Archive for July, 2009

Well, it’s a start

16 July 2009

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.

Hats off to Hilzoy

14 July 2009

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.

“The food is terrible. And in such small portions.”

9 July 2009

“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?”

annie_hallLeonard, 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:


Zombie Bankhouse?

7 July 2009

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.


What the #$*! do we know!?

6 July 2009

WhatTheBleep2Didn’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.



5 July 2009

(Title semi-stolen from the Option ARMageddon site, whose views I disclaim.)

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.


Feeling 1982: Fifteen million unemployed

2 July 2009

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

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.