200 posts later, I’m still agreeing with Nouriel “Dr. Doom” Roubini, whose prognosis for the U.S. economy in 2012 is not good.
The best I can say, and this is better than it sounds, is that recovery has a way of taking us economists by surprise. The 1991 and 2001 recessions look short and shallow in hindsight, but they seemed pretty bleak at the time, like classic “liquidity traps” where monetary policy was powerless to prime the pump. And the economy in 1980-82 seemed to be in absolute shambles. Most of the business cycle literature I’ve read deals with the causes of recessions and depressions, but I’m told there’s a substantial literature on the forces of recovery. I plan to acquaint myself with it this year, and to blog a fair bit about where recovery — especially a genuine, non-bubble-driven recovery — might come from.
The good:Initial jobless claims last week were at their lowest level in three and a half years, back to May 2008, before the financial panic hit and before the recession had been declared. The four-week average is at its lowest level since July 2008. Last week’s number still looks high (366,000), but keep in mind that even in good times the number is usually over 300,000 — layoffs are a regular feature of the U.S. labor market. It should also be noted that unlike the recent drop in the official unemployment rate (from 9.0% to 8.6%), this improvement is not mostly an artifact of unemployment people giving up on their job search and dropping out of the labor force. These are initial claims for unemployment insurance, by people who previously were working. So if this number is down, then either there were fewer layoffs or (less likely, I’d think) fewer laid-off workers bothered to apply for unemployment insurance.
The bad:Nearly half of Americans (48%) are either poor or near-poor, according to new Census data. That includes 49 million who are classified as living in poverty, plus 97 million who are classified as “near poor,” defined as having an income between 100 and 200 percent of the poverty line. Once upon a time many people would dismiss Census poverty data by noting that they failed to include government welfare spending and other anti-poverty tax and transfer policies, and also failed to adjust for the huge variation in the cost of living in different regions of the nation. But the new figures reflect the recently revised Census methodology, which answers those objections. One might also object that the low-income threshold is actually quite high — $45,000 for a family of four — but I would guess that the objectors have not tried to support a family of four on that amount lately. The AP article quotes Robert Rector* of the Heritage Foundation with the old conservative argument that many of these people have TV’s, cars, and houses, ergo they’re not really materially deprived, but I think he’s missing a couple things:
Poverty is a relative measure as well as an absolute measure. Yes, $45,000 would have been opulence for, say, a family in colonial America (which apparently had the highest standard of living in the world at the time). But colonial families grew their own food, spun their own cloth, and were otherwise generally self-sufficient. Also, yesterday’s luxuries often become today’s necessities. For example, two decades ago I spent about $25 a month to stay connected, in the form of basic landline service. Today, staying connected costs me about $350 a month, for cable TV and Internet, cellphone, etc. You can live without all those things, but when everyone around you has them, you will know deprivation. Just because it’s a social construct doesn’t mean it’s bogus.
The burden of consumer debt: Entering the recession, consumer debt was at an all-time high relative to income. Household debt service payments averaged 14% of income and about 28% for renters. Since the recession began, many households are obviously much poorer and finding it much harder to make those payments. Many have, of course, not merely fallen behind but lost their houses and other collateral. The overall debt-service-to-income statistics show that households are successfully deleveraging,with the number down to 11%, but the average surely hides a lot of variation. I expect debt is weighing very, very heavily on most near-poor households — those that still have their houses, that is.
When members of a household are unemployed or underemployed, they are probably just barely keeping up with the living standards of the community or even their own living standards of a couple months or years ago. It’s gotta be painful. Pundits and politicians ignore that reality at their own peril.
(*Also the same person from whom I first heard the suggestion that government policy on poverty should be based on the words of the apostle Paul in 2 Thessalonians 3:10: “That if any would not work, neither should he eat.” I last heard it from Michele Bachmann.)
The euro has always struck me as Germany’s final success at dominating Europe. What two world wars couldn’t accomplish, the Bundesbank could. By the 1990s, Germany looked like such a model of economic rectitude that eleven of its neighbors and near-neighbors (now 16, not counting principalities) were happy to formally link their currencies to Germany, their monetary policies to a European Central Bank that was a continental version of the Bundesbank, and their fiscal policies to a treaty that said deficits and debt should be under 3% and 60% of GDP (which seemed to reflect German fiscal conservatism).
Fiscal conservatism hasn’t fared well since recession began in late 2007. Even without the countercyclical tax cuts and spending increases that many governments enacted, falling GDP has caused most countries’ debt/GDP ratios to skyrocket. Even Germany’s is now over 80%. (And contrary to conventional wisdom, it’s just not true that the European economies now facing debt crises, with the exception of Greece, were running up huge deficits and debt prior to the recession; c.f. Krugman and Dean Baker.)
The news for much of this year has been of sovereign debt crises in Greece and the other “PIIGS” countries (from the “BAFFLING PIGS” mnemonic for the first 12 euro members), Portugal, Ireland, Italy, and Spain. But the most shocking economic news for me this year was the recent report that they held a German bond auction and “nobody” came. Not really nobody, but the German government was only able sell three-fifths of the “bunds” they intended to sell. To be sure, they’d have sold more if they’d been willing to accept lower bids; these bonds were supposed to pay just 2% interest, and that’s about where the yields ended up. The linked article quotes some observers who say the weak auction was due to investor concerns that Germany might be left holding the bag for PIIGS and other euro countries that can’t pay their debts. Others have said it was mostly about currency risk, i.e., the risk that the euro might massively depreciate or even crack up over the 1o-year lifetime of the bonds.
Could a euro crack-up happen? Some experts think it actually will happen, perhaps soon. Peter Boone & Simon Johnson:
‘The path of the euro zone is becoming clear. As conditions in Europe worsen, there will be fewer euro-denominated assets that investors can safely buy. Bank runs and large-scale capital flight out of Europe are likely.
‘Devaluation can help growth but the associated inflation hurts many people and the debt restructurings, if not handled properly, could be immensely disruptive. Some nations will need to leave the euro zone. There is no painless solution.
‘Ultimately, an integrated currency area may remain in Europe, albeit with fewer countries and more fiscal centralization. The Germans will force the weaker countries out of the euro area or, more likely, Germany and some others will leave the euro to form their own currency. The euro zone could be expanded again later, but only after much deeper political, economic and fiscal integration.’
At least the run on the euro is off to a slow start. The euro has had a rough November, but its decline against the dollar was only four and a half cents, or about a penny per week. The euro’s price against the dollar is still higher now than it was in most of 2005-2006.
As has been noted, euro membership has arguably gone from a privilege to a bane for these weaker countries, and possibly for all of them. Before the recession, their governments and firms could borrow cheaply on the international market, as the relatively stable euro provided insurance for the lenders, against getting repaid in devalued currency. But now euro membership takes away two key stabilization tools for them: monetary stimulus from their own central bank, and currency adjustment (a devaluation could help GDP through increased net exports).
The messy euro situation looks like the big wild card for the U.S. economy. (Here the conventional wisdom is actually correct, in my view.) Although the blow to U.S. exports from a double-dip European recession could theoretically be offset by more expansionary fiscal policy, the political prospects for additional stimulus have been dim for a long time. Things would have to get a whole lot worse here before any new stimulus could get past the Republicans in Congress, and maybe not even then.
Today’s new Bureau of Labor Statistics report reveals the instant cure for unemployment: Stop looking for work. I say that not as advice or to be callous, just to explain how it is that November’s meager job growth could coexist with a pretty sizable drop in the unemployment rate, from 9.0% to 8.6%.
Technically, the precise reason is that the low number of jobs added, 120,000 (which is well under the 210,000 needed to restore 5% unemployment in eight years) comes from the BLS’s survey of companies (the “establishment survey”), whereas the 8.6% number comes from its separate survey of households. But even in the household survey, the basic story is the same. The longstanding economic definition of unemployed is not merely “not employed” but “not employed yet actively looking for work.” And it looks like the bulk of the reduction in unemployment was from people who stopped looking.
In the household sample, total unemployment fell by 594,000, which looks great, except that employment grew by less than half that (278,000). “Not in the labor force” (i.e., not working and not looking) grew by much more (487,000). The labor force itself (employed plus unemployed) shrank by 315,000. It’s hard to blame people for giving up looking for work when there are currently 4.2 times as many unemployed as there are job vacancies. (The number was 1.8 when the recession began three years ago.)
Rather than focus on the official unemployment rate or broader measures like the U-6 unemployment rate (now 15.6%; includes discouraged job-seekers and involuntary part-timers), I prefer to focus on the employment-to-population ratio, which is a simpler measure that avoids messy distinctions (e.g., actively vs. passively looking for work vs. not looking at all but might take a job if offered). The employment-to-population ratio has hardly changed at all since September 2009, fluctuating narrowly around its current value of 58.5%. (By comparison, it was 62.0% at the worst of the 2001 recession hangover.)
One could wax metaphysical about work as a bourgeois construct and argue that people are finding spiritually rewarding alternatives to work, but that doesn’t seem to be the case for all that many people here. The BLS report shows that 6,595,000 adult Americans are currently not working and not looking but want to work now. That number (seasonally adjusted) has never been larger — not even at the trough of the recession in mid-2009 and not even when the unemployment rate was over 10%.
If the labor force keeps on shrinking, the official unemployment rate could fall fast, but that’s probably not how we want to get there.
UPDATE 3 DEC. 2011: Brad DeLong does the number crunching I was too lazy to do and produces a specific breakdown of how much of the unemployment rate decline came from labor force shrinkage (25 basis points, or 0.25 percentage points) and how much came from employment growth (15 basis points). So if nobody had left the labor force, the unemployment rate would have fallen to 8.85%.
Chris Rock has a great bit where he says he still loves rap music but is tired of defending it, the misogynistic lyrics in particular. I’ve been a longtime advocate of the Federal Reserve and continue to defend it against various conspiracy-mongers, but I really can’t defend this at all: “Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress.”
The story is not from a conspiracy peddler or a grandstanding politician, but from Bloomberg News, and actually involved investigative reporting. The $13 billion figure is the profit the banks earned from subsidized low-interest loans, etc. The Fed’s total commitment, including loan rollovers, guarantees, and lending limits, was an eye-popping $7.7 trillion. Now, when I first heard a similar figure presented by Congressman Bernie Sanders a few months ago, it looked like a distortion, because it included rollover loans (if I loan you $100 and you pay me back a month later and get a new loan and so on for 12 months, have I loaned you $100 or $1200?) and the total assets on the Fed’s balance sheet have never been much larger than $2 – 2.5 trillion, with a maximum of $1.5 trillion that could be loans to banks. But the non-rollover figures are still staggering. The banks “required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day.”
Other areas for concern (or outrage, take your pick):
These loans covered a much longer period that one might think. They were greatest at the height of the fall 2008 crisis, but they began in August 2007 and lasted until April 2010. Was such a massive amount of subsidized lending justified this whole time?
The identities of the banks were kept secret, until Bloomberg obtained them via a Freedom of Information Act request. Now, the Fed’s usual lender-of-last-resort apparatus, the discount window, is supposed to keep borrowers’ identities secret, but traditionally there was at least supposed to be some stigma attached to discount loans, so that banks didn’t take advantage of the Fed’s low interest rates by borrowing too much. The Fed wouldn’t out them, but it might audit them. While there is a rationale for keeping the borrowers’ names secret — you don’t want to spark a panic by signaling that these banks are in trouble — surely this secretiveness should have some limits? Last year’s Dodd-Frank financial reform bill requires disclosure of discount loans after a two-year lag. This seems modest to me, but tellingly, Fed officials are wringing their hands and saying this will destroy discount lending.
What kind of lender of last resort charges the lowest interest rate in town? The interest rates on these loans got as low as 0.01%. This is a huge subsidy to banks that supposedly can’t get loans anyplace else. A few years ago the Fed reset its discount rate (the rate it charges its borrowers) a notch above the federal funds rate (the rate banks charge each other), presumably so that banks wouldn’t take advantage of the Fed’s low rate. Yet the big banks got to borrow at interest rates below that, and below what anyone else was offering.
The loans appear to have been completely unconditional. This could maybe be justified at the peak of the 2008 crisis, when it seemed like fast action was needed, but before and after too? The Federal government’s TARP loans to banks (which, at $700 billion, now appear puny by comparison) were basically unconditional but at least attempted to impose some restrictions on banker bonuses. With the benefit of hindsight and time, more meaningful restrictions, like radically changing the pay structure so as to discourage taking wild risks with other people’s and taxpayers’ money, and limits on leverage, could be devised, and the Fed wouldn’t have worry about getting them through Congress.
I still favor an independent central bank, with minimal political meddling. But these loans don’t look like the work of an independent entity at all. They scream “regulatory capture” by big banks. Gigantic, secret, and unconditional subsidies like these are a recipe for moral hazard that could make the next financial crisis one of those sequels that’s bigger, costlier, and suckier than the original.
Audit the Fed? Yeah, why not.
UPDATE, 2 DEC. 2011: Felix Salmon and Brad DeLong teach me that my point that the lender of last resort should not have the lowest rates in town was made a long, long time ago, by Walter Bagehot: “Lend freely, but at a penalty rate.” DeLong writes:
“Without the Fed and the Treasury, the shareholders of every single money-center bank and shadow bank in the United States would have gone bust.”
The Republican “starve the beast” strategy of running up huge deficits (preferably by cutting taxes on the wealthy and raining money on military contractors) and then using them as an excuse to cut social programs is nothing new, but this interview tidbit with iconic conservative economist Friedrich von Hayek was new to me:
‘A 1985 interview with von Hayek in the March 25, 1985 issue of Profil 13, the Austrian journal, was just as revealing. Von Hayek sat for the interview while wearing a set of cuff links Reagan had presented him as a gift. “I really believe Reagan is fundamentally a decent and honest man,” von Hayek told his interviewer. “His politics? When the government of the United States borrows a large part of the savings of the world, the consequence is that capital must become scarce and expensive in the whole world. That’s a problem.” And in reference to [David] Stockman, von Hayek said: “You see, one of Reagan’s advisers told me why the president has permitted that to happen, which makes the matter partly excusable: Reagan thinks it is impossible to persuade Congress that expenditures must be reduced unless one creates deficits so large that absolutely everyone becomes convinced that no more money can be spent.” Thus, he went on, it was up to Reagan to “persuade Congress of the necessity of spending reductions by means of an immense deficit. Unfortunately, he has not succeeded!!!”’
The snippet comes from this article about David Stockman, former Republican Congressman and Reagan Office of Management and Budget Director. Another keeper:
‘The deficits were intentional all along. They were designed to “starve the beast,” meaning intentionally cut revenue as a way of pressuring Congress to cut the New Deal programs Reagan wanted to demolish. “The plan,” Stockman told Sen. Daniel Patrick Moynihan at the time, ” was to have a strategic deficit that would give you an argument for cutting back the programs that weren’t desired. It got out of hand.”’
All of which is worth remembering the next time you’re subjected to the hand-wringing of yet another media or political figure who says the deficit is our biggest problem. (Usually these people don’t bother to mention the 25 million unemployed and underemployed, or the $1 trillion output gap.) Yes, the deficit is a problem, but don’t forget where it came from, and especially don’t trust anyone who says reversing the 2001 tax cuts or cutting military spending can’t be part of the solution.
The so-called “supercommittee” of six Democrats and six Republicans, charged last summer with drafting a deal for $1.2 trillion in spending cuts over ten years, failed to do so by today’s deadline. The so-called teeth in last summer’s agreement to form a supercommittee was that Congress would either accept their proposal or submit to $1.2 trillion in automatic, across-the-board spending cuts. Is this good news, bad news, or irrelevant?
Good, says Paul Krugman. To be precise, he said that last week. His reasoning was that cutting spending is counterproductive in a time of economic depression, as it will just exacerbate the depression, so it’s best that they didn’t make a deal to cut spending. Today, he’s a bit more nuanced, noting a Bloomberg.com story about how the supercommittee’s failure is rattling markets but highlighting this aspect of the story (Krugman’s words):
‘. . . what it actually says is that market players fear that the absence of a debt deal means no stimulus. So the actual fear is not that spending won’t be cut enough, it is that it will be cut too much — which actually makes sense, and is consistent with the action in stock and bond markets.
‘But how many readers will get that? The way it’s presented reinforces the false notion that the deficit is the problem.’
Bad, says Kevin Drum. At least if you’re someone like Kevin Drum, Paul Krugman, or me, who thinks it’s foolish to cut social spending in a depression and really isn’t all that keen on slashing the social safety net in general. Unlike Krugman, Drum thinks many if not most of the automatic spending cuts will go into effect. The deal is only good if you’re a Republican who lives to cut social programs. In other words, the Democrats got rolled again, just as in the bogus “debt ceiling authorization” debate. Drum:
‘In any case, this should basically be viewed as a total victory for Republicans. Any alternative plan would have included some tax increases, so failure to come up with an alternative means that we get a big deficit reduction that’s 100% spending cuts, just like they wanted. And the 50-50 split between domestic and defense cuts was always sort of a joke. Republicans never had any intention of allowing the Pentagon’s half of the cuts to materialize, and the domestic spending half of the cuts was about as big as they wanted them to be. Big talk aside, they know bigger cuts would run the risk of seriously pissing off voters.
‘So Republicans got domestic spending cuts that were about as big as they really wanted. They know they’ll never have to implement most of the defense cuts. And there are no tax increases.’
Irrelevant, say the bond markets. The demand for ten-year U.S. Treasury bonds was actually up slightly today, whereas really bad news about the long-term U.S. fiscal position should send demand down and interest rates up. Either the market regards $1.2 trillion over 10 years as no big deal (and it is rather small compared with a national debt of $14 trillion), or they were expecting the supercommittee to fail all along. Or both.
I’d been meaning to write about the Occupy Wall Street movement, but now I’m intimidated, having just read Mohammed el-Erian’s eloquent take on the movement. Although el-Erian, as CEO of the PIMCO investment behemoth, is about as high up the 1% tree as one can be, he is more than sympathetic to the movement. Sympathy is easy. It’s also easy to criticize the movement for its lack of unity and seeming cacophony of voices. But El-Erian, unlike many observers, sees beyond the surface and makes out a powerful, “peaceful drive for social justice,” not unlike the protests in Tunisia and his home country of Egypt:
OWS may pale in comparison to these country examples. Yet it would be both foolish and arrogant to dismiss three important similarities:
First, the desire for greater social justice is a natural consequence of a system shown to be blatantly unfair in its operation and, to make things worse, incapable of subsequently holding accountable people and institutions.
In the US, it is about a system that privatized massive gains and then socialized huge losses; allowed bailed-out banks to resume past behavior with seemingly little regulatory and legal consequences; and is paralyzed when it comes to alleviating the suffering of victims, including millions of unemployed (too many of whom are becoming long-term unemployed, slipping into poverty, and losing access to safety nets). The result is a visible and growing gap between the haves and the have-nots in today’s America.
Second, OWS’s followers will grow as our economy continues to experience sluggish growth, persistently high joblessness, and budgetary pressures that curtail spending on basic social services (such as education and health). Other internal and external realities will also play a role.
At home, our elected representatives seem incapable as a group to respond properly to severe economic and social challenges. Continuous (and increasingly nasty) political bickering undermines the required trio of common purpose, joint vision, and acceptance of shared short-term sacrifices for generalized long-term benefits.
Internationally, Europe’s deepening debt crisis amplifies headwinds undermining an already sluggish American economy that, in the absence of better policy responses, is on the brink of another recession, Should the economy slip from treading to taking on water, the social implications would be profound given that we already have high unemployment, a large fiscal deficit and, with policy interest rates already floored at zero, little policy flexibility.
Third, advances in social media help overcome communication and coordination problems that quickly derailed similar protests in the more distant past.
I couldn’t have said it better myself. I can only hope that el-Erian will speak out forcefully for better government policies, namely the type of wholesale changes that we need to tackle these huge problems that he identifies.
Count me among the skeptics who believe the Fed has pretty much already done all it can to pull the economy out of the deep hole that it’s in. Zero short-term interest rates, purchases of longer-term bonds to keep long-term rates at historic lows, backstopping various asset markets, emergency loans to banks, etc. It’s helped avert a Second Great Depression, which is nothing to sneeze at. Some economists who I usually agree with are convinced that aggressive new policies could pull us out of the current Little Depression, too. They’re smarter than I am, but they have yet to convince me that these policies could work.
The tonic du jour is nominal GDP targeting, by which the Fed would try to reach a certain level of nominal GDP — say, $16. 3 trillion (the current level of potential GDP assuming that, as I’ve read, current GDP is 7% below its potential. Do the math and that’s a $1.1 trillion gap between current and potential GDP). Christina Romer, Obama’s first head of the Council of Economic Advisors, recently backed this approach in a New York Times op-ed. Scott Sumner has been pushing it all along, and there’s now a whole new school of macroeconomics, “market monetarism,” which revolves around nominal GDP targeting. (Economists: see here for Ed Dolan’s helpful explanation of how nominal GDP targeting is a form of Milton Friedman-style monetarism.)
Now, once the Fed announces this new target, how does it actually get there? Romer provides the clearest answer I’ve seen yet:
‘Though announcing the new framework would help, it probably wouldn’t be enough to close the nominal G.D.P. gap anytime soon. The Fed would need to take additional steps. These might include further quantitative easing, more forceful promises about short-term interest rates, and perhaps moves to lower the exchange rate. . . .’
‘Nominal G.D.P. targeting would make it more likely that the Fed would take these aggressive actions.’
That’s clear, but so is weak tea. None of these actions sound all that different from what the Fed is already doing. Proponents of nominal GDP targeting seem to be counting on a huge “announcement effect,” i.e., that people will hear about the Fed’s commitment to raising GDP and will assume that Fed will make it happen. Yet the Fed’s goals already include maximum sustainable employment, which is the employment rate you’d have at potential GDP, so why should this change the public’s behavior? (Although there is a difference between monetary policy goals, like low unemployment, and targets, which now include interest rates, it’s a rather subtle one. I don’t see why it would move markets.)
Another popular tonic is a higher inflation target. Right now the Fed’s unofficial but almost universally acknowledged inflation target is 2%, and for the past few years the core inflation rate has been below or near 2%. When inflation is very low, real interest rates (nominal interest rates minus inflation) can still be high even when nominal rates are also low. In the U.S. in the early 1930s, for example, nominal rates plunged toward 0%, but deflation was raging, so real interest rates were actually quite high. Economic historian Nick Crafts, in a Financial Times op-ed, says that Britain’s recovery from the Great Depression was greatly aided by a combination of low nominal interest rates and rising inflation rates — i.e., negative real interest rates — which promoted homebuilding. Crafts says targeting a higher inflation rate — say, 4% — could do the trick today.
Again, I just don’t see how you get there. Would I like to see lower real interest rates? Sure. But for 4% inflation to happen, a lot of other things have to happen first. Banks need to loan out their excess reserves, people and businesses need to buy stuff with those loans, the money needs to be redeposited in banks, more loans need to be made, etc. That’s how monetary policy works — when it works. Right now, the banks have over a trillion dollars in excess reserves that they’re just sitting on. Banks are not eager to lend, and businesses and households are not eager to borrow. Classic liquidity trap.
Nominal GDP targeting and higher inflation targets sound radical, but are they? Chicago Fed President Charles Evans said in a speech this week that he viewed the 2% inflation target as a medium-run target, not a short-run target, saying that as long as inflation averaged out to 2% over a multi-year period, higher inflation rates would be acceptable in the short term. That statement is consistent with either a nominal GDP target (shoot for low inflation when real GDP is high, tolerate higher inflation when real GDP is low) or an inflation target (let inflation rise when unemployment is high), which suggests that neither of those policies is all that new. Both seem to promise much more than they could ever deliver.
This just in: The Federal Reserve does not control the universe.
Stated differently: The economy is in a liquidity trap (macroeconomists). Or, monetary policy has shot its wad (Pres. Obama to economic adviser Christina Romer in their first meeting, according to Ron Suskind’s Confidence Men). Krugman has been saying this for three years now, and so have a lot of other economists. But until today, I had yet to hear it from a Fed official. Fed Chairman Ben Bernanke has called for Congress to pursue a more expansionary policy fiscal policy, thus implying but not explicitly saying that the Fed has done just about all it can. But in a speech today, Chicago Fed President and Federal Open Market Committee member Charles Evans had the guts to state the obvious:
“I largely agree with economists such as Paul Krugman, Mike Woodford and others who see the economy as being in a liquidity trap: Short-term nominal interest rates are stuck near zero, even while desired saving still exceeds desired investment. This situation is the natural result of the abundance of caution exercised by many households and businesses that still worry that they have inadequate buffers of assets to cushion against unexpected shocks. Such caution holds back spending below the levels of our productive capacity. For example, I regularly hear from business contacts that they do not want to risk hiring new workers until they actually see an uptick in demand for their products. Most businesses do not appear to be cutting back further at the moment, but they would rather sit on cash than take the risk of further expansion.”
Evans went on to suggest a number of measures the Fed should still take, like buying up more mortgage-backed securities to get the housing market going (I’m still on the fence on that one — yes, this is the economy’s weakest sector, but how do you do this without reinflating the housing bubble?), while keeping mum on the subject of whether this would do anything more than just nudge the economy forward, as opposed to bringing us anywhere near full employment. I suppose the question is moot, as long as nobody else is willing to act. Congress is not only unwilling to consider fiscal stimulus but seems to be on the verge of massive budget cuts, either by following the “super committee’s” blueprint or letting an autopilot crash the plane.
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:
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?
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.
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.
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:
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.
. . . 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 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.
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. (Then again, the article implies that Obama’s budget next February will ask every agency for spending freezes or 5 percent cuts.) 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.
Perhaps a better analogy than Hoover in 1932 is 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.
UPDATE, 21 November 2009: Krugman has an excellent piece on the matter here, and a “wonkier” one on deficits and interest rates here.
By the way, I changed the heading from “Barack Hoover Roosevelt?” to the current one, because FDR is so widely associated with pro-active steps like the Works Progress Administration and other jobs programs, fixing and reforming the banking and financial system, and ending the early-’30s deflation by going off the gold standard. While his budget-balancing disaster of 1936-37 and his too-small budget deficits in other years show that he was no Keynesian when it came to fiscal policy, I’d be delighted to see Obama commit to policies that created three million relief jobs per year, as FDR did. The stimulus is creating a fraction of that number, which seems unsurprising considering that the job creation is indirect: rather than create new agencies to directly employ workers in various projects, the government is handing out money to lucky companies in the hope that they’ll hire people. The fear of creating new federal government employees seems even stronger than the fear of deficits.
UPDATE, 4 December 2009: Obama may have talking out of school when he said that last month. In an interview yesterday just prior to the jobs summit, he said the following:
He ruled out an immediate effort to reduce the $1.4 trillion budget deficit until the economy rebounds further and the 10.2% unemployment rate begins to decline. Focusing on the deficit too soon, he said, could risk a “double-dip recession.”
“If we move too abruptly in that direction and we’re not thinking about all the people out there who aren’t working and businesses who aren’t making money, then we’re going to be in a negative spiral that I think would be very destructive,” the president said.
Instead, Obama said, any additional spending and tax cuts intended to spur job growth should be balanced later with deficit-reduction efforts. “The most important thing we could do for our deficits is to have robust economic growth and have people working and businesses selling products and they’re paying taxes,” he said. “That’s a hole that we can fill.”
On the other hand, he also said, “It is not going to be possible for us to have a huge second stimulus, because frankly, we just don’t have the money.” Apparently the government jobs initiatives that the article mentions will somehow not involve government money. Nice free lunch if you can get it.
So what we have is a mixed bag, but I’d say the bag is more empty than full. While it is a relief to hear the president say that he’s aware that sudden deficit-reduction measures could trigger a double-dip recession, he has yet to retract his earlier remark, i.e, this one to Fox News:
“It is important though to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession,” he said.
Yes, if in a spontaneous shower of sparks, holders of U.S. Treasury bonds suddenly decided that mid-1990s debt/GDP ratios (like we have now) were completely unacceptable and decided to dump their T-bonds, interest rates would go up and the economy would go south. Except the economy has already gone south. And the debt-doomsday scenario (which some people have been predicting for decades) just ain’t very plausible. What is plausible, and seems to be the consensus forecast of economists, is that unemployment stays in double digits well into next year and even rises (despite the good news for November). By ruling out any more stimulus spending to counter that unemployment, Obama seems to be ruling in a depression.
Hard to believe that news of double-digit unemployment could be considered good news, but in this case it really is. The standard unemployment rate edged down from 10.2% in October to 10.0% in November; the number of jobs fell once again, but by 11,000, by far the smallest decline in about two years. Consensus forecasts had been for a slight uptick in the unemployment rate and about 150,000 jobs lost.
By one measure, this news from the BLS (Bureau of Labor Statistics) is even better than that. The 11,000 figure is from the BLS’s survey of employers (i.e., “establishments,” “nonfarm payroll employment”), whereas the BLS does a separate survey of households, which shows an increase in employment of 227,000 and a reduction in unemployment of 325,000. (See Table A in the BLS report.) I’m guessing the reason that the administration and the media did not trumpet the household data is because those data are considered less reliable than the establishment data. Still, they’re not worthless, and they are the basis of the unemployment rate figures.
President Obama correctly notes that we’re still not out of the woods yet. The unemployment rate is still about double its normal “full employment” level. The BLS’s alternative measures of the unemployment rate are always worth a look, and they show that the labor market is not only still deep in the woods but in some respects not improved at all:
The long-term unemployment rate was slightly higher in November than in October (5.9% using the standard seasonally adjusted (SA) figure, 5.6% using the non-seasonally adjusted (NSA) figure).
The most comprehensive measure of unemployment and underemployment, the U-6 unemployment rate (which counts all unemployed plus discouraged job-seekers plus involuntary part-timers), is still extremely high: 17.2% (SA) or 16.4% (NSA). The SA figure fell from 17.5% to 17.2%, but that seems to be the seasonal adjustment factor at work. The NSA figure, which corresponds to actual people without any such adjustment factor, was actually slightly worse in November, rising from 16.3% to 16.4%.
With roughly one-sixth of the potential labor force either jobless or underemployed, this is no time to declare victory and withdraw on the job-creation front. Nate Silver argues persuasively that the case for a strong federal jobs bill is a strong as ever.
President Barack Obama outlined new multibillion-dollar stimulus and jobs proposals Tuesday, saying the nation must continue to “spend our way out of this recession” until more Americans are back at work.Without giving a price tag, Obama proposed a package of new spending for highway, bridge and other infrastructure projects, deeper tax breaks for small businesses and tax incentives to encourage people to make their homes more energy efficient….
A major part of his package is new incentives for small businesses, which account for two-thirds of the nation’s work force. He proposed a new tax cut for small businesses that hire in 2010 and an elimination for one year of the capital gains tax on profits from small-business investments.
Obama also proposed an elimination of fees on loans to small businesses, coupled with federal guarantees of those loans through the end of next year. He called for more government spending on infrastructure projects such as roads, bridges and water projects and for new tax breaks for consumers who invest in energy-efficient retrofits in their homes.
Works for me. While I’d prefer to see more direct job creation in the form of federal jobs programs a la the Works Progress Administration or other New Deal agencies, my main reaction is what a difference a couple of weeks makes.
“Though unemployment will remain stubbornly high, and the economic recovery sluggish in 2010, the government doesn’t need to provide another round of stimulus spending to keep the economy afloat, they say.”
That’s a mighty big “though” there! Just how stubbornly high do they expect unemployment to remain?
“The forecasters are not upbeat about the outlook for the job market next year. Though the latest employment data point to the end of a nasty cycle of job cuts, next year’s recovery is not expected to make much of a dent in the unemployment rate, which is hovering around 10 percent. The consensus is that the jobless rate drops by just two-tenths of a percent, to 9.8 percent, by the end of next year.”
That forecast is in line with other general predictions I’ve seen. And each point in the unemployment rate represents about 1.5 million jobless persons. So why not have a jobs program to relieve this stubborn problem? (First, to be fair, let’s note that two of the eleven members of the panel do support another round of stimulus. They are Jan Hatzius, chief economist of Goldman Sachs, and Ethan Harris, head of North American economics for Bank of America Merrill Lynch. When Goldman Sachs and Bank of America are the good guys, maybe there’s something wrong with my profession?)
Edward Leamer of UCLA, whom I have heretofore associated with common-sense empiricism and clear writing, channels his inner Scrooge and mixes his metaphors in offering this beatings-will-continue-until-morale-improves prescription:
‘“The time to short-circuit the negative feedback from job losses is behind us,” said Ed Leamer[,] director of the UCLA Anderson Forecast. “Let the private sector heal the economy.”’
To paraphrase Homer Simpson and Proverbs 21:13: “It’s not that we’re not listening to the cries of the unemployed, honey, it’s just that we don’t care.”
Had the pleasure yesterday of being part of the local NPR station’s (the fabulous WRVO FM) coverage of New York Governor David Paterson’s State of the State address. I was on as the “economic expert” regarding New York’s budget mess, a topic about which I admit to knowing very little (other than that I’m on both sides of the ledger, as a taxpayer and a SUNY professor). Preparing for this stint was enlightening, but the enlightenment has a long way to go.
One thing I learned is that it’s maddeningly hard to get basic information about the New York State budget, like basic breakdowns of expenditures and receipts by category (a NYS equivalent of those pie charts that the IRS includes with the 1040 instructions would be most helpful). Every line of the budget is published information, of course, so I’m not accusing anyone of suppressing it, but I have to think the public discourse about NYS’s fiscal mess would be better if people could find such basic information online. (A colleague of mine said he’d read somewhere that New York does a much worse job than most other states of putting its budget info online.) Once I get around to digging up this information in a library, I’ll post it.
In the meantime, here are some links that I found useful yesterday and some interesting things I learned:
And 2009 ends with a third straight month of double-digit unemployment, the Bureau of Labor Statistics announced today. The official unemployment rate is 10.0%, same as November; the more comprehensive “U-6″ rate of unemployment, underemployment, and discouraged job-seeking is 17.3%.
Will add more later. Meanwhile, The Replacements pretty much said it all about the job market back in 1981:
“Preventing the collapse of the financial system should probably seen as being comparable to a major league outfielder catching a long fly ball. It’s not that easy, but major league outfielders do it.”
– Dean Baker, taking issue with the NYT’s contention that Tim Geithner and Larry Summers have gotten too little credit for preventing an all-out financial collapse in the USA. Baker points out that no major country saw its financial system collapse in this crisis, so the US performance in this regard was nothing special by today’s standards.
“Bernanke is an airline pilot who pulled off a miraculous landing, but didn’t do his preflight checks and doesn’t show any sign of being more careful in the future – thank him if you want, but why would you fly with him again (or the airline that keeps him on)?”
– Simon Johnson, opposing the reappointment of Ben Bernanke as chairman of the Fed. Johnson’s preferred alternative appointment is a surprising one — so surprising that he himself scotched the idea as “crazy.”
It’s been noted that President Obama used the word “jobs” more times (29) than other word in last night’s State of the Union address. Much of that was in connection with a jobs bill that he plans to introduce, and about which he mentioned a few reasonable-sounding specifics. But indications are that he and his party will try to do this one on the cheap, rather than open themselves to the “big spenders” charge or the predictable cries of deficit scolds who think there’s nothing wrong with the economy that a good bloodletting won’t cure.
And, according to polls, last winter’s American Recovery and Reinvestment Act (a.k.a. the stimulus bill) is unpopular. It was too small to make much of a dent in the massive unemployment crisis, and the continued high and rising unemployment has led many to conclude, by that famous fallacy post hoc ergo propter hoc and with the encouragement of countless politicians and talking heads, that the stimulus actually caused the rise in unemployment. Brad DeLong has an excellent column on “America’s Employment Dilemma” right here.
Some on the right have likened the Obama stimulus bill and the still-high unemployment to the New Deal jobs programs and the Great Depression: the argument is, if they didn’t end it, then they must have caused it. (Which is kind of like blaming Doctors Without Borders for an earthquake.) Others make the less extreme but still ridiculous argument that because unemployment is still high, the fiscal stimulus must not have created a single job. (Which is hogwash — Prof. Menzie Chinn of Econbrowser shows that private studies by IHS/Global Insight, Macroeconomic Advisers, and Moody’s Economy.com estimate that the stimulus has created 1.1 to 1.6 million jobs to date, and Chinn himself estimates that the number may be more like 2.9 million. It’s wonkish stuff, but worth a look.)
Anyway, here’s an unpublished letter I wrote a few weeks ago to USA Today in response to a letter that made that bogus argument about how those New Deal programs that employed millions somehow didn’t employ anybody:
Here is another unpublished letter to the editor, this time to The New York Times, in response to a small bit of their roundtable op-ed “Questions for the Big Bankers.“ Some fine folks there, including Simon Johnson, Bethany MacLean (who wrote Enron: The Smartest Guys in the Room), and Liaquat Ahmed (who wrote The Lords of Finance, about the gold standard and the Great Depression), which made it all the more incredible to me that the piece opened with this astonishingly dumb question by James Grant:
Bankers are dealers in money. The Federal Reserve is a creator of money — since the crisis began in August 2007, it has conjured up $1.1 trillion. Given the ease with which these dollars are materialized on a computer screen, how can they be worth anything?
So here was my reply:
Editor:
James Grant says the Federal Reserve has created $1.1 trillion in new money since 2007 and asks how it can possibly be worth anything. If Mr. Grant thinks that dollars have become worthless, then, considering that money is fungible, I want him to know that I would be happy to take the worthless dollars in his bank account off his hands.
(defined, in Washington, as someone else pointing out something you did wrong)’
– James Kwak, in The Baseline Scenario, regarding arguments by a Bush II administration National Economic Council director about who is or isn’t responsible for the deficits that President Obama inherited
The economy added 162,000 jobs in March, which is the most in three years, i.e., the most since before the recession or the financial crisis began. Something to find a small measure of comfort in — small because the unemployment rate still stands at 9.7%. But this is a start.
UPDATE, 5 APRIL 2010: James Hamilton of Econbrowser thinks this is very, very good news, along with such other glimmers of light as the upward trend in manufacturing, as seen in the best reading of the Institute for Supply Management’s “PMI” indicator since 2004. (What is PMI, you and I ask? It is an acronym that no longer stands for anything in particular. It used to stand for Purchasing Managers Index; now it combines multiple measures, including new orders, inventory levels, and labor-market conditions.)
Thomas Hoenig, president of the Kansas City Fed and one of the most incisive critics of the “too big to fail” policy, has an op-ed in today’s NYT about the current financial reform bill before Congress. He says it does far too little to end “too big to fail” — while it sets up a mechanism for big failing financial institutions to be put under FDIC receivership, those financial institutions would still have the political clout to snag a bailout instead.
This may be true, but it seems to be a drawback in any financial reform bill that doesn’t call for the biggest financial institutions to be broken up into smaller ones that are not too big to fail, i.e., which can go bankrupt without significant systemic risk to the economy. Koenig has spoken elsewhere on the need to break up the biggest banks. It’s a position that finds favor among many liberal economists,including James Kwak of the Baseline Scenario (see previous link). Rep. Paul Kanjorski of Scranton, PA has proposed an amendment to give the government power to preemptively break up any financial institution whose failure would impose giant costs on the U.S. economy, but the Senate Banking Committee apparently has nothing like that on the table yet. Alas, the political clout of the big banks may well be enough to make bank size restrictions a non-starter in the Senate. Simon Johnson of The Baseline Scenario says much the same thing here.
Hoenig says that another provision of the bill actually makes things worse by narrowing the Fed’s supervisory role to just the nation’s 12 largest banks, most of which are headquartered in NYC. I do not know what the logic of this provision is, and Hoenig doesn’t say; maybe the idea is for the other banks to be supervised by the FDIC and/or other agencies instead. Whatever it is, Hoenig thinks the Fed needs to give just as much attention to the other 6,700 as to the top 12. As he points out, that would seem to be the whole point of having 11 regional Fed banks besides the one in New York.
UPDATE: Simon Johnson puts it a lot more plainly right here. For the record, Paul Krugman has his doubts that breaking up the banks would help much — see the last three paragraphs of this recent column. I’m with Simon Johnson here. By all means, crack down on fraudulent finance at institutions large and small, but I don’t see how you limit the power of the big banks without limiting their size, too.
The Senate Minority Leader has been talking tough lately about how the best way to reform the financial sector is with just three words: No. More. Bailouts.
Two main drawbacks to this Three Word Game:
(1) The collateral damage to the rest of the economy, notably the credit markets, is likely to be huge if financial behemoths fail;
(2) Politicians and policy makers know that and will tend to choose a bailout over colossal damage to the economy, no matter what they say.
One such politician is the senior Republican senator from Kentucky, who voted for the financial bailout of 2008, along with 74 other senators. (The party breakdown was 39-9 in favor among Democrats, 34-15 among Republicans.)
The NYT has a good piece on the prospects for federal breakups of the big banks. It’s not part of the financial reform bill that the Senate Finance Committee just passed, or the one the House passed earlier, but a group of Democratic senators including Sherrod Brown of Ohio and Ted Kaufman of Delaware just introduced such a measure.
Some numbers to sink your teeth into, from the article:
The banking industry has become much more concentrated as it has grown in recent years. In 1995, the assets of the six largest banks were equivalent to 17 percent of G.D.P.; now they amount to 63 percent of G.D.P. Meanwhile, the share of all banking industry assets held by the top 10 banks rose to 58 percent last year, from 44 percent in 2000 and 24 percent in 1990.
UPDATE: Simon Johnson likes the Kaufman-Brown bill and discusses it at length here. A longer post here about the specious arguments by two senators and Larry Summers in favor of preserving the size of the big banks.
That’s my interpretation of this column, anyway. The NYT‘s Andrew Ross Sorkin and all the other apologists for Goldman Sachs take a different view.
Buffett says the institutions who bought the reeking mortgage derivatives from Goldman have only themselves to blame. They just got outsmarted.
Um, couldn’t we say the same about the lady who bought the kerosene-soaked sugar from the local grocer?
Why was Goldman selling toxic products in the first place? If they knew they were toxic, isn’t that fraud? Isn’t that the basis of the lawsuit?
I’d always liked Warren Buffett prior to reading this column, but now it’s hard not to conclude that he’s just like all the rest who would maintain that nobody on Wall Street bears any blame whatsoever for the financial crisis. Buffett famously said a while back that derivatives were financial weapons of mass destruction. Caveat emptor — said destruction can only be the buyer’s fault.
UPDATE, 7 May 2010: Les Leopold, author of The Looting of America, says all this, and more, right here.
Simon Johnson has yet another fine post on the need to break up the biggest banks, for the sake of financial stability. Unfortunately, he notes, it looks like it ain’t gonna happen, that the SAFE Banking Act sponsored by Sens. Sherrod Brown (D-OH) and Ted Kaufman (D-DE) won’t make it anywhere near the Senate floor.*
The post includes a remarkable quote by Alan Greenspan, who now seems to get it:
“For years the Federal Reserve had been concerned about the ever larger size of our financial institutions. Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution. A decade ago, citing such evidence, I noted that ‘megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail.’ Regrettably, we did little to address the problem.”
Now, Greenspan is a bit like the Bible, Shakespeare, or Adam Smith — comb through all his words and you can probably find something to support your position, whatever it is. But it is striking that he acknowledges the lack of economies of scale brought by big banks and their potential for systemic damage. His regret at not addressing the problem would be more constructive if he could find a concrete proposal to support, like Sen. Kaufman’s bill, for example. (I’m reminded of the old quote A little knowledge that acts is worth infinitely more than much knowledge that is idle.)
* Update: The Brown-Kaufman SAFE Banking Amendment did make it to the Senate floor on May 6, but it was voted down, 33-61. The roll call vote is here. About two-thirds of Democrats voted for it, along with three Republicans. Among the Democrats voting No were Senate Banking Committee Chairman Christopher Dodd and New York’s Chuck Schumer and Kirsten Gillibrand.
Interesting just in its own right, this paragraph from Paul Krugman:
“… the 19th-century economy had much more flexible prices and wages than later came to be the case — not, primarily, because of different institutions, but because it was still largely an economy of small, self-employed farmers. More than half of US workers were in agriculture up until the 1880s. Peter Temin has told me — I can’t find it in a quick search — that the United States didn’t start having modern recessions, with large declines in real GDP, until the Panic of 1873; Britain started having them much earlier, because it became an industrial economy earlier.”
Or possibly not even until the Panic of 1893, which at the time was known as the Great Depression. Some economic history research that I have not seen, but which is cited confidently in this compelling column by Charles R. Morris, concludes that the 1870s contraction was actually quite mild.
Which is not to see that genuine and widely felt “hard times” never occurred in our pre-industrial, pre-1870 economy. Financial panics and deflations were common, and any big drop in farm price surely hurt the real incomes of many farmers, as long as their prices fell more than other prices and farmers had nominally denominated debts. Many economic historians have even said that a “depression” in the early 1770s helped set the stage for the American Revolution. But it does seem we need to have a better understanding of what those early “hard times” were like for the people who experienced them.
This week the Senate passed a financial reform bill that’s at least a bit tougher than looked possible a couple weeks ago. Paul Krugman has a concise rundown on it right here:
“What’s good? Resolution authority, which was sorely lacking last year; consumer protection; derivatives traded through clearinghouses; ratings reform, thanks to Al Franken; tighter capital standards for big players, although with too much discretion to regulators.
“What’s missing? Hard leverage limits; size caps; not much in the way of restoring Glass-Steagall. If you think that too big to fail is the core problem, it’s disappointing; if you think that shadow banking is the core, as I do, not too bad.”
Dean Baker has some additional words here on Al Franken’s credit-rating-agencies reform amendment, which would eliminate the huge grades-for-sale conflict of interest of having companies being rated pay the rating agency for their work. Instead, the Securities and Exchange Commission will assign the rating agency for each new securities issue.
The Senate bill also includes a Consumer Financial Protection Agency, which will be technically independent, as reformers had been pushing for and industry had been furiously opposing. However, the agency will be housed within the Federal Reserve, which reformers had opposed because of the Fed’s dismal track record on consumer protection over the past decade. Supposedly the agency will not have to answer to the Fed’s leadership, but we’ll have to see how that works out in practice. I have not yet seen any word on whether the fabulous Elizabeth Warren, the Harvard Law professor who had been advocating for this agency, would still be interested in heading it.
All told, the bill still leaves much to be desired — Simon Johnson and James Kwak at The Baseline Scenario decry its lack of hard capital requirements or bank size restrictions — but looks a whole lot better than nothing:
After two bubble-based expansions, in which first a tech stock bubble (1990s) and then a housing bubble (2000s) helped fuel huge levels of consumer debt, it seems rational for consumers to conclude that they’ve been living beyond their means and hence to retrench. Today’s report of a 10-point drop in an already-low consumer confidence index is some hard cheese just the same.
The linked story, above, is a good one in that it actually provides information as to what is a “normal” or “good” level of the index. 90 is pretty good, 100 means “strong growth.” So this month’s reading of 52.9 (again, down 10 points from May’s) is awful. The best that can be said for it is that it’s double its all-time low of 25.3 in February 2009.
The story also mentions weakness in the housing market, where the Commerce Dept. reported Wednesday that new-home sales in May dropped 33% from their April level. While a big drop is not shocking in view of the April 30 expiration of big tax credits for homebuyers, it was larger than expected, and the annualized rate of 300,000 new homes purchases is the lowest in the history of the Commerce Dept.’s survey (which began in 1963). Again, considering the giant bubble in the housing market that preceded the current slump, it seems plausible to me that we have not yet hit bottom, i.e., the market may still have some correcting to do.
I hate to sound like a liquidationist, but if it’s true that the economy was on steroids thanks to a housing bubble and a frenzy of consumer debt, then our “natural” standard of living may be a good bit lower than we’d care to admit.
UPDATE, July 4: Dean Baker says the housing bubble still has some deflating to do, in particular in California, New York, and Illinois. He says house prices in those states are still way over trend levels and still abnormally high in relation to rents.
Going into this fourth of July weekend, we learned that the U.S. economy shed 125,000 jobs from May to June and that 16.5% of Americans are either unemployed, involuntary working part-time, or have given up looking. (That’s the “U-6 unemployment rate.”) We also learned that median duration of unemployment is now almost six months; it rose to 25.5 weeks, up from 18.2 weeks a year ago.
It’s one thing to be against a stimulus package because the country’s debt level is too high. It’s not my position, but it is the position of reasonable, otherwise Keynesian-minded economists like Willem Buiter and Jeffrey Sachs. But traditionally a big thing that mitigates recessions is the “automatic stabilizers” of which occur even without Congress passing new tax cuts or spending programs. Taxes go down because incomes are down, and spending on unemployment and welfare benefits goes up because more people qualify for them. For Congress to cut off one of the most important automatic stabilizers is not only callous but sheer idiocy. Yes, the national debt is a problem, but there are fates worse than debt. Obsessing about debt during an economic depression is like worrying about cellulite while you’re starving to death. (Krugman piles on here and here.)
Here’s hoping that the ranks of the unemployed soon include McConnell and the other senators who opposed extending unemployment benefits. (The would be every Republican except the two from Maine, and Democrat Ben Nelson.)
The always excellent Roger Lowenstein has a piece in today’s NYT Magazine about the recent reluctance of the American consumer to spend.
He makes a point that I’d been making and fleshes it out rather well:
American households are rational to cut back on their spending right now, especially while so many of them are deeply in debt and face uncertain job and income prospects in the months, perhaps even years, ahead.
But while individually rational, it makes for a severe economic slump, since consumer spending (or, put differently, goods and services produced for consumers) is two-thirds of GDP. Unless a new bubble comes along to delude consumers into thinking that their wealth in stocks/housing/other is rising so fast that it’s OK to spend more than their income, then we may not have found the bottom yet.
Consider: At the peak of the bubble, in 2008, household debt was 136% of income. After two years of retrenchment, it now stands at . . . 126% of income. Lowenstein quotes an economist as saying that there is no clear-cut correct debt/income ratio, but it seems fair to say that over 100% is not sustainable. Lowenstein notes that just getting it back to where it was in the year 2000, at plausible rates of “deleveraging” (paying down debt), would take about five years. And he might have noted that 2000 was the height of the dot-com bubble; household debt in 2000 was nearly as high as household after-tax income. People like to pass on something to their children and grandchildren, so the normal debt/income ratio would presumably be well under 100%. You’d probably have to go back at least 15 years to find a normal, sustainable debt/income ratio.
Lowenstein quotes another economist as saying “deleveraging cycles” typically last about five to seven years. And today’s debt/income ratio is not typical but is one of the highest on record.
Edward Luce’s recent Financial Times feature, “The crisis of middle-class America,” is a must-read. It seems to be excerpted (lots of “. . .”), but it still contains a ton of detail about two seemingly comfortable middle-class families who’ve seen their living standards fall gradually and then, after the 2008 crisis, abruptly. The piece is mostly a human-interest article, light on statistics and technical explanations, but there is this illuminating quote from Harvard economist Larry Katz:
‘“Think of the American economy as a large apartment block,” says the softly spoken professor. “A century ago – even 30 years ago – it was the object of envy. But in the last generation its character has changed. The penthouses at the top keep getting larger and larger. The apartments in the middle are feeling more and more squeezed and the basement has flooded. To round it off, the elevator is no longer working. That broken elevator is what gets people down the most.”’
Here’s hoping this article is part of a much longer series. Although the early verdict on the 2000s seems about right — two recessions with a bubble-driven recovery in between — people still tend to view the 1980s and 1990s as Prosperity Decades. Based on aggregates like rising real GDP and falling unemployment rates, they were, especially the ’90s. And as the long economic expansion of the Clinton years took hold, the warnings of some economists of a “silent depression” of eroding real wages and disappearing middle-class jobs (especially for non-college-educated workers) became increasingly ignored. Ditto for the wave of warnings about “downsizing” in the mid-’90s, as eloquently reported by The New York Times (and followed up a decade later in a book by William Baumol, Alan Blinder & Edward Wolff that seems to have gotten far too little attention).
Macroeconomics is the study of economic aggregates, so macroeconomists and the macro debate tend to focus on aggregate statistics, even though the bottom line would seem to be how individual people (be they rich, poor, middle class, black, white, old, young, etc.) are doing. The debate over the economy’s performance during the 1980s, which inevitably took a partisan cast as a debate over Reaganomics, generally came down to aggregates. On the pro side, an eight-year economic expansion, falling unemployment, low inflation, a booming stock market, and faster productivity growth than in the 1970s. On the con side, unemployment and poverty rates that skyrocketed in the early ’80s recession and stayed high for much of the decade, rising inequality, and stagnant median real incomes. Either way, people looked to aggregates, which left a lot out. For example, were median incomes stagnant because the incomes of most people were stagnant or because there was a relative increase in the number of poor households even as other people’s incomes rose? And how much of the decade’s prosperity trickled down to families who were at the bottom and middle rungs on the economic ladder when the decade began? Based on the standard aggregated data, including the Census data on income percentiles, we don’t know, because we’re not comparing the same people over time. Reagan defenders and others inclined to ignore the issue of inequality make that excuse again and again: “It’s not the same people!” Which is true but raises the question, So why don’t we just study the same people over time?
An ideal study would combine scores of case studies like the ones in the FT article with analysis of longitudinal data on particular families surveyed over time. There are longitudinal data sources out there (e.g., the National Longitudinal Study, the Panel Survey of Income Dynamics), but I confess I haven’t seen whatever macro studies have been done with them. Seems to me way too much of what we “know” about the macroeconomy is based on aggregates like per-capita GDP and way too little on studies of actual households. But the only to measure the American dream, I think, is one household (or one person) at a time.
Now here’s something you’ll really like . . . a July 1974 live version of the rock classic that inspired the title of this post:
One of the big issues before Congress right now is whether and how to extend the Bush tax cuts, enacted in 2001 and scheduled to expire at the end of this year. Congressional Republicans want to make them permanent. President Obama and many Democrats want to extend the Bush tax cuts for everyone except the very wealthy, i.e., those in the top tax bracket (which would go from 35% back to 39.6%, where it was in 2001).
Throughout this debate I had agreed with the Democratic position, for reasons of both equity and economics. Over the past thirty years, incomes and wealth in this country have become much more skewed in favor of the rich, so as long as we have a progressive tax system why not use it to push back against that trend? (I’m not saying let’s equalize incomes, just that trying to check the increase in inequality is a reasonable thing to do.) Only about 2-3% of households — those earning over $373,651 – are in the top tax bracket, and even then their first $373,651 of income would be taxed at the same rate as before, so the pain associated with raising the top tax rate seems small. On the economic side, cutting taxes for the wealthy provides a smaller boost to consumer spending than just about any other tax cut or benefit increase you can think of. See, for example, the “stimulus bang for the buck” table on page 5 of this testimony by Mark Zandi, Chief Economist of Moody’s Analytics back in April. In the case of making the Bush tax cuts permanent, a dollar of tax cuts would raise GDP by 32 cents, compared with, say $1.41 from an increase in aid to state and local governments or $1.61 for an extension of unemployment benefits. (The logic is that wealthy taxpayers save much of their income, so small differences in their after-tax income won’t affect their spending much, at least not compared with other taxpayers. And increases in government spending increase GDP directly and can, if the government starts jobs programs, employ people directly.) And then there are the tax revenues to consider — those top 2-3% of taxpayers have a huge amount of taxable income, so a 4.6% difference in that top tax rate makes a big difference in the government’s deficit and debt.
But equity and economics are unlikely to carry the day in Washington, D.C. Today’s New York Times has a remarkable op-ed by the same Mark Zandi, titled “A Tax Cut We Can Afford,” in which he argues for extending the Bush tax cuts, sort of. He says they should be extended for the wealthy, too. His reasoning is political: Yes, it would be ideal to let the top rate go back to 39.6% and use the new revenue to pay for jobs programs or bigger jobs tax credits, but that option is not on the table. Republicans and conservative Democrats would undoubtedly block it. Another truly sizable spending stimulus is not on the table either. What is feasible, besides minor measures like the jobs bill passed this month, is . . . extending the Bush tax cuts.
Although extending tax cuts on those making $374,000+ a year is not a great option, Zandi says, raising their taxes and (with effective stimuli off the table) doing nothing with it is a worse option. Most of U.S. GDP is people’s consumption, and even though the rich consume less of their income than other people do, they still consume a lot, so much that their consumption may determine the fate of GDP over the next few years. The Times recently reported that rich Americans have cut back on their spending. The article quotes Zandi yet again: “One of the reasons that the recovery has lost momentum is that high-end consumers have become more jittery and more cautious.” The top 5% of Americans account for one-third of consumer expenditures, according to the piece.
Generally speaking, you don’t raise taxes in a recession. That’s one of the endlessly repeated lessons of the Great Depression (Hoover and Congress raised taxes in 1932, Roosevelt and Congress did so in 1936), and it still applies. Again, if you could raise upper-income taxes and use them to pay for well-targeted stimulus programs, that would be fine, but to quote Zandi again, “it is asking too much of our political system now to get it just right. I’m skeptical that a politicized Congress would be able to pull it off, and failure to do so would leave us next year with higher taxes and a hobbled recovery.”
Zandi says the tax-cut extension for wealthy households should be temporary, to be removed when “the economy is off and running,” with the increase phased in perhaps over a three-year period.
I am pretty well convinced. I’ve been arguing in this space that the severe slump we’re in makes this a terrible time for drastic spending cuts. By the same token, this is not a good time to raise taxes on anyone.
Michael Grunwald of Time has an interesting new article about the specifics of the stimulus spending, which began with “shovel ready” projects that could employ people right away but is now about to move onto “shovel worthy” projects that required more advance planning and are more in line with the Obama Administration’s long-term policy goals on energy, education, etc. The article differs from others I’ve read on the stimulus in that the focus is not on its impact on jobs or GDP but on how these programs may yield a greener energy policy, expanded scientific research and broadband access, and school reform. There’s an analogy to be made with the New Deal, whose early jobs programs were sometimes derided as “leaf raking” or “ditch digging” but which came to include enduring projects like highways, bridges, buildings, and parks.
The $787 million stimulus bill that passed in early 2009 is by now unpopular with the public. A recent poll I saw in The Washington Post this summer (I’ll try to find the link later) found that the public, by a 56-41% margin, actually thought the stimulus had made the economy worse. This is perhaps understandable considering that the unemployment rate has not come down much, but still mind-boggling in the face of empirical estimates by nonpartisan economists that the stimulus saved three million jobs.
The only part of Grunwald’s piece I didn’t like was his claim that “liberals” think the stimulus was not large enough. While that much is basically true, it’s not just political liberals who believe that. Keynesian economists, not all of whom are liberal Democrats, would tend to argue that another big round of stimulus is necessary to push the economy back toward “full employment,” i.e., an unemployment rate of about 5%, maybe 6% (it’s now 9.5%). Three million jobs saved is better than none, but the glass is less than half full considering that there still are eight million more unemployed Americans now than in 2007, before the recession began.
Matt Yglesias presents another poll that tends to suggest that the stimulus’s unpopularity reflects not the content of the stimulus bill but basically just the sad state of the economy and the usual tendency of the public to blame it on the president — i.e., if the stimulus bill was his bill, then it must have been a bad bill, because the economy stinks. Yglesias cites a poll that asks people whether they would like certain measures to be taken. Asked if they would favor “additional government spending to create jobs and stimulate the economy,” 60% said yes. Politicians, take note.
P.S. Today’s title is from J.J. Cale’s “After Midnight,” but the song I felt like posting was this one by The Flamin’ Groovies:
Some thoughts on last Friday’s BLS employment report, otherwise known as “the good one”:
The employment report is pretty good news indeed, especially as regards job creation in the private sector. 151,000 jobs were created overall (in the private and government sectors combined), about twice as many as market analysts had projected. The increases in the length of the workweek and in overtime hours are also welcome news, as these are considered leading economic indicators. (This is because companies often cut the hours of their workers during a recession and extend the hours of their workers in the early stages of a recovery rather than take on the overhead costs of hiring new workers. As the recovery gains steam, they’ll actually hire new workers.)
Alas, the increase in employment, though much larger than expected, is still not large enough to reduce the unemployment rate, still at 9.6%. The increase in employment was offset by new entrants into the labor force, not all of whom found work. All of this happened without any big changes in the labor force participation rate or the more comprehensive U-6 unemployment rate, which is still around 17%.
The increase in weekly paychecks is particularly good news, as Chris Isidore of CNN/Money notes. Isidore points out that the increase comes not so much from higher hourly wages as from longer workweeks. He mentions that 318,000 fewer workers are involuntarily working part-time instead of full-time jobs, compared with last month, and that is a big positive deal for a lot of people.
However, the increase in average weekly hours is not all that big; 318,000 is not that big a number compared with total employment (131 million). The 1.8% month-to-month increase in average weekly hours was the largest in 26 years, as Isidore notes, but that too is less of a big deal than it might seem. It’s an increase from 33.7 hours to 34.3 hours. If you’re rounding to whole numbers, as I like to do to keep things less “statsy,” you’d miss the increase entirely.
A number worth trumpeting, as Isidore does, is the 3.5% year-to-year increase in average weekly wages, from September 2009 to September 2010. That’s especially good considering that inflation over the same span was about 1%, which means a 2.5% increase in real weekly wages. A real wage increase of that magnitude was normal once upon a time (1947-72 and the second half of the 1990s), but for most of the past 40 years real wages have grown very slowly or hardly at all. We’ll take it.
Matt Yglesias, channeling Scott Sumner and Louis Woodhill, makes a good case that the interest rate on bank reserves, which was 0% up until just a couple years ago, should be lowered from its current 0.25%. He suggests lowering it to 0.15%; I’d go lower, to 0.10% if going back to zero is out of the question.
Paying interest on reserves made some sense back in 2008 when the Fed was flooding the system with reserves in order to prevent a deflationary catastrophe. The fear then was that when the economy picked up, banks would start loaning those reserves out and unleash a huge inflation; to prevent that, the Fed put an interest rate on reserves that could be raised whenever it became necessary to “soak up” those reserves. But nothing like that is happening now — instead we have a banking system with about $1 trillion in reserves that they’re not loaning out, and the amount is likely to grow as the Fed makes its monthly $75 billion purchases of longer-term bonds under QE2. The string the Fed is pushing on ought to move a little more if the interest rate on reserves were closer to zero. 0.25% might not sound like much, but it’s more than the federal funds rate on any given day and more than the short-term Treasury bill rate. If banks could only earn 0.10% on reserves, I think they’d be more likely to loan them out, i.e., monetary policy would be more likely to work.
When the recovery finally shifts into high gear (and it could be sooner than most of us think, considering all the “green shoots” among leading indicators at present) and banks start loaning out those reserves, then the Fed can raise the interest rate on reserves. But keeping it this high now gives preemption a bad name.
Everyone from the Chinese to Alan Greenspan is slamming the Fed’s new round of longer-term bond purchases (QE2) as a back-door plot to weaken the dollar. The logic is that the bond purchases should lower interest rates, thereby lowering the demand for dollars and causing the dollar’s price to fall, thereby raising U.S. net exports. That much is true, but it leaves one thing out:
That’s exactly how expansionary monetary policy is supposed to work!
It’s even in a lot of macroeconomics principles textbooks: When the Fed lowers interest rates, the lower rates are supposed to raise GDP by spurring household consumption and business investment (that much is in every principles textbook) and secondarily by lowering the demand for U.S. bonds, thus lowering the demand for dollars and weakening the dollar, thus raising U.S. exports and lowering our imports. This effect is sketchier than the effects on consumption and investment, since net exports are very volatile and do not respond quickly to changes in exchange rates, but it is there.
So why exactly is it currency manipulation when it’s part of QE2 (which is only expected to reduce interest rates by about 20 basis points and so far has actually seemed to raise them a bit, due to inflationary expectations and the Fed’s surprise decision to concentrate its purchases on medium- rather than long-term bonds) but not when it’s part of the Fed’s zero-federal-funds-rate policy? I’m thinking the selective outrage might have something to do with President Obama’s meetings with Asian and G-20 leaders this week. The Chinese are happy to grasp at this new straw in order to deflect attention from their more blatant attempts to keep the yuan low, the Europeans are seeking some company for their draconian budget-slashing misery, and Greenspan is bandwagon-jumping as usual.
P.S. Although I think this particular criticism of QE2 is bogus, I am against QE2 for a host of other reasons, which I’ll get to in another post sometime.
The Conference Board’s index of leading economic indicators is up again, by 0.5%, for each of the last two months. This is very good news, yet it was hardly reported at all.
That wasn’t all of today’s good news, either. Jobless claims (i.e., unemployment insurance claims) were at about the same level as last week’s two-year low. And the Philadelphia Federal Reserve district, which had been very weak, showed astounding improvement in today’s report, with its general business conditions index jumping from near-zero to 22.5, way ahead of the consensus forecast range of 4.o to 9.6. Bloomberg summed up the Philly Fed news as follows:
“Philly Fed data have been lagging regional and national data but not in November. The report’s November index on general business conditions jumped from a zero-flat trend to a prodigious 22.5 to indicate very sharp month-to-month growth. New orders rose more than 15 points to 10.4. Shipments also rose more than 15 points, to 16.8. The region’s manufacturers are showing commitment by adding to their workforces as the jobs index rose more than 10 points to 13.3. . .
“This report points to accelerating strength for what is already solid growth for the national manufacturing sector. Interestingly, these results contrast with Monday’s weak Empire State report from the New York Fed, a report that had been significantly stronger than Philly’s. Month-to-month swings in regional data shouldn’t cloud what is generally a positive outlook and continued leadership for the nation’s manufacturing sector.”
A genuine recovery really does seem to be underway. It’s still not nearly fast enough, but the pace could easily pick up, and these indicators suggest it will. I have other reasons for my current optimism, but I’ll get to those later.
The third-quarter GDP growth numbers are better than originally reported, as today the Commerce Department revised them from their 2.0% initial estimate up to 2.5%. As many commentators have no doubt noted, that’s still short of the 3.0% thought to be necessary to reduce the unemployment rates. But we should not stop there. The more I look at the quarterly GDP figures, especially in the Commerce Department’s full report, which includes a table that breaks down the contribution to percent change in real GDP from each of the main components, i.e., consumption, business investment, government purchases, and net exports, the more it looks like a real recovery is underway.
Looking over those GDP breakdowns over time, a couple patterns emerge. First, as is often noted, fluctuations in business investment tend to be the key to recessions and recoveries. Investment is highly volatile, more so than consumption, and it tends to lead the business cycle. Second, net exports are even more volatile and, unlike investment, don’t have much of a cyclical pattern. They seem to be mildly countercyclical (in a recession that hits the whole world evenly, our imports would fall more than our exports would, simply because we our imports are much larger than our exports to begin with), but whatever cyclical pattern exists seems to be swamped by other fluctuations: just eyeballing the numbers, the GDP contribution of net exports looks like one of those “random walks.” Consider net exports’ percent contribution to real GDP over the past five quarters (i.e., since recovery officially began, or 2009:III-2010:III):
-1.37
1.90
-0.31
-3.50
-1.76
Not much of a trend there –close to -1.5% in the first quarter of the recovery, sharply positive in the second, near zero in the third, huge and negative in the fourth, back around -1.5% in the fifth. These big fluctuations can drive the quarterly real GDP changes, masking what’s happening in the domestic economy. Officially, real GDP over the past five quarters grew by the following amounts (seasonally adjusted at an annual rate:)
1.6
5.0
3.7
1.7
2.5
Again a lot of fluctuation, with the strongest readings coming the two times when net exports’ contribution was either positive or near zero. If we omit net exports to get a closer look at actual domestic spending (i.e., C+I+G, or “domestic absorption,” as development economists call it), the growth of the rest of real GDP over the same span looks like this:
3.0
3.1
4.0
5.2
4.3
A much clearer picture: GDP grew slowly in the first two quarters of the recovery, and thereafter at a much faster clip, about 4%-5%. It looks to me like the domestic U.S. economy has been recovering a respectable pace in 2010. While net exports may continue to be a drag on the economy in the future, especially as our European trading partners opt for the bloodletting approach to their economies, their extreme fluctuation makes me leery of making a definite prediction about net exports. I feel safer in saying that consumption and investment seem to be leading the U.S. recovery and that investment will hopefully pick up further as more businesses come to believe that a genuine recovery is underway.
The BLS unemployment report for November is out, and it ain’t pretty. Less than a third as much job creation (+39,000) as expected, not nearly enough to absorb new entrants into the labor force, so the official unemployment rate edged up to 9.8%. (The comprehensive U-6 unemployment rate was unchanged at 17.0%.)
The private sector added 50,000 more jobs, and the government shed 11,000 jobs. It is a bit hard to disentangle private sector jobs from the government, in view of the fact that the $787 billion stimulus went mostly to the private sector as opposed to new government jobs, but it is rather remarkable how little the government is doing in terms of direct job creation. At the federal level this comes down to politics — in this conservative age, creating 3.5 million temporary government jobs, as the New Deal did each year, is considered a bad thing. Indirectly creating or saving 3.5 million jobs, as the Obama Administration credits the stimulus with having done, is politically viable (or was in early 2009) but hard to prove, which is probably why the stimulus is unpopular with most of the public. At the state and local level, of course, it comes down to balanced-budget requirements — with tax revenues down for the count, everyone’s cutting government payrolls to try to close the budget gap. (Without emergency federal aid to make up the difference, the recession gets magnified at the state and local government level.) If I eyeballed the numbers correctly, employment is down for the year at all three levels of government.
The only good news I noticed in the report was that the number of temp workers, a leading economic indicator of employment, increased for the fourth straight month. (And even then, the increase is smaller than in several months earlier this year.) Another leading indicator, weekly hours worked, did not improve, instead holding steady at 34.3 hours.
Now, the unemployment rate is a lagging indicator, and there are positivesigns of recovery elsewhere, but that’s cold comfort to the nation’s 15 million unemployed. Seems like we’re back to where Merle Haggard was in 1973, especially with Republicans in Congress so far refusing to extend unemployment benefits for the long-term jobless:
Once again: The Fed creates reserves, not money. The Fed buys securities from banks and pays for them by giving the banks reserves, e.g., if it buys a $1000 Treasury bond from a bank, it pays the bank by adding $1000 to the bank’s reserve account at the Fed. This is not the same thing as giving the banks money, because it ain’t money unless it’s (1) cash circulating outside of the banking system or (2) in someone’s checking, savings, or other deposit account at a bank or money-market fund.
This distinction might sound nitpicky, but it’s all-important. The process by which these reserves become money is the process by which monetary policy works, or fails to work. What’s supposed to happen is this:
Fed creates reserves –> banks loan out reserves to households and businesses –> households and businesses spend those funds (raising the Consumption and Investment parts of GDP, hence raising GDP) –> whoever gets paid by them deposits some of those funds in the banks or in money-market funds, and spends some of it –> whoever gets that money deposits some of it and spends some of it –> etc. Money does get created, indirectly, when those loans are deposited or redeposited in the banking system, but not before then.
That’s what happens when monetary policy works. (And yes, there may be some inflation, if the increased demand for consumption and investment goods isn’t met by an increase in their availability.) But that’s not what’s been happening since 2008 — the Fed has been creating reserves, and banks have mostly been sitting on those reserves. Thus no big increase in Consumption, Investment, or GDP, and no corresponding increase in the money supply.
When someone says “The Fed prints money,” what they’re really saying is that they don’t know what they’re talking about.
Optimism is breaking out among economic forecasters. I admit, I share their optimism, as should be clear from my recent posts. My optimism is bolstered by the latest Index of Leading Economic Indicators, which rose in November for the fifth straight month and by the most (1.1%) in eight months.
Two of the big banks cited in today’s New York Times article (first link) predict 4% real GDP growth for 2011, i.e., fast enough to actually reduce the unemployment rate. Unfortunately, as Princeton’s Alan Krueger suggests in the article, that would only be enough to make a modest dent in the unemployment rate. Does the Times still run those “Remember the neediest” taglines, I wonder?
Much as I think recovery is already underway and will pick up steam in 2011, I can’t stop thinking that this recovery, like most recoveries in the past several decades, is likely to leave millions of Americans behind. Will the new Congress care? My main hope is that Republicans’ love of all things voucher will extend to relocation vouchers for the unemployed, to encourage them to move from places like Detroit and Upstate New York to where the jobs are.
P.S. The second link, from 24/7WallSt.com, includes a helpful discussion of the Conference Board’s index of ten Leading Economic Indicators, namely what they are and how some of them might be more like coincident or lagging indicators. The index is still useful, but there’s a reason why nobody is able to extract airtight forecasts from it.
Ex-Reagan Administration official Bruce Bartlett makes some excellent points about Congress’s annual vote on whether to raise the debt ceiling:
it’s superfluous (no other country, as far as he could tell, has such a ritual)
it’s at best a distraction
it allows policymakers to vote for budget-busting tax cuts, wars, new entitlements, etc., while pretending to be deficit hawks because they voted against raising the debt ceiling
worst of all, if the debt-ceiling resolution ever did get voted down, as some Republicans* are eager to do, the USA would immediately have to start defaulting on Treasury bonds as they came due. Two hundred and twenty years of building the world’s best credit rating would be undone in a flash.
(Hat tip: WSJ Real Time Economics)
Of course, as Paul Krugman pointed out recently, in nearly all cases, “Deficit hawkery is just a stick with which to beat down social programs.” So if the object of the game is to whale away at social programs, losing the nation’s stellar credit rating would be worth it. At least on paper. “Deficit hawk” is too tame a phrase to describe a person who would favor such a strategy — “fiscal Armageddonist” is more like it.
*Ironically placed next to Bartlett’s blog post was an ad by Rep. Michele Bachmann (R-Mageddon) to “Tell Congress – Don’t Raise the Debt Ceiling.”
P.S. “Waiting for the End of the World” always sounds better live:
Granted, nobody reads 576-page commission reports, but this newly released, two-year-in-the-making report by the Financial Crisis Inquiry Commission looks pretty good, based on the article about it in today’s NYT. The article states:
‘The commission that investigated the crisis casts a wide net of blame, faulting two administrations, the Federal Reserve and other regulators for permitting a calamitous concoction: shoddy mortgage lending, the excessive packaging and sale of loans to investors and risky bets on securities backed by the loans.
‘“The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done,” the panel wrote in the report’s conclusions, which were read by The New York Times. “If we accept this notion, it will happen again.”’
Right on. And with testimony from more than 700 witnesses to inform those conclusions, there ought to be some good detail within the report.
The above conclusions might seem obvious, but acknowledging the obvious is something that politicians are not good at. And predictably, the commission was split among party lines. The above excerpt is from the majority report. From the article:
‘Of the 10 commission members, the six appointed by Democrats endorsed the final report. Three Republican members have prepared a dissent focusing on a narrower set of causes; a fourth Republican, Peter J. Wallison, has his own dissent, calling policies to promote homeownership the major culprit. The panel was hobbled repeatedly by internal divisions and staff turnover.’
So much for feasible solutions. Even with a Democratic Congress, the financial reform bill we got last year was extremely watered down. Get ready for the next conflagration.
From Mother Jones, this is a picture of what the Senate would look like if its 100 seats went not to the current senators but to the interest groups that have been their largest donors over their careers. The green one, which would have 57 seats, is Finance, Insurance and Real Estate. Lawyers and Lobbyists would have 25 seats. No other group would have more than 5.
I’ve blogged about this topic before. Not raising the debt ceiling would be like pushing the economy off a cliff. With a deficit of $1.5 trillion (and GDP of about $14 trillion), Congress would have to cut spending or raise taxes (or some combination thereof) by more than 10% of GDP. You don’t get that money back. That would be a depression of titanic proportions. It would be ruinous under virtually any circumstances, but all the more so now, at a time of high unemployment. Herbert Hoover’s and FDR’s budget-balancingblunders during the Great Depression would be trivial by comparison. And Congress probably couldn’t come up with $1.5 trillion or anything close to that anyway. Normally we pay off our Treasury bonds as they come due by selling more bonds, which we would not be able to do anymore if the ceiling is kept constant. So we would default on all the maturing debt, and our new bonds would lose their AAA status, instantly and permanently, and we’d have to pay higher interest rates on our new bonds. With enough defaults our bonds would quickly be junk bonds, paying sky-high interest rates. This would add to the federal deficit and debt, possibly a lot. So much for looking out for future generations.
If the Republicans pull the same game of brinkmanship that they did last week in nearly shutting down the government, by convincingly threatening to not to raise the debt ceiling and then raising it at the last minute, the bond market will still go oink (as one of my grad school professors used to say), and interest rates on Treasury bonds will still shoot up, meaning higher interest payments and a higher burden of paying them off. Bond investors hate uncertainty, and if default even looks possible, they will no longer regard Treasuries as riskless.
All of this opposition to raising the debt ceiling is a combination of cynicism, ignorance, and self-sabotage. We do have a long-term debt problem that needs to be addressed, but blowing up the economy is the most idiotic and counterproductive solution imaginable. Threatening to blow up the economy is not much better. As long as the economy is in a slump, the optimal amount of spending cuts is $0 (if continued stimulus is out of the question), not $1.5 trillion. And it would be even more optimal to have no more debt ceiling.
In today’s press conference Bernanke acknowledges the obvious: the economy is worse than we thought and likely to stay that way into 2012. The Fed lowered its official economic growth forecasts and raised its unemployment rate forecasts for 2011-2012. After almost two years of slow but steady recovery and myriad positive straws that one could grasp, the last couple of months have brought mostly lousy news, notably the latest jobs report, which showed a gain of just 54,000 jobs last month, only about a quarter or a sixth as many as we’d need to get unemployment down to normal levels in five years or so.
It’s notable that the imminent end of the Fed’s quantitative easing, all $600 billion of which will be over by the end of the month, brings few calls for another round — everyone seems to agree that we’re in a liquidity trap, in which further monetary stimulus fails to stimulate, because interest rates are already practically 0%, banks are not eager to lend, and companies are not eager to invest in new capital.*
Our best hope, it seems to me, is an almost nihilistic one: the economy somehow recovers on its own, through black-box mechanisms that we still don’t really understand. Business confidence returns, hiring finally picks up, and the economy roars forth. This may be a vain hope, but the “animal spirits” of investors (and consumers) that Keynes wrote about in The General Theory are not really visible, despite the several monthly surveys of business sentiment that are out there.
Our next best hope is another fiscal stimulus. It won’t be like the first one, which is about to run out and was too small anyway, not with a Republican majority in the House that believes spending = death and doesn’t even want to avert a financial crisis by raising the debt ceiling unless the Democrats agree to massive long-term spending cuts.But I could see the two parties agreeing on a big set of tax cuts, which is the usual form that a fiscal stimulus takes anyway (e.g., 1964, 1981, 2001). That has a couple of disadvantages: (1) the “multiplier” effect of a tax cut on GDP is typically empirically estimated to be smaller than that of a spending increase of equal size, because not all of a tax cut gets spent; (2) tax cuts are hard to reverse, as everyone hates seeing their taxes go up, so they could make the long-term debt problem much worse. Still, it’s probably the only politically viable option for a fiscal stimulus.
* The last part of that statement (companies are not eager to invest in new capital) is less true than I had thought. As the Wall Street Journal article linked to below notes, a survey of banks indicated that small businesses were demanding more loans, at least in the first quarter of the year.
UPDATE: This Associated Press article from the next day’s newspapers adds some helpful detail. The headline from the Syracuse Post-Standard’s version of that article says it all: “Slow Economy a Puzzle: Fed chief flummoxed, says troubles could last a while.” My quick take:
(1) The economy has long been in a liquidity trap (Krugman’s definition, i.e., a slump in which monetary policy is no longer effective).
(2) Bernanke has long suspected this himself, but as Fed Chairman he feels obligated to try to stimulate the economy through monetary policy, via unusual, unprecedented channels “that just might work” like QE2.
(3) QE2 has failed to measurably stimulate the economy, because the economy was in a liquidity trap.
(4) Liquidity trap or not, it’s not easy for the Fed to just throw in the towel, so a QE3 might well happen. But I doubt the Street will get all that excited about it, considering what a dud QE2 seems to have been.
Today’s New York Times editorial, “The Worst Time to Slow the Economy,” says it all. Voting against raising the debt ceiling is foolish even in the best of times, and it’s insanity right now. Congress already voted to raise the debt ceiling, or to do the equivalent, when it passed a budget with a deficit. It makes no sense for Congress to vote on the budget again.
Is the economy already in a double-dip recession? The rising unemployment rate (up to 9.2% for June, as announced on Friday, or 16.2% using the more inclusive U-6 unemployment rate) suggests it might be. See John Nichols’s column in The Nation for a good account of the unemployment crisis. Nichols says this is President Obama’s biggest problem, pointing out that no president since FDR has won reelection when unemployment was over 8%. (Nichols said over 7%, but he may have meant “over 7% and change,” as Reagan won reelection in 1984 when unemployment was about 7.5%. But at least it was falling, as it was for FDR in 1936 and 1940.)
While Nichols is correct that high unemployment is Obama’s biggest problem, it’s still true that the debt-ceiling impasse is Obama’s biggest worry. An act of supreme self-sabotage like not raising the debt ceiling could put the economy into free fall. As far as I can tell, Republicans who say it’s no big deal, like most of their presidential candidates, either (1) cynically are hoping it brings about an economic avalanche that sweeps Obama out of power or (2) cluelessly believe the Tea Party rhetoric about how “spending” has caused our current woes and think any shock that compels spending cuts will actually be good for the economy. It’s as if they were taught government purchases were a negative entry into GDP instead of a positive, i.e., GDP = Consumption + Investment + Net eXports – Government purchases, instead of GDP = C + I + G + NX.
If we’re lucky, the Constitution — in particular, the line in the 14th Amendment that says “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned” — will save the day. The whole concept of a debt ceiling as something that Congress can refuse to raise, even to pay off previously issued debt, looks unconstitutional to me. (Former Reagan adviser Bruce Bartlett has forcefully raised this option.) But then again, it’s up to the Supreme Court to make that determination, and, as far as I know, nobody has asked them to yet. Harvard Law School Professor Laurence Tribe, in a New York Times op-ed that I otherwise tended to find unconvincing, points out that someone with standing would have to sue the government and that “increased interest rates would have already inflicted terrible damage by the time the Supreme Court ruled on the matter.”
So maybe the Constitution won’t ride to the rescue. Is there hope for a long-term bipartisan budget deal that could convince Congressional Republicans to raise the debt ceiling? And could such a deal be amenable to those of us who don’t want to shred the social safety net? I guess we’ll find out in a couple weeks.
I don’t say this often, but Eric Cantor is half right. The Republican House Majority Leader’s mantra in the current debate over a long-term budget fix has been “You don’t raise taxes in a recession.” That is good policy advice, and any Keynesian economist would tell you the same. Tax increases lower GDP, indirectly, by lowering people’s disposable income — if they have less money, most people will spend less money, so consumption drops. But any Keynesian economist would also tell you, “Don’t cut spending in a recession.” Cuts in government spending directly lower GDP and indirectly lower it by lowering the consumption of laid-off government workers and government contractors. So neither tax increases nor spending cuts are a good idea in this time of 9.2% unemployment.
(It’s a pity that Cantor doesn’t understand the second part, or pretends not to. But not a surprise. Misrepresenting Keynes is a cottage industry among Republican politicians and pundits. Ezra Klein notes that Cantor wrote in his campaign manifesto of last year that Keynesianism is the theory that “government can be counted on to spend more wisely than the people.” But I digress . . .)
Right now, we’re told August 2 is the deadline for an agreement by Congress to raise the national debt ceiling or face a partial government shutdown in which some Treasury bondholders, government employers, government contractors and/or other government creditors won’t get paid. I’ve written again and again that the whole concept of a debt ceiling is self-destructive and a waste of time — and, as usual, The Onion says it better than I ever could – but the “grand bargain” that the president seeks could easily be self-destructive as well. Both Democrats and Republicans say they want to pass a long-term deficit reduction plan that reduces the national debt by several trillion dollars over the next decade. That’s fine in a broad sense, as health care costs continue to jump by leaps and bounds, two wars continue to drain our resources, and federal taxes as a share of GDP are at their lowest level in a half-century. But if the tax increases and spending cuts kick in while the economy is still in this Little Depression, with unemployment well above its normal range of 5-7%, then the grand bargain becomes a starvation diet.
If we could just fine all politicians and pundits a dollar each time they say “we can’t afford to kick the can down the road any more,” we could pay off the national debt. Barring that, we can at least question that bit of conventional wisdom, telling them, no, it’s not a good idea to raise taxes or cut spending while the economy is still in the tank, and any plan to do either or both that kicks in while unemployment is still above 7% is a bad one. Worse than defaulting on the government’s obligations? Probably not. But a lot worse than doing nothing on both fronts.
So far, the Treasury bond market seems remarkably unconcerned about Washington politicians’ abject failure to reach an agreement on raising the debt ceiling. As of 3:20 pm Monday, after a weekend of dashed hopes for a bipartisan agreement for deficit reduction, the interest rate on 10-year T-bonds was 3.00%, up just 4 basis points from Friday’s close of 2.96%. I admit, I woke up expecting more of a negative reaction from the bond market. What gives?
From what I’ve read, there seem to be two factors at work here, of which the bond market is well aware:
(2) Washington tends to go down to the wire on these deals, and this year “the wire” is Aug. 2, i.e., eight days away. Again, history suggests they’ll get a deal done this time, too.
* The 1979 episode has oddly disappeared down the memory hole, despite two months of hostage-taking over the current debt ceiling and despite the fact that the temporary default of 1979 — it lasted two weeks and was caused by a combination of Capitol Hill shenanigans and computer problems at the Treasury — caused Treasury interest rates to be an estimated 50 basis points higher for years, costing taxpayers billions in increased interest payments on the debt and slowing the economy. (Hat tips: Andrew Sullivan, Bruce Bartlett. The 50-basis-points estimate is from finance professors Terry Zivney & Dick Marcus.)
So is this summer’s repugnant, reckless, Republican posturing over this issue all that different from past obstruction by Democrats and Republicans over the necessary and obvious business of raising the debt limit so that the government can honor its commitments to creditors, employees, contractors, retirees, etc.? I haven’t seen anything this extreme since I started following politics, but then again that’s only been 30 years, and this time-wasting exercise that is the debt-ceiling vote has been around since 1917. (It probably served a purpose back then, as we were entering a world war.) If this time is different, the difference may be the simple fact that a great many Republicans (not just Michele Bachmann and the Tea Partiers but 53% of all Republicans, according to a Pew Research Center poll) think it will be no big deal if the debt limit is not raised by Aug. 2, or perhaps if it is not raised at all. Since President Obama clearly does and is unwilling to press for a clean vote to raise the debt limit with no strings attached, they’ve got him over a table.
I’ve written already that the best deal on the debt ceiling would simply be to raise it (or better still, abolish it), without attaching it to a bill that punishes the economy further by slashing spending and/or raising taxes. The last thing this ailing economy needs is a Grand Bargain to reduce the current deficit. It was disastrous policy during the Great Depression — first by Congress and President Hoover in 1932, then by Congress and President Roosevelt in 1937. I would have thought those historic blunders would not be repeated, but I guess it’s always a mistake to assume that politicians know economics or history. But I’ve said all that before.
What I want to point out here is that we’re due for some ill-timed spending cuts (and maybe tax increases), regardless of what Congress does in the next week. Remember that $787 billion stimulus package that Congress passed in early 2009? It was spread out over two years, so roughly $400 billion a year, about $250 billion of which was spending and $150 billion tax cuts, almost all in 2009-2011. So that stimulus is just about “spent.” The main tax cuts, like extending the patch for the alternative minimum tax, will probably be maintained because they’re politically popular, but the spending almost surely will not. So that’s an abrupt drop of about $250 billion in government spending, or about 2% of GDP, over the next year. This chart from James Fallows’ blog for The Atlantic shows the projected big drop in fiscal stimulus from “Relief measures.” That’s the trouble with stimulus — it’s finite. Congress passes these things reluctantly, and if the economy still needs stimulating when it’s over, people are more likely to conclude that it failed rather than that it was too small (which it was) or that it spared us even worse devastation (which it did).
Now it is possible, perhaps even probable, that Congress will fail to pass any deficit-reduction deal and will end up raising the debt ceiling anyway — after all, that’s what’s happened virtually every previous time that a debt-ceiling vote has come up. But even if Congress ends up not inflicting any new wounds on the economy, we’re looking at big-time deficit reduction that will do plenty of damage on its own.
UPDATE, 1 Aug. 2011: Actually, it looks like it’s already happened. In the dismal GDP figures released last week, the government’s contribution to real GDP growth was negative 1.2 percentage points in the first quarter of 2011, with about two-thirds of the decline coming from the federal government. Government purchases account for about 20% of GDP, so cuts in government purchases reduce GDP. “Fiscal drag,” the economists call it. Federal government purchases fell 9.4% in the first quarter (the unwinding of the stimulus surely had much to do with this), and state and local government purchases fell 3.4%. (In the second quarter federal purchases rose 2.2% and state and local purchases again fell 3.4%.)
P.S. The title’s musical inspiration is forty years off and I’ve used it before, but hey, it’s a good song.
This morning’s surprise news is that, after last night’s fiasco in which House Speaker John Boehner could not round up enough votes for his own deficit reduction plan, 10-year Treasury bond prices are not only not down, they’re actually up, by a good bit. Interest rates on Treasuries, which move in the opposite direction as T-bond prices, are down 10 basis points to 2.84% (as of 11:14 a.m.). What gives?
Well, for one, the bond market may not have been expecting much from Boehner. The media had already been saying that he’s a much-weakened House Speaker, after watching his failure to rein in his Tea Party faithless. And any House Republican plan would likely be dead on arrival in the Senate anyway.
Another possibility is that as it becomes more likely that the government bumps up against the current debt ceiling on Aug. 2, that counterintuitively, T-bonds might actually be seen as safer, as Chris Isidore writes in CNNMoney. Why? Because the single biggest actor on the U.S. economic stage, the federal government, would be officially dysfunctional, even more so than it is now. Today through Aug. 1, at least, the government can meet all of its financial obligations. If Aug. 2 is indeed D-Day, then on Aug. 2 the government becomes a deadbeat, at least to somebody. And quite likely, it would not be T-bondholders. This assumes that (1) the government would still be allowed to issue more debt in order to pay off its maturing debt and (2) the Treasury would prioritize the interest on that maturing debt above its other obligations. As notes on NPR this morning, most commentators seem to agree that it is in the national interest to not stiff any of our bondholders, as an actual default would surely cause interest rates to skyrocket. If Aug. 2 is the beginning of Treasury triage time, then the government would more likely stiff someone else, like government employees (please please start with members of Congress!) and government claimants who lack political clout (i.e., not seniors or the military). This creates a lot of chaos, as people don’t know when they’ll be paid, which makes them less likely to spend or repay money and creates pressure on credit markets. In sum, the market reaction may just be the usual “flight to safety” that occurs when markets think conditions are about to get worse and also more chaotic. This would be consistent with the beating that stocks have been taking lately.
It may also be that the bond market is reacting to other news, like the dreadful GDP figures that just came out today. Real GDP in the second quarter grew just 1.3% (worse than the consensus forecast of 1.8%), and first quarter growth was revised drastically downward to 0.4% (from 1.9%). These numbers are “growth recession” territory (where the economy grows but not fast enough to generate enough jobs to keep unemployment from rising), consistent with the rise in unemployment (from 9.0% to 9.2%) over the last few months. As with the debt-ceiling brinkmanship, these new signs of economic weakness are a plausible reason to pull money out of stocks and put it into Treasury bonds.
But why Treasury bonds, you ask, and not another safe haven? The simple answer seems to be that there are woefully few alternatives. As Isidore puts it:
‘U.S. Treasuries are such a massive market — about $9.8 trillion — that they dwarf the markets of other so-called “safe havens” such as gold, top-rated corporate debt or the bonds of other countries with AAA ratings.’
So worldwide investors still like their chances on the wall of debt that is U.S. Treasuries.
P.S. Richard Thompson’s duet partner here is not Linda Thompson, but Christine Collister.
Good piece here by Jane Sasseen of Yahoo News, about what might happen on Aug. 3, if Congress doesn’t raise the debt ceiling. Without being able to borrow any more money, the government would have a shortfall of $135 billion for the rest of August. That is, the government’s legally obligated payments would still be $307 billion and its expected revenues from all sources would be only $172 billion. Altogether, the “federal government makes payments to some 80 million individuals, companies and entities every month.” Who would get stiffed?
There’s no official order of triage, but it’s widely agreed that Treasury bondholders would get paid first. They’re owed hundreds of billions, but most of that comes from selling new bonds. Only the interest ($29 billion for August) comes out the budget, so the government can be counted on to cover it, rather than do any more damage to its credit rating and future interest rates than it already has.
What seems most likely, according to an expert quoted in the article, is a partial government shutdown, as in 1995:
‘”A de facto shutdown of the government is the real threat, not default, ” says Greg Valliere, chief political strategist for the Potomac Research Group.’
Bad time to work for the federal government. Humorist Andy Borowitz had it right: Let’s save money by paying Congressmen per accomplishment.
Many, including Bill Clinton, have said the debt ceiling is unconstitutional because it goes against the 14th amendment’s clause that the validity of the public debt shall not be questioned. However, it’s also been pointed out that interest on the debt is a relatively small obligation of the government and can easily be paid for out of incoming revenues ($29 B in interest, $172 B in revenues, for August after the 2nd). So it seems to me that a reasonable interpretation of the 14th amendment is that it applies to the government’s debt obligations but not to their obligations to anyone else — government employees, contractors, retirees, veterans, etc. Perhaps that’s why President Obama has said his lawyers don’t think invoking the 14th amendment is a promising solution.
Tom Geoghegan, one of my favorite writers on politics and the law (his book Which Side Are You On? even manages to make organized labor funny), suggests a different “constitutional option”: Article I. Sections 8 and 9 of Article I list the powers of Congress and the limits on those powers, which are quite limited. Article 10, Powers Prohibited of States, says no state shall pass any “Law impairing the Obligation of Contracts.” (Geoghegan’s March article on the subject is also worth reading.) Geoghegan says it’s implied that this would extend to Congress, too, but I’m not so sure — Section 8 gives Congress all sorts of powers that are prohibited of states, as well as the power to “provide for .. the general welfare of the United States,” and the Supreme Court’s interpretation of the “general welfare” clause became a lot more expansive around 1937 (after the kerfuffle over the Court’s resistance to the New Deal and FDR’s attempt to pack the court by increasing the number of justices; the so-called “switch in time that saved nine”). The conservative majority on the Court could conceivably rule that keeping the debt ceiling constant would aid the general welfare by forcing reductions in the size of government or in the burden of the debt on future generations. Lame, far-fetched arguments, to be sure, but those have carried the day rather recently withtheCourt.
So it’s unclear what the way out of this morass will be. If the debt ceiling is not raised, we most likely get a partial government shutdown, which will go on until the Republicans in Congress decide that it’s hurting them at least as much as it’s hurting Obama and the Democrats (see: 1995-96). If we’re lucky, the Republicans realize that before Aug. 2, and the nation is spared a shutdown.
Greg Mankiw has a good column in today’s NYT in defense of embattled Fed Chair Ben Bernanke. How embattled is Bernanke? Mankiw notes an (admittedly unscientific) online CNBC poll from June, in which the question was “Do you have confidence in the way Ben Bernanke is handling the economy?” 95% of respondents answered no.
Mankiw says the Fed has done basically all it can to combat the Little Depression (unfortunately “all it can” is not enough), while steering clear of high inflation. The core inflation rate in recent years has been just 2%, widely believed to the Fed’s unofficial target inflation rate. Mankiw suggests making that 2% target official, but otherwise sees no obvious room for improvement in Bernanke’s performance.
I tend to agree that Bernanke’s Fed has done about all that monetary policy can do here, but Scott Sumner, one of the more interesting monetary thinkers I’ve come across lately, says the Fed actually has a lot more ammunition in its arsenal and compares the situation to the early 1930s, when the Fed increased the monetary base but needed to do a lot more to stem the massive tide of bank failures and monetary collapse. Unfortunately, I’ve yet to find the specifics of his argument, but I’ll share them with you when I do.
Sumner, by the way, loves the idea of a 2% inflation target and even suggests that Mankiw be appointed to the Fed’s Board of Governors. Maybe Mitt Romney (to whom Mankiw is an adviser) can do that next year.
President Obama and Congressional leaders have apparently reached a deal on reducing the deficit, which might end the debt-ceiling crisis for now, assuming Congress passes it. Cause for celebration? More like cause for heavy sighs. I’ve been saying over and over that cutting government spending in an economic slump makes the slump worse. The best that can be said about it is that the (real-world political) alternative is worse, i.e., not raising the debt ceiling.
In a front-page article in today’s NYT a chorus of economists make the same point. In a time of slack demand, don’t weaken demand further by cutting government spending. The headline (from MSNBC.com’s republished version):
The Times could have put this story on its front page months ago. Too late — by now, slashing social spending has gone from Republican fantasy to Washington Wisdom.
The above quote is a favorite of former House Speaker Dick Armey (R-TX). He even used to write it on the blackboard on the first day of class when he was an economics professor. Armey has been out of government for years, but as a founding member of a Tea Party group, he’s been a big influence on that wing of the Republican Party. Not surprisingly, he seems pleased with the pounds of flesh they’ve extracted in the new Budget Control Act of 2011.
Armey and I have different ideas of “dumb.” He favors slashing government spending during our Little Depression and also favors a balanced budget amendment that would supposedly compel further slashing. I think those things are time-tested recipes (the times being 1932 and 1937) for worsening a depression. What do the markets think?
The stock market is on track for its eighth straight day of decline (as of 11:55 a.m., the S&P 500 is down 0.5%, and its biggest drop, 2.6%, was yesterday, when the Budget Control Act finally passed). 10-year Treasury bond prices have been rising, and T-bond interest rates falling, over the same span, now down to 2.57%. How to interpret those numbers?
Hard to do, because nobody (as far as I know) takes scientific polls of market participants to ask them why they did what they did. Armey would probably say, as some commentators have, that stocks have tanked because the $2.1 – 2.5 trillion in cuts over a decade aren’t enough. I would say, as have others, that the market is reacting to the dismal state of the economy and to the likelihood that, as basic macroeconomic theory tells us, the spending cuts will make it even more dismal.
What about bonds? The rosy view would be that T-bond prices have improved because the debt-ceiling vote means no default through 2012 and the spending cuts reduce the overall burden of debt. Armey and I might actually agree that the unrosy view is correct: T-bonds are in higher demand because of a worldwide “flight to safety,” as grim economic news causes people to move away from risky, cyclical assets like stocks and toward safe assets like T-bonds. Again, is the grimmer news the “failure” to slash spending more or the weakening economy?
I’m thinking Armey’s quote fits right now, except it’s the budget bloodletters who are dumb and the markets are rationally reacting by anticipating that they will cause further hemorrhaging of the economy.
P.S. At least one market participant agrees. From the Aug. 2 Financial Times:
‘Jim Reid, strategist at Deutsche Bank, . . . has warned the US could be approaching a “1937 moment” – when authorities removed post-Depression stimuli from still-fragile markets and triggered another recession. This risk, he says, has in fact only been magnified in the markets’ eyes by agreement on raising the US debt ceiling.’
Scott Sumner’s blog The Money Illusion has two provocative posts today that argue that Federal Reserve policy is currently too tight, despite the near-zero fed funds rate, and cite as evidence the extremely low interest rates on 5-year Treasury notes. I’m going to grapple with his monetary policy argument at some later date (the gist of it seems to be that the Fed should target nominal GDP and therefore combat the current slump with much bigger increases in the money supply than we’ve had). For now I want to focus on those 5-year bond rate data, which are bad news indeed.
The most recent 5-year bond yield, as of yesterday, was 1.26%. That’s close to a historic low. What does it mean? The standard interpretation in a money and banking course is that interest rates on 5-year bonds are the average of current and expected future short-term bond rates over the next 5 years (since a close substitute for a 5-year bond is a series of short-term bonds held over the same span), with some allowance for people’s preference for short-term bonds as more liquid (you get your money back sooner) and less risky (you don’t have to worry about market interest rates shooting up after you’ve bought your bond and then being stuck with a subpar yield for a long time). So, the number suggests that people are expecting very low short-term bond yields over the next five years. Short-term interest rates are a function of two big things: the state of the economy (they’re lower in economic slumps) and the expected inflation rate (when inflation falls, lenders and bondholders will accept lower interest rates; and inflation also tends to be lower in economic slumps). And in the case of T-bonds, the interest rates reflect the jitters of worldwide investors — the more nervous investors are about stocks and corporate bonds, the more likely they are to flee to the safety of Treasuries.
So, then, a near-record-low 5-year T-bond rate means investors are expecting (1) economic weakness for the next 5 years and/or (2) low inflation for the next 5 years and/or (3) investor anxiety for the next 5 years. I’d vote for all of the above. And (2) and (3) are common symptoms of (1).
To see just how low these recent 5-year Treasury yields are compared with those of the past nine years, see this Dynamic Yield Curve, which shows the interest rates on T-bonds of different maturities. If you click Animate, yield curves from 2003-present flash by and you’ll see that that the norm for 5-year rates is about 3 to 5%. So the bond market apparently expects the economy to be way below average for the next five years. Even the 10-year bond rate was only 2.66% yesterday (it’s normally above 4%), so a ten-year depression is not only possible but maybe even probable, according to the market.
The stock markets are looking pretty Keynesian today. A 512-point (4.3%) drop in the Dow Jones average today, and drops of 4.8% and 5.1% in the S&P 500 and Nasdsaq; overall a drop of more than 10% (a.k.a. a “market correction”) in the past 10 days. Might it have something to do with the fact that Washington is obsessed with deficit-cutting while the rest of the world is obsessed with jobs and economic growth, or the lack thereof?
Jeff Macke of Yahoo! Finance’s Breakout blog puts it this way:
‘There’s a growing realization among even the most optimistic investors that the United States is entering a new recession — a dreaded “double-dip.” Adding to the pain is the sense that the government and Federal Reserve are out of both ideas and ways to stimulate the economy. Corporate America is sitting on record amounts of cash but is refusing to make new investments with so little end demand for its products. Consumers and corporations are hoarding cash, and the economy appears to be seizing. The debt ceiling debate was a fiasco, snuffing any remaining confidence traders had for help from Washington, D.C.’
Yes, Mr. President (and happy birthday, by the way), the time-suck that was the debt-ceiling negotiations was a “self-inflicted wound,” as you said last night. Now why couldn’t you have said the same about the debt ceiling itself? Worldwide investor confidence could not possibly have been inspired by this fight over a redundant institution that no other democratic country (besides Denmark) has and which serves no purpose besides political grandstanding. You may have looked like the only grownup in the room during that whole travesty, but I think the world would like to see a grownup with a clue. You’re talking about focusing on jobs now, but how on earth are you going to do that having just committed yourself to cutting government spending? If you were a Republican, the (specious) answer would be deregulate the hell out of everything, but traditionally Democrats have looked to fiscal stimuli, be they spending programs (Roosevelt), tax cuts (Kennedy-Johnson), or both (you in 2009). It looks to me like you’ve let the Republicans box you into a corner, and you’ve boxed yourself in even further by parroting their rhetoric about the primacy of deficit reduction and how government, like a family, has to spend less in hard times.
The Budget Control Act of 2011 took another hit today when Defense Secretary Leon Panetta said that the Pentagon could not absorb any more cuts beyond the $350 billion over 10 years in the first round of cuts. The second round calls for across-the-board cuts of $1.5 trillion, including $600 billion from the defense budget, if Congress can’t agree on specific cuts. Panetta said that would “do real damage to our security, our troops and their families, and our ability to protect the nation.” I’ll pass on whether or not he’s right, but I’m pretty sure his objection and the military-industrial complex will carry the day. Which makes it more likely that (a) the budget ax falls even harder on ordinary families who would spend the money they’d receive from the government, or (b) the spending cuts just don’t happen, which is better for the economy but bad for the government’s credibility. The battle over that second round of cuts looks to be nasty, brutish, and horrifying.
The new BLS unemployment numbers (9.1% unemployment rate, 16.1% comprehensive unemployment rate, 117,000 new jobs created) are the talk of the morning. I don’t have much to add to it, but I’ll echo the oft-made point that job growth needs to be twice as fast for the next several years for unemployment to fall to normal levels. I’ll also note that the numbers are a bit better than those of a year ago, but a bit worse than those of March, when unemployment was 8.8%. So although the numbers are better than expected, they’re still underwhelming and we still might be in a double-dip recession.
Instead I want to focus on the other big economic variable. Inflation has been so low over the past few years — in the range of 1-2% — that Ben Bernanke and others have seemed more worried about deflation than inflation. At the same time, some Fed critics have charged that the Fed’s actions to backstop dodgy financial asset markets and flood the banks with new reserves will lead to a massive inflation after the slump is over or a stagflation (stagnant economy with high inflation) even sooner. Some numbers to remember: Inflation has averaged 3% a year over the past century, and close to that over the past few decades. The Fed’s unofficial target for inflation is 2%. What do the markets expect for the years to come?
A good way to answer that question is to compare the well-reported interest rates on regular Treasury bonds with the interest rates on “TIPS” — Treasury Inflation-Protected Securities. The payments on a TIPS bond are adjusted for whatever inflation occurs over the bond’s lifespan. The inflation adjustment is trickier than I’d originally thought — instead of simply adding the inflation rate to the interest rate that arose from the bond’s auction, the interest rate stays the same but the bond’s principal rises, and the interest payments are based on the original interest rate times the new principal. (Ex.: Imagine a 1-year, $1000-face-value TIPS bond that sells at par, i.e., for $1000 and therefore has an interest rate of 0%. If inflation is 3% over the next year, then the principal rises 3% to $1030. The interest is still $0, but the overall yield on the bond is 3% ($30/$1000). That’s a simplified example. It’s more complicated if the interest rate isn’t 0%.) Because the arithmetic can get complicated, it’s easier to look up the “breakeven” rate, which is the inflation rate implied by the different on TIPS and ordinary T-bonds.
(Add to that a conceptual complication: Because the TIPS bond is less risky, since it’s indexed for inflation, it should be in somewhat greater demand than the regular T-bond. So, other things equal, it should command a higher price and pay a lower interest rate. With that in mind, the difference between the interest rates on regular T-bonds and TIPS bonds is roughly the expected inflation rate plus an inflation-risk premium, which reflects people’s uncertainty about future inflation.)
Comparing the interest rates for 5-year bonds last week (when this was originally posted), the T-bonds paid 1.12% and the TIPS paid -0.67%. The implied inflation rate (1.80%, if my spreadsheet math is correct) is actually very close to the difference in the interest rates on the two bonds (1.79%). Apparently the market is expecting the Fed to be just shy of its 2% target over the next 5 years.
Looking at the 10-year bonds, the T-bonds paid 2.47% and the TIPS paid 0.24%. The 2.03-percentage-point difference is again a close approximation of the breakeven rate; my spreadsheet math yields an expected inflation rate of 2.22%, or slightly over the Fed’s target. Together the two breakeven rates imply that the market is expecting inflation to average about 2.6% in years 6 through 10. These numbers provide no guide to where they think that inflation is going to come from (recovery? shortages of gas or food? QE5?), but the weakness in the stock market suggests they’re not expecting a recovery anytime soon. It may just be that their flight to safety has gone into overdrive, and TIPS are in exceptionally heavy demand because they are even less risky than regular T-bonds. So possibly they’re expecting inflation rates of about 1% through 2016 and 2% in 2016-2021, with the remainder being a risk premium.
In sum, the Fed does seem to be hitting its inflation target, more or less, but that’s about all. Bondholders appear willing to lock in near-zero or negative real returns over the next five or ten years, just so they can hold a safe asset. Which suggests they’re scared shitless.
I don’t claim to have the answer to this question. Those who propose an answer other than “nothing” don’t get a lot of airtime, but Dean Baker, one of my favorite gadfly economists, is one of them. He writes today that it is wrong, wrong, wrong to say that the Fed has run out of ammunition. While it is true that the Fed has lowered its usual policy target, the federal funds rate, as far as it can go (0-0.25%) and blown through two unusual policy actions known as quantitative easing (QE), there are other options that every policy economist has heard about. (Whether they’re wise options or not is the real question.) I’ll turn it over to Baker:
‘The Fed could do another round of quantitative easing, although this is likely to have a limited impact. It could also target a long-term interest rate, for example putting a 1.0 percent interest rate target on 5-year Treasury bonds.’
QE3 might well happen, although as Baker notes the impact is likely to be limited, as was the case with QE2. Since QE2 did not seem to roil financial markets, my sense is that there will be a QE3, with a slight downward push on medium- and long-term interest rates. But given the low business and consumer borrowing with today’s low interest rates, I doubt that nudging them further down will make a noticeable difference.
Targeting a long-term interest rate implies a more aggressive form of QE, where the Fed buys and sells long-term bonds in such a way as to control the market for those bonds. This is more than it does in its open market operations for Treasury bills, which are about hitting a target for the fed funds rate (the interest rate on loans of reserves between banks), not controlling the T-bill rate. I’m instinctively a bit leery of handing that much control over the bond market to the Fed, and I suspect financial markets would like it even less.
‘Alternatively, the Fed could pursue a path that Bernanke himself had advocated for Japan when he was still a Princeton professor. It could target a higher rate of inflation, for example 4 percent. This would have the effect of reducing real interest rates. It would also lower the debt burden of homeowners, which could allow them to spend more money.’
I’m really skeptical of this one on two fronts.
I don’t think it’s all that easy for the Fed to raise the inflation rate when the economy is stagnant. (The exception — stagflation in the 1970s — was a case where people lost all confidence in the Fed, and it’s not an episode anyone wants to repeat.) All the textbook models I’ve seen of inflation have it coming from either higher aggregate demand (the horse to inflation’s cart, not the other way around, and precisely what’s lacking in this depression) or from an increase in the money supply. And increasing the money supply is not as simple as dropping cash from a helicopter. In the real world the money supply increases as part of a multi-step process: the Fed gives banks excess reserves, banks willingly loan out those excess reserves to willing borrowers, those borrowers spend them, the cash gets deposited into bank accounts, which are part of the money supply. Note the “willing” parts in there — banks have to be willing to loan out their excess reserves, instead of sitting on huge piles of them as they’re doing now, and households and firms have to be willing to borrow money, instead of holding back out of economic anxiety.
Doubling the Fed’s target rate of inflation (it’s now 2%, unofficially) would not only be a political non-starter, likely leading to Congressional hearings or legislation to change the Fed’s charter, but it seems to rely on massive money illusion, i.e., a public too stupid to know what the inflation rate is. Financial markets can make big mistakes, but ignoring the inflation rate is generally not one of them. As Irving Fisher noted a century ago, if the expected inflation rate jumps from 2% to 4%, then nominal interest rates will also jump by 2 percentage points, leaving expected real interest rates (the ones that matter) unchanged. It is true that real interest rates on old loans and the real burden of old debt would fall, which would be good for debtors and ought to provide a net stimulus to the economy. But creditors would regard a planned inflation hike to 4% as theft, which could not be good for confidence overall and might inhibit future lending. Raising the inflation target to the historic norm of 3% would be better, but then we’re back to the question in (1): How?
I’m still looking for alternative stimuli the Fed could try, including different forms that QE3 could take. If you’ve got any ideas, the comments section is happy to have ‘em.
I’m late to the party on this one, but here’s a novel way to increase the money supply and government revenues: Have the Treasury issue platinum coins of huge denominations. (The usual way of increasing the money supply through Fed actions hasn’t been working so well lately — the Fed has created hundreds of billions in bank reserves, but the banks haven’t been loaning them out and so they haven’t been converted into money.) Brad DeLong:
‘[The Treasury should mint] 100,000 of them, worth $10 million each. Billionaires will want to hold some to be cool. Multi-millionaires will want to hold some so that people think that they are billionaires. Use the proceeds to buy back a lot of long-term debt: that’s $1 trillion of quantitative easing by the Treasury right there.’
Yale Law Professor Jack Balkin appears to have gotten the platinum ball rolling. Paul Krugman is intrigued. So is Matt Yglesias. I still need some time to think it over.
For years I taught money and banking under the impression that U.S. Treasury bonds carried no rating at all. I thought they didn’t need to be rated and that the rating agencies agreed. I thought the fact that bondholders accepted lower interest rates on Treasuries than on any other bonds, even AAA-rated bonds of other entities, meant they regarded T-bonds as the least risky (and most liquid) bonds out there. A related issue is whether there’s any point in rating the debt of national governments whose finances are an open book, unlike those of corporations who open their books for the rating agencies but don’t have to for the public.
Standard & Poor’s downgrading last night of Treasuries from AAA to AA+ reminded me of all that. Do bondholders really need S&P, Moody’s, and Fitch to tell them whether T-bonds are safe? Anybody who follows the U.S. fiscal news — e.g., anyone in the bond market — would have their own judgment on the matter. Call me cynical, but I find the timing of the announcement suspicious. First, it comes rather late, as it was clear five days ago that the Budget Control Act of 2011 was going to pass and what the substance of it would be. Second, it comes at the start of the weekend, two days before the markets reopen; that’s plenty of time for other news to come along and offset whatever effect S&P’s announcement has on the markets. My cynical hunch is that S&P is afraid the announcement will have no effect on the T-bond market, thereby underscoring their own credibility rating, which has been F ever since it came to light in 2008 that they’d been rubber stamping toxic bundles of subprime mortgages as AAA. I think their announcement is their way of gambling that if the T-bond market ever does go south, they can say they called it first. (Kind of like those ridiculous predictions every week on “The McLaughlin Group.”)
As usual, Krugman nails it. He acknowledges that the intransigence of Congressional Republicans makes any kind of meaningful long-term debt deal unlikely, but says:
‘On the other hand, it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?
‘Just to make it perfect, it turns out that S&P got the math wrong by $2 trillion, and after much discussion conceded the point — then went ahead with the downgrade.’
In passing the Budget Control Act, Washington lawmakers put deficit reduction ahead of job creation, against the wishes of the public, Keynesian economists, and even (apparently) the stock market. Yet it wasn’t enough for S&P, who say the way out of this hole is to dig even deeper. No, S&P, slashing spending and raising taxes in a depression doesn’t improve our financial health. Krugman again:
‘More than that, everything I’ve heard about S&P’s demands suggests that it’s talking nonsense about the US fiscal situation. The agency has suggested that the downgrade depended on the size of agreed deficit reduction over the next decade, with $4 trillion apparently the magic number. Yet US solvency depends hardly at all on what happens in the near or even medium term: an extra trillion in debt adds only a fraction of a percent of GDP to future interest costs, so a couple of trillion more or less barely signifies in the long term. What matters is the longer-term prospect, which in turn mainly depends on health care costs.
‘So what was S&P even talking about? Presumably they had some theory that restraint now is an indicator of the future — but there’s no good reason to believe that theory, and for sure S&P has no authority to make that kind of vague political judgment.
‘In short, S&P is just making stuff up — and after the mortgage debacle, they really don’t have that right.’
Ironically, the U.S. attained its AAA rating in 1941, just as we were heading into World War II and the (publicly held) national debt was about to explode, to about 140% of GDP, roughly double what it is now. S&P evidently took the long view then.
Get a load of this chart, from Calculated Risk. It shows job losses in the 11 U.S. recessions since 1948. Our Little Depression is in a class by itself:
(Hat tip: James Fallows.) A few things to take away:
The maximum decline (6.4%) of jobs in the current slump was the worst of any of these recessions.
Even after 18 months of so-called recovery, the current employment decline (5%) is larger than the maximum decline in all but one of the other recessions.
At this point after the start of every other recession (except, ominously, the previous one in 2001), it was over and employment had fully recovered its peak level.
Summing up: It has now been 43 months since the last employment peak, and employment is still down 5%, a bigger job loss than in every recession since 1950. By this time after every other postwar recession (but one) began, employment had fully recovered.
If this isn’t a depression, then economists and the media have redefined depression to mean “something that occurred in the 1930s.”
Yes, I think it did. As of 2:53 pm, the yield on ten-year Treasuries has plunged 20 basis points to an ultra-low 2.36%, their lowest level of the year. It’s the stock markets that are a bloodbath today, with the S&P 500 and Nasdaq down about 6%. Prices for the safe havens of gold and Treasury bonds are both way up. Inasmuch as the S&P downgrade has upped the fear factor, it’s hurt stocks and helped T-bonds.
To qualify this: The S&P’s role here has likely been vastly overstated by the media. (Krugman has already lost his lunch over this one, so I don’t have to.) For starters, when U.S. markets opened this morning, the T-bond market didn’t show much of a reaction either way (down just 2 basis points in the late morning, i.e., basically unchanged) and the stock markets’ initial tumble was not out of line with what they’d been doing the past two weeks (the S&P 500 fell almost 11%), going into the weekend. The snowballing of money out of the stock market and into the T-bond market is something that happened later in the day, not a plausible initial reaction to the downgrade. But plausibly the downgrade added to the general climate of fear, which got a lot more heated by the afternoon, so . . . it still seems that agent 6373 has accomplished her mission.
Many commentators have said that the unfolding crises in Italy, Spain, and the European Central Bank are both more dire and more unpredictable than the revelation that Washington is so dysfunctional that even a disgraced ratings agency thinks so. The weekend’s bigger announcement may have been that of ECB President Jean-Claude Trichet that the ECB would try to alleviate Italy’s and Spain’s debt crises by buying up huge chunks of their debt. Otherwise known as monetizing the debt, the modern-day equivalent of printing money to pay the bills.* The announcement seems to have helped Italy’s and Spain’s sovereign debt markets a bit, as interest rates on those bonds fell slightly, but it casts doubts on the ECB’s credibility as a tough-minded central bank that doesn’t go around picking up the tab for member countries’ large debts.
* You might ask: Doesn’t the Federal Reserve do the same thing when it buys U.S. Treasury bills, notes, and bonds as part of its open market operations and “quantitative easing”? Not quite, though it does count as monetizing the debt. The big difference is that the Fed, with a few distant exceptions like during the world wars, does not try to buy up U.S. government debt just to help out the government. (Will they still be so above the fray if and when hardly anybody wants to buy U.S. Treasuries? I’ll leave that one for my libertarian commenters.)
From today’s Federal Open Market Committee announcement:
‘The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.’
Ouch. This was apparently supposed to be a mild monetary stimulus — the fed funds rate target is being held at 0-0.25% for two full years instead of just for a vague “extended duration” — but it’s also one more dismal forecast, from an authoritative source.
Good article here by MSNBC.com’s John W. Schoen, who lays out some of the Fed’s alternative options and seems underwhelmed by them. For example, the much-discussed “QE3″ option of buying long-term T-bonds in an effort to force long-term bond rates down further has two big disadvantages: (1) Low long-term bond rates don’t seem to have sparked much investment or consumption so far, so it’s doubtful that lowering them further will make much difference; (2) Lowering them even further will reduce the already much-reduced incomes of retirees and others living on interest.
The New York Times joins the chorus of complaints that the Fed has not done enough to jump-start this stalling economy. In yesterday’s lead editorial the gray lady ruefully notes that Ben Bernanke basically ruled out further quantitative easing when he said at the Fed’s June meeting that it would not happen unless there was a heightened risk of deflation. Then the editorial offers a paragraph’s worth of additional measures the Fed could take. One by one:
‘For starters, the Fed could take modest steps, like shifting its portfolio toward bonds with longer maturities, which would help to keep long-term rates low and nudge investors into riskier investments.’
In other words, QE3, or QE2 on steroids. Normally the Fed targets the shortest of short-term rates (the fed funds rate) and does so through its open market purchases and sales of short-term T-bills. And T-bills are the security of choice because the Fed does not want to make too big a splash (at least not directly) in the markets for particular bonds. The logic here is the reverse: of course the Fed wants to make a splash in the bond market by lowering long-term interest rates — that’s the penultimate goal of monetary policy, behind stimulating business investment and consumer spending. In today’s extraordinary circumstances, ending the Little Depression seems more important than not disrupting the bond market. So it’s hard to argue against this one, other than to note that the Fed would probably be monetizing a lot more of the federal debt than otherwise, which could raise inflation fears. (Of note: In the early 1930s Keynes thought the central banks should buy up long-term debt so as to lower long-term interest rates, too. So this isn’t exactly a new idea.)
‘It could reduce the interest it pays on the banks’ huge reserves or even tax the reserves to try to encourage more lending.’
Absolutely. Reduce it to 0%, which was the rate on reserves prior to 2008. Bernanke’s main rationale paying interest on reserves, as I understand it, was to reassure the markets that the huge pools of bank reserves, which the Fed created in response to the crisis, would not lead to a runaway inflation when the economy began to recover and banks loaned those reserves out. The idea was that as the economy recovered the Fed would “soak up” those reserves by raising the interest rate on them so that banks would be less inclined to loan them out. At this point, however, hardly anyone seem to be worried about the inflation threat posed by those reserves. They’re more worried about how they continue to just sit there. Lowering the rate to zero can only help, though maybe not by much.
‘It could also resume buying Treasuries or other securities to provide additional monetary stimulus.’
This is a lot like the first suggestion. It could get more radical if the “other securities” are things like mortgage-backed securities, in which case it’s more like QE1 (when the Fed effectively bought up many of the toxic subprime securities, thereby taking them off the market). This brings to mind the dramatic proposal by Joseph E. Gagnon of the Peterson Institute for International Economics, which has gotten a lot of attention lately. Gagnon: “First and foremost, the Federal Reserve should announce an additional $2 trillion of asset purchases, including longer-term Treasury bonds, agency mortgage-backed securities (MBS), and foreign exchange. This is more than three times the size of the woefully underpowered quantitative easing of late last year (dubbed QE2) and it should be accompanied by a clear statement that more is forthcoming if the economy continues to underperform.” I haven’t digested Gagnon’s proposal yet, but this is what a radical proposal looks like. Krugman and Brad DeLong seem to like it.
‘A more aggressive strategy would be letting inflation rise above the Fed’s comfort level of 2 percent or so to, say, 4 percent. That could help the economy by easing the repayment of debt.’
This would have promise if the Fed could actually control the rate of inflation like that. As I’ve written before, I don’t think it can, not when the economy is in a depression and seems to be tending on its own more toward deflation than to 4% inflation. The Fed has already flooded the banking system with reserves; when they don’t get loaned out (as so many of them haven’t), they don’t raise aggregate demand, the money supply, or the price level.
In sum: The first two steps seem worth taking, but are probably too modest to have much impact. The third step can be about as big as the Fed wants it to be; it has the most potential, though as with QE1 just moving a lot of assets from the private sector onto the Fed’s balance sheet doesn’t necessarily generate a surge of private investment. The fourth step looks impossible at present, even without the inevitable political resistance to the Fed backing down on inflation.
Household consumption has long been the mainstay of U.S. GDP, and asset-bubble-driven consumption in turn helped drive the expansions of the 1990s and 2000s. But consumption spending has been weak in this so-called recovery, growing at only about 2% (annualized and inflation-adjusted) since its trough in spring 2009, and it fell in each of the last three months for which we have data (see graph). On top of that, today’s consumer sentiment numbers are the worst in three decades. To find worse, you’d have to go back to a month that included recession, double-digit inflation, Americans held hostage in Iran, long gas lines, and the eruption of Mount St. Helen’s (this is starting to sound like a pub trivia quiz . . . the answer is May 1980).
File under “Outraged and paying attention”: From the press release accompanying the consumer sentiment survey data (from Thomson Reuters / University of Michigan):
‘”Never before in the history of the surveys have so many consumers spontaneously mentioned negative aspects of the government’s role,” survey director Richard Curtin said in a statement.
‘The Obama administration received poor ratings from 61 percent of respondents, the worst showing among all prior heads of state. [I could not find a rating for Congress, but in recent polls Congress gets even lower ratings than Obama.]
‘”This was more than the simple recognition that traditional monetary and fiscal policy measures were largely spent; it was the realization that the government was unable or unwilling to act,” Curtin added.’
Yes. Imagine if the government had spent this year looking for ways to stimulate the economy rather than contract it through spending cuts. Failing that, imagine if if Obama had forcefully and publicly told the Republicans that it was absolutely unacceptable for them to hold the debt ceiling hostage to their root-canal economics. (It worked for Bill Clinton in 1995-96 with the government shutdown.) At least one branch of government would be seen as more focused on jobs than deficits.
Instead, as Curtin implies, the public rationally concludes that jobs take a back seat to deficit cutting on all major politicians’ agendas. And the attention given to the debt-ceiling debacle has much of the public expecting more of the same in connection with the budget appropriations deadline on Sept. 30, the deadline for the Group of Twelve’s long-term budget-cutting proposal on Nov. 23, and the expiration of the Bush tax cuts on Jan. 1, 2012. It’s easy to imagine the entire rest of the year devoted to partisan trench warfare, isn’t it? Be glad these guys are on vacation.
P.S. Title inspired by The Clash, of course. Alas, poor London. Feels weird to read about traditional looting for a change instead of the financial variant.
Another Kabuki dance has commenced in Washington, now that Congressional leaders of both parties have made their selections for the Gang of Twelve charged with crafting $1.5 trillion in savings in 2013-2022. They have until Nov. 23 to agree on a package of savings. If Congress can’t pass that package, then $1.2 billion of automatic, across-the-board spending cuts (no tax increases) would kick in.
I’d place my bets on none of those things happening. Here’s what I foresee:
1. Negotiations among the twelve constantly are on the verge of breaking down along party lines, especially on the issue of tax increases. Possibly they are unable to reach a compromise at all. Even if they do, few of them will throw much weight behind it.
2. If a budget plan emerges, getting majority support in the House and 60 votes (or 51 votes, if nobody filibusters it) in the Senate will prove impossible. The partisan acrimony will look like open warfare.
3. With the specter of $1.2 trillion in across-the-board cuts, including maybe $500 billion in Pentagon cuts, the Secretaries of Defense, Homeland Security, and other agencies, joined by citizens and interest groups all over the nation, will howl that these cuts would devastate our country. Congress’s approval rating will plummet even further, to about the same level as the Taliban’s.
4. Congress will pass a new bill that says, um, nevermind about all those spending cuts. (This is an inherent problem in trying to tell future Congresses what to do, or even telling oneself what to do a little ways down the road.) Republicans will continue to pummel Obama and the Democrats for overspending, but neither side will be able to push a new deficit-reduction plan through both houses of Congress.
Now, what about the reaction of the markets to all this? I think that most of the market already expects something like this and has basically priced it in. It’s decades-old news that Congress has no stomach for long-term deficit reduction, and obvious by now that the partisan split in this Congress is among the worst ever. If the above predictions come to pass, then the markets and economy will get worse, as this failure becomes definite. As I’ve written before, I think the market is reacting less to the U.S. debt burden than to continued evidence that U.S. politicians are simply not doing their job when it comes to dealing with the Little Depression. I think they’re appalled that Congress and the White House are wasting so much time on this doomed debt deal and have basically painted themselves into a corner with this Nov. 23 deadline and automatic-spending-cuts mechanism. They see the writing on the wall; either Obama, Boehner, Reid, et al. don’t or each side is cynically thinking that they can spin this fiasco-in-waiting to their advantage. Either way, they’re not doing their job. They’ve set themselves up to fall, each side hoping that the other falls further.
Well, yeah. We should worry about the long-term deficit, but when the world is ready to lend us more money at zero real interest rates, the world clearly has other priorities. And so should we — like the 16% of the labor force that’s either unemployed or underemployed. What might we do with all this money the world is so eager to lend us?
The closest thing to a proposal to build things that’s come out of Washington lately is an infrastructure bank, to fund various improvements in the nation’s roads, bridges, levees, and such. A recent Bloomberg editorial praises the idea, and Pres. Obama is urging Congress to create such a bank. The obstacle, not surprisingly, is Congressional Republicans who view all domestic spending as “pork.” In this case, however, the pork is more like bacon bits. From the WSJ:
‘Under the White House plan, the infrastructure bank would augment current highway and transit programs. The bank would receive $30 billion over six years and would issue grants, loans and other financial tools.’
$5 billion a year? Barely a drop in the giant bucket that is the U.S. output gap. And barely a dent in our nation’s gaping infrastructure needs, which the American Society of Civil Engineers (ASCE) estimates as costing $2.2 trillion over 5 years. Way to think big, Mr. President. As Krugman wrote recently, the battle in Washington is between Republicans who want to do nothing and Democrats who want to do very, very little. And outside the beltway, we have a Republican presidential front-runner who thinks that doing anything to help the economy before November 2012 is not only wrong but treasonous.
But heroically assuming for a minute that Washington actually wanted to employ people to fix the nation’s infrastructure, the ASCE’s website provides ample details about where to do it. Talk about “shovel-ready projects.” Meanwhile, my former professor David F. Weiman recounts some of the infrastructural marvels of the New Deal. Even a longtime Great Depression researcher (me) was amazed:
‘The New Deal’s Public Works and Works Progress administrations spurred rapid productivity growth in the midst of the Depression. New roads and electrical power networks paved the way for post-World War II economic expansion built around the automobile and the suburban home. Astonishing 21st-century innovations such as next-day FedEx deliveries and Wi-Fi still rely on these aging investments. We associate FDR with massive hydroelectric dam projects — including the Grand Coulee and Hoover dams in the West, and the Tennessee Valley Authority in the South — but the New Deal also electrified rural America through cooperatives that distributed cheap, reliable power. Nearly 12 percent of Americans still belong to these collectives. Without the New Deal, they would be stuck in the much darker 1920s.
‘As would modern travelers. Without the New Deal, New York commuters would be without the FDR Drive, the Triboroughand Whitestone bridges, and the Lincoln and Queens-Midtown tunnels. There would be no air traffic at LaGuardia and Reagan National airports. D.C.’s Union Station, wired for electricity during the New Deal, would have a very different food court. Between New York and Washington, Amtrak runs on rails first electrified during the New Deal.
‘Out West, the New Deal gave us Golden Gate Bridge access ramps, the Oakland-San Francisco Bay Bridge, the first modern freeways, and San Francisco and LAX airports. Between the coasts, it brought more than 650,000 miles of paved roads, thousands of bridges and tunnels, more than 700 miles of new and expanded runways, improvements to railroad lines, and scenic routes such as the mid-South’s Natchez Trace Parkway. Without the New Deal, of course, some of these would have eventually been built by state and local governments or the private sector — years after America’s recovery from the Depression.
‘Moreover, private infrastructure improvements would have bypassed poor regions such as the South. Because of its vision and virtually unlimited borrowing capacity, the New Deal underwrote Southern modernization with new roads, hospitals, rural electrification and schools. These public investments paid off. After 50 years of stagnation, average Southern incomes began to catch up with the national average during the New Deal era.’
Granted, economic historians have long criticized FDR’s New Deal deficits as being too small to restore the economy to full employment, but neither were they insignificant. An average of 3.5 million workers a year worked in New Deal jobs. From the above it’s clear that a great many of those jobs produced great gains for America’s infrastructure, economy, and society.
It is well known that Republican politicians typically denounce John Maynard Keynes as an apologist for big government and deride “public investment” as a smokescreen for pork-barrel spending (mmm, smoked pork). Steve Benen at The Washington Monthly notes, however, that Republicans in Congress are rather Keynesian in prolifically proposing public investments in their own districts. Which leads him to a clever idea:
‘… how about a new stimulus package focused on granting Republicans’ requests for public investments?
‘Here’s the pitch: have the White House take the several hundred letters GOP lawmakers have sent to the executive branch since 2009, asking for public investments, and let President Obama announce he’ll gladly fund all of the Republicans’ requests that have not yet been filled.’
(Hat tip: Bob Cesca, who sums it up as ‘Keynesian economics as endorsed by the Republican Party.’)
If Obama wants to make this idea more responsible, he could say he’ll do this only for requests that are also on the American Society of Civil Engineers‘ extensive list of needed infrastructure improvements.
It may be the best hope for a new spending stimulus. (A tax-cut stimulus might be easier to get through Congress, but standard economic impact estimates find that tax cuts do less to increase GDP than new spending does. And the type of tax cuts that Republicans tend to favor, like lowering the top marginal tax rate and reducing the capital gains tax rate, do even less, because wealthy people don’t consume much of their extra income.) If Republicans reject it, they’ll look hypocritical for wanting one thing for their districts and another for the nation.
Bruce Bartlett offers a fine economic history lesson on the U.S. top marginal tax rate. Most people know that the top rate has changed quite a bit over time. (For those keeping score: 91% from WW2 to the early 1960s; 70% till the early 1980s; 50% for most of the Reagan administration; 28% in the late 1980s; raised to 31%, then 36%, then 39.6% in the early 1990s; lowered to 35% in 2001). Bartlett compares the top tax rate with the economic growth rates during those intervals and finds basically no correlation. That, too, is not really news (and a more careful study would take other factors into account).
What is striking, however, is how the threshold level of income for the top rate has changed over time. The original income tax, at the height of the Progressive Era during the Wilson administration, set the threshold at $500,000, which is not only higher than today’s $374,000 but was in 1913. The price level has increased more than 20 times since then; adjusting for inflation, the 1913 top tax rate kicked in at $11 million.
The famous tax cuts engineered by Harding-Coolidge-Hoover Treasury Secretary Andrew Mellon in the 1920s lowered that threshold considerably (to $100,000, or $1.2 million in today’s dollars) but in real terms left it still well above today’s. Pres. Franklin Roosevelt raised both the top tax rate and the threshold to sky-high levels (79%, and a threshold that would be $80 million in today’s dollars and may have only affected one person; some called it “the Rockefeller tax”). The threshold fell to $200,000 (equivalent to about $3 million today) during WW2 and basically stayed there till the early 1980s. The “Reagan tax cuts” of 1981 lowered the threshold to $85,600 (not quite $200,000 today). The Tax Reform Act of 1986, which Reagan signed, flattened the tax system further, with a top rate of 28% that kicked in at just $30,000 (about $50,000 today). The “Clinton tax increase” raised the threshold from $86,000 to $250,000, and inflation adjustments have raised it to $374,000 today.
Notice a partisan pattern here? It’s no secret that Republicans think the rich are overtaxed and Democrats think the rich are undertaxed, but the discussion almost always focuses on the top tax rate. What’s often missing is just where the definition of “rich” begins. In the historical record, Democrats (Wilson, Franklin Roosevelt, Clinton) have tended to set the top tax threshold high, whereas Republicans (Harding, Reagan) have tended to lower it. Much of this comes down to different notions of fairness: Democrats tend to favor a progressive income tax in which richer people pay a larger share of their income and poor people pay little or none; Republicans tend to favor a flat income tax (or no income tax), in which everyone pays the same marginal rate. Having the top rate kick in at very high levels of income tends to go hand in hand with a multiplicity of different tax rates and a highly progressive tax structure, whereas having it kick in at low levels of income means a much flatter tax.
Ever since the “Bush tax cuts” of 2001 were passed, many Democrats have talked about raising the top tax from 35% back to 39.6%, but until recently I’d heard surprisingly little talk about raising the threshold.This was surprising to me, because, as Bartlett points out, many people do not regard $250,000 or even $374,000 as particularly rich — at least not if, say, you live in New York City and have a family of four. It’s rather unclever politics to talk about raising the top rate without reassuring upper-middle class people that you’re not going to raise their taxes too. Republicans, with clever simplicity, typically truncate “tax increase on the wealthy” to “tax increase,” implying that it’s a tax increase on everybody. Lately Pres. Obama has called for raising the threshold to $1 million, so that people making $374,000-$999,999 would still pay 35 cents on their last dollar of income but people would pay 39.6 cents on every dollar of income above $1 million.
It is still debatable whether raising anyone’s taxes in a depression is ever a good idea, but ideally whatever major long-term deficit reduction plan Congress passes will go into effect only when recovery is well underway and unemployment is down to, say, 7% or less. When that happens, I agree with Bartlett that raising revenues efficiently and equitably will entail raising taxes on the top brackets (either through raising rates or, better yet, closing loopholes) and raising the top tax threshold.
This recent observation by Dean Baker got me thinking:
‘As noted in today’s lesson on accounting identities, the share of GDP devoted to investment in equipment and software is almost back to its pre-crisis level. And, the saving rate is still below its post-war average, meaning that consumption is high, not low.’
The point about investment is particularly notable. All through this Little Depression we’ve been hearing that companies are reluctant to invest, whether because of pessimism about future sales (me, for example) or because of uncertainty about future taxes and regulations (conservatives). A bit less than half of investment is in equipment and software, so it’s good news that that’s largely come back. The larger part of investment, structural investment (both commercial and residential), is still hurting, however; I’d think the reasons are related to the post-2007 woes in the housing and real estate sector in general.
The Commerce Department’s quarterly GDP reports are a godsend for trying to pinpoint what areas of the economy are strong and which are week. The reports have three one-page tables: Table 1 gives the annualized real percent change for the various GDP components, broken down into a couple dozen sub-components; Table 2 gives the contribution of each one to real GDP growth (e.g., if increased investment caused GDP growth to be 1.0% instead of 0.0%, its contribution is listed as 1.0%); Table 3 gives the dollar value of each component and sub-component. Yesterday’s report contains revised figures for the second quarter of this year, and quarterly figures dating back to 2007. What do they tell us?
First, looking at the yearly figures, in 2008 and 2009, the two years when real GDP actually fell, investment fell even more sharply, and consumption fell somewhat, with positive contributions from net exports and (secondarily) government purchases making up some of the difference. Okay, that’s not news, but it’s worth keeping in mind.
Turning to the quarterly figures, we’ve now had two full years of rising real GDP dating back to the third quarter of 2009, but from 2010:I to 2011:I that growth slowed in every single quarter: 3.9, 3.8, 2.5, 2.3, 0.4%. It rebounded to a still-anemic 1.0% in 2011:II. Those last few growth rates are not enough to keep the unemployment rate from rising, which is the definition of a “growth recession.”
The economy had three consecutive strong quarters in 2010:IV-2011:II, with real GDP growth of almost 4%. What drove that little spurt? In the first two cases, investment, especially inventory investment (which means companies were optimistically producing in expectation of higher sales and/or failed to sell much of what they produced). Equipment and software investment made a modest contribution, and structural investment again made a negative contribution. In the third quarter, investment again led the way (this time sparked by equipment and software), with consumption closely behind. Notably, despite the federal stimulus, the total government contribution to GDP growth was slightly negative in those first two quarters (state and local retrenchment more than offset the federal stimulus) and modest in the third quarter (of note: the modest federal contribution of 0.71% was actually the second-highest since the stimulus began, with the highest being 1.09% in 2009:II. Draw your own conclusion. Mine is that the stimulus was way too small.)
What caused growth to be so slow in the first two quarters of 2011? Government retrenchment led the way, with respective contributions of -1.23% and -0.18%. In the first quarter, most of the retrenchment was at the federal level (-0.81%), which probably represents the winding down of the stimulus. In the second quarter, state and local government retrenchment shaved 0.34% off GDP, while the federal contribution was slightly positive. Also in the first quarter, a surge in imports mostly negated the contribution of increased consumption (1.47%-1.35%).
If we want to look for positives, here are the components of real GDP that grew by at least 3% (annualized, and 3% is about the historic norm for GDP growth) in both quarters of 2011:
investment in equipment and structures: 8.7%, 7.9%
exports: 7.9%, 3.1%
Not bad, but too small in relation to the economy to lead economic growth. Investment in structures was still poor (with a combined contribution to GDP growth in the two quarters of about zero), and rising imports more than offset the improvement in exports. Perhaps the key thing that sticks out is that even without the drags on the economy from government retrenchment and negative net exports, the positive parts of the economy were themselves fairly weak. Consumption contributed just 1.47% and 0.30% respectively; investment just 0.47% and 0.78%. Even without the drags from government and net exports, that’s total growth of just 1.94% and 1.08%. This is still a very slowly recovering economy, still a Little Depression. It also looks like there’s way too much vacant housing and physical plant out there for many people to want to build.
Today’s big news is an unexpected surge in consumer spending in July. After adjusting for inflation, the increase is 0.5%, which is the largest since 2009. It comes after three straight months of decreases in real consumer spending and a historically dismal reading for consumer confidence a few weeks ago.
Granted, the recent plunge in consumer confidence could translate into an immediate about-face in consumer spending, but for now the picture looks quite different. Much of the collapse in confidence was due to the debt-ceiling fiasco and dashed hopes for a budget deal, but memories of that episode may fade, at least as far as their impact on consumer behavior; after all, Congressional dysfunction is nothing new.
The July increases for personal income (0.3%) and consumption (0.8%) pull the year-to-year monthly increases up to 5.3% and 5.1% (in nominal terms). Subtracting the 2.8% inflation over the same period, the real increases are 2.5% and 2.3%.(Source: Bloomberg.com; sorry, no Permalink available.) Still not enough to lead a rapid recovery, as 3% real GDP growth is the norm and at least 4% would be needed to reduce unemployment, but not bad. Dean Baker has noted that consumption is actually fairly high, in the sense that the household savings rate is low by postwar standards. So it appears that consumers are spending, they just don’t have a lot of income to spend.
. . . to be the new chair of President Obama’s Council of Economic Advisers. Krueger is a world-class economist who has produced much fascinating, groundbreakingresearch, and he has ample Washington policy experience. Although Krueger is typically classified as a labor economist, not a macroeconomist, his research is far-ranging and his opinions on macro issues, as expressed in his columns and Economix blog posts for the New York Times, look sensible and well supported.
On the other hand (and there has to be an “other hand” — I’m an economist, after all!), will Obama listen to him? Christina Romer and Austan Goolsbee, Krueger’s predecessors at CEA, gave Obama excellent advice about the need for a strong fiscal stimulus but he ignored it, opting for a stimulus only about half as large as they urged. Neither of them could possibly have agreed with this summer’s bizarre pivot away from jobs toward deficit reduction at a time of 9% unemployment, not to mention the way it opened up the president to Republican debt-default brinkmanship. No wonder Goolsbee was so delighted to leave the job.
The usually excellent Ezra Klein was on “The Rachel Maddow Show” tonight, and for once I’d say he got it wrong. He said Krueger’s policy work experience with Larry Summers in the Clinton and Obama administrations and his tennis partnering with Tim Geithner make him just another insider, not a real change. I see no evidence that Krueger is as willing as Summers or Geithner to kowtow to Wall Street interests, and at this point even Summers seems to be calling for a fiscal stimulus instead of short-term deficit reduction. It looks to me like Krueger is cut from similar nuanced-Keynesian cloth as Romer and Goolsbee, but better connected. The CEA chair who plays doubles with Geithner has a better shot of making a difference.
Dammit, Krugman’s stealing my thunder again — this time, by adding alternative and classic rock YouTube links to his blog posts. Despite his Nobel, he’s modest enough to admit he’s been out of the musical loop since 1990 and to ask his readers for suggestions. I sent mine in. Hope you get to comment #340, Paul. It includes a link to the music page that I’ve been updating for about ten years.
Meanwhile, Loudon Wainwright III has a song about Krugman:
Eric Alterman hits the nail right on the head right here. Just as E. Cary Brown concluded about New Deal fiscal policy in the 1930s, the problem wasn’t that Keynesian fiscal stimulus was tried and found wanting, it’s that it wasn’t tried. Or was barely tried. In the 1930s the federal deficits were too small, were largely offset by budget cutting at the state and local level, and were reversed by a misguided attempt at budget balancing in 1936-37. Sound familiar? A key difference between then and now, however, is that Pres. Roosevelt and the Democratic Congresses of the 1930s believed in direct government job creation. The New Deal added an average of 3.5 million workers per year to the federal payroll. Pres. Obama was under great political pressure to keep that number at zero, and to hope that job creation would come from tax cuts (not promising, since much of that money gets saved or spent on imports) and government contracts (also not promising, since profit-maximizing contractors try to economize on labor costs).
Alas, this famous passage by Keynes no longer seems to be true:
‘The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.’
One could argue that Keynesian economics gave way to another academic branch of economics, like monetarism or new classical economics, but I see little in recent political or policy debates to suggest that either of those schools is being consulted. What about supply-side economics, you ask? It’s not really an academic school of economics, more a fig leaf for certain vested interests. Consider for, example former Reagan budget director David Stockman’s famous admission that the Kemp-Roth/Reagan “supply side” tax cuts were really just a Trojan Horse for cutting taxes on the rich.
Speaking of Reagan, his declaration thirty years ago that “government is the problem” seems to have become the guiding light for economic policy-making in America. Score one for “the power of vested interests.”
1) ‘The rent-a-worker economy’: a reliance on contract workers and outsourcing. Contract workers are easier to let go when conditions worsen. And having made do with less, many companies are eager to try to do the same even when conditions improve.
2) ‘The résumé gap’: a lack of skilled workers, or least of workers with the skills businesses want.
3) ‘Rise of the “plutonomy”‘: an increasingly skewed distribution of wealth is bad for aggregate demand because the rich don’t consume as much of their income as poor and middle-class people do.
4) ‘The China syndrome’: China can make high-tech products too, and often more cheaply than we can, even after taking productivity differentials into account.
5) ‘Somebody start a company!’: ‘. . . start-up activity has plunged. Running 25 percent below its 2006 peak, it is at its slowest pace since the Labor Department began tracking the activity in 1994.’ Reasons cited are tight funding and ‘high uncertainty and low confidence about launching new ventures in a weak economy.’
6) ‘When a home is a dungeon’: The mortgage debt overhang is still large — 11 million Americans are “underwater,” i.e., they owe more on their mortgages than their homes are currently worth. For this and other reasons, consumers are less willing to spend, even relative to a year ago.
The article tries to end on a hopeful note by citing some companies that are actively hiring, but it also notes, ‘Still, overall the country would need to generate about 21 million new jobs by the end of the decade in order to return to a 5 percent jobless rate.’ Let’s do the math: September 2011 to December 2019 is 8*12 + 4 = 100 months. So the economy would have to generate an average of 210,000 jobs per month for the next eight years (and four months) to get unemployment back to its average rate for 1997-2007. Keep that number in mind every time you see a monthly employment report. Number of times since last summer that the U.S. added 210,000 jobs in a month: 2. And the total for August was 210,000 jobs short of that goal.
. . . is how I’d describe this month’s major developments on the fiscal and monetary policy front, namely Pres. Obama’s new jobs proposal and the Fed’s decision to reallocate its Treasury bond portfolio so as to try to push long-term interest rates down.
The Fed’s decision is simpler, so I’ll start with that one. Last Wednesday the Federal Open Market Committee kept its fed funds rate target unchanged at 0-0.25% and announced that it would sell most of its short-term T-bill portfolio and replace it with longer-term T-notes and T-bonds. This is quite a bit less than the “QE3″ (quantitative easing, round 3) that many in the market were hoping for, as it does not involve a net increase in the Fed’s Treasury holdings, and the stock markets took a tumble that afternoon. The media quickly dubbed the Fed’s move “Operation Twist,” after a similar action in 1961. Nobody expects this move to have more than a marginal impact, not when mortgage and other long-term interest rates are already at historic lows, but it’s hard to argue against a positive marginal impact, purchased at so little cost. A Wall Street Journal editorial notes that the 1960s Operation Twist lowered long-term interest rates by about 0.20 percentage points, and “Some experts said that was enough to make the program effective; others deemed it a failure.” It seems to me that any reduction in unemployment from this move, however small, is welcome news at a time of 14 million unemployed.
The President’s new jobs bill is a more complicated animal. (Note that they’ve dropped the term “stimulus package,” apparently out of belated recognition that “jobs bill” is simpler and sounds more appealing and also because the $787 billion stimulus of 2009 is unpopular. I’ve been over this one before: leading estimates are that it saved a few million jobs, which is good, but it was supposed to save all of them, and that obviously didn’t happen. Thus it is unpopular.) The main complication is that it has no chance whatsoever of passing, given knee-jerk opposition to all things Obama in the Republican-controlled House and the Republican-filibuster-strength minority in the Senate. This despite the fact that, as Obama said, that virtually everything in it has been supported by Democrats and Republicans alike. (To be fair, not much in it has been supported by Republicans recently, i.e., since Obama became president.)
Specifics: The American Jobs Act (its official name) has a price tag of $447 billion, most of which apparently would be spent during the next 12 months, so roughly the same yearly amount as the 2009 stimulus. More than half of that is a $240 billion cut in payroll taxes, including a reduction in the payroll tax paid by workers, a cut in the employer share for small businesses, and a tax holiday for new employees. The next biggest item is $140 billion for infrastructure and local aid, notably transportation, retaining and rehiring teachers and first responders, and modernizing public schools. The last area is $62 billion for unemployment insurance extensions, tax credits for hiring the long-term unemployed, and subsidized employment for low-income individuals.
All of this seems reasonable, maybe too reasonable. In a less toxic political environment, this proposal would pass, but just like the 2009 stimulus, it would be way too small to fill America’s jobs deficit. The payroll tax has already been cut to 4.2% (down from about 6.2%), and the jobs bill would cut it to 3.1%, or about $11 on every $1000 of income. Small potatoes. And while poorer workers would surely spend their payroll tax cut, upper-middle class and upper-class workers would probably save much of theirs. The current payroll tax cut is set to expire at the end of this year, and Republicans aren’t crazy about it (they prefer permanent tax cuts aimed at “job creators” in the top tax brackets) but don’t want to be cast by Democrats as favoring tax increases for the little guy, so a further extension of the 4.2% payroll tax rate seems likely.
The payroll tax holiday and ($4000) tax credit for hiring the unemployed should also be expected to have a positive but marginal impact on employment. The number one question in any prospective employer’s mind is “Can I sell the extra output that this person would produce?” Tax holidays and tax credits make a Yes more likely, but only if the product demand is strong enough to almost warrant hiring the person in the first place. Still, we economists live at the margin, and as with the Fed’s Operation Twist, anything that creates jobs at minimal cost is a positive thing.
And now on to costs. This is the main area where I have a problem with the president’s proposal. Obama says the program is fully funded, when really that’s the last thing we should be worrying about during a depression.The more you offset the new spending and tax cuts with spending cuts and tax increases elsewhere, the less stimulus you have. Obama said the program will be paid for by additional spending cuts in the future, closing corporate tax loopholes, and reinstating the “millionaire’s tax” on personal income. (Note: We last had a $1 million tax bracket in 1940, in nominal terms. Adjusting for inflation, we last had a $1 million tax bracket in 1973.) If the spending cuts are sufficiently far off in the future, like when the unemployment rate is back below 6%, they should do little macroeconomic damage. Ditto the closing of tax loopholes — which probably have little to do with hiring anyway — and the millionaire’s tax. As far as I can tell, those tax increases — and some others that I would support, like taxing hedge fund managers’ salaries as ordinary labor income instead of at the lower capital gains rate — would take effect immediately. While I don’t buy the Republican rhetoric about every rich person being a Job Creator, I still don’t think raising taxes in a depression is a good idea. It can wait.
How did I miss this one? Bloomberg News, on Aug. 31, reported that Standard & Poor’s is still giving its highest rating, AAA, to subprime-mortgage-backed securities:
Standard & Poor’s is giving a higher rating to securities backed by subprime home loans, the same type of investments that led to the worst financial crisis since the Great Depression, than it assigns the U.S. government….
More than 14,000 securitized bonds in the U.S. are rated AAA by S&P, backed by everything from houses and malls to auto- dealer loans and farm-equipment leases, according to data compiled by Bloomberg.
The best that can be said about today’s BLS employment report is that it revealed 202,000 new jobs, which is in the right ballpark for how many jobs the economy needs to generate each month for the next eight years in order to get back to a normal unemployment rate. The bad news is that only 103,000 of those jobs are from last month. The other 99,000 are from revisions to July and August, which push those months’ net-new-jobs totals up to 127,000 and 57,000. So the average employment gain for the last three months is less than half of what we need to be on that eight-year recovery track.
It gets worse. Quoth the BLS: “Since April, payroll employment has increased by an average of 72,000 per month, compared with an average of 161,000 for the prior 7 months.” So now we’re down to about one-third of the needed monthly job creation to be on that eight-year recovery track.
NPR’s Planet Money reports that the job market is bad across all demographic groups, even the college educated. While college-educated people age 25 and over are the only group with an unemployment rate below 5%, the BLS historical tables show that the current rate (4.2%) is more than double what it was four years ago (2.0%). And the employment-to-population ratio of this group has fallen almost 3 percentage points (to 73.0%) over the same span.
The employment-to-population ratio is really where the worst news is. Even the expanded unemployment rates, which include discouraged job-seekers and/or involuntary part-timers, have shown some improvement over the past two years. But the improved unemployment rates seem to be entirely an artifact of people dropping out of the labor force. The labor force is actually slightly smaller today (154 million) than it was in mid-2009, at the trough of the recession. The economy has added about 1.6 million jobs since the employment trough of October 2009, but that hasn’t been been enough to keep pace with population. The current employment-to-population ratio (58.3%) is actually slightly lower than that of October 2009 (58.5%), even as the main unemployment rate has fallen from 10.1% to 9.1%.
Along those lines, the BLS’s “Alternate Measures of Labor Underutilization” are instructive. The official (U-3) unemployment rate counts only the jobless who say they are actually looking for a job. The U-4 unemployment rate includes “discouraged workers,” i.e., jobless people who are not looking but would take a job if one came along. The U-5 unemployment rate adds in “marginally attached workers,” who are a similar state of joblessness. Yet the U-5 unemployment rate (10.5%) is only 1.4 percentage points higher than the official rate, which suggests that most of the unemployed are either (1) still looking for work or (2) really not even thinking about it, i.e., have found life, or despair, or something, outside the labor force.
The oft-cited U-6 unemployment rate, which is by far the highest, includes part-time workers who cannot get full-time work. This one is 16.5%, so most of the addition comes from the involuntary part-timers. So 6.0% of the labor force is involuntarily working part time. How does 6% compare with other times? The BLS data here go back only to 1994, so it’s hard to be definitive, but about 3% seems to be the norm. That’s what it was for most of 1994-2007, including even the recession and slow recovery of 2001-2003. That’s right — the involuntary-part-time employment rate is double what it was in the last recession and “jobless recovery.” It edged up to 4% in 2008, above 5% in 2009, reached 6% in September 2010 and has hovered around there ever since. That’s a lot of involuntary part-time jobs, and it adds another dimension of lousiness to the current depression. Also, if those are the kind of jobs this economy is creating, it’s no wonder that many people would rather hold onto their unemployment benefits, which, depending on their previous jobs, might pay more. But that’s a subject for another post.
Stay in school, kids. At least till you’re 25, or maybe for as long as you can. That’s the message of the wildly different unemployment rates for college graduates age 20-24 versus age 25 and over.
The September 2011 unemployment rate for college graduates was 4.2%, which sounds pretty good, even though it’s more than double what it was before the recession. However, that’s for college graduates age 25 and over. I reported this a couple days ago but didn’t have a separate rate for younger college graduates, since that wasn’t in last Friday’s BLS employment report. But the data do exist. The New York Times mentioned today that the jobless rate for college grads under age 25 averaged an eye-popping 9.6% over the past year. Before the recession it was just 3.7%. Which sent me scurrying to The Google.
The latest BLS Current Population Survey shows that the rate was 8.1% as of last month — trending down, but still historically high and only a percentage point less than the overall unemployment rate. And this is just by the official definition of unemployment, which doesn’t include discouraged job-seekers who’ve stopped looking, involuntary part-timers, or college grads working in “high school” (or less) jobs that don’t require a college degree. Evidently it’s a lot easier to keep a “college job” than to land one.
As bad as it is for young college grads, it’s vastly worse for those with less education. Unemployment rates for 20-24 year-olds by educational attainment:
some college, no degree: 12.9%
high school diploma or GED: 22.4%
no high school diploma: 28.5%
With hordes of unemployed young people, thousands of them engaged in mass protests in Wall Street and other locales, this country is reminding me a lot of Europe in the early 1980s. Which makes a bunch of classic English punk and post-punk songs timely again. I’ll go with this one:
I think this is the first time I’ve ever agreed with Grover Norquist on anything: Herman Cain’s tax plan is bogus. Naturally, old Grover and I have different reasons for thinking it so. He says that having three 9% tax rates — income, profits, and sales — is “like having three needles in your arm.” There’s also the conservative objection that a sales tax is just too easy a way to raise revenue, making it harder for Norquist to realize his dream of starving the government beast and drowning it in the bathtub.
Unlike Norquist and Cain, I’m one of those people who’s against regressive taxes, like, you know, a 9% sales tax. As David Weigel at Slate noted, it seems to be about sticking it to that alleged freeloading 47% who don’t pay income taxes (but do pay payroll, excise, and state income taxes). And, as Bruce Bartlett notes, there’s no mention in Cain’s income tax plan of a personal exemption, so the income tax rate is presumably 9% for everyone. So Cain would raise taxes on nearly half the population by up to 18% of their income.
Once upon a time Republicans boasted about taking poor people off the income tax rolls (as with the Reagan tax reform of 1986 and even the Bush tax cuts of 2001), but times have changed. Demanding that almost half of Americans pay an extra 9% of their income in taxes is now the order of the day, as long as that half is the poorer half.
Oh, and if lowering the top income tax rates to 9% weren’t enough Robin Hood in reverse, Cain’s plan would also exempt capital gains from taxes altogether. Imagine, hedge fund managers might not have to pay income taxes at all!
And then there’s the issue of lost revenue from slashing tax rates and shrinking the tax base for the affluent. The basic rationale for progressive taxation is that it raises more revenue more easily than flat or regressive taxation. Cain claims that his upper-income tax cuts would spur so much prosperity that they’d pay for themselves. Stop me if you’ve heard that one before.
That’s who loses from Herman Cain’s “9-9-9″ tax plan, according to analysts at the nonpartisan Tax Policy Center (jointly run by the Urban Institute and the Brookings Institution). Krugman has a quick synopsis.
Income stratum Impact on after-tax income
Bottom 20% -18.7%
20th-40th %ile -15.4%
40th-60th %ile -10.1%
60th-80th %ile -6.1%
80th-90th %ile -2.3%
90th-95th %ile +0.9%
95th-99th %ile +6.5%
Top 1% +19.7%
Top 0.1% +26.6%
Howard Gleckman of the Tax Policy Center notes, “In Cain’s world, a typical household making more than $2.7 million would pay a smaller share of its income in federal taxes than one making less than $18,000.”
I wrote before that the Cain tax plan seemed calculated to appeal to Republicans whose idea of economic injustice is poor people not paying income tax (which happens because they earn less than the standard deduction and personal exemption. Never mind that they do pay payroll taxes, sales taxes, and excise taxes). But even if you do think the tax system is too generous to the poor, you probably don’t think we should raise taxes on the middle and upper-middle class while cutting taxes on millionaires. In fact, a poll this month found that 64% of Americans wanted to raise taxes on millionaires, including 83% of Democrats, 65% of independents, and 40% of Republicans.
The original bank bailout may have been repaid in full, but the big banks are still socializing the losses. This time, it’s among their shareholders. Brad DeLong offers some specifics:
‘Investors in Goldman Sachs have lost more than half their money since 2007 . . .
‘Investors in Morgan Stanley have lost more than three-quarters of their money since 2007 . . .
‘Investors in Citigroup have lost 93% of their money since 2007 . . .
‘Investors in Bank of America have lost 85% of their money since 2007 . . .
‘Investors in Bear Stearns, Lehman Brothers, and Merrill Lynch lost more than 90% if their investments as well . . .’
DeLong’s charts (click above link to see them) show that even after bank stocks started to rebound in fall 2009, the losses have still been huge.
One might think this is just a case of the rich getting poorer, but it’s not that simple. In fact, the distributional consequences seem to run the other way. The stockholders, most of whom are middle-class and upper-middle-class folks, are getting hammered. About half of the population owns stock (granted, the wealthy own most of it), so about half of The Other 99% own stock and are seeing their retirement portfolios shrink along with the rest of their savings. (If you own stock at all, you probably own a lot of big bank stock, because they are weighted heavily in index funds, other mutual funds, and pension funds.)
How has the reduced market value of these firms affected the executives and highest-paid employees at the big banks? Not much, apparently. While I don’t have precise data handy, there have been reports all through this Lesser Depression of huge payouts to bankers, including yesterday’s news of Morgan Stanley. It’s happening in England, too.
P.S. The Wall Street Journal reports that bank losses have been huge of late. Goldman Sachs lost money in the second quarter of this year, and has had six straight year-over-year quarterly losses. Goldman’s stock is down 39% for the year, and Bank of America’s is down 50%. No mention of how (or whether) bonuses will be affected.
Kansas City Federal Reserve Bank President Thomas Hoenig was my favorite recent member of the Federal Open Market Committee, mainly for his outspoken and eloquent criticism of the “too big to fail” policy. I’ve written about his ideas a few times, including here. So now that the Kansas City Fed’s rotating term on the FOMC has come to an end, it’s good to see that President Obama has nominated Hoenig to be Vice Chairman of the Board of Directors of the Federal Deposit Insurance Corporation (FDIC).
Hoenig’s views are summed up in this quote from the article: “We must make sure that large financial organizations are not in position to hold the U.S. economy hostage. We must break up the largest banks.” His March 2009 speech “Too Big Has Failed” lays it out in detail.
Now, I have no idea how much policy-shaping ability the vice chairman of the board of directors of the FDIC has, and Hoenig himself has said the FDIC still lacks adequate resolution-authority powers for closing big bank holding companies, but I’ll be glad to have him back in the loop. Assuming that Senate Republicans don’t block his nomination for one reason or another.
In October 2008, as the financial crisis reached a fever pitch, the Fed started paying interest on banks’ reserves. The rate is very low, 0.25%, but it turns out that at this point in the Lesser Depression, with short-term interest rates even lower (the 3-month T-bill rate is 0.02%, and the 6-month rate is 0.06%), the Fed might actually be breaking the law by doing this. David Glasner of the Uneasy Money blog has a fascinating post about it.
According to Glasner, the Financial Services Regulatory Relief Act of 2006 allowed the Fed to pay interest on reserves but specified that the interest rate on reserves not “exceed the general level of short-term interest rates.” Normally that’s not a problem, and even in October 2008 the 3-month T-bill rate was well above 0.25%. But a month later, as the crisis deepened and panicked investors sought safe haven in T-bills, the rate fell below 0.25%, and there it has stayed ever since (except for a few weeks in 2009).
So if Glasner has interpreted the law correctly (and in typically modest fashion he does not claim to understand it perfectly), the Fed is breaking it. I am absolutely not a Fed basher: the Fed was not breaking the law back in October 2008; it was the worldwide flight to safety that caused short-term Treasury rates to fall to near zero the next month and stay there; and Congress, despite passing that act in 2006, has not seen fit to call the Fed on the carpet on this one. Which suggests that the drafters of this act recognize the extraordinary circumstances of this financial crisis and regard the Fed’s payment of above-market interest rates on reserves as a non-problem, not even enough of a problem to warrant revising the act to allow it. As long as nobody noticed (until this month anyway), why bother?
My opinion may sound contradictory, so I’ll break it into two parts.
I think Congress should revise the law to allow the Fed to pay higher interest rates on reserves, as they may need to if the economy starts to recover rapidly and banks open the floodgates by rapidly loaning out their excess reserves. Fed Chair Ben Bernanke has spoken of how the interest-on-reserves tool allows the Fed to “soak up” banks’ excess reserves before inflation starts to rage, and that may require higher-than-market interest rates on reserves.
But we’re nowhere near that point now. We’re still in a depression, and it makes little sense for the Fed to be paying banks to keep their reserves idle instead of loaning them out. I recognize that part of the rationale for interest on reserves is to keep the banks from tying their reserves up in T-bills instead of loaning them out, but with T-bills paying close to zero interest, that seems unlikely to happen. In the current depression banks have been loading up on T-bills and reserves. Even if they did put more of their reserves into T-bills, that doesn’t exactly tie them up: T-bills are the most liquid assets in the world (they’re often called “secondary reserves”) and banks could easily liquidate them if profitable loan opportunities came along. Right now, I’d say the appropriate interest rate on reserves is 0%.
Would lowering the interest rate on reserves from 0.25% to 0% spur a lot of lending? Doubtful, but it would likely make a difference at the margin in some cases, causing at least a few more loans to be made and a few more jobs to be created. Small potatoes, yes, but I don’t really see a downside here. It would also take some populist pressure off the Fed, which, as a giant financial institution, isn’t terribly popular these days, either among Republicans or among Occupy Wall Streeters. The man on the street is not pleased to hear that the Fed is paying banks interest on the money they don’t use.
“Italy Is Now the Biggest Story in the World,” says Kevin Drum. And he’s not talking about Joe Paterno (whose story I confess to having spent a lot more time following lately than Italy’s). But this is bad: another Eurozone country with a high debt/GDP ratio, soaring interest rates on its government debt, and no currency of its own that could depreciate to revive net exports, and no central bank of its own to expand the supply of credit. Just like Greece, except that Italy’s economy is about six times as large. It’s the fourth-largest economy in all of Europe, in fact.
For months people have been nervously watching Europe’s toxic cauldron of economic depression, austerity, sovereign debt crises, and bank funding problems (verging on crisis), and wondering if and when Europe’s problems might lead to a double-dip recession (or, as I’d call it, a recession within a depression, a la 1937). I wonder if someone else has already written the headline “Italy: Waiting for the Other Boot to Drop” yet.
P.S. If you’ve never heard the expression “Mingya!” then you obviously don’t live in Oswego. The Urban Dictionary will set you straight.
Naked Capitalism has an excellent two-partinterview with Dean Baker, one of the Cassandras who spotted the housing bubble years before it burst and who has been a much-needed gadfly in the ointment of economic news reporting and the economics profession. Baker’s new book, The End of Loser Liberalism: Making Markets Progressive, is available for free download here, including in Kindle and Nook formats. Here are some highlights from the interview, conducted by Philip Pilkington. I’ve highlighted in boldface some lines I found particularly compelling:
PP: Moving on, in the book you make the claim that had the financial system been allowed to melt down we would not actually have ended up in another Great Depression. This is not to say that you don’t recognise that letting the financial system melt down would have caused a lot of problems – for banks, of course, but also for pension funds and the like – but you say that those in charge of the bailouts exaggerated the importance of the financial sector. Could you explain briefly what you mean by this? And what do you think should have been done at the time of the bailouts?
DB: The point here is that we know how to reflate an economy. Massive government spending will do it. It got us out of the Great Depression, although not until World War II created the political consensus for the level of spending that was necessary to actually do the job.
A financial collapse cannot condemn us to a decade of stagnation and high unemployment. That only comes about from a prolonged period of political failure. If we had allowed the banks to collapse in the financial panic of 2008 then we would [still?] have had the opportunity to pick up the pieces and get the economy back on track with a massive stimulus program.
Of course it was best to not let the banks collapse. However the bailout should have come with real conditions that would have ensured the financial system was fundamentally restructured. This would have included breaking up the too big to fail banks (on a clear timetable, not necessarily at that time), serious caps on compensation, a commitment to principal write-downs and other real conditions.
At that time the banks were desperate. Without a big dose of public money they would almost certainly have been insolvent, so they would have had little choice but to accept whatever conditions were imposed. As it was, they almost got President Obama thanking them for taking taxpayer dollars in the bailout.
PP: Any ideas about what could be done with the banks now? Or is the damage already done?
DB: We still need to reform and downsize the financial sector. We don’t have the same leverage over the banks as we did at the peak of the crisis when we could have slapped whatever conditions we wanted on the loans and guarantees they needed to stay alive, but Congress can still pass laws that will rein in the industry.
At the top of the list is a financial speculation tax. A modest tax on financial transactions will do much to reduce the rents in the industry and to eliminate or drastically reduce short-term trading that serves no productive purpose. It will also raise a ton of money.
The second thing is breaking up the too big to fail banks. There is no justification for allowing banks to be able to borrow at below market interest rates because they enjoy an implicit government guarantee.
The third item on my list would be re-instating a Glass-Steagall type separation between commercial and investment banking. The Volcker rule, which limits proprietary trading by banks with insured deposits, was a step in the right direction. However it looks as though the industry is using the rule-making process to turn the law into Swiss cheese. It is likely that most banks will be able to find loopholes that will allow them to do as much proprietary banking as they want.
Anyhow, these would be my top three reforms. Politically, all of them would be very tough sells right now. By contrast, at the peak of the crisis, the industry would have voluntarily agreed to the last two in order to get the money they needed to stay alive.
PP: You write in the book that the idea that the banks repaid all the money from TARP is misleading. Could you explain this, because this myth is very prevalent in the mainstream media?
DB: Yes, this is really kind of a joke. The banks got loans at way below market interest rates from the government, and we are supposed be grateful that they repaid the loans? The difference between the market interest rate and the rate they actually paid amounted to a huge subsidy. This is something that anyone with even a passing familiarity with business or economics would recognize, which is why it is so insulting when political figures go around yapping about how the money was repaid with interest.
To see this point, suppose the government gives me a 30-year mortgage at 1 percent interest. If I make all my payments and pay off the mortgage has the government made money? By the logic of the politicians claiming that we profited by the bailout, the answer is yes.
A serious assessment would look at what the market rate for these loans was at the time they were made. To take one example, just before we lent $5 billion to Goldman through TARP, Warren Buffet lent $5 billion himself. He got twice the interest and a much more generous deal on warrants. Plus he knows that it was likely that the government would bail out Goldman if it got in trouble.
Elizabeth Warren commissioned a study of the implicit subsidies in the bailouts when she was head of the TARP oversight panel. As I recall, it came to over $100 billion on just the first batch of TARP loans to the large banks. This didn’t count the value of later TARP lending, the much larger lending programs from the Fed, nor the extensive set of guarantees provided by the Fed, Treasury, and the FDIC.
All of these commitments involved enormous subsidies. In the business world firms pay huge amounts of money if they want their debt to be guaranteed. And everyone understands that a below market loan is essentially a gift. That is why it is so insulting when they try to imply that the public has profited from these loans.
You can make the argument that it was good policy to subsidize the financial industry to get through the crisis, but to pretend that we did not subsidize them is just dishonest.
Incidentally, the reforms Baker suggests are similar to those recently suggested by Rolling Stone‘s Matt Taibbi as a starting point for the Occupy Wall Street protesters. More on those later.
Somewhat lost in this week’s 
December 5 is the 75th birthday of the 21st Amendment, which ended the ghastly experiment known as Prohibition. I’ll drink to that.
Going into this fourth of July weekend, we learned that the U.S. 
Last week the House of Representatives voted to extend unemployment benefits for the long-term unemployed, as is 
