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World Economy: That Sinking Feeling
Stan Persky, The Tyee
"One might have thought," says Joseph Stiglitz, near the beginning of Freefall, "that with the crisis of 2008, the debate over market fundamentalism -- the notion that unfettered markets by themselves can ensure economic prosperity and growth -- would be over. One might have thought that no one ever again -- or at least until memories of this crisis have receded into the distant past -- would argue that markets are self-correcting and that we can rely on the self-interested behaviour of market participants to ensure that everything works well."

...Summing it up, Stiglitz charges that "America's financial markets had failed to perform their essential societal functions of managing risk, allocating capital and mobilizing savings, while keeping transaction costs low. Instead, they had created risk, misallocated capital and encouraged excessive indebtedness while imposing high transaction costs."

The high transaction costs made for ballooning profits and instant multi-million-dollar bonus compensation for the money managers.

"At their peak in 2007," notes Stiglitz, "the bloated financial markets absorbed 41 per cent of profits in the corporate sector." That's a number worth thinking about. It's a reminder that in the midst of all the razmatazz, the economic system wasn't making money from making things, but making profit by moving money around (often, imaginary money).

While the details of the story are fascinating, the fiscal innovations downright exotic, and Stiglitz's telling of the tale engrossing, there's something more going on here, and the shrewder observers, like Stiglitz, Paul Krugman, and Nouriel Roubini are quick to see it.

"The current crisis," says Stiglitz, "has uncovered fundamental flaws in the capitalist system, or at least the peculiar version of capitalism that emerged in the latter part of the twentieth century in the United States...
(14 July 2010)
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Extend and Pretend: The Russian doll version
ilargi, the automatic earth
The US government is looking at possible solutions for the mess that Fannie Mae and Freddie Mac have long since become. There is, however, no solution available. Period. Simple as that. The government has dug itself into a hole when it comes to mortgages and mortgage-based securities that it cannot find a way out of.

If the government had any sense left, it would get out of the mortgage market by, let's say, yesterday morning. Take apart Freddie, Fannie and Ginnie Mae, along with the Federal Housing Administration, sell off all of their assets at whatever price is being offered (if any), and be done with it already.

But the government has no such sense. It will instead elect to insert more layers of Russian dolls, one after the other, to maintain the illusion that domestic real estate has some actual intrinsic value left. And sure, yes, this does make some sense, if you look at the situation in just the right sort of light.

Selling off all mortgage related assets would have a number of highly predictable consequences. First and foremost, housing prices would plunge like nothing you've ever seen. This would have happened slowly and in a more orderly fashion years ago if not for government guarantees for every dollar spent by homebuyers. Because of these guarantees, those same homebuyers have spent twice as many, if not more, dollars on their home purchases...
(26 July 2010)

Why were resources expunged from neo-classical economics?
Martin Wolf, Financial Times
Something strange happened to economics about a century ago. In moving from classical to neo-classical economics — the dominant academic school today — economists expunged land — or natural resources. Neo-classical value theory — based on marginalism and subjective valuation — still makes a great deal of sense. Expunging natural resources from the way economists think about the world does not.

In classical economics, land, labour and capital were the three factors of production. With neo-classical economics, the standard production function had just two factors of production: capital and labour. Land — by which we mean the totality of natural resources — was then incorporated into capital.

All thinking about the world involves a degree of abstraction. Economics has taken this principle further than any other social science. This is a fruitful intellectual procedure. But it is also risky. The necessary process of abstraction may end up leaving essential aspects of the world out of the analysis. That can be intellectually crippling. I believe that that is exactly what has happened, in this case.

The idea that land and capital are the same thing is evidently ludicrous. It requires us to believe that the economic machine is self-sustaining — a sort of perpetual motion machine.
(12 July 2010)