making tradeoffs between those objectives and prudential concerns as we speak, even in full knowledge of the recent crisis. By revealed preference, their objective function includes a dispreference for crisis but other preferences that override that. Pursuing objectives that are not mine or yours does not render them incompetent. It seems to me that is what US regulators were doing prior to the crisis, and that is what they continue to do today.

  30. JKH writes:


    If a paradigm of entrenched, endemic fraud eclipses the search for competence, then abandon hope, all those who enter. That’s why I find it so difficult to read financial blogs these days – because that is the going in assumption for both the industry and its regulation. Also, the regulatory effectiveness I’m thinking of goes deeper than valuation models for complex positions, of course. It goes to risk taking per se at the point of origin. As a simple example, Canada’s finance minister has reduced permissible amortization periods for mortgages twice in the last several years. I know you’re expecting Canada to be punished for its housing market hubris at some point, but that’s simple stuff. Regulatory competence includes supervisory coordination and aggressiveness.

  31. Steve Randy Waldman writes:

    JKH — I’m not sure we’re really disagreeing.

    “If a paradigm of entrenched, endemic fraud eclipses the search for competence, then abandon hope” states very eloquently the damage that I think has been done by the character of the response to the financial crisis.

    You may argue that me and others like me are contributing to that bad social equilibrium. And that could be true, if we leave the matter at pointing out the entrenched, endemic fraud, and then walk away. There’s a real danger of that. Personally, I’ve been profoundly depressed and distressed by world affairs since 2004 and financial affairs since 2008.

    But then, we financial bloggers do write and argue and resist. Some with greater frequency than, um, others. But I don’t know of any discontented finance bloggers who simply marvel at the institutional perfection of our trap and retreat to contemplating it as an aesthetic object. We are characterizing and identifying problems to help in a fight to change things.

    If competence means “regulatory effectiveness”, and regulatory effectiveness is defined at ensuring that the financial system pursues its public purpose of allocating capital and risk well at minimal cost and risk to the broad public, then sure, competence is what we’re after.

    But I’m resisting that word, because I don’t think that’s what it usually means, and I think it will lead us astrat of “competence” is what we try to pursue. I think that by any ordinary meaning, Timothy Geithner is a really, effing competent guy. He is smart, and an effective leader of his organization. He knows how to build political coalitions and is very successful at achieving his goals and objectives.

    But I think his goals and objectives are wrong. And I haven’t called him corrupt, or a party to any kind of fraud, although I would claim his goals and objectives reflect a perspective that combined views each of which are defensible in isolation into patterns of behavior that yield corrupt ends. But it is a very different thing to say that someone participates in corrupt institutions and contributes to corrupt ends than to say an individual is corrupt. I don’t think that, e.g. Geithner, is corrupt. I think he has a coherent and sincere policy view that is widely shared in his social and professional circle that, when put into practice, leads inexorably to very bad results along a wide variety if dimensions (but happens to benefit those in his social and professional circle).

    Calling people like Geithner incompetent doesn’t strike me as accurate or helpful. Calling the whole institutional context a snakepit of corruption and skulking off dejectedly doesn’t help either. I think that it’s important to recognize that, within the US, what we have is a lot of bright, competent, sincere individuals (as well as some outright corrupt people) pursuing catastrophically misguided objectives.

    To deal with incompetence, you look for more skilled hires — people more knowledgable about finance, better capable of running organizations, able to understand complex transactions, etc. I don’t think we could find any more skilled hires than we have.

    What we need are similarly competent people with very different views. I think that’s just a different issue than incompetence.

    But again, I don’t think we’re disagreeing, except perhaps about definitions.

    I’m less certain that Canada will be punished for housing hubris than you suggest, although I do think it a real possibility. I’m more in the watch-with-an-open-mind phase about Canada than ready to offer certitudes either way. Reducing the length of amortizing mortgages is an interesting way to try to bound housing prices, and is a nice counterpoint to the sterile US debate that assumes “leaning against the wind” must mean raising the policy interest rates. As you say, a good regulator would be aggressive and creative in solving problems, rather than confining consideration to some conventional bad options and then shrugging.

    But in the US, they did that not out of incompetence or direct corruption, but because they genuinely thought pushing against housing prices would be counterproductive. They did not want to actl, so they presented only bad options as alternatives to acquiescence. In the US, the Federal government is now doing everything it can to support and increase home prices (and taking on a great deal of risk via FHA, FHLB as well as the much discussed Fannie and Freddie). You might argue that’s because the situations are different, our housing bubble has burst, Canada’s hasn’t. But by conventional valuation ratios, US housing is still modestly overvalued. US policymakers, then as now, are not making mistakes in choosing means, but in choosing ends. And whether the ends they choose are in fact “mistaken” depends on ones perspective. From my perspective, the appropriate ends are reversion to sustainable prices, unpayable principal written off and losses borne by the managers and shareholders of firms that extended credit unwisely. But that last is the outcome US policymakers are desperately struggling to avoid, for what they believe to be good and public-spirited reasons. They are wrong, catastrophically wrong. But they are not incompetent and many of them are sincere.

  32. Ashwin writes:

    Steve – just to back up your view that our bankers and regulators are not incompetent, but misguided: I wrote a post a while ago which tried to use a “natural selection” argument to make the same point. Given a diversity of viewpoints, the deluded but sincere economic agent will always outperform the deceptive and insincere agent with the same views.

    Also explains why there’s so much animosity between both sides of the debate right now. The elite probably genuinely think they’re saving the world and the rest think they’re committing fraud and looting the taxpayer.

    Yet another reason why I can’t see any meaningful change without some form of systemic collapse that changes the current power structure.

  33. dave writes:


    “I think he has a coherent and sincere policy view that is widely shared in his social and professional circle that, when put into practice, leads inexorably to very bad results along a wide variety if dimensions (but happens to benefit those in his social and professional circle).”

    Is that really sincere? It seems to me that if Geithner is really smart enough to be considered competent, then he ought to be smart enough to see that his policies lead to bad results. So either:
    1) He really is incompetent.
    2) He is competent but his desire for outcomes that benefit those in his social and professional circle as well as himself actually makes him turn off the brain functions capable of seeing what he should be able to see.
    3) He knows the policies and ideas he advances in public are just cleverly designed bunk but he’s laughing all the way to the bank in private.

    Or some combination of all three.

    Whatever the case, it sure doesn’t make him someone who deserves to be in charge, nor a particularly noble person.

  34. […] or a network of 3D animation and video masters who get together as and when projects demand. The quality of their output strictly depends on the quality of humans in their network. […]

  35. JKH writes:


    In his most recent article on Goldman, Matt Tabbai refers to “insane faith-based mathematics” as a significant contributing factor in the financial crisis (but certainly not his main theme). It’s a great description, and the root of it all in my opinion – the required intellectual catalyst for the human failing otherwise. People who get duped by statistics, essentially – the buy side for all those CDOs.

  36. john writes:

    Comments are closed on your “The changing private value of oil in the ground” so I’m commenting here, did you see this from Ed Harrison:,0_

    This proposes the possibility that in a country where a certain absence of the rule of law does not allow the type of highly technical rent seeking our particular corruption formalizes a different form of off balance sheet banking has been occurring, for all practical purposes in cowrey shells. It seems to me if this is true not so much “speculation” per se that driving commodities bubblyness but the normal efforts of traders to sidestep regulation to mint bank money on the sly. The Chinese have the power of a fiat currency and aren’t afraid to use it, but this looks to me like a kind of precocious currency revulsion, while tied to the currency not quite of it.

  37. Detroit Dan writes:

    Suppose that MMT-ers are right, that the fiscal constraints of government are much looser than we conventionally think and its powers of regulation broader. You say, “We have the ability to deal with our problems, but it will require a strong national government focused on the real issues that face the majority of the people, and with a coherent idea of how the economy works.”

    How do you suppose we get that? We do have a strong national government, and it caters, often reflexively and unconsciously, to certain interests while ignoring others that you and I care about. [SRW]

    We may be close to the failure point for the current elite. The Republicans have clearly given up all pretense of seriousness. The Dems are on thin ice, having lost massively in the recent midterm elections. If nothing else, they are politically inept. This should be considered in your evaluation of the Obama team’s competence.

    Moreover, it is obvious that a better understanding macro-economics would help the Dems politically. The Dems have had the better record on the faux problem of the deficit for several decades now. But guess what? The voting public does not care about that. Obama’s efforts to balance the budget benefit no one but the opportunistic Republicans.

    So how do we get a strong national government focused on the real issues that face the majority of the people, and with a coherent idea of how the economy works? Start with a populist politician who leverages the extreme dissatisfaction with the status quo, and promises direct action to deal with longstanding problems. My estimate is that the public will get to that level of dissatisfaction by 2014. In the meantime, we have to believe convince ourselves, and others, that there is a viable alternative to the blatant self-serving hypocrisy of the Republican, and the misguided moderation (conventional wisdom) of the Democrats…

  38. Dan Kervick writes:

    After reading the latest Matt Taibbi expose of Goldman Sachs, it appears to me that the problem isn’t just that bankers are incompetent or misguided. It’s that a certain substantial number of them, in extremely high and prominent places, are profoundly debased, criminal, and nihilistic, and run vast and exceedingly clever quantitative schemes for the effective embezzlement of stupendous troves of our accumulated social wealth, and for the abuse and exploitation of the many somewhat less clever pigeons in our society. It’s not surprising, because the grasping and avaricious mental make-up of the type of person attracted to that line of work, which consists in making money out of money out of money with little connection to world of real goods, doesn’t seem like fertile ground for sobriety and social responsibility.

    I’m inclined to think a much larger proportion of this activity than most economists seem willing to entertain is either socially useless altogether, or carries social costs far in excess of its social benefits. And the compensation benefits for those who do the useful portion of the activity are far higher than they need to be. My guess is that we could extract more-or-less equivalently productive work from our financial sector, the most productive portion of which requires little more than the effective trucking of capital about in our economy in prudently managed ways, without paying the people who do this trucking nearly as much as they receive now.

    Credit is crack. It has always been that way, throughout history. Left to itself without extremely vigilant oversight, it appears the markets for credit explode quickly into dangerous riots of flim-flam. They don’t self-regulate, because the highly individualistic and ruthless buccaneers who are attracted to the most lucrative and important citadels of capital movement are as busy looting and devouring their own firms as they are competing savagely with one another. The ownership and governance structures for administering this sector are too weak and distributed, and the expertise needed for evaluating the propriety of what is occurring too rare and compromised, for organic self-regulation to work.

    What we are faced with is a vast “financial-industrial complex” that controls much of what is left of our government, and needs to be largely dismantled, with the remainder subjugated to public control.

  39. Lord writes:

    I would offer a fourth possibility, a series of crises during each of which modest changes are made some that work for a measure and a time before leading to another, and some that don’t. Stepwise muddling. That is probably the most likely.