First, I agree with Mark Thoma that Mr. Posner apparently has little understanding of macroeconomics, either of old-style Keynesian type, or the new(er) real business cycle type, or certainly New Keynesian approaches. His charge that her current pronouncements are at sharp variance with her earlier academic work really makes me wonder if he's read any of Dr. Romer's previous work. I suspect that he's taken at face value the conservative mis-apprehension that her tax cut paper contradicts the view that government expenditures can have an impact on growth. As I've explained in my responses to reader comments here, Romer and Romer (2008) provided estimates of tax cut multipliers, but no spending multipliers. Hence, a comparison of instrument efficacy is not feasible (comparing multipliers across methodologies can be done, but would be inappropriate).

Second, I would not pass a student out of intermediate macro who wrote in an exam:

The impact of the public-works program on investment is more complicated. But suppose, plausibly in a serious economic downturn such as the one that we're in at present (and that was even more serious back when the stimulus bill was enacted), that a great deal of investment is in the form of passive savings, such as demand deposits and Treasury securities, because people and companies are anxious about their economic prospects, and they want safe savings, rather than savings that would be at risk because invested in entrepreneurial projects.

As Mark Thoma points out, this is confusing a financial investment with physical investment in a NIPA sense.

This confusion tells me that anybody writing far outside their area of expertise should think twice, consult a textbook or two, before committing virtual pen to virtual paper. (I'm not saying one shouldn't write outside of one's area of research expertise on a weblog -- just one has to be careful).

Third, before he pontificates on what economists who work in the government should or should not be doing, I think Mr. Posner should read Martin Feldstein's discussion of how the CEA works ("The Council of Economic Advisers and Economic Advising in the United States," The Economic Journal, Vol. 102, No. 414 (Sep., 1992), pp. 1223-1234 [JSTORE pdf]; excerpt here). Here's a quote:

Although the CEA is physically as well as operationally part of the White House complex (CEA offices are in the Old Executive Office Building adjacent to the White House and within the same security cordon), the economic staff functions in a completely professional and nonpartisan way. My very able and distinguished staff included Larry Summers, who was prominent as chief economic adviser to presidential candidate Michael Dukakis.

The tradition of professionalist is so strong that even in a presidential election year the CEA chairman appoints members of the staff for the coming academic year with the clear understanding that they will continue to serve even if the party in power loses the presidential election. ...

My limited observations, having been a staff economist in the situation mentioned in the last paragraph, is that CEA members (nominated by the President and confirmed by the Senate) do not "leave behind their academic scruples" when they move from academia to government service. That doesn't mean that I think they're correct in their analyses -- just that what they believed when they came in is pretty close to what they say in public. (After all, silence is also an option.)

Fourth, I think any blog post (let alone paper) should be internally consistent. Consider Mr. Posner's (approving) statement:

Most economists, however, believe that it is unrealistic to suppose that people have enough information about the future to adjust their current behavior to expectations of higher taxes, inflation, devaluation, or other possible consequences of an increase in the national debt. There is too much uncertainty.

Then, he says two paragraphs later:

But Romer actually gives some credence to the unrealistic picture of the far-sighted consumer or businessman by arguing that recipients of tax credits authorized by the stimulus bill will spend rather than save the tax-credit money because they will assume that the credits are permanent.

But if in fact consumers do not look forward (as Mr. Posner argues, not as Dr. Romer argues), they will only respond to current changes in disposable income, and in fact the multiplier will look pretty big.

(Actually, I find the biggest problem with Mr. Posner's argument here is that the failure of consumers to respond in a fashion consistent with unencumbered intertemporal optimization w/perfect certainty is not due only to uncertainty, but also liquidity constraints, as well as possibly more exotic utility functions.)

Fifth, Mr. Posner should read a bit more widely. He states:

Romer argues in her talk that by the end of the second quarter of this year, $100 billion of stimulus money had been spent. That is a suspiciously round number, and it is unclear how it was arrived at; but let us assume it is accurate. She then argues that this small expenditure--about two-thirds of one percent of the Gross Domestic Product--is responsible for the fact that the decline in GDP fell (on an annualized basis) from 6.2 percent in the first quarter of the year to 1 percent in the second quarter (though the latter figure is likely to be readjusted upwards).

This assertion is groundless. No one has the faintest idea what effect the stimulus has had.

As someone who had to "fact-check" numbers going into White House policy documents and speeches on occassion, I can say that the numbers are verifiable regardless of Administration (whether they are interpreted in an appropriate fashion is a fair question).

But the more substantive question is whether the math is so nonsensical. As I showed quite clearly in this post, the number Dr. Romer obtained was easily calculated and plausible.

Sixth, my impression is that former CEA staffers and members that have become bloggers are pretty careful with the numbers and analytics -- certainly more so than Mr. Posner. These include Jeff Frankel, Paul Krugman (notwithstanding Mr. Posner's barbs), Andy Samwick, Diane Lim Rogers, and Nouriel Roubini. (see this post for former gov't/Fed economists who became bloggers.)

Plenty of examples of hyperbole in current policy discussions, but here I want to return [0] to the specific topic of whether several key data series examined by economic analysts can be trusted, or whether in fact they are deliberately manipulated by government bureaucrats. Case in point is Econbrowser reader DickF's comments:

The government thinks it can run the economy on data that is years old and inaccurate at best. Also any time numbers are manipulated by government there is a political element involved. The whole reason the numbers are manipulated is to the will be "more normal" but who decides what is normal? In the government political bureaucrats who know their jobs depend on pleasing the politically connected. This is just another reason why centrally planned economies always fail. The hubris in government economic circles is enormous.

...

I am not saying that the agencies are manipulating data to make "each respective Administration look good." Sometimes they manipulate date to make an Administration look worse than it actually is. It depends on their political inclination.

Here are some data revisions for GDP...

I'm cynical enough to believe that numbers quoted by governments and private companies are selected so as to put themselves in as good a light as possible (after all, the Bush White House was happy enough to sit on a global climate change report for a couple of years, and to defund statistical programs that measure the behavior of low income households). But this view is distinct from the perception that the statistical agencies that collect US national income and products account data (the BEA), the CPI and PPI and employment statistics (the BLS), industrial production and capacity utilization (the Federal Reserve), and import and export data (BEA/Census) purposefully and consciously distort and manipulate the data for their own nefarious purposes.

In my view, the reason why so many hold onto these views is because it's so much easier to remain ignorant, and leap to the conspiracy view, than to do the hard work to understand why the statistics are imprecise measures of economic concepts, and why they are revised over time. After all, the former requires nothing more than taking somebody's word, the latter entails reading the supporting documentation, comprehending what the terms used mean, and applying some basic math and statistics skills...And if that's too hard, there are many people trying to help (For instance, Jim Hamilton cited some work by Oldprof on the BLS birth/death model in his last post).

As I noted in my previous post (The Government's Macroeconomic Series: X-Files, Dilbert, or Resource Constraints?), there are (at least) three different categories of explanations for the shortcomings of government statistics. One is the conspiracy view (X-Files), one is the incompetence view (Dilbert), and one is a realization that government statistics are generated by organizations with limited resources, facing legal constraints on data collection, and confronted with an ever-changing structure of the economy.

So, if one wants improved government economic statistics, then tell your elected representative to keep up support for proper funding of the statistical agencies (time series here) FoxBusiness has some reportage.

See also Mark Thoma. Dean Croushore has a good review of why macro statistics exhibit the characteristics they do over different vintages.

Consequently and although I am lukewarm about the idea of green shoots and second derivatives, I am more positive about the narrative presented by BlackRock Inc's Bob Doll when he points to the potential in emerging markets;

Emerging-market stocks may gain an average of 20 percent this year as they rebound faster and stronger than their peers in developed countries, said Bob Doll, vice chairman and chief investment officer for BlackRock Inc. The global economy has probably seen its worst in the past two quarters, with developing nations already starting to emerge from the recession, Doll told reporters in Singapore today.

“If in fact we have seen a bottom in markets and economies are going to recover, the emerging parts of the world will recover the most and the fastest,” Doll said. “After all, their recessions were largely unwanted inventory build-up and not the credit bust in the Western world.” The MSCI Emerging Markets Index has already gained 25 percent this year, with developing countries making up all 10 of the world’s best performers. That’s outpaced the 2.3 percent retreat in the Standard & Poor’s 500 Index.

Now, when it comes to the actual headline number presented, I would assume, for the media I won't venture an opinion. However, the general idea that emerging markets such as India, Brazil and Turkey are among those economies where growth conditions are, relatively, most favorable I am very much in agreement with. Clearly, this is not going to be one way street and as we learned from parsing the data from e.g. Mexico and Argentina it indicate how the swine flu may just have tipped over the economy in the case of the former whereas the latter also looks set to enter an actual recession. However, there are positive signs too, not least in the context of India which Edward recently put under the loop and concluded that conditions might just favor India to rise well above the rest of its peers. After looking at the data myself and from reading this, I am very much inclined to agree. So yes, I do think that emerging markets are going to fly; some of it will be based on real fundamentals and some of it will be the carry trade since in a world where some of the biggest central banks are commited to low nominal interest rates the environment for carry trades are perfect if and when volatility stays down. Just witness Deutche Bank's recommendation that investors sell Euros to buy into the Ruble and Forint (who are these people?!). Astute investors will thus always remember the story of Icarus, but the underlying current is still important here.

Apart from this I want to emphasise two points.

First I think that the points above underpin the general idea that whatever global economy which will emerge in the wake of the current crisis, it will one in which the sources of global demand, yield, and capacity will be more diverse than before. This is of course the positive spin to the fundamental question of who and where global demand will come in the future, not least to satisfy the excess savings which will emerge as more economies become dependent on exports to grow.

Secondly, I want to touch briefly on a related topic which has been dominating the debate on an on-off basis lately. Specifically, I am talking about the prospect of the Chinese Yuan as the future global reserve currency (surpassing the USD) which was given new life recently in the form of a NYT op-ed by Nouriel Roubini in which the (self)-proclaimed economic oracle predicts that we are now entering an Asian century with China as the dominating the economic power. Stefan Karlsson also moves in to steal some of Mr. Roubini's thunder dryly noting that the idea of the Yuan as global reserve currency is not new as he himself predicted it four years ago. Finally, there is Jeffrey Sachs (hat tip: Mark Thoma) who also muses on the prospect of a more diversified global monetary system with the Yuan in a dominant role. 

It is always customary to begin with the points you agree with and let me be very clear here. The days of unilaterally sponsored demand by the US and the subsequent role of the USD is over. There is just no way in which the US can rise to command the same role in the global economy as it did before the subprime crisis hailed the initial fall from grace. However, the idea that China alone will rise from the ashes of this crisis to take over from the US is a fallacy. 

In essence and all the technical issues aside of whether China will choose to issue debt denominated in RMB, whether the focus of trade credits and transactions in general will move towards a favor of RMB etc, any one candidate for reserve currency status would clearly need an open capital account and almost surely, in the present context, the stomach to run a current account deficit. So let us chew on this a bit. If China become the sole economy to "take over" from the US it would mean that China should run a rather substantial external deficit. 

Basically, there are many aspects of being a reserve currency but one surely is the ability to be a net debtor nation. It goes with the territory I would say and especially in whatever "new" global edifice we will be looking at. I think this is what Roubini is missing even if his other points of a more structural and institutional nature are true; clearly China is a force to be reckoned with, but then notice this;

China is a creditor country with large current account surpluses, a small budget deficit, much lower public debt as a share of G.D.P. than the United States, and solid growth.

You can almost smell the carry trade and yield here. There sure looks to be a healthy cake to chew on here, but the thing is that the astute commenters above are not thinking about the fact that within the next decades China will age at an unprecedented speed (perhaps even faster than Japan!). Now, I am not sure whether or not this demographics stuff has trickled down yet but in this context it is important. Clearly, there will be growth in China and she will ascend to command a larger role, but if she opens the capital account we will have the world's biggest firework and a huge version of Latvia. I am  sorry, but if you don't factor in the demographics here you are getting nowhere.

Consequently, I think that Bretton Woods III is a lame duck in so far as it is made up of one currency to take over the USD; there is just no ONE economy out able to shoulder the load. This is what has changed now, the US (or Anglo-Saxons if you will) cannot carry us anymore. Rather I imagine that it will be a basket and although China will be an important part of that basket we also need to look at India, Brazil, Turkey, Chile and a number of other economies. If the discourse solidifies towards China as the economy to single handedly pull the global economy and stage a process of rebalancing it won't be pretty once markets start to factor in the demographic fundamentals in China.

Scott Irwin has collected an archive with some of the difficult-to-find classics in commodity research.

John Hempton (hat tip: Mark Thoma) offered an interesting perspective on the nature of the current problems facing the banking system. Hempton suggested that there are three different numbers we might use when speaking of the problem assets held by the banking system: (1) the loss that banks have already acknowledged or have made loan loss provisions for, which Hempton puts at around 10%; (2) the loss that banks would face if they had to sell the assets right now, which Hempton puts at 50% or $3 to $4 trillion in losses; (3) the loss that would actually be realized if the assets were held to maturity, which Hempton claims would be 25% or $1.5 to $2 trillion in losses.

A question raised by those last two numbers is why buyers are only willing to pay 50 cents for something that's ultimately going to be worth 75. Hempton's explanation is if you buy the assets at 50 cents on the dollar, hold them 5 years over which you'll collect the interest on that portion of the assets that still represent performing loans, and then receive back 75 cents worth of principal, you'd basically be earning a 15% annual rate of return as compensation for the risk of holding these assets.

As I understand it, Hempton is claiming that there is a probability distribution for what the true value of the assets held to maturity is going to be-- might be higher than 75 cents, might be lower than 75 cents, but with expected value of 75 cents. There's no question that risk premia at the moment are very high, but a figure of a 15% expected return seems hard to defend. The highest differential we've seen between Baa-rated and Aaa-rated bonds over the last century was 550 basis points in 1932. The spread fell from 340 basis points in December 2008 to 310 this January.

Yield on Baa-rated bond minus yield on Aaa-rated bond, monthly averages, 1919-2009. Data source: FRED ([1], [2]).

And of course you don't expect to receive 3.1% more on Baa-rated bonds than on Aaa-- 3.1% is the most you could earn. There's also a probability of default built into those numbers, so the expected excess return-- what I would define as the true risk premium-- is necessarily smaller than the yield spread itself.

The recent dramatic values for the TED spread also never exceeded 500 basis points.

TED spread, as obtained from Bloomberg on Feb 17.

If purchasing bank assets today at 50 cents on the dollar doesn't offer an expected return as high as 15%, then it's hard to claim that the expected value of the assets held to maturity is as high as 75 cents. Either 50 cents is too low a valuation, or 75 cents is too high an expectation.

Although I'm not sure which numbers to use, this seems like exactly the right way to frame the problem. Figure out what are the possible parameters for the capital loss that is to be allocated among the various parties-- specifically, a loss that must be borne by some combination of stockholders, creditors, managers, employees, and the taxpayers-- and try to reconcile those numbers with the current liquidation value of the banks.

Whatever the true value of the assets may be, the perceived value is low enough to prohibit the financial system from functioning effectively in the current environment. So what can we do about it? Greg Mankiw articulates why he thinks nationalization is the wrong concept:

I certainly do not want the government deciding who deserves credit and who does not, what kind of investments are worthy of financing and what kind are not. That is a big step toward crony capitalism, where the politically connected get the goodies, and economic stagnation awaits the rest of us.

If the government is to intervene in a big way to fix the banking system, "nationalization" is the wrong word because it suggests the wrong endgame. If banks are as insolvent as some analysts claim, then the goal should be a massive reorganization of these financial institutions. Some might call it nationalization, but more accurately it would be a type of bankruptcy procedure.

Bankruptcy could become, in effect, a massive bank recapitalization. Essentially, the equity holders are told, "Go away, you have been zeroed out." The debt holders are told, "Congratulations, you are the new equity holders." Suddenly, these financial organizations have a lot more equity capital and not a shred of debt! And all done without a penny of taxpayer money!

For myself, I don't know the true value of the assets, but I suspect it's well below 90 cents on the dollar. And I fear that the debt-for-equity swap, though attractive in principle, could prove to be quite a destabilizing process. It would be nice if there were a painless way out of this, but I don't see one.

What we need is not a painless resolution of the crisis, but rather a plan that puts the pain behind us.

Technorati Tags: macroeconomics, economics, bailouts, interest rates, credit crunch

[Joel] Prakken added, "This month's employment loss was driven by the goods-producing sector which declined 126,000 during October, its twenty-third consecutive monthly decline. The manufacturing sector marked its twenty-sixth consecutive monthly decline, losing 85,000 jobs. These losses were compounded by an employment decline in the service-providing sector of the economy which fell by 31,000, the first loss in the serviceproviding sector recorded by the ADP Report since November of 2002."

"Large businesses, defined as those with 500 or more workers, saw employment decline 41,000, while medium-size companies with between 50 and 499 workers declined 91,000. Employment among small-size businesses, defined as those with fewer than 50 workers, declined 25,000. This is the first outright decline in small business employment reported by the ADP Report since November of 2002, and the largest percentage decline since the economy was emerging from recession in early 2002," said Prakken.

Here is a graph breaking down the employment declines.

And here is a figure depicting the implications for the nonfarm payroll employment figures, keeping in mind the loose correlation between the ADP numbers and NFP numbers.

I think Prakken's last point regarding the downturn in small business employment is of substantial interest as policymakers consider options going forward -- and not only because it puts to rest the dichotomy between Wall Street and Main Street. The appropriate policies depend, in part, upon the reasons for why employment is declining -- credit crunch vs. recession. Obviously both are probably at work, but the proportions are of importance. To the extent the credit crunch is the main issue, the Fed and Treasury need to continue their effort to loosen up lending, and at the minimum reduce the likelihood of financial institution bankruptcies.

The last National Federation of Independent Business report did not indicate credit concerns were high; from the October report (pertaining to September):

Regular small business borrowers report that credit is increasingly more difficult to obtain. This has risen to 11 percent in September (12 percent said “harder”, 1 percent "easier") as the creditworthiness of potential borrowers does decline as the economy weakens and customers disappear. Because a slowdown in the economy changes the credit worthiness of potential borrowers as sales and profits decline, more "rejections" will occur even with no change in credit standards by lenders. And, many credit worthy borrowers don’t need credit in a period when business expansion makes no sense and inventories are being reduced, not increased. Thus, the aggregate amount of business loans will fall with no change in credit standards. Regular borrowing activity was reported by 32 percent of the owners (down 2 points), reflecting a reduced need for funds to support inventory accumulation or discretionary capital spending. Both inventory and capital investment plans have been declining as the economy has weakened. So, credit demand is down and fewer loans are being made, but not directly due to a lack of credit availability. Loan demand is lower for many firms. Thirty-three (33) percent reported all their borrowing needs met compared to 6 percent who reported problems obtaining desired financing. The net percent responding favorable was 2 points lower than August and 2 points better than July. Interestingly, 36 percent reported all credit needs met in the tumultuous second half of September, compared to 31 percent in the first few weeks of the month.

Since some of the survey results pertain to the period before the financial crisis, beginning in mid-September, it's of use to see assessments that are more recent. Here is one in contained in Congressional testimony from about a week ago; this statement is from the Chair of the Small Enterprise Committee of the Association of Equipment Manufacturers:

While Wall Street is on a financial roller coaster, I am here to tell you that many small businesses in America are in an economic freefall. AEM members, like the rest of the country, are experiencing challenges due to the credit and liquidity crisis.

....

I have heard from several colleagues on how they are experiencing problems with obtaining lines of credit. One of them, a small manufacturer in rural South Carolina, had an operating line of credit with Wachovia that was secured by a stock portfolio, but with the unraveling of the market their line was frozen. Attempts to restructure their line with Wachovia stopped before they started and inquiries into other banks were met with a "we are only engaging in lending with existing bank customers" type responses. Now my colleague is spending most of his time trying to resolve the issue when he should be working to secure orders in this down market. Still other colleagues of mine have capital to operate but find their orders disappearing, in part because their consumers cannot get credit to make the purchase.

I found this testimony of interest, even taking into account the fact that the representative has an interest in conveying the situation in the starkest terms, because it lays out the web of interconnections to areas which I would not have expected an impact. The testimony continues:

We are now seeing farmers delay the purchase of these inputs [fertilizer, seed, chemicals and fuel] from their "normal" pre-season purchasing patterns as they are having trouble accessing credit and are hesitant to pay such steep prices...

What the foregoing highlights is that for sure credit concerns are important, although the relative importance of decreasing demand is probably rising over time. So, the predictions I made in a post a month and half ago -- about how small businesses will likely be very impacted by this financial crisis -- have to some extent come to pass.

By the way, for those who doubted the reality of the financial crisis, see the Boston Fed's rejoinder (coauthored by Wisconsin PhD Ethan Cohen-Cole) to that Minneapolis Fed "myths" paper (h/t Mark Thoma).

Technorati Tags: small business, credit crunch, employment, Wall Street, and Main Street.

From David Goldstein and Kevin G. Hall, "Private sector loans, not Fannie or Freddie, triggered crisis":

Federal Reserve Board data show that:

• More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.
• Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.
• Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that's being lambasted by conservative critics.

From David Goldstein and Kevin G. Hall, "Private sector loans, not Fannie or Freddie, triggered crisis," McClatchy Papers (October 12, 2008).

The article continues:

What's more, only commercial banks and thrifts must follow CRA rules. The investment banks don't, nor did the now-bankrupt non-bank lenders such as New Century Financial Corp. and Ameriquest that underwrote most of the subprime loans.

These private non-bank lenders enjoyed a regulatory gap, allowing them to be regulated by 50 different state banking supervisors instead of the federal government. And mortgage brokers, who also weren't subject to federal regulation or the CRA, originated most of the subprime loans.

In a speech last March, Janet Yellen, the president of the Federal Reserve Bank of San Francisco, debunked the notion that the push for affordable housing created today's problems.

"Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans," she said. "The CRA has increased the volume of responsible lending to low- and moderate-income households."

In a book on the sub-prime lending collapse published in June 2007, the late Federal Reserve Governor Ed Gramlich wrote that only one-third of all CRA loans had interest rates high enough to be considered sub-prime and that to the pleasant surprise of commercial banks there were low default rates. Banks that participated in CRA lending had found, he wrote, "that this new lending is good business."

One point the article does not touch on is why the states did not regulate more rigorously the banks most involved in subprime lending. The answer is, in part, explained by this item (which I've cited in the past) from the NYT:

The Fed was hardly alone in not pressing to clean up the mortgage industry. When states like Georgia and North Carolina started to pass tougher laws against abusive lending practices, the Office of the Comptroller of the Currency successfully prohibited them from investigating local subsidiaries of nationally chartered banks.

What about the charge that Fannie and Freddie "made" the market so that all these subprime loans could be securitized? There's a grain of truth in there, but I think keeping in mind which loans are going bad is useful, when reading this excerpt.

This much is true. In an effort to promote affordable home ownership for minorities and rural whites, the Department of Housing and Urban Development set targets for Fannie and Freddie in 1992 to purchase low-income loans for sale into the secondary market that eventually reached this number: 52 percent of loans given to low-to moderate-income families.

To be sure, encouraging lower-income Americans to become homeowners gave unsophisticated borrowers and unscrupulous lenders and mortgage brokers more chances to turn dreams of homeownership in nightmares.

But these loans, and those to low- and moderate-income families represent a small portion of overall lending. And at the height of the housing boom in 2005 and 2006, Republicans and their party's standard bearer, President Bush, didn't criticize any sort of lending, frequently boasting that they were presiding over the highest-ever rates of U.S. homeownership.

Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication. One reason is that Fannie and Freddie were subject to tougher standards than many of the unregulated players in the private sector who weakened lending standards, most of whom have gone bankrupt or are now in deep trouble.

During those same explosive three years, private investment banks -- not Fannie and Freddie -- dominated the mortgage loans that were packaged and sold into the secondary mortgage market. In 2005 and 2006, the private sector securitized almost two thirds of all U.S. mortgages, supplanting Fannie and Freddie, according to a number of specialty publications that track this data. [Emphasis added -- mdc]

Now, again, consider which subprime loans, in the graph below, went bad...

Notice that the delinquency rate is highest in the years after Fannie and Freddie are constrained in terms of their subprime holdings. So, more regulation of F&F was a good thing, I'll say, with the benefit of hindsight.

Now, there are more sophisticated, game-theoretic based arguments. In particular, Jim has observed that the mere existence of GSEs with substantial portfolios of MBS's meant that the government -- by insuring Fannie and Freddie -- would implicitly insure the private firms as they expanded their operations, supplanting F&F's market share:

what forces caused the explosion of private participation in a much more reckless replication of the GSE game? A year ago, I suggested one possible answer-- private institutions reasoned that, because the GSEs had developed such a huge stake in real estate prices, and because they were surely too big to fail, the Federal Reserve would be forced to adopt a sufficiently inflationary policy so as to keep the GSEs solvent, which would ensure that the historical assumptions about real estate prices and default rates on which the models used to price these instruments were based would not prove to be too far off.

This is by far the most intelligent and plausible interpretations of how F&F could have contributed in a significant way to the current housing crisis (as separate from the overall crisis, which would have been triggered by some other market given the mixture of securitization, credit default swaps and high leverage [2]). In fact, Mike Dooley and I have made similar arguments about the expansion of contingent liabilities, in the run-up to the East Asian crises [3]. The challenge here is how to test this hypothesis against others; we need to measure the implicit insurance that these private firms felt they had directlyfrom the Fed's intent keep the monetary policy sufficiently expansionary to keep housing prices going up, separate from the insurance committed directly by the Treasury to prevent individual banks from going under. (By the way, this is a separate issue from whether F&F made sense economically in their circa 2006 form; see the analysis by Frame and White. I tend to think the answer is no.)

Interestingly, one of the corollaries of this argument is that it would be hard to disentangle the balance of blame of F&F and the "Greenspan put".

One question I do (or will) have is the following: if the credit card or auto loan securitized markets blow up [4], who are the equivalents to the GSE's?

I think all of this leads to a more nuanced view of the role of CRA and the two GSE's in the crisis. If I had to identify the central factors, I wouldn't point to F&F alone, or CRA alone (if at all). Rather, I'd look to (i) monetary policy (including whether it was lax, and the implications of the "Greenspan put"), (ii) what drove down the returns at the long end of the maturity spectrum ("the conundrum") thus inducing the desperate search for yield, (iii) securitization in the absence of countervailing regulation and (iv) the development of a completely non-transparent and unregulated over-the-counter credit default swap market.

First, what is the source of the crisis? Is it as is asserted here in this statement from John McCain today?

....

There are certainly plenty of places to point fingers, and it may be hard to pinpoint the original event that set it all in motion. But let me give you an educated guess. The financial crisis we're living through today started with the corruption and manipulation of our home mortgage system. At the center of the problem were the lobbyists, politicians, and bureaucrats who succeeded in persuading Congress and the administration to ignore the festering problems at Fannie Mae and Freddie Mac.

These quasi-public corporations lead our housing system down a path where quick profit was placed before sound finance. They institutionalized a system that rewarded forcing mortgages on people who couldn't afford them, while turning around and selling those bad mortgages to the banks that are now going bankrupt. Using money and influence, they prevented reforms that would have curbed their power and limited their ability to damage our economy. And now, as ever, the American taxpayers are left to pay the price for Washington's failure.

...

I certainly concur with the first sentence. But I do wonder about the assertion that the problem started with and is fundamentally driven by Fannie Mae and Freddie Mac. After all, neither of these two institutions were at the heart of the massive surge in subprime mortgages that are the most toxic component of these asset backed securities. Smarter people than me (Justin Fox, Tanta at CR h/t Mark Thoma) have been similarly dubious.

Moreover, the originating entities for these subprime mortgages were not Fannie Mae and Freddie Mac, by large, but rather the banks that the Federal government refused to let state agencies regulate. Or the ones the Treasury's OTS itself failed to regulate. To refresh memories, consider this article from December 18, 2007 NYT:

WASHINGTON-- Until the boom in subprime mortgages turned into a national nightmare this summer, the few people who tried to warn federal banking officials might as well have been talking to themselves.

Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.

But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman.

In 2001, a senior Treasury official, Sheila C. Bair, tried to persuade subprime lenders to adopt a code of "best practices" and to let outside monitors verify their compliance. None of the lenders would agree to the monitors, and many rejected the code itself. Even those who did adopt those practices, Ms. Bair recalled recently, soon let them slip.

And leaders of a housing advocacy group in California, meeting with Mr. Greenspan in 2004, warned that deception was increasing and unscrupulous practices were spreading.

John C. Gamboa and Robert L. Gnaizda of the Greenlining Institute implored Mr. Greenspan to use his bully pulpit and press for a voluntary code of conduct.

"He never gave us a good reason, but he didn't want to do it," Mr. Gnaizda said last week. "He just wasn't interested."

Today, as the mortgage crisis of 2007 worsens and threatens to tip the economy into a recession, many are asking: where was Washington?

An examination of regulatory decisions shows that the Federal Reserve and other agencies waited until it was too late before trying to tame the industry's excesses. Both the Fed and the Bush administration placed a higher priority on promoting "financial innovation" and what President Bush has called the "ownership society."

...

On Tuesday, under a new chairman, the Federal Reserve will try to make up for lost ground by proposing new restrictions on subprime mortgages, invoking its authority under the 13-year-old Home Ownership Equity and Protection Act. Fed officials are expected to demand that lenders document a person’s income and ability to repay the loan, and they may well restrict practices that make it hard for borrowers to see hidden fees or refinance with cheaper mortgages.

It is an action that people like Mr. Gramlich and Ms. Bair advocated for years with little success. But it will have little impact on many existing subprime lenders, because most have either gone out of business or stopped making subprime loans months ago.

...

The Fed was hardly alone in not pressing to clean up the mortgage industry. When states like Georgia and North Carolina started to pass tougher laws against abusive lending practices, the Office of the Comptroller of the Currency successfully prohibited them from investigating local subsidiaries of nationally chartered banks.

Virtually every federal bank regulator was loathe to impose speed limits on a booming industry. But the regulators were also fragmented among an alphabet soup of agencies with splintered and confusing jurisdictions. Perhaps the biggest complication was that many mortgage lenders did not fall under any agency's authority at all.

...

And for some more concrete examples of how deregulatory zeal had an effect, consider this account from the WSJ (March 22, 2007):

Regulators appointed by President Bush often have been more sympathetic to industry concerns about red tape than their Clinton administration predecessors. When James Gilleran, a former California banker and bank supervisor, took over the OTS in December 2001, he became known for his deregulatory zeal. At one press event in 2003, several bank regulators held gardening shears to represent their commitment to cut red tape for the industry. Mr. Gilleran brought a chain saw.

He also early on announced plans to slash expenses to resolve the agency's deficit; 20% of its work force eventually left. When he left in 2005, Mr. Gilleran declared that the OTS had "exercised increased diligence in its review of abusive consumer practices" while reducing thrifts' regulatory burden. But his successor, Mr. Reich, a former community banker, has reversed many of Mr. Gilleran's cuts. Citing "understaffing," he hired 80 examiners last year and plans to add 40 more this year. A spokeswoman for Mr. Gilleran, now chief executive of the Federal Home Loan Bank of Seattle, said he wasn't available to comment.

So, from my perspective, locating the source of the current crisis in corruption/influence peddling surrounding Fannie and Freddie exhibits a misreading of recent history. (More important might have been lax monetary policy and the saving glut, and exemptions from capital requirements for certain investment banks... [see Ritholtz])

Second, how hard will the rescue be given the reckless decisions of the past? It seems that whatever entity is established to purchase these bad assets will require some fiscal outlay. Estimates are all over the place, given that there is so much uncertainty over how much the assets will be bought for and eventually sold; here is one account:

U.S. Debt May Grow $1 Trillion on Rescue, Barclays' Pond Says

By Sandra Hernandez

Sept. 19 (Bloomberg) -- The U.S. may have to borrow an extra $700 billion to $1 trillion to fund the biggest rescue of the financial system since the Great Depression, according to Barclays Capital Inc.'s Michael Pond.

Federal takeovers of Fannie Mae, Freddie Mac, and American International Group Inc.; the central bank's expansion of lending to financial firms; and a slowing economy will add $455 billion to the Treasury's borrowing needs, the New York-based interest-rate strategist estimated. Pond said Treasury Secretary Henry Paulson's plan to rid banks of "hundreds of billions" of troubled assets would bring the amount to $700 billion assuming the plan costs $200 billion.

"We could easily add up to an additional trillion to the outstanding Treasury debt just from the initiatives announced over the past couple of weeks," said Pond, ranked the best Treasury Inflation-Protected Securities analyst in 2008 by Institutional Investor magazine.

The government's liabilities swelled in past weeks as policy makers sought to arrest a growing financial crisis by taking over financial institutions threatened by a shortage of capital.

The Treasury on Sept. 7 took over mortgage-finance companies Fannie Mae and Freddie Mac and said it would buy mortgage-backed debt in the open market. The Fed this week boosted its Treasury auctions to bond dealers by $25 billion, loaned $85 billion to the insurer AIG, and quadrupled the amount of dollars foreign central banks can auction to $247 billion. Paulson today said the government will buy illiquid assets from banks' balance sheets and insure money-market mutual fund holdings.

Deficit Widens

"The odds of the deficit becoming enormous are certainly there," said Nils Overdahl, a bond fund manager in Bethesda, Maryland, at New Century Advisors, which oversees $500 million. "I suspect you will see issuance at a variety of maturities."

The deficit will likely widen to $650 billion in fiscal 2009 because of the U.S. rescue of Fannie and Freddie, analysts at JPMorgan Chase & Co. wrote in a Sept. 12 report.

Over the next decade, the gap between spending and receipts will swell to $5.3 trillion, Goldman Sachs Group Inc. analysts wrote Sept. 10, revising a previous forecast of $3.6 trillion. The non-partisan Congressional Budget Office forecast a record $438 billion deficit for 2009 on Sept. 9.

"The deficit will soar to enormous proportions,'' said Lou Crandall, the chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. ``Even before this week's events, estimates based on visible factors were pointing to a deficit above $500 billion next year, with the prospect of billions of mortgage- backed securities on top of that."

See also this Bloomberg article.

Here, I want to return the issue I've brought up countless times before. We cut taxes, and we embarked upon a war of choice, and in addition to the opportunity and fiscal costs, this constrained our range of actions for the future. Even if you thought the Bush tax cuts of 2001 and 2003 "benefitted" the US economy on net, we know that the war in Iraq has cost on the order of $653 billion nominal dollars from FY03-FY0-09 [2] -- in current dollars that's even more given inflation. Those dollars could have been spent fixing the financial system. Now, we'll have to either borrow or tax to to finance the operation.

So, if you wanted the McCain extension of the Bush tax cuts, and the additional $1.3 trillion tax cuts, then you might wonder about the impact on US borrowing rates. If you were hoping for more domestic initiatives, perhaps to give tax relief to the lower and middle income households, or to invest in infrastructure, the borrowing constraints will be more binding than they otherwise would have been.

Perhaps that's obvious, but sometimes in the midst of crisis, the obvious bears repeating. Here's a picture to illustrate the budget balance outlook pre-intervention....

The purple square is just for illustrative purposes. If you think the Treasury will only have to borrow $350 billion in FY2009, then the orange square is relevant. Further, if we're lucky (and Brad Delong is right), in future years we will recoup all and more of these outlays, so the deficit will be smaller than otherwise. But, in the short run, we'll have to take a hit (of unknown magnitude) now and hope for the best.

Technorati Tags: , subprime, Fannie Mae, Freddie+Mac, and deregulation, Office of Thrift Supervision, and tax cuts.

First, what is the source of the crisis? Is it as is asserted here in this statement from John McCain today?

....

There are certainly plenty of places to point fingers, and it may be hard to pinpoint the original event that set it all in motion. But let me give you an educated guess. The financial crisis we're living through today started with the corruption and manipulation of our home mortgage system. At the center of the problem were the lobbyists, politicians, and bureaucrats who succeeded in persuading Congress and the administration to ignore the festering problems at Fannie Mae and Freddie Mac.

These quasi-public corporations lead our housing system down a path where quick profit was placed before sound finance. They institutionalized a system that rewarded forcing mortgages on people who couldn't afford them, while turning around and selling those bad mortgages to the banks that are now going bankrupt. Using money and influence, they prevented reforms that would have curbed their power and limited their ability to damage our economy. And now, as ever, the American taxpayers are left to pay the price for Washington's failure.

...

I certainly concur with the first sentence. But I do wonder about the assertion that the problem started with and is fundamentally driven by Fannie Mae and Freddie Mac. After all, neither of these two institutions were at the heart of the massive surge in subprime mortgages that are the most toxic component of these asset backed securities. Smarter people than me (Justin Fox, Tanta at CR h/t Mark Thoma) have been similarly dubious.

Moreover, the originating entities for these subprime mortgages were not Fannie Mae and Freddie Mac, by large, but rather the banks that the Federal government refused to let state agencies regulate. Or the ones the Treasury's OTS itself failed to regulate. To refresh memories, consider this article from December 18, 2007 NYT:

WASHINGTON-- Until the boom in subprime mortgages turned into a national nightmare this summer, the few people who tried to warn federal banking officials might as well have been talking to themselves.

Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.

But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman.

In 2001, a senior Treasury official, Sheila C. Bair, tried to persuade subprime lenders to adopt a code of "best practices" and to let outside monitors verify their compliance. None of the lenders would agree to the monitors, and many rejected the code itself. Even those who did adopt those practices, Ms. Bair recalled recently, soon let them slip.

And leaders of a housing advocacy group in California, meeting with Mr. Greenspan in 2004, warned that deception was increasing and unscrupulous practices were spreading.

John C. Gamboa and Robert L. Gnaizda of the Greenlining Institute implored Mr. Greenspan to use his bully pulpit and press for a voluntary code of conduct.

"He never gave us a good reason, but he didn't want to do it," Mr. Gnaizda said last week. "He just wasn't interested."

Today, as the mortgage crisis of 2007 worsens and threatens to tip the economy into a recession, many are asking: where was Washington?

An examination of regulatory decisions shows that the Federal Reserve and other agencies waited until it was too late before trying to tame the industry's excesses. Both the Fed and the Bush administration placed a higher priority on promoting "financial innovation" and what President Bush has called the "ownership society."

...

On Tuesday, under a new chairman, the Federal Reserve will try to make up for lost ground by proposing new restrictions on subprime mortgages, invoking its authority under the 13-year-old Home Ownership Equity and Protection Act. Fed officials are expected to demand that lenders document a person’s income and ability to repay the loan, and they may well restrict practices that make it hard for borrowers to see hidden fees or refinance with cheaper mortgages.

It is an action that people like Mr. Gramlich and Ms. Bair advocated for years with little success. But it will have little impact on many existing subprime lenders, because most have either gone out of business or stopped making subprime loans months ago.

...

The Fed was hardly alone in not pressing to clean up the mortgage industry. When states like Georgia and North Carolina started to pass tougher laws against abusive lending practices, the Office of the Comptroller of the Currency successfully prohibited them from investigating local subsidiaries of nationally chartered banks.

Virtually every federal bank regulator was loathe to impose speed limits on a booming industry. But the regulators were also fragmented among an alphabet soup of agencies with splintered and confusing jurisdictions. Perhaps the biggest complication was that many mortgage lenders did not fall under any agency's authority at all.

...

And for some more concrete examples of how deregulatory zeal had an effect, consider this account from the WSJ (March 22, 2007):

Regulators appointed by President Bush often have been more sympathetic to industry concerns about red tape than their Clinton administration predecessors. When James Gilleran, a former California banker and bank supervisor, took over the OTS in December 2001, he became known for his deregulatory zeal. At one press event in 2003, several bank regulators held gardening shears to represent their commitment to cut red tape for the industry. Mr. Gilleran brought a chain saw.

He also early on announced plans to slash expenses to resolve the agency's deficit; 20% of its work force eventually left. When he left in 2005, Mr. Gilleran declared that the OTS had "exercised increased diligence in its review of abusive consumer practices" while reducing thrifts' regulatory burden. But his successor, Mr. Reich, a former community banker, has reversed many of Mr. Gilleran's cuts. Citing "understaffing," he hired 80 examiners last year and plans to add 40 more this year. A spokeswoman for Mr. Gilleran, now chief executive of the Federal Home Loan Bank of Seattle, said he wasn't available to comment.

So, from my perspective, locating the source of the current crisis in corruption/influence peddling surrounding Fannie and Freddie exhibits a misreading of recent history. (More important might have been lax monetary policy and the saving glut, and exemptions from capital requirements for certain investment banks... [see Ritholtz])

Second, how hard will the rescue be given the reckless decisions of the past? It seems that whatever entity is established to purchase these bad assets will require some fiscal outlay. Estimates are all over the place, given that there is so much uncertainty over how much the assets will be bought for and eventually sold; here is one account:

U.S. Debt May Grow $1 Trillion on Rescue, Barclays' Pond Says

By Sandra Hernandez

Sept. 19 (Bloomberg) -- The U.S. may have to borrow an extra $700 billion to $1 trillion to fund the biggest rescue of the financial system since the Great Depression, according to Barclays Capital Inc.'s Michael Pond.

Federal takeovers of Fannie Mae, Freddie Mac, and American International Group Inc.; the central bank's expansion of lending to financial firms; and a slowing economy will add $455 billion to the Treasury's borrowing needs, the New York-based interest-rate strategist estimated. Pond said Treasury Secretary Henry Paulson's plan to rid banks of "hundreds of billions" of troubled assets would bring the amount to $700 billion assuming the plan costs $200 billion.

"We could easily add up to an additional trillion to the outstanding Treasury debt just from the initiatives announced over the past couple of weeks," said Pond, ranked the best Treasury Inflation-Protected Securities analyst in 2008 by Institutional Investor magazine.

The government's liabilities swelled in past weeks as policy makers sought to arrest a growing financial crisis by taking over financial institutions threatened by a shortage of capital.

The Treasury on Sept. 7 took over mortgage-finance companies Fannie Mae and Freddie Mac and said it would buy mortgage-backed debt in the open market. The Fed this week boosted its Treasury auctions to bond dealers by $25 billion, loaned $85 billion to the insurer AIG, and quadrupled the amount of dollars foreign central banks can auction to $247 billion. Paulson today said the government will buy illiquid assets from banks' balance sheets and insure money-market mutual fund holdings.

Deficit Widens

"The odds of the deficit becoming enormous are certainly there," said Nils Overdahl, a bond fund manager in Bethesda, Maryland, at New Century Advisors, which oversees $500 million. "I suspect you will see issuance at a variety of maturities."

The deficit will likely widen to $650 billion in fiscal 2009 because of the U.S. rescue of Fannie and Freddie, analysts at JPMorgan Chase & Co. wrote in a Sept. 12 report.

Over the next decade, the gap between spending and receipts will swell to $5.3 trillion, Goldman Sachs Group Inc. analysts wrote Sept. 10, revising a previous forecast of $3.6 trillion. The non-partisan Congressional Budget Office forecast a record $438 billion deficit for 2009 on Sept. 9.

"The deficit will soar to enormous proportions,'' said Lou Crandall, the chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. ``Even before this week's events, estimates based on visible factors were pointing to a deficit above $500 billion next year, with the prospect of billions of mortgage- backed securities on top of that."

See also this Bloomberg article.

Here, I want to return the issue I've brought up countless times before. We cut taxes, and we embarked upon a war of choice, and in addition to the opportunity and fiscal costs, this constrained our range of actions for the future. Even if you thought the Bush tax cuts of 2001 and 2003 "benefitted" the US economy on net, we know that the war in Iraq has cost on the order of $653 billion nominal dollars from FY03-FY0-09 [2] -- in current dollars that's even more given inflation. Those dollars could have been spent fixing the financial system. Now, we'll have to either borrow or tax to to finance the operation.

So, if you wanted the McCain extension of the Bush tax cuts, and the additional $1.3 trillion tax cuts, then you might wonder about the impact on US borrowing rates. If you were hoping for more domestic initiatives, perhaps to give tax relief to the lower and middle income households, or to invest in infrastructure, the borrowing constraints will be more binding than they otherwise would have been.

Perhaps that's obvious, but sometimes in the midst of crisis, the obvious bears repeating. Here's a picture to illustrate the budget balance outlook pre-intervention....

The purple square is just for illustrative purposes. If you think the Treasury will only have to borrow $350 billion in FY2009, then the orange square is relevant. Further, if we're lucky (and Brad Delong is right), in future years we will recoup all and more of these outlays, so the deficit will be smaller than otherwise. But, in the short run, we'll have to take a hit (of unknown magnitude) now and hope for the best.

Technorati Tags: , subprime, Fannie Mae, Freddie+Mac, and deregulation, Office of Thrift Supervision, and tax cuts.

David Cho opens his story in the Washington Post with this bombshell:

Regulators had long classified a private Swiss energy conglomerate called Vitol as a trader that primarily helped industrial firms that needed oil to run their businesses.

But when the Commodity Futures Trading Commission examined Vitol's books last month, it found that the firm was in fact more of a speculator, holding oil contracts as a profit-making investment rather than a means of lining up the actual delivery of fuel.

Let's start with some background. The CFTC issues a report each week that summarizes the number of open futures contracts in oil and a number of other commodity markets. The CFTC separates the holders of those contracts into three broad categories-- commercial, noncommercial, and nonreportable. "Commercial" traders are those who report to the CFTC that they are

engaged in business activities hedged by the use of the futures or option markets.

So, for example, if your company has significant fuel costs, you would quite reasonably satisfy that definition of a commercial trader, regardless of whether the particular futures contracts you buy or sell this month are intended to hedge those costs. The CFTC specifically says further that it would classify as a commercial trader

a swap dealer holding long futures positions to hedge a short commodity index exposure opposite institutional traders, such as pension funds.

To an economist, any conceptual distinction between "hedging" and "speculation" is inherently problematic. When an oil refiner takes a position with futures contracts, it is unlikely to be ignoring its own guess as to where prices are heading. But making a bet based on such guesses seems to be the definition many people have in mind when they speak of "speculation." On the other hand, when a pension fund manager takes a modest long position in commodities, that can reduce the overall variance of the portfolio due to the negative correlations between commodity price changes and other asset returns, which would most naturally be described as hedging against inflation risk. The idea that the motives of a given trader can always be classified as either pure hedging or pure speculation, and that the positions of commercial versus noncommercial traders reported by the CFTC give us meaningful information about those motives, strikes me as a very dubious proposition. Discovering a potential "misclassification" could hardly be the basis for becoming legitimately alarmed.

What else does Cho dig up? The article continues:

Even more surprising to the commodities markets was the massive size of Vitol's portfolio-- at one point in July, the firm held 11 percent of all the oil contracts on the regulated New York Mercantile Exchange.

That does sound like a lot, though enough details are left out to make me wonder what is actually being claimed here. Surely Cho doesn't literally mean "all the oil contracts," i.e., light sweet, Brent, heating oil, gasoline, and so on. If light sweet alone, are we talking about just futures, or futures plus options? Or is Cho possibly referring just to one very specific contract, such as the August CL futures contract? And were these positions held outright by Vitol or purchased on behalf of its clients?

Cho gets more quantitative a few paragraphs down:

By June 6, for instance, Vitol had acquired a huge holding in oil contracts, betting prices would rise. The contracts were equal to 57.7 million barrels of oil-- about three times the amount the United States consumes daily.

Again I'd like to know if we're including options somehow in this number. But more importantly, the claim that you can compare the number of notional barrels of oil implied by a futures contract if it were held to settlement with the number of physical barrels that the U.S. consumes repeats the egregious error committed by Michael Masters in his Senate testimony this May. You can't compare the outstanding NYMEX open interest with U.S. daily petroleum consumption numbers directly because they are measured in different units. Open interest is a stock-- it is measured in number of outstanding contracts at a particular point in time. Consumption is a flow-- it is measured in barrels per unit of time. You can't measure how many barrels of oil the U.S. consumes without specifying a time unit. We consume about 20 million barrels per day, or 14,000 barrels per minute, or 7.3 billion barrels per year. With which of these 3 numbers are we supposed to compare 57 million? Fifty-seven million sounds like a lot more than 14,000, and a lot less than 7.3 billion. You can make 57 million sound as big or as small compared with U.S. consumption as you want, because there's an arbitrary time interval associated with consumption that is not associated with open interest. If you want the futures volume to sound big, you compare open interest with daily consumption, as Masters and Cho both do.

Cho was trying the best he could to convince us that unregulated speculation was the cause of this summer's spike in oil prices.

But instead he convinces me that he really couldn't find much of a case.

Technorati Tags: oil, oil prices, oil speculation