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Thursday, August 23, 2007

The Top of Old Smokey Might be Gone

I'm worried that other countries are going to stop trading with us because our lax environmental enforcement - allowing, for example, hundreds of miles of streams to be destroyed to lower the price of energy - gives us an unfair advantage. Here's part of the house that Jack built:

Rule to Expand Mountaintop Coal Mining, by John M. Broder, NY Times: The Bush administration is set to issue a regulation on Friday that would enshrine the coal mining practice of mountaintop removal. The technique involves blasting off the tops of mountains and dumping the rubble into valleys and streams. ... The new rule would allow the practice to continue and expand...

The regulation is the culmination of six and a half years of work by the administration to make it easier for mining companies to dig more coal to meet growing energy demands and reduce dependence on foreign oil. ...

A spokesman for the National Mining Association, Luke Popovich, said that unless mine owners were allowed to dump mine waste in streams and valleys it would be impossible to operate in mountainous regions like West Virginia that hold some of the richest low-sulfur coal seams...

Environmental activists say the rule change will lead to accelerated pillage of vast tracts and the obliteration of hundreds of miles of streams in central Appalachia.

“This is a parting gift to the coal industry from this administration,” said Joe Lovett, executive director of the Appalachian Center for the Economy and the Environment in Lewisburg, W.Va...

Mountaintop mining is the most common strip mining in central Appalachia, and the most destructive. Ridge tops are flattened with bulldozers and dynamite, clearing all vegetation and, at times, forcing residents to move. ...

Roughly half the coal in West Virginia is from mountaintop mining, which is generally cheaper, safer and more efficient than extraction from underground mines...

The rule ... is known as the stream buffer zone rule. First adopted in 1983, it forbids virtually all mining within 100 feet of a river or stream. ...

The Army Corps of Engineers, state mining authorities and local courts have read the rule liberally, allowing extensive mountaintop mining and dumping of debris in coal-rich regions of West Virginia, Kentucky, Tennessee and Virginia.

From 1985 to 2001, 724 miles of streams were buried under mining waste, according to the environmental impact statement accompanying the new rule.

If current practices continue, another 724 river miles will be buried by 2018, the report says. ...

The early stages of the revision process were supported by J. Stephen Griles, a former industry lobbyist who was the deputy interior secretary from 2001 to 2004. Mr. Griles had been deputy director of the Office of Surface Mining in the Reagan administration and is knowledgeable about the issues and generally supports the industry.

In June, Mr. Griles was sentenced to 10 months in prison and three years’ probation for lying to a Senate committee about his ties to Jack Abramoff, the lobbyist at the heart of a corruption scandal who is now in prison. ...

    Posted by on Thursday, August 23, 2007 at 12:24 AM in Economics, Environment, Policy, Regulation | Permalink  TrackBack (0)  Comments (7) 


    knzn's Unpopular Conclusions II

    knzn continues, but not quite from where he left off:

    Did this in Housing seem an obvious bubble?, by knzn: I don’t think I’m going to be continuing yesterday’s post from just where I left off, but hopefully over the course of the next few posts it should become clear why I hold such bizarre beliefs. In this post I’m updating one from last year, in which I argued two points:

    1. It is still reasonable to believe that the housing boom was not a bubble; and
    2. Even if one believes that, one can still be ultra-bearish on housing today.

    continue reading...

      Posted by on Thursday, August 23, 2007 at 12:15 AM in Economics, Housing | Permalink  TrackBack (0)  Comments (2) 


      links for 2007-08-23

        Posted by on Thursday, August 23, 2007 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (0) 


        Wednesday, August 22, 2007

        Michael Woodford: How Important is Money in the Conduct of Monetary Policy?

        Michael Woodford, who knows more than a little bit about this topic, discusses the use of monetary aggregates as a basis for setting monetary policy.

        His bottom line is that monetary aggregates should not be used as targets of monetary policy, or even play a prominent role in policy discussions, but they do have their uses. Many macroeconomic variables are unobservable and, to the extent that monetary aggregates are correlated with these unobservables, monetary aggregates can be used to extract information about them and thus help to determine the potential evolution of the macroeconomy. Thus, Woodford believes that monetary aggregates may contain useful information about the economy, but there is currently no good reason to assign target values to monetary aggregates in the conduct of policy.

        This is the abstract, introduction, and conclusion - the paper itself is a bit technical:

        How Important is Money in the Conduct of Monetary Policy?, by Michael Woodford, NBER WP 13325, August 2007 [open link]: Abstract: I consider some of the leading arguments for assigning an important role to tracking the growth of monetary aggregates when making decisions about monetary policy. First, I consider whether ignoring money means returning to the conceptual framework that allowed the high inflation of the 1970s. Second, I consider whether models of inflation determination with no role for money are incomplete, or inconsistent with elementary economic principles. Third, I consider the implications for monetary policy strategy of the empirical evidence for a long-run relationship between money growth and inflation. And fourth, I consider reasons why a monetary policy strategy based solely on short-run inflation forecasts derived from a Phillips curve may not be a reliable way of controlling inflation. I argue that none of these considerations provides a compelling reason to assign a prominent role to monetary aggregates in the conduct of monetary policy.

        Introduction

        It might be thought obvious that a policy aimed at controlling inflation should concern itself with ensuring a modest rate of growth of the money supply. After all, every beginning student of economics is familiar with Milton Friedman's dictum that "inflation is always and everywhere a monetary phenomenon" (e.g., Friedman, 1992), and with the quantity theory of money as a standard account of what determines the inflation rate. Yet nowadays monetary aggregates play little role in monetary policy deliberations at most central banks. King (2002, p. 162) quotes then-Fed Governor Larry Meyer as stating that "money plays no explicit role in today's consensus macro model, and it plays virtually no role in the conduct of monetary policy."

        Continue reading "Michael Woodford: How Important is Money in the Conduct of Monetary Policy?" »

          Posted by on Wednesday, August 22, 2007 at 06:39 PM in Academic Papers, Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (2) 


          Dean Baker: Wall Street Welfare Wimps Keep Whining

          Dean Baker says ignore the whining from mortgage market participants, what do you expect when people stand to lose millions?:

          Wall Street Welfare Whimps Keep Whining, by Dean Baker: That should have been the headline of the NYT piece reporting that the Wall Street crew are complaining that the Fed has not done enough to help them out. These supposedly informed investors sunk trillions of dollars in mortgage debt that is going bad at a very rapid rate and they desperately want the government to bail them out.

          The reporting should make clear what is going on here. People who earn tens and hundreds of millions of dollars a year because of their alleged skills are now facing a financial disaster. Rather than be willing to live with market outcomes, they are trying to use their political power to force the Fed and Congress to rescue them.

          We shouldn't help people just because they whine, but just as importantly, we shouldn't refuse help just because it looks like we are giving in to the whiners. Thus, it will be important to make it clear that a rate cut or other interventions, if they were to occur, are to address general macroeconomic conditions and protect people who had nothing to do with bringing about the mortgage mess, not to bail out the mortgage industry in particular.

          The Fed cannot do countercyclical policy without easing conditions, that's the only way to stimulate the economy, and when they ease conditions some businesses or investments that would have failed otherwise will be bailed out. But that doesn't mean we shouldn't help. If failure to act will cause an economic downturn that will harm the innocent, then I think the Fed should intervene to protect those who had no hand in causing the problems rather than harming the innocent as a by-product of ensuring that market participants are fully disciplined.

            Posted by on Wednesday, August 22, 2007 at 03:24 AM in Economics, Housing, Policy | Permalink  TrackBack (0)  Comments (34) 


            Robert Reich: When Caveat Emptor Doesn't Work

            Robert Reich:

            When Caveat Emptor Doesn't Work in China -- or in America, by Robert Reich: ...China’s problem isn't too much government intrusion into its economy; it's too little ... of the right kind. Some Chinese toy makers have used lead paint, some Chinese pet-food producers have used toxic chemicals, and makers of counterfeit toothpaste in China have used other toxins.

            A basic free market principle is that when consumers cannot differentiate between risky products and good products, they’ll withdraw from the market, which is what’s happening to China’s consumer exports. China’s responsible exporters are suffering because irresponsible ones have cut corners to make fatter profits, and global consumers can't tell the difference. So the challenge for China is to rein in its rip-roaring free-market capitalists with regulations that better ensure safe products.

            The American financial market is facing much the same challenge. When it became apparent that many sub-prime mortgage loans were far riskier than assumed, and were packaged with other loans, investors began withdrawing from financial instruments altogether. That's because they couldn’t figure out how much risk they had taken on. So the challenge for the United States is to rein in our rip-roaring financial capitalists with regulations that clarify risk...

            The lesson on both sides of the Pacific is that free-market capitalism and government intervention are not on opposite sides of a great ideological divide. Free markets need governments to police them so buyers can be confident about what they're buying. ...

            The practical question, then – in both China and America – is not whether you’re in favor of free markets or government regulation. It’s what kind of regulation is necessary to make markets work.

            And a good guiding principle on market regulation is to ensure that the conditions for competitive markets are met as much as possible. In these two cases, for example, the problem is lack of information. Competitive markets assume full information is present, but as these examples show, that is not always the case.

            When there is uncertainly about the quality of a product, buyers will be more cautious than they would be under the full information outcome. By helping to ensure that information is made available to both buyers and sellers, government regulation allows markets to function more competitively. Thus, these are cases where, contrary to the usual complaint, government intervention improves efficiency. Another example of this is housing. Regulations that force sellers to disclose known problems prior to sale make the market function more, not less efficiently.

            Some people argue that markets will regulate themselves - that over time the cheaters will be forced from the marketplace - but the fact that these regulations were needed in the first place tells you that wasn't working out so well. In the case of housing, for example, people sell very few houses during their lifetime so reputation is not all that important. If you sell a house without disclosing problems thus getting too much money for it, and don't sell again for another ten or twenty years, it's unlikely that the buyers in the second transaction will even know about the sale of the first house so there is little chance of facing a penalty for failing to disclose, i.e. little chance of facing market discipline. Thus, there is little incentive to disclose problems on the second sale and the market failure due to lack of information will persist.

            I suppose a private sector business devoted to collecting and selling such information about buyers could develop, but it didn't and such a firm is caught in a catch-22: if its business is successful so that everyone is afraid to cheat, nobody will need its services (the mere threat that these firms might come into existence does not appear to provide sufficient market discipline either). And it does not completely eliminate the problem in any case. For example, if you are elderly and you are cashing out and you know it's the last sale, why do you care what the rating agency will say on the next sale? There won't be one. Anytime there is a single sale for whatever reason and reputation is unimportant, the threat of market discipline from misrepresenting the product vanishes. Government regulation does not have these problems since it allows you to collect from the seller if problems turn up post sale that the buyer was clearly aware of. And the same outcome - full disclosure - is achieved without the fee that would need to be paid to the private sector firm.

              Posted by on Wednesday, August 22, 2007 at 12:24 AM in Economics, Policy, Regulation | Permalink  TrackBack (0)  Comments (25) 


              links for 2007-08-22

                Posted by on Wednesday, August 22, 2007 at 12:21 AM in Links | Permalink  TrackBack (0)  Comments (0) 


                Tuesday, August 21, 2007

                Treasury Secretaries Then and Now

                Markets seem to be calmer today after Senator Dodd spoke about his meeting with Fed chair Ben Bernanke and Treasury Secretary Henry Paulson:

                Fixing the Credit Crunch, by John Godfrey, WSJ Washington Wire: Senate Banking Committee Chairman Christopher Dodd said Federal Reserve Chairman Ben Bernanke promised to use “all the tools available” to respond to volatility in the nation’s financial markets.

                Dodd, a ... Democrat ... met with Bernanke and Treasury Secretary Henry Paulson ... to discuss the recent volatility in the financial markets and the broader implications for the U.S. economy. Dodd said he also spoke with Paulson and Bernanke about possible additional steps that can be taken to help stabilize mortgage and financial markets and help homeowners nationwide. “I expressed the need for both the Fed and Treasury to use all the tools at their disposal to keep our markets working and so that the business and consumers can have the funds to prosper,” Dodd said.

                “Chairman Bernanke agreed,” Dodd added. He, however, was frustrated with Paulson’s unwillingness to consider increasing the portfolio caps at Fannie Mae and Freddie Mac. “The power exists today with the regulator to lift those caps,” Dodd said. ...

                But there's something odd here. Normally, it is the Treasury Secretary's job to issue statements to calm the market, not the chair of the Senate Banking Committee, but for some reason Paulson has been ineffective. If anything, it seems like markets panic further when he talks which may say something about the credibility of loyal Bushies, even those who have been at Goldman Sachs. It's also a bad sign that Paulson’s free market ideology is getting in the way of the Treasury Secretary taking Bernanke's advice to lift the caps at Fannie Mae and Freddie Mac, so perhaps the markets indifference or negative reaction to his statements is justified.

                To see the difference between how past Treasury Secretaries reacted in the face of a financial crisis and what we have now, recall "The Committee to Change the World" comprised of "The Three Marketeers," Robert Rubin, Larry Summers, and Alan Greenspan that came into being after the LTCM crisis in the late 1990s:

                The Three Marketeers, by Joshua Cooper Ramo, Time Asia, 2/15/99: ...Although the U.S. economy has been nothing but sunshine, it has been a terrifying year in world markets: famed financier George Soros lost $2 billion in Russia last year; a hedge fund blessed with two Nobel prizewinners blew up in an afternoon, nearly taking Wall Street with it; and Brazil's currency, the real, sambaed and swayed and then swooned. In the past 18 months 40% of the world's economies have been tugged from robust growth into recession or depression.

                So far, the U.S. has dodged these bullets, but the danger to its economy is far from over. ... In late-night phone calls, in marathon meetings and over bagels, orange juice and quiche, ... three men--Robert Rubin, Alan Greenspan and Larry Summers--are working to stop what has become a plague of economic panic. ...

                Continue reading "Treasury Secretaries Then and Now" »

                  Posted by on Tuesday, August 21, 2007 at 05:40 PM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (10) 


                  knzn: Basic Macroeconomics is Leading Me to Some Unpopular Conclusions

                  knzn says that, all told, the housing boom was a good thing:

                  I come to bury the Housing Boom, not to praise it, by knzn:  OK, I lied: I come to praise it. Basic macroeconomics is leading me to some unpopular conclusions:

                  1. The housing boom was a good thing; therefore
                  2. Far from worrying about moral hazard, the Fed should be deliberately rewarding those who participated; and
                  3. (At least according to my reading of the macroeconomy) The Fed should encourage the continuation of a housing boom (or something of that nature).

                  My basic argument is quite simple: without the housing boom, there would have been no economic recovery, and…recovery is good.

                  It’s not very controversial that the housing boom was the main reason for the economic recovery, so let’s do a thought experiment in which we re-run the years since 2001 without a housing boom. Would something else have happened instead to produce a recovery? Let’s line up the candidates.

                  First, fiscal policy. We did have a war, two large tax cuts, and a large new entitlement benefiting the age group with the highest marginal propensity to spend. The consensus is that all these were not enough. Perhaps they would have prevented the recession from getting worse, but without the direct and indirect effects of the housing boom, any recovery would have been meager at best. OK, how about a big public works program? Not a bad idea, if you ask me, but this is where we have to begin distinguishing between thought experiment and fantasy. If your conception has a public works program that dwarfs the New Deal being passed by a Republican Congress and signed by George W. Bush, I recommend you get in touch with George Lucas about the special effects.

                  What about an export boom (and/or substitution of domestic products for imports) supported by a weak dollar? That is, after all, the traditional mechanism by which monetary policy is supposed to operate in an open economy with a flexible exchange rate. The first problem that arises is that the US exchange rate against many countries isn’t (and, most emphatically, wasn’t) flexible, and even when it is nominally flexible, the competing products are often effectively priced in dollars. One could imagine a mildly successful beggar-thy-neighbor policy against Europe (supposing that, in the absence of a housing boom, the dollar would have crashed against the Euro in 2002 instead of falling gradually over 5 years). At best, that gives us a mild (and somewhat stagflationary) recovery in the US and a severe recession in Europe (which, as you may recall, had its own problems in the early years of this decade). All in all, the possibilities created by a falling dollar (in place of the housing boom) are not impressive.

                  So what’s left? An investment boom supported by low interest rates? If it didn’t happen when the federal funds rate was at 1%, would it have happened if the rate had fallen to 0%? I tend to doubt it. An investment boom supported by “quantitative easing”? Possibly, but it took Japan years even to hit on that possibility, and the jury is still out on whether quantitative easing was the real reason for Japan’s recovery. The premise that such a policy would have been tried successfully in the US during this decade is speculative at best. Other ideas? Money dropping from the sky? Maybe, but remember, “Helicopter Ben” didn’t take over the Fed until 2006. And so on… Rather than going from the bizarre to the more bizarre, I’m just going to reassert my premise and suggest that the burden of proof is now on anyone who disagrees: Without the housing boom, there would have been no economic recovery.

                  The implication of having no economic recovery is that we would have slack resources the whole time – the sort of event that used to be called a depression before the term fell victim to political correctness. Thus, comparing my counterfactual world to the actual world, all the extra production that we got out of the US economy was done with resources that would otherwise have been wasted. From a macroeconomic point of view, all those extra houses and such were free – a free lunch, if you will. (... in Keynesian economics there has always been a free lunch; that was the main point of the General Theory.) So those who say that the housing boom was a bad thing are saying that we should have turned down that free lunch when it was offered.

                  And what of those who participated in the boom? To my mind, they are in the same category as the Iraqi Shiite rebels in 1991. They helped US policymakers accomplish their laudable goals. ... Sir Alan even flew a mission over their region to drop leaflets touting the virtues of ARMs. And now should we leave them to be massacred? I’m not saying we should invade the mortgage derivatives market and set up a democratic regime by force. But at the very least, don’t we have a humanitarian moral duty to declare a no fly zone?

                  This post is already too long, and I have to get back to my real job. I haven’t even finished arguing my second point, and the third point is clearly going to be the hardest to defend. For now I’m going to have to abort, hoping to continue tomorrow. Have patience, gentle friends...

                    Posted by on Tuesday, August 21, 2007 at 03:33 PM in Economics, Housing, Policy | Permalink  TrackBack (0)  Comments (36) 


                    Yes Andrew, Perhaps Michael Moore Should Run a Taxi Service - But in the Other Direction

                    Andrew Samwick:

                    Perhaps Michael Moore Should Run a Taxi Service, Vox Baby I don't know which of the following statements is more surprising. From the AP:

                    A 35-year-old Canadian woman has given birth to rare identical quadruplets, officials at a Great Falls hospital said Thursday. Karen Jepp of Calgary, Alberta, delivered Autumn, Brooke, Calissa and Dahlia by Caesarian section Sunday afternoon at Benefis Healthcare, said Amy Astin, the hospital's director of community and government relations.

                    The four girls were breathing without ventilators and listed in good condition Thursday, she said.

                    Wonderful. And this part:

                    The Jepps drove 325 miles to Great Falls for the births because hospitals in Calgary were at capacity, Key said.

                    "The difficulty is that Calgary continues to grow at such a rapid rate. ... The population has increased a lot faster than the number of hospital beds," he said.

                    For those of you unclear on the geography, their trip looked something like this and would take about five hours at the posted speed limits. About halfway through the trip, they would pass through Lethbridge, which is home to Chinook Regional Hospital, which claims to offer a "high level neonatal intensive care unit." Not good enough? No beds there either? When they were in Lethbridge, they were about an hour away from Medicine Hat, home to this fine institution and its NICU, or two and a half hours plus a border crossing away from Great Falls. They chose the latter.

                    UPDATE (8/20): At the prompting of a commenter, I found that the doctor's statement about them driving the 325 miles is incorrect, and so too is my travelogue in the last paragraph of the original post (now italicized). Here is a report from the BBC that explains:

                    A medical team and space for the babies had been organised for the Jepp family at the Foothills Medical Centre in Calgary but several other babies were born unexpectedly early, filling the neonatal intensive care unit.

                    Health officials said they checked every other neonatal intensive care unit in Canada but none had space.

                    The Jepps, a nurse and a respiratory technician were flown 500km (310 miles) to the Montana hospital, the closest in the US, where the quadruplets were born on Sunday.

                    My apologies for the hasty and incorrect post, though this notion that "every other neonatal intensive care unit in Canada" had no space is more of an indictment of the system than my original remarks.

                    I'm not sure why going to extraordinary lengths to solve a peak load problem shows the inferiority of the system rather than a commitment to serve patients. This wasn't one infant, this was quadruplets, so it's hardly typical -- space for four babies all at once can be hard to find. According to this report, it's true that the U.S. has more beds per live birth than Canada, "The United States has 3.3 neonatal intensive care beds per 10000 live births, while Australia and Canada have 2.6." But that doesn't seem like a huge difference (by the way, the data were collected in an attempt to explain why health outcomes for infants are worse in the U.S. even though resource usage is higher, so maybe that taxi service Andrew calls for ought to run in the other direction).

                    This is somewhat dated (1991), perhaps things have improved since then, but since we're telling anecdotes and extrapolating to whole systems, maybe that doesn't matter (though this does present actual evidence as well). It indicates that our system also has its problems:

                    As More Tiny Infants Live, Choices and Burden Grow, NY Times: ...[A]s advances allow medicine to save more and more babies, the demand for neonatal intensive care has risen and existing units are bursting at the seams. ... As a result, most neonatal intensive care units have removed walls to squeeze in a few more beds, and hired nurses to work overtime. Most operate at more than 100 percent of their licensed capacity.

                    Dr. Dweck, whose intensive care unit serves five counties north of New York City, said he had to turn away 250 babies each year. ...

                    "Last week there was a 900-gram baby at a community hospital who we knew we could help, but we were horribly overcrowded," Dr. Kleinman said...

                    Would Canada turn away 250 babies each year in their equivalent of five counties, or would they find a place for them to get the care they need, even if it's in the U.S.?

                      Posted by on Tuesday, August 21, 2007 at 07:11 AM in Economics, Health Care, Policy | Permalink  TrackBack (0)  Comments (53) 


                      Fed Watch: Waiting for the Inevitable

                      Tim Duy continues with his analysis of the likelihood that the Fed will cut its target interest rate:

                      Waiting for the Inevitable, by Tim Duy: As I noted yesterday, the Fed let the genie out of the bottle last week; rather than dissipating expectations for a rate cut, the statement had the exact opposite effect. Analyst after analyst is lining up to predict not just a cut, but the beginning of a rate cutting cycle. It is tough to see how they can avoid delivering at this point:

                      The Fed does not want to cut rates; they are searching for a middle ground between maintaining their inflation concerns while promoting stability in the financial markets. Consequently, I do not believe the Fed’s discount rate cut was intended by policymakers to be simply a symbolic move. I think the Wall Street Journal summarizes the Fed’s intentions quite succinctly with:

                      In essence, the Fed is following advice that British journalist Walter Bagehot offered in his 1873 book, "Lombard Street," a copy of which Mr. Bernanke kept on a shelf when he was Princeton professor. In times of "internal discredit" -- when uncertainty leads private players to pull back -- the prescription to the central bank is: Lend freely.

                      Unfortunately, an effort to avoid cutting the fed funds rate at this point is hampered by at least four factors:

                      1. The credibility on the “subprime is contained” story is simply shot. That calls into question their judgment on the ultimate economic impact of the subprime turmoil. Now we need the data to confirm the Fed’s view, rather than giving the Fed the benefit of the doubt until that data arrives. The confirming data is weeks if not months away; market participants will read positive data as old news, while focusing on the weak data.

                      2. The failure of the emergency statement to mention anything about inflation leaves little room to suddenly turn around and scream “inflation” even if inflation holds above their comfort level. That credibility thing again.

                      3. The market has fully and completely embraced the rate cut story – note Monday’s amazing surge in short dated T-bills. If the Fed thought they were having a crisis of confidence last week, just see what happens if they attempt to verbally reverse the new expectations.

                      4. Cutting the discount rate may have very little impact, regardless of the Fed’s intentions. Not only is it widely viewed as just symbolic (regardless of the Fed’s intentions), it does not get to the heart of the matter, the question of the fundamental value of subprime-based assets. Moreover, commentators have noted that given funding alternatives, banks have little incentive to pay the penalty rate, and some believe that the banks that do go to the discount window are simply doing it as a show of support. In essence, the Fed may have nullified the effectiveness of the discount rate when it was changed to a penalty rate – the jury is still out.

                      As far as what all this means for the economy, I already thought the next few months would look weak, and am much more interested in next year. Quick thoughts on the outlook:  Note first the steepness of the yield curve given expectations of easing. About as steep as one can expect given the starting point of low 10 year rates to begin with, and a pretty good signal that the economy will be chugging along quite nicely next year (see also Jim Hamilton on the corporate-Treasury spread). Second, notice that a policy shift now means the Fed would initiate a rate cut cycle on the backside of an inventory correction:

                      Duy822

                      The closest example of such a move was the emergency cuts in the fall of 1998, when, arguably, the Fed did not have the data in hand to show the economy was convincingly on the backside of the inventory correction. You know the story after that. This time, the Fed will be cutting well in advance of any new correction that might be forming.

                      Finally, thinking into 2008, three more points strike me:

                      1. The Chinese government will pull out all of the stops to keep the economy running at full steam through the Olympics. Too much national pride is at stake. Don’t underestimate the power of central planners to dictate short run activity.

                      2. Assuming the Fed does ease, they will be slow to reverse the easing. We have been through this before in 1999.And next year is an election, with the incumbent party looking, shall we say, weakened…not to question Fed independence, but after seven years of this administration, my innocence is lost.

                      3. There is a real chance that productivity is pulling back from the accelerated rates of the late 1990s.At the same time, labor force participation is pretty much topped out for secular reasons.

                      If you buy this story (it is not the only story), then you can do the math on the inflation implications for 2009. You can see why the Fed just might want to keep policy steady – there is a distribution of possible outcomes for the US economy, and the bearish story is not the only one.

                      Tough times for a Fed watcher – knowing the Fed wants to hold steady, but seeing the box they made closing in around them. It is difficult to see what combination of data and events will allow the Fed to hold steady in the months ahead at this point. The best chance for the Fed to avoid a rate cut (a cut they don’t want) is that both the financial markets remain calm and the August jobs report is very strong.

                      [Update: See also Fed Rate Cuts Are a Possibility, Not a Certainty, by John M. Berry]

                        Posted by on Tuesday, August 21, 2007 at 04:05 AM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (0)  Comments (7) 


                        The Fed's First Response to the Crisis May Not be Enough

                        Just a brief follow-up to Tim's post. It appears that the Fed's first response to the financial market problems may not be enough. Recall that as the crisis has been developing, firms holding high-quality mortgage-backed securities in need of liquidity have been unable to find buyers for these securities unless they are heavily discounted. The result has been a "new-fashioned bank run" (see also "A New Type of Bank Run"). To try to alleviate this liquidity problem, the Fed has done two things, it has accepted high-quality mortgage-backed securities as collateral on discount loans, and it has also accepted these securities as collateral in repo agreements. The discount loan change, for example, allows firms to essentially borrow from the discount window using banks as go-betweens. (The firm gives the securities to the bank as collateral on a loan, the bank then gives the securities to the Fed to hold against a discount loan. Thus, the bank passes the securities from the firm to the Fed, and then passes the cash in the other direction making a profit on the exchange.)

                        But a correspondent points to this news from MarketWatch:

                        "Analysts said the rally in short-term T-bills indicated nervousness remained in credit markets, leading investors to seek the safe-haven of government bonds. Expectations that the central bank will cut its key Fed funds rate was also boosting short-term Treasury bonds.

                        "But money failed to convincingly return to the commercial bond market on Monday, where liquidity has been drying up in recent weeks.

                        "Low T-bill yields indicate that liquidity is not yet flowing to those areas of the credit markets that need liquidity most, such as toward the mortgage market and the commercial paper markets, for example, where investors have been on a buying strike," said Tony Crescenzi, fixed-income analyst at Miller Tabak.

                        And, from Reuters, "Two U.S. Companies Involved in Mortgages Move to Raise Cash":

                        The struggling mortgage investment firm Luminent Mortgage Capital and the lender Thornburg Mortgage took steps to bolster their liquidity yesterday, but the companies signaled their troubles were not completely over.

                        Thornburg said it sold $20.5 billion of mortgage assets and reduced its short-term borrowings by an equivalent amount in a bid to reduce its risk of losing access to short-term credit markets. The sale amounted to more than 35 percent of its assets as of June 30.

                        Luminent said it would sell a majority of itself at a deep discount to shore up its financial condition. Arco Capital, a holding company..., will have the right to buy up to 51 percent of the company at 18 cents a share — a price 76 percent below Friday’s closing price.

                        So the liquidity crisis, and corresponding new fashioned bank run, do not appear to be over yet.

                          Posted by on Tuesday, August 21, 2007 at 02:43 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (4) 


                          Four Views on What the Fed Should Do

                          Via email, four opinions about what the Fed should do in response to the mortgage crisis:

                          On What the Fed Hath Wrought (So Far), by Yves Smith: A gut-wrenching two weeks in the credit markets have been capped by unprecedented moves by central bankers. The ECB's offer of an unlimited infusion to member banks the week before last was followed last Friday' by the Fed's discount rate cut, which included stern warnings that those who needed it better use it and a volte-face on its interest rate posture (a bias towards tightening suddenly became a promise that the Fed would provide more liquidity if conditions warranted). The Fed, ECB, and Bank of Japan are continuing to inject funds, albeit at a lower rate.

                          Opinion about the wisdom of the central bankers' actions is coalescing into what we will characterize, broadly, as four views. Note that while some commentators may engage in nuanced fence-straddling, for the most part, the positions are well-defined.

                          For the purpose of simplicity, we'll focus on the Fed, although these comments apply to some degree to other central bankers.

                          Continue reading "Four Views on What the Fed Should Do" »

                            Posted by on Tuesday, August 21, 2007 at 02:34 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (6) 


                            links for 2007-08-21

                              Posted by on Tuesday, August 21, 2007 at 12:21 AM in Links | Permalink  TrackBack (0)  Comments (0) 


                              Monday, August 20, 2007

                              Paul Krugman: It's a Miserable Life

                              Paul Krugman on "new-fashioned bank runs":

                              It’s a Miserable Life, by Paul Krugman, Commentary, NY Times: Last week the scene at branches of Countrywide Bank, with crowds of agitated depositors trying to withdraw their money, looked a bit like the bank run in the classic holiday movie “It’s a Wonderful Life.” ...

                              But bank deposits up to $100,000 are protected by the Federal Deposit Insurance Corporation. Old-fashioned bank runs just don’t make sense these days.

                              New-fashioned bank runs, on the other hand, do make sense — and they’re at the heart of the current financial crisis. ...

                              Traditional banks ... lend out most of the money depositors place in their care, keeping only a fraction in cash. ... Banks get in trouble ... when some event, like a rumor that major loans have gone bad, leads many depositors to demand their money at the same time.

                              The scary thing about bank runs is that doubts about a bank’s soundness can be a self-fulfilling prophecy: a bank that should be safely in the black can nonetheless fail if it’s forced to sell assets in a hurry. And bank failures can have devastating economic effects. ...

                              That’s why bank deposits are now protected by a combination of guarantees and regulation. ... But these ... apply only to traditional banks. Meanwhile, a growing number of unregulated bank-like institutions have become vulnerable to the 21st-century version of bank runs.

                              Consider the case of KKR Financial Holdings..., a powerhouse Wall Street operator. KKR Financial raises money by issuing asset-backed commercial paper ... used by large investors to temporarily park funds — and invests most of this money in longer-term assets. So the company is acting as a kind of bank, one that offers a higher interest rate than ordinary banks...

                              It sounds like a great deal — except that last week KKR Financial announced that it was seeking to delay $5 billion in repayments. That’s the equivalent of a bank closing its doors because it’s running out of cash.

                              The problems ... are part of a broader picture in which many investors, spooked by the problems in the mortgage market, have been pulling their money out of institutions that use short-term borrowing to finance long-term investments. These institutions aren’t called banks, but in economic terms what’s been happening amounts to a burgeoning banking panic.

                              On Friday, the Federal Reserve tried to quell this panic by announcing a surprise cut in the discount rate, the rate at which it lends money to banks. It remains to be seen whether the move will do the trick.

                              The problem, as many observers have noticed, is that the Fed’s move is largely symbolic. It makes more funds available to ... old-fashioned banks — but old-fashioned banks aren’t where the crisis is centered. And the Fed doesn’t have any clear way to deal with bank runs on institutions that aren’t called banks.

                              Now, sometimes symbolic gestures are enough. The Fed’s surprise quarter-point interest rate cut ... at the height of the crisis caused by the implosion of the hedge fund Long-Term Capital Management, was similarly a case of providing money where it wasn’t needed. Yet it helped restore calm to the markets, by conveying the sense that policy makers were on top of the situation.

                              Friday’s cut might do the same thing. But if it doesn’t, it’s not clear what comes next.

                              Whatever happens now, it’s hard to avoid the sense that the growing complexity of our financial system is making it increasingly prone to crises — crises that are beyond the ability of traditional policies to handle. Maybe we’ll make it through this crisis unscathed. But what about the next one, or the one after that?

                              _________________________
                              Previous (8/17) column: Paul Krugman: Workouts, Not Bailout
                              Next (8/24) column: Paul Krugman: Seeking Willie Horton

                                Posted by on Monday, August 20, 2007 at 12:33 AM in Economics, Housing, Regulation | Permalink  TrackBack (1)  Comments (51) 


                                Was the Discount Rate Cut Mostly Symbolic?

                                There's been a lot of talk about the significance of the Fed's cut in the discount rate and whether it was more than a symbolic gesture.

                                The WSJ notes one way in which it may have been more than symbolic. A big problem for those who held mortgage-backed securities was that in many cases they were unable to find buyers, hence these assets could be used in trade for needed liquidity. But if the Fed is willing to accept these securities as collateral on discount loans, then, with banks acting as intermediaries between those holding the assets and the discount window, the liquidity problem is eased:

                                How a panicky day led the Fed to act, WSJ: Over the past few weeks, Wall Street executives peppered Fed officials in New York and Washington with suggestions for easing the logjam in credit markets. One idea was for the Fed to widen the type of assets it accepts in its "open-market operations," when it pumps cash into the economy by buying U.S. government bonds... Some thought the Fed should buy lower-quality mortgages. ...

                                For several days, Mr. Bernanke pondered options with his confidants. ... The officials were looking for a maneuver dramatic enough to shore up confidence, while avoiding a cut in the Fed's main interest rate, the federal-funds rate. Mr. Bernanke was still not convinced the economy needed a cut, and some Fed officials feared it might encourage more of the sloppy lending that led to the crisis.

                                They began to look more closely at the discount window. Banks remain well-capitalized and profitable. But they appeared reluctant to provide credit to companies, issuers of commercial paper and even each other, perhaps out of uncertainty over the safety of their customers or their collateral.

                                Eventually, Fed officials agreed to reduce the rate charged on loans from the discount window (to 5.75% from 6.25%) and try to reduce the usual stigma associated with such loans. By making these direct loans to banks more attractive, the Fed hoped to reassure banks that they could borrow if they needed to -- without the usual penalty to their bottom line or to their reputation...

                                Particularly at times of stress, what the Fed says can be almost as powerful a weapon as what the Fed does. So Mr. Geithner, whose job makes him the traditional liaison to Wall Street, turned to a convenient forum, the Clearing House Payments Co., which is owned by a group of banks and operates much of the plumbing of the nation's financial system. ...Mr. Geithner sought a 15-minute telephone conference call.

                                On the call were commercial bankers who work with Clearing House as well as several top investment bankers...

                                Joined by Mr. Kohn, but not Mr. Bernanke, Mr. Geithner told banks about the discount-rate cut and said they could wait up to 30 days, instead of just a day, to pay back their discount-window loans. "We will consider appropriate use of the discount window...a sign of strength," said Mr. Geithner, according to a participant. ...

                                Another banker participating in the call said of the Fed, "What they came up with is pretty ingenious." Investment banks or hedge funds that hold mortgage-backed securities can't borrow from the Fed directly, but they can bring those securities to banks. In turn, the banks can offer the paper as collateral to the Fed for a 30-day loan.

                                The Fed "really wanted to drive home the point that if [bankers] were complaining about not being able to borrow money against liquid, high-quality securities -- mortgages -- we have no more basis for complaint. We were all given a clear message," says this banker. ...

                                Should the Fed should be intervening in mortgage markets at all? One justification for intervening is that there is a threat to the macroeconomy generally. When the cost of intervening (e.g. encouraging bad economic behavior in the future) is less than the cost of doing nothing (and potentially allowing catastrophic macroeconomic problems and costs to individuals who had nothing to do with the decisions that caused the problems), then intervention is justified.

                                I am still undecided as to how much of a threat problems in these particular markets pose for the macroeconomy generally, but since that uncertainty includes a significant chance that there would be big problems if there had been no intervention, it was prudent of the Fed to react. In any case, it may be time for the Fed to rethink what the term "bank" encompasses in today's financial markets, and to put institutions and regulations in place that can respond appropriately to problems that threaten the overall economy.

                                Update: I see James Surowiecki is thinking along the similar lines,:

                                When the health of the U.S. economy is under serious threat, the Fed should act. But in this case it’s far from clear that the turmoil was an actual menace to the underlying economy... Bailing out hedge-fund managers was great for Wall Street, but it may not have been such a good deal for Main Street.

                                Wall Street so dominates our image of the U.S. economy these days that it’s easy to assume that what’s bad for the Street must be bad for everyone else. But, while it’s true that a complete market meltdown would have disastrous effects on the economy as a whole, market downturns like those of the past few weeks often have only a small effect on businesses and consumers. In part, that’s because much of what happens on Wall Street consists of the shuffling of assets among various well-heeled players, rather than anything that’s fundamental to the smooth functioning of the U.S. economy. ... Similarly, ... stock-market tumbles ... have no concrete impact on most American consumers... And, in the short run, they’re irrelevant to most corporations, too, since few companies actually use the stock market to raise capital. ...

                                That’s not to say that the economy has suffered no fallout from the subprime collapse. The fall in housing prices, the drying up of new construction, and the sharp rise in foreclosures in many areas are having a serious impact on employment and economic growth. But... Cutting the discount rate is not going to help subprime borrowers get new loans, nor will it get the housing market moving again. What it will do is reassure investors and save some money managers from well-deserved oblivion. It may be that the risk of a full-fledged credit crunch was high enough to make this worth doing. But there is something unseemly about watching the avatars of free-market capitalism rely on the government to pay for their bad bets. And there is something scary about contemplating the even bigger bets they’ll make in the future if they know that the Fed is there to bail them out.

                                  Posted by on Monday, August 20, 2007 at 12:24 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (1)  Comments (19) 


                                  Fed Watch: The Genie is Out of the Bottle

                                  Will the Fed cut the federal funds rate? Here's Tim Duy with his latest Fed Watch:

                                  The Genie is Out of the Bottle, by Tim Duy: The Fed clearly does not want to cut the Federal Funds rate, especially in an intermeeting move. They are aggressively looking for alternatives, and pulled a rabbit out of the hat with Friday’s cut in the discount rate. And, as is widely known, this was not simply a symbolic move, made absolutely clear by the Fed’s urging of banks to use the discount window.

                                  But did markets bounce on the discount rate cut, or the Fed’s statement that opened the door for a rate cut? I suspect the latter. The Fed effectively confirmed market participants’ expectations that a rate cut was coming sooner or later, and probably sooner at that. The genie is out of the bottle, and I suspect the Fed will have a hard time getting it back in.

                                  Expectations are important. My expectation was that the economy was going to look weak going into the fall, and that there would be mounting pressure on the Fed to ease. But given the Fed’s resolve, and willingness to look through slowdowns, it was reasonable to believe they would hold steady through the year – and market participants pretty much agreed.

                                  With the Fed statement, however, expectations are now turned upside down, with market participants looking for at least 75bp (intermeeting, September, and October, and maybe again in December) by the end of the year. Can the Fed turn those expectations around in a period of lackluster data, with the nadir of the housing market still ahead, even if the financial turmoil eases? Note that even as late as last Thursday, the Wall Street Journal was still writing:

                                  A stubborn inflation rate along with stronger factory output could keep Federal Reserve officials wary of cutting interest rates despite the latest turmoil hitting markets.

                                  As I noted Friday, the read on data is now decidedly negative. The Fed will not look at the dark side of each piece of data, they never do. I think that the Fed does not want to continue the crisis/ease/bubble cycle of the last decade. I believe they think this is becoming an increasingly dangerous game with inflation at the high end of tolerance. I think some are nervous that the productivity cycle is about to cut against them this time.

                                  And I think that Bernanke & Co. have lost boatloads of credibility with the “subprime is contained” story. And that will make it difficult for them to sell the “housing is contained” story in the coming months.

                                  As an interesting side note, I also believe that global central bankers in general are nervous that the liquidity creation of the last decade will soon come home to roost in the form of higher inflation. But if the Fed cuts, there will be pressure on other central banks to halt, if not follow suit with rate cuts of their own. Think of the pressure on the ECB to cut if the dollar slide against the euro as the result of a Fed rate cut…

                                  Bottom line: The Fed does not want to cut the Federal Funds rate; they want to look through the slowdown. But they have now opened the door to a rate cut, feeding into market expectations for such a policy shift. Closing that door will not be easy.

                                    Posted by on Monday, August 20, 2007 at 12:15 AM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (0)  Comments (2) 


                                    links for 2007-08-20

                                      Posted by on Monday, August 20, 2007 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (0) 


                                      Sunday, August 19, 2007

                                      Does Inequality Cause "Tangible Harm"?

                                      The Economist's blog Free Exchange argues that increases in income inequality have not caused a corresponding increases in unhappiness and asks that egalitarians defend the proposition that inequality is harmful. Chris Dillow answers the challenge:

                                      The tangible harm of inequality, by Chris Dillow: The Economist's blog asks egalitarians to point to some "tangible harm" from income inequality.

                                      In some senses, the question is silly. To see why, imagine a slave society in which the slaves are reasonably content. It would be hard to point to a tangible harm, but something would be wrong.

                                      This just shows that the "tangible harm" criterion is psychologically, economically and philosophically naive. Psychologically so, beecause people adapt to their circumstances, so "losers" don't feel too bad. Economically, because a gain foregone should count as much as a tangible cost; in a slave society no-one can see that freedom creates prosperity better than slavery, but this fact should surely count in our judgment. And philosophically, because inequality matters for more than consequentialist reasons. Justice matters too.
                                      Anyhow, let's address the question. Aside from the ill-health which the Economist mentions - as if death were not tangible enough - I'd cite five other possible harms:

                                      1. Crime. Basic economics says the relatively poor commit more crime than the relatively rich. This is because their opportunities to make money honestly are more limited, and the cost of being imprisonment - foregone earnings - is lower. Empirical work corroborates this. Is it really a coincidence that unequal countries (south America) have more crime than egalitarian ones (Japan, Korea, Scandinavia).

                                      2. Lower social mobility. Societies with higher income inequality have lower social mobility. Politics in the US and the national media in the UK are now largely hereditary occupations. Many of you might think this unhealthy.

                                      3. Slower growth. There are some reasons to think inequality can retard growth, say, by reducing social capital and therefore investment, or by creating credit constraints that prevent potential entrepreneurs.

                                      4. Bad customer service and job dissatisfaction. The inequalities that matter are not merely of income, but of power. Some people have it, some don't. And in companies, these inequalities breed slovenliness and inefficiency. Cloke and Goldsmith put it thus:

                                      Through years of experience, employees learn that it is safer to suppress their innate capacity to solve problems and wait instead for commands from above. They lose their initiative and ability to see how things can be improved. They learn not to care and to accept things as they are. They justify making mistakes and are allowed to be irresponsible and pass the blame to others for their mistakes. They become mindlessly obedient, fatalistic, intransigent and hostile.

                                      5. Inner-city blight. Another consequence of inequalities in power is that poor areas become bad areas, with urban decay, poor schools and crime, because the poor lack the power to get the state to provide proper policing and schools.
                                      So, there are almost certainly tangible harms from inequality. The more awkward question for egalitarians is: would there be more harm done by reducing inequality?

                                      There is also Robert Frank's argument about positional goods:

                                      The conventional wisdom has long been that a growing gap between the rich and the middle class is a bad thing. But that view is now under challenge. Some revisionists, respected economists among them, argue that inequality doesn't really matter so long as no one ends up with less in absolute terms. Using income levels to measure the well-being of individual families, these inequality optimists argue that since the rich now have much more money than before and the middle class doesn't have less, society as a whole must be better off.

                                      Yet "having more income" and "being better off" do not have exactly the same meaning. I will argue that changes in spending patterns prompted by recent changes in the distributions of income and wealth have imposed not only important psychological costs on middle-income families but also a variety of more tangible economic costs. . . .

                                      I'll also note that since the survey data measuring happiness is potentially problematic, the initial premise about happiness and income inequality cn be challenged. One source on this is the paper "Some Uses of Happiness Data in Economicsw" (open link)," by Rafael Di Tella and Robert MacCulloch appearing in the Winter 2006 volume of The Journal of Economic Perspectives. Though they don't competely rule out happiness data as useful, they are cautious:

                                      Happiness data are being used to tackle important questions in economics. Part of this approach is quite natural, as many questions in economics are fundamentally about happiness. But the approach departs from a long tradition in economics that shies away from using what people say about their feelings. Instead, economists have built their trade by analyzing what people do and, from these observations and some theoretical assumptions about the structure of welfare, deducing the implied changes in happiness. Economists who believe that welfare can be measured to some extent by happiness surveys have an easier time. They simply compare measures of welfare, and what causes changes in welfare, under different scenarios. Of course, results based on happiness surveys should be treated critically and cautiously. ...

                                        Posted by on Sunday, August 19, 2007 at 11:34 AM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (74) 


                                        "We are Skeptical of Recent Press Coverage Portraying the Conflict as Increasingly Manageable"

                                        The view of Iraq from soldiers serving there:

                                        The War as We Saw It By Buddhika Jayamaha, Wesley D. Smith, Jeremy Roebuck, Omar Mora, Edward Sandmeier, Yance T. Gray and Jeremy A. Murphy: (Baghdad) Viewed from Iraq at the tail end of a 15-month deployment, the political debate in Washington is indeed surreal. ... To believe that Americans, with an occupying force that long ago outlived its reluctant welcome, can win over a recalcitrant local population and win this counterinsurgency is far-fetched. As responsible infantrymen and noncommissioned officers with the 82nd Airborne Division soon heading back home, we are skeptical of recent press coverage portraying the conflict as increasingly manageable and feel it has neglected the mounting civil, political and social unrest we see every day. ...

                                        The claim that we are increasingly in control of the battlefields in Iraq is an assessment arrived at through a flawed, American-centered framework. ... What soldiers call the “battle space” remains the same, with changes only at the margins. It is crowded with actors who do not fit neatly into boxes: Sunni extremists, Al Qaeda terrorists, Shiite militiamen, criminals and armed tribes. This situation is made more complex by the questionable loyalties and Janus-faced role of the Iraqi police and Iraqi Army, which have been trained and armed at United States taxpayers’ expense. ...

                                        In short, we operate in a bewildering context of determined enemies and questionable allies, one where the balance of forces on the ground remains entirely unclear. (In the course of writing this article, this fact became all too clear: one of us, Staff Sergeant Murphy, an Army Ranger and reconnaissance team leader, was shot in the head ... on Aug. 12; he is expected to survive...) While we have the will and the resources to fight in this context, we are effectively hamstrung because realities on the ground require measures we will always refuse — namely, the widespread use of lethal and brutal force.

                                        Given the situation, it is important not to assess security from an American-centered perspective. The ability of, say, American observers to safely walk down the streets of formerly violent towns is not a resounding indicator of security. What matters is the experience of the local citizenry and the future of our counterinsurgency. When we take this view, we see that a vast majority of Iraqis feel increasingly insecure and view us as an occupation force that has failed to produce normalcy after four years and is increasingly unlikely to do so as we continue to arm each warring side.

                                        Continue reading ""We are Skeptical of Recent Press Coverage Portraying the Conflict as Increasingly Manageable"" »

                                          Posted by on Sunday, August 19, 2007 at 12:42 AM in Iraq and Afghanistan | Permalink  TrackBack (0)  Comments (23) 


                                          Jim Hamilton: Where's the Risk?

                                          Jim Hamilton can't find much evidence that recent financial turmoil signifies fear of an economic downturn:

                                          Where's the risk?, by Jim Hamilton: Usually an economic downturn is associated in a big increase in the spread between corporate and Treasury yields. This spiked pretty dramatically last week, but still has a long way to go.

                                          Ham1
                                          Difference in yield between Moody's Baa-rated corporate debt and constant-maturity 10-year Treasuries based on monthly averages, with NBER recessions indicated as shaded regions. Data sources: FRED [1], [2].

                                          The above graph plots monthly averages of the corporate-Treasury yield spread through July. Going back to 1953, this spread averaged 170 basis points, and typically rose over a hundred basis points during an economic downturn. Insofar as there is a higher probability of default during an economic recession, even risk-neutral investors would require a higher yield on corporate debt when more businesses are failing.

                                          This spread spiked substantially last week, as long-term Treasuries fell 20 basis points while the Baa yield showed little movement. Even so, the current spread of 206 basis points is not much above the long-term average or the short-term range we've seen over the last two years.

                                          Ham2
                                          Daily values for difference in yield between Moody's Baa-rated corporate debt and constant-maturity 10-year Treasuries. Data sources: FRED [1], [2]H.15. and FRB release

                                          If the financial turmoil over the last few weeks reflects fears of a significant economic downturn and financial distress, I would have expected to see an even bigger spread at this point.

                                            Posted by on Sunday, August 19, 2007 at 12:33 AM in Economics, Financial System | Permalink  TrackBack (0)  Comments (8) 


                                            Robert Shiller: Something's Up as 'Buy' Confidence Slips

                                            Robert Shiller takes a look at the stock market's "unusually negative skew":

                                            Something's up as 'buy' confidence slips, by Robert Shiller: The sharp drop in the world's stock markets on Aug. 9 — after BNP Paribas announced that it would freeze three of its funds — is just one more example of the markets' recent downward instability or asymmetry. The markets have been more vulnerable to sudden large drops than they have been to sudden large increases.

                                            Daily stock price changes for the 100-business-day period ended Aug. 3 were unusually negatively skewed in Argentina, Australia, Brazil, Canada, China, France, Germany, India, Japan, Korea, Mexico, the United States and Britain. ... In the U.S., the skew has been this negative only three other times since 1960...

                                            Stock markets' unusually negative skew is not inconsistent with booming price growth in recent years. The markets have broken all-time records, come close to doing so or, at least, done very well since 2003 ... by making up for the big drops incrementally, in a succession of smaller increases.

                                            Nor is the negative skew inconsistent with the fact that world stock markets have been relatively quiet for most of this year. With the conspicuous exception of China and the less conspicuous exception of Australia, all have had low standard deviations of daily returns for the 100-business-day period ended Aug. 3 when compared with the norm for the country. ...

                                            Indeed, one of the big puzzles of the U.S. stock market recently has been low price volatility since around 2004 amid the most volatile earnings growth ever seen. ... One would expect volatile market prices as investors try to absorb what this earnings volatility means. But we have learned time and again that stock markets are driven more by psychology than by reasoning about fundamentals.

                                            Does psychology explain the pervasive negative skew in recent months? Maybe we should ask why the skew is so negative. Should we regard it as just chance or, when combined with record-high prices, as a symptom of some instability?

                                            The adage in the bull market of the 1920s was "one step down, two steps up, again and again." The updated adage for the recent bull market is "one big step down, then three little steps up, again and again," so far at least. No one is looking for a sudden surge, and volatility is reduced by the absence of sharp upticks.

                                            But big negative returns have an unfortunate psychological impact on markets. People still talk about Oct. 28, 1929, or Oct. 19, 1987. Big drops get their attention, and this primes some people to be ... ready to sell if another one comes.

                                            In fact, willingness to support the market after a sudden drop may be declining. The "buy-on-dips stock market confidence index" that we compile at the Yale School of Management has been falling gradually since 2001, and has fallen especially far lately. The index is the share of people who answered "increase" to the question "If the Dow dropped 3 percent tomorrow, I would guess that the day after tomorrow the Dow would: Increase? Decrease? Stay the Same?"

                                            In 2001, 72 percent of institutional investors and 74 percent of individual investors chose "increase." By May 2007, only 48 percent of institutional investors and 59 percent of individual investors chose "increase."

                                            Perhaps the buy-on-dips confidence index has slipped lately because of negative news concerning credit markets, notably the U.S. subprime mortgage market, which has increased anxiety about the fundamental soundness of the economy.

                                            But something more may be at work. Everyone knows that markets have been booming, and everyone knows that other people know that a correction is always a possibility. So there may be an underlying sensitivity to price drops, which could fuel a succession of downward price changes, amplifying public concerns about problems in the economy and heralding a profound change in investor sentiment.

                                              Posted by on Sunday, August 19, 2007 at 12:24 AM in Economics, Financial System | Permalink  TrackBack (0)  Comments (2) 


                                              links for 2007-08-19

                                                Posted by on Sunday, August 19, 2007 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (0) 


                                                Saturday, August 18, 2007

                                                Inattentiveness

                                                Apologies If I've been less attentive lately, and posts the last few days have been mostly just one or two sentences of introduction. Here's why. The pictures are a day behind since this part of Flagstaff is not on the Edge network, though hopefully they will post sometime today (yesterday was Arches National Park in Moab, Utah and I have to say it was pretty cool). So far, as national parks go, I've been to Yellowstone, The Grand Tetons, Rocky Mountain, Arches, and I'm heading off to the Grand Canyon in about half an hour. I wish the iPhone camera was better, but it's all I have so it will have to do.  After today, who knows? I'm deciding where to go next somewhat spontaneously.

                                                Mark

                                                  Posted by on Saturday, August 18, 2007 at 09:09 AM in Miscellaneous | Permalink  TrackBack (0)  Comments (8) 


                                                  The View from Tehran

                                                  Hamid Varzi, "an economist and banker based in Tehran," discusses how the U.S. is viewed by the rest of the world:

                                                  A debt culture gone awry, by Hamid Varzi, Commentary, IHT: (Tehran) The U.S. economy, once the envy of the world, is now viewed across the globe with suspicion. America has become shackled by an immovable mountain of debt that endangers its prosperity and threatens to bring the rest of the world economy crashing down with it.

                                                  The ongoing sub-prime mortgage crisis, a result of irresponsible lending policies designed to generate commissions for unscrupulous brokers, presages far deeper problems in a U.S. economy that is beginning to resemble a giant smoke-and-mirrors Ponzi scheme. And this has not been lost on the rest of the world.

                                                  This new reality has had unfortunate side effects that go beyond economics. As a banker working in the heart of the Muslim world, I have been amazed by the depth and breadth of anti-Americanism, even among U.S. allies, manifested in reactions ranging from fierce anger to stoic fatalism. Muslims outside the United States interpret America's policies in the Middle East not as an effort to spread democracy but as a blatant neocolonialist attempt to solve its economic problems by force. Arabs and Persians alike argue that America's fiscal irresponsibility has forced the nation to seek solutions through military aggression.

                                                  Many believe that America's misguided adventure in Iraq was a desperate attempt to capture both a reliable source of cheap oil and a major export market for the United States. ...

                                                  What have Americans gained from their nation's mountain of debt? A crumbling infrastructure, a manufacturing base that has declined 60 percent since World War II, a rise in the wealth gap, the lowest consumer-savings rate since the depths of the Great Depression, 50 million Americans without health insurance, an educational system in decline and a shrinking dollar that makes foreign travel a luxury.

                                                  The best cars, the best bridges and highways, the fastest trains and the tallest buildings are all to be found outside America's borders. ...

                                                  The bottom line is that America is awash in red ink and seeks the wrong solutions to its debt problems. A return to fiscal responsibility would make America far stronger, both domestically and internationally, than would a continuation of current policies that falsely project strength through idle protectionist threats and failed military aggression.

                                                  Current tensions between the United States and the rest of the world will continue as long as America's military bark is louder than its economic bite.

                                                  A solution to the U.S. debt problem requires radical measures, including: the elimination of corporate tax loopholes, a reversal of tax breaks for the ultra-rich, a bipartisan campaign to eliminate budget "pork," imposition of stringent limits on corporate debt and speculative lending, a vast reduction in military expenditure and, finally, an additional 50 cent per gallon gasoline tax that would slash the federal deficit, curtail energy waste and spur technological breakthroughs.

                                                  Let us hope America heeds the warnings, dispenses with junk-food economics and embraces a crucial diet of fiscal discipline. It remains to be seen, however, whether America's political leaders have the courage to instigate such reforms, and whether Congress is finally willing to do something for the future of ordinary, hard-working Americans.

                                                    Posted by on Saturday, August 18, 2007 at 02:43 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (45) 


                                                    "The Value of Being Undervalued"

                                                    Dani Rodrik on exchange rate policy for developing countries:

                                                    The Value of Being Undervalued, by Dani Rodrik, Project Syndicate: The paramount policy dilemma that emerging markets face nowadays is this: on the one hand, sustained economic growth requires a competitive (read “undervalued”) currency. On the other hand, any good news is immediately followed by currency appreciation, making the task of remaining competitive that much harder. ...

                                                    Your fiscally responsible political party just won the election? Or your commodity exports hit the jackpot? Good for you! But the currency appreciation that follows will likely set off an unsustainable consumption boom, wreak havoc with your export sector, create unemployment, and sap your growth potential. ...

                                                    In response, central banks may intervene in currency markets to prevent appreciation, at the cost of accumulating low-yield foreign reserves and diverting themselves from their primary goal of price stability. This is the strategy followed by countries such as China and Argentina.

                                                    Or the central bank lets the markets go where they will, at the cost of drawing the ire of business, labor, the rest of the government, and, in fact, practically everyone except financial types. This is the strategy pursued by countries such as Turkey and South Africa, which have adopted more conventional “inflation targeting” regimes.

                                                    The first strategy is problematic because it is unsustainable. The second is undesirable because it buys stability at the cost of growth.

                                                    The importance of a competitive currency for economic growth is undeniable. Virtually every instance of sustained high growth has been accompanied by a significantly depreciated real exchange rate. ...

                                                    So what should policymakers do?

                                                    Continue reading ""The Value of Being Undervalued"" »

                                                      Posted by on Saturday, August 18, 2007 at 12:24 AM in Budget Deficit, Economics, International Finance, Monetary Policy | Permalink  TrackBack (0)  Comments (5) 


                                                      Phelps: I Can Afford To Be As Radical As I Want To Be

                                                      An interview with Edmund Phelps:

                                                      Lunch with the FT: Edmund Phelps, by Ralph Atkins, Commentary, Financial Times (free): ...Traditionally, the Nobel prize for economics recognises work that was carried out many decades ago but still has relevance today. [Edmund] Phelps won his for work in the late 1960s that overturned then-conventional wisdom that a stable relationship existed between inflation and unemployment... But he is also renowned for his criticism of continental European “corporatism”, which he believes hampers interaction between entrepreneurs and financiers, and results in Europe relying on the import of ideas and techniques from the US. It is his explanation for continental Europe’s dismal growth in the past decade. ...

                                                      Phelps feels that he is at the stage in his career “where I can afford to be as radical as I want to be. And so I am having a lot of fun thinking about capitalism and trying to imagine how economics would have to be re-written to capture the heart of that kind of system.” Traditional economics, he explains, sees the world as if it were a plumbing system. “It’s basically rooted in equilibrium – things work out as people expect them to do.” Capitalist reality, however, “is a system of disorder. Entrepreneurs have only the murkiest picture of the future in which they are making their bets, and also there is ambiguity, they don’t know when they push this lever or that lever that the outcome is going to be what they think it is going to be – there is the law of unanticipated consequences. This is not in the economic text books, and my mission, late in my career, is to get it into the text books.” ...

                                                      I switch the conversation to Europe, which, Phelps believes, is doomed always to trail behind the US... “I don’t begrudge Europe waiting to see what works in America before expending the resources to adopt this or that new good or technique,” he says. “I just think that the Europeans are depriving themselves of a high-employment economy and they are depriving themselves of intellectual stimulation in the workplace – and personal growth – by sticking to the stultifying, rigid system that I call corporatism.”

                                                      Phelps says Italian friends tell him that things have changed, that “we’re virtually like America now”. But notwithstanding Europe’s impressive growth rebound lately, he sees too much backsliding. ...

                                                      Continue reading "Phelps: I Can Afford To Be As Radical As I Want To Be" »

                                                        Posted by on Saturday, August 18, 2007 at 12:15 AM in Economics | Permalink  TrackBack (0)  Comments (11) 


                                                        links for 2007-08-18

                                                          Posted by on Saturday, August 18, 2007 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (0) 


                                                          Friday, August 17, 2007

                                                          The Fed Changes Its Assessment of Risks

                                                          The Fed issued a statement today changing its assessments of downside risks to output:

                                                          For immediate release

                                                          Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

                                                          Voting in favor of the policy announcement were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Richard W. Fisher; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Michael H. Moskow; Eric Rosengren; and Kevin M. Warsh.

                                                          Brad DeLong also notes that the Fed has cut the discount rate (symbolically) from 6.25% to 5.75% [see also Text of Fed Statement on Discount Rate, Explaining the Discount Window].

                                                            Posted by on Friday, August 17, 2007 at 08:46 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (21) 


                                                            Paul Krugman: Workouts, Not Bailout

                                                            Paul Krugman has a proposal to deal with the consequences of the mortgage market meltdown:

                                                            Workouts, Not Bailouts, by Paul Krugman, Commentary, NY Times: ...According to data released yesterday, both housing starts and applications for building permits have fallen to their lowest levels in a decade, showing that home construction is still in free fall. And if historical relationships are any guide, home prices are still way too high. The housing slump will probably be with us for years, not months.

                                                            Meanwhile, it’s becoming clear that the mortgage problem is anything but contained. ... Many on Wall Street are clamoring for a bailout — for Fannie Mae or the Federal Reserve or someone to step in and buy mortgage-backed securities from troubled hedge funds. But that would be like having the taxpayers bail out Enron or WorldCom when they went bust — it would be saving bad actors from the consequences of their misdeeds.

                                                            For it is becoming increasingly clear that the real-estate bubble of recent years, like the stock bubble of the late 1990s, both caused and was fed by widespread malfeasance. Rating agencies like Moody’s Investors Service ... seem to have played a similar role to that played by complaisant accountants in the corporate scandals of a few years ago. In the ’90s, accountants certified dubious earning statements; in this decade, rating agencies declared dubious mortgage-backed securities to be highest-quality, AAA assets.

                                                            Yet our desire to avoid letting bad actors off the hook shouldn’t prevent us from doing the right thing, both morally and in economic terms, for borrowers who were victims of the bubble.

                                                            Most of the proposals I’ve seen ... are of the locking-the-barn-door-after-the-horse-is-gone variety: they would ... have been very useful three years ago — but they wouldn’t help much now. What we need at this point is a policy to deal with the consequences of the housing bust.

                                                            Consider a borrower who can’t meet his or her mortgage payments and is facing foreclosure. In the past, ... the bank that made the loan would often have been willing to offer a workout, modifying the loan’s terms to make it affordable, because what the borrower was able to pay would be worth more to the bank than its incurring the costs of foreclosure and trying to resell the home. That would have been especially likely in the face of a depressed housing market.

                                                            Today, however, the ... mortgage was bundled with others and sold to investment banks, who in turn sliced and diced the claims to produce artificial assets that Moody’s or Standard & Poor’s were willing to classify as AAA. And the result is that there’s nobody to deal with.

                                                            This looks to me like a clear case for government intervention: there’s a serious market failure, and fixing that failure could greatly help thousands, maybe hundreds of thousands, of Americans. The federal government shouldn’t be providing bailouts, but it should be helping to arrange workouts. ...

                                                            The mechanics ... would need a lot of work, from lawyers as well as financial experts. My guess is that it would involve federal agencies buying mortgages — not the securities conjured up from these mortgages, but the original loans — at a steep discount, then renegotiating the terms. But I’m happy to listen to better ideas.

                                                            The point, however, is that doing nothing isn’t the only alternative to letting the parties who got us into this mess off the hook. Say no to bailouts — but let’s help borrowers work things out.

                                                            _________________________
                                                            Previous (8/13) column: Paul Krugman: It’s All About Them
                                                            Next (8/20) column: Paul Krugman: It's a Miserable Life

                                                              Posted by on Friday, August 17, 2007 at 12:33 AM in Economics, Housing, Market Failure, Policy | Permalink  TrackBack (0)  Comments (119) 


                                                              Tim Duy: Collision Coming

                                                              Tim Duy with more on how the Fed is likely to react to current economic conditions:

                                                              Collision Coming, by Tim Duy: Someone is going to get hurt bad, as financial market participants and Fed policymakers are barreling toward each other. Who will be the first to swerve? Whether the Greenspan put is real or not, markets are convinced that the Fed will flinch in the face of the ongoing panic. Is panic too strong? I think not, at least given the tenor of the financial press. From Bloomberg:

                                                              ''People are losing faith in credit, so the economy is seizing up,'' said Biggs, 74, who runs the Traxis Partners LLC hedge fund in New York and was formerly a strategist at Morgan Stanley.

                                                              Looking out the window, I sense “the economy is seizing up” is something of an exaggeration. There appears to be considerable activity at the local shops, my internet connection is solid, the electricity is on, etc. Some students appear unsteady on their feet, but I suspect this has more to do with post-summer finals revelry than impending economic collapse.

                                                              All joking aside, there is a real concern, and I can not say that I do not share it, that the situation is quickly getting away from the Fed. In my opinion, we are at a point where people no longer have the time to rationally analyze the incoming news, reacting to speculation and rumor rather than fact. Sounds like a good definition of “panic” to me.

                                                              The daily activities of the New York Fed, which have gone unnoticed for years, suddenly becomes an object of intense speculation about the intentions of the Fed. It is as if we have reverted to the days when the Fed did not announce policy decisions. Indeed, speculation is rising that the Fed has secretly cut rates already. Likewise, data analysis has become subject to exaggeration as well. I particularly enjoyed David Gaffen’s remarks from the Wall Street Journal’s MarketBeat:

                                                              Continue reading "Tim Duy: Collision Coming" »

                                                                Posted by on Friday, August 17, 2007 at 12:15 AM in Economics, Fed Watch, Housing, Policy | Permalink  TrackBack (0)  Comments (9) 


                                                                "The Globe's Modern Commerce"

                                                                The importance of the steamboat for economic development in America:

                                                                Steaming into the future, by Kirkpatrick Sale, Commentary, LA Times: Monday, Aug. 17, 1807, was another hot summer day in New York City, and most of the women of fashion on the Hudson River pier, arms linked to laced and ruffled gentlemen, had their pastel parasols up against the sun. It was unusual for such a crowd to gather midday on a Monday.... But a good deal of excitement had been stirred up in the city by the prospect of Robert Fulton's strange and improbable steamboat making its maiden voyage to Albany.

                                                                This was not the first steamboat... But Fulton's was superior in design and engineering. If he made the voyage without mishap that day, it would prove that his craft could go faster than any boat on the river, in any kind of weather, and thus lead to the first commercially viable steamboat operation in the world.

                                                                Interest was particularly high because ... it was widely held that the whole outlandish contraption was likely to explode. ... In his later account, Fulton noted that "in the moments before the word was to be given for the boat to move," the people on deck showed "anxiety mixed with fear" and were "silent, sad and weary." Indeed, "I read in their looks nothing but disaster, and almost repented of my efforts."

                                                                But he had not spent much of the previous five years learning about steam propulsion, and the previous six months and nearly $10,000 of his own money (plus an equal amount from Livingston) actually building the boat, just to give in to a few skeptics. At 1 p.m., he gave the signal for the engine to be powered and the boat to be cast off.

                                                                The boat glided a few yards into the Hudson, then stopped. ... He started examining the machinery and wheels, and in less than half an hour, "the boat was again put in motion" and "continued to move on."... [T]here it was, moving at a steady 4 miles an hour northward, and Fulton proudly noted, "I overtook many sloops and schooners . . . and parted with them as if they had been at anchor."

                                                                Continue reading ""The Globe's Modern Commerce"" »

                                                                  Posted by on Friday, August 17, 2007 at 12:12 AM in Economics | Permalink  TrackBack (0)  Comments (9) 


                                                                  links for 2007-08-17

                                                                    Posted by on Friday, August 17, 2007 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (0) 


                                                                    Thursday, August 16, 2007

                                                                    Compassionate Conservatism

                                                                    The article "The Man Who Killed Compassionate Conservatism" by Michael Schaffer in TNR has the statement:

                                                                    As for Thompson, the original compassionate conservative, there would be no small-government incarnation of the great society on his watch. Rather than reinventing Medicaid, Thompson was called on to twist Republican arms in favor of Bush's prescription drug benefit... It's hard to imagine Thompson the reformist governor being enamored of the open-ended, fuzzy-numbered, nakedly political bill that Thompson the Bush administration factotum helped pass.

                                                                    Reading this reminded me of confusion -- perhaps intentional by those who popularized the phrase -- about the term "compassionate conservatism." It isn't a kindler, gentler brand of conservatism, though that's certainly the impression the phrase is intended to convey. It doesn't mean, for example, government stepping in and helping after an event like hurricane Katrina. It refers to the work of Marvin Olasky, who wrote in his book Renewing American Compassion that reforming the present welfare system often means nothing more than "scraping off a bit of mold." Thus, he advocates scrapping the present welfare system entirely and replacing it with private and religious charity, a system he says was "effective in the nineteenth century." This is compassionate conservatism. It is a rebranding of an old approach, not a fundamentally new idea.

                                                                      Posted by on Thursday, August 16, 2007 at 01:44 AM in Economics, Politics, Social Insurance | Permalink  TrackBack (0)  Comments (47) 


                                                                      Novak: Fed's Secret Plans to Change FOMC Statement Upset by Financial Market Turmoil

                                                                      I don't know what to make of this report from Robert Novak that the Fed was secretly planning a new FOMC statement indicating a bias toward a rate cut, but was derailed by the fallout from the "international credit scares," but I'm skeptical. The report is attributed to "Capitol Hill sources," and the vagueness of the sources along with a general wariness about anything Novak reports makes it hard to evaluate. In addition, the report is very much at odds with what the first Fed official to comment since the financial crisis, William Poole, has said:

                                                                      William Poole, president of the St. Louis Federal Reserve Bank, said the subprime mortgage rout doesn't threaten U.S. economic growth, and only a ''calamity'' would justify an interest-rate cut now. Poole, who confers regularly with regional business contacts, said ... the ... best course is for officials to assess economic figures, including the August jobs report, when they next convene on Sept. 18...

                                                                      Here's Novak:

                                                                      A Rate Cut on Hold, by Robert D. Novak, Commentary, Washington Post: Before the recent global financial crisis began, the Federal Reserve Board under Chairman Ben S. Bernanke was ready to take a subtle step toward easier money in order to stave off U.S. recession fears. Ready for approval was a new Federal Open Market Committee (FOMC) statement ending the central bank's neutrality and putting it on a bias for an interest rate cut. But international credit scares changed all that.

                                                                      The Fed and other central banks moved quickly and in unison last Friday to pump more cash into financial systems, successfully stabilizing markets made jittery by collapsing hedge funds around the world. It was central banking at its best... But Bernanke's broader plans for easier money have to be placed on hold because he cannot be seen as bailing out greedy hedge fund operators. ...

                                                                      While the FOMC's decisions now are disclosed promptly, the central bankers do not disclose and try not to leak their plans. However, according to Capitol Hill sources, they had secretly decided to issue a statement soon changing the Fed's bias toward easing -- which no longer would be in neutral.

                                                                      While such a change in itself can boost the economy, it normally is followed immediately by an actual drop in interest rates. In this case, however, sources indicated that the second step would not come for several months, to coincide, if possible, with good anti-inflation numbers. ...

                                                                      But any kind of easing now -- either abandoning neutrality or a full-scale cut in interest rates -- could make it appear as though Bernanke was less interested in the broader economy than in protecting millionaire hedge fund operators and traders. ...

                                                                      As Bernanke considers his course, the "R" word (recession) is in the air in Washington. That's why the Fed secretly decided to move away from neutrality toward easing, which is now on hold thanks to the global crisis.

                                                                      Update: Tim Duy, who comments further on the Poole statement in his latest Fed Watch, says:

                                                                      ABSOLUTE BS! … When I was in DC, Novak was called "Nofacts".

                                                                      Update: Since the topic is columnists is Washington Post columnists trying to write about the Fed, let me add this. George Will is confused about the Fed's mandate. He says:

                                                                      The Federal Reserve's proper mission is not to produce a particular rate of economic growth or unemployment... It is to preserve the currency as a store of value -- to contain inflation.

                                                                      That would be news to the Fed. For example, Federal Reserve Governor Mishkin thinks there is dual mandate:

                                                                      In the United States, as in virtually every other country, the central bank has a ... specific set of objectives that have been established by the government. This mandate was originally specified by the Federal Reserve Act of 1913 and was most recently clarified by an amendment to the Federal Reserve Act in 1977.

                                                                      According to this legislation, the Federal Reserve's mandate is "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Because long-term interest rates can remain low only in a stable macroeconomic environment, these goals are often referred to as the dual mandate; that is, the Federal Reserve seeks to promote the two coequal objectives of maximum employment and price stability.

                                                                      But unlike George Will, you already knew that. Be wary when reading Will.

                                                                      One more update: Barry Ritholtz has more in "Attention Robert Novak: The Fed isn't at Neutral."

                                                                        Posted by on Thursday, August 16, 2007 at 12:24 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (10) 


                                                                        Fed Watch: First Fed Speaker Comes Out Against Rate Cut

                                                                        Tim Duy evaluates the chances of a Fed rate cut in light of recent price data and comments from St. Louis Fed president William Poole:

                                                                        First Fed Speaker Comes Out Against Rate Cut, by Tim Duy: St. Louis Fed President William Poole became the first Fed official to speak in the wake of recent financial disruption. For those looking for a rate cut before the September meeting, his interview with Bloomberg was not particularly supportive:

                                                                        ''I don't see any impact as yet on the real economy or on the inflation rate,'' he said in an interview in the bank's boardroom. ''Obviously, there could be an impact, but we have to rely on some real evidence.''

                                                                        Barring a ''calamity,'' there is no need to consider an emergency rate cut, Poole said.

                                                                        ''No one has called up and said the sky is falling,'' Poole said today. ''As I talk to companies, their capital spending plans are intact.''

                                                                        Moreover, those looking for a cut in September should note Poole’s warning:

                                                                        Poole said he didn't regret that the Aug. 7 statement retained a bias against inflation. He also said that while consumer price gains are ''moving in the right direction,'' the ''job is not done.''

                                                                        Important comments as they came after the release of today’s CPI report for July. While the trend appears to be in the right direction, the Fed simply lacks conviction inflation will continue to head in their desired direction. Not really that surprising – although core CPI was up just 0.2%, after a downward rounding, note that the 3-month annualized rate stands at 2.5%, well above an acceptable rate.

                                                                        As I noted earlier this week, the Fed is considerably more deliberate than market participants when it comes to changing policy. The flow of data so far is not supportive of a rate in September.  To be sure, retail sales data were not spectacular, but consumer weakness is expected by the Fed – they anticipate a rising savings rate. Industrial production was ahead of expectations, and, most importantly, the June trade figures are likely to push 2Q07 above 4%. Don’t ignore the potential for the external sector to support growth in the quarters ahead. Exports growth looks set to continue, while sagging consumption is likely to come at the expense of import growth – those flat screen TV’s are not made on these shores.

                                                                        Felix Salmon has posted what I believe to be a misleading chart suggesting that the Fed changed policy in the past week. Thankfully William Polley provides some context, noting that the downward pull on the effective Fed Funds rate is being driven by few trades at extremely low rates.  Importantly, he notes that the high end of the trading range remains right where is should be. My interpretation of the low trades is that the New York Fed is erring on side of caution, not unreasonable given the current frenzied state of market participants.

                                                                        I will quibble with this from Polley:

                                                                        Remember also that this infusion of liquidity represents reserves, or base money. It doesn't get multiplied through the deposit process unless banks lend those reserves to create new deposits. Something tells me that's not going to be an enormous risk in this case. Intermediaries are more likely to be carrying some excess reserves at this point.

                                                                        The reason this is not a risk is the seemingly forgotten fact that these are temporary operations – all with the exception of one 14-day operation last Thursday are overnight repos. The money goes in, the next morning it goes out and new money, if necessary, is put in. Financial reporters insist on ignoring the second part of a repo operation. And clearly banks will not lend out money they know they will only hold for 24 hours or less. 

                                                                        Of course, the Fed does also change the size of its portfolio with permanent open market purchases. This would permanently change the amount of base money available for loans and the money creation process. The last such operation was on May 3 for $1.4 billion. I hope the NY Fed is not planning another permanent purchase anytime soon – who knows how it will be interpreted.

                                                                        Bottom Line:  The path to a rate cut will not be as direct as appears to be priced into markets; the Fed will resist until they see hard data to justify a policy shift.

                                                                          Posted by on Thursday, August 16, 2007 at 12:15 AM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (0)  Comments (2) 


                                                                          Alan Auerbach: How to Tax Capital Gains

                                                                          Alan Auerbach explains how to tax capital gains:

                                                                          How to Tax Capital Gains, by Alan Auerbach, Commentary, WSJ: The recent controversy over the taxation of "carried interest" ... demonstrates the problems that can arise from taxing capital gains differently from other types of income. While it's relatively simple to change the way we treat carried interest, it would be far better to undertake an overall reconsideration of the way we tax capital gains.

                                                                          As President Reagan and others who crafted the Tax Reform Act of 1986 understood, different tax rates on different types of income-producing activities often distort economic decisions and increase the tax system's complexity. Their solution was a broad-based tax with low and uniform marginal tax rates. The identical rate was applied to capital gains and to wage and salary income. But the reform survived only a few years, and we now confront the old problems magnified by two decades of financial innovation.

                                                                          We can do better, and here are some guidelines:

                                                                          Increase the capital gains tax rate, but not the "lock-in" effect. ...[T]axing capital gains has a big impact on investors' decisions about when to sell capital assets. Higher tax rates delay sales, causing investors to be "locked in" to their current holdings...

                                                                          By itself, an increase in the capital gains tax rate worsens the lock-in effect. But this impact can be offset by other desirable changes, such as indexing capital gains for inflation ... and taxing capital gains at death. (Currently, we do not collect capital gains taxes when someone dies; this makes people want to hold onto appreciated assets throughout their lifetimes.) So-called "constructive realization" (i.e., taxation of capital gains at death) could help solve our current estate tax impasse by substituting capital gains revenues for some of the lost estate taxes. ...

                                                                          Reconsider how best to encourage innovation and risk-taking. Some argue that low capital gains tax rates can spur the formation and development of new enterprises, for the payoffs from successful start-ups flow to their owners largely in the form of capital gains. But ... only a miniscule fraction of the economy's capital gains are associated with new ventures. A low capital gains tax rate is a very poor way to encourage entrepreneurial activity. It would be far better to carefully tailor tax provisions to spur innovation...

                                                                          Don't raise the cost of capital. ...Lowering capital income taxes reduces the cost of capital and spurs investment; raising these taxes increases the cost of capital and discourages investment.

                                                                          But not all capital income taxes equally influence the cost of capital. Capital gains taxes have a relatively weak impact on the cost of capital because a large share of the tax revenues is associated with income not generated by new investment. Thus only a small portion of the capital gains realized over the next several years will result from today's investment, so changing the tax rate on the gains won't influence today's investment much. By contrast, tax provisions targeted toward new investment, such as the bonus depreciation scheme introduced in 2002, tie tax reductions to new investment and thereby produce a bigger bang for each buck of tax reduction. Offsetting an increase in the capital gains tax rate with a revenue-neutral tax reduction that targets new investment is likely to reduce the cost of capital. ...

                                                                          There are, of course, more sweeping tax reform alternatives available. Some proposals would move us from taxing income toward taxing consumption, or toward taxing capital gains as they accrue, rather than only when assets are sold. There are coherent and attractive proposals available to implement either of these approaches. But we need not wait for the next grand tax reform to improve on our current method of taxing capital gains.

                                                                            Posted by on Thursday, August 16, 2007 at 12:12 AM in Economics, Taxes | Permalink  TrackBack (0)  Comments (14) 


                                                                            links for 2007-08-16

                                                                              Posted by on Thursday, August 16, 2007 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (2) 


                                                                              Wednesday, August 15, 2007

                                                                              David Leonhardt: Remembering a Classic Investing Theory

                                                                              David Leonhardt says the "stock run-up of the 1990s was so big ... that the market may still not have fully worked it off"

                                                                              Remembering a Classic Investing Theory, by David Leonhardt, New York Times: More than 70 years ago, two Columbia professors named Benjamin Graham and David L. Dodd came up with a simple investing idea that remains ... influential... In the wake of the stock market crash in 1929, they urged investors to focus on hard facts — like a company’s past earnings and the value of its assets...

                                                                              Their classic 1934 textbook, “Security Analysis,” became the bible for what is now known as value investing. Warren E. Buffett took Mr. Graham’s course at Columbia Business School in the 1950s and, after working briefly for Mr. Graham’s investment firm, set out on his own to put the theories into practice. Mr. Buffett’s billions are just one part of the professors’ giant legacy.

                                                                              Yet somehow, one of their big ideas about how to analyze stock prices has been almost entirely forgotten. The idea essentially reminds investors to focus on long-term trends and not to get caught up in the moment. Unfortunately, when you apply it to today’s stock market, you get even more nervous about what’s going on.

                                                                              Most Wall Street analysts, of course, say there is nothing to be worried about, at least not beyond the mortgage market. In an effort to calm investors after the recent volatility, analysts have been arguing that stocks are not very expensive right now. The basis for this argument is the standard measure of the market: the price-to-earnings ratio. ...

                                                                              In its most common form, the ratio is equal to a company’s stock price divided by its earnings per share over the last 12 months. ... The higher the ratio, the more expensive the stock is — and the stronger the argument that it won’t do very well going forward.

                                                                              Right now, the stocks in the Standard & Poor’s 500-stock index have an average P/E ratio of about 16.5, which by historical standards is quite normal. ... The core of Wall Street’s reassuring message, then, is that even if the mortgage mess leads to a full-blown credit squeeze, the damage will not last long because stocks don’t have far to fall. ...

                                                                              Mr. Graham and Mr. Dodd ... would have had a problem with the way that the number is calculated today. ... They realized that a few months, or even a year, of financial information could be deeply misleading. ...

                                                                              So they argued that P/E ratios should not be based on only one year’s worth of earnings. It is much better, they wrote in “Security Analysis,” to look at profits for “not less than five years, preferably seven or ten years.” This advice has been largely lost to history. ...

                                                                              Today, the Graham-Dodd approach produces a very different picture from the one that Wall Street has been offering. Based on average profits over the last 10 years, the P/E ratio has been hovering around 27 recently. That’s higher than it has been at any other point over the last 130 years, save the great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other words, that the market may still not have fully worked it off.

                                                                              Now, this one statistic does not mean that a bear market is inevitable. But it does offer a good framework for thinking about stocks. Over the last few years, corporate profits have soared. ... In just three years, from 2003 to 2006, inflation-adjusted corporate profits jumped more than 30 percent... This profit boom has allowed standard, one-year P/E ratios to remain fairly low.

                                                                              Going forward, one possibility is that the boom will continue. In this case, the Graham-Dodd P/E ratio doesn’t really matter. It is capturing a reality that no longer exists... The other possibility is that the boom will prove fleeting. Perhaps the recent productivity gains will peter out (as some measures suggest is already happening). Or perhaps the world’s major economies will slump in the next few years. If something along these lines happens, stocks may suddenly start to look very expensive.

                                                                              In the long term, the stock market will almost certainly continue to be a good investment. But the next few years do seem to depend on a more rickety foundation than Wall Street’s soothing words suggest. Many investors are banking on the idea that the economy has entered a new era of rapid profit growth, and investments that depend on the words “new era” don’t usually do so well. ...

                                                                              Dean Baker says he gets it "almost" right:

                                                                              Leonhardt Gets It Right on Stock Market Valuations (Almost), by Dean Baker: NYT columnist David Leonhardt does a good job of spreading some basic commonsense on stock prices. The stock price should reflect earnings. Leonhardt notes that current PEs are about 27 against trend earnings, far higher than the historic average.

                                                                              The reason for including the "almost" is that Leonhardt felt the need to say that maybe stocks aren't over-valued if profits keep growing rapidly (sounds like Alan Greenspan in the 90s). Well don't hold your breath on that one. Profits peaked in the 3rd quarter of 2006 and were down sharply in the 4th quarter of 2006 and the first quarter of 2007. It's always possible that they will bounce back, just like it's possible that President Bush will sign the Kyoto agreement, but I don't know anyone who will bet on either event.

                                                                                Posted by on Wednesday, August 15, 2007 at 12:33 AM in Environment, Financial System | Permalink  TrackBack (0)  Comments (47) 


                                                                                Robert Samuelson: Global Warming Simplicities

                                                                                Robert Samuelson on global warming. There's plenty to talk about here, but my internet connection is less than perfect at the moment, so I am going to leave this one (and the others today) to comments:

                                                                                Global Warming Simplicities, by Robert J. Samuelson, Commentary, Washington Post: We in the news business often enlist in moral crusades. Global warming is among the latest. Unfortunately, self-righteous indignation can undermine good journalism. A recent Newsweek cover story on global warming is a sobering reminder. It's an object lesson on how viewing the world as "good guys vs. bad guys" can lead to a vast oversimplification of a messy story. Global warming has clearly occurred; the hard question is what to do about it.

                                                                                If you missed Newsweek's story, here's the gist. A "well-coordinated, well-funded campaign by contrarian scientists, free-market think tanks and industry has created a paralyzing fog of doubt around climate change." This "denial machine" has obstructed action against global warming and is still "running at full throttle." The story's thrust: Discredit the "denial machine," and the country can start the serious business of fighting global warming. ...

                                                                                The global-warming debate's great unmentionable is this: We lack the technology to get from here to there. Just because Arnold Schwarzenegger wants to cut emissions 80 percent below 1990 levels by 2050 doesn't mean it can happen. At best, we might curb the growth of emissions.

                                                                                Consider a 2006 study from the International Energy Agency. Using present policies, it projected that emissions of carbon dioxide ... would more than double by 2050; developing countries would account for almost 70 percent of the increase. The IEA then simulated an aggressive, global program to cut emissions that is based on the best available technologies: more solar, wind and biomass energy; more-efficient cars, appliances and buildings; more nuclear energy. Under this admitted fantasy, global emissions in 2050 would still slightly exceed 2003 levels.

                                                                                Even the fantasy would be a stretch. In the United States, it would take massive regulations, higher energy taxes or both. Democracies don't easily adopt painful measures in the present to avert possible future problems. ...

                                                                                One way or another, our assaults against global warming are likely to be symbolic, ineffective or both. But if we succeed in cutting emissions substantially, savings would probably be offset by gains in China and elsewhere. ...

                                                                                Against these real-world pressures, Newsweek's "denial machine" is a peripheral and highly contrived story. ... The alleged cabal's influence does not seem impressive. The mainstream media have generally been unsympathetic; they've treated global warming ominously. ... Nor does public opinion seem much swayed. ...

                                                                                What to do about global warming is a quandary. Certainly, more research and development. Advances in underground storage of carbon dioxide, battery technology (for plug-in hybrid cars), biomass or nuclear power could alter energy economics. To cut oil imports, I support a higher gasoline tax -- $1 to $2 a gallon, introduced gradually -- and higher fuel-economy standards for vehicles. These steps would also temper greenhouse gas emissions. Drilling for more domestic natural gas (a low-emission fuel) would make sense. ...

                                                                                But the overriding reality seems almost un-American: We simply don't have a solution for this problem. As we debate it, journalists should resist the temptation to portray global warming as a morality tale -- as Newsweek did -- in which anyone who questions its gravity or proposed solutions may be ridiculed as a fool, a crank or an industry stooge. Dissent is, or should be, the lifeblood of a free society.

                                                                                  Posted by on Wednesday, August 15, 2007 at 12:24 AM in Economics, Environment, Regulation | Permalink  TrackBack (0)  Comments (34) 


                                                                                  The Thing to Fear is Lack of Fear

                                                                                  Martin Wolf says that without fear, financial markets "go crazy":

                                                                                  Fear makes a welcome return, by Martin Wolf, Commentary, Financial Times: ...Panic follows mania as night follows day. ... Ours has been a world of ... confidence, cleverness and too much cheap credit. This is not new. It is as old as financial capitalism itself. The late Hyman Minsky, who taught at the University of California, Berkeley, laid down the canonical model. The process starts with “displacement”, some event that changes people’s perceptions of the future. Then come rising prices in the affected sector. The third stage is easy credit and its handmaiden, financial innovation.

                                                                                  The fourth stage is over-trading, when markets depend on a fresh supply of “greater fools”. The fifth stage is euphoria, when the ignorant hope to enjoy the wealth gained by those who came before them. The warnings of those who cry “bubble” are ridiculed, because these Cassandras have been wrong for so long. In the sixth stage comes insider profit-taking. Finally, comes revulsion.

                                                                                  In the latest cycle, displacement began with the huge cuts in interest rates in the early 2000s, which drove up prices in housing. The easy credit was stimulated by innovations that allowed those making the loans to regard their service as somebody else’s problem. Then people started to buy dwellings to resell them, not live in them. Subprime lending was a symptom of euphoria. So, in a different way, was the rush of bankers into hedge funds and of the wealthy and big institutions into financing them. Then came profit-taking, falling prices and, last week, true revulsion.

                                                                                  This was what George Magnus of UBS bank calls a “Minsky moment” . It was the moment when credit dried up even to sound borrowers. Panic had arrived.

                                                                                  The correct policy response is also well known. ... The central bank must save not specific institutions, but the market itself. It must advance money freely, at a penal rate, on good security.

                                                                                  In providing money to the markets last week and this, the ... central banks have been doing their jobs. Whether the terms on which they have done this were sufficiently penal is another matter.

                                                                                  Financial markets, and particularly the big players within them, need fear. Without it, they go crazy. Moreover, it is impossible for outsiders to regulate a global financial system riddled with conflicts of interest and dominated by huge derivatives markets, massive trading by highly leveraged hedge funds and reliance on abstruse mathematics and questionable statistical models. These markets must regulate themselves. The only thing likely to persuade them to do so is the certainty that the players will be allowed to go bust. ...

                                                                                  The world has witnessed four great bubbles over the past two decades – in Japanese stocks in the late 1980s, in east Asia’s stocks and property in the mid-1990s, in the US (and European) stock markets in the late 1990s and, finally, in the housing markets of much of the advanced world in the 2000s. There has been too much imprudent finance worldwide, with central bankers and ministries of finance providing rescue at virtually every stage.

                                                                                  Unfortunately, there is every chance of repeating mistakes. A bail-out has already occurred in Germany... More are likely. US legislators want Fannie Mae and Freddie Mac to bail out the mortgage markets.

                                                                                  The pressure on the Federal Reserve to cut interest rates will also grow. ... The consequences [of this implosion] cannot be “ring-fenced”, as those of LTCM were. Trust in counterparties and financial instruments has fled. The likelihood is a period of recognising losses, tightening credit conditions and deleveraging.

                                                                                  Such a period, desirable in itself, will lead to strong pressure for swift declines in interest rates, at least in the US, and so for another partial bail-out of a crisis-prone system. This pressure should be resisted as long as possible. ...

                                                                                    Posted by on Wednesday, August 15, 2007 at 12:15 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (44) 


                                                                                    links for 2007-08-15

                                                                                      Posted by on Wednesday, August 15, 2007 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (0) 


                                                                                      Tuesday, August 14, 2007

                                                                                      "Mr. Rove’s Attempt at a Great Republican Society"

                                                                                      Joshua Green says there is a "contradiction at the heart of 'compassionate conservatism'":

                                                                                      A ‘Great Society’ Conservative, by Joshua Green, Commentary, NY Times: There is a paradox at the heart of Karl Rove’s tenure in the White House, and it is a key to understanding why he failed to remake American politics, despite ambitious plans to do so. ... Conservatives believe the Great Society programs that liberals pushed in the 1960s demonstrated that government engineering doesn’t work. Lyndon Johnson’s War on Poverty failed, this critique goes, because liberals simply didn’t understand the limits of government’s power to transform culture. ...

                                                                                      [T]here can be little dispute that Mr. Rove pursued his vision of a new political order with the activist zeal of a 1960s Great Society liberal. From the outset of the Bush administration, Mr. Rove aimed to create a “permanent majority” for Republicans, just as Franklin Roosevelt did for Democrats in the 1930s, and as William McKinley and his campaign manager Mark Hanna — Mr. Rove’s hero — did for Republicans in the 1890s.

                                                                                      As Mr. Rove sought a political realignment that would create a durable Republican majority, he seized on government as his chief mechanism. He tried to realign American politics principally through the pursuit of major initiatives that he believed would reorient a majority of Americans to the Republican Party: establishing education standards; rewriting immigration laws; partially privatizing Social Security and Medicare; and allowing religious organizations to receive government financing.

                                                                                      The only thing that united these government actions was the likelihood that they would weaken political support for Democrats. Social Security privatization would create a generation of market-minded stockholders. Pork-barrel spending on religious organizations would keep evangelical Christians engaged in the political process — and pry loose some African-American voters by funneling money to black churches. No Child Left Behind would appeal to voters who traditionally looked to Democrats as the party of education. And generous immigration policies would persuade Hispanics to vote Republican.

                                                                                      Mr. Rove’s entire vision for Republican realignment was premised on the notion that he could command government to produce the specific effects that he desired. But as a conservative could have predicted, his proposed policies unleashed a series of failures and unintended consequences.

                                                                                      Mr. Rove had extraordinary power within the administration to shape domestic policy. But pushing through many of his programs proved difficult. On Social Security and immigration reform, Congress and the country weren’t prepared to embrace his vision. Like a 1960s liberal in love with the abstract merits of a guaranteed income, Mr. Rove misread the mood of the country and tried to do too much.

                                                                                      Mr. Rove married a liberal’s faith in the potential of government to a conservative’s contempt for its actual functioning. This was the contradiction at the heart of “compassionate conservatism,” and it helps explain the tension between the president’s fine words about, say, helping those hurt by Hurricane Katrina, and his actions.

                                                                                      Conservatives don’t have a lot to celebrate these days. Mr. Rove’s attempt at a Great Republican Society has left his party in tatters...

                                                                                      Of course, there is a bright side. If nothing else, Mr. Rove has strengthened the conservative critique of what happens when you try to engineer great societal changes through government policy. Perhaps conservatives can find some solace by telling themselves they were right all along.

                                                                                      The language is careful to talk about changing culture and society rather than the effectiveness of particular government programs, but it leaves the impression that this example helps to prove the general case about government effectiveness. While it's true that Rove and company were unable to push society where it did not want to go, I don't think it says much about the effectiveness of government programs generally.

                                                                                      Take the two main examples above, Social Security and immigration reform. On Social Security, try as they might, conservatives were unable to end or substantially alter the existing program. If the program was a failure, reform plans would not have faced such stiff opposition. On immigration reform, it's not as though a program was put into place and then failed, it never got past the proposed legislation stage. So it's hard to generalize too much about the effectiveness of government programs from that example.

                                                                                      But I think there is a lesson about government programs to be learned from this administration. As events like hurricane Katrina showed, who's running the programs matters, and it matters more than I thought. However, those instances don't prove government failure either, no more than the existence of an incompetent manager at a firm proves private sector failure. All it shows is that if you put incompetent people in charge of things, then bad things can happen.

                                                                                        Posted by on Tuesday, August 14, 2007 at 12:33 AM in Economics, Politics, Social Insurance | Permalink  TrackBack (1)  Comments (44) 


                                                                                        John Campbell: Who are the Noise Traders?

                                                                                        John Campbell on "Households, Institutions, and Financial Markets":

                                                                                        Households, Institutions, and Financial Markets, by John Y. Campbell, NBER Reporter: Economists studying asset pricing have begun to grapple seriously with the extraordinary diversity of financial market participants. Investors, including both households and financial institutions, differ in their overall resources, current and future labor income, housing and other assets that are expensive to trade, tax treatment, access to credit, attitudes towards risk, time horizons, and sophistication about financial markets. My recent research measures and models this heterogeneity, with a particular focus on time horizons and financial sophistication.

                                                                                        Behavioral finance emphasizes that some investors are likely to be more sophisticated about financial markets than others. Early behavioral models emphasized a distinction between "noise traders" and sophisticated arbitrageurs, the former trading randomly and creating profits for the latter.1 This of course raises the question of who can be described as a noise trader. Discussions at conferences are sometimes reminiscent of the old verse "It isn't you, it isn't me, it must be that fellow behind the tree". Recent literature has argued that institutional investors act as arbitrageurs, while the household sector as a whole may play the role of noise traders.

                                                                                        Continue reading "John Campbell: Who are the Noise Traders?" »

                                                                                          Posted by on Tuesday, August 14, 2007 at 12:24 AM in Academic Papers, Economics, Financial System | Permalink  TrackBack (0)  Comments (9) 


                                                                                          Will Consumers in the U.S. Force Change in China?

                                                                                          Can "the fickle American consumer" bring about change in China?:

                                                                                          China's new revolutionaries: U.S. consumers, by Nathan Gardels, Commentary, LA Times: Who would have thought that tainted pet food and toys would threaten to unravel the authoritarian export model of Chinese growth that the brutal Tiananmen Square crackdown in 1989 was partly meant to secure? China's then "paramount leader" Deng Xiaoping, who had been purged during the Cultural Revolution, could well imagine how political upheaval would derail China's stable path to prosperity. But it surely never entered his mind, nor that of his descendant comrades, that the fickle American consumer would one day become, as the students in the square wanted to be, the agent of revolutionary change in China.

                                                                                          In the name of sovereignty, China's leaders for a long time have gotten away with suppressing their own citizens while ignoring the get-gloriously-rich-quick corruption that has thrived in the absence of the rule of law. But, thanks to globalization, China's export reliance on the U.S. market has imported the political demands of the U.S. consumer into the equation. Americans won't hesitate to cut the import lifeline and shift away from Chinese products that might poison their children or kill their pets.

                                                                                          Unlike organized labor or human rights groups, consumers don't have to mobilize to effect change; they only have to stop spending. And their bargaining agents -- Wal-Mart, Target, Toys R Us -- have immensely more clout than the AFL-CIO and Amnesty International in fostering change in China.

                                                                                          Ironically, the United States' "most favored nation" trade treatment for China (and its later entry into the World Trade Organization), which labor and human rights groups so virulently opposed in the past, has become a Trojan horse. China's future is now so linked to the American consumer that Beijing will be forced to curb corruption and strengthen regulation through the rule of law or face the certain doom of its export-led growth. ...

                                                                                          For consumers to trust Chinese products, they must trust regulation of those products. And regulation cannot be trusted without the rule of law, which doesn't bend to bribery, fraud and quanxi (connections). ...

                                                                                          [T]he ultimate paradox of Deng's soft totalitarianism is that privatizing people's lives will ultimately deprive the authorities of their power. As more people come to enjoy private freedom, fewer will abide it being taken away. Globalization, it seems, has accelerated this process by forging a kind of objective coalition of the growing Chinese middle class and the American consumer in favor of the rule of law. ...

                                                                                          Savvy consumers are not likely to buy China's response of prosecuting or executing high-level officials -- "killing the chicken to scare the monkey." They simply want the lead removed from their children's toys or they will take their purchases elsewhere.

                                                                                          Of course, a move toward the reliable rule of law is not democracy, but it is a big step on the long march in that direction.

                                                                                          Some years ago, the once-famous but now forgotten dissident, Wei Jingsheng, lamented how the attention of global public opinion and that of most Chinese had shifted "from Democracy Wall [where Wei was arrested for putting up posters calling for democratic political reforms] to the shopping mall."

                                                                                          Now, especially as the spotlight of next summer's Olympics approaches, it seems the tables may be turning again.

                                                                                            Posted by on Tuesday, August 14, 2007 at 12:15 AM in China, Economics, Regulation | Permalink  TrackBack (0)  Comments (21) 


                                                                                            links for 2007-08-14

                                                                                              Posted by on Tuesday, August 14, 2007 at 12:06 AM in Links | Permalink  TrackBack (1)  Comments (2) 


                                                                                              Monday, August 13, 2007

                                                                                              Paul Krugman: It’s All About Them

                                                                                              Paul Krugman on the similarity between President Bush and leading contenders for the Republican nomination for president:

                                                                                              It’s All About Them, by Paul Krugman, Commentary, NY Times: Ask not what your country can do for you — ask what you can do for your father’s political campaign.

                                                                                              Last week, ... a woman ... asked Mr. Romney whether any of his five sons are serving in the military and, if not, when they plan to enlist.

                                                                                              The candidate replied ... “It’s remarkable how we can show our support for our nation, ... and one of the ways my sons are showing support for our nation is helping to get me elected, because they think I’d be a great president.”

                                                                                              Wow. ... Mr. Romney apparently considers helping him get elected an act of service comparable to putting your life on the line in Iraq.

                                                                                              Yet the week’s prize for most self-centered remark by a serious presidential contender goes ... to ... Rudy Giuliani [who] has lately been getting some long-overdue criticism for his missteps both before and after 9/11. For example, ... Mr. Giuliani is being attacked for his failure to take adequate precautions to protect those who worked on the cleanup at ground zero from the hazards at the site. Many workers have since been sickened by the dust and toxic materials.

                                                                                              For a politician whose entire campaign is based on the myth of his leadership that fateful day ... anything that challenges his personal legend is a big problem. So here’s what Mr. Giuliani said last week...: “I was at ground zero as often, if not more, than most of the workers. ... I was exposed to exactly the same things they were exposed to. So in that sense, I’m one of them.”

                                                                                              Real ground zero workers, who were digging through the toxic rubble while Mr. Giuliani held photo ops, were understandably outraged. ...

                                                                                              What’s striking about these unintentional moments of self-revelation is how much Mr. Romney and Mr. Giuliani sound like the current occupant of the White House.

                                                                                              It has long been clear that President Bush doesn’t feel other people’s pain. His self-centeredness shines through whenever he makes off-the-cuff, unscripted remarks, from his jocular obliviousness in the aftermath of Hurricane Katrina to the joke he made ... when visiting the Brooke Army Medical Center, which treats the severely wounded: “As you can possibly see, I have an injury myself — not here at the hospital, but in combat with a cedar. I eventually won. The cedar gave me a little scratch.”

                                                                                              What’s now clear is that the two men most likely to end up as the G.O.P. presidential nominee are cut from the same cloth.

                                                                                              This probably isn’t a coincidence. ... To be a serious presidential contender, after all, you have to be a fairly smart guy — and nobody has accused either Mr. Romney or Mr. Giuliani of being stupid. To appeal to the G.O.P. base, however, you have to say very stupid things, like Mr. Romney’s declaration that we should “double Guantánamo,” or Mr. Giuliani’s dismissal of the idea that raising taxes is sometimes necessary to pay for things like repairing bridges as a “Democratic, liberal assumption.”

                                                                                              So the G.O.P. field is dominated by smart men willing to play dumb to further their personal ambitions. We shouldn’t be surprised, then, to learn that these men are monstrously self-centered.

                                                                                              All of which leaves us with a political question. Most voters are thoroughly fed up with the current narcissist in chief. Are they really ready to elect another?

                                                                                              _________________________
                                                                                              Previous (8/10) column: Paul Krugman: Very Scary Things
                                                                                              Next (8/17) column: Paul Krugman: Workouts, Not Bailout

                                                                                                Posted by on Monday, August 13, 2007 at 12:33 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (73) 


                                                                                                Mark Gertler: Don't Blame the Fed

                                                                                                Mark Gertler says that monetary policy from 2003 to 2005 helped to stabilize the economy and hence is not to blame for current problems in financial markets:

                                                                                                Bernanke Co-Author Says Fed Was NOT ‘Too Easy for Too Long’, WSJ Economics Blog: Mark Gertler, a prominent economist and close associate of Ben Bernanke, says the Fed didn’t create the current turmoil by keeping interest rates too low earlier this decade, as some have argued. Rather, Mr. Gertler, ... says investors and lenders became more comfortable with risk thanks to the greater stability of economic growth and inflation in recent decades. That “Great Moderation,” says Mr. Gertler, reflects better monetary policy. ...

                                                                                                For the second time in recent days The Wall Street Journal’s editorial page suggests that the recent turmoil in credit markets is due to “the Federal Reserve’s willingness to keep money too easy for too long” during 2003-2005. This kind of reasoning leaves me scratching my head: There is simply no hard evidence to support it. The only telltale sign of when a central bank has been too easy is rising inflation. While it is true that the ... personal consumption expenditures price index excluding food and energy, crept a bit above 2% for a period of time, this is hardly an indication of profligate monetary policy.

                                                                                                Understanding the recent financial market turbulence requires a more nuanced view: Since the early 1980s there has been a significant drop in the volatility of the macroeconomy. .... This phenomenon, known as the Great Moderation, is true not only for the U.S. economy but also for industrialized economies across the globe, with the notable exception of Japan. Most serious observers attribute the Great Moderation to three main factors: (i) good luck (smaller shocks); (ii) structural change (e.g. financial market innovations that have improved borrowing capacity); and (iii) improved monetary policy. While there is debate over the relevant importance of each factor, my own view is that each deserves about equal credit.

                                                                                                The decline in the aggregate volatility of the macroeconomy has naturally lead to a decline in both risk premia and credit spreads. This in itself should not be a problem. However, it is also possible that the relatively long period of tranquility ... has lead to a sense of complacency in financial markets, which in turn has lead investors to fail to appropriately discount risk and lenders to not apply standards that are sufficiently tight. It is also possible that there has been abuse of the existing regulatory system, particularly involving mortgage lending. These kinds of factors play out once the markets are put under stress and only serve to magnify the turmoil, as has been the case recently.

                                                                                                Now, about monetary policy during 2003-2005: By keeping interest rates low in the absence of inflationary pressures, the Fed prudently insured against a Japan-style stagnation. It is not unreasonable to suggest, further, that this period provides an illustration of how the Fed has contributed to the Great Moderation. So, oddly enough, Fed policy may be relevant to current financial market volatility not because it was bad, but rather because it was good!

                                                                                                  Posted by on Monday, August 13, 2007 at 12:24 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (22) 


                                                                                                  Fed Watch: Playing Chicken

                                                                                                  Tim Duy on the likelihood that the Fed will cut rates in coming months:

                                                                                                  Playing Chicken, by Tim Duy: Wow – what a week! One could almost forget that there was an FOMC meeting less than seven days ago. Ancient history as far as financial market participants are concerned, as the surge of Fed lending in the overnight market seemingly made the Fed’s stated inflation concerns seem almost naïve, moving up expectations, once again, for that inevitable rate cut. My caution is to remember that the Fed tends to act more deliberately than markets.

                                                                                                  A sizeable portion of the rise in expectations for an imminent rate cut is clearly attributable to remarkably bad, sensationalistic financial journalism that fed into the turmoil. For criticisms, see Dean Baker and Calculated Risk, for example. The Fed’s actions last week did not constitute a change in policy. Note also that the use of mortgage backed securities as collateral is not new (although the size is impressive). Instead, the Fed was carrying out its stated policy objective – to keep the federal funds rate at its 5.25% target. Jim Hamilton provides a great summary of relevant analysis on this point, concluding with

                                                                                                  The bottom line is that the Fed was doing exactly what it needed to do. But the fact that this was needed is a very troubling development.

                                                                                                  A troubling development, indeed. Interestingly, I warned a couple of weeks back that the economy was likely to run into a period of turbulence that would cause a reevaluation of the Fed’s policy stance, albeit it happened a bit sooner than I anticipated. And so far, all the actors are playing their roles to perfection; with market participants clamoring for a rate cut while the Fed holds steady while making sufficient liquidity available to hold the fed funds rate at its target. Assuming the Fed sticks to its policy statement of just last week, policymakers will be hesitant to cut rates in an inter-meeting move, or even in the September meeting.

                                                                                                  Continue reading "Fed Watch: Playing Chicken" »

                                                                                                    Posted by on Monday, August 13, 2007 at 12:15 AM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (0)  Comments (3) 


                                                                                                    links for 2007-08-13

                                                                                                      Posted by on Monday, August 13, 2007 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (2)