Niall Ferguson: On Davos and Keynes

1 post / 0 new
sendow's picture
Status: Member (Offline)
Joined: Jul 30 2008
Posts: 1
Niall Ferguson: On Davos and Keynes

Niall Ferguson, whose "The Ascent of Money" recently aired on PBS, has a column in LA Times questioning the collective delusion that he is observing.,0,6972232.column


Niall Ferguson
February 6, 2009

It began as a subprime surprise, became a credit crunch and then a
global financial crisis. At last week's World Economic Forum in Davos,
Switzerland, Russia and China blamed America, everyone blamed the
bankers, and the bankers blamed you and me. From where I sat, the
majority of the attendees were stuck in the Great Repression: deeply
anxious but fundamentally in denial about the nature and magnitude of
the problem.

foretold the bottom of the recession by the middle of this year. Others
claimed that India and China would be the engines of recovery. But
mostly the wise and powerful had decided to trust that John Maynard
Keynes would save us all.

I heard almost no criticism of the
$819-billion stimulus package making its way through Congress. The
general assumption seemed to be that practically any kind of government
expenditure would be beneficial -- and the bigger the resulting deficit
the better.

There is something desperate about the way economists are clinging to
their dogeared copies of Keynes' "General Theory." Uneasily aware that
their discipline almost entirely failed to anticipate the current
crisis, they seem to be regressing to macroeconomic childhood,
clutching the Keynesian "multiplier effect" -- which holds that a
dollar spent by the government begets more than a dollar's worth of
additional economic output -- like an old teddy bear.

need to grow up and face the harsh reality: The Western world is
suffering a crisis of excessive indebtedness. Governments, corporations
and households are groaning under unprecedented debt burdens. Average
household debt has reached 141% of disposable income in the United
States and 177% in Britain. Worst of all are the banks. Some of the
best-known names in American and European finance have liabilities 40,
60 or even 100 times the amount of their capital.

delusion that a crisis of excess debt can be solved by creating more
debt is at the heart of the Great Repression. Yet that is precisely
what most governments propose to do.

United States could end up running a deficit of more than 10% of GDP
this year (adding the cost of the stimulus package to the Congressional
Budget Office's optimistic 8.3% forecast). Nor is that all. Last year,
the Bush administration committed $7.8 trillion to bailout schemes, in
the form of loans, investments and guarantees.

Now the talk is
of a new "bad bank" to buy the toxic assets that the Troubled Asset
Relief Program couldn't cure. No one seems to have noticed that there
already is a "bad bank." It is called the Federal Reserve System, and
its balance sheet has grown from just over $900 billion to more than $2
trillion since this crisis began, partly as a result of purchases of
undisclosed assets from banks.

Just how much more toxic waste is out there? New York University economistNouriel
Roubini puts U.S. banks' projected losses from bad loans and securities
at $1.8 trillion. Even if that estimate is 40% too high, the banks'
capital will still be wiped out. And all this is before any account is
taken of the unfunded liabilities of the Medicare and Social Security
systems. With the economy contracting at a fast clip, we are on the eve
of a public-debt explosion. And similar measures are being taken around
the world.

The born-again Keynesians seem to have forgotten
that their prescription stood the best chance of working in a more or
less closed economy. But this is a globalized world, where
uncoordinated profligacy by national governments is more likely to
generate bond-market and currency-market volatility than a return to

There is a better way to go: in the opposite direction. The aim must be not to increase debt but to reduce it.

used to happen in one of two ways. If, say, Argentina had an
excessively large domestic debt, denominated in Argentine currency, it
could be inflated away -- Argentina just printed more money. If it were
an external debt, the government defaulted and forced the creditors to
accept less.

Today, America is Argentina. Europe is Argentina.
Former investment banks and ordinary households are Argentina. But it
will not be so easy for us to inflate away our debts. The deflationary
pressures unleashed by the financial crisis are too strong -- consumer
prices in the U.S. have been falling for three consecutive months. Nor
is default quite the same for banks and households as it is for
governments. Understandably, monetary authorities are anxious to avoid
mass bankruptcies of banks and households, not least because of the
downward spiral caused by distress sales.

So what can we do?
First, banks that are de facto insolvent need to be restructured, not
nationalized.(The last thing the U.S. needs is to have all of its banks
run like Amtrak or, worse, the IRS.) Bank shareholders will have to
face that they have lost their money. Too bad; they should have kept a
more vigilant eye on the people running their banks. Government will
take control in return for a substantial recapitalization, but only
after losses have been meaningfully written down. Those who hold the
banks' debt, the bondholders, may have to accept a debt-for-equity swap
or a 20% "haircut" -- a disappointment, but nothing compared with the
losses suffered when Lehman Bros. went under.

life-support for dinosaur banks should not and must not impede the
formation of new banks by the private sector. It is vital that state
control does not give the old, moribund banks an unfair advantage. So
recapitalization must be a once-only event, with no enduring government
guarantees or subsidies. And there should be a clear timetable for
"re-privatization" -- within, say, 10 years.

The second step we
must take is a generalized conversion of American mortgages to lower
interest rates and longer maturities. About 2.3 million U.S. households
face foreclosure. That number is certain to rise as more
adjustable-rate mortgages reset, driving perhaps 8 million more
households into foreclosure and causing home prices to drop further.
Few of those affected have any realistic prospect of refinancing at
more affordable rates. So, once again, what is needed is state

Purists say this would violate the sanctity of
the contract. But there are times when the public interest requires us
to honor the rule of law in the breach. Repeatedly in the course of the
19th century, governments changed the terms of bonds that they issued
through a process known as "conversion." A bond with a 5% return was
simply exchanged for one with a 3% return, to take account of falling
market rates and prices. Such procedures were seldom stigmatized as

Another objection to such a procedure is that it
would reward the imprudent. But moral hazard only really matters if bad
behavior is likely to be repeated, and risky adjustable-rate mortgages
aren't coming back soon.

The issue, then, becomes one of fairness: Why help the imprudent when the prudent are struggling too?

solution would be for the government-controlled mortgage lenders and
guarantors, Fannie Mae and Freddie Mac, to offer all borrowers --
including those with fixed rates -- the same deal. Permanently lower
monthly payments for a majority of U.S. households almost certainly
would do more to stimulate consumer confidence than all the provisions
of the stimulus package, including tax cuts.

No doubt those
who lost by such measures would not suffer in silence. But the benefits
would surely outweigh the costs to bank shareholders, bank bondholders
and the owners of mortgage-backed securities.

Winston Churchill once remarked, will always do the right thing --
after they have exhausted all other alternatives. If we are still
waiting for Keynes to save us when Davos comes around next year, it may
well be too late. Only a Great Restructuring can end the Great
Repression. It needs to happen soon.

Niall Ferguson is a
professor at Harvard University and Harvard Business School, a Fellow
of Jesus College, Oxford, and a senior fellow of the Hoover
Institution. His latest book is "The Ascent of Money: A Financial
History of the World."


Login or Register to post comments