The administration has apparently ditched Keynesian economics in favor of Philistine economics, calling for a domestic spending freeze or even spending cuts in the midst of double-digit unemployment.
Focusing on deficit reduction during a depression did not work for Herbert Hoover in 1932, and I’m at a loss to see why Obama’s economists are embracing spending cuts now. The article does quote budget director Peter Orszag as saying cutting spending too fast could undermine the recovery, so I can only hope that they do not mean to make these cuts until recovery is well underway. Given the dim prospects for a rapid recovery, the economy may not be ready to absorb any deep spending cuts for many years to come.
Actually, a better analogy than Hoover in 1932 might be Franklin D. Roosevelt in 1936-37. At that time the U.S. economy had been recovering for about four years (after bottoming out in early 1933) but was still in depression, with unemployment above 9%. But FDR, deciding it was time to focus on the budget deficit instead of the economy, cut spending and raised taxes (as the Fed doubled bank reserve requirements to soak up the vast excess reserves out there — which also sounds like a recent conversation), and the economy nosedived. Had FDR and the Fed been less leery of deficits and excess reserves, the depression might not have lasted until World War II.
This morning brings the news that unemployment has reached double digits for the first time since 1983, rising from 9.8% to 10.2%. And the U.S. economy has had a net loss of jobs for 22 straight months, the longest on record, dating back 70 years (to, yes, the end of the Great Depression). There are 15.7 million unemployed, including a record 5.6 million who have been unemployed for six months or more. Since the recession officially began in December 2007, the number of unemployed has more than doubled, by 8.2 million.
The U-6 unemployment rate – which also counts discouraged and marginally attached job-seekers and involuntary part-timers – is now at an alarming 17.5%. That’s the highest in the fifteen years that the government has been keeping track of that alternative measure.
. . . while selling $40 billion of mortgage-backed securities that it claimed were safe. The article, by Greg Gordon of McClatchy Newspapers, is based on a five-month investigation.
Yves Smith at Naked Capitalism has a few words on the matter and on the article, here.
This week’s news from the Commerce Department is that real GDP grew at a 3.5% annualized rate in the 3rd quarter of 2009, which is the best quarterly growth rate in two years. And some economists, including the National Bureau of Economic Research’s (NBER’s) Jeffrey Frankel, are saying the recession probably ended sometime this summer. Meanwhile, a poll of MSNBC readers finds that 82% think the recession is still raging, 9% think the economists are right, and 9% don’t know. (Yes, online polls are unscientific, but earlier, professional surveys I’ve seen of the public also found them to be more pessimistic about the economy than the experts.)
Are the economists that obtuse, or is the public that dumb? Even if one’s preferred is answer is “Both,” I think the split is due to two different definitions of “recession.” The NBER and the economics profession define a recession as a general period of economic decline, whereas I bet most people define it as a weaker-than-usual economy. I would argue for throwing the word out altogether when discussing the economy.
Use “contraction” to denote a period of actual decline, just as the 1929-33 collapse was called the Great Contraction.
Use “depression” to denote a period of economic weakness, just as 1929-early 1941 was the Great Depression. I argued in March that we were in a depression, but if “depression” sounds too harsh because people associate it with the Great Depression, then say “slump.”
Right now, the different professional and public definitions of “recession” (just as with “money” and “investment”) just makes economists seem that much more out of touch.
It must be cold comfort to the 14.5 million unemployed Americans to hear that unemployment is a “lagging indicator” and that the job market should pick up sometime after the economy picks up. Especially when the signals for the economy itself are still mixed. The most frightening news is that there are currently six unemployed job seekers for every vacant position out there. And even that’s counting only the “officially” unemployed and not the underemployed or the jobless people who’ve given up looking. The NYT has the story here.
The Kinks have the cautionary don’t-quit-your-old-job-until-you’ve-found-a-new-one tale here:
Krugman’s latest column is a gem. The problem, he says, is not the level of financial-industry pay but its asymmetry — lavish rewards for short-term profits, no responsibility for long-term losses or systemic damage — and the perverse incentives that result. Once again, it’s a case of “privatize the profits, socialize the losses.”
Judging from the quote from President Obama, it doesn’t look like this administration is going to do anything about it, though. Sigh.
Economist Richard Thaler has a thought-provoking, argumentative piece in today’s NYT that takes a critical look at the current debate about a public option, or government-run option, for health insurance. The gist of Thaler’s column is that having a public option is unlikely to make much of a difference, at least if it is required to break even. Interesting stuff, especially coming from a sometime Obama adviser and top behavioral economist.
Democratic National Committee Chairman Howard Dean has a new book out about health care which says a public option is absolutely essential for serious reform, but evidently Obama and Health and Human Services Secretary Kathleen Sebelius have backtracked on that one or were not so keen on it in the first place. Thaler reminds us that the two key issues here are (1) covering the uninsured and (2) bringing down costs. Whether and how that can be done with health insurance cooperatives, the leading proposed alternative to a public option, will be two of the big questions in the weeks to come.
UPDATE, August 18: Rethinking the Economy has a pointed rebuke to Thaler. So does Dean Baker. Both suggest he dismisses the public option much too blithely.
Both of those countries saw real GDP growth of 0.3% (or about 1.2% annualized), which is better than negative, but less than half of what normal GDP growth looks like. (The average for the last 30 years is 2.9% per year.) And in a real, robust recovery the economy is supposed to grow faster than normal; it has to, to get back to its potential. If GDP in those two countries had fallen by 0.1%, they would still be considered to be in recession — should so much importance be attached to a difference of 0.4% in a three-month period?
533,000 jobs lost in November. The last time the U.S. labor market had a month that bad, it was 1974 and I was nine years old.
And if those figures aren’t bad enough, the accompanying Bureau of Labor Statistics (BLS) report is even gloomier. Add in the “phantom unemployed” (discouraged job-seekers who’ve given up looking for work) and the “underemployed” (people involuntarily working part time instead of full time), and the more broadly measured unemployment rate is 12.5%.
A brief interview in Der Spiegel, from 7 October 2008, still timely. Shiller says the policymakers’ biggest mistake was in failing to recognize or do anything about the housing bubble until it was too late. Unfortunately, the interview does not include follow-up questions on what might have been done to gently deflate the bubble, but Shiller probably addresses that in his current book. (I’ll post some words on that when I get it.)
Unlike most other economists I’ve read, Shiller actually kind of liked the initial bailout plan — i.e., for the government to buy up to $700 billion of toxic mortgage securities from banks. Kind of: “It’s like plugging holes in a sinking ship. You only have so many hours before the ship goes down. You can’t think about how the ship should be designed or nautical engineering.” I wonder what he thinks of the revised plan for bank capital injections.
In an article in the January 2009 Vanity Fair, Nobel Prize-winning economist and former Clinton economic advisor Joseph E. Stiglitz points a few fingers (or maybe just the middle one) at the individuals and the laissez-faire mindset that he deems responsible for the current mess. It’s a good, intense read.
Not hard to see why Stiglitz parted ways with the Clinton Administration in 1997 (Jonathan Chait tells the tale in this 1999 article), or why Washington might not be his kind of town, but I do hope his views will get a hearing in the Obama Administration, even if Stiglitz himself is elsewhere.
Hello? Does Obama believe we currently finance our deficits by printing money, as opposed to selling Treasury bonds? I sincerely hope that this was just a garbled version of his usual, and reasonable, point that although we need a big fiscal stimulus now, we need to bring the national debt under control in the long term. (Some, like David Stockman back in the 1980s, have sketched a worst-case scenario in which our national debt gets so out of control that eventually the government has to print money to pay its bills, thereby causing a hyperinflation. Possibly Obama was alluding to those fears, but since they’ve been basically groundless all along in the U.S. case, he’d be better off not feeding those fears.)
My larger concern is that when President Obama’s brilliant economic advisers disagree with each other, as economists are known to do, will he be knowledgeable enough to make the right call for the right reason?
(modified from a 2 Dec. 2008 post)
UPDATE, 17 DEC.: Listening to NPR’s Marketplace this morning, it occurred to me that Obama just might have been referring to the dramatic steps taken by the Federal Reserve this year, which are basically equivalent to creating money. But his next sentence — “So at some point, we’re also going to have to make some long-term decisions in terms of fiscal responsibility” — implies he was talking not about monetary policy but fiscal policy. The concern still stands.
I couldn’t resist posting these two items together:
Henry Blodget, the disgraced former equity analyst for Oppenheimer, busted by then-New York Attorney General Eliot Spitzer and the U.S. Securities and Exchange Commission for securities fraud, has a compelling, thought-provoking essay in the December 2008 Atlantic, titled “Why Wall Street Always Blows It.” To be sure, it’s often self-serving, especially his claim that we’re all guilty, not just financial professionals (shades of those great scenes on “The Simpsons” when Homer, after totally screwing everything up, says, “Now let’s not play the blame game”). But it’s informative just the same, and a good read too. I thought his point about a larger credit bubble was well taken:
“Why did the housing bubble follow the tech bubble so closely? Because both were really just parts of a larger credit bubble, which had been building since the late 1980s. That bubble didn’t deflate after the 2000 crash, in part thanks to Greenspan’s attempts to save the economy.”
Spitzer, the more recently disgraced former New York Attorney General-turned-Governor, has begun his rehabilitation just as Blodget did: by writing a column for the online magazine Slate. Spitzer’s first column is a critical look at the financial industry bailouts, which he sees as cascading from excessive consolidation in the industry, to the point where so many financial institutions become “too big to fail” that policymakers have almost no choice but to perform these lavish bailouts when things go bad. It’s an interesting point, a bit different from the usual point about excessive deregulation, as the banking industry had been consolidating well before the Gramm-Leach-Bliley deregulation of 1998. But I don’t buy Spitzer’s conclusion that antitrust action to break up the big banks is needed. There do seem to be significant economies of scale in banking; I think it’s no coincidence that the banking industry is also highly concentrated, in fact more so, in the European social democracies.
Right on target. Simple, but illustrates the phenomenon that seems to underlie just about all of this: the desire for reward without risk (not just a free lunch, but a delicious calorie-free lunch) on the part of investors who should know better, and the eagerness of investment managers without scruples to con them into thinking they had just the ticket for that.
“President-elect Barack Obama’s economic team is drawing mostly rave reviews, but some see too much of the old regime that helped get us into this mess. In particular, Lawrence Summers and Timothy Geithner, nominated for the respective positions of National Economic Council Chairman and Secretary of the Treasury, have some explaining to do.” — the old version of this blog, circa 26 Nov. 2008
(No no no, I’m not accusing the Times of copying me. If only.)
The Times‘ main beef with Geithner is that the Fed has been less than forthcoming, maybe less than truthful, in explaining why they let Lehman Brothers go bust and then bailed out AIG two days later. The apparent inconsistency in saving one and not the other is one thing, maybe forgivable in view of what unchartered waters these were, but making up bogus excuses about a lack of legal authority to help Lehman is worrisome.
My beef had been about (1) Geithner’s drafting of the AIG bailout itself, which seemed to give no-strings-attached bailouts a bad name, and (2) his history as a protege of the deregulation-happy Robert Rubin in the Clinton Administration. Chris Whalen, via Naked Capitalism, has the rundown on (1).
Overall, I’m confident that Geithner, as reported, is a bright guy who learns from his mistakes and, as president of the New York Fed, knows the tools of the trade as well as anybody. And I doubt there’s anyone of similar experience whose record is spotless. But the Senate will have to grill him on these matters.
OK, so we should worry about deflation. Deflation is economically destabilizing and particularly destructive in a recession, as it raises the real burden of debt and the real interest rate, as well as inducing consumers to postpone purchases in the hope of future price decreases. And in the current slowdown there’s already been considerable deflation here and abroad of housing, asset, and commodity prices. But . . .
The news that U.S. consumer prices just had their largest one-month drop in at least 61 years (the records only go back to 1947) does not look like a big deal to me. Ditto the previous month’s near-identical news about a then-record drop in U.S. consumer prices in Oct. 2008. The media seem to be trumpeting it as the latest sign of the apocalypse, but all of that 1.7% drop in the consumer price index (CPI) was due to a big drop in energy prices, and as a child of the 1970s I’m still inclined to think of any energy-price drop as a good thing, whatever the cause. The “core” CPI (which excludes food and energy prices) was unchanged, and the CPI for food prices rose by 0.2%.
(The story was about the same in Oct. 2008: the overall CPI fell by 1%, the food CPI rose by 0.3%, and the core CPI fell by only 0.1%. Although the news reports noted that this was the first drop in the core CPI since the devastating recession of 1982, 0.1% is hardly a decline at all. Considering the band of error that inevitably surrounds these figures, and considering the slight rise in food prices (the other excluded category from the core CPI) , I think it would be a lot more informative to say that Oct. 2008 was a month of falling energy prices and price stability otherwise.)
Side note: Experts are saying that the falling energy prices are directly due to the recession. It does appear that the demand for gasoline (and by extension, the amount of driving we do) is a lot more cyclically sensitive than I ever would have guessed. Especially considering how the demand for gas seems to be very price inelastic in the short run. Maybe we simply cut back on a range of expenditures (travel, shopping, downtown entertainment) that entail driving, causing the demand for gas to drop?
(modified only slightly from a post on my old blog circa mid-Nov. 2008 )
I don’t think anybody was expecting the new federal funds rate target to be a range, but everybody was expecting a rate cut, and we got one, from an already-low 1% to a new-record-low 0 – 0.25%. I also don’t think anybody is expecting it to turn the economy around, considering the failure of already-low short-term rates to do that, but Wall Street’s broad stock indexes were up 5% for the day. My guess is the traders see the move as a sign the Fed is still doing all it can and then some.
“It was looting, and it is high time the media starts describing it in those terms.”
While most of us might picture a looter as some guy breaking into a store during a blackout and stealing TV’s, Smith is serious. He rests his definition on a 1994 NBER paper by economics Nobelist George Akerlof and David Romer, which concludes:
“Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.”
Exactly, says Smith, who says the investment bank executives did exactly that: “pay themselves more than their firms are worth and then default on their debt obligations.“ He laments that nobody in the media has put it this bluntly, let alone called it looting. More often it gets ignored, or seen as an inevitable by-product of that almighty engine of progress, financial innovation.
I agree with Dean Baker’s repeated argument that the U.S. financial sector has been bloated beyond rationality and that the economy would function better with a smaller, simpler financial sector that didn’t try to peddle so many dubious-to-worthless products to households, consumers, institutions, etc. Smith, impatient with those who “are still urging that we not squelch ‘financial innovation’,” offers up a gem of a quote from Martin Mayer, who called financial innovation
“… a way to find new technology to do what has been forbidden with the old technology….Innovation allows you to go back to some scam that was prohibited under the old regime.”
“… regulators who were assigned to oversee Wall Street dropped the ball.”
“Financial regulatory reform will be one of the top legislative priorities of my administration. And as a symbol of how important I view this reform, I’m announcing these appointments months earlier than previous administrations have.”
“Instead of appointing people with disdain for regulations, I will ensure that our regulatory agencies are led by people who are ready and willing to enforce the law.”
All this is in marked contrast to what I read in The New York Times on Thansksgiving eve, in a profile of the next National Economic Council Chair, Lawrence Summers, who appeared to dismiss the notion that deregulation was a major factor in the crisis (New York Times, 25 Nov. 2008). David Leonhardt of the Times put it this way: ”As Treasury secretary starting in 1999, he shepherded a couple of bills that helped deregulate financial markets, and he has made it clear that he doesn’t buy the notion that these laws caused the financial crisis.” Either Summers is shooting down a straw man that says the laws were the sole cause of the crisis (which I don’t think anybody is arguing), or he’s saying the laws did not contribute to the crisis, period. Leonhardt interrupts his glowing profile to state, “I wish he and other Clinton administration alumni were a bit more introspective about what they might have done differently.” Me, too.
I stated these concerns a couple weeks ago on the old version of this blog, 25-26 Nov. 2008. Here’s the rest of it:
The Best and the Brightest?
Incoming National Economic Council Chairman Lawrence Summers is a brilliant man, but he seems to have had a hand in the current mess. As Treasury Secretary under President Bill Clinton, he shared Robert Rubin’s and Alan Greenspan’s support for financial deregulation in the late 1990s, including signing off on Senator Phil Gramm’s Commodity Futures Modernization Act in 2000, which deregulated credit default swaps and other derivatives.
Everyone’s expecting some fairly big fiscal stimulus bill to emerge early next year from Congress and to be signed by President Obama, but let’s not forget about what’s happening right now at the state level. Most states are constitutionally required either to pass a balanced budget or to have their governor submit one, so right now the talk in the statehouses, notably here in New York State where I live, is all austerity all the time.
Austerity budgets — draconian spending cuts, tax increases, or some combination thereof — are the last thing any economy needs during a recession. The backfiring “Hoover” tax increase of 1932 is forever held up as one of the Lessons From the Great Depression. Another lesson, familiar to economic historians though not so much the general public, is that the overall fiscal stimulus during the 1930s was actually quite small, as the New Deal deficits (which were actually not that huge in relation to the economy, as Paul Krugman reminds us) were largely offset by budget-balancing efforts at the state and local level. (The classic reference is E. Cary Brown’s “Fiscal Policy in the Thirties,” American Economic Review, 1956.)
This point about the government’s overall fiscal thrust might be even more important now than in the 1930s, when much if not most of the (partial) recovery of 1933-41 came from monetary expansion, mostly in the form of gold inflows from Europe. (Christina Romer, the incoming Chair of the Council of Economic Advisers, has an article about this, “What Ended the Great Depression?”, in The Journal of Economic History.) Right now, by contrast, the Fed is trying everything and then some, and doesn’t seem to be able to get the economy going again. So it may be up to fiscal policy.
Right now it seems to be mostly talk at the federal and state levels. The White House and Congress are in lame-duck mode, so nothing very concrete is being proposed. State legislatures are home for the holidays, and in states like mine where the governor has to submit a balanced budget but the state doesn’t have to pass one, there’s even less certainty. My take is that the federal stimulus package should not skimp on aid to state and local governments. For all the dysfunction of some state governments (like my own), their budgets reflect the needs and priorities of their people to at least some degree, and ignoring them just seems like bad policy. (I remember, when Clinton was getting started in 1993 and talking about an economic stimulus plan, hearing David Gergen deride the new president’s planned aid to state and local governments as “walking-around money for mayors.” I’m sure those kinds of dismissals will be common in the halls of Congress in 2009.)
My nightmare is that Congress passes a “Washington Knows Best” stimulus package that mostly stiffs the states and instead puts the funds into projects of its own choosing. Thousands of Bridges to Nowhere, and fifty state governments in distress. If that happens, the recession could be a long one, and could feel like a depression for anyone who works for a state or municipal government.
A useful personal investing article in the Dec. 26 New York Times about bonds, pointing out that bonds and bond funds have also fallen victim to the financial crisis and concluding with a helpful list of what’s available. But hey, NYT, bonds aren’t just for old people! (The headline: “Older Investors Should Examine the Risks in Bonds.” Oh well, I’ve seen worse headlines — will somebody please inform their headline writers that “printing money” and “issuing Treasury bonds” are two different things?)
By now, the personal finances are way overdue for a rebalancing. Burton Malkiel, author of the great A Random Walk Down Wall Street, suggests the following portfolio allocation for people my age (early 40s):
60% STOCKS (20% international, 20% growth & income, 10% small cap, 10% growth; all in stock funds, not individual stocks)
35% BONDS (12.5% GNMA mortgage bond funds, 12.5% high-grade bond funds, 10% T-bills)
5% CASH (money market funds or short-term bond funds)
I can’t follow that completely, as I derive too much pleasure from the lottery tickets known as individual stocks (and I figure it’s not too reckless as long as they’re a small part of the overall portfolio), and I’m not putting any money into Treasury bills while they’re paying 0% interest, but it still looks like sound advice. Having a third of your stock holdings be international stocks sounds especially logical (not that European or Japanese stocks have been going gangbusters themselves lately).
Some stock-market links from a couple months ago, when the Wall Street crisis was in full roar:
So I’ll meet you at the bottom if there really is one
They always told me when you hit it you’ll know it
But I’ve been falling so long it’s like gravity’s gone and I’m just floating
A recent Associated Press article about the forthcoming Obama stimulus plan is somewhat encouraging on the state-aid front. I’ve been arguing vociferously that any stimulus package that doesn’t include massive aid to states and localities is a sucky stimulus package. Basic services like schools depend on state and local tax revenues, which have taken a beating during the current slump. The article’s emphasis is mostly on infrastructure projects, but here’s a glimmer of hope:
“In addition, states would get up to $200 billion over two years for Medicaid health coverage for the poor and to narrow state budget gaps, which are forcing layoffs and cuts in services.”
Up to $100 billion per year … Is that good? It looks like a lot, but I’ve yet to see a projection of the combined deficits of the fifty states plus D.C.
Another glimmer of hope, on the schools front:
“Obama’s vision of infrastructure goes beyond repairing or building roads and bridges. It includes modernizing schools, boosting high-speed communications networks and installing technology at hospitals and doctors’ offices to electronically access medical records.”
So far, so good. But still, almost all the talk is about rebuilding our infrastructure. We see it again in this Dec. 28 op-ed by Larry Summers, which just barely hints that some of the stimulus money might be directed at schools and basic health-care services (and does not mention general state aid at all). Not that there’s anything wrong with infrastructure, but it almost seems like Obama advisers feel like it’s politically perilous to talk about aiding the states, as if the average American is going to blame the states for their woes (a la the Big Three automakers and the unpopularity of the bailout). To be sure, there are a lot of people out there who have that “I say, let ‘em crash” mentality, but that’s all the more reason to make the case for aid now.
UPDATE, Dec. 30: I posted this on Sunday (and had made a similar point in “Fiscal Policy in the Oughts” a week earlier), and voila, Paul Krugman’s NYT column on Monday, titled “Fifty Herbert Hoovers,” says the same thing! Thanks for reading, Paul. I kid, I kid — no such delusions of grandeur here. As comedian Owen Benjamin put it when asked about comics stealing each other’s material, there’s only so many premises out there.
I’d figured the financial bailout was a combination of
(A) the reasonable (a finger in the dike to avert a systemic collapse) and
(B) the mendacious (Wall Street using its massive political clout to call in the feds to save it from itself and receiving a platinum parachute from the ex-Goldman Sachs boss at the top of the Treasury).
(C) the hand that feeds us (Buck up, foreign investors! Don’t pull your love out on us, baby):
“Indeed, it’s no secret on Wall Street and in Washington that the real targets of President Bush’s $700 billion bailout plan were the foreign funds, including “sovereign wealth funds,” that keep America’s financial system afloat. Unless these foreign financiers — principally China and Japan — get reassurance that the global financial system can function properly again, America’s long period of growth and power may be coming to a close.”
This has been the fear ever since the ’80s: what happens when foreign investors decide it’s time to pull up their stakes in America? Now that would be a harsh episode of “cut and run.”
For now, my new answer to the $700 billion question is “All of the above.”
“Most people subject to foreclosures are good people who received good advice that they could refinance their homes when the adjustable rate changed. No one had a crystal ball buffed enough to know that values would fall below what their homes were purchased for.”
Good advice? “You’ll never have to pay more than the teaser rate? Even if you got a subprime loan because you’re not a good credit risk, in a few years time you’ll be able to refinance at a super-low interest rate? If you do refinance, the original adjustable-rate mortgage (ARM) won’t have a stiff prepayment penalty? The market price of your home will rise so fast that you can borrow however much you need against it?” (The mantra that “housing prices always go up” wasn’t even true at the time — adjusted for general price inflation, housing prices were basically no higher in 1999 than in 1979, and they fell during the first halves of the 1980s and 1990s. I think “always” really meant “even during the stock-market collapse of 2000-2002.” Kind of a short time horizon there.)
A crystal ball would have been nice, but a simple reading of past data about housing prices and interest rates and an understanding of why banks would issue ARMs in the first place would have been enough to produce some sensible advice. (Or failing that, just pick up a money and banking textbook and look for “mortgages, adjustable-rate” in the index. I’ll save you the trouble; you’ll find something like this: “Changes in interest rates can be very risky for banks. Adjustable-rate mortgages allow them to transfer that risk to the borrower. Since borrowers are usually not in a good position to absorb such risks, they usually avoid adjustable-rate mortgages.”) Granted, it seems true that all that crappy advice about how anyone can buy a home on cheap credit and bear no risk was considered good advice in much of the mortgage and housing markets up until about a year ago, and I’m sure many of the people giving that advice meant well. But they were following the herd and were either unwilling or unable to look up basic information on house price trends or ARMs. So don’t convict them of fraud. But don’t consider them competent at their jobs either.
A recession should tip the scales in favor of attending college, yes? It’s part of every Econ 101 course: the opportunity cost of attending college includes the income you’d making at whatever job you’d be working at otherwise. So as career opportunities fail to knock, college or grad school looks like a much better option, yes?
Excessive credit card debt seems to have been a major part of the bubble that just burst (and may still have some bursting to go), so it might not even be a good thing if banks were to relax their current credit-card standards. But a broadening of federal student loan and grant programs might be a sensible investment in human capital, as part of the forthcoming stimulus package.
“Americans enter the New Year in a strange new role: financial lunatics.
“… the collapse of our financial system has inspired not merely a national but a global crisis of confidence. Good God, the world seems to be saying,if they don’t know what they are doing with money, who does?….
“The instinct to avoid short-term political heat is part of the problem; anything the S.E.C. does to roil the markets, or reduce the share price of any given company, also roils the careers of the people who run the S.E.C. Thus it seldom penalizes serious corporate and management malfeasance — out of some misguided notion that to do so would cause stock prices to fall, shareholders to suffer and confidence to be undermined. Preserving confidence, even when that confidence is false, has been near the top of the S.E.C.’s agenda.
“It’s not hard to see why the S.E.C. behaves as it does. If you work for the enforcement division of the S.E.C. you probably know in the back of your mind, and in the front too, that if you maintain good relations with Wall Street you might soon be paid huge sums of money to be employed by it.”
The first half also tells “the strange story of Harry Markopolos,” an officer at a Boston investment management company who blew the whistle on Bernard Madoff’s Ponzi scheme for nine years beginning in 1999 with repeated communications to the S.E.C. that got ignored. (Lewis and Einhorn tout Markopolos as a natural for the S.E.C.’s next Chief of Enforcement. If only.)
I don’t have time to write anything much this morning, but I did want to not write anything about this political sideshow in Illinois and the U.S. Senate. So here it isn’t.
The closest I’ll get is to excoriate the media for ignoring everything else about President-elect Obama’s press conference yesterday about the economy. Toward the end he took one off-topic question about his Senate heir apparent, and the MSNBC talking heads talked about virtually nothing else for the rest of the day. (Or at least until I turned the TV off, which was not soon enough.)
President-elect Obama and Congress are talking about a federal stimulus package that includes a substantial though as-yet-undetermined amount of aid to states and, possibly, localities. Earlier this month Ohio Gov. Ted Strickland made an eloquent case for still more federal aid, to make up for more of the huge shortfall in revenues that normally go to education:
To many, the nation’s credit card debt seems a perfect symbol of America’s bubble economy. Business Week even speculated this past fall that credit cards might follow housing as the next meltdown in our financial system. It seems logical enough: just as securitized subprime mortgages wreaked financial havoc, revolving credit-card loans are almost inherently subprime, as credit cards are easy to get, charge high interest rates, and have much higher default rates than regular bank loans. And a good deal of credit-card debt has also been securitized into collateralized debt obligations and other such lipstick-on-a-pig formulations. Some of them may still even carry bogus AAA ratings.
My hunch is that in tough times, an unpaid credit-card balance weighs on a person a lot more heavily, even if that person is still gainfully employed. So credit-card debt could be a major inhibitor of consumer spending, and yet another rock in the ongoing economic landslide.
On the surface, this looks pretty bad: the guy who would be the head of the agency that oversees the IRS, failing to pay his Social Security and Medicare taxes for four years in a row (2001-2004). But not so fast. Most of us have those taxes withheld directly from our paychecks and don’t think about them otherwise. Geithner, by contrast, was working for the International Monetary Fund (IMF), where employees don’t pay federal income tax. Several of my grad school friends went to work for the IMF, and I distinctly remember them saying, it’s great, we don’t pay taxes. The incoming administration’s talking points on the matter (take them with a grain of salt if you want) note that this confusion is very common among IMF employees.
“If you don’t understand how it’s making money, maybe it’s not making money.”
Had Bernie Madoff’s investors followed this advice, they might be $50 billion richer. (Had all the buyers of securitized subprime mortgages followed this advice, the world might be several trillion dollars richer.) One thing about the Madoff scandal that has me wondering was the comment from an industry participant about how it was obviously a Ponzi scheme, based on Madoff’s claim that his fund returned 8 to 12 % every year, come rain or come shine. The participant said that was impossible, given the volatility of the markets. Which has me thinking a few things:
(1) Isn’t that what hedge funds attempt to do — earn high returns while hedging away most of the risk? 8-12% is about what the stock market averages, and it seems like a fund could find a way, by setting excess gains aside or using put options or something much fancier (which, yes, I wouldn’t understand) to deliver a strong, steady return. It would probably average a couple points less than the stock market averages (say, 8% versus 10%), but investors would surely flock to such high risk-adjusted returns.
(2) If, in fact, this is near-impossible to do, as the market participant said, then what sort of returns are hedge funds actually earning? How much of that information is made public? (Not too much, I’m guessing, since hedge funds are basically unregulated.) How many of these funds are actually Madoff-type Ponzi schemes that haven’t been exposed yet? Even if they’re not engaged in anything terribly crooked, shouldn’t there be more transparency as regards their holdings and returns? Even five of the world’s biggest hedge fund managers seem to think so, based on their appearance before Congress last November.
(3) I need to learn a lot more about hedge funds. Next on my reading list: Roger Lowenstein’s When Genius Failed: The Rise and Fall of Long-Term Capital Management.
Thomas Friedman has a thought-provoking column in Sunday’s New York Times, titled “Time for (Self) Shock Therapy.” Unfortunately, one of the thoughts provoked is “A lot of this is oversimplified,” but there are still some good ideas and some good exposition in it. On the eve of the inauguration, Friedman suggests that President Obama’s first White House meeting should be with the presidents of the 300 biggest banks, and he should tell them there’s a new sheriff in town. The first paragraph of Obama’s imaginary indictment of the bankers is nicely put, especially the heart metaphor:
“Ladies and gentlemen, this crisis started with you, the bankers, engaging in reckless practices, and it will only end when we clean up your mess and start afresh. The banking system is the heart of our economy. It pumps blood to our industrial muscles, and right now it’s not pumping. We all know that in the past six months you’ve gone from one extreme to another. You’ve gone from lending money to anyone who could fog up a knife to now treating all potential borrowers, no matter how healthy, as bankrupt until proven innocent. And, therefore, you’re either not lending to them or lending under such onerous terms that the economy can’t get any liftoff. No amount of stimulus will work without a healthy banking system.”
Friedman then has Obama announcing a thinning of the herd, kind of like FDR’s bank holiday of 1933, whereby the healthy banks would be recapitalized and the sick banks liquidated: Read the rest of this entry »
A deluge of things to write about — the Democratic fiscal stimulus plan and reactions, the deepening recession worldwide, the apparent easing of the credit crunch, President Obama’s proposed new financial regulations, and perhaps most of all the continued woes of the big banks and the search for a solution — but only a droplet of time to write. That’s the start of the semester for you.
. . . if you sing the praises of free markets while working for a public university.”
I forget who said that (Yoram Bauman?), but I thought of it again after seeing the Cato Institute’s full-page ad in today’s (Jan. 28 ) New York Times, against a fiscal stimulus package. It was signed by a few hundred economists, the overwhelming majority of whom teach at state schools (as do I). I didn’t have time to get an exact count, but the first ten were all at state schools, as were about eighty percent of those above the fold. Given that the gist of the ad was that we need to reduce the “burden of government,” maybe they could offer to help shrink or privatize their schools?
At least one person on the list, Jeffrey Miron, is consistent in opposing state-funded higher education (which he has done in past op-eds) while teaching at a private university. For most of the rest, I think the Disposable Heroes of Hiphoprisy said it better than I can.)
Yesterday (28 Jan. 2009) the House of Representatives passed an $825 billion stimulus bill on an almost-perfect party line vote (about 95% of Democrats voting yes, 100% of Republicans voting no). For a breakdown of the $825 billion, which is about two-thirds new spending and one-third tax cuts, go here. Absent from the new spending was an originally proposed plan to make contraceptive services reimbursable by the federal Medicaid program. (President Obama asked House Democrats to remove it after Republican leaders singled it out for ridicule.) My understanding is that the proposal did not have a specific price tag but was estimated to cost about $200 – $300 million.
House Minority Leader John Boehner (R-Ohio) was widely quoted as asking, “How can you spend hundreds of millions of dollars on contraceptives? How does that stimulate the economy?”
Methinks Rep. Boehner has a problem with contraception (or that some of his constituents and benefactors do), but just in case this was a serious question, here’s a serious answer: Read the rest of this entry »
Alan Blinder has long been both one of the best policy economists and one of the best writers in the profession, so it’s no surprise that his recent New York Times column, “Six Blunders En Route to a Crisis,” has great pith. He is fair-minded enough to “omit mistakes that became clear only in hindsight.” The list, in his words:
wild derivatives, sky-high leverage, a subprime surge, fiddling on foreclosures, letting Lehman go, TARP’s detour.
For quick insights on the current crisis, it’s a great resource.
(Note: The title I provide is the one from the print edition. The online edition employs a more prosaic title that does not allude to either Pirandello or Nixon.)
The sticking point in the lingering credit crunch seems to be the remaining toxic assets (or dodgy assets, as the Brits call them) on the balance sheets of so many banks, especially the big problem banks that are getting government bailouts or are in line for them.
The sticking point in the policy question of how to remove those toxic assets as an obstacle to normal financial intermediation seems to be valuation, i.e., as Winston Churchill is said to have put it, a matter of haggling over the price. No small haggle, this. It’s often said that there is no market for these assets, and that appears to be true in the sense that there seems to be an unbridgeable gulf between what banks say those assets are worth (97 cents on the dollar?) and what they’ll fetch on the open market (38 cents on the dollar? The numbers are from a New York Times article, 2 Feb. 2009, and refer to a particular mortgage-backed bond. A division of Standard & Poor’s estimated the bond’s value at 87 cents or 53 cents under a less optimistic scenario. ) Treasury Secretary Tim Geithner’s plan for the remaining $350 billion of last fall’s bank bailout is due to be unveiled Tuesday, and advance word is that it calls for the Treasury to buy up a lot of those toxic assets and quarantine them in a “bad bank.”
Last Friday’s unemployment report for Jan. 2009 is bad old news by now — 598,000 jobs lost in January (worst one-month job loss since 1974); 3.6 million lost since the recession began in Dec. 2007, half of that in the last three months; an unemployment rate of 7.6% (worst since 1992). But as with most unemployment reports, the news beneath the surface is even worse.
For starters, the reported data, like most economic data, are seasonally adjusted, so they take into account the fact that economic activity is heavier in some months (like December) than others (like January). Seasonal adjustments are well and good as regards making valid comparisons across time, but it’s hard to seasonally adjust people. The not-seasonally-adjusted unemployment rate for January was an eye-popping 8.5%.
And, once again, the standard unemployment rate is only for people actively looking for a job and does not count discouraged job-seekers, involuntary part-time workers, etc. The BLS adds those into the “U-6 unemployment rate,” which is the one that shows the full amount of misery, and for January it was 13.9% (seasonally adjusted) or 15.4% (not seasonally adjusted).
“In January 2008, there were 12 triple A-rated companies in the world. At the same time, there were 64,000 structured finance instruments, such as collateralised debt obligations, rated triple A.”
This is a topic I’m sure I’ll be returning to many times. Among my greatest post-election disappointments was Larry Summers’s comment that it was a misconception that deregulation was somehow responsible for the financial crisis. Hello? And I still don’t know what to think about Tim Geithner — New York Fed experience a big plus, accomplice role in flawed Paulson bank bailout and AIG handout a red flag (though the “just following orders” defense may apply here). Clearly Geithner and the overall economic policy of the Obama Administration will be much more of a known quantity after 11 a.m. this morning when Geithner gets his “moment in the sun” to announce the new bailout plan.
Many economists have been warning that the net-worth problems of the banks are a lot bigger than the $700 billion that’s been allocated to deal with them. Some have said a TARP II, TARP III, etc., to the tune of $2 trillion or so may be necessary to fix the banks once and for all. Now Dr. Doom himself, Nouriel Roubini, says the banking system is just plain insolvent, and by about $3.6 trillion. The specter of 1990s-Japan-style zombie banks in the U.S. is no longer a specter but a reality, it seems.
‘“I think they know how big it is, but they don’t want to say how big it is. It’s so big they can’t acknowledge it,” said John H. Makin, an economist at the American Enterprise Institute, referring to administration officials. “The lesson from Japan in the 1990s was that they should have stepped up and nationalized the banks.”’
When someone from the American Enterprise Institute says it’s time to nationalize, then it’s probably time for policymakers to show a little openness to it (e.g., “only as a last resort,” “we’re not ruling out anything”).
Real GDP kind of did fall 5% last quarter, just as consensus forecasts had it and worse than the official drop of 3.8%. This story’s a couple weeks old (been busy), but just as the latest unemployment numbers are much worse than they look, the fact that the actual (annualized) drop was “only” 3.8% is actually a sign of weakness, not strength. The NYT and other sources noted that a big reason for the discrepancy was a surprise increase in unsold inventories.
What struck me was the item in the Commerce Department news release that showed that the inventory pile-up actually accounted for all of the discrepancy. It was 1.3% percent of GDP, i.e., the entire difference between the 3.8% drop in GDP, and the 5.1% drop in “real final sales of domestic product.”
The new Economist has a great piece on Irving Fisher, the great American monetary economist who articulated the destructive aspects of deflation better than anyone before him. Fisher was a weird dude — eugenics and Prohibition were among his passions — but his “Debt-Deflation Theory of Depressions” (the lead article in the first issue of Econometrica in 1933) lives on. Virtually every monetary economist since, from Milton Friedman to Ben Bernanke, has absorbed Fisher’s lessons. So has the Federal Reserve. Nobody tries to defend deflation anymore.
A fine piece in the new Forbes, “The Real Lesson of the New Deal,” by ex (in more ways than one) Reaganite Bruce Bartlett, complements it nicely. Bartlett sketches the devastating effects of deflation in the early 1930s and throws in some sensible points about policy in the Great Depression. (Hat tip: Jeff Sachse.)
The “credit crunch” was at the heart of the media coverage of the financial crisis as it came to a crescendo last fall, but I haven’t heard much about it lately. From what I do hear, the credit markets have loosened up quite a bit, with the big exception of mortgage loans that once got repackaged as securities. Seems nobody wants to buy mortgage-backed securities (new or old) anymore, which is more than understandable. I don’t either.
John Authers of the Financial Times recently noted that the commercial paper market, whose tightening last fall was evident in a big spike in interest rates, has eased considerably, as has the market for corporate bonds:
‘… there is evidence that banks’ problems may have been ring-fenced for the short-term. As Mark Lapolla of Sixth Man Research in California points out, use of the Federal Reserve’s commercial paper facility, for making short-term loans to companies, has dropped in the past few weeks, so businesses are finding other sources of finance. Large companies are issuing bonds after months when this was impossible.’
Authers seems to think the risk of a systemic collapse is now past:
‘The market believes that financial stocks could go to zero without damaging the rest of the economy. They are down 28 per cent for the year while no other sector is down more than 12 per cent.’
But in the current media firestorm over bank nationalization, maybe it’s time to abolish the word as harmful to thought. (David Paul seems to agree.)
I’ve used the term myself and like the idea of the government temporarily seizing control of the big zombie banks, but “nationalization” has been bandied about so loosely that it’s lost its meaning. Many people described the Bush-Paulson capital injections (via purchases of preferred stock that gave the government small nonvoting stakes in some banks) as nationalization, when they were really just crude subsidies (as Willem Buiter pointed out). And if it’s nationalization for the government to temporarily take over a failing bank so as to help depositors and creditors, avoid systemic risk and arrange for the orderly sale of its assets, then we’ve been doing it for over 75 years, ever since the creation of the FDIC. In fact, by some compellingaccounts, Sheila Bair’s FDIC has been the one shining light in this crisis.
So far, my summary understanding of the AIG mess is something like this: The company diligently acquired a AAA credit rating and then recklessly exploited it by selling “naked” (unhedged, no offsetting position) credit-default-swaps to anyone and everyone. Unlike the failing banks, AIG wasn’t directly involved in the subprime securities business, but their problems became AIG’s problems when many of them began defaulting on their obligations — obligations which were insured by . . . AIG. So now AIG also has obligations that no honest financial institution can pay. And because AIG is one of the world’s largest corporations, it accounts for huge chunks of many institutions’ stock and bond/loan portfolios. “Too big to fail,” blah blah blah.
“Frontline’s” excellent hour-log documentary of the financial crisis, “Inside the Meltdown,” aired on PBS a few weeks ago. I was pleased to find out just now that the whole thing is online and free. I highly recommend it.
I’m not being alarmist. It’s worth noting that before the 1930s “depression” was the standard term for a substantial economic contraction, what would now be called a recession. The 1930s depression was termed “great” because it was indeed the worst ever, so bad that it became a proper noun, the Great Depression. Some are calling today’s slump the Great Recession, which is a waste of keystrokes.
I remember my father calling the 1982 recession a depression, and I think he was right: the worst slump since World War II, 10% unemployment (peaking at 10.8%), including the permanent loss of millions of industrial jobs.
I say that not because I’ve been a fan of the Treasury Secretary’s job performance so far (far from it), but because positions like Treasury Secretary, Securities and Exchange Commission Chair, and President of the United States should be well compensated.
In the case of finance-related positions, anyone who was previously working high up in the industry or even in a Fed bank must take a huge pay cut to take on a job that brings power and prestige but also frustration and blame. Cases in point: Geithner and new SEC Chair Mary Schapiro. Now, neither is going to have any trouble paying the bills: Geithner made more than $400,000 last year at the New York Fed and received a similarly sized severance package; Schapiro made almost $3 million as head of the Financial Industry Regulatory Agency (the securities dealers’ self-regulatory board) and got a severance package of over $7 million; but still.
Geithner’s salary at Treasury: $196,700.
Schapiro’s salary at the SEC: $162,900.
After adjusting for the much higher cost of living in Washington, DC than in Oswego, NY, the head of the SEC barely makes more than I do. (Not that I think I’m overpaid. . . )
$61 billion in fourth-quarter losses, tens of million in new bonuses, mostly to people in the most toxic financial products division on Earth, namely their Financial Products division.
And the bailouts just keep on comin’. Word is that the bonuses will be restrained in the future, but why not in the present, when AIG has already received $170 billion in government funds? AIG’s line is that the bonuses were contractual obligations made before the company’s implosion, but aren’t bonsuses supposed to be paid out of company profits? AIG has gone from hosing its shareholders to hosing the taxpayers. And if the government has a plan for dismantling this atomic bomb of a company, it’s doing everything in its power to suggest otherwise. Seems that “Welfare Cadillac” was written about forty years too early:
UPDATE, 16 March 2009: Sunday’s NYT had a sensible editorial on the matter. News of the backlash and the identities of AIG’s counterparties was all over the wires on Monday. Warren Buffett’s warning that credit derivatives were financial weapons of mass destruction looks truer than ever — AIG’s bottomless obligations now seem to be married to the federal government’s bottomless pocket. While the systemic risk from letting AIG fail was huge (and no doubt still is), is it really a worse risk than all-out banana-republic bankruptcy for the U.S. government?
Industrial capacity utilization is at its lowest level since 1982 (when we had double-digit unemployment), and down 11% from a year ago (when we were already in a recession).
Excellent-sounding suggestion about how to stop those abonimable AIG bonuses, from Bill Black, Tom Ferguson, Rob Johnson, and Walker Todd (The Huffington Post, 16 March 2009). Even if it doesn’t succeed in stopping the bonuses, their suggestion to break off AIG’s toxic Financial Products Division (like a hedge fund attached to an insurance company, as Ben Bernanke described it) from AIG’s main business, and then treat the Financial Products Division like the bankrupt entity it is, is very appealing.
The NYT has another sensible editorial about AIG and who it’s been paying off with the $170 billion in bailouts it’s received so far. Under the bailout, the company has been paying off many credit default swap (CDS) holders in full, which is a great way to burn through hundreds of billions of dollars with lightning speed. And now we know that a good chunk of those billions went to CDS creditors like Goldman Sachs who, like AIG, are wards of the state. (To be fair, a substantial but smaller amount of CDS payouts went to state governments.) The only relief I can think of is Herb Stein’s old line: the good thing about something that can’t go on indefinitely is that it won’t.
Paul Krugman has some unpleasant arithmetic about the plan, which takes as its starting point the way the plan would subsidize the private institutions (not individuals) that would buy those toxic assets. Reportedly the subsidy would take the form of “non-recourse loans” in which the borrower (and toxic asset buyer) would only have to put up 15% of the price paid for the asset, the asset itself would be the collateral for the loan, and if the asset went bad the lender could default and owe only the bad asset. Just like a 15% margin loan, except some margin loans allow the lender to demand repayment of the whole thing.
This is the most sensible thing I’ve heard from him yet — a proposal for FDIC-type powers for the government to temporarily take over too-big-but-failing-anyway financial institutions like AIG, clean house, and sell off their remaining assets. I once thought the FDIC already had those powers, but apparently that’s so only for regular commercial banks, not bank holding companies or other financial Goliaths. (FDIC Chairperson Sheila Bair explains it here.)
The new proposal doesn’t necessarily conflict with anything in yesterday’s plan to subsidize the worst financial institutions by overpaying for their worst assets, but it does suggest that the Obama Administration really does have plans to regulate them and is not kidding itself (Pollyannish recent rhetoric to the contrary) that all of them are fundamentally sound.
OK, the Geithner 2.0 plan officially looks wretched. When I’m agreeing with the top Republican on the House Financial Services Committee, you know there’s a problem. And the problem is not merely that the plan is a lousy deal for the taxpayers because it throws lavish subsidies at institutional buyers of toxic assets and grossly overpays the banks who would sell those assets; that’s all been said before. The new problem is that it wouldn’t even remove toxic assets from the banking system! As the Financial Times reports:
‘US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system.’
Can you say “playing with the house money”? Unfortunately, that would be your house and my house.
It’s not completely clear that Geithner’s Treasury will allow this to go forward, as a Treasury official says that a bank’s supervisors will weigh in on whether the bank is healthy enough to buy assets. But Geithner and Obama have implied that all of our big banks are fundamentally sound (shades of Herbert Hoover, John McCain, and Lake Wobegon), so I suspect that the ink is already wet on those supervisors’ rubber stamps.
Seems like we’ve made literally zero progress since Halloween 2008: captured regulators attempt to prop up insolvent banks with hundreds of billions of dollar bills and won’t even consider that some of them might need to be closed. Cue Mark Fiore’s “Zombie Bank” cartoon.
Unemployment up to 8.5%, highest since 1983, and U-6 unemployment (including discouraged job-seekers and involuntary part-timers) up to 15.6%.
As usual, it’s even worse than it looks. Those numbers are seasonally adjusted for the fact that unemployment is usually worse in winter months like March. Cold comfort, so to speak, for the unemployed themselves. The non-seasonally-adjusted (NSA) numbers are worse: 9.0% for regular (U-3) unemployment, 16.2% for U-6 unemployment.
Today’s title courtesy of that awesome Boston band of the mid-’80s, The Dogmatics:
= percent of U.S. bank assets controlled by the four largest commercial banks (JPMorgan Chase, Citigroup, Bank of America, Wells Fargo; source: Martin Wolf in the FT). That four-firm concentration ratio is up sharply from 39% in Feb. 2003 (source: Frederic Mishkin’s money and banking textbook, ~2004 edition).
‘A White House spokesman, Ben LaBolt, said the compensation was not a conflict for Mr. Summers, adding it was not surprising because he was “widely recognized as one of the country’s most distinguished economists.”’
Some have already called for breaking up the biggest financial institutions, to the point where none of the ones remaining are “too big to fail,” and then letting market discipline or effective regulation keep them in line. All well and good, but these stats, especially the last two, recall the original 19th century rationale for antitrust action: The biggest firms just have too much political power. Small is not only beautiful, but small firms are less likely to be writing the laws of the land.
Yahoo Finance’s Tech Ticker has a nine-minute interview with George Soros, and a quick summary, here.
Nothing too shocking here, but on target and well stated.
Simon Johnson’s latest analysis of the situation is even better, though his assessment of the circle-the-wagons politics of it all is mighty bleak. Don’t miss Johnson’s link to a January 2009 WSJ piece about financial economist Raghuram Rajan, one of the high-profile Cassandras who predicted the current implosion and who met a hostile “Jane, you ignorant Luddite” response from a star-studded 2005 gala of economists including Larry Summers.
(The money quote from Summers: “[I find] “the basic, slightly lead-eyed premise of [Mr. Rajan's] paper to be misguided.” Lead-eyed? Not in the dictionary; seems to be a fishing term. Maybe he said “Luddite” and was misquoted?)
Not really. The deflation came mostly from lower energy prices. The “core” inflation rate, which excludes food and energy prices, was 1.8%.
Likewise, the modest price dip of the past month (0.1% each month) was also driven by falling energy costs. Non-energy prices rose slightly.
What is the source of these falling energy prices? Some of it seems to be a function of the sagging economy (poorer people drive less), but I expect there’s favorable supply shock in there somewhere. And I have to think it nets out to a favorable supply shock for consumers as a whole.
Remember the good old days when “creative accounting” was an oxymoron?
Ever since Citigroup last month projected a profit for the first couple months of the year, big banks have been startling the Street with better-than-expected quarterly earnings reports. And for a while, the Street was overjoyed and stock prices shot up for banks and overall. But um, shouldn’t we have been taking these profit figures with a big grain of salt?
Advance manipulation (read: lowering) of expectations so that you can miraculously beat those expectations is an old, old game.
Accounting chicanery played no small part in getting us into the current mess. Covering up losses to impress the market, just like covering up profits to thwart the taxman, is legal and commonplace, under generally accepted accounting practices.
An excessive focus on short-term profits also played a big part in getting us into this mess. Shouldn’t we be looking at other factors, too? In particular: Bank share prices were way down because of the widespread belief that the banks were either insolvent or headed that way. Positive short-term profits (cash flow) and solvency (assets greater than liabilities) are two different things, and can coexist at least for a little while.
The federal government has subsidized the big banks to the tune of tens of billions of TARP money apiece. Shouldn’t that make it easier for them to be profitable? (The whole point was that the banks would loan that money out profitably. Granted, that hasn’t happened to the desired extent — I just heard on the radio that total lending is lower now than before the TARP legislation — but banks are surely using their TARP money for something that generates income, like T-bonds, no?)
“Too big to fail” evidently means “too big to fail a stress test,” too. Although the results of the recently conducted stress tests on the nineteen largest U.S. banks won’t be made public until May 4, the advance word on Friday, April 24 was a Whole Lotta Rosie. From the NYT:
‘On Friday, the Federal Reserve reported that the banks whose books it had analyzed recently had enough capital to offset a raft of new losses, . . .’
So everybody’s solvent! And those toxic assets are both nutritious and delicious! I bet my students would love it if I could get Tim Geithner or the Fed to write my final exams — nobody would be allowed to fail.
‘. . . reinforcing the belief that the government would support the largest banks even if their financial health eroded, and buoying the stock market.’
Um, didn’t the government already do that, to the tune of $700 billion, not counting the Fed’s waves of loan/subsidies? But of course those subsidies came with some conditions, from the understandable ($500,000 pay cap) to the asinine (don’t hire no foreigners), so the big banks are naturally eager to pay back those loans and return to looting. As long as they can still count on a fresh round of bailouts when their losses become too gaping to hide, they’re in a perfect position. The old mantra of “privatize the profits, socialize the losses” doesn’t quite convey the apparent duplicity at work here. It leaves out the “fabricate the profits” and “hide the losses” steps.
Somewhat lost in this week’s media-created milestone of the first hundred days of the Obama Administration, and the inevitable comparisons to Pres. Franklin D. Roosevelt’s momentous First Hundred Days (so momentous that they became a proper noun) is FDR’s even more extraordinary accomplishment in his first ten days: the resurrection of the U.S. banking system. Such resurrection, as you may have heard, has so far eluded Pres. Obama and his predecessor. Are there lessons from how FDR and his guys did it?
First, a quick timeline: FDR took office on March 4, 1933 (after that, the 20th Amendment moved the inauguration date up to January). On March 5, he declared the famous “bank holiday.” On March 9, he got Congress to pass the Emergency Banking Act, to give his administration unprecedented powers over the banks. On March 12, he gave his first “fireside chat,” assuring people that the banks were about to reopen and would be healthy when they did. On March 13 (day 10), banks reopened in 12 cities. By March 16, the administration’s massive audit and purge operation, more than 70 percent of U.S. banks had reopened, while others were closed.
Economic historians are in less-than-complete agreement about the New Deal’s overall macroeconomic impact, with a substantial minority in a recent survey agreeing with a proposition that the New Deal harmed the economy. But there does seem to be consensus that the bank overhaul was a great success. Even FDR advisor-turned-harsh-critic Raymond Moley described it in glowing terms. With the president’s signing of the Emergency Banking Act, he wrote in After Seven Years (a classic among Roosevelt bashers), without sarcasm, “The sequence of bold, heart-warming action had begun.”
The personnel involved in the great bank triage operation, which involved some 15,000 banks (i.e., twice as many as we have now) were various Treasury and Federal Reserve officials, with Secretary of the Treasury William Woodin at the helm. In Moley’s words:
‘ . . . as I look back at those frenzied days, it seems to me that the country has never quite realized the extent to which Woodin, [Hoover's Undersecretary of the Treasury Arthur] Ballantine, and, last but no means least, [Hoover's Acting Comptroller of the Currency F.G.] Awalt helped to restore the confidence of the country by a rapid and unprejudiced approximation of the equities — social as well as financial — involved in each case. . . .’
‘Capitalism was saved in eight days, and no other single factor in its salvation was half so important as the imagination and sturdiness and common sense of Will Woodin.’
Mister, we could use a man like William Woodin again.
A bill to allow bankruptcy court judges to modify the terms of troubled mortgages, “cramming down” the amounts owed so as to avoid foreclosures and make these debts and troubled assets more manageable, failed in the Senate, getting just 45 votes. En route to the bill’s failure, its chief sponsor, Sen. Dick Durbin (D-IL) said the banks “are still the most powerful lobby on Capitol Hill. And they frankly own the place.“ The NYT noted that the White House, despite backing the bill, did not go to bat for it in its final days.
The Treasury has delayed the release of its “stress tests” of the 19 largest banks, apparently because their credulous-looking certification that all 19 banks are currently solvent is not rosy enough for some of the banks, notably Citigroup. Word is that Citi and Bank of America are contesting the results, even though the tests (1) appear to have used the banks’ own questionable data on the values of their toxic assets and (2) minimize the amount of hypothetical “stress” these banks might be subject to, by entertaining only fairly optimistic worst-case scenarios. Various economists have said the tests were rigged in the banks’ favor, but evidently some banks are pushing to make them even more so. Yves Smith offers the full bill of indictment here.
Ever since Fed Chairman Ben Bernanke said a few weeks ago that we may be glimpsing the first “green shoots” of recovery, it’s been a cockeyed-optimism fest among media commentators. As always, developments in the stock market have gotten way too much attention (Paul Krugman wryly noted on TV that the stock market has predicted six of the last one recoveries), and they’ve done much to fuel the optimism. As of yesterday’s close the S&P 500 is up more than 30% from its low of 676.53 just two months ago (March 9). Sucker’s rally or not, it’s moving in the right direction.
Commentators have also seized on the BLS’s latest unemployment release as a good tiding, which would seem like a reach given that the official unemployment rate rose from 8.5% in March to 8.9% in April. The cliche of the day is that employment has “bottomed out.” Let’s crunch the April numbers:
It’s part of a lengthy cover story in Sunday’s New York Times Magazine. There’s a good synopsis of it here in The New Republic online, and another one by NYT economics writer David Leonhardt, with annotations, here on the Times’s Economix blog. Some highlights:
Clinton says he totally blew it in acceding to Greenspan’s call that derivatives should be unregulated.
He also says that his backing of Gramm-Leach-Bliley (i.e., allowing banks and investment banks and insurance companies to merge) would have been wise only if, as he expected, there was going to be appropriate regulation and oversight of the new financial supermarkets. Had he known there would be none in the next two presidential terms, he would have opposed it.
Very interesting. He’s a lot more open about his administration’s shortcomings in this department than, say, Larry Summers has been. Just in the little bits I saw, Clinton is thoughtful and persuasive.
He also touches on the important distinction between regulations/prohibitions and oversight, with financial supermarkets as a case in point. When you can count on having good regulators who provide adequate oversight, then you can allow certain activities that might otherwise better be prohibited. Then again, is “deregulation with proper oversight” too clever by half (not to mention oxymoronic)? We shouldn’t be learning about this policy approach a decade after these deregulatory policies were put in place. Who was speaking up for proper oversight during the Bush years?
Krugman has it right here, in yesterday’s NYT. I’d been planning a post on the recent spate of fear-mongering about the deficit, and Krugman covers a lot of the same ground. One of the arguments against deficits is that they may lead to high inflation down the road, if the government leans on the central bank to “inflate away the debt” (i.e., jack up the price level so as to reduce the real burden of the national debt), but Krugman notes that there are precious few such examples in recent (post-WWII) history. He concludes:
‘. . . it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.
‘Needless to say, the president should not let himself be bullied. The economy is still in deep trouble and needs continuing help.
‘Yes, we have a long-run budget problem, and we need to start laying the groundwork for a long-run solution. But when it comes to inflation, the only thing we have to fear is inflation fear itself.’
” ‘As Treasury secretary starting in 1999, [Larry Summers] shepherded a couple of bills that helped deregulate financial markets, and he has made it clear that he doesn’t buy the notion that these laws caused the financial crisis.” — David Leonhardt, New York Times, 25 November 2008 (more here)
In this weekend’s NYT Magazine, Summers’ old boss, Bill Clinton, takes full responsibility for the failure to regulate credit derivatives, those most opaque and easily abused of financial instruments. We already knew that Summers, his predecessor Robert Rubin, and Fed Chairman Alan Greenspan backed the blanket exemption of credit derivatives from regulation. What we did not know until this week, however, was just how much they regarded financial deregulation as a holy sacrament. (OK, so we did know that about “Alan Shrugged” Greenspan.)
A Washington Post feature on Brooksley Born, the head of the Commodity Futures Trading Commission at the time, makes this plain. In 1998 Born wrote a “concept paper” pondering the possible merits of derivatives regulation, prompting a circling of the wagons by Summers, Rubin, Greenspan, and Securities and Exchange Commission chairman Arthur Levitt:
‘In early 1998, Born’s plan to release her concept paper was turning into a showdown. Financial industry executives howled, streaming into her office to try to talk her out of it. Summers, then the deputy Treasury secretary, mounted a campaign against it, CFTC officials recalled.
‘”Larry Summers expressed himself several times, very strongly, that this was something we should back down from,” [Born aide Daniel] Waldman recalled.
‘In one call, Summers said, “I have 13 bankers in my office and they say if you go forward with this you will cause the worst financial crisis since World War II,” recounted [Michael] Greenberger, a University of Maryland law school professor who was Born’s director of the Division of Trading and Markets.’
Neil Young saw it all coming in 1981, on his re*ac*tor album:
Everyone has an opinion on GM’s Chapter 11 bankruptcy filing this week, as well as the Obama Administration’s bailout/buyout of the carmaker. Robert Reich gets it right, I think, in a Financial Times column, “General Motors holds a mirror up to America.” Reich asks what the goal of the bailout is, and rejects a few possible answers before concluding that it’s basically a cushion, designed to give GM’s workers and community some time to adjust to still-harder economic and psychological blows ahead. People are queasy about the idea of bailouts, but they sense that they could be next and so do not protest too much.
Don’t ask me why a George F. Will quote from the mid-eighties has stuck with me all these years, but here it is in full: “All economic news is bad news. All economic news is good news.” True in the old-time Phillips-curve-tradeoff sense that rapid growth may be inflationary, true in the modern sense that the current depression (or recession, if you insist) is forcing households to live within their means, which is good for them but bad for GDP, etc. Lately there’s been a spate of economic news, mostly bad (reduced bank lending, weakening credit outlooks for the G-7 governments, tumbling house prices, foreclosures as far the eye can see, GM’s bankruptcy filing, etc.), but a few top business economists and at least one top academic economist are saying the recession is over, or just a couple months away (Financial Times, 4 June).
The academic optimist is Robert J. Gordon, long established as one of the world’s leading empirical economists. Gordon bases his prediction on new unemployment claims, which may have already peaked a few weeks ago at almost 660,000 a week, based on data ending May 23. Past cycles typically reached their trough four to six weeks after the peak of new unemployment claims. Assuming that this recession is typical enough to follow that pattern (eh), Gordon says the contraction either ended last month or will end this month.
U.S. manufacturing orders were the other major ground for optimism mentioned in the FT article. The ISM manufacturing survey showed a slight expansion in new factory orders, the first expansion since the recession begain in December 2007. The article also noted that U.S. consumer confidence, as measured by the Conference Board, increased significantly from April to May (from 40 to 54.9, which is still well below the benchmark value of 100) and that “housing has bottomed in volume terms even if prices are still falling.”
Today’s unemployment news — U.S. unemployment rose again, from 8.9% to 9.4% — will be shrugged off by some as a “lagging indicator,” as it is true that unemployment often continues to rise even after GDP starts to grow again and the National Bureau of Economic Research declares the recession over. (Remember how often the recoveries of the early-to-mid 1990s and 2000s were referred to as “jobless recoveries”?) I personally would like to see a more employment-centric measure of recessions and expansions, but I guess you could create one easily enough from the BLS employment figures.
Paul Krugman has mixed feelings about the Labour Party’s shellacking in this week’s elections. Me too. It’s hard to feel sorry for Prime Minister Gordon Brown, who as Tony Blair’s Chancellor of the Exchequer was a Big Swinging Deregulator to rival the Greenspan-Rubin-Summers axis in the U.S. Krugman:
‘Do Mr. Brown and his party really deserve blame for the crisis here? Yes and no.
‘Mr. Brown bought fully into the dogma that the market knows best, that less regulation is more. In 2005 he called for “trust in the responsible company, the engaged employee and the educated consumer” and insisted that regulation should have “not just a light touch but a limited touch.” It might as well have been Alan Greenspan speaking.
‘There’s no question that this zeal for deregulation set Britain up for a fall. Consider the counterexample of Canada — a mostly English-speaking country, every bit as much in the American cultural orbit as Britain, but one where Reagan/Thatcher-type financial deregulation never took hold. Sure enough, Canadian banks have been a pillar of stability in the crisis.’
Trivia question: How much money has the Federal Reserve printed in its entire ninety-five-year history?
Answer: $0. The Bureau of Engraving and Printing, part of the federal government’s Department of the Treasury, prints all the money. And none of those bills become “money” (i.e., part of the money supply, M1 or M2) until they’re held by the public anyway.
Am I being pedantic? After all, those dollar bills are “Federal Reserve Notes” and are delivered to the twelve Federal Reserve Banks upon request. I don’t think it’s pedantic, though, as there’s a world of difference between printing money and dropping it from a helicopter (as described in countless economics classrooms and which would be very inflationary) and how those bills actually do hit the street (generally not covered in econ classes, an omission that has always mystified me*, and which is not so inflationary).
Anyway, what brought on this post is the constant chatter in the media and the blogosphere about how the government or the Fed is printing money. (Of course this chatter is most pronounced on the right. The three minutes I heard of Limbaugh’s show this year were devoted to some witless sarcasm about we should all be allowed to print counterfeit money because the government is already doing it. Har de har.)
. . . and too big to regulate. JP Morgan Chase, Goldman Sachs, Morgan Stanley, and seven other megabanks got permission from the Obama Administration to repay their combined $68 billion in TARP debt to the government. The government made a profit on the loans, and the banks are now out from the under the thumb of the TARP restrictions on executive pay and hiring. Win-win, right?
Well, no, not for the taxpayers who are still implicitly on the hook for these ten behemoths should anything go wrong. They are no more regulated than they were before the crisis, and there is no FDIC-like resolution system in place that would allow for the orderly failure of these financial supermarkets should they become insolvent (again?). It would be rational for their managers to conclude that the institutions are still “too big to fail” and to return to reckless decision-making a la “heads I win, tails the taxpayers lose.” Today’s Financial Times has an excellent editorial on the matter. Wish I’d written it myself; the next best thing is to cut and paste most of it here:
What caused the crisis? It seems like most of the plausible answers I’ve heard come down to one of two basic explanations:
(1) “We were living beyond our means” — Congressman Dan Maffei (D-NY), in a WRVO Community Forum in Syracuse last week that included, um, me. Sounded very reasonable coming from Congressman Maffei, less so coming from stockbroker/ investment advisor/ author Peter Schiff on the other night’s “Daily Show”, probably because of the diametrically opposite policy prescriptions the two draw. Maffei backs the stimulus bill and wants to see the economy recover as soon as possible; Schiff is an adherent of the Austrian school and thinks a good old bloodletting (oops, “liquidation” or “correction”) is just what the doctor ordered. Either way, this explanation has a lot going for it, as it explains the rash of subprime mortgage borrowing, home equity loans, maxed-out credit cards, etc.
(2) A “global savings glut” led to stock and housing bubbles, which finally burst — Fed Chairman Ben Bernanke, Nobel economist / NYT columnist Paul Krugman. The idea here is that while we spendthrift Americans were running up huge debts, people in other countries, notably China and Japan, as well as the minority of wealthy Americans with high savings rates, had large pools of savings seeking a good risk-adjusted return. And they invested much of it here, in Treasury bonds, thereby keeping U.S. interest rates low; in the stock market, reinflating the late 1990s bubble; in the corporate bond market, lowering rates on all bonds, even junk bonds; and in real estate, largely through securitized collections of other people’s mortgages. (By some accounts, demand created its own supply of mortgage-backed securities — after the 2001 stock debacle, investors were looking for an alternative to stocks and thought real estate looked promising.) A particular problem here seems to be that many investors opted for wildly risky investment vehicles, like investing in “diverse” portfolios of dodgy mortgages or blindly handing their money over to a Bernie Madoff or a Robert Allen Stanford, without realizing they were risky.
So who’s the party of fiscal responsibility again? That mantle seems to be claimed by whichever party does not occupy the White House. In the late 1970s, Ronald Reagan and other Republicans charged that Jimmy Carter’s deficits (although puny in retrospect) were inflationary and needed to be stopped. As president in the 1980s, Reagan presided over the largest deficits ever (in absolute terms) and the first-ever major peacetime increase of the national debt-to-GDP ratio in history. Leading Democrats pounded him for the deficits, and Reagan swatted them away as “born-again budget balancers.” Dick Cheney said later (quoted in one of the Bush 43 administration tell-all books), “Reagan proved that deficits don’t matter.” Economists by and large weren’t buying it, but aside from relatively high real interest rates and relatively low levels of business investment, the economy was prospering as it hadn’t in two decades, and Democratic attacks on Republican deficits found little traction. Just ask Walter Mondale.
mostly fell during the 1970s, as appears to be the norm for the economy in peacetime (at least in non-recession years);
more than doubled during the 1980s and all through Bush 41’s presidency, from about 24% to 54%, likely due to tax cuts, the Reagan military buildup, and the growth of health care costs and entitlements spending;
fell sharply during the Clinton years to about 34% in 2000, likely due mostly to the booming economy and the post-USSR “peace dividend”;
rose sharply in the Bush 43 presidency, likely due initially to the 2001 recession, tax cuts, and Medicare prescription drug expansion, then to the Iraq and Afghan wars, rising health care and entitlement costs, the aging of the population (including early baby boomer retirements), and of course the 2008 recession and bank bailouts.
For all the talking heads’ bloviating about the massive inflation to come from current Fed policies and the spending stimulus, as well as the media’s eagerness to pronounce the recession over, you can be forgiven for not noticing that deflation has not exactly gone away. The Bureau of Labor Statistics announced yesterday that over the past 12 months wholesale prices dropped 5 percent and today that over the same span consumer prices dropped 1.3%; the respective declines were the largest since 1949 and 1950.
I said a few months ago that I was not particularly worried about deflation, and I’m still not, as it seems mild by historical standards and because expansionary Fed policies are making sure that money-stock growth is strong. But an awful lot of people have assumed away the recession and are now wringing their hands about the threat of inflation, and these data suggest both impulses are premature.*
I’ve been skeptical all along. So have Brad DeLong and Paul Krugman. It’s hard to say we’ve hit bottom when industrial production continues to fall, by 1.1% in May and by 13.4% over the past year, the worst 12-month showing since 1946. Industrial capacity utilization is at a record-low 68.3%. (The capacity utilization data go back to 1948.)
But it does appear that some economic indicators, like employment, are at least declining at a slower rate, so “bottoming out,” as opposed to “has already bottomed out,” may be appropriate. The question is how long it’ll take for the economy to start growing again, as opposed to staying at a low level. James Kwak of The Baseline Scenario offers a good rundown of the “green shoots” debate here.
The Economist looks at the decline in jobless claims over the past four weeks and declares the U.S. recession to have “cleared the hump” (equivalent to “bottomed out,” from a “been down so long it looks like up to me” perspective). But they predict a less-than-robust recovery:
‘It’s the return to the jobless recovery. And what that means for the population groups most affected—blue collar workers, those with less education, and so on—is that for years to come, work will be difficult to find and wages will lag. The recession will not end for everyone at the same time. Millions of workers will continue to struggle years after output numbers get out of the red.’
(h/t: Vanessa Cruz)
A commenter suggests that the decline in jobless claims may just mean that a lot of people’s unemployment insurance ran out, which, given the millions of long-term unemployed, is plausible.
Some stronger signs that recovery is on the horizon are in the just-released Index of Leading Economic Indicators, by the Conference Board. The index looks at ten different economic data series (including unemployment claims) which tend to move in the same direction as the overall economy but a few months earlier. Seven of those indicators were up in May; three were down. Overall, the index grew 1.2%, its second monthly gain in a row and its largest gain since March 2004.
The Obama Administration’s new Financial Regulatory Reform plan hit the streets yesterday. At 85 pages, it’s a lot to digest. Today’s Washington Post has pretty good coverage, including this excellent summary chart. Joe Nocera of the New York Times has some pointed criticisms, the gist of which is that Obama’s reforms, unlike FDR’s, do not go far enough.
Probably the biggest step forward is that the plan calls for giving someone the authority to close and liquidate insolvent financial behemoths like AIG and Citigroup. Right now, the FDIC can shut down failing banks, but nobody can do the same with financial supermarkets like AIG and Citigroup. In a similar view, it also empowers the Fed to oversee huge, systemically important financial institutions and require them to hold more reserves and take fewer risks. Both of these changes seem to go a long way toward resolving that tension between moral hazard and “too big to fail.”
Another step that looks welcome is the establishment of a Consumer Finance Protection Agency, along the lines suggested by the estimable Elizabeth Warren, the Harvard Law Professor who chairs the Congressional Oversight Panel that monitors the TARP bailouts. In this 2004 interview with Bill Moyers she offers a critical, detailed assessment of credit-card-company abuses and sensible ideas for reform. Her two-part interview with Jon Stewart this past April is worth watching as well. Warren has been rumored as the person to lead this new agency. Had an effective consumer protection agency been in place earlier this decade, we might have avoided the stampede into dubious adjustable-rate mortages and option ARMs. Not surprisingly, the financial services industry is critical of the idea of such an agency.
To paraphrase Benjamin Franklin, a nation that chooses deficit reduction over its economic health will soon have neither.
A story that I’d missed a couple days ago was the results of new polls from the NYT and the WSJ, allegedly finding Americans to be apoplectic about the federal budget deficit and down, down, down on the $787 spending stimulus. The poll results are described by Catherine Rampell of Economix, Paul Krugman on his blog, and Andrew Leonard on Salon. Considering the disastrous effects of budget cutting during the Great Depression (first in 1932 under Hoover, then in 1937 under FDR), the results does not seem to bode well for future recovery efforts. “A nation of Herbert Hoovers” was Salon’s headline.
It’s easy to read these poll results and conclude that Americans want the economy placed on a starvation diet. But is that the correct conclusion? Rampell takes a closer look at the NYT poll and isn’t so sure. She points out another question, which asks what America’s biggest problem is, and notes that only 2% say the budget deficit. That puts it well behind the economy (38%), jobs (19%), and “health care” (7%). An accompanying chart of Gallup poll results since the 1930s show that not since the mid-1990s has the budget deficit been seen as the nation’s top problem by more than 5% of the public.
For once, I agree wholeheartedly with a Wall Street Journal editorial. (OK, I could do without the mixed sports metaphor in the title (“A Triple-A Punt.” How bush league). The piece raps the Obama Administration’s new financial reform plan for giving the credit rating agencies a free pass. Some key excerpts:
‘The government-anointed judges of risk at Standard & Poor’s, Moody’s and Fitch inflicted upon investors the AAA-rated subprime mortgage-backed security. They also inflicted upon the world’s nest eggs the even more opaque AAA-rated collateralized debt obligation (CDO). Without the ratings agency seal of approval — required by SEC, Federal Reserve and state regulation for many institutional investors — it would have been nearly impossible to market the structured financial products at the heart of the crisis. Yet Team Obama suggests only that regulators reduce the agencies’ favored role “wherever possible.”. . .
Another BLS employment report, more bad news. In every month since April 2008, the U.S. unemployment rate has either risen or held steady. It’s currently at 9.5%, the highest since late 1982, and 14.7 million people are unemployment (or 15.1 million if one uses the non-seasonally-adjusted data, i.e., the data that count the actual unemployed without filtering for seasonal fluctuations). For adult men, the unemployment rate is an even 10%. Nonfarm payroll employment fell by 467,000, about 100,000 worse than economists had expected.
U.S. unemployment rate, 1980-2009
It gets worse still. Think of 5% unemployment as the benchmark, as many economists consider 5% to be the “natural” rate of unemployment, i.e., about the lowest unemployment rate that the economy can sustain without generating higher inflation. The unemployment rate has been that low or better quite often in recent years, including about four years in 1997-2001 and about three years in 2005-2008 (click chart to see it properly). Right now, however, 5 percent (actually 5.1%) is the long-term unemployment rate, i.e., the number of people unemployed 15 weeks or longer divided by the total labor force.
Although precise causes of the current crisis are still a matter of some debate, it’s generally agreed that adjustable-rate mortgages (ARMs) played no small part in the housing bubble and its subsequent bursting. ARMs, once very rare, because very common during the bubble, especially for subprime borrowers. Dean Baker notes that in 2004-2006 ARMs made up 35% of all new mortgages, up from single digit levels previously. And quite a few (though not necessarily most) mortgage defaults occurred after the “teaser rate” period of these mortgages ended and the “resets,” or higher, market-based interest rates became effective. Some of the mortgage holders could not make the higher monthly payments and thus defaulted. (Others could afford the higher monthly payments but didn’t deem them worth paying, especially if they were “underwater” in the sense of their mortgage debt being larger than the resale value of their house.)
Today’s NYT column by University of Chicago behavioral economist Richard Thaler, titled “Mortgages Made Simpler,” got me thinking about this. Thaler laments the often bewildering complexity of many mortgages today, but casually dismisses the notion of requiring all mortgages to be simple fixed-rate mortgages. A little too casually, I’d say. He just says that complexity is necessary for “innovation,” without providing evidence that mortgage innovation has been helpful. Fellow Chicago economist Austan Goolsbee (drawing on an NBER working paper by Kristopher Gerardi, Paul Willen & Harvey Rosen), provided a fair bit in a March 2007 NYT op-ed, arguing that mortgage innovation has made many more mortgages possible, especially for younger, poorer, and minority applicants. The argument now looks rather dated in view of the tidal wave of subprime foreclosures, as well as the increasing realization that tying oneself down with a mortgage is not a great idea for everyone (e.g., people with low and variable income, people who might want to relocate soon, people who live in cities where rent is cheap relative to house prices — which was a lot of cities during the housing bubble). It also raises the question, Why can’t banks just issue fixed-rate mortgages with higher interest rates to their riskier customers?
Thaler says they shouldn’t have to, but that they should be required to offer every customer a fixed-rate mortgages as an option, alongside whatever complex mortgages they want to offer them.* I call it the Baskin-Robbins approach: 31 flavors, many of them quite unusual, but always including vanilla, chocolate, and strawberry for those folks who don’t get out much. The plain-vanilla-mortgage option is a good idea, but it raises another question: Why weren’t banks doing that all along?
One big reason is surely that interest rates, including regular mortgage rates, were at historic lows in the first half of this decade, when the bubble began. Banks and other lenders did not want to be locked into receiving such low interest rates for the next 15 or 30 years, so they pushed ARMs. Fed Chairman Greenspan’s crazy-ass claim that ARMs made sense for American consumers likely fueled this fire. Even so, ever since ARMs began in the 1970s and 1980s as a response to volatile interest rates, it’s been well known that ARMs transfer risk from the bank to the borrower. Which makes them a dicey deal for all but the richest borrowers (who don’t actually need the loan but might want it to get the mortgage interest deduction on their taxes and can afford the risk of higher interest payments) and clairvoyants who know what interest rates are going to do in the next 15 or 30 years. So why why why did so many people enter into ARMs?
My hunch is that ARMs were a form of predatory lending in many, perhaps most cases. Banks seem to have actively pushed ARMs on many borrowers. (A former student of mine told me that a bank actually pulled a bait and switch on her and her husband, substituting an ARM for a fixed-rate loan at the last minute. I suspect there are many other such cases.) Others who would steer clear of the mortgage market because they know they can’t afford a particular fixed monthly payment might be suckered in with a low enough teaser rate and unctuous assurances that interest rates will still be low at the end of the teaser period or that they’ll have no trouble refinancing at a lower rate. This seems to me an area that needs more investigation.
Didn’t see the movie, but the title is one that any student of economics must ponder on a regular basis. Case in point: our attempts to understand the current crisis, which is the reason I set up this blog in the first place. While there does seem to be a general consensus that the crisis involved the bursting of a bubble of some kind, there seems to be strong disagreement on the specifics, even among economists who are smart, fair, and thorough.
A few weeks ago I noted that there were two basic explanations of the crisis that were both plausible and consistent with each other: (1) overindebted Americans whose luck finally ran out and (2) a global savings glut. Money inflows from abroad helped fuel the housing and stock-market bubbles, and also made U.S. interest rates cheaper, thus making it easier for spendthrift Americans to keep on borrowing. Americans have been living beyond their means since 1981 (we know this because the trade balance has been negative during that time, meaning that imports have made up the gap between what we purchase and what we produce), and foreigners have been our eager enablers by purchasing U.S. stocks, bonds, property, and other assets. Aggregate statistics show that American indebtedness increased greatly in the past decade — to the highest levels since 1929! — and of course the housing market (and to a lesser extent the stock market) became a historic bubble in this decade. The usual story is that the runups in stock and housing prices encouraged Americans to spend more and more, even to the point of going further into debt, as their equity was rising and in many cases, like home equity loans, they could even borrow against it. Then the housing bubble burst, and the stock bubble followed suit, and suddenly Americans were a lot less wealthy and therefore cut back their spending, causing GDP to fall.
Still sounds plausible, but is it true? Some recent empirical studies cast a lot of doubt on both of those explanations.
I admit, I really don’t know if any major U.S. banks are insolvent or if the banking system as a whole is insolvent. A few months ago, it seemed to be conventional wisdom, with few dissenters outside of Tim Geithner’s Treasury Department. But around the time of the Treasury’s “stress tests” of the largest banks on May 7, which incredibly nearly all of those banks passed, the stock market was once again smitten with the banks. As John Authers of the Financial Times notes, the S&P 500 Financials Index rose 8.3% the next day, to 175.8, a level more than twice as high as their March low. Financial stock prices have since tumbled by about 14% to 151.5 (as of July 6), but they’re still 85% above their low. A healthier sign still is that credit default swap contracts for bank loans and bonds indicate that the market thinks bank credit is slightly less risky than it was two months ago. Are we out of the woods yet?
Doubtful. The banks still aren’t lending (business and consumer loans are down slightly, real estate loans are about the same), and they’re still sitting on vast piles of reserves ($688 billion, up from $2 billion a year ago). Possibly this is just a rational response to a recession and a general worsening of consumers and firms as credit risks, but it looks like a continuing credit crunch, in which even good credit risks can’t get loans, and it does not look like the behavior you’d expect from healthy banks.
“How dead is Keynes?” asked economist James Tobin in 1977, when Keynesian economics was starting to lose ground in economics departments to more theoretically elegant alternatives like new classical economics, and when the stagflation of the mid-1970s sapped many people’s confidence in Keynesian policy prescriptions. Tobin said Keynesian economics was still the best macroeconomic theory out there, and that standard Keynesian pump-priming remedies for recessions like deficit spending and monetary expansion still worked. True as those words might have been, however, Keynesian economics was not faring well in the court of public opinion, neither among academic economists nor among policymakers. Paul Volcker’s Federal Reserve invoked monetarism, not Keynesianism, in its draconian anti-inflationary policies of the early ’80s, and President Reagan, of course, sold his tax cuts as “supply side” economic policies designed to restore incentives to work and save.
It’s fair to say that nothing really did come along to supplant Keynesian economics on the policy front. Even Reagan’s “supply side” tax cuts had most of their impact through traditional Keynesian channels — putting more money in people’s pockets for them to spend — than by influencing people to supply more labor or save more. The estimated impact on labor supply was meager. The personal saving rate actually fell (graph from Calculated Risk). And President Bush 43’s early 2001 tax rebates worked much the same way — though they weren’t enough to prevent the recession of that year, they did mitigate it. But it’s hard to imagine any Republican politician of the last 30 years announcing, as President Nixon once did, “I am now a Keynesian.” Even Democratic politicians seem less than eager to embrace Keynes.
Fast forward to President Obama’s and Congress’s $787 billion, two-year stimulus package. Republicans have been calling it a failure practically ever since the time the ink on the bill was dry, and the American public seems to be getting increasingly impatient with, if not skeptical of, the stimulus. Unemployment keeps creeping up, after all, most recently to 9.5%. Warnings about the country’s long-term debt problems, to which the stimulus makes some contribution (however overblown in some quarters), have become ever more dire. Andrew Leonard of Salon has a nice little update on the politics and economics of the stimulus, titled “Is the Obama economic rescue plan a failure?”
Leonard, citing Barry Ritholtz of The Big Picture, says the real problem, contrary to Republican critics who say the stimulus is just worthless “spending” as if government purchases weren’t part of GDP (and as if tax cuts weren’t part of the stimulus, too), is not that the food is so bad but that the portions are too small:
Hilzoy, one of the political blogosphere’s brightest lights, is retiring from blogging after this week. Bummer.
If you’re not familiar with Hilzoy, she is a philosophy professor who began blogging for Obsidian Wings in 2002, around the time of the Iraq war vote. Her political posts were always on target and level headed, and her range of topics broadened somewhat over time. Her posts on the financial and economic crisis compare favorably with those of virtually any economist’s site. Very often, they’re better, as she fleshes out her arguments with just the right amount of (non-technical) detail. Come to think of it, Hilzoy’s econ posts are just about exactly what I’m aiming for here at Blogging Through the Wreckage.
And to think your real identity is still a secret, Hilzoy. You’ve got a lot less ego than I do. We’ll miss ya.
Two of the most odious contributors to the financial crisis were the government’s too-big-to-fail policy and the brazenness of many financial institutions, including the credit rating agencies, in helping to disguise and then market so many garbage securities. So two of this week’s developments look like good news, however small:
(1) The federal government refused a second bailout for The CIT Group. (You can read about their first bailout, last December for $2.3 billion, here.) CIT is expected to file for bankruptcy, which isn’t great news, as CIT is the largest lender to small businesses and some of that lending may stop, and as the government/taxpayers’ $2.3 billion stake gets wiped out. But it may be the lesser of two evils. As the WSJ points out, CIT is only one-tenth the size of Lehman Brothers,and the systemic risk in refusing this request seems much less than the moral hazard risk of granting it. (I must admit, the WSJ does seem to have the best conservative editorial page in the business. Not that that’s my highest compliment.)
(2) Calpers, the largest pension fund in California, is suing the three leading credit rating agencies for providing “wildly inaccurate” AAA ratings of structured investment vehicles (SIVs) of various dodgy assets including subprime mortage-backed securities. The amount of the suit wasn’t disclosed, but Calpers bought $1.3 billion of bad SIVs in 2006, so that’s a good lower-bound estimate. While market discipline would be preferable to billion-dollar lawsuits, that horse escaped from the barn a long time ago. This is the first I’ve heard of anyone holding these agencies accountable.
Just in case you missed cartoonist Ward Sutton’s hilarious rendering of the General Motors bailout in last Sunday’s NYT, “GM/DC: Back in the Black,” here’s the link.
And in case that whets your appetite for the old school video of AC/DC’s original . . .
His term ends in early 2010. Obama’s decision on his fate will probably come much sooner. I tend to think he should be reappointed, not least because the apparent alternative is Larry Summers. I’d like to see some other macro/policy economists get consideration — Brad DeLong, for example — but I’ve heard basically no other names mentioned besides Bernanke and Summers.
I think many if not most economists would give Bernanke about a D for his handling of the housing bubble and the expansion of 2005-2007 but at least a B for his handling of the financial crisis and macroeconomic fallout. (It would be an A if not for the mixed signals in bailing out “little” Bear Stearns and not “big” Lehman Brothers.) It seems like he’s learned that bubbles are not a benign phenomenon and that the Fed can act to stop them.
Last Sunday’s NYT had an excellent point-counterpoint on the question of Bernanke’s reappointment, a true heavyweight matchup between Nouriel (“Dr. Doom”) Roubini, arguing for, and Monetary History of the United States co-author (with Milton Friedman) Anna Jacobson Schwartz arguing against. Both columns are well worth reading and re-reading over the next few months.
(This time you’ll have to find the Clash video yourself. Sorry.)
So many problems out there — health care costs, climate change, mortgage crisis — and so many complicated solutions being pursued. Some solutions that economists would tend to favor that do not seem to be part of the current political debate involve eliminating a couple of expensive tax loopholes, for health insurance and mortgage interest, and imposing a carbon tax.
All of these would raise a lot of revenue, and tax increases of any kind are like kryptonite to politicians and of course counterproductive in a recession, but they could be made revenue-neutral by cutting tax rates or increasing the personal exemptions or standard deductions. Or, when the economy has recovered, tax increases like these could be part of a deficit-reduction package.
The federal government’s “cash for clunkers” program has been the hot economic news item the past two weeks. The program is novel, visible, finding lots of takers, and by far the most popular item in the stimulus package. It is not without its critics, however, on both the economic and environmental fronts. Let’s review the debate.
The first national “cash for clunkers” proposal, as far as I know, came from the eminent macro/policy economist Alan Blinder in a NYT column about a year ago. Blinder noted that smaller-scale programs had already been implemented in several states and Canadian provinces. He touted it as a “public policy trifecta”: (1) It would help the economy at low cost: he estimated the cost of a good national program at about $20 billion, cheap in comparison with the then-stimulus of $168 billion (not to mention this year’s $787 billion stimulus). (2) It would do a lot to reduce exhaust pollution, an estimated 75% of which comes from cars over 12 years old. As for the apparent waste of retiring old cars that still have some life in them, he said they could be refitted with new emissions controls and resold, or their scrap metal could be recycled. (3) It would be progressive in its impact, since it’s mostly poor people that drive those old clunkers.
My former graduate macro professor Willem Buiter had a typically hilarious and typically negative response, sarcastically titled “Please torch my car.”
. . . would of course be the first Federal Reserve Chairwoman. But the word on the street is that San Francisco Federal Reserve Bank President Janet Yellen is said to be on the very short list of possible Fed Chair nominees, along with Larry Summers and a Ben Bernanke re-appointment.
Yellen is an intriguing possibility. Hands-on experience as S.F. Fed president (including a seat right now on the Federal Open Market Committee, the Fed’s policy-making group), stints on the Fed Board of Governors and as chair of the Council of Economic Advisers during the Clinton Administration, longtime tenured economics professor at Berkeley. I’ve read a few of her papers on macro theory and policy, and she writes unusually well for an economist. (Her review article on efficiency-wage theories of unemployment was probably the clearest thing I read in my entire first year of grad school.) And for what it’s worth, she’ll have good advice at the breakfast table: she’s married to economics Nobel laureate George Akerlof. (Democrats are big on the whole “two for the price of one” concept, no?)
For the first time since the recession officially began in December 2007, the unemployment rate fell last month, from 9.5% to 9.4%. Professional optimists had already been declaring the recession over, and this welcome news added fuel to their fire. How good is this news, anyway?
As always, the first place is to look is the original report from the Bureau of Labor Statistics (BLS). First, a few important component numbers:
-155,000 = change in total employment from June to July
-267,000 = change in total unemployment “
+637,000 = change in total number of people not in the labor force “
The first two numbers look good: the decline in employment is much smaller than in previous months, and the ranks of the unemployed fell by more than a quarter million. But the last number is the largest and strongly suggests that hundreds of thousands of people have simply given up looking for work. Small wonder, when there are 5.0 million Americans who have been unemployed for six months or more. (That’s more than the total number of unemployed just a few years ago, I believe.)
No big surprise today — the Federal Reserve decided to keep its short-term interest rate target unchanged at 0 – 0.25%. Nobody expected them to raise rates, and there was no real way to lower them, so voila!
The bigger story, which is really not all that big but is being presented as a Fed statement that the recession is all but over, is that the Fed said it would wrap up its $300 billion purchase of Treasury securities a bit ahead of schedule, by the end of October. Considering that the Fed has already bought $253 billion of those securities, this is no big deal and doesn’t preclude another big monetary stimulus if conditions worsen in the next few weeks. (The conspiratorially minded could even charge that the Fed is ramping up its monetary stimulus by buying all those bonds sooner, but nobody appears to be saying that.)
It’s all a good excuse for a video clip from a good and acclaimed band that I’m still hoping to develop a passion for someday:
Somewhat lost in this week’s 
