Mutatis Mutandis – Anatomy of an Atypical Financial Crisis

It is difficult to begin a post about Larry Summers – and his suitability for Chairman of the Federal Reserve – due to the sheer volume of current commentary. I’ve refrained from writing too much about Summers because I don’t know much more than the average pundit and therefore cannot add much.

However, I recently read Larry Summers’ decades-old, prescient analysis of the emergent possibility of a financial crisis in the modern monetary system, and the role of central bankers therein. It would not be an overstatement to claim that every ounce of thought and analysis in this paper flies in the face of Summers’ contemporary detractors vis-a-vis his position on both financial deregulation and monetary imperatives. Larry Summers likes regulation mutatis mutandis – he supports it at the core with necessary alterations on the side.

Before I continue, I anticipate a common response from detractors will suggest Summers’ revealed preference for deregulation contradict views expressed in 1991 and must clearly have evolved since. Two points:

  • It is well within the realm of reason that Summers’ views towards regulation did evolve due to the illusory stability of American finance between 1995 and 2006. However, as a rational Bayesian agent, we can be certain that he has the intellectual and analytical foundation to revise his priors as a result of the 2007 crash, whose course he presciently anticipated in 1991. His support of Obama’s regulatory regimen in recent years lends support to this argument.
  • Summers’ aversion to the harsh – even crude – style of derivatives regulation proposed by Brooksley Born does not confirm the argument that Larry Summers opposes any and all financial regulation. It confirms the argument that Larry Summers opposes Brooksley Born. But that’s just not as sexy.

Larry Summers’ unfortunate response to Raghuram Rajan’s warning – in which regulators are accused of Ludditery – are at the heart of a liberal backlash against Summers. Also unfortunately, this does not capture his opinion on regulation. From “Planning for the Next Financial Crisis” (1991, linked above), Summers argues:

Kindleberger’s preconditions for crisis are as likely to be satisfied today as they ever have been in the past. It is probably now easier to lever assets than ever before and the combination of reduced transactions costs and new markets in derivative securities make it easier than it has been in the past for the illusion of universal liquidity to take hold. Asset price bubbles are now as likely as they have ever been. Bubbles eventually burst. The increased speed with which information diffuses and the increased use of quantitative-rule- based trading strategies make it likely that they will burst more quickly today than they have in the past.

The thrust of Summers’ discourse is that the risk of financial crisis had not decreased over the decades leading into the 1990s and may well have increased. While he accepted the contemporary establishment opinion that the risk of panic to the real economy had subsided, he rejects the notion that this emerges from any fundamental efficiency of markets, rather the emergence of Keynesian-style economic stabilizers:

If financial crisis is less likely now than it used to be, the reason is the firewalls now in place that insulate the real economy from the effects of financial disruptions. Most important in this regard is the federal government’s acceptance of the responsibility for stabilizing the economy. Automatic stabilizers that are now in place cushion the response of the economy to changes in demand conditions.

Indeed, Summers goes further to suggest that the risk of financial panic per se has increased with the dominance of the new, derivative-driven financial system:

I conclude that technological and financial innovation have probably operated to make speculative bubbles which ultimately burst more likely today than has been the case historically.

Therefore, critics like Dean Baker – and, yes, Paul Krugman – should be cautious when accusing Summers of not foreseeing the housing bubble and crash in the 2000s. As Krugman himself has argued, we must judge the analytical value of a position not by specific predictions or bets – on which count Larry Summers summarily fails – but by the analytical model behind a prediction. I am now more confident that Summers, like Krugman and others on the left, had the foresight and firepower to incorporate the events of 2007 into their intellectual framework. (I’m personally more impressed by someone using an analytical model to suggest that something big is possible than someone saying something will happen for donkey’s years only to be proved right by the Law of Large Numbers).

Before I go on, let me provide the context in which Summers’ paper was written. The early ’90s were in many ways a time of free banking revival on the right and monetarist conceptions of business cycle moderation in the mainstream. It was not vogue to militate the idea of an activist central bank whose role extends beyond blanket provision of liquidity and ensuring a steady growth in monetary base.

In 1991, conceiving a 2007-esque crisis would have been unimaginable. Yet Summers carefully builds a fictional scenario of financial panic – from its animal spirit antecedent to its dystopian consequent – militating the following:

The result was the worst recession since the Depression. Unemployment rose to 11 percent and real GNP declined by 7 percent. For the first time since the war, there was a decline from year to year in the consumption of nondurable goods.

I don’t cite this paragraph to describe something so mundane as a recession, but the infinitesimally-close resemblance it holds to our own reality. Again, Summers never predicted that this crisis will occur, but notes that within his intellectual framework it could occur. Something, again, that sets him apart from his contemporaries in the early noughties, let alone nineties.

Summers discusses four possible paradigms in which we may respond to a financial crisis that so dearly affected the real economy:

  • Free banking.
  • Monetarist lender-of-last-resort.
  • Classical (Bagehot, 1873) lender-of-last-resort.
  • Modern Pragmatic View.

It’s a detailed discussion, and I want to keep my remarks concise. (Needless to say, Summers politely declines the train-wreck of an idea that is free banking.) Ultimately, he supports what he coins a “modern pragmatic view” which includes broadly:

  • Keynesian stabilizers.
  • Targeted (TBTF) bailouts in the case of financial crisis.
  • Regulation. (Read this one again, if you must).
  • Absolute provision of liquidity.

While a lot of this is mainstream stuff that shouldn’t surprise anyone, I want to highlight a few nuggets that are certainly relevant today:

A minimalist view of the function of the central bank would hold that, in the face of a major disturbance, it should use open market operations to make sure that the money stock, somehow de- fined, is not allowed to decline precipitously; a more activist view would seek to insure that it rises rapidly enough to offset any decline in velocity associated with financial panic. On this monetarist view, there is no need for the Fed to make use of the discount window or moral suasion in the face of crisis. It suffices to make enough liquidity available.

In the emphasized, Larry Summers effectively endorses the benefits of nominal income targeting – were we to stipulate that he is an “activist”. (His recent columns, editorials, and speeches on the importance of employment, and danger of hysteresis convinces me that he is). At the time, a standard monetarist argument held that targeting money supply growth would sufficiently stabilize the business cycle and insulate the real economy from financial panic. The equation of exchange states that:

mv = pq

where m is the money supply, v is the velocity of money, p is the price level and q is the real output. This simplifies to:

y_nominal = mv

Monetarists therefore argue that the central bank should target m. However, Larry Summers correctly argues that during financial panic there is a shortage of safe assets and hence money demand increases, diminishing the velocity v. Hence, to maintain output while accounting for velocity is now simply called targeting nominal income.

I have many times said I don’t know what Summers’ views on monetary policy are. While this doesn’t increase my confidence too much, I’ll note it is incumbent to accept Summers has considered, acknowledged, and supported the benefits of a nominal income target.

We also know little about Summers’ current attitude toward the central bank asset purchases known as quantitative easing (QE). Japan first engaged in this “exotic” policy in the early 2000s having hit the zero lower bound. Most economists would not support this policy, and certainly did not one decade ago. Here is Summers two decades ago:

Yet another [possible treatment to financial panic] is direct intervention to prop up asset prices. If this is possible, it will serve to increase confidence in the financial system and reduce the need for reductions in interest rates that would otherwise lead to a currency collapse. Journalistic accounts such as Stewart and Hertzberg ( 1987) suggest that manipulation of a minor but crucial futures market played an important role in preventing a further meltdown on Tuesday, 20 October 1987. They also assign a prominent role to orchestrated equity repurchases by major companies. Hale (1988) argues that the primary thrust of Japanese securities regulation in general, and especially in the aftermath of the crash, is raising the value of stocks rather than maintaining a “fair” marketplace.

In this capacity, it’s not too hard to believe that Larry Summers anticipated something proximal to the new “market monetarist” position. Indeed:

Quite apart from whatever it does or does not do to back up financial institutions that get in trouble, the Federal Reserve has the ability to alter the money stock through open market operations. In the face of a defla- tionary crisis like the one described above, it is hard to see why it would not be appropriate to pursue an expansionary monetary policy that would prevent the expectation of deflation from pushing real interest rates way up. The use of such a policy would at least limit the spillover consequences of financial institution failures. Whether it would be enough to fully contain the damage is the issue of whether a lender of last resort is necessary, the subject of the next section.

In fact, the “market monetarist” movement has two wings. Those occupying the sturdy, monetarist-activist position like Scott Sumner who argue that fiscal policy is entirely irrelevant and those like Paul Krugman and Brad DeLong who occupy a nexus of Keynesian-Monetarist beliefs militating for both monetary and fiscal easing along with regulation.

It is very clear that at least in the above paper, Larry Summers falls solidly with Krugman and DeLong noting the dangers of budget balancing during a financial crisis:

[Emerging stability] is largely the result of the expansion of government’s role in the economy. When the economy slumps, government tax collections decline and government transfer pay- ments increase, both of which cushion the decline in disposable income. The mirror image of stability in disposable income is instability in the government deficit. Hence, automatic stabilizers cannot work if the government seeks to maintain a constant budget deficit in the face of changing economic conditions.

Perhaps the most vicious criticism of Larry Summers comes from an ultra-Left wing of commenters and economists that allege a conspiratorial tie between Summers and Wall Street embodied by his support for big bailouts (which I do not support) and supposed deregulation. In fact, this is just not the case:

Lender-of-last-resort policy is probably an area where James Tobin’s in- sight that “it take a heap of Harberger triangles to fill an Okun gap” is relevant. It may well be that the moral hazard associated with lender-of-last-resort in- surance is better controlled by prudential regulation than by scaling the insur- ance back. This at least is the modern pragmatic view that has worked so far.

The reference to Harberger triangles and Okun gap is an old quip in favor of Keynesian stimulus: suggesting the gains from employment (a closing Okun gap) are orders of magnitude more important than deadweight losses emergent from taxation (Harberger triangles).

Summers only suggests that during a crisis it is dangerous to let big banks fail and it is better to take a vaccination than unscientifically reject a cure for fear of its side effects. While this position certainly creates a moral hazard and excessive risk taking among big banks, Summers is clear this is handled better with regulation (!!!) than failure, phrasing the argument in terms many on the mainstream left must accept:

 It is difficult to gauge the price of this success. Almost certainly, the subsidy provided by the presence of a lender of last resort has led to some wasteful investments and to excessive risk taking. I am not aware of serious estimates of the magnitude of these costs. Estimates of the cost of bailouts, which represent transfers, surely greatly overestimate the ex ante costs of inappropriate investments. If the presence of an active lender of last resort has avoided even one percentage point in unemployment sustained for one year, it has raised U.S. income by more than $100 billion. It would be surprising if any resulting misallocation of investment were to prove nearly this large.

I fall to the left of many fellow mainstream critics of Summers and hence for many other reasons reject the purported pro-bailout stance. Regardless, with the sort of sane regulatory policies that Summers above clearly supports, I would be more at rest.

Summers carefully notes why the former three policy paradigms (free banking, classical,  and monetarist) fail. In this, he anticipates many of the too-optimistic arguments made by those like Scott Sumner or David Beckworth in favor of a rules-only nominal income target. Indeed, in another paper, he questions the value of a rules-based policy entirely:

[I]nstitutions do the work of rules, and monetary rules should be avoided…Unless it can be demonstrated that the political institutional route to low inflation — to commitment that preserves the discretion to deal with unexpected contingencies and multiple equilibria — is undesirable or cannot work, I don’t see any case at all for monetary rules.

But in this paper itself, he notes that the biggest reason for contemporary economic stability comes not from more efficient markets, monetary rules, or even activist lenders-of-last-resort but deep, automatic stabilizers. He notes:

A major difference between the pre-and post- World War I1 economies is the presence of automatic stabilizers in the postwar economy. Before World War 11, a $1-drop in GNP translated into a $.95 de- cline in disposable income. Since the war, less each $1 change in GNP has translated into a drop of only $.39 in GNP. This change is largely the result of the expansion of government’s role in the economy.

He furthers a powerful case against crude monetarism by noting many reputational externalities from bank failures:

 But the analysis of the potential difficulties with a free banking system suggests that support of specific institutions, rather than just the money stock, may be desirable. De- clines in the money stock are just one of the potential adverse impacts of bank failures. Bank failures, or the failure of financial institutions more generally imposes external costs on firms with whom they do business and through the damage they do to the reputations of other banks. Private lenders have no incentive to take account of these external benefits, and so there is a presump- tion that they will lend too little.

The point here may be put in a different way. Because of the relationship- specific capital each has accumulated, reserves at one bank are an imperfect substitute for reserves at another. Maintaining a given aggregate level of lend- ing is not sufficient to avoid the losses associated with a financial disturbance. 

I thought that last point was especially powerful.

I would sum Larry Summers’ opinion on relevant regulatory institutions as the victory of regulation and moral hazard in a tension between the goal of discouraging risky behavior and resolving the crisis. I would sum Larry Summers’ opinion on monetary policy as erring on the side of expansion and liquidity in a tension between the goal of discouraging inflation while promoting employment.

Miles Kimball argues that any potential candidate to head the Fed must note their position on the following three items:

  • Eliminating the “Zero Lower Bound” on Interest Rates.
  • Nominal GDP Targeting.
  • High Equity Requirements for Banks and Other Financial Firms.

I cannot know Summers’ position on the first – though I will note the e-money argument is still very heterodox, and hence I find it impossible that Janet Yellen will support it and only highly improbable that Larry Summers will.

I noted earlier that Summers accepts any activist monetary policy must increase money supply adjusting for a fall in velocity, which is an effective nominal GDP target. It is for the reader to interpret his position on activist monetary policy as an item, and the extent to which he has revised his views today.

Finally, we can read Kimball’s last item specifically as support for higher equity requirements but more broadly as a belief that regulation is important. While equity requirements are distinct from capital requirements, they share some similarity and Summers wrote here “Raising bank capital requirements would seem to be an obvious approach”, signaling support. Raising equity requirements (that is, forcing banks to finance themselves with stock instead of debt) are in every which way better and hence should receive even more support.

On the topic of regulation – the irony that Larry Summers is the bête noire of the Left vis-a-vis regulation is becoming very clear. If anything, Larry Summers supported a form of deregulation in the ’90s but had the correct intellectual framework and has hence updated his priors correctly since 2007. There is no evidence that Graham-Leach-Bliley (the repeal of Glass-Steagall) was the cause of the recent crisis, and even less evidence that Summers critique of Brooksley Born’s harsh opposition towards derivatives trading can be translated into his opposition of smart derivatives regulation overall.

This paper convinces me that Larry Summers was well-ahead of the curve in a way more respectable than just guessing a random crisis (like Steve Keen – in retrospect, as John Aziz points out, this was a poorly chosen jab. Keen, like Summers, had a model. Others did not.). Rather, he teases out the very specific method in which such a panic might occur and analytically understands exactly what we would need to insulate the real economy and employment.

In 1991, few others could have so presciently described the reasons why the economy is more stable today, how the financial system is becoming riskier, and what role the central bank can or should play to fix that.

What more do you want from your Chairman of the Federal Reserve.

(Oh by the way,  for the record and for the little my two cents are worth, I’m officially noting Larry Summers as my top choice for the job).

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  1. I’m no economist, and I’m certainly never going to trump you or DeLong in economic thought.

    So let me try to explain why, as a layperson, I’m uneasy about Larry Summers. It seems to me that all the defenses mounted on his behalf are based on some piece of theoretical work he has done. Again, I’m no economist, so I’ll accept at face value that this work is ahead of the curve, prescient, containing insights that others missed, distinguishing him as one of the best theoretical economists of his generation. Yet, in apparent contrast with the theoretical Larry Summers stands the actual Larry Summers. Fundamentally, none of the arguments against him seem to be based on the belief that he is not smart, a good theoretical economist, etc. They are based on things he actually did. And in that light, the defenses of Summers seem to boil down to “no, really, trust us, this time he’ll get it right!” This 22-year old paper might show that Summers was ever further ahead of the theoretical curve than we thought, but that’s it.

    So while in the paper we have the theoretical Larry Summers noting the dangers of balancing the budget during the financial crisis, the actual Larry Summers pressured Korea to balance its budget.

    In the paper, theoretical Larry Summers talks about the moral hazard created by bailing out big banks. The actual Larry Summers champions GLB and the merger of Citi and Travelers into an organization that would become a ward of the state 10 years hence.

    Theoretical Larry Summers testifies that “questions have been raised as to whether the derivatives markets could exacerbate a large, sudden market decline”. Actual Larry Summers gives us the CFMA.

    Theoretical Larry Summers believes fiscal policy is crucial to the recovery. Actual Larry Summers is the chief economic adviser to a president who lowballs his one shot at fiscal policy. (Theoretical Larry Summers then returns to co-author a paper with DeLong that would have been hugely useful three years prior, but has approximately zero impact on current policy.)

    You get the point. When people start talking about how great Larry Summers is, I can’t help but feel like I’m watching a sports agent talk a baseball team into signing a 30-year old pitcher with a cannon for an arm but a career win percentage well below 0.500. If the case for Larry Summers were so awesome, you wouldn’t be citing a paper he wrote 22 years ago (before he held any of many positions of power he has since held) as your primary basis and DeLong wouldn’t be sounding like Jay Bilas talking about “tremendous upside potential”. The fact that his supporters cite nothing from his tenure with the Clinton and Obama administrations speaks volumes.

    To put it more simply and concisely… this Larry Summers that you’re talking about sounds great. But the challenge is to convince people that it’s the Larry Summers they’re actually going to get if he takes the reins.

    • I’m no economist either and you’ve certainly made a good case for your argument.

      Let me just make a few points. As I noted, supporting CFMA and opposing Brooksley Born doesn’t equate to opposing any and all regulation of derivatives indeed we would expect 2007 to revise his beliefs.

      While we may question his beliefs on monetary policy, I’m almost sure the smaller fiscal stimulus package was an error of politics. However, all said and done, it is not the NEC’s job to involve itself with such.

      Your point is well-taken, but I wanted to highlight the side of Larry Summers that very few people, DeLong included, have discussed.

      By the way, I might add Larry Summers’ position on Kyoto was wrong. There is no other way to put it. I fundamentally disagree with his earlier view that harming the domestic economy (whatever that means) is grounds to exempt the world’s largest emitter absolutely and per capita from groundbreaking international protocol. But he is coming around on that, and it is irrelevant to his agency as a central banker (though, in this particular case, speaks poorly of his analysis).

      I wouldn’t say Summers was ahead on “the theoretical curve”. I think a better phrase might be the “ideal” Larry versus the “practical” Larry. Theoretical economics, of course, involves crazy assumptions and a lot of math. Larry Summers’ 1991 discussion was very frank, atheoretical, practical, and prescient.

      Furthermore, in his capacity as a Fed Chair, I do think Summers has more legroom to operate at his ideal, a luxury absent in his previous political appointments.

      • The Kyoto thing grinds my gears too, as does his alleged statement to Gray Davis during the 2000-2001 CA energy crisis that the problem was CA’s environmental regulations, not market manipulation, but I’m trying to leave those aside as not directly relevant to him being Fed chair.

        The “ideal” vs “practical” is probably a better way to put it. And in fairness to Summers, in politics you never get to be your ideal self, and fact is, we have a lot more of “practical” Larry to judge than many other people. If you’re around political power with considerable influence for a long time, like Summers, there’s probably going to be something in your record for people to hate on. On the other hand, if we had Bernanke’s record as Fed chief to judge his first appointment on, our expectations would probably be different, but in 2006, most of what we had was academic work. All that said, it’s still understandable that people are thinking, wait, haven’t I been on this ride before?

  2. Aziz said:

    There is no evidence that Gramm-Leach-Bliley (the repeal of Glass-Steagall) was the cause of the recent crisis

    There’s no evidence that it caused the crisis, but it is definitional that the banking structure that existed at the time was shaped by Gramm-Leach-Bliley (i.e. “supermarket” financers engaging in depository banking, underwriting, brokering, advising clients, prop trading, etc). And what made the banks too big to fail? Their structure — when the market tanked, deposits were threatened, and so they were bailed out to protect depository funds. It’s possible that without Gramm-Leach-Bliley we could have had a crisis much like LTCM in 1998 where the crisis was contained.

    This paper convinces me that Larry Summers was well-ahead of the curve in a way more respectable than just guessing a random crisis (like Steve Keen).

    Steve Keen did not “guess a random crisis”. He used Minsky’s work to anticipate a debt-deflationary deleveraging crisis stemming from the rising debt load and rising debt service costs. The financial crisis stemming from the bursting shadow banking bubble was itself not part of his model, but the broader effects of that crisis were exactly in his model. It’s fashionable in the blogosphere to hate on Keen these days, but from reading his work I consider his predictions — based on the ideas of Minsky, Fisher and Keynes — an accurate description of what later occurred.

    And, if Summers really held the conviction that:

    It is probably now easier to lever assets than ever before and the combination of reduced transactions costs and new markets in derivative securities make it easier than it has been in the past for the illusion of universal liquidity to take hold. Asset price bubbles are now as likely as they have ever been. Bubbles eventually burst. The increased speed with which information diffuses and the increased use of quantitative-rule- based trading strategies make it likely that they will burst more quickly today than they have in the past.

    Then why did he engage in deregulatory activities that he must have known made a Kindlebergerian crisis — stemming from the “illusion of universal liquidity — more likely?

    • You’re right about Keen. My comment here was wrong, and I’ve edited the post to reflect this.

      As far as TBTF is concerned the kind of bailouts we experienced was institutionalized as far back as 1985 when the Cleveland Branch explicitly recognized this in a report. So the excessive risk taking may well have persisted.

      There is also a case to be made suggested all too rarely that GLB softened the blow of this crisis. What if JP Morgan wasn’t legally allowed to purchase Bear Stearns, or Bank of America purchase Merril Lynch?

      The scale of subsidy would have to be larger in this case, and contagion would have been more rapid.

      You definitely recall that I don’t support bailouts and it’s where myself and Summers (along with most everybody else in the mainstream) disagree.

      In my post I discussed why Summers may have engaged in the activity he warned about here. Note that this at least suggests he has the intellectual framework required to update his priors in response to 2007 correctly. This 2010 report tells me he did:

      • Al said:

        The link doesn’t seem to work anymore. However, Summer’s ability to assess matters ex-post isn’t particularly relevant to a title that demands real time decisions, otherwise known as a job. Even if the next potential crisis follows the same shape as the last, a strong Fed chairman must overcome personal biases and institutional pressures at relevant moments. That is difference between academia and practice. It’s why MBA professors shouldn’t necessarily manage 401Ks.

        Also, your comment about Brooksley Born suggests that you seriously overestimate the radicalness of her efforts. Reading the CFTC’s concept paper–the one that triggered the backlash from Greenspan/Rubin/Summers–it’s difficult to spot the “blunt” transformative proposals:

        “The Commission emphasized that it is mindful of the industry’s need to retain flexibility permitting growth and innovation, as well as the need for legal certainty. The release does not in any way alter the current status of any instrument or transaction under the Commodity Exchange Act. All currently applicable exemptions, interpretations and policy statements issued by the Commission remain in effect, and market participants may continue to rely on them. Any proposed regulatory modifications resulting from the concept release would be subject to rulemaking procedures, including public comment, and any changes that imposed new regulatory obligations or restrictions would be applied prospectively only.”

  3. Watch out for those storm clouds over your parade!

    Could you explain how the ability (after 1999) of a holding company to own both a depository and an underwriting bank, whose balance sheets have to be kept separate, and/or the ability of one person to sit on the boards of both types of institutions simultaneously, made a Kindlebergerian crisis more likely?

    Because that’s all Gramm, Leach, Bliley did–repealed sections 20 and 32 of the Banking Act of 1933. Sections 16 and 21–which define commercial and investment banks, and separate them–are still the law. As is the FDIC, the other major part of ‘Glass-Steagall’.

    And even if #16 and 21 had been repealed, since they were all about corporate securities, not mortgage backed securities (in which depository institutions were never prohibited from dealing), how would that have changed anything?

    If Brooksley Born’s power grab had succeeded, and the CFTB got to oversee interest rate swaps and currency swaps–credit default swaps were virtually unknown in 2000–rather than the banking and securities regulators, what would she have done that would have made a difference?

    • I assume you’re replying to John Aziz because we seem to agree on this point.

      In any case, see my reply to John above.

  4. Pingback: Assorted links

  5. ralph said:

    Ashok, I very much enjoyed your review of his early paper. I cannot but argue that, while Summers has said and written quite a few intelligent and subtle things that are very good, he has not **very strenuously acted** on those beliefs in any position that we know of — this is, I take it, the core of the point about the practical Larry and the ideal Larry. We have, instead, tons of “priors” given to us by paper after memo after book that Larry’s published beliefs do not tend to stand up when he is in a job context with power involved. In fact, there’s plenty of evidence to suggest that his active philosophy is to bend analysis toward the desires of power.

    In this, I do not suggest that he is evil, or any such thing: Had I another choice, I would vote for someone quite to the left of Obama — but I don’t. Larry would likely be far better than many others. But the real priors, I suggest, are the actions and stated opinions we now know of from the times he was working. These still do not directly speak to the role of regulation, but the Born evidence alone is reasonably telling. I just think you’re misapprehending the real priors. :-)

    Great post, however, because of all the close reading, strong argumentation, and the result for people who want to think about it. Thanks!

  6. ralph said:

    And, for an a propos quote from today to make the point again: “Bernanke is a great case in point where his conduct as Fed chair has been much more similar to his remarks in Fed meetings as a Fed governor than to his published writing as a Princeton professor. For better or for worse practical experience with the institution tempered his ideas.”
    :-) How would you construct your priors to account for this? :-)

    • Yep, that’s a great point. His writing and hand-wringing to Japan suggested far more aggressive action.

  7. Andy said:

    There’s not that much difference between capital and equity. The Tier 1 capital calculation mostly consists of taking out risky/intangible items from shareholder equity and is almost always lower than equity.

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