Wednesday, October 15, 2008


The President of the Federal Reserve Bank of San Francisco remarked today that "The U.S. economy appears to be in a recession". With a Central Bank that has such acute powers of observation and such impeccable timing, and one that has created about $1400 Billion of new dollars all for nothing, why should we worry?!

Our government's response to the crisis has involved one market intervention after another. One day we are "providing liquidity", the next day we're "buying troubled assets", and the next day we're "injecting equity into financial institutions".

With all the new acronyms created over the past several months ("TAF", "TSLF", "TARP", "EESA", etc.), our financial Scrabble board has run out of letters..

As we intervene in the market, endogeneity in asset pricing--the vital cog that keeps our pricing mechanism alive and the bulwark that holds up our free market economy--is destroyed. We resort then to being a few guys in a small room with a naked bulb, cigars, etc., determining prices.

It is no wonder that investors are choosing to sit on the sidelines rather than try to out-guess the next move of the Government's 'Plunge Protection Team'.

The market has now voted on the current plan - twice. The first time, from the 1:30pm passage on October 3, the market plunged for the worst week since the Great Depression. The votes are in for the most recent version:

We need to go in a new, bold direction. One that does not attempt to manipulate the market (a futile endeavor in any event, which should be clear by now). One that ignites, rather than interferes with, the free market's engine of growth.

Here is our plan:


1) Stop the presses

Literally. No more liquidity to be created. No more bailouts. The current plan, to buy bank shares is doomed to failure. In macroeconomic history, there has never -- NEVER -- been a time when institutional intervention to shore-up prices / wages / exchange rates has managed to defeat the endogenous power of the market. NO MORE GOOD MONEY AFTER BAD.

2) Jump-start the economy by rebuilding American infrastructure to again be the best in the world

Spend on bridges, airports, trains, education, power-grids, broadband access, etc.

The Confidence of both Consumers and Investors is currently at rock-bottom.

Consumers used a high proportion of the recent "stimulus checks" to pay down debt.

Likewise, banks are likely to use a high proportion of the recent capital injections to fill the massive holes made by the toxic Level 3 Assets on their balance sheets.

Attempting to "flow" money through either consumers or lenders, in the current environment, is doomed to fail. In rare situations, where confidence is totally lacking, direct Government spending is the best and fastest way to achieve a jump-start.

A massive program of infrastructure spending and investment, with the goal of re-establishing American infrastructure as the best in the world, is urgently needed today.

3) Enlist prominent, respected Americans to voluntarily market these REBUILDING AMERICA BONDS to the American public.

The faces of this effort should be Americans who have earned the universal respect of their countrymen. If willing, these would include luminaries such as Warren Buffet, Tiger Woods, Paul Volcker, Bill Cosby, Rudy Giuliani, Clint Eastwood, Oprah Winfrey, Bill Gates, and others of similar stature. No-one in the current leadership has any credibility, and as such should not be seen as the "face" of this project.

4) Borrow the funds from Mom & Pop America

From the time of our country's Founding, Main Street America has never refused the call to service. After 9/11, in a moment when Americans were eager to serve in a common purpose, our Government asked them simply to shop. Certainly consumer spending was helpful, but many have argued that this was a missed opportunity.

We must seize on the can-do spirit and natural patriotism of the American people and invite them join in rebuilding America.

Speaking with many "Main Street" Americans, a clear theme as emerged: Angry as they are with the situation, and disgusted as they are with current leaders, Americans want to help the economy get back on track! Rather than go back to the well with foreign lenders, market this issuance first and foremost to Americans.

And, importantly: Not one penny more would be spent than is voluntarily subscribed by purchasers of the REBUILDING AMERICA BONDS.

5) The REBUILDING AMERICA BONDS would pay a coupon which is indexed to inflation (much as "TIPS"). The bonds would pay a regular coupon, and the interest rate paid would be adjusted every six months. In this way investors can't lose from the effects of inflation.

6) Total Transparency, unlike any Government program before, would be a central component

a) We tell lenders exactly where the money will go on a state-by-state basis -- for example, residents of New Jersey will be told which specific airports, school districts, power grids, and university programs are being funded.

b) Websites will show where the money is being spent and the services provided and the amounts transacted, for any bondholder to see.

7) We must not subsidize alternate energy research.

Let the venture capital--the smart money--bring the new ideas to fruition. Once this happens, we must then nurture the infant alternate power industry to maturity by giving real tax breaks. This approach will ensure that the innovating companies are not forced to spend scarce resources hiring expensive lobbyists to compete for a fat share of federal subsidies, but instead, will be able to direct their resources to hiring real research scientists. The same applies to biotech, nanotech, or any number of other promising new industries.

Government spending is a blunt instrument - successful development in emerging technologies requires much more deftness and finesse than can be applied through any government-run program.

8) Tax cuts for all--for the next year at least.

One of the biggest mistakes that led to the Great Depression was a savage increase in taxes. This is no time to repeat that mistake. This applies equally to taxes on capital and income - as both investors, and consumers, are needed once the REBUILDING AMERICA program gets the economy moving.

9) Capital will flow back to the American economy.

Once foreigners see that we are reinventing America again, the global money will flow back in. No-one will want to be left out on the sidelines as America becomes the hottest emerging economy on the planet.

America is at her best under adversity. She has shown this time and time again. Our friends love this quality about her; our enemies have repeatedly discovered this quality at great cost. It is time to show the world what we can do.

-Farrokh Langdana, Ph.D.
Rutgers University Business School



  1. Can we purchase the Rebuilding America Bonds on credit I think we're low on Savings?

  2. Lol... good one...

    Actually, despite Americans very low savings rate, there are still $7 Trillion in savings overall, plus an unknown amount of "mattress money"...

  3. It is very interesting to see that Bernanke FED is taking a different approach than the Greenspan FED in creating liquidity. Greenspan used to direct the FOMC to buy the treasuries with the newly created dollars. Treasuries as assets used to match currency as liabilities. When Bernanke woke up to the fact that we has serious financial crises he started creating alphabet soup-bowls (T.A.F etc) which was mainly trading treasuries for MBS i.e. "toxic waste". The result was that the treasury as a component of the FED balance sheet has been cut in half over the last year. Its place has been taken by a complex set of loans, collateral and repurchase agreements identified under vague terms. This new money is going as a special privilege to banks and not widely distributed to the system as with Greenspan FED. The FED balance sheet is mentioned below.

    It looks like FED is totally oblivious to the amount of toxic waste in the global financial system. They are currently desperately trying to save the same financial institutions that went gambling-gone-wild and got us into this mess. The free market principles are thrown out of the window. The right thing to do was to let those companies fail and start again. There would be regional banks which would have stepped up and taken leadership.

    The current issue is not about liquidity. It is about SOLVENCY. There is lot of money around with those SWF's and foreign governments. They have been burned in the markets to support the big financial institutions. So they have now backed off. They are very afraid to lend as they are not sure if the institution that they are lending is solvent or not.

    Comments on the current rescue plan.

    The step 2 in the rescue plan seems to ask for more government intervention.

    Was it not in introduction and step 1 mentioned that history has showed that government intervention does not work? It was also mentioned that "Attempting to "flow" money through either consumers or lenders, in the current environment, is doomed to fail."

    Here you are relying on the same government that you said should not intervene to spend directly into projects which are not needed at the time. What is the point of making new roads when there are enough roads around? Why should airports be created/expanded in the name of expansion when the air traffic is considerably down and there is no end demand for flying?
    What you are suggesting is similar to "attempting to flow money to the consumers or lenders" via government intervention. It has never worked in history. That extra build out may be useful 50 years later but at desperate times with no end-user demand, they are not necessary.

    Just creating employment in the name of creating it, is wasteful spending. The government should not be involving in wasteful spending when it desperately needs any amount of money it can hang onto. It can be argued that deficit spending should be encouraged at bad times but are we not enough in the hole right now that we need more deficits? And we all know that during good times the government never bothered to shore up its balance sheet that can be wisely used during downturns.

    Instead the government should be spending constructively by trying to prop up business.

    Most Americans have no savings. Why would most mom & pop give money to the government when they see that they are going to have a very hard time making their ends meet in these uncertain times? The times when you have mentioned that Americans came to assist the government calls is when the economy was a little better and the people had decent jobs and savings. When times are bad with wide spread unemployment there are chances that the Rebuilding American Bonds may not be a huge success with mom & pops.
    And these Rebuilding American Bonds will have unintended and undesired consequences.
    Everyone who has money or some savings will go ahead and buy these Rebuilding American Bonds as they will be paying a guaranteed rate of return plus inflation.

    What that will do is

    a. No money will be put in banks. So the banks won't have any deposits to lend to new businesses or make any new loans. The banking industry will be in dire shape.

    b. As more and more dollars pour in the government will get involved in more wasteful spending in areas where it is totally not needed. Expecting the government to have accurate accounting standards is a little wishful thinking in my opinion.

    d. Another reason they will not engage in starting a new business will be the fear of government stepping in with their huge dollars and riding them out of business. For e.g. a builder may not build new houses because the government may probably be building houses and giving it away at very low cost or a pharmacist may not open a new pharmacy store for his business with the fear that the government may start selling drugs cheaply and over run him.

    e. Everyone's eyes will be on the government wanting to do something in every walk of their life. They will be just waiting what the next step the government takes. The government will be stepping in almost everywhere trying to do something. This will eventually lead to more socialism which is very difficult to repeal.

    f. The global money will immediately start buying Rebuilding America bonds as much as they can get their hands on. They have been buying US treasuries at very low interest rates for a long time. This will be better than buying US treasuries as it will give them more rate of return than they get from the treasuries.

    Also there is no guarantee that if you try prominent Americans to market REBUILDING AMERICA BONDS will work. What if that rebuilding America does not work as fast as or as well as everyone expected. Those prominent Americans will lose face and next go around no one will trust anyone when they are trying something like this in the future.

    What I suggest in-addition/alternate is as below

    1 Need the dollar to be backed by something.

    2 Raise rates :-
    The rates have been low for too long. The savings rate of Americans needs to be increased. The savers, those living below their means, have been thrown under the bus for the last 20 years. They need to be rewarded for doing the right thing. Also this will develop a saving attitude, i.e. putting money aside for saving instead of spend spend and spend like no tomorrow. We need a change in attitude.

    3 The savings will be pouring into banks which will be getting money to lend for new businesses, loans etc. This will make the banks/lending institutions eventually stronger. Strong Financial industry is a very important pillar for a sound economy.

    4 Small businesses should be encouraged. The loan-rate for small businesses should be low. Government should be identifying areas where/what businesses can grow. Those businesses will create jobs where there is end-user demand.

    5 Bring manufacturing back to the United States. Give special tax-breaks or grants to companies that build in America. Slowly and steadily real jobs will be created.

    6 The government can step in and fix the health-care mess so that it becomes affordable for everyone. There are lots of people discouraged and sitting on the sidelines because of some chronic health issue. They are just clinging to their jobs afraid to lose their coverage. We need to free that creativity.

    7 Government should reduce expenses. That may include asking the government employees to take a pay cut. And also once economy gets back on track the size should be reduced.

    8 Some version of Glass-Steagall act is needed to prevent the financial institutions from becoming too big to fail.

    9 No bailouts to anyone. FDIC or some similar organization should be vigilant to make sure no one becomes too big to fail. This does not mean that the regulations should be rope for the businesses.

    10 Lower taxes.

    Lower taxes will spur more productivity which in turn will create more jobs.

    11 Can we get Ron Paul for president? He will take care of the FED and lot of government spending.

  4. WOW
    I am going to have lie down!
    Nice blog Prof Langdana. I agree..but disclose i am biased :)


  5. Forwarded to Timothy Geithner, Eric Schmidt, David Plouffe, and ... let's hope someone takes notice.

  6. Government programs are not necessarily a blunt instrument. The internet was created by ARPA, the research arm of DoD:

    Energy independence is a policy decision, it won't come from the market on its own. The market doesn't care whether we're energy independent or not, it's something we need to want.

  7. Interesting… I might try some of this on my blog, too. It’s quite interesting how you sometimes stop being innovative and just go for an accepted solution without actually trying to improve it… you make a couple of good points.
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  8. When should we begin we have lots of work to do rebuilding the economy.

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