virtues of a “limited purpose banking” system, one that would greatly reduce banks’ abilities to take on risk

TO BE NOTED: From the NY Times:

---

April 15, 2009, 2:28 pm

The Post-Recession Appetite for Risk and Regulation

By Catherine Rampell

Wednesday, in his speech at Georgetown, President Obama proclaimed that “It is time to lay down tough new rules of the road for Wall Street to ensure that we never find ourselves here again.”

But just how restrictive will, and should, those rules be? Will there indeed be a permanently lower tolerance for financial risk-taking, when risk-taking and financial innovation have been a prized part of economic growth over the last few decades?

The lead-up for such “tough new rules” so far has been somewhat equivocal. America — unlike its European counterparts — has generally prioritized temporary stimulus over “permanent” regulation in the face of an economic contraction. We like to address a particular market failing in the short-term, rather than reassigning the way markets work for the long haul. In fact, America’s long-term trend over the last few decades has been toward less, rather than more, regulation. That political habit may be hard to break, no matter the volume of populist calls for straight-jacketing the private sector.

Still, a few prominent economists — whose discipline is usually seen as the bastion of laissez-faire — are fighting to sharply reverse this decades-long, freer-financial-market trend.

For example, Paul Krugman, the Nobel laureate and Times Op-Ed columnist, last week wrote about the need for new regulations to make banking “boring again” — in other words, by legally limiting bankers’ abilities to get too creative with the ways they slice, dice and assemble their financial toys.

Amar Bhidé, a business professor at Columbia University, has similarly argued for a return to “primitive finance,” which would mean greatly limiting what commercial banks are allowed to do, and reviving a more stringent version of Glass-Steagall.

And Laurence Kotlikoff, an economics professor at Boston University, has vocally proselytized the virtues of a “limited purpose banking” system, one that would greatly reduce banks’ abilities to take on risk. In this system, commercial banks would initiate only AAA-rated mortgages and business loans (approved and rated by the government, rather than by private ratings agencies), and then bundle and sell those loans within mutual funds. And that’s all these banks could do.

These aren’t the only economists arguing for what may sound like extreme curbing of the financial system. Other critics have more or less called securitization a dirty word, and suggested that the process of bundling loans and other financial products may be inherently toxic (no matter how much we upgrade the ratings agencies). They also fear that morally hazardous bailouts may yet increase banks’ appetites for reckless risks.

Others say, though, that we may emerge from the current crisis with financial institutions that are much more risk-averse than they were before the recession. In this situation, perhaps tighter regulations would not be necessary; perhaps they might even be detrimental. An economy needs some desire to assume risks in order to function and to grow, and perhaps, then, the government should be encouraging more financial innovation when the private sector’s instinct is to pull back. Besides, some say, maybe having a major financial meltdown only every 80 years or so isn’t such a bad track record, given the economic growth the existent system has produced (or at least enabled).

It will be interesting to see which, if any, of these views wins out in the coming months.

Readers, I put the question to you: What kind of financial system will emerge — either due to market forces or regulatory forces — once the dust of this crisis settles? And what kind of financial structure should we want to emerge?"

Brokering the bailout of Long-Term Capital Management in 1998 by invoking the specter of systemic collapse encouraged banks to ignore the risks

TO BE NOTED: From the WSJ:

"You Can't Rush a Recovery

While small business struggles, Goldman Sachs was protected from its AIG mistakes.

By AMAR BHIDé

The U.S. has already committed nearly $3 trillion to rescue the financial system and domestic auto makers, according to a recently released report by a special inspector general.

Treasury alone has announced plans to fork over more than $600 billion in TARP funds, and Treasury Secretary Timothy Geithner seems to announce a scheme a week to jump-start the economy. Unfortunately, just as vigorous thumping won't accelerate -- and can even disrupt -- the rebooting of a computer, unpredictable interventions and improvised initiatives jeopardize rather than hasten robust economic recoveries.

Sustainable recoveries cannot be rushed because individuals and firms can't instantly pick the best possible alternative. We can't immediately auction off our labor to the highest bidder, for instance. Rather we must devote time and effort to finding a suitable job. Once we find a position that satisfies us and learn to do it well, we are loath to leave.

But miscalculations may end presumptively permanent arrangements: We may be laid off from a job we thought was safe because our employer built a new plant to satisfy demand that did not materialize. Then we not only have to search for a new job but also unwind old arrangements -- negotiating severance or selling our home if we have to move to a new city.

Similarly, our employer has to figure out how best to downsize or redeploy excess capacity. And in a recession, searching for new arrangements and the unwinding of old ones -- and anxiety that our turn may be next -- is widespread.

Our government plays an important ameliorative role. Unemployment benefits stop major dislocations from creating the widespread hunger and homelessness experienced in the Great Depression. They also prevent the anxiety of more than 90% of the workforce that remains employed from turning into a panic.

Bankruptcy laws and courts facilitate the orderly unwinding of obligations that individuals and businesses can no longer meet or easily resolve through bilateral negotiations (as is often the case when a troubled business faces many creditors with different kinds of claims). A bankruptcy code that quickly salvages the greatest possible value from failure is crucial for our economic dynamism.

The Federal Deposit Insurance Corporation (FDIC) immediately assumes the liabilities of failed banks and then gradually disposes of their assets -- a process that has ended the bank runs that used to trigger depressions until the 1930s. But beyond amelioration and providing the judicial (or in the case of the FDIC, quasi-judicial) procedures for reorganization, there is little more that the government can do to accelerate the unwinding and renewal necessary to put the economy back on an even keel.

The process involves a sequence of negotiations and experiments that cannot be truncated by throwing in more resources. As Frederick Brooks wrote in his celebrated book on software development, "The Mythical Man-Month: Essays on Software Engineering": "When a task cannot be partitioned because of sequential constraints, the application of more effort has no effect on the schedule. The bearing of a child takes nine months, no matter how many women are assigned." "Brooks's Law" suggests that increasing the size of software teams may delay development.

The wide variety of problems and circumstances in an economic downturn precludes the effective use of a single solution. And the federal government doesn't have the capacity to determine adjustments on a case-by-case basis. The late Nobel Laureate Friedrich Hayek taught that the "man on the spot" with the appropriate local knowledge was much more capable of making good investment decisions than a central planner.

Similarly, the men and women who are closest to the situation have a huge advantage in unwinding the consequences of past miscalculations. The terms of a problem loan are best renegotiated by the borrower and the bank that made the loan. How to cut costs and excess capacity in the automobile industry is best figured out by management, the UAW, bondholders and creditors, under Chapter 11 if necessary.

Ad hoc interventions in the financial markets by the executive branch and Federal Reserve that override private renegotiations and judicial procedures have done serious, long-term harm. Brokering the bailout of Long-Term Capital Management in 1998 by invoking the specter of systemic collapse encouraged banks to ignore the risks of trading with overextended counterparties and laid the groundwork for our current debacle.

The folly was compounded by the bailouts of Bear Stearns and AIG. The bailouts also undermined vital public confidence in the fairness of our system. While small businesses struggle to recoup bills owed by failed customers, the likes of Goldman Sachs, which miscalculated the creditworthiness of AIG, were made whole -- and could thus pay bonuses amounting to many times the incomes of most taxpayers.

Former Treasury Secretary Henry Paulson's Super-SIVs and TARPs eroded rather than helped restore confidence by promoting the belief that things must be really awful for the government to suspend due process and operate in secrecy. The schemes also delayed the actual cleaning up of the balance sheets of large banks. It did so by insulating them from FDIC discipline, and by creating the expectation that the next taxpayer-funded initiative would offer even more cash for their trash.

Mr. Geithner, who was closely involved with the AIG bailout, offers no change we can believe in. His latest scheme is called the Public-Private Partnership Investment Program. But there is actually very little private skin in this game: It gives a handful of wealthy financiers huge nonrecourse loans to enable them to purchase toxic assets that the market supposedly won't buy at a "fair" price. As the housing crisis has shown, providing subsidized nonrecourse loans creates asset bubbles, not true price discovery. And bribing buyers to ramp up prices smacks of market manipulation.

Suppose that, when the financial crisis broke two years ago, our leaders had shown a Churchillian steadfastness and allowed the normal realignment to play out under a predictable judicial and regulatory regime. The prices of stocks, bank debt and houses would still have crumbled and unemployment risen. Although recovery wouldn't have been immediate, we'd at least have progress, instead of a sullen paralysis and futile efforts to turn the clock back.

More loans would have been renegotiated and foreclosed properties auctioned off. The FDIC would already be engaged in finding a good home for the loans and deposits of a megabank or two. That agency, now operating with about one-third the staff it had in the 1980s, could also have used some of the bailout money that helped pay for bonuses at AIG and its counterparties to recruit, train and retain more employees.

Best of all, more entrepreneurs and innovators, who capitalize on the opportunities to be found in the midst of turmoil, could have been building the foundations of a prosperous future.

Mr. Bhidé is a professor at Columbia Business School and author of "The Venturesome Economy" (Princeton University Press, 2008)."

Let’s revive the radical idea of narrow banking

From Naked Capitalism:

"In Praise of More Primitive Finance"

Analysts, regulators, and politicians are beginning to recognize that most if not all of the widely touted benefits of modern finance redounded only to its purveyors. The decidedly retro Canadian banking system, with simple products, high equity requirements, and relatively modest securities operations that focus on domestic customers, is the soundest in the world. As Theresa Tedesco noted in the New York Times:

The five major chartered banks, the few regional banks and handful of large insurance companies are all regulated by the federal government. Canadian banks are relatively constrained in the amounts they can lend. Canadian banks are required to have a bigger cushion to absorb losses than American banks. In addition, Canadian government regulations protect the domestic banks by limiting foreign competition. They also keep banks broadly owned by public shareholders....

Canadian banks are known to be risk-averse, and this has served them well. While their American counterparts were loading up their books with risky mortgages, Canadian banks maintained their lending requirements, largely avoiding subprime mortgages. The buttoned-down banks in Canada also tended to keep these types of securities on their books, rather than packaging them and selling them to investors. This meant that the exposures they did have to weak mortgages were more visible to the marketplace.

The big five Canadian banks — Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Bank of Montreal — survived the recent turmoil relatively unscathed. Their balance sheets remain intact and their capital ratios are comfortably above requirements.

Columbia University professor Amar Bhide, writing at the Berkeley Economic Press, endorses the idea of a reinstitution of simpler banking practices. The first part of his article offers an insightful, in many respects novel, critique of how we got in our mess. Bhide sees it as long in the making:

The financial debacle— the first to implicate the widespread use of complex financial instruments, rather than simple speculation or imprudent lending— isn’t just the result of the recent missteps of bankers, rating agencies or mortgage brokers. Rather, finance has been on the wrong trajectory for more than half a century. Its defects derive from the academic theories and regulatory structures that have evolved since the 1930s—dysfunctional foundations that have not drawn the scrutiny they deserve. And without addressing the deep defects, we are likely to lurch from crisis to crisis.

His recommendation is straightforward:
Reversing many age-old dysfunctions isn’t likely. We aren’t going to retrain business school processors in the art and science of traditional fundamental analysis or due diligence. Nor is repeal of the Securities Acts or the reprivatization of financial firms on the cards.

We could, however, go a long way to limiting future meltdowns by a simpler more primitive regulatory regime that keeps banks from enabling dangerous and opaque schemes.

Let’s revive the radical idea of narrow banking and tightly limit what banks (and any other entities that raise short term deposits from the public) can do: nothing besides making loans—after old-fashioned due diligence— and simple hedging transactions. The standard would simply be whether the loan can be monitored by bankers and examiners who do not have PhDs in finance.

Anyone else: investment banks, hedge funds, trusts and the like can innovate and speculate to the utmost, free of any additional oversight. But, they would not be allowed to trade with or secure credit from regulated banks, except through prudent loans whose collateral and terms can be monitored by run-of-the-mill bankers and examiners.5 This simple, “retro” approach—a more stringent Glass-Steagall Act—would protect depositors, limit the risks of financial contagion, allow the FDIC and Fed to focus on their primary responsibilities, and not require new agencies or more regulators. Less, would in fact, be more.

Speculations and bubbles would not be eliminated, but walling off the banking system would limit the extent of collateral damage. When the internet bubble burst, for instance, nearly half a trillion dollars of wealth evaporated. But because very little bank lending was involved the impact on the economy as a whole was modest.

Some would, of course, lose. Money market funds would lose their free ride—the howls of protest emanating from money market funds at proposed rules that they take some responsibility for their investment choices6 are telling. Financial engineers would lose access to cheap credit—alarming those who claim that the “sophistication” of the U.S. financial system is a prime cause of U.S. prosperity. But, although a modern economy does need the effective provision of some financial basics, such as risk capital, credit and insurance, claims that all the bells and whistles that have been developed over the last couple of decades are a net plus are implausible. Can we really believe that a financial sector now receives more than thirty percent of domestic corporate profits—double its share from twenty five years ago7—because it has produced improvements in mobilizing or allocating capital of that magnitude?

More likely, innovators and entrepreneurs in the real economy prospered in spite of the talent and funds that were taken up by the expansion of the financial sector. So if the financial sector shrinks back to the basics, so much the better for long run prosperity."

Me:

Don said...

Since I'm pushing this idea, here's another good post from the FT:

http://blogs.ft.com/economistsforum/2009/01/putting-an-end-to-financial-crises/#more-315

"This limited purpose banking is a modern version of narrow banking proposed by Frank Knight, Henry Simons, and Irving Fisher. Banks would hold deposits, cash checks, wire money, originate loans, and market mutual funds, including money market funds with no guarantee of par value redemption.

With limited purpose banking, financial crises would largely disappear. Banks would never fail, never stop originating loans, never expose the public to massive liabilities, and never see their stock values evaporate. Banks would be stable, boring economic cogs - like gas stations.

The Fed would also gain full control of the money supply. To expand the money supply, the Fed would continue buying treasuries from the public and supplying cash. But banks wouldn’t be multiplying and contracting M1 (cash plus demand deposits) based on their ever changing decisions about lending deposited funds.

Milton Friedman, who also advocated narrow banking, blamed the Depression on the Fed’s failure to offset the M1 money multiplier’s collapse. In the past year the M1 multiplier has contracted by over 40 per cent, forcing the Fed to double base money. If the multiplier shoots back up, we could see the money supply and prices explode.

What about investment banks, brokerage firms, hedge funds, and insurance companies? What’s their right financial order?

Again, regulate to purpose. Investment banks take companies public and assist in mergers and acquisitions. They shouldn’t be permitted to invest in their clients’ companies. Brokerage firms are here to help us buy and sell assets, not to gamble on spreads. Hedge funds are here to help limit risk exposure. They aren’t here to insure these risks themselves. Finally, insurance companies are here to diversify risk, not write insurance against aggregate shocks.

The FFA and “less is more” limited purpose banking won’t prevent asset markets from occasionally going nuts. But the functioning of financial markets will no longer be in question. Nor will con artists, parading as “financial engineers,” ever again be free to wreak havoc on the nation’s finances and its citizenry.

Christophe Chamley is a member of Boston University and the Paris School of Economics. Laurence J. Kotlikoff is professor of economics at Boston University"

Read the whole thing.

Don the libertarian Democrat

March 2, 2009 10:08 AM

We could go crazy with these stimulus packages and destroy the free-enterprise ethos that has sustained innovation for the past several centuries.

From Brave New Deal:

"Feb 12 2009, 9:33 pm by Reihan Salam

Listen to Amar Bhidé

As Clive Crook and Arnold Kling remind us, even the most brilliant economists are not very good at settling basic questions over how the world works. To a greater extent than most of us would care to admit, we're relying on gut instincts, crude heuristics, and, yes, ideological biases. I'll be the first to admit that I have a favorite guru. When media outlets are looking for an optimistic, heterodox voice amidst the economic gloom, they are increasing turning to the extraordinary Amar Bhidé. The son of a successful entrepreneur who also happened to be a Stalinist and a bombmaker for pro-independence Indian terrorists, Bhidé sticks out like a sore thumb in the gray, colorless world of business punditry. He is also, in my view, the most brilliant and insightful economic thinker around, and he is the author of my favorite book of 2008 by far, The Venturesome Economy.

I was hoping to see Bhidé of Columbia Business School give a talk earlier today, but I had to miss it thanks to an ill-timed cold. Like Nicholas Nassim Taleb, author of The Black Swan, Bhidé is a critic of Bayesian thinking. He elaborated on this theme in a short piece on banking regulation that recently appeared in BusinessWeek.

Until the 1930s, economists had two views of uncertainty. John Maynard Keynes and Frank Knight (who then dominated the University of Chicago's economics department) treated uncertainties as elements that couldn't be quantified. Followers of the 18th century mathematician Reverend Thomas Bayes, on the other hand, quantified uncertainties as if they were bets placed on a roulette wheel.

In Bhidé's view, the triumph of the Bayesian view has lulled us into a false sense of security, one that has been shattered by recent events. Read the whole thing.

The focus of the book is, to quote the subtitle, "how innovation sustains prosperity in a more connected world." In the course of a detailed examination of how VC-baked businesses innovate, Bhidé outlines a framework for understanding how new ideas become successful new products. It turns out that cranking out scientists and engineers who perform basic research isn't the key to prosperity, a claim advanced by any number of economic Cassandras who fret over the supposed "threat" posed by the growth of R&D in China and India. Rather, mid-level and low-level innovations play a role that is at least as important. To get a good sense of Bhidé's brilliantly quirky take on the global economy, check out (if you can) The Economist's review, which I believe was written by veteran correspondent Vijay Vaitheeswaran.

First, [Bhidé] argues that the obsession with the number of doctorates and technical graduates is misplaced because the "high-level" inventions and ideas such boffins come up with travel easily across national borders. Even if China spends a fortune to train more scientists, it cannot prevent America from capitalising on their inventions with better business models.

That points to his next insight, that the commercialisation, diffusion and use of inventions is of more value to companies and societies than the initial bright spark. America's sophisticated marketing, distribution, sales and customer-service systems have long given it a decisive advantage over rivals, such as Japan in the 1980s, that began to catch up with its technological prowess. For America to retain this sort of edge, then, what the country needs is better MBAs, not more PhDs.

America also has another advantage: the extraordinary willingness of its consumers to try new things. Mr Bhidé insists that such "venturesome consumption" is a vital counterpart to the country's entrepreneurial business culture.

This last point strikes me as particularly important. Most graybeards tells us that American consumers have to change their spendthrift ways, and this is surely true to an extent -- but those spendthrift ways have, in Bhidé's view, been a source of American technological leadership, as he explained to Maria Bartiromo.

As we speak, people of middle to low incomes are buying iPhones, and they're buying them smart because they're buying them to use as substitutes for computers. Many macroeconomists just think of consumption as one big lump of stuff. In fact, it's a whole bunch of things, some of which are good for the economy in the long run and some of which are less good. So I think we'll see a cutback in the kinds of things people consider dispensable. They may eat out less. They may not trade up to a larger home. But history suggests there will be no cutback in the consumption of the kinds of new technologies and products that ultimately make the economy grow.

Bhidé's contrarianism doesn't end there. Though he's no reflexive nationalist, Bhidé remains confident in the resilience of the American economy. But he is also deeply skeptical about both the bank bailouts and the various stimulus proposals floated by right and left.

One of the few things I agree with Paul Krugman about is that competitiveness is a dubious notion. One can talk about competitiveness in the Olympics, but competitiveness in terms of economic growth puts things in completely the wrong frame. We are living a world where there is going to be, in the long run, more prosperity in more parts of the world. As prosperity increases in more parts of the world, the U.S. share of world GDP will decline, and that is a good thing. But in the next couple of years, we could completely mess this up and go in the direction of socialism. We could go crazy with these stimulus packages and destroy the free-enterprise ethos that has sustained innovation for the past several centuries. I would rather have a slower recovery than try to accelerate the process and destroy the foundations of the free-enterprise system.

But like it or not, that's not an option that's on the table. "

Me:

Don the libertarian Democrat February 12, 2009 11:33 PM

From the FT:

http://blogs.ft.com/economistsforum/2009/01/putting-an-end-to-financial-crises/#more-315

"With the government ready to absorb losses, banks are talking outrageous risks knowing that Uncle Sam will cover them if things go south. Raising the trivially low capital requirements of banks, as Paul Volker’s Group of Thirty Commission just proposed, won’t change this behaviour.

What will change this behaviour is to not let it happen. Banks should be allowed to initiate only conforming, i.e., government-approved, AAA-rated mortgages and business loans. These would be long-term, fixed-rate loans with 20 per cent-down and payments below 25 per cent of income.

The government, via the Federal Financial Authority, would use tax records to verify loan payment-to-income ratios. It would also spot check collateral. Once approved, the banks would bundle and sell “their” loans within mutual funds.

Again, traditional bank runs wouldn’t arise. And today’s bank runs, which entail lenders and equity investors avoiding risky banks, wouldn’t either. Why? Because banks would bear zero risk. Mutual fund owners would bear risk, but not the banks. And these lenders would know they were buying government-approved AAA-rated loans, not Bear Stearns‘ CDOs.

This limited purpose banking is a modern version of narrow banking proposed by Frank Knight, Henry Simons, and Irving Fisher. Banks would hold deposits, cash checks, wire money, originate loans, and market mutual funds, including money market funds with no guarantee of par value redemption.

With limited purpose banking, financial crises would largely disappear. Banks would never fail, never stop originating loans, never expose the public to massive liabilities, and never see their stock values evaporate. Banks would be stable, boring economic cogs - like gas stations.

The Fed would also gain full control of the money supply. To expand the money supply, the Fed would continue buying treasuries from the public and supplying cash. But banks wouldn’t be multiplying and contracting M1 (cash plus demand deposits) based on their ever changing decisions about lending deposited funds.

Milton Friedman, who also advocated narrow banking, blamed the Depression on the Fed’s failure to offset the M1 money multiplier’s collapse. In the past year the M1 multiplier has contracted by over 40 per cent, forcing the Fed to double base money. If the multiplier shoots back up, we could see the money supply and prices explode.

What about investment banks, brokerage firms, hedge funds, and insurance companies? What’s their right financial order?

Again, regulate to purpose. Investment banks take companies public and assist in mergers and acquisitions. They shouldn’t be permitted to invest in their clients’ companies. Brokerage firms are here to help us buy and sell assets, not to gamble on spreads. Hedge funds are here to help limit risk exposure. They aren’t here to insure these risks themselves. Finally, insurance companies are here to diversify risk, not write insurance against aggregate shocks."

Now Bhide:

"A RADICAL IDEA, REVIVED

Here is my modest, quasi-libertarian, proposal: To prevent future meltdowns, let's revive the radical idea of narrow commercial banking. Let's tightly limit bank activity to taking deposits and making loans—loans that bankers and regulators who aren't theoretical mathematicians can monitor. (Simple hedging to reduce the risks of making long-term loans with short-term deposits would be allowed.)

Anyone else—investment banks, hedge funds, trusts—would be allowed to innovate and speculate, free of additional oversight. But they wouldn't be permitted to trade with or secure credit from regulated banks, except through prudent, well-secured loans. None of this would require new agencies or more regulators.

Such new limits might alarm those who claim the "sophistication" of our financial system is a prime source of U.S. prosperity. But while a modern economy needs financial basics—risk capital, credit, insurance—it's foolish to believe that the bells and whistles created in the past few decades have been a net plus. Does anyone really think the financial sector now receives more than 30% of domestic corporate profits—double its share 25 years ago—because it has made improvements of that magnitude in mobilizing or allocating capital? "

Even though I'm a follower of Fisher, I previously that this idea was too restrictive. But now, seeing the possible proposals, this idea seems worth considering, especially if it will allow another non-guaranteed part of our financial system that allows innovation. That's better than a system that stifles innovation, which many of the proposals will.

"FYI, the author of the research, Amar Bhide, is a friend of mine, and also unfailingly smart and provocative.": What About Me?

One reason to read blogs is to pick up on stories that you missed. I check out the NY Times off and on all day, and yet missed the following story by one of my favorite reporters, Steve Lohr. Via Yves Smith on Naked Capitalism:

"BARACK OBAMA may have to surrender his BlackBerry when he moves into the White House, in the interests of presidential security and confidentiality. But there is every sign that his administration will pursue a pro-technology agenda.

In speeches and policy statements, Mr. Obama has repeatedly emphasized a need to maintain America’s technology leadership in the world and to invest government funds to do so. His campaign platform declared that government policy must “foster home-grown innovation” and “help ensure the competitiveness of United States technology-based businesses.” Two of his favorite proposals — roundly endorsed by technology industry leaders and university scientists — are to double federal funding for basic research over the next several years and to train many thousands more scientists and engineers."

Yes. Call me skeptical. I'm not in favor of a Technology Czar either, if for no other reason than it helps proliferate the appellation "Czar". For one thing, it should be "Tsar".

"But such steps would likely amount to well-intentioned but misguided policies that risk doing more harm than good, according to Amar Bhidé, a professor at the Columbia Business School. In a new book, “The Venturesome Economy” (Princeton University Press), Mr. Bhidé makes a detailed argument that contradicts the prevailing view of expert panels and authors who contend that the nation’s prosperity is threatened by the technological rise of China and India, and that America’s capacity for innovation is eroding. To arrest the decline, they insist that more scientists and engineers, and more government spending on research, are sorely needed."

That pretty much describes all government policies. It would be hard to throw the idea out based on that reasoning. I'd read the book, except it will simply confirm what I already believe. It's like Taleb' s books. I can't really judge their import and accuracy, since I'm hardwired into a similar world view.

"Mr. Bhidé derides the conventional view in science and technology circles as “techno-nationalism,” needlessly alarmist and based on a widely held misunderstanding of how technological innovation yields economic growth. In his view, many analysts put too much emphasis on the production of new technological ideas. Instead, he observes, the real economic payoff lies in innovations in how technologies are used."

Okay. This is not a new thesis. I'll tell where I first had it hardwired into me. It is a masterpiece entitled "Mechanization Takes Command", by S. Giedion:

"The brilliant Minoan age, the last matriarchy, possessed not only bathtubs, but sewer systems and water closets. Sir Arthur Evans' tireless excavating has given us better insight into this early period than we have, for instance, into the Greek gymnasium. The painted terra-cotta tub that Evans pieced together from the queen's apartment in the Palace of Knossos in Crete informs us that this type of bath, like many other Minoan habits, was taken over by the Greeks of the Mycenean period, around 1250 B.C. The Cretan tub, modest in dimensions, fits the description of the Mycenean bath in which the Homeric heroes bathed. When Homer, looking back from around 800 B.C., tells of the bath ceremony, he refers to it as the restorative following 'soul exhausting toil.' The stress here falls not upon cleanliness but upon relaxation.

The present-day type of bath, the tub, is actually a mechanization of the most primitive type. It belongs in the category of external ablution. The tub is understood as an enlarged washbowl. No period before ours has so unquestioningly accepted the bath as an adjunct to the bedroom. Each of its components was the outcome of a slow, tedious mechanization; hence the bathroom with running water emerged only toward the end of the last century, while not until the time of full mechanization between the two World Wars was it taken for granted. "

In other words, the technology, which is often already available, needs to await its use and economy.

"America’s competitive advantage, Mr. Bhidé explains, resides mainly in its creative use of information technology, especially in the large and growing services sector, led by companies like Wal-Mart.

“Wal-Mart and its followers are as much a part of the technological success of America as Silicon Valley,” he said."

So said Giedion.

"The globalization of science and technology research, Mr. Bhidé added, should actually work to the advantage of the United States economy, so long as America remains the best place to commercialize inventions. As the rest of the world becomes a richer source of inventions, there is less need for the United States to come up with such a large share itself — and policy, he says, should reflect that reality.

“I’m not arguing for reductions in research spending in the United States,” he said. “But in a world where investment in high-level science and technology is increasing, there is no compelling reason to invest a lot more.”

I've no idea. I'd probably spend a hell of a lot more on it, but that's just my personal preference. Where the money would come from I haven't a clue. Maybe TARP.

"The flaw in Mr. Bhidé’s thesis is that it amounts to a “false choice,” said Robert D. Atkinson, president of the Information Technology and Innovation Foundation, a nonpartisan research group. Most of the economic gains from technology, Mr. Atkinson agrees, do come from its innovative use. “But that doesn’t mean that the basic research is not critical,” he said.

In fast-moving fields, Mr. Atkinson said, there are immense benefits from the knowledge produced in research projects quickly spilling over into ventures that become powerhouses in new industries. Google, which grew out of a digital library project funded by the National Science Foundation, is among a host of such examples. Where the invention is done, Mr. Atkinson notes, is often vital."

A "false choice". What's the false choice here, if you don't mind spelling it out? Is it:

Economic gains from technology come from:

1) Innovation

2) Basic Research

I left out "most", because that's a fudge word, meaning "I've no research backing up my claim, but I feel pretty good about it nonetheless. So don't push me on it".

First of all, the use of "most" took it out of the realm of false choice, since it then became a question of emphasis, not a clear demarcation needed for a false choice.

Second, I don't think that Bhide claimed anything like 1, since he said that he didn't think that research funding should be cut. I'm sure it's fine to disagree with him, but it hardly constitutes a flaw in his thesis, where "flaw" means something like this:

"a defect impairing legal soundness or validity."

"Yet, Mr. Bhidé argues, policy choices and tradeoffs have to be made, and they should be guided by a deeper understanding of how innovation, in all its forms, contributes to economic growth. That analysis, conducted over the last six years, is the basis of his 508-page book, which adds to the emerging field of “innovation economics.”

I'm sure that we're all waiting anxiously for the models used in "innovation economics" to be constructed. We can't wait to begin misusing them for our own purposes.

"His research builds on, but is also critical of, the doctrine of “new growth theory,” developed in the 1980s and ’90s. That theory holds that new ideas are the key engine of growth and presents mathematical models, created by economists like Paul M. Romer of Stanford, to simulate the process. The models have been used to justify increasing government subsidies for research.

But what the math models do not — and cannot — capture, Mr. Bhidé writes, is “all the various forms of knowledge generated by the massively multiplayer innovations game that sustains economic growth.”

Tell that to the Quants.

"What gets short shrift, Mr. Bhidé said, is “midlevel innovation.” The category, by his definition, is a broad one, ranging from a venture capitalist tweaking a business model to trim costs by a few percent to a technician fine-tuning his company’s business software to save a couple of data-entry steps in the accounting department.

These midlevel innovations, Mr. Bhidé said, do not show up in patent counts, and individually they are small steps indeed. But they add up, especially because there is so much of that kind of unsung innovation across the American economy."

Let's make a CDO out of this. We'll call the midlevel innovations the Mezzanine Tranche. I'll bet they work, you bet they default.

"While others bemoan the state of American education, Mr. Bhidé, who graduated from the elite Indian Institute of Technology in Mumbai before he earned advanced degrees at Harvard, is impressed with the general level of creativity and practical skills across the nation’s work force."

Did everybody on the planet go to Harvard but me?

"Every day, for example, millions of workers are using spreadsheets to do simple what-if calculations to improve some process or operation in their businesses, he said. “In the end, it comes down to individuals, and you don’t need to be a trained scientist or engineer for this broad swath of creatively productive work,” he observed. “You need a somewhat more open mind, a willingness to experiment and to innovate in the use of technology, not create it.”

The individuals bit is my Human Agency explanation used in this particular case.

"So instead of tilting policy toward the apex of the education system, Mr. Bhidé suggests, it may make more sense to invest scarce government resources further down — say, in upgrading community college programs. “The modern information technology economy is going to need a lot of foot soldiers,” he said.

“And our supply of high-level science and ideas in most fields far exceeds our capacity to use it.”

It's like our brains. Well, at least mine. No need to include you, intrepid reader, in this.