Archive for December, 2008

Should stupidity be a crime?

31 December 2008

First, two favorite quotes:

Never attribute to malevolence what can be adequately explained by incompetence. (author unknown)

It is better to fail conventionally than to succeed unconventionally. (-John Kenneth Galbraith)

And now the latest bit of excuse-making about the housing crisis, in the last two lines of an appraiser’s letter to the editor in The Washington Post, 30 Dec. 2008:

“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.

Dean Baker makes much the same point, but aims it at a different target: the “experts” who were blind to the housing bubble.

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An answer to the $700 billion question?

29 December 2008

That question being, Why????

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).

But buried deep in Michael Hirsh’s review of Niall Ferguson’s new financial history of the world is this nugget, which we shall call

(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.”

One more time: Don’t stiff the states!

29 December 2008

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.

Clinging to your stocks and bonds

29 December 2008

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:

Credit Crunch: the board game

24 December 2008

From The Economist.

Funny stuff, and looks like you can actually play it if you take the time to print out all the pdf’s.

Fiscal policy in the oughts

22 December 2008

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.

Now this is more like it

18 December 2008

Today in announcing his nomination of Mary Schapiro to head the Securities and Exchange Commission, President-elect Barack Obama picked up where he left off on “Meet the Press” on 7 Dec., when he declared his support of strong regulation of financial markets.  Obama’s two-minute statement today was strong as well:

“… 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?

Thou shall not crucify mankind on a cross of financial innovation

18 December 2008

I’d been meaning to use that line for a while, and Yves Smith of Naked Capitalism provides a perfect opening this morning, with a nice long post that I hope he won’t mind my cannibalizing.  Smith argues that many of the recent Wall Street bonuses are not just excessive, but a form of looting:

“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.”

The Fed does the expected, sort of

16 December 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.

fed funds chart 2008 dec 16

All the way down

What, me worry about deflation?

16 December 2008

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.)

  • Also, Fed Chairman Bernanke is strongly anti-deflation, as this 2002 speech makes clear. The Fed’s current response to the crisis, whatever its defects, seem to reflect that stance.
  • 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 )