HOISTED FROM OTHER PEOPLE'S ARCHIVES: Unprofessionals Spreading Misinformation Edition
In which John Cochrane claims that Walter Bagehot's "Lombard Street" & all subsequent analyses of lenders-of-last-resort are not economics...
People are pushing back on me—nobody believing that John Cochrane in March 2009 was as moronic as he was.
Few people believing that in the late winter of 2009 one of the most important things Sebastian Mallaby thought he should do from his perch at the CFR was to run a conference in which people who understood anything at all about a financial crisis were as scarce as hen’s teeth.
But at least some of the lurkers in email will credit that, back in Those Days, the usually reliable Chrystia Freeland offered no pushback at all to a panel she was running that was, largely, insane.
However, it now can be found only at the WayBack Machine. CFR has trashed the record of its conference.
So here is what John Cochrane was saying back then:
Nobody in the Great Depression… was fooling enough to think that toxic assets were the problem or that the government, by somehow stirring up the liquidity of $10 trillion of toxic assets, was going to make the banks look all right again. This is an amazing fairy tale we've been telling ourselves for eight months now. Think of every step of the chain. Stirring the pot is going to make everything more valuable. Making everything more valuable is going to make the banks look solvent again. Making the banks look solvent again means people are going to start buying bank stocks. Banks are just dying to go and lend if only they had more equity -- it's not just going to happen. Well, that one we're inventing on our own.
My job is a finance professor so let me mention a few things about securities. Fundamentally what happed in the '20s to '30s and in the recent time to now has very little to do with the Fed. The risk premium was very low in the boom and is very high now. There's almost no economics that describes how the Federal Reserve, by monkeying around with three months of Treasury bills and reserves, can lower long-term interest rates, but absolutely no economics that says how the Federal Reserve is in charge of the risk premium, and that's what was going on. People were willing to hold mortgages, stocks, risky bonds at amazingly low premiums on the way up and now they want very high premiums on the way down. That's not something the Federal Reserve is in charge of.
Let me say something nice also about Glass-Steagall. It had many faults but its essential wisdom is that if there's something systemic that you're going to bail out, you draw a circle around that and then you say, this is not systemic and will be allowed to go under. That's what we're going to have to do, and our current Treasury plans still don't envision that. They envision we're going to let these monster businesses keep going and somehow perch a little fairy of regulation on everybody's shoulders to make sure they do the right thing. That just is not going to work.
General -- well, a last couple of general comments. Many things are depressingly the same. Policy is chaotic. Who would invest in this climate? It's not about toxic assets; it's about who wants to go in on a deal with Darth Vadar, who can change his mind at any moment? That's the uncertainty that's keeping things from getting going and that's what's slowing the rebuilding of financial markets. We're facing growth-destroying marginal tax rates, an excuse for the government takeover of large and completely unrelated sectors, class warfare, vindictive ex post taxations. This is the chance for a credit crunch -- which normally resolves itself fairly quickly -- to turn into a Great Depression. And perhaps most of all there is the danger of learning the wrong lessons; that our grandchildren will have to come back to the next meeting to say, what were the lessons -- the lessons mis-learned of the last time around?
My great hope is that the bounce-back will be quick before the quack medicine can be said to have worked. (Chuckles.) Just as we sort of -- as people think that this insane idea of fiscal stimulus -- which I'll go on with later if I get a chance -- came from Roosevelt's experience with no reason why it should work, there is a danger of thinking all of the crazy stuff they're doing now will have caused the bounce-back, if that happens, in five years, but my only hope is that it happens quickly and doesn't leave us with another Great Depression.
It’s not as if Cochrane thinks the entire subfield of financial-crisis-&-lender-of-last-resort economics from Walter Bagehot’s Lombard Street through Charlie Kindleberger’s Manias, Panics, & Crashes to, say, Andrew Hauser’s (2021) “From lender of last resort to market maker of last resort via the dash for cash” is wrong.
Cochrane is unaware that that subfield exists.
Which is a stunning and unprofessional degree of ignorance that still boggles my mind.