Thursday, January 29, 2009

Quote of the day

Quote of the day:
It's a recession when your neighbor loses his job; it's a depression when you lose yours.
Harry S Truman, in Observer, April 13, 1958
33rd president of US (1884 - 1972)

via McArdle. Her post on the paradox of thrift is a good one:
If we (hypothetically) decide to eliminate takeout from our menu and eat tuna sandwiches instead, we are saving money. But the restaurant loses it. By foregoing spending, we are pulling money out of the economy. This is the insight behind the liquidity trap--if everyone tries to hoard money by selling more goods and services while buying fewer, the total demand for goods and services will drop, and we will make ourselves worse off.

There's a problem with this crude, version, of course: it's only true if we hoard the money in the form of cash. If we put it in the bank and the bank lends it out, that money will be spent by whoever borrows it.


The problem is that the banks aren't lending. We're hoarding money, and they're hoarding it even more--they don't have to fix the transmission or buy antibiotics. So as in Keynes' example, the money really is just sitting there.

It's worth remembering that this is why the banks are at the heart of our problems. Even fixing underlying issues--like forcing write-downs of the home values securing recent mortgages--will not make them lend if they think they need higher capital to ride out potential storms. That's why even good liberals and Democrats are focused on rebuilding balance sheets, aka giving the banks free money.
Not everyone can de-leverage at the same time.

Speaking of leverage, why the system allowed financial institutions to be so leveraged (i.e. swamped with debt) is a complete mystery to me. Some investment banks were allowed to have a 30-to-1 or 40-to-1 debt to capitial ratio. That just sounds stupid on the face of it. (Looking around the net, I'm not even sure I fully understand what that the debt to net capital ratio is. So I'm less sure what sounds like a good ratio.)

Maybe instead of giving money to existing banks, we should just set up a bunch of new banks that don't have to de-leverage before they start lending out money.


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