Roughly five minutes into Shutter Island, I knew more or less how it would end. For a film that invests another two hours and fifteen minutes in building to an ostensibly shocking twist ending, this is not a particularly good thing. All the more so when the film in question is the work of someone who many cinephiles (and I count myself one of them) consider to be the world’s greatest living filmmaker. Shutter Island is most certainly not a bad film, but from the likes of Martin Scorsese, it cannot be considered anything other than a disappointment.

One could argue, of course, that we should simply be grateful to see another Scorsese film at all. In an era when most of his contemporaries from the 1970s New Hollywood era have either burned out (William Friedkin, Peter Bogdonavich), died (Robert Altman), or retreated into comfortable mediocrity (Steven Spielberg, George Lucas), the fact that Scorsese is still making films, and still making them with something like the uncompromising intensity of his youth, often seems like reason enough to be indulgent.

Indeed, now that he has been canonized, it is easy to forget that twenty years ago Scorsese seemed to be finished as a major filmmaker. Until his 1990 comeback with Goodfellas, a film so ferocious that it almost leaps off the screen and attacks the viewer, Scorsese had meandered through much of the previous decade, apparently lost in a Hollywood that had turned to the blockbuster opening weekend and the high concept event picture as the answer to its post-television malaise. In a cinema that had come to be defined by films like Star Wars, Scorsese’s raw, violent, low-tech realist style and his desperate, tortured, sometimes psychotic characters appeared to have no place.

Post-Goodfellas, however, having not only survived but established himself as a veritable living legend, Scorsese has come to represent a great deal more than his individual films. He is a symbol – especially to film critics – of a type of filmmaking which, to a great extent, no longer exists today, although a great many of use sorely wish it did. This may go some way toward explaining the unique attitude of most film critics towards his recent work, which has largely been one of gentle indulgence. For the most part, they have been kind, while quietly noting that Scorsese’s later films are not quite of the same iconic quality as Mean Streets, Raging Bull, Taxi Driver, and even Goodfellas. Even Scorsese’s best director Oscar for The Departed was greeted with a certain temperance, with many noting that it was more of a lifetime achievement award than anything else.

To a great extent this is an unfortunate state of affairs, because it both underrates much of Scorsese’s recent work and ignores his occasional failures. There is no doubt that films such as The Age of Innocence, Kundun, and Bringing Out the Dead, while they have their moments, pale next to the director’s previous masterpieces. At the same time, however, the last two decades have produced films like Casino, Gangs of New York, and The Departed, which are not merely great films, but often display a side of Scorsese that does not appear in his more celebrated works, deepening his legacy and complicating the conventional assessment of his oeuvre. Most notably, while Scorsese has become more “mainstream” than he was in the past, his films have ironically become darker and bleaker than they were before. For all their brutality and realism, films like Mean Streets and Raging Bull nonetheless ended with a sense of redemption for their protagonists; perhaps a bitter and difficult one, but redemption nonetheless. Scorsese’s more recent films, like Gangs of New York, The Aviator, The Departed, Casino, and even Goodfellas, end with their characters either dead or trapped in a metaphoric limbo from which, it is hinted, they may never emerge.

The understandable but unfortunate decision to treat Scorsese as an icon rather than a developing filmmaker has not only led critics to ignore some of his later films’ virtues; it has also led them to ignore their flaws. This seems particularly glaring in regard to Shutter Island, toward which most critics have reacted in the typical fashion, which is something along the lines of “Its great, but not quite as great as…” before proceeding to cite one of the director’s 1970s triumphs. The truth, however, is that even viewed in the context of Scorsese’s work in the 1990s and 2000s, Shutter Island is a major failure.

The film is, as everyone likely knows by now, a thriller; but it is not a particularly good one. The plot, such as it is, is remarkably cliched: Sometime in the 1950s, federal marshals Teddy Daniels (Leonardo DiCaprio) and his partner Chuck Aule (Mark Ruffalo) are ferried to an isolated island off of Massachusetts which houses a state of the art prison for the criminally insane. A patient has inexplicably gone missing, and Daniels and Aule are charged with finding her. There is no way off the island, a hurricane is bearing down, and as the investigation proceeds, it becomes clear that everything – naturally – is not what it seems. Daniels, who in the finest Scorsese tradition is tortured by traumatic events in his past, quickly becomes convinced that a dark conspiracy is at work. To recount any more of the plot would ruin the film for anyone who has not seen it, but suffice it to say that most of the film’s surprisingly long running time is taken up by red herrings, false trails, and the kind of powerhouse set pieces that Scorsese can direct in his sleep. By the time the twist ending – which, as noted above, is obvious almost from the beginning – rolls around, one has the depressing sensation of having watched a master trying his best to keep us all entertained but, in the end, is just going through the motions.

To be fair, this is not entirely Scorsese’s fault. The film’s story is, to put it bluntly, depressingly generic, and no amount of cinematic pyrotechnics can obscure the fact that, as talented as Scorsese undoubtedly is with the camera, we have seen this story done – usually better – a thousand times before. The film’s acting is equally problematic. While there are some good performances, especially from Ben Kingsley as the prison’s disconcertingly mild-mannered administrator – and it is always a treat to see Max Von Sydow in anything – Leonardo DiCaprio is simply not capable of the kind of emotional intensity and range required by the film’s central character. While his collaboration has been a boon to Scorsese’s recent career, allowing the director to command budgets which he could not acquire otherwise, DiCaprio lacks the preternatural talent displayed by the likes of Robert DeNiro and Daniel Day-Lewis, whose work with Scorsese is justifiably legendary. One cannot imagine DiCaprio giving the kind of titanic performance DeNiro delivered in Raging Bull, and in Gangs of New York he was simply dwarfed by the towering presence of Day-Lewis. Shutter Island is, unfortunately, no exception to this, and while DiCaprio does his best to appear sweaty, tortured, traumatized, and driven, his performance is ultimately a shallow one, never shedding the pretty-boy immaturity which has haunted DiCaprio’s work from the beginning.

Nonetheless, this is a Martin Scorsese picture, and any director as obsessively fixated on his work as he reportedly is must ultimately bear the blame for his failures. In some ways, however, this failure is not surprising. Despite his undeniable brilliance, Scorsese is not particularly good at making thrillers or at making genre films in general. His greatest talent has always been for human drama, and once hemmed in by the rules and regs of a particular genre, his talent often seems to become mechanical and soulless. Even his celebrated gangster films are more about character and sociological observation than adhering to the formal mores of the genre. His one previous attempt at a thriller, 1991’s Cape Fear, is an enjoyable but forgettable potboiler, carried mostly by Robert DeNiro’s charismatic central performance.

Shutter Island is even more obviously a case of Scorsese being out of his natural element. While the visuals are flawless and the director seems to have packed the film with homages to every thriller ever made, this ultimately leaves the viewer unmoved. While watching it, one cannot help feeling that we have seen this film before – and better – at the hands of Mario Bava, Alfred Hitchcock, Roman Polanski, Roger Corman, and no doubt many others older and more obscure who Scorsese has excavated from his reportedly encyclopedic knowledge of cinema. But homage is not by definition interesting, and ultimately Shutter Island feels like a shallow and pointless exercise; the work of a slumming genius who is capable, and must know he is capable, of a great deal more.

Follow Benjamin Kerstein on Twitter.

Paul Krugman is calling for war — a trade war on China, that is. He proposes to impose up to a 25% tariff on imports from China to force them to revalue their currency against the dollar, and start chipping away at their $30 billion/month current account surplus.

Trade war flies against everything we know about free markets, comparative advantage and all the rest. On the other hand, there have been instances where the US has held the dollar overvalued, creating contractionary effects in the economy that persisted until the overvaluations ended. Krugman mentions a 1971 episode, but dollar (and sterling) overvaluation was persistent throughout the Sixties. There was also the second half of the Twenties. Most of the world suffered through a recession and banking panics in 1930 following the US stock market crash, but recovered pretty quickly. The US, on the other hand, entered the Great Depression and didn’t really do anything good to start fixing things until the dollar was devalued by 40% during 1933 and early 1934.

Something really quite different is going on now, however, and it’s unclear exactly what it means.

Trade imbalances historically have been impossible to sustain over time because they tended to have large, visible effects. The US dollar by some measures flipped from the undervaluation of 1934 to overvaluation by 1959 or so. At that point, it made sense for other countries to sell their dollars back to us in return for gold, which they did until we had next to no gold left. At that point, Nixon ended dollar-gold convertibility. The imbalance was literally unsustainable. Trade imbalances tended to self-correct.

Now the Chinese are the ones who are creating the imbalance by undervaluing their money relative to both the dollar and the euro. (Their surplus against the Europeans is almost as large as the one they run against us.) But money isn’t gold anymore. You can create more of it just by tapping a computer keyboard. So there’s nearly no friction preventing China from accumulating surpluses at levels that no one has ever seen before. I’ve always considered this the primary reason why we had a housing bubble and are now having bubbles in US Treasury debt and probably the stock market too.

Krugman is absolutely right when he says that it’s no threat for the Chinese to talk of selling off their dollar reserves. Ben Bernanke said in no uncertain terms when they first started rattling that saber back in 2007 that he was ready to buy back all their paper. And there’s no doubt that he can do that. And he can soak up the inflation too, by selling away other assets.

But what happens if we put a huge import tariff on them? I’m still trying to figure that out. I guess the theory would have to be that if we suddenly make Chinese imports far more expensive, that somehow American manufacturers will step up, build a whole batch of new factories with unionized labor forces, and start making all the crap we can’t afford to buy from the Chinese.

Five years ago, the US private sector was still leveraging up, and our current account deficit was about $500 bn. Now we’re running fiscal deficits three times that large and will keep doing so, even as the private sector continues to leverage down.

It has to come back to efficiency. The government is manic about making rules, following rules, and documenting all their rule-following. They just seem unable to do anything without spending five times as much money as private actors spend to do the same thing. That’s at least theoretically acceptable in case of the things govt must do, like maintain a national defense establishment.

But now our govt’s policy is to do by itself all kinds of things that the private sector can do. Building automobiles was last year’s thing. This year, we’re taking over student loans. And then there’s still healthcare, the energy industry, and the least sensical govt monopoly of all, education.

So if we’re paying govt prices for more and more of the things we should be doing ourselves, there’s no way to avoid getting poorer and poorer over time. We’re living like a person without a job who goes to expensive restaurants every night when she should be buying macaroni and cheese, and then compounds the mistake by putting it all on her credit card.

Chris Dodd is proposing standing up a new consumer protection agency to keep “predatory” bankers from lending money to consumers who shouldn’t be borrowing in the first place. Implicitly Dodd is saying that consumers aren’t smart enough to know when they’re living beyond their means. What we really need is a government protection agency, to prevent predatory bond market investors from lending to the US government.

Follow Francis Cianfrocca on Twitter.

So we have the Chinese that have roughly a $30 billion per month current account surplus against us. (Never mind how remarkable it is that this number is about 3% of GDP.) That surplus has to find its way into US assets somehow. That accounts for perhaps a third of the bid for Treasury debt that represents new issuance rather than rolls of existing debt.

The new issuance amounts to something like a trillion and a half dollars a year. That’s the real amount of the federal budget deficit, shorn of the various bullshit stories that the president tells to make it sounds a little better than it is. This is the amount that is added to our public debt, which needs to be financed permanently (at unpredictable interest rates) or get paid off someday.

That trillion-plus dollars also represents spending in the overall economy. You can’t deny that it’s pumping up nominal GDP. You can very well deny (and I do) that it represents money well-spent or efficiently spent, on goods and services that actually improve people’s lives or (God help me, but this sounds old-fashioned) reflect people’s free choice as to what they want to spend money on.

But where’s all that money coming from? Who are the investors that are willingly and freely lending a trillion-plus brand-new dollars to the US govt this year?

A lot of the money is coming from US banks. They get funds from the Federal Reserve in the form of overnight reserves, and then turn around and lend the money to the US Treasury by buying bills, notes and bonds. You can make a significant amount of money without taking any risk doing this, which means it’s a very efficient use of bank capital, which in turn makes it very profitable.

This is a traditional way of getting the banking system healthy again after recessions, and it’s also one reason why investors have been bidding up the stock prices of too-big-to-fail banks lately. It’s going to take a lot longer than usual this time because the capital losses were unusually large, but it’ll still work.

In the meantime, though, the Federal government has a ready source of funding for fiscal deficits. The Chinese are only supplying a relatively small piece of the new money we have to borrow every month. They only have to buy as much as their surplus amounts to. Under the previous Administration, when deficits were never bigger than a third of what they are now, the Chinese in some years couldn’t buy enough Treasury paper to meet their needs (that’s one reason why the yield curve inverted at mid-decade). Now, they’ll never have any trouble. But again, they’re nowhere near the whole amount.

The ultimate source of the money funding a very large part of the budget deficit is the Federal Reserve itself. The steep yield curve is making high deficits possible.

This would be entirely defensible and probably sustainable IF high deficit spending was intended solely as a temporary measure to get us out of recession. That indeed was the rationale for the $800 billion stimulus package we got a year ago.

But now the economy is out of recession, and we’re STILL projecting trillion-plus deficits for the rest of the decade. We’re mainlining on low-cost borrowings from the Fed to fund this spending, which isn’t countercyclical at all. Instead, it’s going to be about expanded entitlement spending, and (presumably) brand-new spending on health insurance, anti-carbon energy policy, and education subsidies.

At some point, the yield curve won’t be able to keep funding those deficits. Bank balance sheets will become healthy enough to start funding riskier (and thus more profitable) lending. When that happens in normal recoveries, there’s no problem because fiscal spending winds down as, by definition, it’s not needed anymore.

But this government is now addicted to cheap borrowing. We’re either going to have a nasty cold-turkey event in the medium-term, or else we’ll never get out of this low-growth period. Either outcome is possible.

Follow Francis Cianfrocca on Twitter.

It’s time for your weekly dose of Coffee and Markets, featuring The New Ledger’s Francis Cianfrocca, a podcast brought to you by the fine folks at Andrew Breitbart’s BigGovernment.com and LibertyPundits.com, your home for conservative podcasts. In this week’s edition, we’ll talk about the fallout from a failed attempt by Senators Dodd and Corker to make new financial regulations bipartisan, the latest activity on the bond markets, and what’s next for Obamacare.

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You can subscribe to the podcast by following the links above, and if you’d like to email us, you can do so at coffee[at]newledger.com. We hope you enjoy the show.

Related Links:

TNL: Obamacare’s Two Americas
Frum: Will Health Reform Cause the Next Bailout?
The Hill: No Votes on HCR Pile Up
HCN: Democrats Consider Drastic Moves to Pass Health Care Bill
T-Shirt: Lobby the Rahm Emanuel Way

Here’s the worst thing you probably haven’t heard about President Barack Obama’s health care plan, which he and his allies are about to force through the Congress despite enormous opposition from the American people: it makes everything onetime vice presidential nominee John Edwards once said about the class divide of “two Americas” come true.

The dirty little secret of this plan—which wouldn’t be a secret if opponents of this legislative package weren’t distracted by a dozen other wrongheaded policies in it—is that it will bring a major and irreversible upheaval to America’s labor markets. In a time of economic tension, this plan will displace millions of workers and push more people into becoming contract employees, resulting in increased instability for working families.

One of the many original stated goals of the White House’s health care reforms was the promise that you can keep your health plan if you like it. However, the White House wanted to give businesses much-needed relief from burdensome health costs. Like the desire to create a new entitlement while reducing the budget deficit, these aims are nearly impossible to reconcile, so Obama chose a path that accomplishes neither.

The president’s plan penalizes an employer for not providing insurance, but the government will subsidize the health care of workers without employer-provided insurance. This effectively allows workers to receive the same compensation package they get today, but with government footing the health-benefits part of the bill, so employers have no need to make up the difference in cash.

The economic benefits of that subsidy far outweigh the penalties—for low income workers, it can result in an enormous difference of over $17,000 per year.

It’s obvious what will happen under this plan: it will not make economic sense for any small business which employs lower-income workers to offer health insurance. And any small business which does so will almost certainly fail, burdened by higher costs than their competitors.

This dilemma could be solved by making the penalties more draconian, but that too would cause business failures, and as with the individual insurance mandate, too steep a penalty would make the plan even more coercive and unpopular.

As John Goodman of the nonpartisan National Center for Policy Analysis recently described it, “High-paid workers with employer-paid insurance will cluster in some firms, while average- and below-average-wage workers will cluster in others. Overall, ObamaCare will create irresistible economic pressure to restructure the entire labor market.”

The only likely outcome of this plan will be for companies to drop coverage entirely. Younger, lower-income workers will be eligible for a subsidy and forced into the health exchanges. That will compel them to do something that doesn’t make economic sense. Most young workers don’t use health care much—unless you give them an incentive to over-consume care by paying for it up front for them.

There’s a final step here, though, that’s critical to understand: once those younger and lower-income workers are forced into a system that eliminates rational decision-making, they are made beholden to these taxpayer funded subsidies, and face massive penalties if their income rises such that they lose the subsidies. The marginal tax penalty for an individual moving up from to $40,000 a year to $45,000 is massive, as also for families earning $95,000 versus $90,000, creating an artificial cliff that dramatically penalizes success.

Thus a new picture of Obamacare emerges: it will force people to pay for what they don’t want and purchase what they don’t need, in a massive expansion of the size and power of government. The entire proposal functions not as a method of improving care or lowering premiums but as a massive regressive tax falling disproportionately on the young and those on the lower end of the income scale. And once in place, it will trap its supposed beneficiaries in ways that cannot be undone.

Combine this regressive tax with a massive increase in spending via a government entitlement which will only grow, and you have a recipe for long-term economic stagnation and the permanent enshrinement of two Americas into our national social policy.

Ben Domenech is editor of The New Ledger and managing editor of Health Care News.

The Israeli press must have been happy to wake up this morning. While the arrival of American Vice President Joe Biden in Israel was an event, no one expected much more from it than the usual exhortations of goodwill and a few gestures toward reviving the peace process. Yesterday’s announcement by the interior ministry that it has approved the building of 1,600 new housing units in Ramat Shlomo, a religious neighborhood in East Jerusalem, however, handed our hapless press corps nothing less than a full-blown diplomatic incident.

The circumstances under which the plans were approved and announced remain unclear, with both Prime Minister Benjamin Netanyahu and Interior Minister Eli Yishai claiming that it took place without their knowledge and professing their embarrassment over the timing of the announcement. According to Haaretz, Yishai professed on Israeli radio that “The district committees approve plans weekly without informing me,” and “If I’d have known, I would have postponed the authorization by a week or two since we had no intention of provoking anyone.”

The report goes on to say,

Netanyahu told Biden during their meeting in Jerusalem earlier in the day that he had had no prior knowledge of the decision to authorize the additional construction, and added that the program had been drafted three years ago and only received initial authorization that day. It could take several months, Netanyahu assured him, before the program is granted final approval.

It is true that the Netanyahu government has been quite explicit about not including Jerusalem in its voluntarily settlement freeze, and that the plans in question have been given only technical approval and may never actually be put into effect. Given the labyrinthine nature of Israeli government bureaucracy, moreover, it is at least plausible that both men were genuinely ignorant of what their own subordinates were doing. Nonetheless, the Obama administration, currently struggling at home, is attempting to salvage its reputation in the Middle East by restarting negotiations and Ramat Shlomo is over the Green Line in the East Jerusalem the Palestinians claim as their future capital. As anyone could have predicted, the Palestinians are now up in arms, negotiations may be once again in jeopardy, and there is no doubt that, as a result, Biden is extremely displeased.  Indeed, according to Haaretz, the vice president responded to the announcement by issuing a written statement that read, in part, “I condemn the decision by the government of Israel to advance planning for new housing units…. The substance and timing of the announcement, particularly with the launching of proximity talks, is precisely the kind of step that undermines the trust we need right now.” This is the rough diplomatic equivalent of a shrieking fit of rage.

Given Netanyahu’s preference for appearing stable, statesmanlike, and in control, not to mention his own enormous personal investment in the special relationship with the United States, none of this can be particularly encouraging. A man who has built much of his career on image and on controlling that image, Netanyahu now looks weak, feckless, and barely in control of his own government. Ben Caspit, a columnist for the Hebrew daily Maariv, summed up the situation in scathing terms that have, unfortunately, yet to appear in English. In my own crude translation, Caspit states in part that Biden “arrived here in order to try and rebuild the chemistry between the White House and Jerusalem, to dispel suspicions, to create some kind of relationship, maybe a new beginning. And what happened? Within a quarter of an hour, we lost him too.” Employing two extremely derogatory Yiddish terms, he concludes, “The shlemiel is the one who dumps hot soup over the shlemazel. Benjamin Netanyahu is both.”

Caspit’s rhetoric may be – in the finest tradition of the Israeli media – unduly harsh, but there is no doubt that Netanyahu has some damage control to undertake. The question that immediately springs to mind, however, is how did such a diplomatic debacle occur? If the announcement and its timing were, in fact, intentional, a handful of possible scenarios immediately suggest themselves. They are, of course, speculative, but in the wasp’s nest that is Israeli politics, they are not entirely out of the question.

If Interior Minister Eli Yishai was aware of the announcement and Netanyahu was not, as Caspit himself hints, then one must keep in mind that Yishai is not from Netanyahu’s Likud party, but rather the religious Shas party. Yishai does not answer to Netanyahu, but to his party’s “spiritual leader,” an elderly and easily irritated rabbi named Ovadia Yosef. Historically speaking, Shas has tended to play the role of power broker in various coalitions, and it is not impossible that Yosef, Yishai, or both decided to take this opportunity to remind Netanyahu that Shas remains a powerful independent member of the coalition that is more than ready to play the spoiler should the need arise. Moreover, while Shas tends to be more dovish than some of the other religious parties, they were less than thrilled with the settlement freeze and the Obama administration in general, and may have decided to take it upon themselves to remind the Americans of who actually controls Jerusalem; something with which, ironically, Netanyahu may not be entirely unhappy.

It is also possible, of course, that Netanyahu was himself aware of the announcement and its timing, and allowed it to go forward. While this seems unlikely, given his need for US approval of a possible military strike on the Iranian nuclear program, it is at least plausible for two reasons: First, it would signal to Netanyahu’s right wing coalition partners that he will not bow to American pressure to make unacceptable concessions – particularly in regard to Jerusalem – and that he is willing to absorb considerable political damage as a result.

Second, it would play into what may be Netanyahu’s long term strategy in regard to the Obama administration. He may be convinced (as many Israelis are) that Obama is at best indifferent and at worst hostile to Israel’s interests, and that any serious resumption of the peace process at Obama’s hands can only be to Israel’s disadvantage. As a result, Netanyahu’s plan may be to simply wait Obama out. Aware of the fact that American public opinion is still overwhelmingly pro-Israel and equally aware of Obama’s growing domestic unpopularity, Netanyahu could simply be playing out the clock until the midterm American elections in November, expecting – not unreasonably – that the Democrats will be handed a major defeat and a far weaker and more pliant Obama administration will be the result.

If this is the case, then Netanyahu’s tactics would be well within the Israeli political tradition. Israel’s first prime minister, David Ben-Gurion, for example, tended to feign illness in order to stave off meetings at which uncomfortable demands would be made. While he has done nothing so crude, Netanyahu may nonetheless have succeeded in staving off the possibility of painful negotiations – and possible concessions – at relatively low political cost and, in terms of his coalition, possible political advantage.

All this being said, the most likely scenario is indeed the most obvious: that this incident is the result of bureaucratic mismanagement and extremely bad timing. Even if this is the case, however, the long term advantages Netanyahu may gain in the face of a short term debacle are still real. Any good politician has to be able to turn crisis into opportunity when the need arises, and for better or worse, Netanyahu is an excellent politician.

Benjamin Kerstein is Senior Writer for The New Ledger.

In March of last year, I posed the admittedly radical question: is there anything worth saving in Detroit? Wouldn’t the city where sirens never sleep be better off if we just burned it to the ground and started afresh? Dubbing it “urban policy chemo,” I got some significant pushback from some corners of the internet.

The best help to Michigan’s economic woes might come from razing much of the Motor City… This is beyond broken windows theories — we’re talking about broken houses, buildings, skyscrapers; an entire broken community, economy and polity.

Now, the Mayor of Detroit himself has come around to my view — and the views of professional urban policy experts. The city, facing $300 million in deficits and an unemployment rate approaching 50%, can no longer afford to patrol the husks of the city. His plan: bulldoze roughly a quarter of the buildings.

“Things that were unthinkable are now becoming thinkable,” said James W. Hughes, dean of the School of Planning and Public Policy at Rutgers University, who is among the urban experts watching the experiment with interest. “There is now a realization that past glories are never going to be recaptured. Some people probably don’t accept that, but that is the reality.”

I have to applaud Mayor Dave Bing, son of Northeast Washington, for making this decision, which has to cost some significant political capital and destroyed any illusions about an easy path to revitalization. But the point is, spending less than $30 million in federal funds to tear things down and start afresh is the only way to have any hope of a comeback. One-third of Detroit’s lots are vacant anyway.

Here’s what I wrote back in March:

Razing these former houses and condemned businesses — now transformed into tinderboxes for arson, crime, and urban decay — until you achieve critical mass would end the problem of oversupply and the roughly one-third overvaluation of homes. Demolition crews would provide jobs at least for the short term.

If we don’t do it ourselves, the societal ramifications for these communities could well effect a far more terrible result, as do-it-yourself arsonists have been doing in Detroit for years. Taxpayer funds for Detroit is just a band-aid on cancer: it won’t change the endpoint for the city, and buy delaying the fundamental change that needs to occur, it will only make things worse in the long run.

Now, it’s a bit more complex than all that. Despite the hyperbole of my question, there are things worth saving in downtown Detroit, and opportunities for development in the near future. Don’t be fooled by lazy journalists who love pictures of abandoned stuff. But clearing out a sizable portion of the deadwood will help make those properties worth saving more attractive to outside investment. It’s generally better to have a park next door than a crumbling building.

I’ll be curious to see what innovators like Aaron Renn think about this.

Follow Ben Domenech on Twitter.

The leaders of Germany, France, and Greece have all come out now to blame Greece’s (and the euro’s) troubles on speculation in credit-default swaps. Picturesquely, the Greeks say that a CDS is an insurance policy purchased by an arsonist on the house he intends to torch.

Looked at from the investor’s point of view, a CDS is what adds liquidity to the asset that gets created when he lends money to build the house. The house doesn’t get burned down by the guy who lent the money to build it. It burns down when the people who live in it smoke in bed. This whole story is a smoke [sic] screen to keep the Greeks from getting blamed for running budget deficits four times higher than eurozone rules allow, and then lying to cover that up.

But is there a larger issue here? What happens if we restrict the use of CDS?

Think of the practical difference between stocks and bonds. Most people have an expectation of liquidity in stocks (and in things like bank deposits). Liquidity means you can buy or sell an instrument, in size, on short notice, without significantly moving the market.

All else equal, a liquid asset is more attractive to own than an illiquid one, and accordingly priced somewhat higher. To see why, imagine that your bank allowed you to write checks only two days out of each month, effectively converting your checking deposits to time deposits. You’d demand that the bank pay you interest on the deposits. Time deposits have a lower value (reflected in the cost of the interest you demand) because they’re less liquid.

Stocks on publicly-traded companies are generally very liquid, at least in the block sizes traded by retail investors, because there’s an active secondary market for them. This adds to their value.

Bonds have *never* had this kind of liquidity (except for on-the-run Treasury debt). If you buy a corporate bond, no matter what kind of investor you are, you’ve traditionally done so in the expectation that you’d hold the bond until maturity. If that was a long time (say, 30 years, or 100 years for French railway bonds, or forever for British consols), then you would demand a very high rate of interest to compensate you for everything that go wrong in that time.

The credit-default swap is an instrument that overcomes the illiquidity of fixed-income assets. For the first time in history, it’s possible to buy and sell the credit risk of a note or bond. This makes it possible for more people to own them, and for their owners to be able to realize their value in a much shorter time frame when needed. It also (and this is the problem the Greeks have) makes it possible for people to reduce their exposure to debt if the issuer proves over time that he’s less creditworthy than you thought he was.

Because you can’t easily buy and sell most debt instruments, a CDS gives you an easy way to buy and sell their credit risk, which is a major component of their value. It’s almost as good. And because the CDS in effect makes debt more liquid, *it increases its value and generally reduces the interest rate.* That’s the key point, and that’s what we lose if we give up on the CDS, which is only one of a whole range of recent technical innovations intended to make more investor capital available to more users.

Stock markets have generally been more liquid than bond markets, which is a big reason why they suffer crashes and volatility. (In fact, economists have concluded many times that volatility in stocks partially offsets the value that comes from their higher liquidity. Now that’s some wicked math, if you ever want something to break your brain on.) Bond markets have historically been a lot more stable. When Marilyn Monroe said that “gentlemen prefer blondes,” she was playing on a much older phrase: “gentlemen prefer bonds.”

And the lower liquidity is one reason for the greater stability. Now, with CDS, bond markets can be nearly as liquid as stock markets. That’s why they’re more volatile and prone to unjustified large price swings and crashes. It’s also why countries like Greece, which has no business borrowing large amounts of money, can do so at rates once reserved for disciplined borrowers like Germany.

There are pluses and minuses to severely restricting CDS usage (or at least to requiring they be standardized, as option contracts have been). Let’s recognize that the whole world will pay a lot more for capital if we do. Especially since the basic fiscal policy of the US is to borrow heavily because borrowing is politically cheaper than raising taxes or cutting spending.

There’s nothing that’s more real than credit risk. Let’s say I lend you a dollar in full recognition of the risk that you may not pay me back. I can certainly quantify that risk, and it serves to discount the value of the asset I own, which is nothing more than your promise to pay me a nominal dollar on a future date certain. (Together with whatever interim interest payments we’ve negotiated.)

Standard practice for centuries has been to discount risk in this way. If you’re a borrower without credit risk, like the US govt, I’ll lend you 100 cents to get back 100 cents. If you’re a triple-A corporate credit (of which, if memory serves, there are a grand total of FIVE), then I might lend you 98.5 cents in order to get back 100, plus the interest. If you’re less creditworthy, then I might only lend you 85 cents against your promise to pay me 100 plus interest. And so it goes.

If I have no choice but to stick with you until the note matures, then you and I are married in a fundamental business sense. I might be able to convince a bank to lend me money against your note, but of course they will discount your note more heavily than I did, and they’ll also discount ME and charge interest. That’s a standard way to obtain finance, but still I’m married to you for the duration of your note. Sorry, till your note matures. Duration means something different in bond-land.

But I can measure your credit risk, by a variety of means, many of them subjective. What if you default to someone else on a note just like mine? That’s an obvious one. But what if your boss starts to whisper that times are a little tough, and you should only count on a 4% raise this rather instead of 5%. Do you see how that affects the likelihood that you’ll pay me back on time?

If I can withstand your credit risk for the whole term of the note, fine. But I lose the flexibility to change my mind. If you buy a stock, you have that flexibility because you can choose to sell on a moment’s notice, also based on subjective factors. Being able to trade credit risk isn’t any less real or valuable.

It’s one thing to have this conversation as individuals. But what if I were a public pension fund? I lend you money so I can use your interest payments to pay my retirees every month. Can you see that, if there’s even the slightest risk that you might not pay off, that I can’t even lend you the money in the first place? And if your circumstances change during the term of the note, my retirees are totally exposed. I wouldn’t even consider lending money to anyone who looks anything like you, and in fact it would probably be illegal or counter to my charter to do so.

The availability of a CDS changes all of that. The CDS turns the credit risk of billions of little notes into a large liquid thing that can be traded and moved around. This fact by itself isn’t the problem. The problem is that there is a totality of risk around the world, whether it’s liquid or not, and we don’t have perfect tools for measuring it or even for detecting it all. A properly regulated CDS market might in fact make the financial system MORE stable by making total systemic risk more transparent, something that has never been possible before.

The bottom line question is: how much credit are we willing to have in the world? Most of Wall Street’s rocket science is aimed at squeezing more credit out of the same amount of capital.

It’s very, very clear that we overshot. We created more credit than we should have, in large part because the math we used underpredicted total risk. (Well, it actually underpredicted the incidence of long-tail events.) As I’ve been saying since mid-2007, the world suddenly saw that problem and immediately overcorrected for it. If you recall, from late 2007 until Sept 08, the term we used was “credit crunch,” rather than “economic crisis.” That’s why it was plain to me that major economic weakness was ahead, even as we were having record highs on the stock market and up-5% quarters on GDP.

Governments softened the blow by essentially converting all that private credit to public credit, which is risk-free. So we haven’t fundamentally solved the problem of determining exactly how much credit you can safely create from a given amount of capital, and (what is mathematically far harder) how to plot that optimal credit quantity against time. While the past 20 years have been about running that calculation overconfidently, the next 20 will be about doing so underconfidently. I hope you can see that this is all orthogonal to specific pieces of technology like CDS.

I would argue that, because it’s impossible to predict the timing or severity of long-tail events, there is a proper role for a govt authority in providing a backstop to the system, ASSUMING a more correct distribution of total risk across the timeline. That more or less happened in late 2008, which is why I was immediately in support of TARP and never questioned it for a second. What has happened since then is that we’ve elected a govt that takes a far more expansive view of their proper role, and that’s screwing up everything.

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The latest issue of New York magazine has an extended profile of the Cheney family by Joe Hagan, which is worth reading in its entirety. It’s notable both for its evenhanded tone — there are a few tacked on asides, and suggestions of political mythmaking, but it’s otherwise devoid of the normal ridiculous tone which infects so many Cheney profiles — and its forward looking outlook, focused primarily on the vice president’s daughter. Cheney’s history has been written and written again — the Washington Post series, the essays, the books — and it’s refreshing to read a slightly different take on the man.

The aging political warrior, who many expected to fade into the shadows when he left office, gives no sign of going quickly or quietly. Despite his numerous heart problems, despite the continued attacks on his tenure, and despite his politically divisive nature, it appears that Cheney is going to have a significant role to play in shaping the Republican Party of the future.

What’s surprising to consider, less than two years removed from the end of George W. Bush’s presidency, is that Cheney may well be the only person to emerge from the Bush administration who has that power.

The amount of policy influence wielded by some former Bush administration officials on current debates is still significant, but in political terms, nearly all of Bush’s clan is on the outs. Insulated from the populist surge of the last few years, and tainted by poor decisions, W’s political team has very little to do with the direction of the GOP. Consider the total rejection of the Bush clan’s approach in their own state of Texas just last week — Kay Bailey Hutchison had gained near-total endorsements from ex-Bushies — prompting one prominent GOP consultant to suggest to me that “I think Karl [Rove] is just completely out of touch with what’s happening on the ground.”

A few years ago, a statement like that would’ve been laughed out of the room. Today, it’s an open question.

Cheney, though, is the exception to this rule. The White House’s decision to elevate him as an opponent last year was profoundly unwise, and his direct confrontation of President Obama plays well to the CPAC crowd. He’s adopted a public approach that he was unable to under the hesitant communication policies of Bush, and bears more than a passing resemblance to Winston Churchill’s wilderness years — one can easily see Cheney on Meet the Press today, glowering at the camera, intoning: “You were given the choice between war and dishonor. You chose dishonor, and you will have war.”

Newt Gingrich summarized Cheney’s argument succinctly in a speech last year: “The reason we have Guantanamo Bay is that we have people there who want to kill us. They are called terrorists. It’s good not to have terrorists anywhere near us because it makes it harder for them to kill us.” That’s a message in sync with the majority of the American people — by 3-to-1 odds according to some polling — and thanks in part to Obama’s poor rollout of his decisions, and the ludicrous security risk of conducting a civilian trial of Khalid Sheikh Mohammed in New York, Cheney’s already won his first political victory. And Obama’s supporters know it: as Jonathan Alter wrote yesterday, “this is a complete cave and it makes everyone involved look craven.”

The anger Cheney brings out of the left — and, frankly, the middle — glosses over a few facts worth noting. If I have one complaint with the New York magazine piece, it’s that it still casts Cheney as a “hard-right conservative.” Yet by nearly any measure, Cheney himself is a socially liberal and fiscally moderate Republican — he is and was to Bush’s left on abortion policy and same-sex marriage, and his record of endorsements is entirely moderate and establishment candidates (including KBH). His hard-right credentials are confined only to the arenas of national security and foreign policy.

Liberal commentators who jokingly suggest Cheney is building the basis for a 2012 campaign ignore the truth that, even removing health from the equation, Cheney himself would never survive a national Republican Primary. He is popular today among conservatives because he is advancing a winning argument, and because many on the right, still angry at John McCain’s non-confrontational campaign, enjoy seeing Obama confronted by a serious man wielding a rhetorical sledgehammer. Cheney’s surprise appearance at CPAC this year had a point to it: even though Ron Paul won a plurality of votes in the event’s minor straw poll, as long as the former vice president gets that kind of reaction from the base, it’s a sign that the party base will reject any attempt to regain majority status by appealing to the antiwar libertarian’s active supporters.

The question going forward is whether Cheney’s daughter, Liz — who this piece describes as a possible candidate for the Virginia Senate seat currently held by Jim Webb (George Allen and Ed Gillespie are two other mentioned possibilities, but Allen’s got a challenging road, and it is hard to see any basis for the election of Gillespie) — is cut from her father’s cloth. The profile paints her as a staunch defender of her father’s views, and she’s clearly a capable and blunt advocate on television, but it remains to be seen whether she can be a less divisive politician than her father, building and uniting a coalition as one of the voices of the new GOP. With her father’s connections and a good deal of natural media savvy, she’ll have every opportunity to do so.

As for the pater familias, Cheney will continue to do what he does: argue, insist, and infuriate. He is very good at this.

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Before a single town hall, debate, primary or caucus, Mitt Romney’s blown his chances for the presidency in 2012. What the 2008 also-ran had to say today on Fox News Sunday was the same thing I and others have witnessed him say a half dozen times over the past few months behind closed doors — a stubborn refusal to admit any similarity between President Obama’s national health care plan and his own disastrous solution in Massachusetts.

Here’s one quote:

There’s a big difference between what we did and what President Obama is doing. What we did, I think, is the ultimate conservative plan. We said people have to take responsibility for getting insurance, if they can afford it, or paying their own way. No more free-riders. And we solved this at the state level, not a federal plan, but a state plan.

James Pethokoukis, who blogs over at Reuters, had an interesting post the other day about Romney’s TARP problem — essentially arguing that Romney’s weak explanations for his continued support of TARP will function as a “scarlet T” for conservatives in the 2012 primaries. [Note: Both I and Francis have argued on Coffee & Markets that a vote for TARP is not only forgiveable, but justified. More than one conservative voted for TARP, and I think they can defend that vote today. Support for the auto bailouts and the stimulus package, however, are both completely unjustified.] But the blowback that will come for Romney’s support for TARP pales in comparison both to the stubborn silliness of his defense for the Massachusetts plan, and for his inability to recognize the opportunity this moment presented.

First, a simple statement of fact: the similarities between the current plan pending on Capitol Hill and what was proposed in Massachusetts’ Commonwealth Care approach are great indeed. The Boston Herald’s Michael Graham has even referred to it as “Obamacare: The Beta Version.” As Phil Klein has detailed on more than one occasion, there is very little daylight here:

For one thing, while the Romney camp would like to argue that the bill he signed did not raise taxes, in actuality, it did include a mandate that individuals purchase insurance or pay a penalty. In arguing against Obamacare, conservatives have described the mandate as a middle class tax hike. Republican candidates will spend all of 2010 describing it as such, and if anybody else were running against Obama in 2012, it would be used to argue that he violated his pledge to not raise the taxes of those making under $250,000. If Romney wants to spend the Republican presidential primary siding with Democrats and the Obama administration in arguing that the individual mandate isn’t a tax, I’m sure his opponents will be thrilled.

The CATO Institute put together a fairly definitive study outlining the poor outcomes of the Commonwealth Care plan, and Jeff Emanuel detailed the failings in cost and access on TNL last year in stark terms:

Far from reducing the cost of health insurance, Massachusetts’s individual mandate has driven costs up at twice the average national rate. This was entirely predictable; after all, what can possibly reduce downward pressure on a price more effectively than a legal requirement to purchase it, whatever the cost? According to the Connector, the least expensive price for an insurance policy for a 50 year old non-smoker in 2008 was $3,599 a year ($299.94 per month), with a $2,000 deductible. Next door in Connecticut, that price was just $1,468 a year ($122.36 per month, with a $2,500 deductible) – and Connecticut hadn’t even spent $1.3 billion on controlling and engineering their state’s health care marketplace!

This has had political ramifications, too — Soren Dayton and Mark Hemingway have both argued that one reason Massachusetts voters supported Scott Brown in his surprising upset were their negative experiences with Romney’s plan.

What should be most frustrating to Romney’s more intelligent supporters is that he missed a strategic opportunity to become the strongest voice against Obama’s plan, in a way that could’ve set him up as a defender of pro-market, pro-small business solutions. Romney could easily have given speeches along the lines of:

“Look, I did the best I could in Massachusetts, I tried a coverage plan along these models, and just look what happened. Higher taxes, higher costs, lower access, and only a marginal decrease in the uninsured. And that was the best plan we could get! This model didn’t work in my state, and it won’t work nationally. I’ve learned from my mistake, and President Obama should, too.”

Romney’s got a new book out, which I haven’t read yet but which Ron Brownstein suggests indicates he can’t decide between a reasonable campaign and an angry one (if you can’t do populist, do angry). From most reports, Romney has not yet decided how he’ll run in 2012 — though signs point to a more honest, pragmatic, pro-business approach than his attempt in 2008 to be all things to all right-wingers.

It’s early, of course — who knows who’ll even run — but even with a presumed advantage in money, name identification, and organization, when you consider Romney’s association with big business and Wall Street, his inability to connect with common people, and his refusal to reject his mistaken health care plan, it’s hard to see how he’ll navigate the primaries when he is sure to have stronger candidates to fend off than John McCain and Mike Huckabee. And if I recall, even with a massive lead in money, organization and endorsements, he couldn’t beat them, either.

Computers are new, and so are capital asset pricing models. But the basic tools of finance and capitalism that underlie how business gets done have been with us, essentially unchanged, for a long time. Our bond/capital/money markets are modern developments of very old ideas. The word “bank” comes from the Italian for the tables set up by Venetian proto-financiers in public places. Short-term repo was invented in the Middle Ages.

The tulip-bulb bubble in 17th century Holland developed in illiquid put and call options. (No one knew how to accurately price these until the late 1960s, but they were in use for centuries. The standard rule was that at-the-money, they were worth something like 3%, as good a guess as any.)

And Marcus Goldman started his powerhouse investment bank by walking the streets of 19th century Manhattan, factoring materials purchases for tailors and bagelmakers, literally carrying around pieces of what became known as “commercial paper” in his hat.

What’s different today that makes these financial structures somewhat ill-adapted? Inflation.

According to several recent studies, all known hyperinflations occurred in the 20th century, with one exception (which came during the Reign of Terror). And even without hyperinflation, money-supply expansion has been steady and continuous throughout the 20th C. It was relatively static for centuries before.

What made me think of this was how destructive the current policy response to the housing bubble is. The bubble has only deflated part-way, maybe half of what it should. The government is so terrified of foreclosures that they’ve pursued, and will shortly accelerate, a policy of keeping homeowners in their homes, no matter what happens.

Why would we do this? To avoid the deflation of the Thirties, which was triggered by widespread defaults leading to a chain reaction of capital destruction. Twelve months ago, this was generally considered among the less-likely but not out-of-the-question outcomes.

That’s because money is lent on a nominal basis, not adjusted for inflation, and always has been. When inflationary overpressure tries to correct, it leaves vast wreckage among all the private actors who have contracts in force at overvaluation. For every foreclosed homeowner, there’s a bank that’s going to take a nasty hit to capital. This is baked into the procedures we use to finance economic activity.

So the government is madly, vainly, trying to keep home prices high by inhibiting foreclosures, and mortgage prices high by having the Fed and Fannie/Freddie continue supporting them. This is part of why our economy will have a tepid, jobless recovery. And that’s the *best* case.

I promise, I’m not turning into a hard-money Ron Paulite. But I do think some form of hard money is going to creep into international dealings. That’s more or less the subtext when the Chinese ruminate about finding a new reserve currency to supplement dollars. The US economy needs to adjust to its lower secular levels of productivity, as we swing from wealth creation to wealth consumption. Simultaneously, living standards in other countries will need to rise relative to ours.

The world will need some robust channels for transmitting these signals so the needed changes can happen nondisruptively. We’re not there yet.

We have occasion to comment on some strange written offerings from Paul Krugman. Yeah, I know, “dog bites man.” Nevertheless, some discussion is in order.

First off, let’s take a look at Krugman’s latest editorial, which contains the following:

Take the question of helping the unemployed in the middle of a deep slump. What Democrats believe is what textbook economics says: that when the economy is deeply depressed, extending unemployment benefits not only helps those in need, it also reduces unemployment. That’s because the economy’s problem right now is lack of sufficient demand, and cash-strapped unemployed workers are likely to spend their benefits. In fact, the Congressional Budget Office says that aid to the unemployed is one of the most effective forms of economic stimulus, as measured by jobs created per dollar of outlay.

But that’s not how Republicans see it. Here’s what Senator Jon Kyl of Arizona, the second-ranking Republican in the Senate, had to say when defending Mr. Bunning’s position (although not joining his blockade): unemployment relief “doesn’t create new jobs. In fact, if anything, continuing to pay people unemployment compensation is a disincentive for them to seek new work.”

In Mr. Kyl’s view, then, what we really need to worry about right now — with more than five unemployed workers for every job opening, and long-term unemployment at its highest level since the Great Depression — is whether we’re reducing the incentive of the unemployed to find jobs. To me, that’s a bizarre point of view — but then, I don’t live in Mr. Kyl’s universe.

Now see, this is just bizarre, because it would appear that Krugman forgot his own writings on the subject. Lucky for him, James Taranto was kind enough to remind Krugman what he–and Krugman’s wife, Robin Wells–wrote on the issue of unemployment benefits:

Public policy designed to help workers who lose their jobs can lead to structural unemployment as an unintended side effect. . . . In other countries, particularly in Europe, benefits are more generous and last longer. The drawback to this generosity is that it reduces a worker’s incentive to quickly find a new job. Generous unemployment benefits in some European countries are widely believed to be one of the main causes of “Eurosclerosis,” the persistent high unemployment that affects a number of European countries.

So . . . um . . . isn’t this precisely what Kyl said? And by denouncing him for the comment, didn’t Krugman effectively repudiate his own work–along with that of his wife–on the issue of unemployment benefits?

But this isn’t the only recent weird entry in Krugman’s oeuvre. Just a couple of days ago, Krugman ridiculed the notion that because of the economic innovations that Milton Friedman and like-minded economists urged Chile to adopt, the country because rich enough to augment its living standards, and with it, its building codes, thus preventing the recent devastating earthquake in Chile from inflicting even more damage. One of Krugman’s counters to this argument is the following:

As a number of people have pointed out, there’s this little matter of building codes. Friedman wasn’t exactly fond of such codes — see this interview in which he calls such codes a form of government spending, because they “impose costs that you might not privately want to engage in”.

Pretty damning! Except . . . well . . . the Princeton professor didn’t exactly reveal the full quote from Friedman, as this comment, and this one, and this one all point out. Too bad that Krugman has not seen fit to correct the misleading impression he gives concerning Friedman’s views on this subject.

And too bad that Krugman seeks to mislead concerning Chile’s economy. He argues that free market policies have had nothing to do with Chile’s economic success, because that success was too far removed from the time Friedmanite policies were implemented. But his commenters call him out on his evidence. This comment points out that in fact, Chile’s economic success came soon after the implementation of Friedmanite policies, and that the graph Krugman uses is utterly deceptive. And here, we are reminded that there is something very political about how Paul Krugman reads and describes a graph showing a GDP trend.

Tyler Cowen picks apart Krugman’s post as well. I may disagree with some of Cowen’s own critique of Chile’s economic performance, but at the very least, Cowen’s critique is more balanced, fair, and nuanced than is Krugman’s ham-handed attack. Concerning Krugman’s remark that Chileans hate the pension reforms that took place under the influence of Friedman and other Chicago economists, there is plenty of evidence–see this, for example–that the pension reforms delivered impressively for Chileans.

Finally, note how Krugman strives to ensure that Friedman is given no credit whatsoever for any of the good things that went on in Chile. But when it comes to things like fanning fears of food poisoning, Krugman is more than happy to blame Friedman. Never mind that countries were Friedmanite policies are not in evidence suffer from food poisoning outbreaks as well. Never mind that it is more than a little hypocritical to claim that Friedman could not possibly have had anything to do with good and palliative developments, but must have been responsible for all bad things that happened, and that are about to happen. I know that Paul Krugman hates Milton Friedman with a vengeance. And of course, it would surprise no one to find out that Krugman waited for Friedman to die before launching his jeremiads; recall that George Shultz once commented of Friedman that “everyone likes to debate Milton . . . when he leaves the room,” and one most emphatically leaves the room when one passes from this world to the next.

But still, after a while, doesn’t all of this Friedman-bashing just get a little pathetic?