The term "inflection point" has become one of those overused bits of meaningless jargon in political discourse.  I'm rather more fond of the notion of a "focal point" -- that is to say, an event or cluster of events in which everyone that cares about a particular problem focuses on the same set of stylized facts -- after which, they conclude that, gee, maybe the status quo set of policies ain't working so well and there should be a new status quo. 

The fall of 2008 was one such focal point, during which there was remarkable consensus that a Keynesian boost in public spending was the only way to avert another Great Depression.  At the fiirst G-20 leaders summit in  Washington, there was consensus on expansionary fiscal policy.  Oh, sure, there were grumblings about "crass Keynesianism," but even Germany reluctantly went along. 

The Greek sovereign debt crisis was another such focal point.  Greek profligacy seemed to be a synecdoche for excessive government borrowing and lax fiscal discipline.  With the global economy seemingly still in the doldrums, a lot of Europrean governments climbed on the "expansionary austerity" bandwagon.  By the Toronto G-20 summit in June 2010, the consensus had switched from Keynesian stimulus to fiscal rectitude.  Oh, sure there were mutterings about "short-term austerity makes no macroeconomic sense whatsoever in a slack economy" but even Barack Obama started talking about slashing government spending. 

Are we at another focal point?  Consider the following:

1)  According to the New York Times' Stephen Castle, European leaders now seem to recognize that austerity on its own ain't working: 

Bowing to mounting evidence that  austerity alone cannot solve the debt crisis, European leaders are expected to conclude  this week that what the debt-laden, sclerotic countries of the Continent need are a dose of economic growth.

A draft of the European Union summit meeting communiqué calls for ‘‘growth-friendly consolidation and job-friendly growth,’’ an indication that European leaders  have come to realize that austerity measures, like those being put in countries like Greece and Italy,  risk stoking a recession and plunging fragile economies into a  downward spiral.

2)  The data is starting to come in on governments that have embraced austerity whole-heartedly, and it's pretty grim.  Cue Paul Krugman on Great Britain:

Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.

Nor is Britain unique. Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.

And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.

3)  Even commentators who would be tempermentally sympathetic with austerity are starting to bash Germany question whether it's a solution.  Consider Walter Russell Mead: 

It takes some truly talented screw ups to come up with a worse plan for Greece than the one the Greeks have developed for themselves, but the Germans have risen to occasion in fine form....

Deep reform is needed if Greece is to stay in the euro, and so far the Greek political establishment — firmly backed by public opinion — is digging in its heels.  Much whining, much talk, many promises and precious little action seems to be the favored Greek approach to the crisis.  On the other hand, the austerity policies the Germans favor are hopelessly biased in favor of German banking interests and are aimed more at the preservation of the reputations of German politicians than at helping Greece.

The German political establishment seems willing to destroy Europe to avoid telling German voters the truth about how stupid it has been. 

[UPDATE:  For exhibit B of this trend, see this Niall Ferguson interview with Henry Blodget.  My favorite part of the interview is this quotation:  "I think the reason that I was off on that was that I hadn't actually thought hard enough about my own work.... My considered and changed view is that the U.S. can carry a higher debt to GDP ratio than I think I had in mind 2 or 3 years ago."]

4)  U.S. 4th quarter data reveals that, consistent with GOP criticisms, the government has been the real drag on the U.S. economy.  Not quite consistent with GOP criticisms:  the reason why the government is dragging down the U.S. economy.  Cue Mark Thoma: 

[P]remature austerity -- cutting spending before the economy is ready for it -- is taking a toll on the recovery. The fall in government spending reduced fourth-quarter growth by 0.93 percent; if government spending had remained constant, GDP growth would have been 3.7 percent, rather than 2.8 percent. 

This is the opposite of what the government should be doing to support the recovery. We need a temporary increase in government spending to increase demand and employment through, for example, building infrastructure. That would help to get us out of the deep hole we are in. Instead, the government seems to be trying to make it harder to escape.

We do need to address our long-run budget problems once the economy is healthy enough to withstand the tax increases and program cuts that will be required. But the idea of "expansionary" austerity has failed. Austerity in the short-term simply makes it harder for the economy to recover and delays the day when you can finally address budget issues without harming the economy. The lesson is that government needs to support the recovery, not oppose it through a false promise that contraction of one sector in the economy will be expansionary.

5)  Central banks are acting more gung-ho on expansionary monetary policy.  The unspoken quid pro quo in Europe seems to the that the ECB will expand its balance sheet and turn on the monetary taps in return for some kind of fiscal compact.  The U.S. Federal Reserve announced a zero-interest rate policy for the next three years.  Even China is showing (halting) signs that its reverted back to monetary easing. 

Given that the United States has been the country to move the slowest on austerity, and given that the United States is doing the best job among the OECD economies (an admittedly low bar) of restoring confidence among investors and paying down non-governmental debt, have we reached another focal point? 

One could argue that Krugman and Thoma are just biased in favor of Keynesianism, that Greece and the other Club Med countries haven't really embraced austerity, that the Euromess is dragging down British economic growth, and that the long-term numbers on developed country debt are really very scary.  There are some large grains of truth in many of those statements. 

It doesn't necessarily matter, however.  Greece was not a genuine harbinger of the fiscal problems of large markets -- but it was a useful hook for austerity advocates to spread their gospel.  What matters now is not whether these perceptions about the failure of austerity are 100% accurate, but whether they are accurate enough to become the new conventional wisdom. 

What do you think? 

I swear, I wasn't going to watch tonight's CNBC debate on economic policy.  I'd had a long day, I was tired, and Wednesday night at the Drezners we watch The Middle and Modern Family.  But since neither of those shows were on the air tonight, I switched over to the debate. 

Oops. 

While Rick Perry's major league gaffe will command all the headlines, I thought the most reealing answers were given to the first question of the night -- what to do about Italy?  Here are the responses of the co-frontrunners:

HERMAN CAIN:  "There's not a lot that the United States can directly do for Italy right now, because they have -- they're really way beyond the point of return that we -- we as the United States can save them."

MITT ROMNEY:  "Well, Europe is able to take care of their own problems. We don't want to step in and try and bail out their banks and bail out their governments. They have the capacity to deal with that themselves."

The responses by Ron Paul, Rick Perry and Jon Huntsman were similar in tone and content. 

Now, philosophically, there's a logic to these answers, avoiding moral hazard and all.  But recall how earlier this week conservatives were castigating Barack Obama for giving Western Europe the cold shoulder?  I believe Michael Goldfarb phrased it as a problem of Obama "abandoning allies." 

I raise this because, if the eurozone actually did need American help, the response by the GOP candidates for president would be to... abandon America's allies.

One of Richard Nixon's saltier lines on foreign economic policy was, "I don't give a f**k about the lira."  I think it's safe to say that the current GOP doesn't give a f**k about the euro. 

The National Journal's Jim Tankersley frames this exactly right:

Europe’s problems should absolutely terrify anyone who cares about the American economy; its sovereign debts could infect banks around the world, potentially triggering a new wave of financial crisis, and a European recession would drag on already slow U.S. growth.

But the candidates who assembled at the CNBC debate in Detroit treated those threats as a far-away nuisance, like famine in Africa or an earthquake in Mongolia: very serious, very sad, not our problem....

It’s stunning that a Republican field that includes a former ambassador, a former House speaker and two successful former businessmen – and which, to a candidate, gushed over the virtues of markets throughout the debate – so casually brushed aside the struggles of the world’s largest collective economy (the Eurozone is bigger, economically, than the United States) and America’s largest trading partner.

You don’t have to believe America should bail out Italy, Greece or the entire Eurozone – a straw-man concept that no one in Washington is even floating, but several candidates took pains to denounce on Wednesday night – to recognize that the United States has a role to play in averting another global financial crisis. At the very least, you should expect lawmakers, and presidential candidates, to be making plans for how to respond if the European crisis escalates.

There were no such plans to be found on the debate stage on Wednesday.

Indeed. 

You humble blogger has been skeptical but not dismissive of the Occupy Wall Street phenomenon.  My general assessment was that it did reflect ongoing frustrations about trendlines in the American and global economy, but that in all likelihood the decisions of a few banking bureaucrats would have more of an effect than these protests. 

As I've noted before, the big problem with networked movements of this kind is what happens over time: 

What happens when the coalition of like-minded individuals stop being of like mind? These sorts of protests can be very powerful on single-issue questions where a single policy change is desired. Maintaining this level of activism to affect the ongoing quotidian grubbiness of politics, however, is a far more difficult undertaking. Even if people can be mobilized behind the concept of "Policy X is Stupid!" getting the same consensus on "Policy Y is the Answer!" is harder. Over time, these kind of mass movements have an excellent chance of withering away or fracturing from within. See, for example, the Tahrir Square movement in Egypt.

Another thing, and this is important: unless the people in these movements actually vote in elections, then their agenda will be thwarted in the long run. Even if these kinds of networked movements are new, the political imperative to get elected and re-elected is not. If they don't vote, then officials have a pretty powerful incentive to curry favor with the people who do vote, don't take to the streets and don't like these young whippersnappers with their interwebs have different policy preferences.

I bring this up because n+1 relays some of the internal deliberations among the Occupy Wall Streeters.*  Let's take a peek, shall we? 

Friends, mediation with the drummers has been called off. It has gone on for more than 2 weeks and it has reached a dead end. The drummers formed a working group called Pulse and agreed to 2 hrs/day at times during the mediation, and more recently that changed to 4 hrs/day. It’s my feeling that we may have a fighting chance with the community board if we could indeed limit drumming and loud instrumentation to 12-2 PM and 4-6 PM, however that isn’t what’s happening.

Last night the drumming was near continuous until 10:30 PM at night. Today it began again at 11 AM. The drummers are fighting among themselves, there is no cohesive group. There is one assemblage called Pulse that organized most of the drummers into a group and went to GA for formal recognition and with a proposal.

Unfortunately there is one individual who is NOT a drummer but who claims to speak for the drummers who has been a deeply disruptive force, attacking the drumming rep during the GA and derailing his proposal, and disrupting the community board meeting, as well as the OWS community relations meeting. She has also created strife and divisions within the POC caucus, calling many members who are not ‘on her side’ “Uncle Tom”, “the 1%”, “Barbie” “not Palestinian enough” “Wall Street politicians” “not black enough” “sell-outs”, etc. People have been documenting her disruptions, and her campaign of misinformation, and instigations. She also has a documented history online of defamatory, divisive and disruptive behavior within the LGBT (esp. transgender) communities. Her disruptions have made it hard to have constructive conversations and productive resolutions to conflicts in a variety of forums in the past several days.

At this point we have lost the support of allies in the Community Board and the state senator and city electeds who have been fighting the city to stave off our eviction, get us toilets, etc. On Tuesday there is a Community Board vote, which will be packed with media cameras and community members with real grievances. We have sadly demonstrated to them that we are unable to collectively 1) keep our space and surrounding areas clean and sanitary, 2) keep the park safe, 3) deal with internal conflict and enforce the Good Neighbor Policy that was passed by the General Assembly.

This description sounded faintly familiar, and then I remembered -- it was a replay of every dorm meeting I attended when I was a first-year in college. 

Don't worry, OWS sympathizers -- a few hours after this was posted, there was the following update: 

Crisis averted: tonight at the General Assembly, the working group of drummers, Pulse, in a spirit of conciliation and generosity, brought forward a proposal to limit their drumming from 12 to 2 and 4 to 6 PM only. The proposal had been worked out through weeks of mediation with the direct action working group. It was considered a first step toward showing the community board that the community in Zuccotti Park can regulate itself. The proposal was approved by consensus by the General Assembly, with applause and rejoicing on all sides.

Good on OWS for resolving some conflict, but this little window into their internal deliberations suggest the hard limits on their movement.  If the transaction costs of  regulating drumming are this massive, I'm extremely dubious about their ability to agree on concrete policy proposals and articulate them effectively to anyone outside their band of sympathizers -- especially since I'm not sure that all of their views will resonate within the mainstream of American public opinion. 

Am I missing anything? 

*I confess that part of me is still wondering if this is satire. 

While Occupy Wall Street has been garnering many headlines with outrage about the financial sector, the Bank of International Settlements just released a paper that's likely to have more actual impact on said financial sector.  The paper is an effort to estimate the costs and benefits from requiring global systemically important banks (G-SIB's) to increase their capital buffers.  From the executive summary: 

[R]aising capital requirements on the top 30 potential G-SIBs by 1 percentage point over eight years leads to only a modest slowdown in growth. GDP falls to a level 0.06% below its baseline forecast, followed by a recovery. This represents an additional drag on growth of less than 0.01 percentage points per year during the phase-in period. The primary driver of this macroeconomic impact is an increase of lending spreads of 5-6 basis points. Soon after implementation is complete, growth is forecast to be somewhat faster than trend until GDP returns to its baseline. The aggregate figures conceal significant differences across countries, which reflect differences in the role of G-SIBs in the domestic financial system and in current levels of bank capital buffers. International spillovers are also important, and in some countries are likely to be the dominant source of macroeconomic effects.

The overall results are robust to variations in key assumptions. Using a longer list of banks, scaling by assets rather than lending, shortening the implementation period, or limiting the ability of authorities to offset slower growth with monetary or macroprudential policy were all found to increase the growth impact, but not markedly.

What will be the effect of the full package of the Basel Committee's proposals for stronger capital requirements - the set of buffers that will be required of all banks under Basel III, combined with the additional buffers to be carried by G-SIBs? The impact of the Basel III proposals, using the end-2009 global capital levels as a starting point, was calculated by the MAG [Macroeconomic Assessment Group] in 2010. On top of this, we assume for illustrative purposes that the top 30 G-SIBs will need to raise their capital ratios by an additional 2 percentage points, and that both parts of the reform are implemented over eight years. Adding together these two components, we find that the impact is again quite small, with GDP at the point of peak impact forecast to have fallen 0.34% relative to its baseline level. Roughly 0.04 percentage points are subtracted from annual growth during this period, while lending spreads rise by around 31 basis points. As before, different assumptions lead to different effects, with faster implementation or a weaker monetary policy response increasing the impact on GDP.

The benefits of the G-SIB framework relate primarily to the reduction in the exposure of the financial system to systemic crises that can have long-lasting effects on the economy. The LEI estimated the benefits of Basel III by multiplying the degree to which it reduces the annual probability of a systemic crisis, by an estimate of the overall cost of a typical crisis in terms of lost output. Drawing on the [Basel Committee Long-term Economic Impact Study's] results, the MAG estimated that raising capital ratios on G-SIBs could produce an annual benefit in the order of 0.5% of GDP, while the Basel III and G-SIB proposals combined contribute an annual benefit of up to 2.5% of GDP - many times the costs of the reforms in terms of temporarily slower annual growth.

Let me just translate how the BIS would put this to a lay audience:

Hey, you know how Jaime Dimon and all the other bankers who contribute to the Institute for International Finance, American Bankers Association, and Financial Services Forum keep saying that raising their capital requirement is "anti-American" and will lead to catastrophic economic consequences?  Yeah, well, they don't know what the f**k they're talking about.  Raising their capital requirements causes a extremely small dip in expected growth -- and by small we mean less than one tenth of one percent of GDP.  This is massively outweighed by preventing the expected lost output that would result from recessions triggered by another financial crisis. 

Now, it's not terribly surprising that global regulators will say that they're right and the banks are wrong.  One would expect that the interest group power of Wall Street, however, would have the upper hand.  What is surprising, as the Wall Street Journal's Sara Schaefer Munoz notes, is that the banks seem to be losing their battle with regulators:

The tug-of-war between banks and regulators over post-crisis financial rules has so far moved in the watchdogs' favor with banks largely failing to upend the tougher proposals in the U.S. and Europe....

Even before Monday's report, regulators didn't seem responsive to the industry's arguments. In the U.S., lawmakers have already determined that the country's big banks must hold more capital, but haven't yet specified how much.

The Dodd-Frank financial overhaul law, enacted more than a year ago, mandated many new restrictions on banks but left it to regulatory agencies to write the rules. Wall Street and the financial industry have spent millions of dollars lobbying to shape the rules, with little success so far.

They lost in their efforts to block new limits on the fees they can charge merchants when consumers use debit cards. Regulators are expected to vote Tuesday to issue a proposed "Volcker Rule," a part of the Dodd-Frank law designed to curtail trading activities at bank. Now they appear likely to fail in their efforts to block or water down a rule requiring them to hold extra capital.

In 2010, securities and investment firms spent a record $101.6 million on lobbying, up from $92.3 million in 2009, according to the Center for Responsive Politics. Through early October 2011, the firms had shelled out $49.5 million.

There are plenty of ways in which large banks can continue to fight the suggested rules, particularly on the implementation side.  Still, this is not how open economy politics traditionally works.  Traditionally, bank preferences are communicated to national governments, which then get expressed in BIS/Basle Committee meetings.  This certainly happened in the actual Basel III negotiations.   This kind of back and forth, in which regulators appear to trump the arguments of the financial sector, is highly unusual. 

I confidently predict that this post will not generate the kind of comments that, say, an Occupy Wall Street post has in the past week.  That's kind of a tragedy, because this ongoing tug of war between the BIS and IIF will likely have more far-reaching consequences than anything those protestors achieve. 

Developing....

I was fortunate enough to give a talk at my alma mater over the weekend and chat informally with some of the political science undergraduates over some food from an Indian restaurant that didn't exist when I was in school and I can't believe how much greater their range of ethnic food choices are than when I was in school and their life is great and college life was much tougher back in my day while we broke bread. Inevitably, the question of Occupy Wall Street came up and whether it would go anywhere.

Now, in many ways, this phenomenon has many of the features of networked movements that have been at the center of The Slaughter-Drezner Debates (although in this case Slaughter seems a bit more disdainful of the movement's potential). If you read here or here or here, you'll see all the advantages of a networked structure outlined in painstaking detail. This ragtag group of rebels has managed to get coverage on The Daily Show, generate associated online movements like the "We Are the 99%" Tumblr, generate headlines through mass arrests over the weekend, and inspire similar movements in other cities.

So … what did I say to these impressionable young adults?

I said two things. First, I said the moment was ripe for this kind of movement. You have an ample supply of network technologies to start a movement, and rising economic inequality to create the necessary social purpose for such a movement. Indeed, the surprising thing about Occupy Wall Street isn't that it's happening -- it's that it took three years for it to happen.

The other thing I said was that for this group to generate more than a thousand people or so out in the streets, however, their message has to resonate culturally with people who would otherwise not want to go out onto the streets. And here's where I start to be a bit more skeptical. I'm not sure the latest manifesto is really cogent enough -- beyond a rejection of corporations as we know them -- to generate much sympathy with broad swaths of the American people. And, as I've said before, unless you attract people who vote, this kind of thing will generate news coverage and not much else.

Could they attract a larger crowd? After reading Time's Nate Rawlings, I'm skeptical:

While "Occupy Wall Street" has become more organized, its demands haven't coalesced into a coherent message. The only thing its various constituent groups appear to have in common is a deep-seated anger at inequality in this country. For them Wall Street symbolizes that unfairness, but the groups have other concerns as well. Many want to redistribute wealth; others want to enlarge government social programs. Some are protesting against the wars in Iraq and Afghanistan. Daniel Levine, a journalism student from upstate New York, said he was taking a stand against the controversial method of natural gas extraction known as hydrofracking in his hometown – but also noted that the practice can bring jobs to economically disadvantaged regions.

Just as it lacks a single message, the "Occupy Wall Street" movement has been defined by the absence of a clear leader. Participants say that is by design, and point to the committees that have sprung up to tend to the daily needs of those camped in Zuccotti Park. It isn't clear that they want a single leader, and many think the movement is better of[f] without one. “It's kind of cool how it's growing organically,” one said. “People just need to give it time and it'll come together.”

Maybe, over time, that will happen. There's a political paradox, however, that Occupy Wall Street faces. Without clear and coherent demands, there will be little to inspire ordinary citizens to take to the streets. Articulating clear and coherent demands, however, will destroy the very gestalt that the people currently on the streets seem to like some much.

Still, unions have started to come out in support of this movement. The U.S. economy is in a bad way, and the festering eurocrisis could make it really bad. So maybe external conditions will eliminate this paradox for the protesters.

So that's what I think. What do you think?

I was pretty dismissive of Standard & Poor's debt downgrade last month.  Re-reading that post, I stand by my political analysis of events going forward.  Furthermore, the recovery of U.S. equity markets, the sharp reduction of yields on U.S. debt, and the failure of the other ratings agencies to follow suit are further data points suggesting that the S&P decision was flawed. 

There's reality and perceptions of reality, however.  On that latter front, after a recent expedition to Washington, I've concluded that regardless of whether S&P was right, they've won the argument in terms of perception.  The summer debt debacle is, in many ways, the political equivalent of Hurricane Katrina.  Perceptions of the Bush administration never recovered from that event, even though one could plausibly argue that the policy outputs of Bush's second term were better than the first term.  Neverthelesss, Katrina was an inflection point that has caused a number of actors to reassess their perceptions about the political and policy competency of the White House and Congress. 

Something similar seems to have happened with the debt deal.  Politico's Ben White relays the dramatic effect on consumer confidence: 

The Conference Board this week reported the biggest monthly decline in consumer confidence since the height of the financial crisis in 2008, its consumer confidence index falling from a reading of 59.2 to 44.5, the lowest in two years....

“The debt ceiling negotiation is an extremely significant event that is profoundly and sharply reshaping views of the economy and the federal government,” Republican pollster Bill McInturff wrote in a presentation of survey work he has done recently that suggests the debt ceiling debate has led to a significant shift in public opinion.

The partisan struggle over raising the debt went on for weeks before Obama finally announced on the night of Aug. 1 that a deal had been reached that resolves the issue for now. But while Washington has moved on to its next drama — the deliberations of the so-called supercommittee agreed to in the deal — its psychological impact has resonated widely.

McInturff said the result has been “a scary erosion in confidence” in both the economy and the government “at a time when this steep drop in confidence can be least afforded. … The perception of how Washington handled the debt ceiling negotiation led to an immediate collapse of confidence in government and all the major players, including President Obama and Republicans in Congress.”

A recent Washington Post poll found that 33 percent of Americans have confidence in Obama to make good decisions on the economy and just 18 percent have confidence in Congressional Republicans to do so.

These are especially dangerous readings when Federal Reserve Chairman Ben Bernanke has essentially said it is up to politicians to help boost the economy now that the Fed has fired nearly all its monetary policy bullets.

Speaking of Bernanke, he had this to say at Jackson Hole last week: 

[P]erhaps most challenging, the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses. Although details would have to be negotiated, fiscal policymakers could consider developing a more effective process that sets clear and transparent budget goals, together with budget mechanisms to establish the credibility of those goals.

Ten days before Bernanke's speech, FP's Josh Rogin reported that Secretary of State Hillary Clinton had acknowledged the global ramifications of the debt fracas, telling a forum at National Defense University: 

I happened to be in Hong Kong a few weeks ago, and I said confidently that we were going to resolve this; we were not going to default; we would make some kind of political compromise.

But I have to tell you, it does cast a pall over our ability to project the kind of security interests that are in America’s interest. This is not about the Defense Department or the State Department or USAID. This is about the United States of America. And we need to have a responsible conversation about how we are going to prepare ourselves for the future

Clinton's statements were confirmed by officials I talked to while down in DC. 

So, can this perception be changed?  Here, I'm bearish in the short-term.  These kind of perceptions can be self-fulfilling.  Economic growth is a remarkable political palliative, but growth looks anemic for a good long while.  The Obama administration can try to change the narrative, but that's almost as difficult as Inception -- for the same reasons: 

As Reinhart and Rogoff have observed, the economic aftereffects of debt crises are long-lasting.  From here on out, the political effects of such crises will be on full display. 

As someone who studies global political economy, this is fascinating.  As a U.S. citizen, this is utterly depressing. 

[WARNING:  THE FOLLOWING IS A VERY PESSIMISTIC GLOBAL POLITICAL ECONOMY POST] 

So, just to sum up the past week or so of global political economy events: 

1)  U.S. government debt got downgraded by Standard & Poor;

2) Global equity markets are freaking out;

3) The eurozone appears to be unable to solve its sovereign debt problem

4) London Britain is burning;

5) The Chinese are pissed that they appear to be underwriting downgraded, debt-ridden train-wrecks... and this is on top of being pissed about their own train wrecks.

This all sounds very 2008, except that it's actually worse for several reasons. First, the governments that bailed out the financial sector are now themselves the object of financial panic and political resentment. Second, the tools used to try and rescue the global economy in 2008 are partially to blame for what's happening right now. Despite all the gnashing of teeth about the Fed twiddling its thumbs, it's far from clear that a QE3 would actually stimulate anything besides a rise in commodity prices.

With both Europe and the United States unable to stimulate their economies, and China seemingly paralyzed into indecision, it's worth asking if we are about to experience a Creditanstalt moment.

The start of the Great Depression is commonly assumed to be the October 1929 stock market crash in the United States. It didn't really become the Great Depression, however, unti 1931, when Austria's Creditanstalt bank desperately needed injections of capital. Essentially, neither France nor England were willing to help unless Germany honored its reparations payments, and the United States refused to help unless France and the UK repaid its World War I debts. Neither of these demands was terribly reasonable, and the result was a wave of bank failures that spread across Europe and the United States.

The particulars of the current sovereign debt crisis are somewhat different from Creditanstalt, and yet it's fascinating how smart people keep referring back to that ignoble moment. The big commonality is that while governments might recognize the virtues of a coordinated response to big crises, they are sufficiently constrained by domestic discontent to not do all that much.

So... is this 1931 all over again?

There are three aspects of the current situation that make me fret about this. The first is the sense that developed country governments have already tapped out all of their politically feasible methods of stimulating their economies. This is the time when both politicians and voters start to ask themselves, "Why not pursue the crazy idea?"

The second is whether the Chinese government will do something to satiate their nationalist constituency. Neither Joe Nye nor James Joyner thinks this is likely, and I tend to agree that any effort at economic coercion will hurt China as much as the United States. When autocrats are up against the wall, however, then they might take risks they otherwise would never consider.

The third is this working paper on what causes societal unrest in developed economies (h/t Henry Farrell). The abstract suggests more trouble on the way:

From the end of the Weimar Republic in Germany in the 1930s to anti-government demonstrations in Greece in 2010-11, austerity has tended to go hand in hand with politically motivated violence and social instability. In this paper, we assemble crosscountry evidence for the period 1919 to the present, and examine the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor.

So... there are, unfortunately, numerous reasons to think that we're headed down a bad road... which is the pretty much point of this post.

Readers are encouraged in the comments to offer counterarguments for why things aren't as bad as 1931. I'll be offering some thoughts about why 1931 won't happen again later in the week.

American politicians are super-mad at Standard & Poor's for downgrading U.S. debt even after the debtopocalypse was averted earlier this week.  These same politicians seem torn between pointing out that S&P  sucks at math and blaming the other political party for the S&P screw-up. 

I really don't care about that as much as the debate over whether S&P got its political analysis  right.  Here's the key paragraphs of the actual Standard & Poor statement: 

[T]he downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011....

Compared with previous projections, our revised base case scenario now assumes that the 2001 and 2003 tax cuts, due to expire by the end of 2012, remain in place. We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the act.

Felix Salmon, thinks that this analysis is spot on:   

[T]he US does not deserve a triple-A rating, and the reason has nothing whatsoever to do with its debt ratios. America’s ability to pay is neither here nor there: the problem is its willingness to pay. And there’s a serious constituency of powerful people in Congress who are perfectly willing and even eager to drive the US into default. The Tea Party is fully cognizant that it has been given a bazooka, and it’s just itching to pull the trigger. There’s no good reason to believe that won’t happen at some point.

David Weigel concludes that the S&P political analysis is fair:

This is not crazy.This what Republicans imply about the supercommittee -- they will not accept plans that increase taxes, and despite the fact that they've agreed to let the Bush tax cuts lapse on January 1, 2013, they are making noises about not accepting a return of the rates. The best possible scenario, if we assume that stance, is what I wrote about today -- tax reform plans that start in the supercommittee and win over a committed Congress.

Kevin Drum, however, thinks that S&P's political analysis is way off: 

S&P shouldn't be in the business of commenting on a country's political spats unless they've been going on so long that they're likely to have a real, concrete impact on the safety of a country's bonds. And that hasn't happened yet. There's no serious macroeconomic reason to think Americacan't service its debt and there's no serious political reason to think the Tea Party has anything close to the power to provoke a political meltdown in which wewon'tpay our debt....

[S&P]should care only about the safety of U.S. bonds, and for the moment anyway, there's no legitimate reason to think either that we can't pay or that we won't pay. The bond market, which has all the same information as S&P, continues to believe that U.S. debt is the safest in the world, and in this case the market is right. S&P should stop playing dumb political games and stick to its core business.

I side, mostly, with Drum.  It's totally fair for S&P to factor politics into their assessment of sovereign debt.  Indeed, a key trend in sovereign debt analysis over the past five years has been the recognition that political fundamentals can matter as much as economics.  That said, if ratings agencies are going to do this, then their political expectations can't just be retrospective -- they need to do some actual forecasting.  Instead, they looked at recent weeks and extrapolated into the future. 

There are three factors that should give S&P pause before assuming that political dysfunction could lead to no increae in tax revenue.  First, as Drum points out, despite all the displays of ideological inflexibility, in the end the debt ceiling vote secured a strong majority of the GOP House caucus.  Some Tea Party members were willing to risk a crisis, but not actually go and perpetuate one.  It was not a Great Moment in Democracy, but in the end a deal was done.  You can't dock for intransigence without noting the outcome. 

Second, unlike the debt ceiling, deadlock in late 2012 means that the Bush tax cuts expire.  Either a lame-duck Obama or a newly-re-elected Obama will be able to make that fiscal decision (no way any faction in Congress musters the 2/3 vote necessary to override).  As Jonathan Chait has repeatedly observed, that dynamic is the opposite of the debt ceiling episode, in which case paralysis led to bad fiscal outcomes.  If S&P thinks partisan gridlock will persist on Capitol Hill, then the conclusion to draw is that taxes will go up. 

Third -- and this is pretty important -- S&P has failed to observe the political aftereffects of the debt deal.  As I argued previously: 

[T]he thing about democracy is that it has multiple ways to constrain political stupidity and ideological overreach. The first line of defense is that politicians will have an electoral incentive to act in non-crazy ways in order to get re-elected. The second line of defense is that politicians or parties who violate the non-crazy rule fail to get re-elected. So, in some ways, the true test of the American system's ability to stave off failure will be the 2012 election.

The first line line of defense has been breached, but the second line of defense looks increasingly robust.  Public opinion poll after public opinion poll in the wake of the debt deal show the same thing -- everyone in Washington is unpopular, but Congress is really unpopular and GOP members of Congress are ridiculously unpopular.  At a minimum, S&P needs to calculate how the current members of Congress will react to rising anti-incumbent sentiment.  If they did that analysis and concluded that nothing would be done, I'd understand their thinking more.  I didn't see anything like that kind of political analysis in their statement, however.   

In the end, I suspect Moody's and Fitch won't follow S&P's move, so this could be a giant nothingburger.  Still, if these guys are going to be doing political risk analysis, it might help to actually have some political scientists on the payroll.  Based on their statement, S&P is simply extrapolating from the op-ed page, and that's a lousy way to make a political forecast. 

Am I missing anything? 

After last night's stunningly useless set of speeches, I'd put the odds of the U.S. not raising the debt ceiling by August 2nd at 1 in 2. Like many other observers, I'm finding it increasingly difficult to envision a deal that would get through the Senate while attracting a majority of House Republicans [You meant a majority of the House of Representatives, right?--ed. No, I meant a majority of House Republicans. I'm pretty sure that Boehner and the rest of the House GOP leadership will refuse to pass any debt ceiling plan that relies too much on House Democrats.]

So, it's gonna be a fun few weeks for those of us who study the global political economy. Let's start by thinking the unthinkable -- what will happen if there is a default?

I've expressed my feelings on the matter already, and I'm hardly the only one. That said, I've also hedged my bets been flummoxed by the lack of market reaction to the DC stalemate. The lack of market reaction to date has emboldened House GOP members to stand fast. Could they be right?

Tom Oatley, who pooh-poohed my fears of the debtpocalypse last week, makes an interesting point about the composition of U.S. debt-holders:

By these figures, about 63% of US government debt is owned by central banks (foreign and domestic) and/sovereign wealth funds. Most of these entities are American friends and allies. Another 4% is owned by US state and local governments. That leaves 33%--about $4.8 trillion--in private hands. Of this, the financial institutions with the most restrictive regulations regarding asset ownership (depository institutions) own only 2% of the total ($290 billion). Mutual Funds, who may or may not have to dump downgraded debt, hold another 9% ($1.35 trillion).

What's the point? The discussion about the impact of US default revolves around the market response to default. Useful to recognize that most of the US government debt is held by public-sector agents who are much less sensitive to balance sheet pressures and regulatory constraints. These public sector agents are also substantially more sensitive to "moral suasion" and direct appeal than private financial institutions. The structure of ownership of US debt might dampen the negative impact of any default that does occur.

This is pretty interesting. Oatley focuses on "moral suasion," but there's also a national-interest motive for many U.S. debtholders. Most of the official holders of U.S. debt have a strong incentive for a) the value of their holdings not to plummet; and b) the United States economy to continue to snap up other their exports. If China, for example, is buying up U.S. debt to sustain its own growth, then neither a technical default nor a ratings downgrade should deter China or other export engines from continuing to buy U.S. debt even if there's a spot of trouble.

So it appears that complex interdependence will force America's rivals to continue to hold U.S. debt even after the debtpocalypse!! The United States in the clear, right?

Not so fast. Here are five "known unknowns" I can think of that might complicate Oatley's analysis:

1) What if the creditors form a cartel? In my 2009 paper, this was the one scenario that gave me the heebie-jeebies, because it's the one scenario under which creditors can wring geopolitical gains from debtor states. Any kind of default can act as a focal point moment in which U.S. creditors decide it's time to apply a haircut to American power and influence.

I don't think this is going to happen, because the national interests of American debtholders remain divergent. That said, if U.S. allies interpret default as a signal of U.S. unreliability in times of crisis, then all bets are off.

2) What about the economic nationalism of China? China is the largest foreign debtholder, which gives it a certain agenda-setting power in moments of crisis. There are a lot of compelling reasons why China would decide to try to minimize the economic disruptions . On the other hand, there's a lot of resentment on Chinese Internet boards already about the Chinese purchases of U.S. debt. During a period in which the CCP is already concerned about domestic instability, one could envision a scenario whereby they try to mollify nationalists at home by acting out against the United States.

3) What would be the effect of a mild market reaction on the House of Representatives? The less the markets react, the less that the House GOP will feel a need to do anything. There will come a point, therefore, when official debtholders might need to signal to the House that, in IPE lingo, "s**t needs to get done." That signal would in and of itself roil markets, not to mention the effects the current uncertainty is already having on the real economy.

4) What is the fiscal shock from a default? There are two causal mechanisms through which a default could affect the global economy. The first is through panic and uncertainty roiling financial markets. The second, however, is from a dramatic fiscal contraction due to limited government spending. Given the lackluster state of the current recovery, it wouldn't take much to tip the United States back into recession.

5) What if there's another AAA bubble? FT Alphaville's Tracy Alloway provided another interesting chart earlier this month on the distribution of AAA securities:

As Alloway warns:

[W]atch 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.

It’s one reason why the sovereign crisis is well and truly painful.

It’s a global repricing of risk, again, but one that has the potential for a much largerpop, so to speak.

We know that a downgrade of U.S. Treasuries would likely lead to a downgrade of state and municipal bond ratings as well. We also know that the ripple effects from the collapse of asset-backed securities were much larger than anticipated before the 2008 crisis. This is why the possible knock-on effects of downgrade so many AAA asserts makes me itchy. Even if banks and other financial institutions have minimal exposure to U.S. Treasuries, I don't think it's possible for them to have minimal exposure to all U.S.-based AAA sovereign debt.

These are just the five known unknowns that I could think of in the past hour -- there are probably many, many more. Readers are strongly encouraged to add them in the comments.

Dear Chinese overlords alien visitors robot masters zombie hegemons post-apocalyptic historians: 

Greetings.  My goal in this message is to explain to you why the most powerful country in the world committed financial seppuku in the summer of 2011 AD*. 

To set the stage:  by now you know that the U.S. Congress was obligated to increase the debt ceiling in order for the United States government to continue to function normally.  President Obama, Democrats in Congress, and most of the Republican leadership recognized the gravity of the situation.  The GOP leadership, however, wanted to use the debt cekiling vote as leverage to get President Obama to commit to significant deficit reduction.  After much haggling over "grand bargains," there was a recognition that no such deal could be passed.  As a backup, leaders from both parties reluctantly advocated a bill that hiked the ceiling and put off questions about long-term deficit reduction to the future. 

The problem was, a political faction emerged that some called "debt kamikazes."  These were politicians and interest group leaders -- all Republicans -- who genuinely believed that nothing of consequence would happen if the debt ceiling wasn't raised.  There were a few others who did believe it and were nevertheless copacetic with that outcome -- I'll get to that group later. 

Sounds absurd to your futuristic ears, you say?  Consider my evidence. The Daily Beast's John Avlon detailed the position of the 2012 GOP presidential candidates:

Michele Bachmann believes it’s all a hoax. Tim Pawlenty told an Iowa crowd, “I hope and pray and believe they should not raise the debt ceiling.” Ron Paul based his first presidential ad on a call to not raise the debt ceiling, proclaiming “No Deals.”  And Rick Santorum has said that raising the debt ceiling should be avoided until a Balanced Budget Amendment to the Constitution is passed.... 

Even supposedly responsible Republican presidential candidates like Mitt Romney—whose campaign slogan might as well be ‘He’s the Sane One’—are finding it politically beneficial to flirt with debt-ceiling denial, announcing a ‘cut, cap and balance’ proposal without revenue increases as his ‘line in the sand’ for supporting raising the debt limit.

There were also interest group coalitions called "Tea Party" organizations that pressured their members of Congress not to raise the debt ceiling.  As CNN's Shannon Travis chonicled, these organizations believed that the effects of more government spending were far more disastrous than defaulting on the debt: 

What they're saying around the country is, "Do not raise the debt ceiling. It's that simple. It's time for Congress to get its fiscal house in order," Tea Party Patriots co-founder Jenny Beth Martin told CNN. The group is the nation's largest tea party organization.

Martin explained that her group's supporters want a balanced-budget amendment, significant spending cuts and lower taxes. And they don't want the debt limit raised.

Brendan Steinhauser, director of federal and state campaigns for the Washington-based FreedomWorks, explained that he and other activists understand the possible financial implications if the debt limit is not raised (emphasis added)

Similarly, Red State blogger Erick Erickson  wrote an open letter  to the House GOP that boiled down to "do not believe the doom and gloom." 

Now, future historians, you might argue that neither Tea Party activists nor presidential candidates (Bachmann excepted) were in Congress and therefore did not matter.  However, what's important to understand is that these views were prevalent inside the House GOP caucus as well.  The Washington Post's David A. Fahrenthold provided a detailed description of the members of the House of Representatives who thought a default wouldn't be such a big deal.  Rep. Mo Brooks (R-AL) offered the most extreme example of House GOP thinking:

As the Aug. 2 deadline looms, the debate over how to resolve the debt-ceiling crisis is being complicated by legislators such as Crawford who think the crisis is not as bad as it’s made out to be.

On Thursday, several House Republicans said they didn’t believe predictions that economic calamity would result from a missed deadline. That opinion — held despite a stream of warnings from both parties’ leaders — could make it difficult for the House to pass a debt-ceiling deal.

Rep. Mo Brooks (R-Ala.), another freshman, said that a much bigger fear was that raising the debt ceiling would enable Washington to spend itself into paralyzing debt in a few years.

“A debt-ceiling problem, as large as it is, is not anywhere near as a big or as bad as” that, Brooks said. If Aug. 2 arrives without a deal, Brooks said, the federal government could continue paying creditors. He said that a show of tough fiscal self-discipline could actually improve creditors’ confidence.

“There should be no default on August 2,” Brooks said. “In fact, our credit rating should be improved by not raising the debt ceiling.”  (emphasis added)

Lest you think the view that a default was not such a big deal was limited to backbenchers, Outside the Beltway's Steven Taylor found House Budget Chairman Paul Ryan telling CNBC that a "technical default" of a few days wouldn't be a big deal:

If a bondholder misses a payment for a day or two or three or four — what is more important is you are putting the govegnment in a materially better position to better pay its bills going forward.

Now, at this point, I'm sure you, future post-apocalyptic historians, must be scratching your third eye heads, thinking the following: 

WHY???!!! 

Why, why did these human beings maintain these beliefs in the face of massive evidence to the contrary?  Why did these people continue to insist that default wasn't that big a deal when Federal Reserve Chairman Benjamin Bernanke (a Republican first appointed by Republican president George W. Bush) insisted that there would be a "huge financial calamity" if the debt ceiling wasn't raised?  Why did their belief persist when Moody's, Standard & Poor's, and Fitch Ratings all explicitly and repeatedly warned of serious and expensive debt downgrades if the ceiling wasn't raised?  Why did they stick to their guns despite news reports detailing the link between the rating of federal government debt and the debt of states and municipalities?  Why did they stand firm despite the consensus of the Republican Governors Association and the Democrat Governors Association that a failure to raise the debnt cailing would be "catastrophic"?  Why did they refuse to yield despite bipartisan analysis explaining the very, very bad consequences of no agreement, and nonpartisan analysis explaining the horrific foreign policy consequences of American default?  Why did they not understand that even a technical default would cost hundreds of billions of dollars**, thereby making their stated goal of debt reduction even harder? 

Most mysteriously, why did these people throw their steering wheel out the window despite witnessing the effect of the 2008 Lehman Brothers collapse, which revealed the complex interconectedness of financial markets?  Treasuries were far more integral to global capital markets than Lehman, but the debt kamikazes refused to recognize the possibility that a technical debt default would have unanticipated, complex, and disastrous consequences.  Why? 

I would like to be able to offer you a definitive answer, I really would, but I can't.  The implications listed in the previous paraqgraph seemed pretty friggin' obvious to a lot contemporaneous observers at the time.  As near as I can determine, there are four partial explanations for why the debt kamikazes persisted in their belief that nothing serious would happen:  One explanation, which I've detailed here, is that the debt kamikazes refused to budge because refusing to budge had yielded great political rewards in the past. 

Another explanation is that the debt kamikazes convinced themselves that no possible alternative was worse than the federal government accumulating more debt.  They looked at countries like Greece and Portugal and decided that the U.S. was only one more Obama administration away from such strictures. 

A third explanation was the general erosion of trust in economic experts during this period.  To be fair to the debt kamikazes, many of the prominent policymakers who warned about calamities if the debt ceiling wasn't raised had pooh-poohed the effects of the housing bubble in 2005, or the collapse of that bubble in 2007. 

The final explanation goes back to those people who acknowledged that a default might be a big deal, but were nevertheless OK with the outcome.  These debt kamikazes had undergone a fundamental identity change.  That is to say, despite all their protestations to the contrary, they were no longer loyal Americans.  They were loyal to Republicans first and Republicans only.  Erick Erickson made this logic pretty clear in his open letter to Congress: 

Now is a time for choosing. Now is your time for choosing.As I pointed out to John Boehner yesterday, despite what the pundits in Washington are telling you, it is you and not Obama who hold most of the cards. Obama has a legacy to worry about. Should the United States lose its bond rating, it will be called the “Obama Depression”. Congress does not get pinned with this stuff.

As Outside the Beltway's Doug Mataconis explained in response: 

[I]n this quote above Erickson is clearly saying that he’d be okay with sending the economy into the tank by failing to raise the debt ceiling because he thinks it would benefit the Republican Party....

He’s perfectly fine with economic collapse because he thinks the President of the United States and the Democratic Party will take the blame, and the Republican Party will benefit. The economic pain that will be suffered by his fellow Americans is secondary, it seems, to the political gains he thinks can be made from throwing the nations economy over the brink. How is that different from someone else hoping that, say, the Iraq War had gone horribly wrong immediately before the 2004 elections because it would hurt the Bush Administration and the GOP?

The answer, of course, is that it isn’t. Willfully hoping that the country is harmed because it might potentially benefit your political party is perhaps the most cravenly partisan thing that anyone would ever wish. You are saying to your fellow citizens that you don’t care that something bad is about to happen because, in the end, it will mean that more Republicans will be elected. Frankly, I find it disgusting.

That's the best set of answers I can give you.  I'm sure, future post-aopocalytpic historians, that you have devised new and sophisticated methodologies to unearth the mysteries of the past.  I hope you can solve this historical puzzle -- because me and my contemporaries are thoroughly flummoxed.  

I wish you the best of luck, and once again, apologies for the whole collapse-of-Western-civilization-thing that happened in 2011.  Our bad. 

*To translate into your time scale, 15 B.B. (Before Lord Beiber, Praised Be His Hairness)

** 100 billion U.S. dollars = 15 BieberBucks

Your humble blogger has not been contributing to the Osama-a-thon here at FP blogging all that much, because he was busy being a moosehead attending the 2011 Estoril Conference.  Many Important topics were covered at this conference, including: 

1)  The eurozone crisis;

2)  The global governance crisis;

3)  The crisis in the Middle East;

4)  Other global security challenges;

5)  The life and times of Larry King. 

It was that kind of conclave. 

Actually, that really doesn't do it justice.  Here's a link to the opening video.  Even that doesn't do it justice -- the opening ceremonies featured a sporano suspended 50 feet in the air, a gospel choir, a drum corps, and what I can only assume are the backup dancers for Lady Gaga's music videos. 

For a rundown of what the Big Cheeses said at the conference, check out my Twitter feed.  The major substantive takeaway I got from the conference is that Portugal would like to do a serious hurt dance on Fitch, Moody's, and Standard & Poor.  Half of the conference presenters were Portuguese, and most of the audience was as well.  Here is a sampling of the questions the Portuguese asked anyone talking about anything remotely related to economics: 

"Why do the bond rating agencies still influence markets after they failed so badly in 2008?"

"Shouldn't the bond-rating agencies be punished for their malfeasance last decade?"

"Aren't the bond-rating agencies to blame for everything bad that has happened since 2008?"

"What do you think of the idea of creating a European standard-ratings agency?"

"Say, has anyone thought about taking the heads of the bond-rating agencies and putting them in a duffel bag?" 

OK, I made that last one up, but not the others. 

Obviously, the Portuguese have very good reasons to be stressed out.  And the bond-rating agencies deserrve an awful amount of flack.  Still, the idea that they -- and they alone -- triggered both the 2008 financial crisis and Europe's sovereign debt crisis is absurd.  They are far more the symptom than the cause of the crisis. 

More blogging after my eyes adjust to not seeing Lady Gaga's backup dancers everywhere I turn the weekend. 

The Troubled Assets Relief Program expired yesterday. I've blogged about how this program was both cost-effective and a pretty significant policy achievement. This appears to be the expert assessment as well. The Wall Street Journal's Deborah Solomon and Naftali Bendavid explain:

It will ultimately cost far less than the initial $700 billion price tag that stunned a nation. Major banks are profitable and can raise capital. Credit spreads -- a key measurement of risk -- are down to pre-crisis levels.

The White House now projects TARP will lose at most $50 billion, down from $105 billion projected earlier this year. Privately, Treasury Department officials say the U.S. may not lose a dime, and could ultimately make money depending on how some investments fare, in particular American International Group Inc. and General Motors Corp. In a $14 trillion economy, $50 billion is less than 1% of economic output.

"The incredible irony here is that TARP probably succeeded wildly beyond anybody's imagination," said Alan Blinder, a Princeton University economist who co-authored a paper crediting the administration's economic policies with preventing a second Great Depression. "Suppose the original TARP bill had been to spend $50 billion to avert a catastrophe. Would anyone have blinked?"

Or consider the Financial Times story by Tom Braithwaite:

[A]ll of the consequences have to be judged against late 2008 and early 2009 when fear stalked the markets and nationalisation of the biggest US banks looked a possibility.

Making a play on a famous MasterCard commercial, Mr [Lee] Sachs outlines what the country got in return for its investments in the banks. “Dividends? Five per cent. Equity warrants? Two per cent. The economy not turning into the second Great Depression? Priceless.”

Despite this fact, however, TARP is ridiculously unpopular with the American people. 

Oddly enough, this might be a very good thing, for two reasons. First, the likelihood that the latest financial reform bill will prevent a future financial crisis is exactly nil. There will be moments down the road when the financial sector will come crying to Washington.   

TARP's biggest problem, however, was that it badly exacerbated the moral hazard problem. If banks know that they are insured against catastrophe, this gives them an incentive to act in a more risk-loving manner to maximize profits -- thereby increasing the probability of a catastrophe. While this might be a good thing in some sectors of the economy, finance is not one of them. 

TARP's political unpopularity, however, could help to eliminate the moral hazard problem. As Solomon and Bendavid observe: 

Perhaps the biggest fallout from TARP is that it precludes another TARP. Should the financial sector run into trouble, the chances of another government bailout are essentially nil. For many on Capitol Hill and beyond, the end of bailouts is a good thing. But some worry TARP's legacy could be a more devastating financial crisis down the road.

"The greatest consequence of the TARP may be that the government has lost some of its ability to respond to financial crises," concluded the Congressional Oversight Panel, which oversees TARP and has been one of its biggest critics.

Now, truth be told, I'm not sure this is entirely accurate. Sure, rescue packages are unpopular now -- but let the Dow Jones Industrial Average fall 800 points and politicians might react differently. If, however, the political perception is that no more bailouts from D.C. will be forthcoming, then it might condition financial players to act in a more prudential manner.

In other words, the Tea Party activists on the right and the netroots activists on the left might be the political lobbies that do the most to preserve the integrity of the U.S. financial system. 

I'll be spending the rest of the day savoring this irony. I welcome commenters trying to burst my cognitive bubble, however. 

Political scientists have a ton of explanations for why good policy might be bad politics, and vice versa. There are limits to that perverse correlation, however. A common-sense narrative is that is a policy actually yields concerete and positive results, then it should be perceived in a more favorable light. I mean, that's pretty straightforward, right? 

Politico's Ben Smith has an excellent article pointing out one whopper of an exception to this general rule: the Troubled Asset Relief Program, or TARP: 

The Troubled Asset Relief Program is widely viewed as the original sin of the Obama administration -- though it was put together under President George W. Bush and succeeded far beyond expectations. It’s widely seen as the tipping point for disgust with elites and insiders of all kinds -- though it could also be seen as those insiders' finest moment, a successful attempt to at least partially fix their own mistakes....

"It's become demonized on the left and the right by screamers -- Glenn Beck and Rachel Maddow -- who have no interest in the facts; they’re just interested in hyperbolizing and generating attention," lamented New Hampshire Sen. Judd Gregg, a key player in guiding the measure through the upper chamber and one of the few Republicans willing to talk about TARP in positive terms.

Perhaps it’s not a coincidence that Gregg is retiring from the Senate at the end of the year -- or that hardly anyone from either party is joining him in praising TARP....

The consensus of economists and policymakers at the time of the original TARP was that the U.S. government couldn’t afford to experiment with an economic collapse. That view in mainstream economic circles has, if anything, only hardened with the program’s success in recouping the federal spending.

A study this summer by former Fed Vice Chairman Alan Blinder and Moody's chief economist Mark Zandi was representative of that consensus. They projected that without federal action -- TARP and the stimulus -- America’s gross domestic product would have fallen more than 7 percent in 2009 and almost 4 percent in 2010, compared with the actual combined decline of about 4 percent.

"It would not be surprising if the underemployment rate approached one-fourth of the labor force," they wrote of their scenario. "With outright deflation in prices and wages in 2009-11, this dark scenario constitutes a 1930s-like depression."

Despite this policy success, public attitudes towards TARP are pretty hostile.  Of course, part of that is due to some ignorance over the content of TARP itself: 

Polls suggest the public has only the haziest view of what TARP was. It's often conflated -- not least by politicians who voted for it and now seek to muddy the waters -- with the stimulus, a piece of policy whose supporters and foes have fallen into a much more familiar debate about the role of government and public spending....

Even Nevada GOP Senate nominee Sharron Angle at one point referred to TARP as "the stimulus." And few Americans seem to know that the banks at the center of TARP have paid the money back -- with interest.

Pollster Ann Selzer asked voters this summer, "Do you think the Troubled Asset Relief Program, known as TARP, was necessary to prevent the financial industry from failing and drastically hurting the U.S. economy, or was it an unneeded bailout?"

Fifty-eight percent of Americans said TARP was unneeded. Only 28 percent called it "necessary." 

Smith is correct to point out the myriad ways in which TARP has been lumped in with the other bailouts and stimulus programs that got enacted in 2008 and 2009. No doubt the mass public would not necessarily be able to pick, choose and evaluate each individual bailout/stimulus program.

Still, it's very troubling to see a manifest policy success get almost no love whatsoever from its creators. Over the long run, good policy should translate into good politics. The failure of that to occur in this case could lead to some very perverse policy outcomes after the midterms. 

I have a review essay of four books about Big Finance in the latest issue of The National Interest entitled "First Bank of the Living Dead."  The books reviewed were:  Sebastian Mallaby's More Money Than God, Robert Reich's Aftershock, Nouriel Roubini and Stephen Mihm's Crisis Economics, and John Quiggin's Zombie Economics.  Despite my obvious affinity for zombies, I tried to avoid any favortism towards Quiggin's awesome brilliant spot-on unorthodox metaphor. 

The opening paragraph: 

Earlier this year, Goldman Sachs CEO Lloyd Blankfein attempted to justify his professional existence, proclaiming, “We’re very important. We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. . . . We have a social purpose.” This all sounds good enough, except that finance went from being responsible for 2.5 percent of GDP in 1947 to 7.7 percent in 2005. And at the peak of the housing bubble, the financial sector comprised 40 percent of all the earnings in the Standard & Poor’s 500. The incomes of the country’s top-twenty-five hedge-fund managers exceeded the total income of all the CEOs in that index. And by 2007, just about half of all Harvard graduates headed into finance jobs. If capital markets merely serve as conduits from savers to entrepreneurs, then why does such a large slice get siphoned off to compensate people like Lloyd Blankfein? To put it more broadly, what is the role of finance in a good and just society?

And the thesis paragraph: 

Some of these books address some of the big questions some of the time. Most of the authors, however, focus on the retrospective at the expense of the prospective. With the partial exception of Roubini and Mihm’s Crisis Economics, these authors seem more concerned with looking back at the halcyon days of the postwar era than looking forward to the twenty-first century. Unfortunately, none of these books recognizes two important facts of life. First, at present, no economic model perfectly captures the interrelationship between the financial sector and the global economy. Second, no matter what regulatory arrangements are put in place, the next global financial order will last no longer than a generation—because whatever ideas replace the current ones will also prove fallible over time.

I fear that last paragraph reads a bit harsher than the rest of the essay.  I learned something from all four books, and enjoyed engaging with all of them. 

Go read the whole thing.