Meltdown DiagnosticsDaniel Gross takes readers' questions about the financial crisis, nationalization, and his new book, Dumb Money.

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Daniel Gross: Hi Boston—good point. You're right there wasn't mass chaos in Japan during its lost decade. But Japan probably has greater tolerance for low growth than the U.S. for a couple of reasons. The population growth there is very low, and they have very little immigration. All of which means that if the economy kind of bumps along, if the pie doesn't get that much bigger, everybody still has roughly the same to eat.
That's not the case in the U.S. We have a higher birth rate than Japan, and we have lots of immigration. Check out the Census Bureau for the rate at which our population grows. The # of jobs needs to grow something like 1.5 percent per year just to keep up with growth in our labor force. This dynamism explains why we have a comparative mania for growth. We need the pie to get bigger, since there are more mouths to feed each year. And it explains why even a shallow recession feels really bad.

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Lyme, Conn.: I look forward to reading your book. I do not know if you cover these areas, yet I will offer a few opinions and would appreciate your comments on them. I find two large mistakes a number of business leaders and economists made were 1. They realized that econometric and similar economic models are helpful in forecasting along movements as recorded in the past, there are few if any economic models that are able to correctly predict when major turnarounds in past performances occur and 2. while it indeed is appropriate to look more at the most recent data than old data, the attention to more recent data failed to include historic data that observes that our economy tends to move in cycles. Very few economists and business leaders foresaw and were prepared for an economic downturn.

Daniel Gross: Hi Lyme—Yes, I do hit on both those points in my book. One of the real failures in recent years has been in the forecasting industry. Everybody seems to suffer from what I call "pro forma disease." They take the results of the last few years and project them endlessly into the future—i.e. if housing prices rose at 10% per year for the past four years, they'll do so for the next four. That's part of how we got into so much trouble. And many of the models constructed on Wall Street only dealt with information from recent years. In addition, models don't seem to account for the fact that the shape of the economy - of the U.S. and the world at large—have changed a great deal.

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Glendora, Calif.: Traditional IOUs represent the value of some real item—a cow or a chicken or a new roof—and are thus implicitly "marked-to-market" at all times. This means that the value of money is a function of the perceived value of real items rather than the inverse, which is a quality of fiat money. Is there a monetary system which would allow the close simulation of the IOUs while allowing easy circulation of the money? If electronic asset transfer was common worldwide, would it change your answer?

Daniel Gross: As long as we're going to stay off the gold standard, and as long as the money in circulation is a function of the demand for it, we'll always be in the situation where currencies fluctuate against real objects. IOUs, as you describe, aren't that much different from currency today. Yes, they represent the value of a real item. But the value of those items fluctuates all the time—a cow can be worth $10 one day and $8 the next.

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New York: These guys are many things, but they're not dumb. It seems to me that we should be able to fill up a number of max prisons with some of these guys, if there's the political will to do what's right. Looks like the Wall Street chiselers are counting on prosecutor incompetence and short attention spans. That didn't work out well for Ken "Kenny Boy" Lay or Abramoff, to site two examples, though, did it? What are the prospects here for criminal prosecutions? And what are the prospects that government officials may be implicated in covering up for their buddies?

Daniel Gross: Hi New York—there undoubtedly will be criminal prosecutions, especially of the ponzi schemes and in the mortgage industry. But I'm not that optimistic about widespread prosecution. Because much of the crime was simply incompetence or blindness. Take the SEC. Chris Cox and his team did a simply horrible job overseeing the industry. But nobody is arguing that they broke any laws, or that they were bribed to do so. They just did so because they weren't very good at what they did, and may have been blinded by ideology. The same holds for Alan Greenspan.

At the investment banks, there was probably a lot of fudging of numbers—telling the public one thing while knowing another thing in private. But some of the biggest debacles, say, Citigroup, happened because the people running the company didn't have a clue about the entirely legal (but ultimately destructive) things going on at the bank.

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Washington D.C.: In terms of assigning blame for the current economic crisis, some would seek to lay the greater part of it at the hands of Democrats in Congress, saying that they "distorted" the mortgage market by encouraging non-market based standards for lending to help their political base. Despite the obvious and simplistic ideological prism applied in this critique (market vs. government), is there any validity to this claim? Of the bad debt out there, how much of it is the direct result of any "non-market" based lending? How much of it is the result of competition for credit business? Is bad debt the sole cause of the crisis? Were banks forced to make the loans?

Thanks!

Daniel Gross: In a word, no. First, Democrats didn't control Congress in this period. Republicans controlled the House since 1994. From 2001-2006 there was basically one-party rule in Washington.

Second, the worst offenses in lending didn't take place in the regulated mortgage industry, the types of people who were subject to government rules and regulations about lending. They took place in the shadow banking industry—subprime firms that sprung up and the Wall Street investment banks that first funded them and later came to own them. In addition, the problems with subprime and other lending were amplified because investment banks decided to make CDOs out of them, and to trade them with huge amounts of leverage—something Congress had no impact on.

Finally, as I argue in my book, mortgages were only part of the story. Banks are going to lose billions of billions of dollars on loans they extended to private equity firms for mega buyouts, which has nothing to do with mortgage lending.

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Rhode Island: Hi Dan,

Love your columns in Slate.

Could you please decipher the real truth about Obama's proposed change in the way upper income folks would deduct charitable expenses?

To hear the talking heads go on about it, you'd think he was eliminating the deduction entirely, which would be devastating to charities.

Yesterday on NPR, I heard Peter Orszag make a comparison between the amount Bill Gates would get to deduct for a $1000 charitable contribution vs. what a middle income person would get to deduct for the same amount. I didn't quite get it.

Can you clarify? Bottom line, do you think Obama's proposed change would lead to upper income donors giving less?

Thanks.

Daniel Gross: Sigh. If there's anything that's been worse than the talking heads on Iraq, it's the talking heads on the economy. They simply, by and large, don't know what they're talking about.

As I read it, the proposal is to reduce the portion of charitable deductions a wealthy person could write off against taxable income, from, say, 36 percent to 28 percent. So if you give $100, it reduces your taxes by $28 instead of $36.

As for whether that leads rich people to give more or less money, I'm not sure. Look, charity is complicated. There are 1,000 reasons people give money. Lots of people who don't take tax deductions give money away (i.e. in Salvation army kettles, or to the homeless, or to their church). The ability to get a tax deduction is only one motivating factor. They make donations in memory of a loved one, or to enhance their social standing, or because they have too much money to spend. Do you think Warren Buffett and Bill Gates are giving away their fortunes because of the tax break associated with it? Some of the greatest acts of charity—Andrew Carnegie giving away his fortune—came before there was even an income tax.

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Single mom in Fla.: I am not a Zen master but I lack rage/envy/bluster at the 'masters of the universe' whose hubris takes some of the blame. I need my energy to focus on these issues:

1. When will credit begin to flow again?

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