Hat tip to Arnold Kling for pointing out the return of Scott Sumner to the blogosphere in the form of his contribution to the ongoing food fight over the role of the GSEs (the public-private hybrids FNMA AKA “Fannie Mae” and the Federal Home Loan Mortgage Corporation AKA “Freddie Mac”) in creating the financial crisis. Why food fight? See this post from Tyler Cowen for a flavor of the argument, esp. see the appearance of prominent financial blogger Barry Ritholtz in the comments of Tyler’s post, chiding Tyler for having gone over to the Dark Side.

There’s lots of good insight in Dr. Sumner’s post and I commend it to your attention. See especially the first two graphs in the post, the first of housing starts per million population and the second of bank losses, real GDP, and CPI cost of living. Of the second Dr. Sumner writes:

I see three separate crises. A “misallocation of resources into housing crisis,” a “federal bailout of banks crisis,” and a high unemployment crisis. Who’s to blame for each?

followed by his interpretations.

I don’t have a great deal to add to this but I’ll supply a few minor observations. First, the market for housing has multiple different components and the components behave differently. Among these components are “buy and hold” (people who buy houses and live in them more than five years), hybrid owner/speculators (people who buy houses, live in them for a shorter period, and then move on), and speculators (those who buy houses to resell them for a profit). The long period, illustrated in the first chart, of housing start increases without a serious decline, undoubtedly encouraged a lot of people to go into the second two classifications. Some, maybe many, of those have been wrung out by the decline in housing prices and the increased difficulty in securing credit.

I think the most likely way to interpret that graph is that interest rates stayed too low for too long, a signal failure of policy on the part of the Fed.

I don’t really have a dog in the GSE fight. I think there are plenty of reasons to dislike the GSEs, corruption being the greatest. However, between the two warring camps (GSEs caused the financial crisis/no they didn’t) those who take the former position have yet to make the case that the GSEs were both necessary and sufficient for the financial crisis. IMO there’s a better case that Chinese trade policy coupled with Chinese monetary policy were both the necessary and sufficient for the crisis, given human nature.

At any rate I think that the problems with our economy go back much, much farther than the last ten years and the financial crisis, like an injury to the body, has revealed weaknesses that were there all along.

The graph above is from a post at FT Alphaville that Tyler Cowen has characterized as “the most important blog post in the world today”. From the post:

The financial crisis had a lot to do with triple-A ratings being slapped on to subprime securities which didn’t warrant them, we know that. The report says between 1990 and 2006 ABS accounted for 64 per cent of the total growth in the amount of AAA-rated fixed income, compared with 27 per cent attributable to the growth in public debt, 2 per cent to corporate and 8 per cent to other products.

But watch what starts happening from 2008 and 2009.

The AAA bubble re-inflates and suddenly sovereign debt becomes the major force driving the world’s triple-A supply. The turmoil of 2008 shunted some investors from ABS into safer sovereign debt, it’s true. But you also had a plethora of incoming bank regulation to purposefully herd investors towards holding more government bonds, plus a glut of central bank liquidity facilities accepting government IOUs as collateral. Where ABS dissipated, sovereign debt stood in to fill the gap. And more.

Felix Salmon interprets the enormous growth in AAA bonds:

The big-picture thing to remember when looking at this chart is something which I’ve said many times before — that it wasn’t an excess of greed and speculation which led to the financial crisis, but rather an excess of overcaution, with an attendant surge in demand for triple-A-rated bonds. On a micro level, triple-A securities are safer than any other securities. But on a macro level, they’re much more dangerous, precisely because they’re considered risk-free. They breed complacency and regulatory arbitrage, and they are a key ingredient in the cause of all big crises, which is leverage.

Yves Smith is contemptuous of that explanation:

Now anyone who had read the Financial Times in 2006-early 2007 or was in the credit markets then would know that this statement, “it wasn’t an excess of greed and speculation which led to the financial crisis, but rather an excess of overcaution” is demonstrably counterfactual. All you had to do was look at the spreads for risky assets. There was a simply astonishing compression between the yields of perceived-to-be-risk-free assets, such as Treasuries and their toxic counterfeits, the AAA rated tranches of CDOs and CLOs, and risky assets, like the lower-rated tranches of the same bonds, as well as junk bonds. If there was “overcaution” you would have seen a wide spread between AAA bonds and lesser-rated bonds.

But to Felix’s point, demand for AAA paper was robust. But that was not the result of caution; two big drivers of demand (particularly for “manufactured” AAA paper, the kind created by structured credit legerdemain, was as repo to serve as collateral for OTC derivatives positions, and for bonus gaming. In the 1980s, the ONLY acceptable collateral for repo was Treasuries; that started expanding as time went on to other AAA rated assets (and even lower rated assets, but the haircuts were significant).

[…]

I have a sneaking suspicion that while derivatives outstandings took a hit in the crisis, between a rise in risk aversion and a concerted effort in credit default swaps land to reduce the notional amount outstanding by netting out offsetting positions, that the old pattern of derivatives outstanding growing more rapidly than the economy has resumed. And now that no one is terribly interested in using AAA rated CDOs as collateral for repo, Treasuries are probably even more important as repo collateral than they were before the meltdown.

A second, significant demand for AAA rated paper was structured credit product creators uncharacteristically eating their own cooking because it enabled them to game their firms’ bonus systems. If you hedged an AAA instrument with a credit default swap from a high rated counterparty, Basel II allowed firms to treat it as having no capital requirement (and there was considerable latitude in the rules as to how much or little hedging was necessary to achieve this happy outcome). US banks in theory had analogous capital weightings, but their higher funding costs for this sort of activity and less permissive treatment of the hedges meant they didn’t do this sort of trade in anywhere near the same volume (save at Merrill, which engaged in accounting chicanery).

The net effect of these so-called negative basis trades were to allow the trading desks to credit FUTURE income (often years into the future), namely, the yield on the instrument less the funging and hedge costs, discounted to the present and was credited to the desk’s P&L. Nothin’ like getting paid on income never to be earned.

I see this as very compatible with Arnold Kling’s reaction:

The nonfinancial sector wants to issue risky long-term liabilities and to hold safe short-term assets. The financial sector accommodates this by doing the opposite. But sometimes the financial sector gets too big. The financial crisis was a signal that the financial sector needed to shrink.

It didn’t.

Assuming the facts of the graph are correct, I see several possible interpretations:

1. There’s an enormous volume of legitimate AAA bonds out there.
2. In response to the financial crisis governments have borrowed a lot of money to offset the decline in asset-based securities and it’s legitimately rated AAA.
3. Like good courtiers the ratings agencies have continued to grant AAA ratings to government debt whether it warrants it or not, cf. Moody’s recent threat to downgrade the U. S. The party will go on for a good, long time.
4. Borrowing will soon become much more expensive.
5. Yves Smith’s explanation.
6. Some other explanation (if you’ve got one please supply it in the comments).

Or some combination. Tyler Cowen summarizes the situation: “We weren’t as safe as we thought we were. And we still aren’t.”

Here’s a technology that I hadn’t heard of. It seems that Joule Unlimited has genetically engineered a cyanobacterium (they won’t say which one) that can produce liquid hydrocarbons from sunlight, air, and water. The water can be waste water, salt water, pretty much any water. The air should have plenty of carbon dioxide (something I’m told we have too much of). The hydrocarbons produced don’t have to be oil (as some other biofuel technologies produce). They could be ethanol, gasoline, or diesel. No refining required.

Joule has leased 1,200 acres of land in New Mexico for a pilot program:

In Massachusetts, Joule reported that they have signed a lease for 1,200 acres in Lea County, New Mexico, with the potential to scale the project up to 5,000 acres for production of renewable diesel and ethanol directly from sunlight and waste CO2.

The agreement with Lea County is the first to be completed as part of Joule’s production facility siting program. Joule stated that Lea County meets their production requirements, including high solar insolation, access to non-potable water and waste CO2. In addition, Joule could benefit from $19 million in state incentives to facilitate operations at commercial scale.

What’s their target for costs?

“At full-scale production, Joule expects to deliver diesel and ethanol for as little as $20/bble and $0.60/gallon respectively, including current subsidies,” the company now says.

Whoa…wasn’t that $30 per barrel diesel, before? Did Joule just drop its costs by 33 percent? Sure ‘nuf.

A peer reviewed article in Photosynthesis Research has confirmed JU’s potential to produce 15,000 gallons per acre per year. Let’s see. Just for fun let’s assume they can achieve 10% of that. 1,500 gallons per acre X 1,200 acres is 1.8 million gallons per year. The U. S. uses something like 10 million barrels per day. 42 gallons per barrel, 365 days per year… Sounds doable to me.

This is a technology worth keeping tabs on. Potentially game-changing.

There an old article on this technology here.

Hat tip: Tigerhawk

Les Hinton, publisher of the Wall Street Journal and CEO of Dow Jones & Co., has resigned:

Rupert Murdoch accepted the resignations of The Wall Street Journal’s publisher and the chief of his British operations on Friday as the once-defiant media mogul struggled to control an escalating phone hacking scandal with apologies to the public and the family of a murdered schoolgirl.

The scandal has knocked billions off the value of Murdoch’s News Corp., scuttled his ambitions to take control of a lucrative satellite TV company, withered his political power in Britain – and is threatening to destabilize his globe-spanning empire.

The controversy claimed its first Murdoch executive in the United States as Les Hinton, chief executive of the Murdoch-owned Dow Jones & Co. and publisher of the Wall Street Journal, announced he was resigning with immediate effect.

Murdoch’s British lieutenant, Rebekah Brooks, stepped down earlier Friday.

Hinton had worked for Murdoch’s News Corp. for 52 years, since he was 15 years of age, before stepping down. He is considered one of Rupert Murdoch’s staunchest supporters and closest allies. If Hinton is being thrown under the bus, I can only interpret it as a sign that Murdoch himself and his son, James, are at risk.

Update

The resignation letters are here.

I’ve frequently pointed out, here and elsewhere, that a good deal of past Soviet and present Chinese economic growth resulted from transferring relatively unproductive agricultural labor to manufacturing. In the middle of the 20th century the Soviet economy was the marvel of the world just as the Chinese economy is now and much of its economic growth was for just that reason. The Soviets had the aggravating problem that they did not increase agricultural production while they did it as the Chinese have. A key problem with this strategy is that eventually the process of transition ends. Then what?

How much of American economic growth during the second half of the 20th century was for a similar reason? Unlike the North the American South had large numbers of small farms and even subsistence agricultural right into the 1960s. Rather than examine the multiple reasons for the transition I think I’ll just leave it as a question.

How great a role did the resurgence of the South in the second half of the 20th century play in total U. S. post-war growth?

From a Japanese McDonald’s ad. Hat tip: dustbury who sees an aversion to clowns in it.

The rainbow frog, last seen by European explorers 87 years ago, has been found and photographed for the first time:

Called the Sambas stream toad or Bornean rainbow toad, the elusive amphibian was last spotted by European explorers in 1924.

The toad has unusually long limbs and a pebbly back covered with bright red, green, yellow, and purple warts.

Like many other colorful amphibians, the toxic toad’s appearance is likely a warning to potential predators, said Robin Moore, an amphibian expert with Conservation International.

“You can see the skin is rough, which usually indicates the presence of poison glands,” Moore said.

“You probably don’t want to put this in your mouth.”

Putting it in my mouth was certainly my first reaction.

I urge you to read Carmen Reinhart and Kenneth Rogoff’s op-ed at Bloomberg:

Those who remain unconvinced that rising debt levels pose a risk to growth should ask themselves why, historically, levels of debt of more than 90 percent of GDP are relatively rare and those exceeding 120 percent are extremely rare (see attached chart 2 for U.S. public debt since 1790). Is it because generations of politicians failed to realize that they could have kept spending without risk? Or, more likely, is it because at some point, even advanced economies hit a ceiling where the pressure of rising borrowing costs forces policy makers to increase tax rates and cut government spending, sometimes precipitously, and sometimes in conjunction with inflation and financial repression (which is also a tax)?

As I mentioned earlier today I don’t care about the debt ceiling. As far as I’m concerned it should be abolished entirely. I do care about the debt. I think it’s practically and morally heinous. It is a tax on the future, on future generations. We’re still paying off the debts incurred during the Spanish-American War.

I don’t know whether I’ve mentioned it before but the first time I viewed the opening credits to Monty Python’s Flying Circus, nearly forty years ago now, I’d had a few drinks and was seriously concerned that I was hallucinating. I felt a bit like that when I read this article:

Despite the obesity epidemic, North Carolina Democratic Sen. Kay Hagan, Wisconsin Democratic Rep. Tammy Baldwin, and Academy Award-winning actress Geena Davis are pushing legislation to encourage the media to produce healthier images of women.

They say women and girls feel overly pressured to be thin.

The trio convened with teenage Girl Scouts Wednesday to promote their bill, the Healthy Media for Youth Act, which would facilitate research on how the media affects women, create a grant program for youth empowerment groups, and establish a National Taskforce on Women and Girls in the Media to set standards ”that promote healthy, balanced, and positive images of girls and women.”

“Children are consuming more media than ever, but unfortunately, the images they see often reinforce gender stereotypes, emphasize unrealistic body images or show women in passive roles. The need for more positive images of girls in the media is clear,” said Baldwin. “I’m proud to sponsor legislation that will help girls and young women see themselves in a new and stronger light.”

One of my former business partner’s many witticisms I think of as a sort of reverse-Voltaire: “I agree with what you say but I deny to the death your right to say it.”. I completely agree that television and movies should portray more realistic images of women. Does a 6′ tall former underwear model who weighed between 120 and 130 lbs. at the height of her career really make a good standard bearer for such a cause?

With age and childbirth she has, understandably, put on a little weight. Promoting healthy body images for women in the media at this point sounds like a career move as much as a deeply held conviction.