Will Next Time Be Different?

 

by Raghuram Rajan   Tweet

CHICAGO – Carmen Reinhart and Kenneth Rogoff, in their excellent, eponymous book on debt crises, argue that the most dangerous words in any language are “This time is different.” Perhaps the next most dangerous words are “Next time will be different.”

These words are often uttered when politicians and central banks want to bail out some troubled segment of the economy. “Yes,” one can almost hear them saying, “we understand that bailing out banks will subvert market discipline. But you cannot expect us to stand by and watch the system collapse, causing millions of innocent people to suffer.

We have to live with the hand we are dealt. But next time will be different.” They then use every tool they have to prevent economic losses on their watch.

The government’s incentives are clear. The public rewards them for dealing with the problem at hand – whether building levees to protect houses built on a flood plain or rescuing banks that have dodgy securities on their balance sheets. Politicians and central bankers gain little by letting the greedy or careless face the full consequences of their actions, for many innocent people would suffer as well.

A sympathetic press would amplify their heart-rending stories of lost jobs and homes, making those counseling against intervention appear callous. Democracies are necessarily soft-hearted, whereas markets and nature are not; government inevitably expands to fill the gap.

To the extent that the rough justice meted out by markets or nature teaches anyone to behave better, it has consequences far beyond the horizon of anyone in power today. When asked to choose between the risk of being known to posterity as the central banker who let the system collapse and the intangible future benefits of teaching risk takers a lesson, it does not take genius to predict the central banker’s decision.

Democracy tends to institutionalize moral hazard in sectors that are economically or politically important, such as finance or real estate, allowing them to privatize gains and socialize losses.

Even though the authorities insist that the next time will be different, everyone knows that they will make the same decision when confronted with the same choice again.

So, knowing that next time will not be different, the authorities try their best to prevent a “next time.” But risk takers have every incentive to try their luck again, knowing that, at worst, they will be bailed out. In this cat-and-mouse game, risk takers have the upper hand.

For one thing, risk takers are typically small, cohesive interest groups that, once rescued, have a powerful incentive, as well as the resources, to buy the political influence needed to ensure a return to the status quo ante. If risk takers were allowed to face more serious losses, they would have fewer resources to fight political attempts to constrain their risky activities.

Moreover, the public does not have a long memory, a long time horizon, or an appetite for detail. Even as the United States’ voluminous Dodd-Frank bill tried to ensure that bankers never subjected American taxpayers to undue risk again, public attention had moved on to the state of the real economy and unemployment.

Why focus on financial regulation when the risks of an immediate collapse are small, and when the details are so tedious? As technical experts and lobbyists took over, and the public lost interest, Dodd-Frank became friendlier and friendlier to the banks.

So how can this one-way betting be stopped? The scary answer may be that it does not end until governments run out of money (as in Ireland) or the public runs out of sympathy (as in Germany vis-à-vis the rest of Europe).

To avoid that fate, governments should start by recognizing that the system is programmed to respond to deep distress, and that they can do nothing about it. But they must try to ensure that they do not destroy incentives by doing too much. And they must offset the distortions created by intervention in other ways.

For example, the US Federal Reserve has essentially guaranteed the financial sector that if it gets into trouble, ultra-low interest rates will be maintained (at the expense of savers) until the sector recovers.

In the early to mid-1990’s, rates were kept low because of banks’ real-estate problems. They were slashed again in 2001 and kept ultra-low after the dot-com bust. And they have been ultra-low since 2008. Senior Fed policymakers deny that their interest-rate policy bears any responsibility for risk taking, but there is much evidence to the contrary.

It would be difficult for the Fed to respond differently if the financial sector gets into trouble again. But it does not have to maintain ultra-low interest rates after the crisis has passed, especially if those rates have little impact on generating sustainable economic activity. Doing so merely rewards banks for their past excesses – and taxes savers.

More importantly, if the Fed wants to restore incentives for risk takers and savers, it should offset the effects of staying “low for long” in bad times by increasing interest rates more rapidly than is strictly necessary as the economy recovers.

This will, of course, be politically difficult, because the public has been programmed to think that ultra-low rates are good, and higher rates bad, for growth, without any consideration for the long-term sustainability of growth.

Finally, the pressure on governments to intervene would be lower if individuals had access to a minimum safety net.

Official US policy is so activist in downturns (regardless of its effectiveness) partly because unemployment is so costly to workers – who have little savings, unemployment benefits that run out quickly, and health care that is often tied to a job.

A stronger safety net for individuals might allow politicians to accept more corporate or financial-sector distress, and help bolster their claim that next time really will be different.

Raghuram Rajan, a former chief economist of the IMF, is Professor of Finance at the University of Chicago and the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.

Can Asia go it alone?

By ANDREW LEE  andrewlee@thestar.com.my


Tweet

Asia Alone: The Dangerous Post-Crisis Divide from America
Author: Simon S.C. Tay
Publisher: John Wiley & Sons

OVER the past three years, we have seen a shocking decline in Western supremacy. The 2008 financial crisis brought about the collapse of Lehman Brothers, once a symbol of Wall Street arrogance. The eurozone is having trouble raising funds due to a lack of confidence in its stability. America is having trouble convincing its own people that they are able to rebound from this decline, let alone the rest of the world. Lest we forget, many Western powers are still involved in the war in Afghanistan that looks no closer to an end than in 2001.

It seems that there has been a shift in the global balance of power towards the east, with countries like China and India fast gaining influence in political and, more importantly, economical issues worldwide. However, despite bringing wealth and success to parts of the world that have long been neglected by the West in the past (Africa, South America and Asean for instance), their rise has brought about a new problem it could lead to a siege mentality, a method of thought motivated similarly by the ridiculous “with us or against us” phrase coined by George Bush during the War on Terror.

In fact, it is not difficult to see how Asian countries might come to such a conclusion. In Simon S.C. Tay's latest book, Asia Alone: The Dangerous Post-Crisis Divide from America, he argues that some of America's policies just before and immediately after September 11 have served to alienate many countries in the East, who now look to China and India for inspiration and growth instead of their long-time partner.

In addition to the negligence of America, Tay also states a growing togetherness among Asian countries (notably the Asean countries) in the final decade of the 20th century chiefly to create more opportunities and to combat Western arrogance and economic control. For instance, Dr Mahathir Mohamad is often remembered for his controversial policies, good and bad, the effects of which are still felt in Malaysia today.


However, at times, it is easy to forget that he often waged a one-man war against Western post-imperialism first by insisting on using Japan as a model of economic growth, and more importantly, by learning to say no to the International Monetary Fund (IMF) bailout plan in 1998.

The destruction of Indonesian and Thai societies brought about by their acceptance of the IMF bailout, and Malaysia's subsequent recovery proved that the Western way is not always the best, and that Asian countries do indeed have other options available to them economically.

Another theme of Tay's book is American arrogance he states many examples, from the bombing of the Chinese embassy in Kosovo to bloodshed in the Middle East and Afghanistan.

However, perhaps the two symbols of American arrogance most relevant to this book take place, once again, in South-East Asia.



Al Gore's snub of Malaysian hospitality in Kuala Lumpur during Anwar's imprisonment and the “sight of IMF president Michael Camdessus, standing imperiously, arms folded, while President Suharto of Indonesia bowed and signed papers to accept IMF terms” goes to show further how America believed that, politically and economically, their methods were the best.

The once popular notion of the United States being the champions of the free world was beginning to erode to be replaced by the image of that of a bully, preying on the weak. It seemed for a moment that, during the Asian Financial Crisis and the war in Iraq, Asia burned and the one country with the capability to help decided to turn a blind eye.

Numerous books have been written on the rise of China and India as superpowers, so I will not dwell on it here. What can be said is that their rise has added more belief that Asia is able to go alone. Many barriers still exist to cooperation, not least socially, as many Asian countries still hold historical grudges.

Yet, the feeling is that somehow, we are more dependent on one another than ever before. It would be wise to thread carefully though. Despite bringing about a wealth of opportunities for the East, those who champion China's cause as the new global superpower should note alarmingly that, in the past, all competition between rising powers and the undisputed leaders at the time have led to armed conflict. In reality, China's ascent to superpower status is still highly dependent on American decline than it is on its own growth.

In November 2009, a little over a year after the fall of Lehman Brothers, President Obama visited Japan. In addition to calling himself America's first Pacific President', this time it was the President of the United States who bowed in respect to an Asian leader. If America indeed lost Asia over the last decade, it has signalled its intentions to regain its trust. The question is whether or not it is a trust worth having.

Obama says he was bullied at school

Tweet

US President Barack Obama is pictured during an event to prevent bullying in the East Room of the White House in Washington, March 10, 2011. [Photo/Agencies]

WASHINGTON - President Barack Obama smiled when he said his large ears and funny name once made him a target of school-yard harassment. But he was all seriousness Thursday when he told a White House conference on bullying that torment and intimidation must not be tolerated.

School bullying is not a rite of passage for youth, Obama said on Thursday as part of an initiative to change the way Americans perceive the dangerous behavior.

President Obama shared his own experience with bullying as a child.

"I have to say, with big ears and the name that I have, I wasn't immune," he said to laughter. "I didn't emerge unscathed."

Obama and first lady Michelle Obama addressed school administrators, teachers and parents at a White House conference on bullying prevention, where they launched the website stopbullying.gov.

Speaking as a parent and as a victim, Obama urged everyone to help end bullying by working to create an atmosphere at school where children feel safe and feel like they belong.

"If there's one goal of this conference, it's to dispel the myth that bullying is just a harmless rite of passage or an inevitable part of growing up," Obama said. "Bullying can have destructive consequences for our young people."

"As parents, it breaks our hearts to think that any child feels afraid every day in the classroom, or on the playground, or even online," Michelle Obama said.

The conference highlighted public-private partnerships to address bullying, including initiatives by Facebook and the MTV music channel.

Some 13 million students, about a third of all those attending school, are bullied every year, the White House said. Experts say that puts them at greater risk of falling behind in their studies, abusing drugs or alcohol, or suffering mental or other health problems. Kids who are seen as different because of their race, clothes, disability or sexual orientation are more likely to be bullied.

US President Barack Obama and first lady Michelle Obama thank participants in an event on prevent bullying in the East Room of the White House in Washington, March 10, 2011.[Photo/Agencies]

US President Barack Obama speaks at the Conference on Bullying Prevention as first lady Michelle Obama listens in the East Room at the White House in Washington, March 10, 2011. [Photo/Agencies]