Skeptonomics

This afternoon I co-led a forum on the financial crisis with my Evergreen colleague Peter Bohmer. I had a flash as I was preparing: at some future point we could be in for a reverse tsunami.

Here’s the idea: A real tsunami begins with an outward flow of water. If you’re standing on the beach and suddenly the water line retreats 10 or 20 meters, it’s time to race for higher ground. Now consider the opposite phenomenon. The massive Fed/Treasury spending spree to hold the crisis at bay, thus far unsuccessful, is being financed by a massive capital inflow. Some of this comes from foreign CB’s eager to do their part, but a big part is the result of global capital flight to the supposedly least risky currency. Suppose we get out of this alive and calm returns to the markets. Most of those people are going to want to bring their money back—that’s the reverse tsunami. How do we finance that? The Fed’s balance sheet will be wall-to-wall junk.

OK, just getting to that moment will be a big victory.

Paul Krugman has given us a first stab at a leverage-constrained intermediary-driven model of financial contagion. Its point is well-taken, but in my view it misses a very large piece.

I won’t reproduce the math (all basic algebra), but will make the argument verbally: Krugman’s model captures the effect that a falling asset price has on intermediaries’ portfolio capacity for this asset, assuming a fixed capital requirement: the price goes down, so holdings have to decline too in response to diminished equity. This assumes that the extent of leverage is externally imposed, for instance by a responsible regulator.

As we know, however, such regulators have been in short supply. Rather, desired leverage can be viewed as endogenous, a function of perceived risk. A falling asset price can therefore generate a potential double-whammy: for any given degree of leverage it reduces holdings, and it can also increase perceived risk exposure, reducing desired leverage still more.

If this is correct, one potential irony in renewed regulatory vigor (such as demanding more prudent policies on the part of institutions the government acquires an equity stake in) is that it intensifies deleveraging and puts further downward pressure on assets. Such an effect would not arise in interventions that touched a small corner of the global financial system, like Sweden’s in the early 90s, but it would have to be taken into account in the emerging global rescue. This would be an argument for public banking, as I’ve advocated here before, since such a system could be scaled up to whatever level of finance is deemed necessary, rather than relying on private sector willingness to lend and take positions.

On Oct. 3 I posted a piece that pointed out the similarities between my proposal for public banking and Andrew Feldstein’s. Not only was the general idea roughly the same, we both proposed the same figure for initial capitalization, $300B. Since my proposal appeared three days earlier, I harbored suspicions. I couldn’t find contact information for Feldstein, so I posted my doubts on the website of Joe Nocera, the New York Times columnist who was the source for AF’s proposal. After waiting for two days and not seeing any response, I went public about my suspicions here. I tried to make it clear that I had nothing to go on but coincidence, but in retrospect my writing could be interpreted as leaving a different impression.

What I’ve learned since: (1) Nocera and the Times are justifiably concerned about apparent accusations of plagiarism against one of their quoted sources. (I was contacted today.) (2) Feldstein privately communicated his proposal to Nocera on the same day I posted mine three minutes earlier. Talk about an idea being in the air!

So to set the record straight: the similarity and simultaneity of Andrew Feldstein’s suggestion and mine are entirely and remarkably coincidental. Whatever the truth content of my philosophical musings on the difference between academic and commercial conceptions of intellectual property, they do not apply in any way to this particular episode. And if Feldstein’s investment strategies are as farsighted as his policy proposals, you might want to take a look at his hedge fund.

So now the Fed will directly purchase unsecured commercial paper, something a “real” financial institution does as a matter of course (except during a panic). Because even its resources are limited, it is acting on the liability side of the ledger as well, for the first time offering to pay interest on the deposits of commercial banks. (This also encourages banks to be less than fully lent, offsetting the credit creation implications of the Fed’s buying binge.)

If you put these two items together, you have the beginning of what I called Plan B in my earlier post on the subject. There is no need to bail out the private sector: it is possible to create a publicly owned and operated financial entity to carry on the normal tasks of issuing credit, pooling risk and supporting long-term investment. To go further down this road, the Fed would (a) expand the range of assets it would consider buying, and (b) offer competitive returns on deposits and shares of investment funds. Of course, it would be much better for this operation to be spun off to a new entity to avoid conflicts of interest and operational overload.

The overall situation is still in flux, and in particular it is not clear whether it will be possible to unfreeze private financial channels. It may be that, not only is public banking the best strategy—it may be the only one.

While attention was elsewhere, congress voted to give lend GM, Ford and Chrysler a $25B bailout all their own. I can remember a time not so long ago when that would have been considered real money. Critics protest: why should we prop up Detroit? What about Toyota and Honda, for instance: they produce in this country too, no?

But this misses the point. Toyota and Honda don’t need the money; they’ve been designing and building fuel-efficient vehicles for years. We should reward the Big 3 for binging on SUV’s and starving their research engineers.

It’s official: Henry Paulson is now authorized to begin shelling out the first tranche in his $700B plan to refloat financial markets. Don’t pull your money out from under your mattress just yet, however.

1. This is just a beginning. The writedowns in the mortgage market are estimated at $2 trillion and the bubble is still unwinding. The losses in derivative assets will be greater still. The bailout buys time but it does not constitute a solution.

2. The problem of pricing assets will be enormous. There is a technical problem, of course, in determining the price of something that no one currently bids for, but a deeper issue lurks. The plan was sold on the basis of highly ambiguous wording. It was stated for public consumption that the only problem is liquidity, and that the Fed/Treasury can solve it by offering to buy assets at their hold-to-maturity value. Everyone knows, however, that the real problem is solvency, and that the unspoken intention is to overpay in order to slip cash to players who might otherwise go under. No doubt it is possible to do this quietly, a few billion at a time, like the US military does in Iraq, but this is not big enough or fast enough to rescue the markets. There will need to be big, big overpayments, and in their search for congressional votes the plan’s backers couldn’t hope to ask for such a mandate. This means that everyone connected with the operation will be looking over their shoulders, worrying that, if they follow the unstated intent of the law, they will be held personally accountable.

But look on the bright side: mental illness will now be covered under more private health insurance plans (for those dwindling few that have them), and small timber-dependent communities out here in the Pacific northwest will be able to keep their schools open. So the bill will have some successes to crow about.

This is the title of piece of mine just published in the Post-Autistic Economics Review. I happen to be a fan of science (I’m so pre-postmodern) and would like economics to move in that direction. Let me know what you think.

As loyal readers of EconoSpeak know, on Sept. 24 I posted a relatively substantial proposal that I headlined “Plan B: How to Restore Financial Markets Without a Bailout”. Three days later, I was surprised to see almost the same plan referred to in a New York Times column, but attached to the name of Andrew Feldstein, the director of a hedge fund. What struck me is that, not only were the two key general ideas—the public financial intermediary, the window to acquire distressed assets at market prices—the same, even the initial capitalization was pegged at an identical $300B. (Some of the details revealed in a followup Times blog were different and, honestly, not as good.) In my line of work, this is a prima facie case of plagiarism.

What this probably represents, however, is a difference in culture. In the academic world that I inhabit, there is a strong expectation that all borrowed words or ideas will be attributed to their source. Failure to do this constitutes an intellectual scandal; on the positive side, we try to impress our peers with a bottomless pile of citations. (This is called “scholarship”.)

The business world is different. There the rule is, if it ain’t nailed down you can take it. Having a bright idea and getting mentioned in the Times is worth real money. I can imagine that Feldstein’s fund may get an extra investor or two (or dissuade an existing investor from fleeing) by the halo effect of this publicity. I was dumb enough not to copyright my idea, so what do I expect?

Actually, while I like to have my ego stroked every now and then, and while I would come down hard on any student who submitted a paper that plagiarized, I don’t really care about attribution in this case. I would like this idea to be given a fair hearing, and someone with a hedge fund is likely to have a wider audience than me. In fact, I rather like the notion that an obscure economist can release an idea on some little corner of the web, it can bounce around for a while, and then reappear dressed up in real money.

Both McCain and Obama are effectively running against Bush, but neither is able to frame his argument in a coherent way. That is, we have criticisms of this policy or that one, but no general position that ties them together and makes them look like anything more than random corrections. McCain’s problem is obvious—he’s really running against his party (the “maverick” trope)—but what about Obama?

Republicans have put forward different frames over recent years, but two are central to actual policy: free-market economics and the unrestricted, hegemonic use of police and military power (“standing tall”, “keeping us safe”). You could say that the current financial crisis blows away the first and that Iraq discredited the second. So this is an opportunity for the Democrats to engage in a little frame replacement to their own advantage. Instead, what do we get?

Obama talks about the Iraq disaster in an apolitical fashion, as a simple error in judgment. As one who saw through the bs from the beginning, he claims to have superior judgment compared to someone like McCain. What’s missing, however, is how his rejection of Bush’s war reflects a broader position on military and foreign policy. No doubt he is afraid of being labeled “soft”, and this explains his reckless belligerence regarding Pakistan. Yet it would not be very difficult to construct a politically saleable alternative to the shoot’em up philosophy of Bush/McCain.

You’d think he would do better on the economic side. The lessons of the financial mess are straightforward and lend themselves to a reframing of the public role in directing the economy. Still, Obama goes only halfway. He talks repeatedly of the “failed philosophy of the last eight years”, but he says nothing about what the new philosophy should be.

A failure to frame is politically disabling on multiple levels. It cedes too much of the political turf from the outset, and does nothing to predispose the voters to support you. It means that every policy initiative has to start from zero, with no ideological headstart. Above all, it represents an abandonment of the leadership role of politics, the struggle to change the political center of gravity. If one side hammers relentlessly on its frames and the other talks about competence and judgment—well, we know what you get.

There is no evidence at this point that the Democrats are prepared to conduct a political fight in broad daylight to change the direction of this country.

I’ve been thinking mostly about the global portion of the loop—how the dollars we send abroad on the current account (and now, just a bit, on net private capital outflows) are returned to us—and its operation under the Paulson plan. The Fed/Treasury team is proposing to allow this recycling to proceed under an asset cleansing program: the Fed removes the bad assets from our creditors’ portfolios while the Treasury replaces them with nice, reliable T-bills. (Metaphor: TARP as a giant mollusk in the sea of finance.) So far so good.

But this is only part of the picture. The other part is the domestic sector. Our current account deficit says that, as a country, we consume about 6% more than we produce, where “consume” in this context means total demand and not just the household piece of it. So the recycling process has to actually get the money into the hands of those who will spend it. This means credit expansion of some form. To be more specific, capital spending is very weak at present, and households are now holding up the tent. They have been borrowing against largely fictitious real estate equity and, to a lesser extent, running up credit cards and drawing down savings. If the popping of the housing bubble and the retrenchment of consumer credit mean that these channels are no longer available, how do we keep the engines running?

Basically, there are two channels still open: fiscal deficits and further drawdowns of savings. In the case of the former, it is important to be able to identify how the deficits will enter the spending stream. I worry that much of the eleven-figure disbursement will simply keep financial institutions, now highly risk-averse, afloat. This maintains existing wealth for the small minority that holds most of it, but it doesn’t translate into effective demand. And eating up savings can go only so far. Say what you want, the asset bubble(s) promulgated by earlier rounds of recycling at least propped up domestic spending. I worry that, even if the bailout keeps the global loop in operation, it will not be able to reconnect it to the domestic loop. The result will be a monster recession.

In the last several days there has been an emerging consensus among well-informed analysts (like this and this) regarding the Fed/Treasury plan to bail out financial markets. It goes something this: the US financial sector faces a liquidity crisis on top of a solvency crisis. The liquidity part is that financial intermediaries (only some of them banks) are increasingly unable to meet their obligations to depositors and counterparties because they have no access to credit. Highly leveraged, they do not have the resources at hand to carry on their business. If this were the entire problem, the Fed could solve it by offering to buy mortgage-backed securities and similar assets at their actual market value. In that case there would be no bailout, just an infusion of liquidity to tide the markets over.

But there is an underlying solvency crisis: as housing values have declined, assets tied to them are no longer worth the financial obligations institutions have incurred in acquiring them. A large portion of the financial system (no one knows at this point how large this is) has negative net worth. This is why Bernanke has spoken of purchasing assets at their face rather than market value.

There are two gigantic problems with the bailout scheme, in addition to all the smaller ones. First, overpaying banks, investment funds and other financial players to the tune of hundreds of billions of dollars is an ethical and moral hazard nightmare. These people have made obscene fortunes in wild speculation; now that their bets have gone sour is it the public’s duty to cover their losses? Second, it is not even clear that the strategy will work. We don’t know how much it will take to bring the financial sector back to life, partly due to the lack of transparency that helped get us into this mess in the first place, and also to the understandable reluctance of firms to mark down all the paper that has declined in value. It may well be that between one and two trillion dollars will be needed to get the markets back on their feet, and this may exceed the financial and political resources of the federal government.

A big improvement (championed by Paul Krugman) would a buyout of the firms rather than the assets, even as an option as formulated in the Dodd proposal. Still, and especially in light of the difficulty in disentangling viable portfolios from moribund ones, the cost may be too great. It would be nice to have something completely different on the table. So read on: here is a Plan B, an alternative to bailouts that might restore a functioning credit mechanism to the US economy.

The concept: The existing approach tries to bring existing institutions out of insolvency and credit gridlock. Plan B allows these institutions to go belly up but rapidly creates a parallel financial mechanism to rescue sound assets from the rubble while offering credit to new borrowers. Rather than providing a public prop, it provides a public alternative.

The plan: Create a new publicly-financed, publicly-run enterprise; for the purposes of this description we can call it Fund US. Its initial capitalization would be provided by a Treasury issue. The amount could well be much less than the $700B (or $1.4 trillion in borrowing authority) that headlines the existing plan. This is because the fund would be permitted to leverage up to some reasonable ceiling—say six-to-one. So give it $300B as an initial allocation.

One initial function of Fund US would be to open a window for the purchase of existing financial assets at fair market value. This is not necessarily the same as the value of the moment, since, by its size relative to the markets as a whole, Fund US would be a price-maker. One possibility would be to honor prices as of September 15, before any general public plan was broached. Another, specifically for MBS’s, would be to use an algorithm based on a decline of the Case-Schiller Index to long run trend. Either way, this would protect the genuine value of financial wealth tied to housing from the cascade of defaults likely to sweep through the private sector.

The other main function would be to serve as an all-purpose financial intermediary to the US economy and to foreign interests that do business here. It would underwrite existing loans or other contracts, originate new credit and assemble a portfolio of financial assets in a manner consistent with prudent management. On the liability side, it would accept deposits and sell instruments like mutual funds and secondary debt. In other words, it would do what the current system does, subject to greater constraint.

What could assure this constraint? Here are some ideas: (1) The limit on leverage would be statutory. (2) Full transparency could be written into the legislation authorizing Fund US. All assets and liabilities would be publicly reported and all terms made explicit. (Small borrowers and lenders could have their individual identities protected for privacy purposes.) (3) There could be systems of oversight and undersight. The first would be provided by an outside board of disinterested specialists, primarily academics in the fields of accounting and finance. For the second, we might have front-line employees, who analyze and perform individual transactions, constitute themselves into a review body. This entity could give frequent public assessments of the quality of the Fund’s activities and their adherence to overall policy objectives—institutionalized, routinized whistle-blowing capacity. (4) All employees of the Fund, top to bottom, should be paid fixed salaries—no commissions or bonuses. (5) The Fund’s goals should be to maintain the value of public equity, minimize aggregate risk and have the capacity to supply credit sufficient to meet the needs of the economy. Profit maximization, returns in excess of what is necessary to supply a net worth buffer, would not be a goal.

Of course, one paragraph cannot possible provide sufficient detail to demonstrate that such an institution is feasible. On the other hand, how many paragraphs do we have at this point for the mega-bailout?

Two additional elements of Plan B are required to complete this brief sketch. First, Fund US would not be a chartered monopoly. Any financial institutions that survive the ongoing shakeout can compete against it, as can startups. Indeed, because of its lack of incentive for aggressive marketing on both sides of the ledger, it may eventually evolve toward being a financial intermediary of last resort. This would be fine. Second, for competition in this market to be constructive, new regulation must be extended to all players along the lines currently being discussed. In particular, limits on leverage and transparency requirements should apply to all intermediaries, whatever their institutional morphology.

I will not make any great claims for Plan B. Its details require much more working out. There is also a valid concern that it may not be possible to get a massive new institution up and running before existing credit channels freeze up. It would have been much better to have developed a public fund slowly and carefully during the pre-crisis phase, but who was thinking this far ahead? I am less bothered by the ideological objection to a public institution taking on the functions of private firms and competing with them. To take one example, more than half of all the assets in the German banking system are in public and cooperative banks. Germany isn’t utopia (and one of its state banks was mauled because it indulged in dubious US assets), but it is, along with China, the world’s leading industrial exporter. It runs a huge trade surplus with the US, largely due to the strength of its small and medium-size enterprises. Small firms in Germany are global players because they have the same access to capital as big ones, something that can’t be said for the US. This is not to say that we should copy the German template, just that there is no reason to assume that public financial institutions can’t support a successful modern economy.

Plan B is offered to you as a stimulus to creative thinking about the current imbroglio. I would be interested to find out if it can withstand scrutiny.

According to today’s New York Times, it’s the beleaguered US taxpayer. In fact, the word “taxpayer” appears five times in their report on Fed/Treasury actions, always in connection with where the burden will fall. But this is flatly wrong.

In case my previous post was too oblique, let me say it bluntly: Taxpayers are not and will not be the ones to finance the bailout of the financial sector. There will be no tax increase to pay for it, nor will there be drastic (eleven-figure) cuts in other federal spending. It will be financed by substantially greater public borrowing from sovereign creditors, especially the People’s Bank of China and the various entities of the Gulf Cooperation Council. (Russia is an uncertainty in light of its own financial crisis.) The feasibility of the bailout depends entirely on the continued willingness of these deeply authoritarian countries to continue recycling their mountainous piles of dollars into dollar-denominated assets—formerly including private sector debt but now public debt exclusively.

In the absence of this external support, no bailout plan is remotely possible.

A question I sometimes ask my intro macro students is, could the Fed, if it wished, conduct open market operations by buying (and later perhaps selling) famous paintings, rock memorabilia, etc.? This tests their understanding of the concept: any asset can be used to inject or absorb liquidity. Little did I suspect that the asset in question might be vast swaths of suburban tract housing. But the recent announcement that the Fed’s acquisition of junk mortgages would be partly financed by $100B in new Treasury issues indicates that the bailout is being insulated as far as possible from monetary policy.

But this is interesting from the standpoint of global capital flows too. Many of the investments of the last few years, like Chinese purchases of Fannie and Freddie stuff and Gulf capitalizations of US banks and shadow banks, aren’t looking very good right now. All indications, in fact, are that sovereign funds are rebalancing as fast as they can away from anything that bears the slightest whiff of the US housing market. But where can they go and still stay in dollars? Answer: the Fed can buy up the tainted assets our creditors no longer want to hold, financed by new Treasury bonds, financed by these same creditors. The creditors are happy (or at least placated) by being able to shift away from risk, the capital inflows needed to finance the US external deficit keep flowing, and enough domestic credit market players are refloated to keep the debt game going a while longer. In theory the Fed/Treasury risk laundering scheme could be extended to new classes of debt, like consumer credit and corporate paper, as their quality deteriorates. The longer it continues, the longer US employment and income can be buoyed up by borrowing, giving the macroeconomy a semblance of stability. I’m getting the feeling, however, that this is an endgame scenario, not a new financial equilibrium.

Reports out of Minneapolis, combined with memories of New York during the 2004 Republican convention, make it clear that police across the country are adopting a new tactic to suppress demonstrations: they conduct mass arrests of as many demonstrators as they can, remove them from the action, then drop the charges. No doubt they are acting on studies that show that this is a cost-effective way of limiting protest activity, but it is also a clear violation of civil rights. A quick and dirty economic analysis suggests a possible solution.

False arrest has always been a problem, but an important countervailing factor has been the sheer cost of imprisonment and trial. The individual cop does not bear this cost, but the political jurisdiction does, and this gives them at least some incentive to reign in the most egregious miscreants on the police force. It would be far too optimistic to say that this incentive is strong enough to enforce a respect for civil liberties all on its own, but it probably leads to less infringement than we would otherwise have. The great Wobbly free speech fights of the pre-WWI era, in which an army of activists would descend on a town in order to get themselves arrested for the horrible crime of speaking freely in public places, were based on this cost. A town would find that granting freedom of speech, compared to the cost of confining and trying dozens or hundreds of IWW activists, was the “lesser evil”.

No such incentive operates against the tactic of mass arrest, followed by dismissal of charges. For the hundreds, including several journalists, herded onto a bridge in Minneapolis by riot police, handcuffed, led away, held and then released (too late for them to participate in the planned demonstration timed to coincide with McCain’s acceptance speech), the only incremental cost to the city was the plastic hand-ties. Next time they could go green and make them out of potato starch so they can be composted.

The point is that there needs to be a real cost. And in human terms, of course, there is a cost, the inconvenience and denial of rights experienced by those who are rounded up. Hence my proposal: those who care about this issue should promote a policy of financial compensation for any citizen who is arrested and then released without charges being filed. It is government’s way of saying, sorry for hassle—we made a mistake and will reimburse you for it. Suppose the amount were $100. This would have an insignificant effect on local budgets as long as the false arrests were occasional, honest mistakes. But if the police deliberately detain 500 citizens without cause they are exposing the taxpayers to an extra $50,000 payout. This might be enough to nip this tactic in the bud; if not there is always the possibility of giving the compensation an upward nudge.

This is an entirely feasible reform, as far as I can see. It has an obvious fairness value in situations where individuals are unfairly detained. And it would have minimal effect on local finances unless the tactic of mass false arrest is being contemplated.

My institution, beloved Evergreen with its moss-covered halls, is eager to be greener than green. Like many of its ilk, it especially wants to be able to say that its operations are carbon neutral. Since there is no way that its footprint (either production or consumption based) can go to zero, this means offsets. In preparation for a meeting on this topic, I’ve been thinking about what it means for an enterprise to achieve neutrality, and I’d like to float some of these ruminations.

1. Evergreen is different from most other colleges or companies in that it maintains a large forest. Each year our trees get bigger and more organic matter gets built into the soil, so that represents a big plus in the carbon ledger. From a simple accounting standpoint there can be no dispute. Nevertheless, what does it mean for an entity (like Evergreen) to operate two divisions, so to speak, a working college and an intact forest? Does this mean that we have a license to spew more carbon in our educational operations than we would if we deeded the forest to a land trust? Perhaps the problem lies in the rather arbitrary goal of carbon neutrality. If you will be fixing a certain amount of carbon in one branch of your operations, it may mean that your proper goal overall is a corresponding degree of carbon negativity.

2. And even in the absence of a forest, what is the magic of neutrality? From an economic point of view, the goal should be to maximize the value added (broadly defined) per unit of carbon. This involves reducing the footprint for a given level of services, maybe more services for a given footprint, maybe a better mix of services from a carbon standpoint that will do both. But looking only at the footprint side misses the point. (1) Some services are worth having even if they are relatively, and unavoidably, carbon-intensive. (2) In an ideal world, some institutions would end up having higher footprints than others, with the goal of equalizing net social benefits per ton of carbon. Specifically, it may be (and as an academic I am dogmatically convinced that) a college does more good than almost any other type of organization in society. In that case, it may well be wrong for a college to crimp its services in the pursuit of carbon savings; other savings elsewhere (like hedge funds) are more crimpable. Even more specifically (and with even more self-interest on my part), what about faculty travel to conferences? Very bad, carbonically, but think of the immense social benefit that comes from the networks we geniuses establish among ourselves. Better that, oh, sales reps for academic software companies stay at home and do their pitching via remote teleconferencing.

3. Then there is vexing issue of buying carbon offsets. I’m on record as saying that, in a voluntary environment like the one we have now, offsets are OK, but once we have a mandatory carbon cap they should be seen as a hole in the bucket. I will stand by that, but what happens when you adopt the goal of carbon neutrality? The fact is, if an organization takes neutrality as its mission, it really does trade off its own emission reductions against the purchase of offsets. Since offsets are unreliable (additivity problems, principle-agent problems), how should they be discounted in carbon calculations? I still think that, all else equal, it is peachy to purchase an offset, but if the price includes not taking some other beneficial action that was available, all else is not equal and all bets are off. So, if you can reduce air travel but you don’t because you’ve bought some offsets instead, if the offsets don’t do what they promise you don’t meet your goals. Once again, I think the root problem is the assumption that neutrality is a magic point on the carbon meter, and that reductions above or below that level (as opposed to getting to it) are of second-order significance. If you drop that and view all reductions as intrinsically good (leaving aside costs), the notion of a tradeoff between reducing your own emissions and buying offsets vanishes. And that’s how it should be. The goal should be calibrated to what an institution can accomplish. If you have the possibility to significantly cut your carbon footprint you should try to do that. If you have a good financial mechanism for purchasing offsets, do that too. Good is good.

4. We are (or maybe only I am) getting tied into knots over nothing. At the moment we are in a strange situation: most of the public recognizes the necessity of combating climate change and there is near-consensus at institutions like Evergreen that we have to begin taking action now. Meanwhile, the federal government is in the hands of what can only be described as a hydrocarbon cult, determined to thwart any threat to their beloved industry. This can’t continue much longer, and I’m convinced it won’t. Not only do both major presidential candidates back a mandatory carbon cap, the corporate sector seems to be on board too. (They will do whatever it takes to minimize their own financial exposure, but that’s a different story.) Chances are, in a year we will have legislation that puts a limit on greenhouse gas emissions and drives the price of carbon fuels way up. Then the big challenge facing everyone will be how to cope with it. Places like Evergreen won’t need a carbon neutrality task force; they will be forced to dramatically curtail their footprint just like everyone else. Students who now commute by car won’t be able to afford it any more, so you have to find other commuting and housing options for them or you lose your students. Heating bills will explode, so you have to find ways to use less fuel for heating. And yes, faculty travel to distant conferences will become a lot more expensive, so solutions will have to be found there too. Repeat: instead of wracking our brains about how to calculate our carbon footprint, we will be struggling to control costs. This will lead us to reduce our footprint whether we want to or not, which is the point of the legislation. Maybe, just maybe the institutions that take action today to reduce carbon emissions will be better positioned to survive the coming cap, but that will be because they have taken action on their own operations, not because they bought a thick portfolio of offsets.

So the bottom line is that, in voluntary carbon policy, as in most other aspects of this issue, we are losing valuable time by asking the wrong questions. There are ultimately only two questions that make sense for us individually and collectively: how can we get a fair, effective, rational climate policy pronto, and how can we cope with it once we have it? If Evergreen has a few grand to invest in offsets, I’d rather see it put the money into political action for better policy. And rather than pulling me into a task force to measure our carbon footprint operation by operation, I’d like them to enlist me and anyone else they can corral into an effort to forecast the impact that national policy will have on us so we can start preparing today.

My apologies for going middlebrow, but that’s my take on the new Woody Allen movie, “Vicky Christina Barcelona”. PC almost pulls it out. Since this is an economics blog, I’d like to ask, has anyone else noticed that the money just seems to be there in Woodyland? People have jobs mainly as a source of identity, but in fact they just pass Go every now and then, and their bank accounts are recharged so they can enjoy the comfortable life without worrying about how much it costs. Only in this magical world would a woman’s choice between a young Wall St. go-getter and a “bohemian” artist have no financial implications.

In general, I’m not reassured that the Republicans have put a Christian fundamentalist on their national ticket. Sarah Palin holds beliefs about such matters as creationism and God’s will (Jesus pays close attention to natural gas pipelines) that make me cringe. But I would suppress all that if she would make the connection between biblical teachings (Leviticus, chapter 25, various verses) and disorder in financial markets.

The passages I’m thinking of describe a jubilee which is to take place on the fiftieth year; all debts are foregiven, property (particularly in humans, as was common back then) redistributed, and liberty proclaimed. From a narrow economic point of view, periodic dissolution of debt claims has the virtue of avoiding the sort of overly leveraged, and therefore highly fragile, financial structure that is a recurrent threat to prosperity. This is the one “thou shalt” that we really should.

Incidentally, I think that in this, as in other matters, we should prefer a loose reading of scripture. If the jubilee were entirely predictable in its fifty year rotation, the credit mechanism would collapse as the big event approached: who would lend if there were a certain date on which a universal default was scheduled? But maybe Einstein was wrong and God really does throw dice. In that case, we could interpret Leviticus as advising us to establish a stochastic jubilee, such that in each year there would be a 2% chance of its occurrence. This could be done by picking an envelope out of a drum on nationwide TV. (Imagine the ratings: you could take in a lot of revenue just by selling the advertising.) The downside is that an extra 2% risk premium would be attached to all loans, but we could learn to live with it.

So why is it that those who proclaim their belief in every word of the bible conveniently forget its most far-reaching economic proposal?

The EU is preparing make even more costly mistakes in its carbon emissions reduction program. Reuters reports that draft legislation will increase offsets to fully a fourth of (paper) reductions. If past experience is a guide, this means that the true cap has just been lifted again, and that billions more euros will be made in profits at the ultimate expense of consumers. (The difference between the increase in revenues companies get by charging more for carbon-intensive products and the cost of manufacturing an offset is the source of rents divvied up by buyers, sellers and financial packagers of offsets.) Will the US legislation we enact next year be equally corrupt and ineffectual?

My fellow Americans,

In the last year the price of energy, and especially gas at the pump, has gone way up. While it has come down a little in recent weeks, it is still much higher than before, and it is squeezing the budgets of families all across the country. This expense is all the more difficult to bear at a time when the economy is sputtering and paychecks are stagnating. People are looking for answers.

What I am going to say today will surprise you – but I will get to that later. First, I want to clear up the issue that everyone is talking about right now, offshore oil drilling. What’s my position on that?

If you listen to the energy experts, they all agree that drilling for more oil off our coasts will have little effect on the prices we pay for gasoline and other energy products. First, it will take many years before exploration uncovers productive oil fields, and more years to build the platforms and transportation systems to bring this oil to the market. So no matter what we do about this issue today, it will not have an effect on today’s prices. But the experts also say that the potential output of these fields, compared with global supply and demand, is simply not enough to move prices more than one or two percent. If we had another Saudi Arabia lying off our coast it would make a big difference, but we don’t. So, while I wish there were a simple decision we could take that would bring immediate and substantial relief to families struggling with energy costs, I don’t think offshore drilling is the answer.

But the issue won’t go away. This is an election year, and the polling companies are working overtime to tell us what the public thinks about every topic. And if we can believe their numbers, a large majority of Americans think that we should give offshore drilling a try anyway, on the principle that if you have a problem you should do everything you can.

We live in a democracy. If a substantial majority favors a policy, and if the policy does no harm, we should respect the will of the people. So, even though I’m not optimistic about what more drilling can do, I’m willing to reverse the ban we’ve had in recent decades.

Democrats in the House and Senate are preparing legislation along these lines. To keep to the requirement of “do no harm”, this legislation will see to it that any offshore oil production adheres to strict environmental standards, so that we don’t have oil spills fouling our beaches — the problem that led to the ban in the first place. We will also have controls on the ability of big oil companies to reap windfall profits from these finds: their oversized profits are part of the problem and cannot be part of the solution. Together, these stipulations will guarantee that a change in policy on offshore drilling, whatever its benefits, will not impose significant costs. If Republicans agree to a careful, responsible shift in regulation we can move forward quickly.

But as I said, whether we drill a little more or a little less will not have much impact on sky-high energy costs. If we are serious about addressing this issue, we must move beyond the debate over drilling and address the underlying causes. That is my real purpose today.

We should begin with a sobering fact: while energy prices will continue to fluctuate unpredictably, in the long run they are headed up, up, up. In part this is because the supply of scarce resources like petroleum is starting to reach its limit. Experts disagree about just when this peak supply will occur, but they agree that the day is not far off. In the meantime, the demand for oil and other energy products is rising quickly in countries like China and India. We are happy to see anyone anywhere move out of poverty and into a more comfortable lifestyle, but we should also recognize that this means they will be able to afford to buy more cars, heat their houses to a more comfortable temperature and in general use more energy. Between a plateau of supply and a rising curve of demand, we are facing a future of scarce and expensive energy.

But there is another side to energy prices. In previous speeches I have talked about the urgent necessity of weaning America from its dependence on oil and other fossil fuels. Avoiding conflict over oil supplies is central to our national security, whether it is about getting drawn into battles in oil-producing countries like Iraq and Iran, or finding a way to end warfare where oil fields and oil pipelines are at stake, as is now the case in the conflict between Russia and Georgia. The less reliant we are on these supplies, the more we can focus on the true threats to our security, like groups that would commit wanton acts of terror against our population. The fixation on oil is distorting our priorities and fomenting violence around the world.

Just as urgent is the demand to prevent catastrophic climate change. Already the concentration of carbon in the earth’s atmosphere is entering the danger zone, and every day our factories, power plants and automobiles are pushing that number up higher and higher. No one knows where the tipping point is, the level of greenhouse gases that can trigger a process of self-reinforcing climate change that we will be powerless to stop. We must drastically reduce our consumption of fossil fuels, and quickly, if we are to keep faith with future generations that will inherit whatever world we leave them. And there is little we can do as a country that would more restore our standing in the world than to shoulder our share of the burden in preserving a liveable planet.

For all these reasons, we have to kick the fossil fuel habit. And this will mean higher prices, much higher than today. So, not only are we unable to repeal the law of supply and demand to bring down these costs, in fact we need higher prices to achieve our core national objectives. What then can we do?

Here is where I will ask you to think outside the box. What I will propose to you today is that the problem is not the price of oil and other energy products as such, but where the money goes. When you pay four dollars or more at the pump for a gallon of gas, your hard-earned money is on its way to a foreign country or a fabulously profitable oil company. It’s gone: you will never see it again.

But suppose we did something different. Instead of paying high prices to far-off governments or oil profiteers, suppose we paid it to ourselves, so that we could actually get it back. This is what I’m going to suggest.

The way to do this is by actually raising the price of oil. You could do it through a tax. The way I’ve proposed, in my climate change plan, is to have a limited number of permits for bringing fossil fuels into the economy, and to make energy companies pay for every one of these permits. Of course, they will pass this cost along to you, the consumer. This is how a market economy works. It will lead to innovation, as businesses and households find new ways to conserve energy. But the bottom-line result is that, to kick the fossil fuel habit, we will be paying a lot more for whatever we continue to use.

Yet here is the key point: the extra cost you will pay will not go to a foreign government or an oil company. It will come right back to you. Specifically, I am proposing to put all of these revenues from higher energy prices into a big pot, and then pay out the money in equal amounts to every American citizen. This is the simplest and fairest solution. I want to be very clear: this money will not be kept by the government. It is yours. I promise, here and before all of you, that at least 95 cents of every dollar collected in selling fossil fuel permits will be given back to the people, quickly, efficiently, fairly. Economists who have studied this idea estimate that the amount each of us would receive would be something like $1000 per year. Any additional public programs for energy research or conservation would be financed out of tax revenues as they are, or more accurately as they should be, today. The extra money you pay for energy would be earmarked, virtually all of it, to return to you.

This plan has many benefits. It will do more for our national security than any other single step we can take. It will restore America’s leadership role in the fight against climate change. It will be an added benefit for the most vulnerable Americans, those who are at the bottom of the economic ladder and use the least energy already: they will get back much more than they pay. But what I want to emphasize is that this is the only meaningful long run solution to the problem of runaway energy costs. Energy costs will rise, and in some respects we even need them to rise. But the problem is that, under the current system, every dollar we pay for energy is a dollar lost. The solution is to change the system so that we get this money back, literally, every one of us. It is the responsibility of government to set up this system and then get out of the way, so that the money can return to the public in the simplest, fairest and most direct manner. On the international front, if we can convince enough other countries to take a similar stand, and I think we can, the overall effect will be to bring down global demand substantially, so that much less of our energy bill ends up in foreign or corporate hands.

Unlike offshore drilling, the proposal I’ve just outlined is not in the news. The pollsters aren’t asking you what your position is on it. But, also unlike offshore drilling, it gets to the heart of the problem. We can’t legislate energy prices down and we shouldn’t try. But we can protect the budgets of our families and our economic health as a nation by turning Americans into recipients of energy money as well as payers of it. So this is my answer to out-of-control energy costs: let’s get this money back. Let’s take control of our energy problems and protect our standard of living at the same time. Let’s have a future in which, when you read headlines about higher energy prices you think, “That’s more money in the bank, for me.” Let’s get the energy money back.

If you want to hear what I have to say about child labor, here’s a link to Against the Grain, a KPFA (Berkeley) radio show that interviewed me today. CS, the show’s host, really does his homework; he’s great at cutting through the distractions and getting to the point. In another life I used to do what he does now (for WORT in Madison) and can appreciate what it takes to do it well.