comments from Jared Bernstein on Ezra Klein's narrative

But I’ve come to view the deleveraging point as only one part of the problem, and one that’s actually hard to parcel out from the lousy jobs market, which is the main constraint on consumers.  The Fed’s debt service ratio—the share of income households are spending to service their debt—is the lowest it’s been since the mid-90s (though the fact that it’s still falling suggest the deleveraging cycle isn’t over).

I think the bigger problem is in the banks, and it’s born of that extremely combustible combination: debt and psychology.  When an equity (as opposed to a debt) bubble pops, markets move quickly to mark down the asset inflation born of speculation.  A share of stock in some worthless fad that was worth $1,000 on Monday can be worth $1 by Friday.
 
Debt bubbles don’t work that way.  Debt-based assets don’t get “marked-to-market” in the same way as stocks.  De-nile ain’t just a river, and banks who hold such assets can engage in “extend and pretend” in a way they can’t when an equity bubble pops.  This is especially the case in a housing bubble.  Holders of non-performing mortgages that are deeply underwater—and more than half of the 11 million underwater mortgages are more than 25% below sea-level—convince themselves that these assets turned liabilities will resurface and sail again someday.
 
And in fact, some will.  But many won’t and to admit that and mark them down means the bank needs to find more capital to keep its balance sheet in shape.  Basically, a debt bubble injects human nature into the problem, and our nature is to cross our fingers and engage in magical thinking about zombie assets coming back life.

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First, the fact that we failed to recognize the depth of the recession was not at the heart of the problem.  Other trusted voices—Klein mentions Krugman and Stiglitz (I’d add Dean Baker and Larry Mishel)—were warning that things were going to be worse than our forecast, and we heard them.  I myself, as quoted in Ezra’s piece, told the NYT in December of 2008: “We’ll be lucky if the unemployment rate is below double digits by the end of next year.”  (And see footnote 1 in Romer/Bernstein, e.g.)

We wanted to the largest package we could get and that was arguably what we ended up with.  Moreover, the damn thing worked pretty much like we thought it would.   Our mistake was failing to follow up on the initial success.

As Carmen Reinhart herself says in the piece, the Recovery Act prevented recession from morphing into depression.  The engine was racing in reverse, and our actions and those of the Fed shifted it into neutral, where we’ve been stuck ever since, and stuck at an unacceptably high level of under-capacity.

What kept us from doing more?  In fact, we did do more, but again, not enough.  We extended unemployment benefits, the first time homebuyers credit, the Hire Act, the payroll tax holiday, a small business lending bill, and more.

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So part of our problem is that nobody does counterfactuals—what would have occurred absent the intervention.  That’s understandable, and we should have tried harder to communicate that issue to the public.  Still, I’m not sure if we could have made a difference.  I do know that talking about green shoots didn’t help (I remember some critic at the time suggesting that we must be smoking green shoots).

But I actually think the “green shoots” mistake is an important hint.  One reason to go there is because if you believe things are truly getting better—if you really think that soon the private sector can pick up the growth baton—then you can pivot away from spending toward deficit reduction.  And the internal desire to do that is always strong in the White House—at times like this, too strong.

This isn’t just an Obama issue.  FDR did the same thing.

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In other words, one of the reasons we historically under-react to economic downturns is an irrational fear of temporary deficit spending.  The main question we want to ask both back then and right now is not “is the deficit getting too large” but “is it large enough?”  As long as the economy is operating under capacity and the spending is temporary—think Recovery Act, not Bush tax cuts—to do too little in the name of deficits, bond vigilantes, and Treasury rates (which are now at historic lows), is to condemn millions to unnecessary unemployment, declining living standards, and even, in the case of the young, permanent scarring.

I’ll have a lot more to say about this in an article coming out soon in the journal Democracy, and it’s but one of many dynamics that contributes to the immunity that Klein discusses.  And, yes, for many in Congress it’s a tactic—they don’t care about the deficit other than its use a cudgel against doing something to help someone other than their funders.  But as long as we fail to understand the dynamics of deficits—their need to expand as much as necessary in bad times and contract in good ones—we will never be able to meet the market failures we face now or in the future.

(And I deleted the Yglesias CAP blog link in the right column because of his shitty comment system. Bye Matt. Best of luck.)