Automatic destabilizers

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.

Last week the House of Representatives voted to extend unemployment benefits for the long-term unemployed, as is customary in times of very high unemployment, but the Senate failed to do the same.  The 58-38 vote in favor was not enough to overcome that repugnant, anti-democratic obstacle known as the filibuster. Senate Minority Leader Mitch McConnell said he and the Republicans could not support the extension of benefits unless they were paid for with equivalent spending cuts elsewhere, like in the stimulus bill.  In other words, prudence dictates that we rob Peter to pay Paul.

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 next Federal Reserve Chairwoman

. . . 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?)

Clashing clunkers

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.”

Selective-attention deficit disorder

debt/gdp ratio

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.

As we can see from the red line in the diagram, courtesy of my former professor Willem Buiter, the debt/GDP ratio (our best measure of the overall burden of federal deficits and debt):

• 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.

So what? you ask . . .

Big swinging deregulators

” ‘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.’

Cognitive capture, anyone?

The paper was released, and it didn’t cause a crisis.  Unregulated credit default swaps, on the other hand . . .

Mark Thoma has a synopsis of the Post story on Economist’s View.  (Hat tip: Baseline Scenario.)

(For a helpful primer on the rise and fall of the original BSDs, see Daniel Gross’s Slate column of 25 September 2008.)

Too big to say no to

Banking news of note this past week:

• 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.

Much ado about nationalization

The word “nationalize” has at least one great use, in the punchline of a hilarious Winston Churchill story.

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 compelling accounts, Sheila Bair’s FDIC has been the one shining light in this crisis.

Nationalize it, mon

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.”