Entry tags:

economics

Ben Stein is Dangerously Ignorant
Ben Stein is a comedian, so perhaps it's all part of an elaborate joke. What Ben Stein isn't is an economist, or even a well-informed amateur. However, for no better reason than the fact that his father (Herb Stein) was a well-known economist, the New York Times is in the habit of publishing Ben Stein's meditations on economic matters, to the great detriment of the Times' readers and its reputation. Usually, I ignore this waste of valuable media real-estate, but this morning, reading Times articles on my hand-held gizmo, I was duped into reading an article all the way to the end, only to find Ben Stein's byline tucked away at the very bottom.

At which point I said to myself: "Oh, that explains everything."


The jumping off point for the article is a critique of an analysis written by Goldman Sachs economist Jan Hatzius. Stein summarizes thus:

Dr. Hatzius, who has a Ph.D. in economics from “Oggsford,” as they put it in “The Great Gatsby,” used a combination of theory, data, guesswork, extrapolation and what he recalls as history to reach the point that when highly leveraged institutions like banks lost money on subprime, they would cut back on lending to keep their capital ratios sound — and this would slow the economy.

This would occur, he said, if the value of the assets that banks hold plunges so steeply that they have to consume their own capital to patch up losses. With those funds used to plug holes, banks’ reserves drop further. To keep reserves in accordance with regulatory requirements, banks then have to rein in lending. What all of this means — or so the argument goes — is that losses in subprime and elsewhere that are taken at banks ultimately boomerang back, in a highly multiplied and negative way, onto our economy.
[...]
I found especially puzzling the omission of the highly likely truth that the Fed would step in to replenish financial institutions’ liquidity if necessary.

This is a little strange: Stein begins by talking about the impact of the sub-prime crisis on banks' capital, and then, without explanation, he starts talking about banks' reserves and the Fed's ability to inject liquidity into the banking system (again, by creating new reserves). In the first couple of paragraphs, it looks like it could simply be sloppy editing. But the paragraph about the Fed makes it perfectly plain: Ben Stein thinks that banks' capital and banks' reserves are the same thing.

A bank's reserves are its total assets of particular types -- specifically, vault cash plus deposits with the Federal Reserve system itself. The calculation of a bank's reserves ignores most of the bank's assets (like loans) and all of its liabilities.

A bank's capital is the value of all of its assets (like loans) minus the value of all of its liabilities (like deposits). When a loan goes bad, its value as an asset is reduced or eliminated, which means that the loss is a hit to the bank's capital.

Banks are required to meet legal requirements for both capital and reserve levels, but the requirement are also quite different. The required reserves for a bank depend on the level of deposits the bank accepts in transaction accounts (basically, checking accounts). The required capital for a bank depends on the level of its assets, i.e. on how much it lends.

Finally, there's the role of the Federal Reserve. The Fed can create reserves in the banking system. It does this by buying non-reserve assets (like Treasury securities) and paying for them by increasing the selling bank's reserve balance. (When you write a check from one bank, and it is deposited in another, the result is simply to move reserves between the banks; the total amount of reserves in the banking system remains the same. The Fed has the magical power to "write checks" that come from nowhere, thus increasing the total reserves of the banking system as a whole.) So the Fed can create reserves. But it cannot create capital.

And there's the rub. Hatzius's paper describes the impact of the sub-prime crisis on bank lending via the hit to banks' capital. Stein dismisses this, because the Fed can create reserves, and because Stein doesn't know that these are completely different things.

Which is to say, Ben Stein rather clearly doesn't have the slightest idea what he's talking about. Why in the world is the New York Times squandering valuable column inches on this guy?