Saturday, February 28, 2009
Should Democrats "ratchet down their hostility to newspapers and begin crusading on behalf of these imperiled organizations"?:
MSM, RIP, The Editors, The New Republic: ...Thirty-six percent of Americans now say that the press "hurts" democracy. Many others wouldn't express their feelings in ... such ... terms but share the basic disrespectful sentiment. Put another way, the crisis in journalism is even deeper than the crisis in its business model. It is suffering a crisis of legitimacy.
We all know the long list of scandals that has bloodied the profession--from Jayson Blair to Judith Miller to Dan Rather. But to focus only on these wrecks both misses the point and blames the victim. Just as the press has been slammed by the tides of technology, it has been hit hard by the political culture. The master narratives of both the right and the left have come to include the same villain: the hypocritical, biased elite media. And their combined grouching has helped foment the anti-media backlash.
On the right, the history of press-bashing is venerable... But during the Bush years, and thanks to Fox News, the critique of the liberal media was canonized...
A mirror version of this ... emerged on the left. In this telling, it was the timid, lazy press corps that failed to rigorously challenge the president's core (mendacious) claims about his tax cuts and rationale for heading to war. Very valid criticisms. But these specific objections morphed into populist broadsides against what the left came to describe as "the mainstream media"--avatars of establishmentarian groupthink who bend to the latest conventional wisdom emerging from D.C. cocktail parties and neurotically fret that they might be just as biased as their conservative critics allege. On The Huffington Post and its ilk, you would find rants about how "Beltway media really makes no effort to do anything other than parrot totally out-of-touch conventional wisdom--no matter how inane, stupid and ridiculous it is."
This rhetoric creates a poisonous atmosphere. By assaulting the credibility of the press, it destroys its authority in the culture, giving cover to politicians who would rather avoid dealing with reporters in the first place. ... When the administration needed to make its case, it took to the local press or Fox News, where it had no fear of probing questions.
At times, Obama has hinted that he will borrow from the Bush playbook and deal with the press only as he pleases, using new technology to vault over the old arbiters. Fortunately, that hasn't been his methodology in recent weeks... This is fortunate, because Obama is presiding over a turning-point moment in media history.
Obama can help set a tone for liberals, convincing them to ratchet down their hostility to newspapers and begin crusading on behalf of these imperiled organizations. The media deserves liberal critics, who hold it accountable. But it also deserves liberal defenders because a press working toward the ideal of objectivity is often the only means of blunting government or business run amok... Even the press's fiercest critics have been forced to acknowledge and fear its findings--an authority that will never exist in a world consisting entirely of partisan outlets. ...
Many venerable newspapers and magazines will close in the coming weeks and months; the ones that remain will be attenuated. But the old ideals embodied in these institutions must not be permitted to join the carnage.
When the press does its job well, it deserves defenders, and when it does a lousy job, it deserves being taken to task. The complaint seems to be that the criticism is without foundation, and there's some of that, but the fundamental problem is not, in my view, the people doing the criticizing, it's the media companies themselves. The argument also seems to treat "media" as something other than Fox News. I agree that the term journalism conjures up another image, as it should, but presently Fox News isn't clearly separate from other media outlets, far from it, and the commingling of all of these sources of information in the minds of the public is part of the problem. If journalists in the mainstream media want respect, they need to differentiate themselves from the "partisan outlets," including calling foul loudly and in no uncertain terms when Fox or whomever crosses the line, and they also need to do a better job themselves of establishing and maintaining their credibility through solid reporting.
Janet Yellen discusses a report on "the macroeconomic implications of oil price movements":
Discussion of “Oil and the Macroeconomy: Lessons for Monetary Policy” by Janet Yellen, President, FRB SF1: It’s a pleasure to discuss this thoughtful and comprehensive report on the macroeconomic implications of oil price movements. Even though we are no longer faced with sky-high oil prices, the issues discussed here remain important and policy relevant. It is hard to believe that oil prices will not go up again sometime in the future, so it is vital that we learn from the last episode, both about how the economy is likely to be affected and how monetary policy should respond.
Perhaps not surprisingly, most of my discussion relates to the latter topic, namely the Fed’s policy response to the swings in oil prices over the last seven years.
- What Remains of the Keynesian Revolution? - Angry Bear
- The Great Solvent North - NYTimes.com
- Is Bank Nationalization Still a Radical Idea? - NYTimes.com
- Fed Officials Weighing ‘Exit Strategy’ for End of Recession - Bloomberg
- Don't believe the "baby-faced politicians lose" stud) - Andrew Gelman
- Faces and elections: an update - Andrew Gelman
- Bernanke’s Test - FT
- Treasury and Citi - Angry Bear
- Was that liberal enough for you? - Clive Crook
- Taxing financial pollution: Mandatory liquidity charges - voxeu.org
- First-ever Economics Bloggers Forum - Kauffman Foundation
Friday, February 27, 2009
Christina Romer's speech at the Chicago Booth forum at the University of Chicago:
The Case for Fiscal Stimulus: The Likely Effects of the American Recovery and Reinvestment Act: There are many thrills to my new job:
- Three gates have to open to allow me to park each morning.
- I get to speak frequently with the leader of the free world.
- And, as a courtesy I get to see the Federal Reserve’s Greenbook forecast in real time rather than with a five-year delay.
Actually, the biggest thrill of all is that after more than two decades of studying macroeconomic policy, I had the privilege of helping to craft what is without question the boldest countercyclical fiscal action in American history. ...
Over the past several months, there has been much discussion about whether the act will do enough to get the country back on track. I am extremely optimistic that it will, and thought it would be useful to spend my time today explaining why. In the process, I will explain why I disagree with some arguments that have been made against the recovery plan. ... I will strive to do my CEA best to give a balanced, dispassionate assessment.
The first issue is what it would mean for the policy to work. The President gave a very concrete metric: he wanted a program that would raise employment relative to what it would be in the absence of stimulus by 3 to 4 million by the end of 2010. Some on the blogosphere (such as the best man at my wedding, Greg Mankiw) call this metric meaningless: they complain that because we never observe the outcome under the no stimulus baseline, it isn’t verifiable. But it is, in fact, the intellectually sound and appropriate metric to use. Exactly what any macroeconomist would ask of a policy is what are its effects, holding constant all the other forces affecting the economy. I feel the strongest evidence that the President’s metric is a good one is that it has focused the debate on the right issue. Numerous forecasters, from Mark Zandi to Macroeconomic Advisers to CBO to the Federal Reserve, have looked at what they expect the Act to do. Rather than fighting over the differences in the no-stimulus baselines, which are substantial and largely outside the control of policymakers, the debate has centered on what the policy would accomplish.
Of course, one can also debate the baseline and the question of whether creating or saving 3 to 4 million jobs will be enough to fully heal the economy. But, it is important to acknowledge that creating or saving that many jobs would be a tremendous accomplishment.
This discussion of what the bill is intended to do leads naturally to the more important question of whether it will actually accomplish the President’s goal. This involves two issues. One concerns the effects of a typical fiscal change. What will a quintessential increase in government spending or cut in taxes do to output and employment? The other concerns the particular fiscal changes in this bill. Are there aspects of its structure or timing, or of the economic environment in which it is taking place that would lead us to expect the effects to be different from usual?
Let me start with the issue of the effects of fiscal policy in general. If we cut taxes by 1% of GDP or increase spending by a similar amount, what will that typically do to the economy? I will be the first to point out that estimating these multipliers is difficult and that there is surely substantial uncertainty around any estimate. But, I feel quite confident that conventional multipliers are far more likely to be too small than too large. David Romer and I have argued that omitted variable bias is a rampant problem in estimating the effects of fiscal policy. One good way to illustrate this is to discuss Robert Barro's approach to estimating multipliers. Barro has argued that a reasonable way to estimate the effects of increases in government spending is to look at the behavior of spending and output in wartime. But, consider one of his key observations – the Korean War. If he were using just this observation, Barro would basically divide the increase in output relative to normal by the increase in government purchases relative to normal during this episode. When one does this, one gets a number less than one. From this Barro would conclude that the multiplier for government spending is less than one. But, other things were going on at this time that also affected output. Most importantly, taxes were raised dramatically; indeed, the Korean War was largely fought out of current revenues. The fact that output nevertheless rose substantially is in fact evidence that the effects of increases in government spending are very large.
To address the problem of omitted variables, David and I used narrative evidence to isolate tax changes uncorrelated with other factors affecting output. We read Congressional reports, Presidential speeches, the Economic Reports of the President, and other documents to identify relatively exogenous tax changes. We found that the estimated effect of these changes is very large. A tax cut of 1% of GDP raises GDP by between 2 and 3% over the next three years.
Unfortunately, doing the same kind of narrative analysis for government spending would be very difficult: there are vastly more spending changes than tax changes, and the motivations for them are less easily classified. But, the same issue of omitted variables is surely present. As the war example illustrates, spending changes are often taken at the same time as tax changes that push output in the opposite direction. Also, spending increases are often taken in recessions, where other factors are clearly reducing output. As a result, it is likely that conventional estimates of spending multipliers are also biased downward.
In estimating the effects of the recovery package, Jared Bernstein and I used tax and spending multipliers from very conventional macroeconomic models. We used simulations based on the realistic assumption that monetary policy would remain loose, and on the assumption that people would treat the individual tax cut as permanent. This last assumption is justified by the fact that the President ran on a permanent middle class tax cut and just included it in his budget. In these models, a tax cut has a multiplier of roughly 1.0 after about a year and a half, and spending has a multiplier of about 1.6. As I have suggested, it is very hard to claim that those are excessively large. Indeed, if you want to know why I am more optimistic than some, it is probably because I believe my own research. I think that both the change in taxes and the change in spending may pack more bang than the official Administration estimates assume. Before leaving multipliers, one issue that has come up is the interaction with the financial crisis. A common argument is that fiscal stimulus will have less effect because financial markets are operating poorly and lending is not flowing. I want to offer a different view. I think it is possible that fiscal policy will have even more oomph in this situation. When households and businesses are liquidity-constrained by reduced lending, any money put in their pockets is more likely to be spent.
More fundamentally, there is strong reason to believe that a recovery in the real economy is salutary to the financial sector. When people are employed and buying things, loan defaults fall and asset prices are likely to rise. Both of these developments would surely be helpful to stressed financial institutions. This is, I believe, a key lesson of the Great Depression. In the Depression, the end of deflation, renewed optimism, and increased employment and output were as crucial to the recovery of the financial system as the more direct actions taken to stabilize banks. Thus, real and financial recovery reinforced each other. So, fiscal policy to raise employment may help to restart lending and in that way generate a more durable recovery.
So much for the generic effects of fiscal policy. What about the particular actions called for in the Recovery Act? ...[...entire speech...]
The fourth quarter GDP figures have been revised:
In Revision, G.D.P. Shrank at 6.2% Rate at the End of 2008, by Catherein Rampell, New York Times: The economy at the end of last year contracted at a far faster rate than initially estimated... With the exception of government spending, every major component of the economy shrank. ...
Output fell 6.2 percent at an annualized rate in the fourth quarter of 2008, revised downward from a previous estimate of a 3.8 percent decline. ...
The economy took the biggest hits in exports, retail sales, equipment and software, and residential fixed investment.
The downward revisions, though, came primarily because of a larger-than-anticipated contraction in inventories of unsold goods. ... Some hail the decline in inventories as potentially good news.
“The only plus to take out of this is that inventories weren’t as high, and that implies you don’t have to cut as much this quarter to get them back under control,” Mr. Gault said. He added that inventories were still too high, and he expected companies to further scale back their production, especially in response to the dismal consumer spending numbers. ...
Households also saved much more of their paychecks than initially estimated. ...
And if the data on new unemployment claims are any indication (which they are), the economy is continuing to plunge at least as fast.
As Brad DeLong says, I think we’re going to need a bigger stimulus.
[T]he government will increase its stake in the company to 36 percent from 8 percent.
Under the deal, Citibank said that it would offer to exchange common stock for up to $27.5 billion of its existing preferred securities and trust preferred securities at a conversion price of $3.25 a share, a 32 percent premium over Thursday’s closing price.
Paul Krugman finds lots to like in Obama's proposed budget:
Climate of Change, by Paul Krugman: Elections have consequences. President Obama’s new budget represents a huge break, not just with the policies of the past eight years, but with policy trends over the past 30 years. If he can get anything like the plan he announced on Thursday through Congress, he will set America on a fundamentally new course.
The budget will, among other things, come as a huge relief to Democrats who were starting to feel a bit of postpartisan depression...: fears that Mr. Obama would sacrifice progressive priorities in his budget plans ... have now been banished.
For this budget allocates $634 billion over the next decade for health reform. That’s not enough to pay for universal coverage, but it’s an impressive start. And Mr. Obama plans to pay for health reform, not just with higher taxes on the affluent, but by putting a halt to the creeping privatization of Medicare, eliminating overpayments to insurance companies.
On another front, it’s also heartening to see that the budget projects $645 billion in revenues from the sale of emission allowances. After years of denial and delay by its predecessor, the Obama administration is signaling that it’s ready to take on climate change. ...
Many will ask whether Mr. Obama can actually pull off the deficit reduction he promises. Can he actually reduce the red ink from $1.75 trillion this year to less than a third as much in 2013? Yes, he can.
Right now the deficit is huge thanks to temporary factors (at least we hope they’re temporary)... But if and when the crisis passes, the budget picture should improve dramatically. ... So if Mr. Obama gets us out of Iraq (without bogging us down in an equally expensive Afghan quagmire) and manages to engineer a solid economic recovery — two big ifs, to be sure — getting the deficit down to around $500 billion by 2013 shouldn’t be at all difficult. ...
So we have good priorities and plausible projections. What’s not to like about this budget? Basically, the long run outlook remains worrying.
According to the Obama administration’s budget projections, the ratio of federal debt to GDP. ... will soar over the next few years, then more or less stabilize ... at a debt-to-GDP. ratio of around 60 percent. ... [S]ooner or later we’re going to have to come to grips with the forces driving up long-run spending — above all, the ever-rising cost of health care.
And even if fundamental health care reform brings costs under control, I at least find it hard to see how the federal government can meet its long-term obligations without some tax increases on the middle class. Whatever politicians may say now, there’s probably a value-added tax in our future.
But I don’t blame Mr. Obama for leaving some big questions unanswered in this budget. There’s only so much long-run thinking the political system can handle in the midst of a severe crisis; he has probably taken on all he can, for now. And this budget looks very, very good.
More on the budget:
There must be a Facebook joke here somewhere:
Can we tell from pols' faces if they're competent?, by Jordan Lite, 60-Second Science Blog: We really do judge a book by its cover — and, it seems, the competence of politicians by their faces. What's more, adults and kids see the same competence — or, as the case may be, ineptitude — in a person's visage, which helps explain why children can accurately predict presidential elections, according to new research published today in Science.
Swiss adults unfamiliar with French politics were shown 57 pairs of photos of opponents from an old French parliamentary election and asked to pick which ones looked most competent. In a separate experiment, Swiss kids ages 5 to 13 played a computer game that enacted Odysseus' trip from Troy to Ithaca. Then, using the same pairs of photos, researchers asked the kids which candidate they'd choose to captain their ship. In both experiments, the adults and children tended to pick the winners of the election.
"Adults and children infer competence in precisely the same way, whether that [person] is six or seven — or 67. That is the shocking finding here," study co-author John Antonakis, a professor of organizational behavior at the University of Lausanne, tells ScientificAmerican.com. "This stereotype is already formed in young childhood, which leads us to suggest this mechanism is innate or develops very, very rapidly at a young age."
The study didn’t examine what, exactly, led people to see competence in one face more than another. ...
None of this is to say that the truism "don't judge a book by its cover" is obsolete. While our judgments about competence tend to translate into election results, they're not so great at predicting true leadership. What does correlate with a president's performance is his estimated IQ — not his face, according to a 2006 study in Political Psychology.
"If people were good at inferring how smart people are from a distance," Antonakis says, "all the politicians we elected would be very clever."
Battle of the Barbecues, Kansas City: The Kaufmann Foundation brought together many bloggers and many servings of Kansas City barbecue. (Isn't America a great country? I met Mark Thoma for the first time and tomorrow we talk about blogging and the future of the world.) Then we voted, using Borda Point Count. Tim Kane tells me:
Oklahoma Joe's wins handily. Arthur Bryant's loses handily. Others are close. (Hmmm ... looks like a normal).
It's been fun to meet the people behind the posts. [Update: more here.]
This voxeu.org column argues that bank nationalisation is the best hope we have for avoiding a “lost decade like Japan":
The case for and against bank nationalisation, by Matthew Richardson, Vox EU: Treasury Secretary Timothy Geithner’s financial plan calls for stress tests at the large complex financial institutions (LCFIs). These tests are due to start this week. They will involve estimates on the eventual losses due to default on a wide variety of assets.
Economic analysts have already performed such a test at the aggregate level. The results were not pretty. For example, Goldman Sachs looked at the US banking sector’s holdings of the current “toxic” pool of assets, such as option ARM residential mortgages, subprime residential mortgages, Alt-A residential mortgages, credit card debt, second liens/home equity loans, consumer auto loans, and commercial real estate. Expected losses come in at around $900 billion. These losses give the banking sector very little wiggle room. Therefore, there is the real possibility that some LCFIs are bankrupt – the face value of their liabilities exceeds the current value of their assets.
- How did Japan get lost? - Free exchange
- The silence of the keynesian econ-bloggers - Nick Rowe
- Words for a Shaken People - Michael Kinsley - washingtonpost.com
- Asian success mythology - William Easterly
- Nationalizing Citi may be the least-bad option. - Daniel Gross
- The frequent trade-off of "politeness" and "civility"... - Richard Serlin
- No, Wait! You Got It Backwards! - The Baseline Scenario
- Three links on the deficit at the end of this post.
Thursday, February 26, 2009
Travel day today, but here's something:
The Long and Short of It, by Mark Thoma, CIF, UK Guardian: President Barack Obama's State of the Union-style speech on Tuesday night presented a mixture of economic policies. Some, such as "extended unemployment benefits and continued healthcare coverage to help ... weather this storm", are devoted to short-run issues related to the economic downturn. Others, such as polices to "address the crushing cost of healthcare" and investments in "technologies like wind power and solar power, advanced biofuels, clean coal and more efficient cars and trucks", are devoted to longer-run structural issues that we need to resolve. [...continue reading...]
Paul Collier rejects the utilitarian basis for reducing carbon emissions and replaces it with "a rights-based notion of ethics":
I don't buy economists' case for fighting climate change, Paul Collier, Commentary, The Guardian: ...In his Review on the Economics of Climate Change - widely regarded as the most important and comprehensive analysis of global warming to date - Lord Stern argued that in cold cost-benefit terms, it made sense for the present generation to make sacrifices because the benefits to future generations would be so substantial. ...
Necessarily, this approach ... depends .... upon a degree of ethical decency: if we thought only of ourselves, then our cost-benefit calculus would tell us to let the future fry. Stern's analysis rests upon a utilitarian calculus that is standard in applied economics: each person, whether alive or yet to be born, counts as equal, except that giving the same benefit to someone who is rich counts as less valuable than giving it to someone who is poor.
Prior to the publication of the Stern review, the main battleground was scientific: is climate change a reality...? Post-Stern, that battleground has now shifted to ethics. ...[T]he challenges have come from two ethical positions that ... cannot be readily dismissed.
One challenge is the elitism ... in overriding democracy: according to the utilitarian calculus the government should value the interests of the future far more highly than most voters would do. Indeed, if we are guilty of radically undervaluing the future, then this neglect applies not just to carbon emissions, but to all the other ways in which we could help the world of the future. The government should force us to save far more than we do... Are we radically neglecting the future by not saving enough? ...
The other ethical challenge questions the transfer from the poor to the rich that would be implicit in reducing carbon emissions: we, the current generation, are the poor who are to make sacrifices for future generations, who are likely to be much wealthier than we are... And so, on the utilitarian calculus, radical egalitarians should be opposed to curbs on carbon: let the rich fry.
Personally, I doubt whether the utilitarian calculus is the right ethical framework ... to think about global warming... Take the valuation of the future: are we radically undervaluing the interests of future people?
Of course, we cannot tell how the future will feel, but one simple test is to ask ourselves how we feel about the past - are we angry that our great-grandparents did not live more frugally so that we would now be richer? ...
Is there an ethical basis for being concerned about global warming that does not depend upon the notion that quite generally we are radically negligent about future people? I think that there is, but this concern depends upon a rights-based notion of ethics rather than on utilitarianism. Most professional economists will at this point stop reading because they will think that rights are a quagmire. But here goes.
Natural assets such as biodiversity, and natural liabilities, such as carbon, are not owned by the current generation, because we did not create them. We have them because previous generations passed them on to us, and we are obliged to do the same. If we deplete natural assets, or run up natural liabilities, we have an obligation to compensate future generations...
It is fairly obvious that adequately compensating the future for letting it fry is likely to be a more expensive undertaking than curbing our carbon emissions. Remember that future people are likely to be much richer than we are, and so what they would regard as fair compensation would be prodigious. ...
Ultimately, in a democracy our policy decision rules must rest on ethical principles that are widely shared by citizens. I suspect that most people feel that they should reduce carbon emissions, but the key issue is why? Is their motivation better captured by the utilitarian calculus used by economists, or by a sense of custodial obligation towards our natural legacy, of which carbon is but one instance?
One more from Tim:
As part of the application process, banks must submit a plan for how they intend to use this capital to preserve and strengthen their lending capacity – specifically, to increase lending above levels relative to what would have been possible without government support. The Treasury Department will make these plans public when the bank receives the capital under the CAP. (italics added.)
This is refreshing; unlike the initial TARP program, Treasury is not giving the impression that banks will increase lending - only that lending will contract by less than otherwise expected, all else equal. Avoidance of a absolute collapse seems to be a reasonable goal. I would prefer that we moved to avoidance of the Japanese scenario as well, but perhaps I just need to learn to be happy with small steps.
Of course, I can't see that it would be hard for the recipient bank to pick a safe baseline for lending in the absence of Treasury support (like zero). Nor will it be easy to explain to the taxpayer that they should continue to expect lending to contract. But at least we can say we were warned.
Tim Duy has doubts about how effective TALF will be:
Will TALF Do The Job?, by Tim Duy: The Administration is putting high hopes on TALF, especially now that the program will reach as high as $1 trillion (remember when $1 trillion was a lot of money?). It has always seemed to me that TALF would fall short of the mark. The key constraint:
Eligible collateral includes U.S. dollar-denominated cash ABS that are backed by auto loans, credit card loans, student loans, or small business loans that are fully guaranteed by the SBA, and that have a credit rating in the highest investment-grade rating category from two or more nationally recognized statistical rating agencies and do not have a credit rating below the highest investment grade rating category from a major rating agency.
The expansion of TALF to CBMS also requires AAA-ratings. I suspected that limiting the program to investment grade securities would severely curtail the effectiveness of the program for one simple reason - that, relative to expectations of officials, investment grade borrowers are relatively few, and they have maintained that status by not accumulating excessive debt, so already they are not inclined to borrow. The spending bubble was not driven by high grade debt; it was driven by low grade debt disguised as high grade debt. Focusing on high grade debt as the solution will thus prove insufficient to give the economy much traction.
Two recent stories tend to support this point. First, from the Wall Street Journal:
The government's $200 billion program to revive the market for securities backed by consumer loans may end up providing little help to the very industry that needs it most: U.S. auto makers.
As the Federal Reserve hashes out final terms of its Term Asset-Backed Securities Loan Facility, or TALF, it is becoming clear that securities that help finance auto dealers mightn't meet some criteria. That would block a form of funding that auto companies had hoped would provide immediate relief as they fight for survival.
The problem came to a head because of credit ratings. The Fed has insisted that any deal it helps finance be given a triple-A rating from Moody's Investors Service, Standard & Poor's or Fitch Ratings. Bankers said this kicks out deals backed by loans to auto dealers because S&P and Moody's, in particular, have cut the ratings on such securities over the past several weeks as the industry grapples with potential bankruptcy filings and weaker demand for U.S. cars.
The second is from Bloomberg:
The Fed, through the TALF, could reduce the cost of financing commercial real estate by taking as collateral CMBS already traded in the secondary market rather just new bonds, said RBS analyst Lisa Pendergast in Greenwich, Connecticut.
Accepting bonds from the secondary market would be a “big deal” for reviving credit, said Jan Sternin, a senior vice president at the Mortgage Bankers Association in Washington.
The central bank also should make loans with at least a five-year term against CMBS, Pendergast said. The TALF is now geared to make loans of no more than three years against collateral, a misalignment with the typical five- or 10-year term of commercial mortgages.
“Nobody would buy a 10-year asset with a three-year loan,” she said.
The Fed initially proposed a one-year term for TALF loans it will make before revising to a three-year period in December.
Without TALF support, borrowers would have a tougher time refinancing maturing debt and avoiding delinquency or foreclosure, said Chip Rodgers, senior vice president at the Real Estate Roundtable, a trade group in Washington.
The Fed has said it will only accept newly issued AAA-rated CMBS collateral. Presumably, newly issued CMBS could be used to refinance maturing debt, assuming the refinanced debt could be rated AAA. And, I suspect, therein lies the heart of the industry's conundrum. Given the deterioration in credit quality, we can presume that much of the maturing debt is rated at something less than AAA. Much less. Consequently, the TALF would do little to help refinance maturing commercial mortgage debt, at least directly (I would not count on the indirect effect of building confidence in dodgy assets via liquidity programs). They know it - the article contains a telling quote:
Atlanta Fed President Dennis Lockhart said today that commercial real estate is “the one domestic factor that keeps me up at night.”
“Many banks are pretty heavily exposed to commercial real estate,” he said in Orlando, Florida.
Lockhart must sleep well compared to me; I have a laundry list of economic issues that keeps me up at night.
If the maturing debt cannot be refinanced at reasonable interest rates, then rising defaults and additional asset markdowns will play further havoc on the banking industry. The Fed cannot fix this if they limit their loan programs to AAA-rated ABS as the problem debt by definition has a lower rating. This appears to be the signal the industry is sending, so holders of CBMS want the next best thing - the Fed to absorb the risk of the existing AAA-ABS:
Top-rated commercial mortgage bonds are currently trading at about 10.82 percentage points more than benchmark interest rates, compared with 2.32 percentage points a year ago, Bank of America Corp. data show. In January 2007, the debt traded at 0.22 percentage point.
Seems those "top-rated" bonds are riskier than expected. Better to sell them off to the Fed (and eat the haircut) while they are still AAA rated. Of course, it may already be too late; ratings are dropping fast:
Moody's Investors Services downgraded an additional $23.89 billion of commercial mortgage-backed securities amid concerns that losses would grow from increased leverage, reduced reserves to pay debt and loan losses.
The move follows the ratings firm's announcement last week that it would review the ratings of some $300 billion of bonds backed by commercial-real-estate loans. More than a quarter of those securities are vulnerable to multiple-notch credit downgrades.
Last Thursday, Moody's said it will apply new assumptions about falling property cash flows and stressed capitalization rates, which are the ratio of net income to its value, when considering the rating of the bonds. The review is slated to be completed within 60 days.
Including the latest round of downgrades, $62.09 billion of CMBS has been downgraded by Moody's the past week.
The commercial real-estate market had held up better than the residential real-estate market, but it began to deteriorate quickly at the end of 2008 as the recession deepened.
The ratings firm had expected cumulative losses of 2% on commercial bonds issued between 2006 and 2008, but it has increased that to 5%.
Moody's, which on Tuesday downgraded 124 classes and affirmed 69, expects a significant decline in future property cash flows on higher tenant defaults, bankruptcies and a sharp decline in lease-renewal rates. Those cut include 47 tranches valued at $6.6 billion from Wachovia Corp., which was acquired by Wells Fargo Co. five weeks ago, 11 classes valued at $3.8 billion at J.P. Morgan Chase & Co. and 10 classes valued at $2.8 billion at UBS AG.
Existing CMBS might not be rated AAA for long.
Bottom Line: TALF limitations provide protection for the taxpayer, but curtail the program's effectiveness. This is not meant to imply that efforts should not be made to support the normal functioning of credit markets; simply to keep expectations about effectiveness in check.
- Government Offers Details of Bank Stress Test - NYTimes.com
- Turning Japanese - Paul Krugman
- The Crumbling Ivory Tower - NYTimes.com
- Schizofinance - Angry Bear
- Obama’s rescue plan buoys bank shares - FT
- Are We Overestimating Foreclosures? - Public Offering
- Buying assets, recapitalising banks, and getting incentives right - voxeu.org
- Obama to Seek Higher Tax on Affluent to Pay for Health Care - NYT
Wednesday, February 25, 2009
This ad appeared in the Washington Post today:
Statement (pdf of actual ad)
Although its collapse has dominated recent media coverage, the financial sector is not the only segment of the U.S. economy running into serious trouble. The institutions that govern the labor market have also failed, producing the unusual and unhealthy situation in which hourly compensation for American workers has stagnated even as their productivity soared.
Indeed, from 2000 to 2007, the income of the median working-age household fell by $2,000- an unprecedented decline. In that time, virtually all of the nation’s economic growth went to a small number of wealthy Americans. An important reason for the shift from broadly-shared prosperity to growing inequality is the erosion of workers’ ability to form unions and bargain collectively.
A natural response of workers unable to improve their economic situation is to form unions to negotiate a fair share of the economy, and that desire is borne out by recent surveys. Millions of American workers – more than half of non-managers – have said they want a union at their work place. Yet only 7.5% of private sector workers are now represented by a union. And in all of 2007, fewer than 60,000 workers won union status through government-sanctioned elections. What explains this disconnect?
The problem is that the election process overseen by the National Labor Relations Board has become drawn out and acrimonious, with management campaigning fiercely to deter unionization, sometimes to the extent of violating the labor law. Union sympathizers are routinely threatened or even fired, and they have little effective recourse under the law. Even when workers overcome this pressure and vote for a union, they are unable to obtain contracts one-third of the time due to management resistance.
To remedy this situation, the Congress is considering the Employee Free Choice Act. This act would accomplish three things: It would give workers the choice of using majority sign-up-- a simple, established procedure in which workers sign cards to indicate their support for a union – or staging an NLRB election; it triples damages for employers who fire union supporters or break other labor laws; and it creates a process to ensure that newly unionized employees have a fair shot at obtaining a first contract by calling for arbitration after 120 days of unsuccessful bargaining.
The Employee Free Choice Act will better reflect worker desires than the current “war over representation.” The Act will also lower the level of acrimony and distrust that often accompanies union elections in our current system.
A rising tide lifts all boats only when labor and management bargain on relatively equal terms. In recent decades, most bargaining power has resided with management. The current recession will further weaken the ability of workers to bargain individually. More than ever, workers will need to act together.
The Employee Free Choice Act is not a panacea, but it would restore some balance to our labor markets. As economists, we believe this is a critically important step in rebuilding our economy and strengthening our democracy by enhancing the voice of working people in the workplace.
Henry J. Aaron, Brookings Institution
Katharine Abraham, University of Maryland
Philippe Aghion, Massachusetts Institute of Technology
Eileen Appelbaum, Rutgers University
Kenneth Arrow, Stanford University
Dean Baker, Center for Economic Policy and Research
Jagdish Bhagwati, Columbia University
Rebecca Blank, Brookings Institution
Joseph Blasi, Rutgers University
Alan S. Blinder, Princeton University
William A. Darity, Duke University
Brad DeLong, University of California/Berkeley
John DiNardo, University of Michigan
Henry Farber, Princeton University
Robert H. Frank, Cornell University
Richard Freeman, Harvard University
James K. Galbraith, University of Texas
Robert J. Gordon, Northwestern University
Heidi Hartmann, Institute for Women’s Policy Research
Lawrence Katz, Harvard University
Robert Lawrence, Harvard University
David Lee, Princeton University
Frank Levy, Massachusetts Institute of Technology
Lisa Lynch, Brandeis University
Ray Marshall, University of Texas
Lawrence Mishel, Economic Policy Institute
Robert Pollin, University of Massachusetts
William Rodgers, Rutgers University
Dani Rodrik, Harvard University
Jeffrey D. Sachs, Columbia University
Robert M. Solow, Massachusetts Institute of Technology
William Spriggs, Howard University
Peter Temin, Massachusetts Institute of Technology
Mark Thoma, University of Oregon
Lester C. Thurow, Massachusetts Institute of Technology
Laura Tyson, University of California/Berkeley
Paula B. Voos, Rutgers University
David Weil, Boston University
Edward Wolff, New York University
An email suggestion:
Leaving Economics to the Economists, Not the Politicians, by David White: Politicians explaining economics to the general populace is like having baseball stars explain theoretical physics for the masses... There is nothing simple or sound bite-sized, or easily understandable, about the complex tangle of interwoven threads that make up the current economic crisis – the fact that the world’s most gifted economists ... are having real trouble getting their collective arms around exactly what needs to be done to fix a painfully obviously broken economic system, should tell us something about the presentation of economics issues for the average layperson by the average politician. ... Is it any wonder, therefore, that, when faced with an implosion of our financial institutions and world economies, which some have compared to the Great Depression of the 30’s, that few, if any, can really follow the economics issued presented?
Gov Bobby Jindal of Louisiana ... is about to make a huge mistake, which is a working lesson in this principle. Gov. Jindal has said he will turn down the Obama Stimulus Package Federal dollars aimed for Louisiana... The Hannity’s and Limbaughs of the Talking Heads political world have gone to great lengths demonizing the Stimulus (and everybody who rode in on it), comparing it to Socialism and it’s inevitable boogeyman following close behind: Communism. Even Newsweek’s cover proclaims: “We’re all Socialists Now.” This has directly led to the mistake that Jindal is about to make.
Let’s get real for a moment here. Anybody who has ever received Unemployment, or Social Security, or Veteran’s Benefits, or a whole host of other government-supplied money, has dipped a toe into the vast wading pool of Socialism... When banks fail and the FDIC (or S&L’s, and the FSLIC) takes them over – some 14 so far this still new year - we are witnessing Socialism in action right here in the good old US of A – it’s not something new at all. Let’s not all be quite so shocked about the fact that our brand of Capitalism has morphed light years past the unbridled, free-ranging form that allowed 19th Century Robber Barons and the Big Four to run America ... as their own fiefdoms for decades until the Populist movement of the early 20th Century came along... Without welfare, food stamps, disability benefits (both on the state and federal level), and many other such societal safety nets,... our homeless numbers [would be even larger than] now.
When all other economic re-tooling mechanisms have been tried and failed and the Federal Funds Rate is effectively at zero;... the idea of providing economic Stimulus ... is the only arrow left in our quiver to fight this good fight. ‘Stimulus means spending,’ as the President bluntly said..., and we have to get used to that and learn to make that do the job which it is designed to do, or we have to get used to the fact that we are embarking on our own Lost Decade like Japan’s in the ‘90’s...
Making this complex knot of economic trouble into a political issue at this critical juncture is an instance of complete denial of the reality all around us... It is the kind of exploitation that we don’t need right now, even though I am sure that riding this media horse has generated huge TV and radio ratings...– but, it is totally counter-productive when we should all be rowing in the same boat as the river continues to rise. The thousands who could have been employed in Louisiana and the thousands more who finally could have re-built their Katrina-destroyed homes and businesses with the Federal Stimulus money that Gov. Jindal is about to give back, will, in the end, be very sorry he did that. I predict that Gov. Jindal will be, too.
More Banks Behaving Badly: To be sure, banks, even those under financial pressure, need to pursue appropriate marketing and client development efforts if they expect to survive the crisis. It is just part of doing business. At the same time, firms under such intense public scrutiny should be cognizant of how such activities will be perceived. At a minimum, scale them back from Gatsbyesque enterprises. Apparently no one at Northern Trust got that memo. For those of you without time to waste at tmz.com:
Northern Trust, a Chicago-based bank, sponsored the Northern Trust Open at the Riviera Country Club in L.A. We're told Northern Trust paid millions to sponsor the PGA event which ended Sunday, but what happened off the golf course is even more shocking.
- Northern Trust flew hundreds of clients and employees to L.A. and put many of them up at some of the fanciest and priciest hotels in the city. We're told more than a hundred people were put up at the Beverly Wilshire in Bev Hills, and another hundred stayed at the Loews Santa Monica Beach Hotel. Still more stayed at the Ritz Carlton in Marina Del Rey and others at Casa Del Mar in Santa Monica.
- Wednesday, Northern Trust hosted a fancy dinner at the Ritz followed by a performance by the group Chicago.
- Thursday, Northern Trust rented a private hangar at the Santa Monica Airport for dinner, followed by a performance by Earth, Wind & Fire.
- Saturday, Northern Trust had the entire House of Blues in West Hollywood shut down for its private party. We got the menu -- guests dined on seared salmon and petite Angus filet. Dinner was followed by a performance by none other than Sheryl Crow.
There was also a fabulous cocktail party at the Loews. And how's this for a nice touch: Female guests at the Chicago concert all got trinkets from ... TIFFANY AND CO.
The expected Congressional response can be found here.
Not to worry; Northern Trust recieved only $1.6 billion in TARP money, but didn't ask for it. It was just taxpayer money anyway - you know, little people. They also laid off 450 people, but, again, little people, so also no worries.
More evidence that the US response to the financial crisis has degenerated into a sad joke.
- Enough With the Moral Hazard Fears - James Surowiecki
- Green Fights - The Bellows
- Environmental Economics vs Environmentalism - Tim Haab
- The Bernanke rally - Econbrowser
- Bernanke Says Recovery Is at Least a Year Away - NYTimes.com
- Killing (or Maiming) a Sacred Cow: Home Mortgage Deductions - Economix
- Obama’s misguided timetable - Clive Crook
- Greenspan could have found cure at pharmacy - John Kay
- How bank bonuses let us all down - Taleb - FT
- On So-Called “Irresponsible” Borrowers - Matthew Yglesias
- Fiscal Policy for the Crisis - voxeu.org
- Fed's Duke Defends Community Reinvestment Act Again - RTE
- Bernanke: You Say Nationalization, I Say Partnership - RTE
- The Beleaguered Banks Get Ready for Their Big Test - Time
- Talk and the Economy, Part II - The Balance Sheet
- Should We Assume the Worst? -: The Balance Sheet
- After the Stimulus: Now What? - Fred Block - Dissent Magazine
- I hope Hillary fails - Worthwhile Canadian Initiative
- Unsung Hero Resurrects US Tied Aid Reporting - William Easterly
- Tangible Common Equity for Beginners - The Baseline Scenario
- Bizarre bird behavior predicted by game theory - EurekAlert
- Bernanke warns of instability risks - FT
Tuesday, February 24, 2009
Was bad advice to developing countries partly responsible for the financial crisis? According to this, the answer is yes:
How China helped create the macroeconomic backdrop for financial crisis, by Moritz Schularick, Economist's Forum: Over the past decade, China and other emerging markets accumulated foreign currency reserves to insure against the economic and political vagaries of financial globalisation. They were wise to do so. Countries with larger reserves are weathering the storm relatively better than those who have bought less insurance.
Although purchasing insurance policy might have been sensible from the perspective of each country, collectively these currency interventions prepared the ground for the global crisis. Emerging markets, most notably China, helped to create the macroeconomic backdrop for the current financial crisis by subsidising interest rates and consumption in the US. ...
[After] the Asian crisis... Emerging markets heeded Martin Feldstein’s advice and took out an insurance policy against the vagaries of financial globalisation. By running current account surpluses, intervening in foreign exchange markets and building up currency reserves, Asian and other emerging economies were sustaining export led growth and buying insurance against future financial instability.
These policies turned developing markets into net capital exporters to the developed world, mainly to the US. ... Yet the accumulation of large war chests of foreign reserves through currency intervention carried negative externalities.
The arrangement opened a Pandora’s Box of financial distortions that eventually came to haunt the global economy. The glut of savings from emerging markets has been a key factor in the decline in US and global real-long term interest rates, despite the parallel decline in US savings.
Lower interest rates in turn have enabled American households to increase consumption levels and worsened the imbalance between savings and investment. And because foreign savings were predominantly channeled through government (or central bank) hands into safe assets such as treasuries, private investors turned elsewhere to look for higher yields. This ... unleashed the ingenuity of financial engineers who developed new financial products for the low interest rate world, such as securitised debt instruments.
This is not to say that reserve accumulation was the only cause for the current crisis. Yet the core issue remained the Chinese willingness to fund America’s consumption and borrowing habit. Without this support, interest rates in the US would almost certainly have been substantially higher, acting as a circuit breaker for the developing debt-consumption bubble.
Beijing and others cannot be blamed for reckless lending into the housing bubble or leverage in western financial institutions, but it is clear that a vast amount of capital was flowing from a developing country ... to one of the richest economies in the world. ...
From the perspective of emerging markets, the academic debate as to whether reserve levels have grown excessive has been answered almost overnight in the current crisis. It is clear to policy makers from Buenos Aires to Budapest and Beijing that one can’t have too many reserves in a world of volatile capital flows. ... Have we therefore come to a crossroads for financial globalisation...? After the dust has settled, members of the economics profession will have to think hard about what the right policy advice ... should be. ...
The liquidity coming into the US from Asia and other sources such as the oil producing countries was a factor in the crisis, as were low interest rates under Greenspan, but the availability of large amounts of liquidity on easy terms in and of itself is not enough for problems to develop. How the liquidity is used is the important factor, and if the proper regulatory safeguards are absent, the liquidity may not be used very wisely (as we now know all too well).
With the proper regulatory apparatus in place, or with financial instruments that truly disperse and reduce risk as promised, the reserve balance insurance polices pursued by developing countries do not have to lead to a financial crisis. Distortions are one thing, a crisis is something else and the mere existence of distortions does not lead, by necessity, to a meltdown of the financial system. I am not arguing that no distortions existed, but the crisis was not a necessary consequence of those distortions. The article notes that "Beijing and others cannot be blamed for reckless lending into the housing bubble or leverage in western financial institutions," and I agree. With the proper regulatory framework in place, the crisis need not have happened, and I can't see how the absence of effective regulatory safeguards is the fault of the polices pursued by countries anxious to protect themselves from a repeat of the Asian crisis.
Andrew Leonard reacts to Ben Bernanke's remarks on the economic outlook:
Ben Bernanke makes the case for strong government, by Andrew Leonard: The headline for the Wall Street Journal News Alert Tuesday morning reads "Bernanke Says Recession Should End This Year."
But the text of the message, summarizing the news from the Federal Reserve Chairman's testimony before the Senate Banking, Housing, and Urban Affairs Committee Tuesday morning adds a big "if":
"2010 'will be a year of recovery,' if actions taken by the government lead to some stabilization in financial markets."
And the actual text of his prepared remarks reveals further qualification: (Italics mine.)
If actions taken by the Administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability -- and only if that is the case, in my view -- there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery.
That's not just a big "if." That's a giant, honking, humongous, get-down-on-your-knees-and-pray-for-salvation "if." Ben Bernanke predicts that we can hope for an economic recovery next year, only if government action is effective -- and that includes, in his view, Treasury Secretary Tim Geithner's plan to bring stability to the banking system, the details of which are still unknown. ...
So let's retitle that WSJ News Alert: "Bernanke Warns That Without Aggressive FDR-Style Strong Government Action to Boost the Economy, We're Doomed."
The belief that policy will work is important too, and Andrew's comments reveal how much lack of faith there is right now that policymakers can do anything to turn things around. We've gone from giving policymakers - the Fed in particular - credit for helping to bring about the Great Moderation to wondering if they can moderate anything at all. I still believe policy can help, but given how this has been handled to date, the general loss of faith is easy to understand.
Update: This doesn't do much for confidence:
Mysterious plans, by Paul Krugman: I’m trying to be sympathetic to the various plans, or rumors of plans, for bank aid; but I keep not being able to understand either what the plans are, or why they’re supposed to work. And I don’t think it’s me.
So the latest is that we’re going to convert preferred stock held by the government to common stock, maybe. James Kwak has a good explanation of what that’s all about. And it’s not at all clear what is accomplished thereby.
Here’s my stylized picture of the situation:
At the top are a bank’s assets. Below are its obligations to various parties, with decreasing seniority from left to right. I’ve drawn it to embody a pessimistic assumption about the bank’s finances, because those are the cases we’re interested in: the bank’s assets aren’t enough to cover its debts. Nonetheless, the stock, both preferred and common, has a positive market value. Why? Because of the Geithner put: the bank is protected from collapse, keeping the creditors appeased, but stockholders will get the gains if somehow things turn up.
What we want to do is clean up the bank’s balance sheet, so that it no longer has to be a ward of the state. When the FDIC confronts a bank like this, it seizes the thing, cleans out the stockholders, pays off some of the debt, and reprivatizes.
What Treasury now seems to be proposing is converting some of the green equity to blue equity — converting preferred to common. It’s true that preferred stock has some debt-like qualities — there are required dividend payments, etc.. But does anyone think that the reason banks are crippled is that they are tied down by their obligations to preferred stockholders, as opposed to having too much plain vanilla debt?
I just don’t get it. And my sinking feeling that the administration plan is to rearrange the deck chairs and hope the iceberg melts just keeps getting stronger.
Privatize The Banks Already, by Simon Johnson: ...In some important and not good ways, we have already nationalized the financial system.
There’s the direct ownership that the government received through TARP and the reupping with Citi, BoA and some others. These stakes are obviously not (yet) voting stock, but the taxpayer certainly has capital at considerable risk.
Then we have the lines of credit provided by the Federal Reserve which, without a doubt, were instrumental to the survival of almost all major banks during the fall - and arguably remain critical today. The taxpayer has further downside risk here.
And, most importantly perhaps, we have the expansion of the Fed’s balance... In effect, the Fed is becoming a commercial bank as well as a central bank.
The government is essentially taking over the role of intermediation - take funds in and lend them out - for the US economy. This is a form of nationalization, and it will lead to all the lobbying and politically directed credits we have seen in other nationalized financial systems; taking away this credit once the economy starts to recover will not be easy. We have state control of finance without, well, much control over banks or anything else - we can limit executive compensation (maybe) but we don’t get to appoint directors (or replace entire boards) and we have no say in who really runs anything. Responsibility without power sounds accurate. ...
How then do we really privatize? By exercising leadership: take over insolvent banks and immediately reprivatize them. ... The taxpayer retains a significant number of shares (or the option to buy common stock) as a way to ensure upside participation...
Above all, we need to encourage or, most likely, force the large insolvent banks to break up. Their political power needs to be broken, and the only way to do that is to pull apart their economic empires. It doesn’t have to be done immediately, but it needs to be a clearly stated goal and metric for the entire reprivatization process.
No argument here. If there are good reasons to have banks so large their failure could bring down the entire system, a situation that gives them quite a bit of political leverage, I haven't heard them. There are questions about whether having many small banks as opposed to a few big banks reduces systemic risk, and if not, whether having lots of small banks makes policy intervention to stabilize and clean up the system more difficult when problems do arise - having just a few banks might be easier. But breaking up the banks does reduce political and economic power and I see no reason not to make this "a clearly stated goal and metric for the entire reprivatization process."
Macroeconomics gets the headlines, especially lately, but there's a lot more to economics than the study of abstract aggregates used as barometers of economic performance. Robert Stavins follows up on his post arguing that market failure is common in the environmental domain with an explanation of why simple solutions to these problems are often inadequate:
The Myth of Simple Market Solutions, by Robert Stavins: I introduced my previous post by noting that there are several prevalent myths regarding how economists think about the environment, and I addressed the “myth of the universal market” – the notion that economists believe that the market solves all problems. In response, I noted that economists recognize that in the environmental domain, perfectly functioning markets are the exception, not the rule. Governments can try to correct such market failures, for example by restricting pollutant emissions. It is to these government interventions that I turn this time.
A second common myth is that economists always recommend simple market solutions for market problems. Indeed, in a variety of contexts, economists tend to search for instruments of public policy that can fix one market by introducing another. If pollution imposes large external costs, the government can establish a market for rights to emit a limited amount of that pollutant under a so-called cap-and-trade system. Such a market for tradable allowances can be expected to work well if there are many buyers and sellers, all are well informed, and the other conditions I discussed in my last posting are met.
The government’s role is then to enforce the rights and responsibilities of permit ownership, so that each unit of emissions is matched by the ownership of one permit. Equivalently, producers can be required to pay a tax on their emissions. Either way, the result — in theory — will be cost-effective pollution abatement, that is, overall abatement achieved at minimum aggregate cost.
The cap-and-trade approach has much to recommend it, and can be just the right solution in some cases, but it is still a market. Therefore the outcome will be efficient only if certain conditions are met. Sometimes these conditions are met, and sometimes they are not. Could the sale of permits be monopolized by a small number of buyers or sellers? Do problems arise from inadequate information or significant transactions costs? Will the government find it too costly to measure emissions? If the answer to any of these questions is yes, then the permit market may work less than optimally. The environmental goal may still be met, but at more than minimum cost. In other words, cost effectiveness will not be achieved.
To reduce acid rain in the United States, the Clean Air Act Amendments of 1990 require electricity generators to hold a permit for each ton of sulfur dioxide (SO2) they emit. A robust permit market exists, in which well-defined prices are broadly known to many potential buyers and sellers. Through continuous emissions monitoring, the government tracks emissions from each plant. Equally important, penalties are significantly greater than incremental abatement costs, and hence are sufficient to ensure compliance. Overall, this market works very well; acid rain is being cut by 50 percent, and at a savings of about $1 billion per year in abatement costs, compared with a conventional approach.
A permit market achieves this cost effectiveness through trades because any company with high abatement costs can buy permits from another with low abatement costs, thus reducing the total cost of reducing pollution. These trades also switch the source of the pollution from one company to another, which is not important when any emissions equally affect the whole trading area. This “uniform mixing” assumption is certainly valid for global problems such as greenhouse gases or the effect of chlorofluorocarbons on the stratospheric ozone layer. It may also work reasonably well for a regional problem such as acid rain, because acid deposition in downwind states of New England is about equally affected by sulfur dioxide emissions traded among upwind sources in Ohio, Indiana, and Illinois. But it does not work perfectly, since acid rain in New England may increase if a plant there sells permits to a plant in the mid-west, for example.
At the other extreme, some environmental problems might not be addressed appropriately by a simple, unconstrained cap-and-trade system. A hazardous air pollutant such as benzene that does not mix in the airshed can cause localized “hot spots.” Because a company can buy permits and increase local emissions, permit trading does not ensure that each location will meet a specific standard. Moreover, the damages caused by local concentrations may increase nonlinearly. If so, then even a permit system that reduces total emissions might allow trades that move those emissions to a high-impact location and thus increase total damages. An appropriately constrained permit trading system can address the hot-spot problem, for example by combining emissions trading with a parallel system of non-tradable ambient standards.
The bottom line is that no particular form of government intervention, no individual policy instrument – whether market-based or conventional – is appropriate for all environmental problems. There is no simple policy panacea. The simplest market instruments do not always provide the best solutions, and sometimes not even satisfactory ones. If a cost-effective policy instrument is used to achieve an inefficient environmental target — one that does not make the world better off, that is, one which fails a benefit-cost test – then we have succeeded only in “designing a fast train to the wrong station.” Nevertheless, market-based instruments are now part of the available environmental policy portfolio, and ultimately that is good news both for environmental protection and economic well-being.
- Clinton Urges China to Keep Buying U.S. Treasury Securities - Bloomberg
- A very simple macro model of the last few years - Nick Rowe
- Lockhart: Fed Needs to Have Exit Strategy - Real Time Economics
- Obama's part in an ethics-based economy - Project Syndicate
- Is There a Speculative Bubble in Gold? - EconoSpeak
- What Part of ‘Stimulus’ Don’t They Get? - NYTimes.com
- The villains aren't criminals. They're morons. - Daniel Gross
- The Myth of Simple Market Solutions - Rob Stavins
- Obama's Goal: Halving the Budget Deficit by 2012. Really? - Robert Reich
- Why capitalism requires “nationalisation” - Economists' Forum
- FRB Atlanta - Lockhart - Speech
- The Output Gap: Neoclass.ical Synthesis, New Classical and New Keynesian - Econbrowser
Monday, February 23, 2009
From Tim Duy:
Billions of Dollars Later..., by Tim Duy: Billions of dollars later, and consumer credit continues to contract...and now at least one firm is paying paying cardholders to drop their accounts. From Bloomberg:
American Express Co., the largest U.S. credit-card company by purchases, is paying some cardholders $300 each to close accounts so the lender can reduce the risk of defaults as the recession deepens.
People who got the offer to “simplify” their finances must pay off their entire credit-card balance by April 30, according to New York-based American Express. Enrolling in the program cancels a customer’s account and may lead to forfeiture of reward points or rebates, the company said on its Web site.
“What AmEx is trying to do is move to the front of the line in terms of getting paid back” by customers who owe debts to multiple lenders, said Michael Taiano, an analyst at Sandler O’Neill & Partners with a “hold” rating on the company. “They clearly grew loans faster than their competitors in the years leading up to this financial crisis.”
American Express was a recipient of TARP funding, albeit a "nominal" $3.39 billion. What makes this interesting is that not only is American Express not expanding lending - the selling point of the original TARP proposal - they are using the funds (money is fungible) to explicitly contract lending. Such a vivid illustration of the industry's challenges. And those challenges are only building. As the US government is goading investors with a line in the sand, consumer defaults are swelling:
Consumers are falling behind on credit-card payments as U.S. unemployment reached 7.6 percent last month, the highest rate since 1992.
This is just consumer debt; commerical debt pressures, including real estate, are building as well. With the situation rapidly deteriorating, the anticipated stress tests look like a smoke screen to buy time in yet another emphemeral effort to restore the elusive confidence that policymakers hope will magically restore the system.
Whatever news comes out of Washington regarding the plan of the day for the banking system, I hope one thing is soon made clear to the public - fixing the financial system is not the same thing as expanding lending. We are way past that point; you can't fix the system with more bad loans. If Treasury Secretary Geithner tries to sell his plans as the solution that will revive credit growth, I suspect he will further test the already strained credibility of the government. A more honest approach: We are simply trying to prevent the financial system from outright collapse.
Ezra Klein says there's little need for worry about the fiscal responsibility summit today, policymakers are finally getting the message that the true problem is rising health care costs in both the public and private sectors, not entitlements. That's good news, but I still plan to keep my eyes and ears open just in case the urge to compromise in order to move things forward threatens to also compromise important social programs:
How Entitlement Reform Became Health Reform, by Ezra Klein, American Prospect: It's testament to how deeply the idea of an entitlement crisis has embedded itself in Washington that news that Obama planned a "fiscal accountability summit" was immediately taken as proof by The Washington Post that he was readying a frontal assault on Medicare, Medicaid, and Social Security.
It was an understandable leap for the paper to make. Fiscal responsibility has, in this town, long been an anodyne synonym for entitlement reform. The "responsible" part signaled that you were courageous enough to cut treasured social programs in service of the national debt. The left, which never bought into this ruthlessly austere vision of responsibility, reacted with a defensive fury. It had just spent eight years protecting the entitlement programs from sharp-knifed "reformers." Would it have to do so again?
Today's "White House Fiscal Summit" ... will feature speeches from the president and vice president and "breakout" sessions... Notice what's not in there: Entitlement Reform.
Its absence is the product of a quiet but powerful change in thinking that has taken place in the offices of elite Washington and, now, the halls of the White House. Where a decade ago the looming fiscal threat of entitlement spending led economists and budget wonks to wear out their worry beads, today a more subtle understanding of our fiscal future dominates. In this telling, there's no such program as SocialSecurityandMedicareandMedicaid. There's Social Security, which ... needs little, if any, help. And then there's health-care reform. "That," says Henry Aaron, a senior economist at the Brookings Institution, "is the big kahuna."
How this happened depends on whom you talk to. Dean Baker ... points to the 2005 Social Security privatization fight. ... That forced left-of-center wonks who'd not thought much about the crisis to confront the numbers...
Aaron locates his light-bulb moment in a paper written by Richard Kogan, Matt Fiedler, Aviva Aron-Dine, and Jim Horney for the Center on Budget and Policy Priorities. He remembers sitting around a table with ... an array of ... economic luminaries while Kogan and Horney presented their findings. "The long-term fiscal outlook is bleak," they wrote, and "rising health care costs are the single largest cause."
Aaron says that the "meeting was sort of a slap-the-forehead moment. I said 'you guys are saying there is no problem other than a health-care financing problem long-term!' Credit goes to them, in my opinion." ...
What everyone agrees on is that the thinking entered government in the person of Peter Orszag. In 2007, Orszag was named director of the Congressional Budget Office. From that perch, he brought Kogan and Horney's thinking to the halls of Congress. Orszag liked to show a particular slide in his public presentations... Government spending and Social Security, it says, will hold relatively constant in coming years. It's Medicare and Medicaid that chew up federal spending.
This graph, however, could be used as evidence for a simple focus on Medicare and Medicaid. The programs are unsustainable. They need to be slashed. The next slide in Orszag's presentation is titled "misdiagnosing the problem." The fiscal threat, it argues, is not more beneficiaries or ... factors internal to Medicare and Medicaid. It's the cost per beneficiary. Orszag has a graph for this, too...
And since Medicaid and Medicare pay for health services on the private market, this can only be fixed through broader health reform. Orszag ... will lead today's "health care" breakout session. Richard Kogan works for him. So it's no surprise that asked for details on today's fiscal summit, one senior administration official told me that "the most likely outcome at this point is that we focus on health care given that it's the key to our fiscal future." Another explained the focus starkly. "Health is mathematically bigger,"... The rumors originally held that eager entitlement cutter Peter G. Peterson would give the day's keynote. Now Robert Greenstein, director of the very think tank that released Kogan and Horney and Cox's paper, will speak.
Fiscal responsibility, in other words, is no longer a stand-in for entitlement reform. In Obama's Washington, it means health reform.
It's time to subject large banks to a serious stress test, and then nationalize any bank that is deemed insolvent:
Banking on the Brink, by Paul Krugman, Commentary, NY Times: Comrade Greenspan wants us to seize the economy’s commanding heights. O.K., not exactly. What Alan Greenspan,... a staunch defender of free markets ... actually said was, “It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring.” I agree.
The case for nationalization rests on three observations.
First, some major banks are dangerously close to the edge — in fact, they would have failed already if investors didn’t expect the government to rescue them if necessary.
Second, banks must be rescued. The collapse of Lehman Brothers almost destroyed the world financial system, and we can’t risk letting much bigger institutions like Citigroup or Bank of America implode.
Third, while banks must be rescued, the U.S. government can’t afford, fiscally or politically, to bestow huge gifts on bank shareholders.
Let’s be concrete here. There’s a reasonable chance ... that Citi and BofA, together, will lose hundreds of billions over the next few years. And their capital ... isn’t remotely large enough to cover those potential losses.
Arguably, the only reason they haven’t already failed is that the government is ... implicitly guaranteeing their obligations. But they’re zombie banks, unable to supply the credit the economy needs.
To end their zombiehood the banks need more capital. But they can’t raise more capital from private investors. So the government has to supply the necessary funds.
But ... to bring these banks fully back to life would greatly exceed what they’re currently worth. ... And if it’s basically putting up all the money, the government should get ownership in return.
Still, isn’t nationalization un-American? No, it’s as American as apple pie.
Lately the Federal Deposit Insurance Corporation has been seizing banks it deems insolvent at the rate of about two a week. When the F.D.I.C. seizes a bank, it takes over the bank’s bad assets, pays off some of its debt, and resells the cleaned-up institution to private investors. And that’s exactly what advocates of temporary nationalization want to see happen ... to major banks that are similarly insolvent.
The real question is why the Obama administration keeps coming up with proposals that sound like possible alternatives to nationalization, but turn out to involve huge handouts to bank stockholders.
For example, the administration initially floated the idea of offering banks guarantees against losses on troubled assets...: heads they win, tails taxpayers lose.
Now the administration is talking about a “public-private partnership” to buy troubled assets from the banks, with the government lending money to private investors for that purpose. This would offer investors a one-way bet: if the assets rise in price, investors win; if they fall substantially, investors walk away and leave the government holding the bag. Again, heads they win, tails we lose.
Why not just go ahead and nationalize? ... All the administration has to do is take its own planned “stress test” for major banks seriously... And once again, long-term government ownership isn’t the goal: like the small banks seized by the F.D.I.C. every week, major banks would be returned to private control as soon as possible. ...
The Obama administration, says Robert Gibbs, the White House spokesman, believes “that a privately held banking system is the correct way to go.” So do we all. But what we have now isn’t private enterprise, it’s lemon socialism: banks get the upside but taxpayers bear the risks. And it’s perpetuating zombie banks, blocking economic recovery.
What we want is a system in which banks own the downs as well as the ups. And the road to that system runs through nationalization.
Fiscal policy is like getting grandfather's musket down out of the attic, where we locked it away to stop the kids (politicians, or perhaps ourselves) playing with it. It's an ugly, unreliable, inaccurate, slow, dangerous, weapon to use, and nobody can remember how the damned thing works.
- Deficit Hawks Target Social Security, Medicare Again - Robert Kuttner
- Nice Work If You Can Get It - James Surowiecki
- Casey Needs a Mulligan - İyigün Blog
- Hacker on healthcare and institutional change - The Monkey Cage
- As Doubts Grow, U.S. Will Judge Banks’ Stability - NYTimes.com
- Disagreements About Stimulus Embroil G.O.P. - NYTimes.com
- Late Starter - David Warsh
- Ben Stein Watch - Felix Salmon
- Principal Reduction or Interest Reduction? - Richard Green
- Tax Credits for Job Creation and Retention - FRBSF
- Obama aims to halve deficit by 2013 - FT.com
- Digesting the N-word - Models & Agents
Sunday, February 22, 2009
Another quick hit: Republican Bruce Bartlett (budget story here):
Exposing Republican stupidity, by Bruce Bartlett, Politico: It appears from leaks about Obama’s budget that the scenario I have long envisioned will finally come to pass. Republicans will be forced to deal meaningfully with the Bush tax cuts, which Obama apparently plans to allow to expire at the end of next year.
Republicans wrote this legislation with expiration dates as a trick to avoid budget rules that make it difficult to enact permanent tax cuts. Now they are going to say that this constitutes the largest tax increase in history even though their own legislation bequeathed it.
I hope Obama stands firm; not because I want taxes to rise, but because it exposes Republican stupidity. They could have had permanent—and more effective—tax cuts in the first place if they had been willing to negotiate with Democrats. They refused to do so and deluded themselves that they could just extend their tax cuts forever. They were wrong.
Here are a couple of notable items I don't have time to do anything with. First Jeff Frankel:
A New Depression? The Lessons of the 1930s, by Jeff Frankel: We often hear the question “isn’t this economic crisis becoming as bad as the Great Depression?” Economists can offer a variety of reassurances, but each of them is quite circumscribed... [...continue reading...]
Next, Susan Woodward and Bob Hall:
The right way to create a good bank and a bad bank, by Woodward and Hall: Policymakers continue to struggle to figure out how to turn a troubled bank into a good bank and a bad bank. Under the good-bank/bad-bank policy, the good bank will operate free from concerns about troubled assets, because these assets will be held by the fully independent bad bank. Most discussions of the separation of a bank in this way presume that the government must inject a lot of new capital to create a well-capitalized good bank together with a still-solvent bad bank. The math seems simple–the troubled bank has almost no capital, so if the capital has to be split between the two banks, a well-capitalized bank will need new capital. [...continue reading...]
Jamie Galbraith wonders why the standard, mandated procedure for handling failing banks isn't being used on large banks such as Citigroup or Bank of America
How To Improve The New Bank Rescue Plan?, by James K. Galbraith, National Journal: Improve what bank plan?
There are laws on these matters. Let me first refer you to William K. Black...:
Whatever happened to the law (Title 12, Sec. 1831o) mandating that banking regulators take ‘prompt corrective action' to resolve any troubled bank? The law mandates that the administration place troubled banks, well before they become insolvent, in receivership, appoint competent managers, and restrain senior executive compensation (i.e., no bonuses and no raises may be paid to them). The law does not provide that the taxpayers are to bail out troubled banks.
There is no exception in this law for Citigroup or Bank of America. If the bank is troubled, the regulators need to be on the case. If the bank is not troubled, then why are we talking about a a bad asset rescue fund of two trillion dollars?
The administration should follow the law. Pass-through receiverships are the legal way to resolve troubled or failed banks. They are also the proven way. ... There is no coherent reason to avoid the proven path, in favor of the wild experiment. And particularly not, when the law is very clear. ... [Note: Jamie also discusses the Ed Leamer plan later in his post]
The point about this not being the time to experiment is similar to the conclusion I came to here in a discussion of Ricardo Caballero's plan to end the crisis by having the government guarantee the future price of bank shares.
- You Call That Fact-Checking? - Discover Magazine
- Bank Nationalization: A Viewer’s Guide - The Baseline Scenario
- Everyone Loves Google, Until It’s Too Big - NYTimes.com
- Obama's Plan to Slash Deficit, Despite Stimulus Bill - NYTimes.com
- There's no reason for non-recourse - Interfluidity
- How Renewable Energy and Storage Solutions Stack Up - SciAm
- Springtime for Banks - The Baseline Scenario
- How the state influences volunteering - voxeu.org
- Deflation risk down but not out - Econbrowser
- The return of capital controls - Buiter - voxeu.org
Saturday, February 21, 2009
I don't buy into the idea that talk is a major factor driving the length and depth of the downturn, but Robert Shiller does:
Can Talk of a Depression Lead to One?, by Robert Shiller, Commentary, Economic View, NY Times: People everywhere are talking about the Great Depression... It is a vivid story of year upon year of despair. This Depression narrative, however, is not merely a story about the past: It has started to inform our current expectations.
According to the Reuters-University of Michigan Survey of Consumers earlier this month, nearly two-thirds of consumers expected that the present downturn would last for five more years. President Obama, in his first press conference, evoked the Depression in warning of a “negative spiral” that “becomes difficult for us to get out of” and suggested the possibility of a “lost decade,” as in Japan in the 1990s. ...
The attention paid to the Depression story may seem a logical consequence of our economic situation. But the retelling, in fact, is a cause of the current situation — because the Great Depression serves as a model for our expectations, damping what John Maynard Keynes called our “animal spirits,” reducing consumers’ willingness to spend and businesses’ willingness to hire and expand. The Depression narrative could easily end up as a self-fulfilling prophecy.
The popular response to vivid accounts of past depressions is partly psychological, but it has a rational base. We have to look at past episodes because economic theory, lacking the physical constants of the hard sciences, has never offered a complete account of the mechanics of depressions.
The Great Depression does appear genuinely relevant..., and many people have been spooked by the story.
To understand the story’s significance in driving our thinking, it is important to recognize that the Great Depression itself was partly driven by the retelling of earlier depression stories. In the 1930s, there was incessant talk about the depressions of the 1870s and 1890s; each of those downturns lasted for the better part of a decade. ... Early in the Great Depression, people were concerned that, as one observer put it in 1931, we may “pass through a long period of mediocre business activity like that of the 1890s.” ...
Should President Obama have reinforced the Great Depression story? Perhaps he had to take that risk to promote the economic stimulus plan, and not just hope for some accident to save us. The story was already entrenched in our consciousness, and will be with us until we see a real, solid boost from the stimulus package and its likely successors.
What will the recession do to political stability around the world? Robert Skidelsky says the rulers of some countries could have a rough ride ahead of them:
Shaky social contracts during downturn, by Robert Skidelsky, Project Syndicate: "Enrich yourselves,” China’s Deng Xiaoping told his fellow countrymen when he started dismantling Mao Zedong’s failed socialist model. In fact, elites everywhere have always lived by this injunction, and ordinary people have not minded very much, provided that the elites fulfill their part of the bargain: protect the country against its enemies and improve living conditions.
It is this implied social contract that is now endangered by economic collapse. Of course, the terms of the contract vary with place and time. In 19th century Europe, the rich were expected to be frugal. Conspicuous consumption was eschewed. The rich were supposed to save much of their income, as saving was both a fund for investment and a moral virtue. And, in the days before the welfare state, the rich were also expected to be philanthropists.
In the opportunity culture of the United States, by contrast, conspicuous consumption was more tolerated. High spending was a mark of success: what Americans demanded of their rich was conspicuous enterprise.
Societies have also differed in how wealthy they allow their elite to become, and in their tolerance of the means by which wealth is acquired and used. ...
The global economy’s downturn increases countries’ political risk to varying degrees, depending on the severity of the shock and the nature of the implied social contract. Political systems in which power is least controlled, and the abuse of wealth greatest, are most at risk. The more corrupt the system of capitalism, the more vulnerable it is to attack.
The general problem is that all of today’s versions of capitalism are more or less corrupt. “Enrich yourselves” is the clarion call of our era; and in that moral blind spot lies a great danger. ...
In estimating political risk today, analysts must pay particular attention to the character of the political system. Does it allow for an orderly transition? Is it competitive enough to prevent discredited leaders from clinging to power? Analysts also must pay attention to the nature of the implied social contract. Broadly speaking, the weakest contracts are those that allow wealth and power to be concentrated in the same few hands, while the strongest are built on significant dispersal of both.
Deepening economic recession is bound to catalyze political change. The Western democracies will survive with only modest changes. But strongmen who rely on the secret police and a controlled media to maintain their rule will be quaking in their shoes. ...
The big countries with the highest political risk are Russia and China. The legitimacy of their autocratic systems is almost entirely dependent on their success in delivering rapid economic growth. When growth falters, or goes into reverse, there is no one to blame but “the system”.
Igor Yurgens, one of Russia’s most creative political analysts, has been quick to draw the moral: “the social contract consisted of limiting civil rights in exchange for economic wellbeing.
At the current moment, economic well-being is shrinking. Correspondingly, civil rights should expand. It’s just simple logic.” The rulers in Moscow and Beijing would do well to heed this warning.
Charles Wyplosz argues that "Much as it was necessary to let Lehman Brothers go down the pipe before bailing out the remaining banks, it may be necessary to let a profligate government default and ask for IMF assistance":
Bailouts: the next step up?, by Charles Wyplosz, Vox EU: A few months ago, we were anxiously discussing whether governments should bail out banks. They did. And then they went into the business of bailing out car companies, just as central banks – a branch of government – started to lend directly or indirectly to the private sector. And now we start discussing whether governments should bail out… governments within the euro area.
Should some governments bailout other governments in Europe?
This is less revolutionary than it seems. After all, this is exactly what the IMF does and there is a long history of bilateral aid, some of which in emergency conditions. What is striking is that government bailouts are explicitly banned in the Maastricht Treaty. Of course, any piece of legislation can be circumvented and, surprising as it may be, rumor has it that the German government is already exploring clever ways to do so. When we remember that the no-bailout clause of the Treaty was a German request, we realize how desperate the situation is. Should we, indeed, cut our right arm after having cut the left one?
It may be surprising that governments – which routinely help each other via the IMF, the World Bank and other international organizations – have found it necessary to introduce the no-bailout clause within the euro area. One could have imagined the opposite, that intra-European solidarity is upped as the European Union becomes “ever closer”, in particular as countries decide to share the same currency. In some way it did, through the development of the Regional Funds, explicitly designed to redistribute income from richer to poorer regions. So, why then, the ban on mutual government assistance?
The logic of the no-bailout clause
The answer is pretty obvious: moral hazard. If a government knows that, under some circumstances, part of its expenditures will be paid for by other governments, then sooner or later it will take advantage of the arrangement. Given European governments’ long history of dubious fiscal discipline, there is every reason to imagine that this would happen sooner rather than later. The seriousness of the moral hazard issue is hardly controversial. Indeed, all international loans are subject to strict conditions or rules designed to mitigate moral hazard. But that does not yet explain why the situation is so acute within the euro area that it requires a special clause.
The answer must be that moral hazard is compounded by the sharing of a currency. The fear is that a country’s default would trigger a number of particularly harmful reactions that would spare no other euro area member country. For example, a default by the Greek government could lead international investors to run on other government debts. In fact lists are already widely discussed in banking circles, spilling into the media and blogs the world over. A default, or a string of defaults, could lead to massive capital outflows, weakening the euro and creating the risk of inflation at a time when the ECB is fighting the recession. Already fragile banks may suffer significant losses and tilt over into outright bankruptcy themselves, dragging each other below the floating line. But bankrupt governments cannot bailout bankrupt banks, even less carry on counter-cyclical policies. The only solution, then, would be massive money creation and its eventual outcome, massive inflation. Since price stability is a fundamental objective of the Single Currency, this scenario was felt as impossible to even contemplate, hence the no-bailout rule.
Rules and discretion: Should we violate the no bailout rule?
As is well-know from the rules vs. discretion literature, any black-and-white rule runs the risk of being extremely counter-productive under some circumstances. When the unexpected happens, the temptation to renege becomes huge. Here we are. The question, then, is whether the costs of reneging exceed the costs of upholding the rule. The answer is by no means obvious.
Bailing out one or more governments does not have to be financially costly to the lenders if they charge the market rate. This, presumably, is what lies behind the idea of issuing EU bonds. The cost, therefore, comes mainly from the moral hazard side. This would undoubtedly require the adoption of a strong version of the Stability and Growth Pact, since the current one, which replaces a previous version that failed, clearly did not succeed in pushing many countries toward fiscal discipline.
Given the many limitations of the pact, strengthening it would be a real cost in the aftermath of the crisis. To realize how counterproductive the pact can be, it is enough to observe how the Commission is too paralyzed by its desire to uphold the pact to play any constructive role in encouraging a coordination of fiscal policies. Better solutions, which focus instead on national institutions, are possible but unlikely to be considered after a bailout. The alternative to a strengthened pact is an exacerbated moral hazard, which could eventually sap the monetary union.
Letting member-state governments default, could create havoc of untold proportions, as noted above. Or could it? When they wrote the no-bailout clause, the Maastricht Treaty Founding Fathers were clearly impressed by the New York City affair of the 1970s. The City informed the State of New York that it was about to declare bankruptcy and would do so unless bailed out. The State informed the Federal Government that it too would default unless bailed out, which could destroy Wall Street and the US financial system. The Federal Government responded to the State of New York “please default”, a message that was then passed on to the Mayor. No one defaulted. And then, after the City had made substantial progress, the Federal Government provided a loan on which it subsequently made good profit. Even better, the City of New York has since become fiscally disciplined.
The no-bailout clause is much better than the Stability and Growth Pact provided that it is enforced when it is needed. T’is the time.
Let one of the profligate government default
Much as it was necessary to let Lehman Brothers go down the pipe before bailing out the remaining banks, it may be necessary to let a profligate government default and ask for IMF assistance before punching a hole in the no-bailout clause.
It was necessary to let Lehman fail? At some point we needed to begin letting banks fail, but not until the system was sufficiently stable, and the events that occurred after Lehman was allowed to fail made it was clear we weren't yet at that point.
There are risks either way. By taking a strong, public position that you will not bailout a government that is in trouble no matter what, don't you run the risk of causing capital flight from countries anywhere near the edge, which could then cause a default that might not have occurred otherwise (and you could end up with an even larger problem - see Lehman)? Or am I missing something?
Ricardo Caballero proposes that the government guarantee the future price of bank shares as a means of halting "the deadly spiral of fear and panic":
How to Lift a Falling Economy, by Ricardo J. Caballero, Commentary, Washington Post: ...Since Treasury Secretary Timothy Geithner's recent announcements, shares of the main U.S. financial institutions have imploded yet again. The Dow Jones industrial average keeps falling. And to make matters worse, politics has decidedly entered into the process of economic policymaking... Talk of nationalizations has become widespread, as if government takeovers were a panacea, further reinforcing the deadly spiral of fear and panic. ...
Here is a proposal: The government pledges to buy up to twice the number of bank shares currently available, at twice some recent average price, in five years.
While the policy is about future (and unlikely) interventions, the immediate impact would be enormous. In particular, it would turn around the negative dynamics of stock markets, and it would allow banks to raise private capital.
The most direct effect would be an increase in the price of banks' shares, as the pledge puts a floor on the price, but the upside potential is huge once we get over the hurdle posed by this crisis. That is, buying equity from these banks would become like buying Treasury bonds plus a call option on the upside. By the strong forces of contagion, this rise would immediately spread to non-financial shares. Consumers, especially retirees, would see some of their wealth replenished; insurance companies' balance sheets would improve; destabilizing short sellers and predators would be wiped out (as happened in Hong Kong in 1997); and we would have the foundations for a virtuous cycle.
The second, and reinforcing, effect would be the stabilization of the financial sector, as banks would possess the conditions necessary to raise private capital. Until now, banks have not wanted to raise capital because it would be highly dilutive at current prices. Potential investors have no interest in injecting capital because there is an enormous fear of further dilutions, especially through public interventions or, worse, outright nationalizations. A pledge to support the shares would reverse these dynamics and quickly recapitalize the banking sector.
How much would this cost taxpayers? Probably nothing. It is unlikely that the crisis will last five years... If the market prices surpass the government-pledged sale prices, there would be no cost to taxpayers. There ... is no real reason not to try such a proposal...
Update:See the comments by James Kwak.
- Nationalization fears - Paul Krugman
- White House Says Banks Should Stay Private - naked capitalism
- Nationalization, schmationalization - Andrew Leonard
- Good Banks' Are Cost Effective Way Out of Financial Crisis - Willem Buiter
- Stimulus Says ‘Buy America.’ Good Luck With That. - NYTimes.com
- Rising Worries on Rescue Roil Banks’ Shares - NYTimes.com
- Stiglitz: Too Little, Too Late (but Better Than Nothing) - Public Offering
- The Lucas Critique - EconoSpeak
- Inflate it Away? - Angry Bear
Friday, February 20, 2009
Hope and Trust, and the Mini Depression, by Robert Reich: When the history of the Mini Depression of 2008-2010 is written by future historians, the word "distrust" will appear again and again.
Financial stocks are in free fall because no one trusts financials any longer. ...[I]t has become clear (even to Alan Greenspan) that the only way anyone is going to trust what they see on bank balance sheets is if bank regulators take over troubled banks, at least until those balance sheets are washed clean. ...
Meanwhile, economic distrust is spreading around the globe. What started two years ago with a sub-prime lending problem in the United States is now global, the ugly consequence of untrustworthy global capital markets and inadequate worldwide demand (led by fearful consumers in the United States). ...
Given all this, America's stimulus isn't nearly large enough. At the least, it should be replicated, proportionally, by every major economy. Central banks around the world must also continue to lower interest rates and open their lending windows. Bank bailouts must be coordinated. Protectionism should be avoided.
In this world of economic distrust, it's vitally important that President Obama and his administration maintain credibility on the economy. Raising false expectations would do far more harm than good. In remarks aired this morning ... former president Bill Clinton said... "...I just would like [Obama] to end by saying that he is hopeful and completely convinced we're gonna come through this." Clinton's suggestion is understandable but misguided. Happy talk at this point in time is so incongruous with what most Americans (and others around the world) know and are experiencing that it could undermine Obama's credibility.
The truth is that no one has any idea how long this crisis will last or exactly how to reverse it. ... And because restoring trust is so central to mending the economy, our leaders must be extremely careful not to indulge right now in the audacity of hope.
I think the most important element along these lines is to give people confidence that the administration knows what it is doing, i.e. that it understands the problem and has a plan to deal with it. They did well with the housing plan, there was some disagreement with it on some points, but overall it was received well and there was no sense that it was based upon a failure to understand the problem, that ideology rather than analysis controlled the outcome, or that the plan had no chance of helping.
That was quite a contrast to the roll out of the still in development bank rescue plan. Some people have defended it, even its vagueness, but overall my view is that it did not give people confidence in the administration's ability to deal with this problem, and in fact probably led to more distrust in their abilities than before the announcement.
However, the bank bailout episode isn't over and apparently more details about the bailout plan will be coming soon, so we'll see how it all plays out once the actual plan is presented. I expect there will be many who disagree with the approach the administration takes, more than with the housing plan no matter what they decide to do, and that will make recovering lost trust harder. It's not impossible, but it will be harder (though if nationalization were to be ruled out I think the reactions won't be largely unfavorable). But if the plan is based upon a solid foundation, if it leaves a path to temporary nationalization of troubled institutions, and if it does not have a tin ear politically, trust can still be recovered. So we shall see.
Update: I meant to add one more thing. Nationalization of banks is a politically difficult step to take, and I think the administration is correct to worry about how it would play and to try to set the stage for temporary nationalization before moving in that direction. In that regard, it's been interesting to watch Republican after Republican, Greenspan for example, slowly come over to the idea that nationalization is unaviodable in some cases since their doing so gives political cover to the nationalization step. The administration can argue "we don't like it any more than anyone else, and we did our best to avoid it, but as you can see from the Republicans gradually accepting the inevitability of nationalization, we really had no choice." If this is what they had in mind all along, to let the political cover develop before moving, then it's fairly clever, but I suspect the truth is that they really did want to avoid nationalization, but are also coming to the realization - at least I hope they are - that it cannot be avoided.
Sununu's talking point - that the crisis was the government's fault, and in particular the role played by Fannie and Freddie - has been thoroughly debunked:
Supply Curves Slope Up. Demand Curves Slope Down, by Brad DeLong: There is one huge argument against the claim that the crash in the mortgage market was in some sense the fault of excessively risky lending by the GSEs Fannie Mae and Freddie Mac which pulled the private sector along behind them: it is that Fannie Mae and Freddie Mac lost market share as all the loans that have now gone bad were made.
As Milton Friedman always used to say: supply curves slope up, and demand curves slope down. If something is due to a change in supply that causes movement along the demand curve, price will go down and quantity will go up. If something is due to a change in demand that causes movement along a supply curve, price will go down and quantity will go down.
Between 2001 and 2006 the "price" at which Fannie Mae and Freddie Mac sold mortgages--the terms they set--certainly went down. But did the quantity go up? No: Fannie Mae and Freddie Mac together had made a much smaller share of mortgages in 2006 than in 2001: 37% as opposed to 48%. Price went down, and quantity went down.
This means that the dominant feature of the mortgage market in the 2000s was not an expansion of supply by Fannie Mae and Freddie Mac pushing their implicit government guarantee past the limits of prudence, but was a reduction in demand for Fannie Mae and Freddie Mac's products as private-sector mortgage lenders aggressively pursued and took away their markets.
At least, this is the dominant feature if you follow Milton Friedman and believe that typically supply curves slope up and demand curves slope down.
Or, from an entry here: It Wasn't Fannie and Freddie.
One last note. It's pretty sad that John Stewart clearly has a better understanding of economics - much better - than a former senator who has been a member of the Committee on Finance and the Joint Economic Committee. No wonder the Republicans screwed the economy up so much - they can recite the ideological talking points that "tax cuts make it better, government makes it worse," but most of them don't seem to have a clue what makes the economy tick.
Sylvain Leduc of the San Francisco Fed gives the economic outlook for the U.S. along with a forecast of the effects of the stimulus package. The forecast shows that (1) the fiscal stimulus package will help (and note that government spending is preferred to tax cuts), (2) even though the recovery package will help, there will still be a large gap in unemployment in both 2009 and 2010, and (3) if parts of the stimulus package don't come online until 2010, that is a feature not a bug given the substantial delay expected in the recovery of unemployment. Output growth is expected to recover by 2010 (according to their forecast), but the expectation is that unemployment will take longer than output to recover [and I should have noted that this is based upon a fairly rosy forecast]:
The recovery later this year will largely be based on the effects of a substantial fiscal stimulus package. Clearly, there is a lot of uncertainty regarding the impact of the fiscal stimulus. First, the effects will depend on when it is spent. Analyzing the fiscal stimulus proposal adopted by the House of Representatives in mid-January, the Congressional Budget Office estimated that only a little more than half of that $816 billion package would be spent in 2009 and 2010, partly because of delays in establishing new government programs. It is likely that similar delays will apply to the fiscal package expected to be signed into law.
Second, the impact of the fiscal stimulus also will depend on how tax cuts and government spending affect the economy, an issue subject to debate. Our assessment is that tax cuts are somewhat less effective than government spending in stimulating the economy in the short run, since households typically save part of the increase in disposable income. This may be truer this time because the saving rate is increasing. In contrast, government spending initially affects GDP one-for-one since all of the funds are spent.
Using the fiscal multipliers estimated by Macroeconomic Advisers, a private forecasting firm, we find that the fiscal stimulus package has a sizeable impact on our growth forecast, particularly in 2009. Moreover, we forecast that the unemployment rate would climb to nearly 10% absent the fiscal initiative. However, while the stimulus package will help reduce the slack in the economy, it will not be enough to bring a return to full employment.
The complete outlook (with this part repeated) is on the continuation page:
Will recovery from the slump be a long, drawn out, painfully slow process?:
Who’ll Stop the Pain?, by Paul Krugman, Commentary, NY Times: Earlier this week, the Federal Reserve released the minutes of the most recent meeting of its open market committee... Most press reports focused either on the Fed’s downgrade of the near-term outlook or on its adoption of a long-run 2 percent inflation target.
But my eye was caught by the following chilling passage...: “All participants anticipated that unemployment would remain substantially above its longer-run sustainable rate at the end of 2011, even absent further economic shocks; a few indicated that more than five to six years would be needed for the economy to converge to a longer-run path characterized by sustainable rates of output growth and unemployment and by an appropriate rate of inflation.”
So people at the Fed are troubled by the same question I’ve been obsessing on lately: What’s supposed to end this slump? No doubt this, too, shall pass — but how, and when?
To appreciate the problem, you need to know ... we’re in the midst of a crisis that bears an eerie, troubling resemblance to the onset of the Depression; interest rates are already near zero, and still the economy plunges. How and when will it all end?
To be sure, the Obama administration is taking action to help the economy, but it’s trying to mitigate the slump, not end it. The stimulus bill, on the administration’s own estimates, will limit the rise in unemployment but fall far short of restoring full employment. The housing plan announced this week ... will help many homeowners, but it won’t spur a new housing boom.
What, then, will actually end the slump?
Well, the Great Depression did eventually come to an end, but that was thanks to an enormous war, something we’d rather not emulate. The slump that followed Japan’s “bubble economy” also eventually ended, but only after a lost decade. And when Japan finally did start to experience some solid growth, it was thanks to an export boom,... not an experience anyone can repeat when the whole world is in a slump.
So will our slump go on forever? No. In fact, the seeds of eventual recovery are already being planted.
Consider housing starts, which have fallen to their lowest level in 50 years. That’s bad news for the near term. It means that spending on construction will fall even more. But it also means that the supply of houses is lagging behind population growth, which will eventually prompt a housing revival.
Or consider the plunge in auto sales. Again, that’s bad news for the near term. But at current sales rates, as ... Calculated Risk points out, it would take about 27 years to replace the existing stock of vehicles. Most cars will be junked long before that,... so we’re building up a pent-up demand for cars.
The same story can be told for durable goods and assets throughout the economy: given time, the current slump will end itself, the way slumps did in the 19th century. ... But recovery may be a long time coming.
The closest 19th-century parallel I can find to the current slump is the recession that followed the Panic of 1873. That recession did eventually end without any government intervention, but it lasted more than five years, and another prolonged recession followed just three years later.
You can see, then, why some Fed officials are so pessimistic.
Let’s be clear: the Obama administration’s policy initiatives will help... — especially if the administration bites the bullet and takes over weak banks. But still I wonder: Who’ll stop the pain?
- Already lost - Free exchange
- The US government must take risks - The Economists' Forum
- A Step in the Right Direction - The Baseline Scenario
- The PPI says: Service Sector Deflation is Almost Here - BusinessWeek
- Within Any Possible Universe, No Intellect Can Ever Know it All - SciAm
- Housing Plan: The Virtues of Moderation - Ed Glaeser - Economix
- Who's Afraid of the Fiscal Responsibility Summit? - Ezra Klein
- Japan is taking a beating - News N Economics
- A story about evidence (on fiscal policy) - Knowing and Making
Thursday, February 19, 2009
Robert Reich says there are lessons in the Great Depression, but they won't be found among right-wing talking points:
The New Deal and the New New Deal: Countering Conservative Claptrap, by Robert Reich: ...One of the oddest of right-wing claims is that FDR's New Deal didn't pull America out of the Great Depression, so Barack Obama's "New New Deal" won't, either. While it's true that the New Deal didn't end the Great Depression, three points need to be impressed on the hard-pressed conservative mind:
1. The New Deal relieved a great deal of suffering by establishing social safety nets -- Unemployment Insurance, Aid for Dependent Children, and Social Security for retirees. Most have remained, a worthy legacy. But because the structure of the economy has changed..., there are gaping holes in the safety net which a New New Deal should fill...
2. FDR's public works spending did help the economy somewhat. By 1936, U.S. the economy was showing some life. ... But FDR cut back on public-works spending, and the economy sank back into its former torpor. A warning to Obama: Don't worry about so-called "fiscal responsibility" when aggregate demand still falls far short of the economy's total capacity.
3. The Second World War pulled the nation out of the Great Depression because it required that government spend on such a huge scale as to restart the nation's factories, put Americans back to work, and push the nation toward its productive capacty. ... Yes, the national debt ballooned to 120 percent of GDP. But the debt-GDP ratio subsequently declined -- not just because post-war spending dropped but because the economy continued to grow... Lesson: The danger isn't too much stimulus, it's too little stimulus.
Calculated Risk isn't quite as optimistic as Atlanta Fed President Dennis Lockhart:
Fed's Lockhart sees "catalysts for the start of modest recovery". by Calculated Risk: Excerpts from a speech by Altanta Fed President ... Lockhart today:
[T]he economic outlook is not indefinitely bad. Most forecasts, my own included, see catalysts for the start of modest recovery in the second half of the year.
I think almost everyone agrees with the "not indefinitely bad" comment. But I'm interested in what Lockhart sees as "catalysts for recovery":
With production falling—and expected to decline significantly more this quarter—I expect some reduction of excess business inventories, putting producers in a position to expand output as spending returns.
Right now it appears inventory levels are too high. ... So Lockhart might be correct, but it is too early to tell if producers will reduce inventory enough in the first half of 2009 to expand output in the second half of the year.
There are signs lower mortgage interest rates are helping housing markets on the margin. The January pending sales number was up, and there has been a spurt in refinancing activity. If historically low mortgage rates can be sustained over the coming months, I expect more buyers will be drawn into the market.
Actually the most recent pending home sales number was for December and the reason it showed an increase was because of more activity in areas with significant foreclosures.
Several factors should lift consumer spending as the year progresses. These factors include the dramatic fall in energy prices, greater stability in the housing market, and improving consumer confidence.
This is very possible, but I don't see evidence of this yet.
I should mention that last week the U.S. Census Bureau reported an unexpected increase in retail sales during January. I would like to see further confirmation of the underlying strength hinted at in this report, but on its face, the pickup in consumer spending is encouraging.
This is just one month of data and could be related to gift cards, so I wouldn't read much into that small increase.
Also contributing to the upturn seen in the consensus outlook are the large and targeted fiscal, credit, and monetary policies of the government and the Federal Reserve ... The intent of these aggressive and unprecedented policy actions is to support spending and fix the dysfunction in credit markets...
Indeed, we have seen modest, but hopeful, signs that financial markets are improving. ...
I think we can start looking for some rays of sunshine, but I don't see anything yet.
And once things do stop their downward slide, however long that takes, that doesn't mean that we can sound the all clear sign, step aside, and let the things take care of themselves (and suddenly move towards, say, balancing the budget). My reading of the aftermath of financial crises in the US and elsewhere in the world is that recovery is generally a slow, drawn out process. The depth of the downturn depends critically on the timing and effectiveness of the policy response, and that is its most important function of policy, but it can also help to shorten the recovery process once things turn around. Thus, once it finally does stop raining, it's still possible that without both monetary and fiscal policy actively engaged in the recovery process, the economy could experience a long period of overly sluggish growth as the economy crawls back to its long-run equilibrium. So let's be careful not to pull back on the policy levers before we are sufficiently certain that the economy can sustain itself on its own.
Did JFK's decision to use tax cuts rather than government spending in an attempt to jump start a stalled economy help to cause, through a series of events, "an angry and disheartened public ... to hate the Democrats, hate liberals, and hate government," and did JFK's tax cuts therefore help to bring Richard Nixon to the White House?:
What would Galbraith say?, by Richard Parker, Commentary, Boston Globe: Dear Mr. President,
In a future two-volume work, I intend to deal with the relation of a President to economists. I will naturally urge that he listen to them attentively, and indeed with a certain respect and awe. But in times of economic challenge, the President must have a sense of what the people want. Economists only know what people should want - or sometimes what they used to want. - John Kenneth Galbraith to President Kennedy, August 1962
Treasury Secretary Timothy Geithner's debut ... of his ... rescue plan sent Wall Street into a tailspin... The Plan - clearly crafted by the Larry Summers-led economic team - had been fiercely opposed by top White House political advisers (including David Axelrod). The political people apparently feared The Plan, however sketchy, made the White House look like it was bringing back last year's arsonists to be this year's firefighters - while doing too little for the millions trapped in our still-burning economy.
To Ken Galbraith, all this would have been eerily familiar (and alarming)... John F. Kennedy ... entered office in 1961, during what was then the worst downturn since the Depression. JFK was a new, young, and untested president, uncertain in economics, a leader attuned to bipartisanship (he chose a Republican investment banker as treasury secretary). His economists were all Keynesians... But they disagreed about what to do. ...
White House chief economist Walter Heller, a tax specialist ... favored ... deep tax cuts. Ken Galbraith ... wanted spending - deficit spending - that focused on building schools, roads, and parks, and creating public jobs...
Galbraith had a ... worry:... Costs for ... war weren't in Heller's economic models. If war came in Vietnam, he knew spending would soar but that Congress would put off raising taxes to pay for it. The "wrong" stimulus strategy ... might destroy the New Frontier if the package was mismanaged, and decided only by the economists and their models.
Finally, after months of argument, Kennedy imposed a compromise: Heller's tax cuts first, then Galbraith's major public spending. JFK was unsure of his decision, but ... stimulus was clearly needed. Getting tax cuts passed first by a conservative Congress would be easier.
Kennedy['s]... tax cuts ... went into effect in 1964 under Lyndon Johnson. Initially, the economy soared - but then LBJ plunged deeper into Vietnam, and war costs soon drove heavy deficits that in turn triggered inflation. Congress dragged its feet about raising taxes quickly enough to curb inflation.
Soon enough, an angry and disheartened public began to hate the Democrats, hate liberals, and hate government. A faltering economy, along with a worsening war, brought Richard Nixon to the White House.
Galbraith's warnings had proved right, because reality had proved more complex than the economists' models.
It's an important lesson to ponder 40 years later: In times of economic crisis, presidents should listen to economists. But then they must listen to the American people, because the stakes aren't just economic.
A Decade as Bad as the Great Depression, by Michael Mandel: Over the past ten years, the S&P 500 is down 50% adjusted for inflation (February 17, 1999 to February 17, 2009). By my calculation, the stock market was down roughly 50%, adjusted for inflation, in the worst ten years of the Great Depression (September 1929 to September 1939).
When you add in the fact that real wages were stagnant over the past ten years and debt soared, I think we will look back at the last ten years as a decade of despair. As an optimist, I’m going to bet on the next ten years as being better. ...
- Fed Takes Back Door to Inflation Targeting - Real Time Economics
- Bernanke Defends Fed’s Efforts and Pledges Further Action - NYTimes.com
- Banks finding it hard to bite the reform bullet - Rajan and Diamond
- A crisis in sociology? - Understanding Society
- Deriving the New Keynesian Phillips Curve with Calvo pricing - John Barrdear
- A $2 trillion decrease in net international investments - voxeu.org
- Obama's housing plan: The Michelle Malkin critique - Andrew Leonard
- Was Einstein Wrong?: A Quantum Threat to Special Relativity - SciAm