Here-- OR --Here

First, I agree about the problems of allowing such high levels of leverage among banks, consumers, and corporations. That said, we have the tough problem that the "right" level of leverage is a function of economic stability -- the more stable the economy, the higher the "safe" level of leverage. But this level finding process is pro-cyclical. The problem is exacerbated by hubris that causes people to ignore data from historical crises (e.g. 1929) under the assumption that "it can't happen again." Qualitatively, we can all agree that too much leverage is a recipe for disaster. Quantitatively, we find that reasonable people can have reasonable disagreements about how much is too much in the context of a modern "well-run" economy.Second, I'm shocked that an economist would actually recommend reducing homeowner's principal (I can understand a populist doing so, but not an economist). Yes, I can see that reducing the principal would reduce the foreclosure rate. And I can even see how reducing the principal could (under very particular conditions) actually increase the value of MBS. But, the conditions under which reducing the principal will increase the value of the MBS are quite narrow (extremely high foreclosure rates, high-quality borrowers, borrower has a fixed-rate mortgage, long-term economic downturn). If foreclosure rates are low, the value lost to write-downs on non-foreclosers exceeds the value gained by avoid a few foreclosures. If borrower quality is low (e.g., NINJA loan borrowers), the foreclosure rates won't drop because the borrower really never could afford the home. If the borrower has a non-fixed mortgage (e.g., ARM, option-ARM, interest-only loans), then required amount of principal write-down will be excessive. If the economic downturn is short-lived, then the value of the home and payment capacity of the borrower will recover without the need for writing-off the principal. In general, most mortgages would not be helped by a write-off of principal and such a step would only damage banks further. But the bigger downside is the impact on new mortgages. Would you lend money knowing that the government might impose a write-off of principal or other type of cram-down? To the extent that homes become even less affordable because of uncertainty about mortgage contracts, the housing market will suffer much more severely and undo any benefits provided by reducing the principal.Third, Geanakoplos is shocked by the money poured into insolvent banks. At one level, I can understand this but I would expect any decent economist to look deeper. But any deeper analysis will show that banks are the logical leverage point for halting a much more dangerous spiral. It's far easier for the government to assess the financial capacities of a few dozen (or hundred) banks and take corrective action than to either: 1) assess the financial capacities of millions of mortgage-payers and the long run consequences of interceding at the consumer level; 2) assess the impact of a massive series of bankruptcies on consumers, bondholders (e.g., pension, funds, insurance companies, etc.), and bank counterparties.Levin's ideas are perhaps more reasonable, but would require more thought to respond to. He seems to prefer direct job creation to tax cuts, but I only partial agree with this. Direct job creation is only good to the extent that is creates indirect long-term job creation. Adding infrastructure to reduce road congestion would do this. The Keynsian dig-a-hole-fill-it-in would not. I also think that tax cuts can be good. Yes, some people use tax cuts to pay down debt (Levin sees this as bad). But I see it as a good phenomenon because it is debt that got us into this mess and that debt will continue to kill the economy until it's repaid, restructured, or inflation attenuates the debt to sustainable levels. Some tax cuts are better than others (just as some government public works jobs are better than other). Corporate tax cuts (or tax credits) for R&D, training, and capex would help companies create new products, new jobs, and new factories.Finally, some of the inability to find long-term solutions to the housing/economic crisis is also the fault of continually over-optimistic central bankers, government officials, economists, and analysts. If the economy is only 6 months away from recovery (which it has been for the last 15-18 months), then we don't need long-term solutions because we can just wait for the short-term bout of foreclosures/declines to end. Too many of the stimulus solutions have been band-aids made under the assumption that all we are only experiencing a small rough patch or minor loss of confidence. These optimists fail to appreciate the long-term dangers of high levels of debt to consumers, corporations, banks, or the government.

We need to deleverage just don't do it in such a crisis.We need to improve people's education and Banks need to be careful when conceding credit. The amount of leverage in the system needs to be controled (hedge funds, derivatives).Anyway if the US are able to resume growth and to export then employment will rise some months after the bottom and leverage will be reduced (more wealth).The question with keynesianism here is:- do we want to fix a mess by first destroying what's left (everybody gets poor)- or, do we want to fix it trying to make everybody a bit richer by investing public funds now (everybody gets a bit richer or at least a bit less rich)Leverage can be a good thing if the growth in assets is higher than the cost paid on the debt. Of course, history tells us that too much leverage is very dangereous especially when it's associated to greed and non social responsible agents.At the end of the day the world economy is a huge competition of nations and firms. Those wo can innovate, produce high quality products, export to other countries, and are able to increase wealth will be able to repay debt and mantain their competitive advantage.

Listening to Geanakoplos I was caught by surprise...QuoteOriginally posted by: hamstermy (completly unrealistic) proposal for better fed policy would be:1 economy is down, reserve ratio is down, interest rate is down2 business ideas pop up, financing is required3 business issues equity, debt issuance is likely to follow 4 reserve ratio is increased a little bit5 banks become a little bit more closefisted >> back to 2 and 3...6 unexspected market saturation, catastrophe,...all business goes down7 reserve ratio slumps, banks can write off quickly >> 1However, looking at collateral, leverage, or resereve ratios,... whatever it might imply, is toooo late!!! You cannot fix anything with Geanakoplos' analysis. Geanakoplos stress about overoptimistic people. That might be a factor, of course. But there is the other side, called competition between banks or respectively lenders. If banks don't serve a bubble they are out of the race, thus will disapear sooner or later. You cannot fix the issue by blaming overoptimistic consumer, or fingerpointing competing banks. Actually, Geanakoplos' "Leverage cycle" is nothing new, it just recite the idea behind the well known Wicksell Process. I would rather think how a bank would manage flexible reserve ratios or expectation about changing reserve ratios ?!

yale thread