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In praise of stimulus and bailouts.

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead

By Alan S. Blinder

443 pages; Penguin Press, 2013

Alban Blinder, one of the real true believers in the government crisis-management response of Keynesian economics and multiple federal bailouts, has now released After the Music Stopped, a book with his take on the recent financial crisis. He served on President Bill Clinton's Council of Economic Advisers (CEA) and also had a brief tenure under Chairman Alan Greenspan as the vice chairman of the Fed. More recently Blinder has held what might be called the "Al Hunt seat" as an opinion writer for the Wall Street Journal, playing the role of big-government advocate, regularly motivating dozens of disapproving readers to unleash a torrent of critical letters to the editor every time he appears on the Opinion page. If, as expected, Fed chairman Ben Bernanke steps down in early 2014, Blinder is considered a possible pick for the next chair, albeit in the second tier of candidates behind Janet Yellen, Roger Ferguson, Larry Summers, Tim Geithner, and Donald Kohn.

After the Music Stopped has a number of positives going in its favor. The information is presented in an easy-to-read format that is a cross between one of Blinder's Princeton lectures and an International Monetary Fund report. It has charts aplenty and informational boxes that break out issues like "Contagion and Financial Panics" separately so the reader can either drill down and review a topic if basic knowledge is required or skip the box entirely if the reader is already familiar with the topic.

In many parts of the book, Blinder's conclusions make a lot of sense: He recognizes that the Fed was "adding fuel to the housing boom" with its monetary policy in the buildup of the bubble during the 2000s. He also recognizes that getting rid of Glass-Steagall was not a chief cause of the financial crisis. His discussion of the stress-tests of European financial institutions and especially his comments on the lack of realism in their implementation is also quite good, although he gives far too much credit to similar stress tests in the United States, saying that "they marked the end of the acute stage of the financial crisis and the beginning of the return to normalcy."

Ducking blame | Probably my greatest curiosity in anticipating Blinder's book was to see how he would present the causes of the financial crisis and either accept or deflect blame for it. After all, many rightly blame the Clinton administration (in which he served) for kick-starting the homeownership craze that ultimately led to the housing bubble and the subsequent credit collapse. Serving on Clinton's CEA, Blinder would have been in agreement with--if he was not an architect of--the plan to boost homeownership. The administration bragged about the rising homeownership rate and ran on it as a campaign issue in 1996. (I should note that George W. Bush did the same in 2004.)

In the first chapter of the book, Blinder gets off to a promising start when he notes that "homeownership simply reached an unnatural high of 69 percent of all American housing units in 2004 and 2005--up from 64 percent a decade earlier." Unfortunately this passage does not segue to the logical step of issuing a mea culpa for the Clinton administration's role in driving up homeownership to an unnatural, unsustainable level through its pro-homeownership policies. Instead he tries to pin the blame for mortgage and consumer overleveraging almost solely on the George W. Bush administration:

   [T]here was a bit of a debt explosion
   between 2000 and 2008 ... [as] total
   household debt (mortgage plus personal)
   rose from about 100 percent of GDP to
   about 140 percent in only eight years.
   The lion's share of that increase came in
   mortgage indebtedness.

While it is true that household debt rose steadily during the Bush-43 years, it was rising steadily before he took office. The upward trend actually started during the mid-1980s after mortgage rates fell from their peak in the high teens. According to Bureau of Economic Analysis and Federal Reserve data, the ratio stood at roughly 45 percent before its uptick, and it reached 70 percent about the time Bush 43 took office. While it is true that the ratio continued to climb to nearly 100 percent, some of this increase was due to the forward momentum of the policies implemented during the Clinton era. Additionally, it's unclear how Blinder comes up with the calculation that household debt reached 140 percent of gross domestic product-he cites not one source for that number, which makes it difficult to agree with his conclusions.

He is skeptical that Fannie Mae and Freddie Mac had much of anything to do with the crisis: "Facts like these make it hard to see how anyone can cast Fannie and Freddie in leading roles in the run-up to the crisis, and the [Financial Crisis Inquiry Commission's] majority agreed with this assessment." First of all, it is very clear based on the size of their market share, the losses they sustained, and their duopoly position in the conforming secondary market that Fannie and Freddie were a significant part of the overall push toward increasing homeownership. What "facts" does Blinder cite for the proposition that they did not contribute to the housing bubble? The two GSEs' "balance sheets shrank slightly over the 2003-2007 period" and "their market shares in the mortgage business fell dramatically." But what Blinder neglects to explain is that, as detailed in a 2011 Wall Street Journal column on the subject, Fannie and Freddie's next step was critical: "seeking to regain lost market share, [the GSEs] loaded up on riskier subprime and Alt-A loans in 2006 and 2007 just as the housing market was starting to tank." Unfortunately Blinder does not choose to bolster his argument with one of his illuminating charts that covers the entire timeframe from 2003 to 2008.

Blame the libertarians | Blinder also blames the financial crisis on bubbles as an "unavoidable consequence of speculative markets," a financial system with "far too little regulation for the public good," and the "libertarians" in charge of the Federal Reserve:

   It was led for more than eighteen years by
   Alan Greenspan, a self-described disciple
   of the libertarian philosopher Ayn Rand,
   and proud of it. Greenspan was, shall we
   say, a less-than-enthusiastic regulator.

For good measure Blinder makes the further point that Ben Bernanke "also characterized himself as a libertarian--before the crisis." So there we have it: the libertarians are to blame for the whole mess, notwithstanding the fact that both Greenspan and Bernanke did some very un-libertarian things as part of the build-up of the bubble and in response to the financial crisis.

Blinder also lobs a few shots at Bush's treasury secretary, Henry Paulson, a "firm believer in free markets," who similarly did some absolutely un-libertarian things during the crisis. Finally, Blinder makes an apparent reference to another group of "libertarians," so-called "moral hazard Ayatollahs" who criticized the Bear Stearns bailout and tried to tie the hands of the interventionists pushing through the bailout. In particular, he besmirches Anna Schwartz for being a member of this group.

He also criticizes what I think was one of the few good decisions made during the response to the crisis-allowing Lehman Brothers to fail--as the primary cause that transformed a run-of-the-mill recession into the "Great Recession." This point is at the core of Blinder's argument, but he presents an amazing lack of evidence to support it. For example, he shows that economic data after the September 15, 2008 fall of Lehman look really, really bad, but he shows little direct linkage between the failure at Lehman and what happened afterward. After all, a lot of bad things were happening that September, including the meltdowns of Fannie Mar, Freddie Mac, and MG, along with the collapse of large banks and savings associations like the failure of Washington Mutual and the run on Wachovia. Blinder relies on the so-called "interconnectedness" argument and talks of the "cascade of failures and near failures that

followed the Lehman bankruptcy." The weakness with this argument is that it has been discredited by many with post 2008 research into the makeup of Lehman's liabilities, the best and most recent analysis of which has been completed by Hal Scott in his paper "Interconnectedness and Contagion" (November 20, 2012).

Keynesians to the rescue? I Regarding the newly minted Obama administration in January 2009, which was responsible for extinguishing the mess it inherited, Blinder gushes: "President-elect Obama assembled what many at the time called a dream team." His first exemplary case of a dream team member? Tim Geithner. Maybe a few bloggers in those early Obama administration days used the "dream team" label, but I am not aware of any serious analysts who did.

Blinder's overall conclusion is that the interventions on the monetary, financial, and the fiscal side (including the infamous Troubled Asset Relief Program) worked. He trots out a study he and Mark Zandi compiled to prove this point, but of course the underlying assumption of that study is that Keynesian stimulus and intervention as a general practice work, so it is not an especially surprising conclusion:

   And it worked. The worst was avoided.
   Financial markets returned to something
   approximating normalcy much faster
   than seemed likely. There was no Great
   Depression 2.0.

As for the future and the unwinding of the massive Fed interventions through the various "quantitative easings," Blinder is convinced that this will be a piece of cake: "Can't the Fed just retrace its steps, like a hiker who cuts bark off trees to mark her path and then follows it back to the trailhead? In large measure, the answer is yes." He later adds, "unless [Federal Open Market Committee] members are derelict in their duties, their error [in executing an exit] should be modest." In recent weeks there has been great anxiety and volatility in global markets in anticipation of the mere possibility of phasing out the Fed's quantitative easings. A much more turbulent exit than Blinder anticipates appears likely.

Overall there is not really much new here and Blinder could have easily put this book out for release in 2010, 2011, or 2012. One has to wonder why it came out as late as 2013. A perusal of his notes and sources in the back of the book finds a bland mixture of many an article from the New York Times, Washington Post, and Wall Street Journal, and of course lots and lots of his editorials and studies.

So if you are the type who gets highly frustrated by Blinder's arguments in print, this book will merely be a 443-page dose of the same. Unfortunately with a book, as opposed to one of his editorials, you cannot zip off a nice letter to the editor to vent your built-up frustration.

VERN MCKINLEY is a research fellow at the Independent Institute and author of Financing Failure: A Century of Bailouts (Independent Institute: 2012).
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Author:McKinley, Vern
Date:Sep 22, 2013
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