Over the weekend, reader David Ricketts suggested that I ask Ben Stein, the comedian economist who inexplicably has a column in the New York Times, to eat his hat. Since I am in a generous mood on this Inauguration Day, I will do just that.
For reasons that probably should not be delved into deeply, Ricketts spent the weekend rereading a Ben Stein column from Dec. 2, 2007, "The Long and Short of It at Goldman Sachs." At the time, Felix Salmon, Dean Baker, and Yves Smith all conducted exhilarating displays of Stein-demolition, so it might seem like I am coming late to the party.
But some bad columns only ripen to their true fullness of wrongheadedness after the slow passage of time. And so it is with Stein. Never mind the ostensible thesis of the column -- that Goldman Sachs runs the universe and was pushing dire forecasts of the economic future to boost their own trades. Heck, if any Wall Street institution did run the universe, Goldman Sachs would be the most likely suspect, so I have no particular problem with that conspiracy theory, provided it is properly argued.
The fun part in looking back at this column is watching Stein scoff at the deeply bearish pronouncements of Goldman Sachs' chief economist, Jan Hatzius. This is the kind of scoffing that does not benefit from hindsight.
First, Stein summarizes a recent paper by Hatzius.
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 think we can all agree that, yes, this is exactly what actually turned out to happen. Hatzius nailed it. But Stein didn't see it that way.
As I interpret it, Dr. Hatzius was saying that the financial system would possibly not be able to adjust to a level of financial losses that are large on an absolute scale but small compared with aggregate credit or the gross domestic product. He is also postulating that lenders would have to retrench so deeply that lending would stall and growth would falter -- an event that, again, has not happened on any scale in the postwar world, except when planned by the central bank.
In other words, with the greatest possible respect to Dr. Hatzius, his paper is not really what I would call a serious overview of the situation. It is more a call to be afraid and cautious based on general principles that he embraces and not on the lessons of history.
To be fair, the vast majority of economists failed to predict how the housing bust/subprime meltdown would set off a cascade that incited the worst economic crisis since the Great Depression. But I dare say few got it wrong with such a tour-de-force of willful arrogance as Ben Stein.