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October 31, 2009

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LOL! Without predictions, sir, I believe we'd both end up without jobs. Didn't blow off your last reply, BTW, but the answers will require additional thought, as does this additional info you're bringing to the table.

I think, however, that I'll end up having to use the dread word "malinvestment".

"[B]ankruptcy does not destroy actual physical assets, land or human capital."

When the bankruptcy is due to one firm's bad luck or bad management, true. Some other firm in the same industry will find a use for it.

When the change is involved in broader changes in the industry or the economy, then the bankruptcy changes the physical asset into a deteriorating building full of expensive machinery that's obsolete, in the wrong place, or simply redundant. The people who used to work there are now competing for entry level work elsewhere.

It isn't all private sector stuff either. Every day I drive past an empty school building on my way to work. The aging bedroom community kept it open for a declining number of children who lived nearby until the money suddenly wasn't there.

"[T]he psychological effects can be long-lasting." But it isn't that kind of psychological. Once Sill Middle School is closed and everyone gets used to it, there isn't any reason to open it again unless there's a sudden influx of families with school-age children.

"So perhaps the United States need not worry about our long-term fiscal problems." This depends on how strongly you feel that the underlying real economy is - healthy? strong? balanced? nonstagnant? (suggestions welcome). If it isn't, is the environment you're describing the best one for the real economy to evolve in a way we'd like?

David, you make a statement here that I think puts the cart before the horse:

"When the change is involved in broader changes in the industry or the economy, then the bankruptcy changes the physical asset into a deteriorating building full of expensive machinery that's obsolete, in the wrong place, or simply redundant. The people who used to work there are now competing for entry level work elsewhere."

In this case, the bankruptcy doesn't change anything. It merely recognizes the reality of the situation. If I have a productive asset, after a BK my creditors or the folks that buy my stuff on liquidation will have a productive asset. If I have a buggy-whip factory, they'll have a buggy-whip factory. To my mind, this is akin to taking a charge-off on a bad loan and writing down that amount on your loan loss reserve; it's merely bringing the accounting in line with the facts on the ground, where the loan I'm writing off went bad long before.

Bernard's completely right here, I think. In fact, he's pretty much nailed the basic critique of Austrian liquidationism. The Austrian school believes that there needs to be some sort of grinding period of negative growth during which resources are taken out of declining sectors and moved to more productive use.

As Bernard points out, there's no reason for that to be true. Once a firm and its creditors have written off their old assets, there's no reason why they can't stay in production if there's a market, or immediately charge off and do something more renumerative if there isn't.

After all, it didn't take mass unemployment to get the economy to shift resources out of widget-making and into house-building during the last decade.

In other words, unless you want to worship at the feet of the moral hazard gods, there isn't any reason not to use government spending to make recessions as light and quick as possible.

David also has the essential point. An empty building is no longer producing rental services. But under normal conditions the purchasing power formally spent on those services is either being spent on something else or invested somewhere in buying stuff that will be used to produce something in the future. The empty building is an eyesore, but not a drain on the economy ... unless its presence demoralizes people somehow.

But there are two catches in this fancy pollyanism. First, recessions hurt. They may not have to, there may be no reason not to make them hurt less, but it is painful to be shoved out of building houses by layoffs and falling wages rather than pulled into it by a boom.

Second, as an empirical matter, recessions caused by financial collapses (as opposed to other things) do in fact seem to produce long slow and grinding recessions, from which the economy may never fully recover, at least not in a time frame of a decade or more.

Makes them something worth trying to avoid, I think, rather than just clean up after.

One could argue that the IMF's "pre-crisis trend" line is unrealistic, as there's always going to be another economic crisis, sooner or later.

Peter

There will always be another recession, but there's not always going to be a financial crisis. Some countries avoid them altogether; those nations are the implicit baseline.

The U.S. avoided them for a very long time. Heck, given the quick way in which the first Bush Administration wrapped up the S&L collapse, the U.S. didn't have any between 1933 and 2007. Lots of recessions, no financial crises.

I'm not sure whether we're disagreeing or agreeing in different words. But.

"Once a firm and its creditors have written off their old assets, there's no reason why they can't stay in production if there's a market, or immediately charge off and do something more renumerative if there isn't."

If I have the terminology right, you're thinking in terms of an extremely low-friction economic universe. This is intellectually appealing but doesn't match what I see out the window.

"In this case, the bankruptcy doesn't change anything. It merely recognizes the reality of the situation."

No, because the bankruptcy itself also changes things. Say there was one more buggy whip factory than the market could support. When did it become inexitable that yours would be the one to go under, and that you wouldn't be able to find a white knight or successfully diversify?

Or, to continue with my real-world example, it's hard to imagine an ATL with a recent POD that has Sill Middle School functioning as a middle school with an ever-shrinking number of pupils, but not hard to imagine one where it's used for offices or special programs or rented to other agencies, instead of sitting empty while the school board tries to find someone who will give more than 25% of what they consider fair value.

The financial crisis, of course, makes things worse.

"In other words, unless you want to worship at the feet of the moral hazard gods, there isn't any reason not to use government spending to make recessions as light and quick as possible."

In principle I agree, but suspect we're far apart on details. And I think the moral hazard gods are going to become more and more vengeful.

We're agreeing in different words.

For the moral hazard gods to become more vengeful, people would have to start taking bigger risks. Does that seem likely?

I consider "too big to fail" as a type of moral hazard and complacency as (somewhat paradoxically) a type of risk-taking.

If you've heard that GM is seriously trying to shake up it's corporate culture, frex, please pass it on; I would consider that very good news.

Hi, David,

http://www.nytimes.com/2009/11/13/business/13auto.html?ref=business

This is a very serious attempt to shake up the corporate culture.

More broadly, GM was only "too big to fail" in the context of a widespread financial crisis. If the economy had been healthier, the government would have almost certainly let it go down.

After all, against my expectations, the Obama Administration burned through political capital by taking the company over. No support for anything seems to have been generated, as best as I can tell, with the possible exception of Michigan opinion polls.

Thank you! This is good news. Hope it sticks.

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