Thursday, October 8, 2009

Mutual guarantee institutions "are better than banks at screening and monitoring opaque borrowers"

Mutual guarantee institutions and small business finance, by Francesco Columba, Leonardo Gambacorta and Paolo Emilio Mistrulli
BIS Working Papers No 290
October 2009


A large body of literature has shown that small firms experience difficulties in accessing the credit market due to informational asymmetries. Banks can overcome these asymmetries through relationship lending, or at least mitigate their effects by asking for collateral. Small firms, especially if they are young, have little collateral and short credit histories, and thus may find it difficult to raise funds from banks. In this paper, we show that even in this case, small firms may improve their borrowing capacity by joining mutual guarantee institutions (MGIs).

Our empirical analysis shows that small firms affiliated with MGIs pay less for credit compared with similar firms which are not MGI members. We obtain this result for interest rates charged on loan contracts which are not backed by mutual guarantees. We then argue that our findings are consistent with the view that MGIs are better than banks at screening and monitoring opaque borrowers. Thus, banks benefit from the willingness of MGIs to post collateral since it implies that firms are better screened and monitored.

JEL Classification Numbers: D82, G21, G30, O16

Keywords: credit guarantee schemes, joint liability, microfinance, peer monitoring, small business finance

Has the economic stimulus program helped or hurt?

Stimulus Scam, by Richard W. Rahn
The Washington Times on October 8, 2009

Has the economic stimulus program helped or hurt? Administration officials keep saying the stimulus program has been beneficial, but where is the evidence?

There are several ways to see if it is working as advertised. First, what did the proponents say would happen when they were pushing the plan versus what has happened? Second, how has the United States fared compared to other nations that had smaller or no stimulus programs? Third, how have the results to date compared to what pro-stimulus, Keynesian-school economic theorists advocated versus what other theorists (principally Austrian-school) who largely opposed the stimulus plans said?

U.S. unemployment already has reached 9.8 percent, with 15.1 million Americans unemployed, and more than 7.1 million jobs have been eliminated since the beginning of the recession. President Obama's economic advisers said in the beginning of this year that the unemployment rate would rise to 9 percent with no stimulus package and would only rise to a maximum of 7.9 percent with the stimulus bill, peaking during this past summer. Stimulus proponents clearly have failed the first test (despite Vice President Joseph R. Biden Jr.'s revisionist statements) and there is zero evidence for their claims that more jobs would have been lost without the stimulus package.

One might argue that the stimulus had worked if the results in the United States were better than in other countries that had smaller or no stimulus packages. The recession has been global, and every country has been affected negatively. Only Great Britain attempted to put in a stimulus package that was relatively as large as the U.S. package. A crude measure of economic stimulus is the size of the deficit relative to gross domestic product. During recessions, tax revenues decline in all countries, so most will run a deficit whether they intend to or not. A stimulus package normally contains a mix of government spending increases and tax cuts, resulting in a deliberately larger deficit.

The United States and Britain have by far and away run the largest deficits as a percentage of GDP (i.e. the most stimulus), yet the U.S. and Britain, along with Italy and Russia, had not bottomed out in second-quarter 2009, while the rest of the 10 largest economies were showing real growth in the second quarter. Russia's poor performance is largely a function of relying very heavily on the export of raw materials rather than developing a broad-based economy as all the others in the Big 10 have done.

The three countries with the smallest deficits (the least stimulus) — Brazil, China and Germany — have all turned the corner rather quickly and are growing. German Chancellor Angela Merkel has just announced she is going to push tax cuts, which should give the German economy an additional shot in the arm.

While the data set is too small with the top 10 countries (which collectively account for a large majority of the world's GDP) to draw definitive conclusions, the existing evidence indicates that a big stimulus package seems to delay recovery, while little stimulus leads to a quick return to economic growth.

Finally, what do the competing economic theorists say? The Keynesians say that if the government increases spending to stimulate demand and create jobs for those who do not have them, this should lead to a less painful downturn and a quicker recovery. The Austrian (aka Hayekians) free-market sorts say recoveries occur on their own once asset and labor prices fall from inflated levels of the previous boom and excess inventories are worked off. This usually happens within 16 months unless government attempts to mitigate these necessary price adjustments, which will delay the recovery. (Apologies to both my Austrian and Keynesian friends for trying to summarize their views in one short paragraph.)

The Keynesians never really get a fair test of their theory because politicians always take the Keynesian notion that it is OK to increase government spending as a license to spend the extra money on themselves and their friends rather than on those who might actually benefit. (This self-dealing process is well explained by the public-choice school of economics.) A few examples from the current stimulus program should suffice. Congress increased spending on itself last year by 10.9 percent and by another 5.8 percent this year for a grand total of $4.7 billion. (Remember, it was just 15 years ago when the Gingrich Republicans ran against the "billion dollar Congress.") Given that the number of members of Congress remains fixed at 535, why should their budget go up any faster than inflation?

Congress and the administration also have gotten into the venture capital business, which enables them to dump infinite quantities of money into their rich friends' pockets. Bill Frezza, a principled venture capitalist, using Fox News and other venues, has been blowing the whistle on these unsavory and destructive practices. Did you know that Al Gore and friends just received almost $600 million to develop another expensive ($88,000) hybrid electric sports car with your tax money? The chances of taxpayers getting their money back are less than of General Motors Corp. and Chrysler paying off all their loans, which is close to zero. Paradise defined: being politically well-connected when stimulus money is around.

The only things one can say for sure about stimulus money is that it will add to the deficit, ultimately driving up interest rates and taxes; and much of it will be wasted and/or stolen, neither of which benefits the unemployed. By any objective measure, the stimulus program has been and will continue to be a failure — but don't expect the Washington politicos ever to admit it.

Richard W. Rahn is a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.

Would a Stricter Fed Policy and Financial Regulation Have Averted the Financial Crisis?

Would a Stricter Fed Policy and Financial Regulation Have Averted the Financial Crisis?, by Jagadeesh Gokhale and Peter Van Doren
Cato, October 8, 2009

Many commentators have argued that if the Federal Reserve had followed a stricter monetary policy earlier this decade when the housing bubble was forming, and if Congress had not deregulated banking but had imposed tighter financial standards, the housing boom and bust—and the subsequent financial crisis and recession—would have been averted. In this paper, we investigate those claims and dispute them. We are skeptical that economists can detect bubbles in real time through technical means with any degree of unanimity. Even if they could, we doubt the Fed would have altered its policy in the early 21st century, and we suspect that political leaders would have exerted considerable pressure to maintain that policy. Concerning regulation, we find that the banking reform of the late 1990s had little effect on the housing boom and bust, and that the many reform ideas currently proposed would have done little or nothing to avert the crisis.

Commentators have also argued that the popularization of financial products such as teaser-rate hybrid loans for subprime homebuyers and credit default swaps for investors is to blame for the financial crisis. We find little evidence for this. Housing data indicate that the majority of subprime hybrid loans that have entered default had not undergone interest rate resets, and the default rate for subprime hybrid loans is not much higher than for subprime fixed rate loans. Concerning swaps, although their introduction may increase financial inflows into risky sectors, their execution through a clearing-house or regulation via other means would not necessarily have avoided the mispricing of risks in underlying contracts. Capital requirements for the credit default swaps that were used to insure mortgage-backed securities would have been low because housing investments were not considered risky.

Full text:

Jagadeesh Gokhale is a senior fellow at the Cato Institute and the author of Social Security: A Fresh Look at Reform Alternatives (forthcoming). Peter Van Doren is a senior fellow at the Cato Institute and the editor of Cato's Regulation magazine.

Grand Mufti on Islam, Israel and the United States

Islam, Israel and the United States. By Sheikh Ali Gomaa
Peace among the Abrahamic faiths will be built on respect and the law.
WSJ, Oct 08, 2009

America and the West have been victims of violent extremists acting in the name of Islam, the tragic events of 9/11 being only the most egregious of their attacks. Western officials and commentators are consumed by the question, "Where are the moderates?" Many, seeing only the extremism perpetuated by a radical few, despair of finding progressive and peaceful partners of standing in the Muslim world.

However, reconciling Islam with modernity has been an imperative for Muslims before it became a preoccupation for the West. In particular, the process dates back to the 19th century, when what became known as the Islamic reform movement was born in Al Azhar University in Cairo, Islam's premiere institution of learning.

At the Dar al Iftaa, Egypt's supreme body for Islamic legal edicts over which I preside, we wrestle constantly with the issue of applying Islam to the modern world. We issue thousands of fatwas or authoritative legal edicts—for example affirming the right of women to dignity, education and employment, and to hold political office, and condemning violence against them. We have upheld the right of freedom of conscience, and of freedom of expression within the bounds of common decency. We have promoted the common ground that exists between Islam, Christianity and Judaism. We have underscored that governance must be based on justice and popular sovereignty. We are committed to human liberty within the bounds of Islamic law. Nonetheless, we must make more tangible progress on these and other issues.

We unequivocally condemned violence against the innocent during Egypt's own struggle with terrorism in the 1980s and 90's, and after the heinous sin of 9/11. We continue to do so in public debates with extremists on their views of Islam, in our outreach to schools and youth organizations, in our training of students from all across the world at Egypt's theological institutions, and in our counseling of captured terrorists. As the head of the one of the foremost Islamic authorities in the world, let me restate: The murder of civilians is a crime against humanity and God punishable in this life and the next.

Yet, just as we recommit to reinforcing the values of moderation in our faith, we look to the United States to assume its responsibility for the sake of a better relationship between the West and Islam.

First, it is essential that the U.S. confront the fear and misunderstanding that has often pervaded the public discourse about Islam, especially in the media.

Second, while we must strive to reinforce the common principles that we share, we must also accept the reality of differences in our values and in our outlook. Islam and the West have distinct value systems. Respect for our differences is a foundation for coexistence, and never for conflict.

Finally, there must a true commitment to the rule of law, and to sovereign equality, as the legitimate basis for international relations. While some of the divide between Islam and the West lies in the realm of ideas, it lies mostly in the realm of politics. The violence and the aggression to which many Muslim countries have been subjected are the main sources of a deep and legitimate sense of grievance, and they must be addressed.

Israel's occupation of Palestine must be brought to an end; its continuation is an affront to the fundamental tenets of justice and freedom that we all seek to uphold. In Iraq and Afghanistan, full sovereignty and independence must be restored to their people with the withdrawal of all foreign forces. President Barack Obama's historic address to the Muslim world from Cairo on June 4 was a landmark event that opened the door to a new relationship between Islam and the West, precisely because it acknowledged these imperatives. Yet much work needs to be done by both sides.

This week in Washington I am participating in the Common Word Initiative, a group of religious leaders hosted by Georgetown University's Center for Muslim-Christian Understanding. While the focus of this initiative has been to foster dialogue between Islam and Christianity, I will call for its expansion to include representatives of all the Abrahamic faiths. The road ahead will be difficult, but we can, God willing, arrive at a more peaceful future together.

Dr. Gomaa is the Grand Mufti of Egypt.

Islamists misrepresent the liberal legacy of the Ottoman Empire

Bring Back the Caliphate. By Soner Cagaptay
Islamists misrepresent the liberal legacy of the Ottoman Empire.
WSJ, Oct 08, 2009

The reaction in Turkey to the recent death of Ertugrul Osman, heir to the Ottoman throne and successor to the last Caliph, could not be more shocking. Islamists in kaftans and long beards gathered in Istanbul two weeks ago to bury the titular head of the world Muslim community, a scotch-drinking, classical music-listening Western Turk who until recently lived on New York City's Upper East Side.

The Islamists' embrace of Osman, a descendant of the westernized Ottoman sultans, provides a periscope into the Islamist mind: Islamism is not about religion or reality. Rather it is a myth and a subversion of reality intended to promote Islamism, a utopian ideology. Osman, raised by a line of West-leaning caliphs and sultans, loved Atatürk's Turkey, yet the Islamists abused his funeral and the memory of the caliphate, changing it into a symbol for their anti-Western, anti-secular and anti-liberal agenda.

Were Ertugrul Osman alive and were the Ottomans around today, he would be Sultan Osman V and no doubt, he would be going after the fundamentalists who abused his funeral in an attempt to distort his legacy.

Despite what the Islamists want the world to believe, the Ottoman caliphate was not anti-Western. The Ottoman Empire always interacted with the West—an interaction that goes all the way back to 16th-century Sultan Suleyman the Magnificent, who envisioned himself as the Holy Roman emperor. In the 18th and 19th centuries, the Ottoman sultans and caliphs embarked on a program of intense reforms to remake the Ottoman Empire in the Western image to match up with European powers. To this end, the caliphs launched institutions of secular education, and paved the way for women's emancipation by enrolling them in those schools. By the beginning of the 19th century, the sultans and caliphs of the Ottoman Empire embodied Western life and Western values. The last caliph, Abdulmecid Efendi, considered the Ottoman state a Western power with a Western destiny. An enlightened man and avid artist, the caliph's sought-after paintings, including nudes, are on exhibition at various museums, such as Istanbul's new museum of Modern Art.

It is therefore wrong to represent the Ottoman Empire as the antithesis to the secular republic Atatürk founded in 1923. True, when Atatürk turned Turkey into a secular republic in 1923 by abolishing the Ottoman state and the caliphate, Atatürk did noteradicate the sultan-caliphs' legacy. Rather, he fulfilled their dream of making Turkey a full-fledged Western society. Atatürk's reforms are a continuation of the late Ottoman Empire—he merely pursued Ottoman reforms to their logical conclusion.

Moreover, Atatürk was the product par excellence of the Ottoman Empire. He was raised in Salonika, the hub of cosmopolitanism and Western culture in the reforming empire. He studied in secular Ottoman schools, and he was trained in the Westernized Ottoman military.

The debate over the Ottoman caliphate's legacy has ramifications not only for Turkey, but also for contemporary Muslims and the Western world's desire to counter radical Islamists. Years before emergence of al Qaeda, the caliphs produced an antidote against radical jihadists, a progressive vision for a Western-oriented Muslim society. The sultan-caliphs built the institutional foundations of this society, including the first Ottoman parliament and constitution of 1876, and planted in it seeds of Western values, such as secular education and women's emancipation. Modern Turkey owes its existence as much to Atatürk as to the sultan-caliphs who were among the first to promote liberal and Western values in a Muslim society.

Now, the Islamists want to usurp the caliphate and its legacy. The fundamentalists first distort the caliphate's politics, reimagining it as an anti-Western institution. Then, they portray the revival of this invented caliphate as the ultimate political dream in an anti-Western ideology.

Eighty years ago, the Ottoman caliph-sultans imagined a Turkey that is more akin to modern Turkey than to the Islamist society envisioned by al Qaeda or others who dismiss Atatürk's dream of a Western Turkey and liberal values as anomalies. Ertugrul Osman himself told Turkish journalist Asli Aydintasbas shortly before his death that "the republic has been devastating for our family, but very good for Turkey."

Caliph Osman was Turkish by birth, Muslim by religion, and a Westerner by upbringing. I want my caliph back, and so should all Muslims who want deliverance from the distorted and illiberal world envisioned by the Islamists.

Mr. Cagaptay is a senior fellow at the Washington Institute for Near East Policy and author of "Islam Secularism and Nationalism in Modern Turkey: Who is a Turk?" (Routledge, 2006).

Down with capitalists, nations, bosses, families, etc. - Commonwealth

Brothers in Marx. By Brian C Anderson
Down with capitalists, nations, bosses, families, etc.
WSJ, Oct 08, 2009

Review of: Commonwealth
By Michael Hardt and Antonio Negri
Harvard University Press, 434 pages, $35

Astonishingly, given the ruin associated with his name, Karl Marx is back in fashion. The global economic downturn has spurred sales of "Das Kapital" to an all-time high; Michael Moore with his latest movie rivals the Original Communist in denouncing the evils of capitalism; and for the past year the news media seem to have delighted in running obituaries for the owners of the means of production. Michael Hardt and Antonio Negri, then, are nicely positioned to take advantage of Marx's revival with the publication of "Commonwealth," which re-imagines Marxism for the 21st century.

Mr. Hardt teaches literature at Duke University and is a postmodernism-steeped radical—that is to say, he is an American college professor. Mr. Negri, a political theorist, has a more unusual background. Three decades ago, the Italian government believed that he was the secret intellectual leader of the leftist terrorists called the Red Brigades and that he was the architect of the group's 1978 kidnapping and murder of Christian Democratic Party leader Aldo Moro. Unable to build a sufficient case to try Mr. Negri for murder—he has always denied the allegation—Italian authorities convicted him of "armed insurrection against the state." Facing 30 years in the slammer, Mr. Negri scooted to France, where he remained, a philosopher in exile, until 1997, when he returned to Italy to serve the remainder of a reduced sentence. He is a left-wing guru whose field work has occurred far from the faculty lounge.

"Commonwealth" completes a trilogy that began in 2000 with "Empire" and continued with "Multitude" in 2004. The book is a witch's brew of contemporary radicalism. Capitalism deserves to die, Messrs. Hardt and Negri believe, for it has abused and corrupted "the common." The common isn't just "the fruits of the soil, and all nature's bounty," they tell us; it is the universe of things necessary for social life—"knowledges, languages, codes, information, affects." Under capitalism, nature is ravaged, society brutalized.

Yet the conditions for people's emancipation are budding within capitalism, the authors believe (just as Marx believed in the mid-19th century). Unlike the factory laborer of yesterday, today's knowledge worker has less and less need for a boss. Companies extract the most value from the worker, we're told, when he is left alone to create, connect and collaborate as he sees fit. This is also true of "affective labor" that offers services to the public, "even in the most constrained and exploited circumstances, such as call centers."

Messrs. Hardt and Negri propose getting rid of bosses, of course, but they also target another bugaboo of the hard left, private property. The possession of property supports unjust power structures—why not agree that the "common wealth" of the human and natural worlds should be everyone's responsibility, everyone's resource? Welcome to The Communist Manifesto 2.0.

"Commonwealth" updates Marx's championing of the proletariat as the agent of revolution. The authors prefer "the multitude," which includes workers of all kinds, naturally, but also gathers the mighty forces of identity politics: black and Hispanic activists, radical feminists, "queer" transgressives and others purportedly harmed by global capitalism. They don't all get along, Messrs. Hardt and Negri admit, so the left must persuade this army-in-waiting to value the importance of "revolutionary parallelism." No Black Power movement that treats woman or homosexuals badly, for instance, will win the day. After the revolution, we're told, identity politics, like class warfare, will dissolve.

For the revolution to succeed, three supposedly corrupt forms of the common must be destroyed. Some of the harshest language in "Commonwealth" targets the family: Mom, dad and the kids might not know it, but they are part of a "pathetic" institution, a "machine" that "grinds down and crushes the common" with "the blindest egoism." Messrs. Hardt and Negri cry: "Down with the family!" The two other killers of the world's spirit: the corporation and the nation. When the multitude seizes "control of the means of production and reproduction," we're promised, the evil trio will wind up on Marx's ash heap of history.

The authors warn the rulers of the capitalist world that if they want to survive a little longer, they need to enact reforms, including global citizenship, a right to income for everyone and participatory democracy. But Messrs. Hardt and Negri don't think that their warning will be heeded. Revolution will erupt—and soon. It could be violent, a prospect that does not seem to trouble them: "What is the best weapon against the ruling powers—guns, peaceful street demonstrations, exodus, media campaigns, labor strikes, transgressing gender norms, silence, irony, or many others—depends on the situation." Pirates, the rioting Muslim banlieusards of Paris and the Black Panthers all are praised in "Commonwealth" as heroes of disruption.

Messrs. Hardt and Negri make little effort to build arguments in support of their wild assertions and predictions. They write as if ignorant of the 20th century and of much else, including economics and social science. (They still quote Lenin and Mao as if they were sources of wise political and economic analysis.) How would abolishing private property not lead to a threadbare totalitarian state, as it has in the past? The authors promise it will be different this time, without explaining why. If you abolish the family, how will children grow into flourishing adults? We must take it on faith that the post-family world will be just fine. (The word "children" almost never appears in the book.) How do the authors explain away capitalist globalization's record of elevating millions of people out of poverty? Answer: They don't.

"Commonwealth" is a dark, evil book, and it is troubling that it appears under the prestigious imprimaturof Harvard University Press. Countless millions were slaughtered by adherents of Karl Marx in the 20th century. God help us if the scourge returns in the 21st.

Mr. Anderson, the editor of City Journal, is the author of "Democratic Capitalism and Its Discontents" and, with Adam Thierer, "A Manifesto for Media Freedom."