also good for us: a weaker dollar will help our exports, at Europe’s expense

From the NY Times:

---

May 15, 2009, 7:48 pm

China and the liquidity trap

I liked this David Leonhardt article about the China-US economic relationship. But I do have a problem with this passage:

The most obviously worrisome part of the situation today is that the Chinese could decide that they no longer want to buy Treasury bonds. The U.S. government’s recent spending for bank bailouts and stimulus may be necessary to get the economy moving again, but it also raises the specter of eventual inflation, which would damage the value of Treasuries. If the Chinese are unnerved by this, they could instead use their cash to buy the bonds of other countries, which would cause interest rates here to jump, prolonging the recession.

Um, no. Right now we’re in a liquidity trap, which, as I explained in an earlier post, means that we have an incipient excess supply of savings even at a zero interest rate. (By the way, I’ve had a chance to see the transcript of the PEN/ NY Review event, and I don’t think I was misrepresenting Niall Ferguson’s position.)

In this situation, America has too large a supply of desired savings. If the Chinese spend more and save less, that’s a good thing from our point of view. To put it another way, we’re facing a global paradox of thrift, and everyone wishes everyone else would save less.

Or to put it a third way, the argument that a reduction in China’s dollar purchases would be contractionary for America because it would drive up interest rates is equivalent to the argument that fiscal expansion is contractionary for the same reason — and equivalently wrong.

But what if China doesn’t spend more, but just reallocates its reserves from dollars to, say, euros? The answer is, that’s also good for us: a weaker dollar will help our exports, at Europe’s expense.

One of the things I tried to tell the Chinese was precisely that the old co-dependence no longer exists. For now, at least, their dollar purchases are an unalloyed bad thing from America’s point of view."

Me:

If China were buying lots of US bonds, and then stopped, couldn’t that have an effect on the demand for bonds and hence interest rates if the slack isn’t taken up by other investors? Let’s say that this view was taken as a sign that the US is no longer safe in the view of the Chinese, and other investors thought that as well? Couldn’t they choose to buy bonds elsewhere, thereby causing us to raise our rates? To the extent that somebody has to buy something, how can the demand and price for it not matter? I don’t see the analogy with crowding out in the stimulus. I’m saying that a large part of the reason that investors are buying our bonds is their perceived safety. If that were to deteriorate, how could it not cause a problem for our bonds? — Don the libertarian Democrat

these turnover numbers tell a clear story: layoffs aren’t the main problem. A lack of hiring is.

TO BE NOTED:

---

May 15, 2009, 11:38 am

Layoffs Aren’t the Main Problem

By David Leonhardt

What makes the Great Recession different from all other recent recessions is not mainly the number of workers being laid off. It’s how few workers are being hired.

Look at this chart, from the Labor Department’s latest report on labor turnover (which Catherine Rampell also wrote about recently):

Source: Bureau of Labor Statistics

It makes the current recession look qualitatively different from the 2001 recession, right?

The line in the chart is showing the rate at which employers hire new workers. (To be more precise, it is the total number of workers hired in a given month, divided by total nationwide employment, expressed in percentage terms.) Hiring has essentially fallen off a cliff over the last year and a half. It’s far lower than it was during the 2001 recession.

Now consider this chart, which shows the rate at which companies lay off workers:

Source: Bureau of Labor Statistics

Layoffs have clearly soared in the last six months. And the layoff rate has been high for longer in this recession than it was in 2001. But it has not hit a new peak. It’s merely tied its old peak. The layoff rate was roughly the same in March 2009 as it was in March 2001. (Unfortunately, these numbers exist back to just 2000, but another survey suggests the peak layoff rate in the 1990-91 recession was at least as high as the current rate.)

You don’t see these numbers on hires and layoffs very often. The much better known statistic is the net number of jobs added or lost, which comes from the Labor Department’s monthly employment report. The most recent report showed that 539,000 jobs had been lost in April. This net number is the difference between the hiring and layoff numbers, along with a couple of other categories, like the number of workers who quit their jobs.

Imagine, for example, a company that has 100 workers at the start of the month. If it lays off 6 of those workers and hires 5 new workers, the monthly employment report will show a net loss of 1 job. But the turnover survey will show the details behind that net loss: 6 layoffs and 5 hires.

When people talk about the enormous job losses of the last year, they tend to assume that job cuts are the main reason. But these turnover numbers tell a clear story: layoffs aren’t the main problem. A lack of hiring is.

Why? How should the government respond? How should the country’s long-term economic policies be changed to reverse this long-term decline in hiring? All are good, hard questions.

It’s hard to see how we’ll find the right solutions if we are misdiagnosing the problem."

the aggressive steps taken by the government have so far muted the impact of “deleveraging”

TO BE NOTED: From the NY Times:

"Economic Scene
As Job Losses Slow, a Recovery Could Move In

By DAVID LEONHARDT

Ben Bernanke sounded more optimistic on Tuesday than he has in a long time, and President Obama has talked about glimmers of hope. The stock market has risen 34 percent from its 2009 nadir.

On Friday morning, we will get the clearest sign yet of whether these glimmers are real. That’s when the Labor Department will release its monthly jobs report, the single most important economic indicator out there. As bad as the job market is, it no longer seems to be getting worse at an accelerating pace. In both February and March, the economy lost fewer than 670,000 jobs; in January, it had lost 741,000.

In past recessions, a slowdown in the rate of job loss has been a telling sign. A few months after that, the economy typically began growing again. The vicious cycle turned virtuous.

After a stretch of unrelenting bad news, dating to last year, the economic signals have been more mixed lately. In just the last week, data on home sales, manufacturing and the service sector have all been better than expected. This welcome news has caused many of us who are pessimistic about the economy’s near-term fortunes to reassess.

“At the moment,” says Joshua Shapiro, chief United States economist with MFR, a New York research firm, “those forecasting nearer-term recovery have the recent data on their side.”

There is still a strong case to be made that the economy won’t feel truly healthy anytime soon, not this year or perhaps even next.

The overhang from the 20-year bubble in stocks and then real estate won’t simply go away. As Mr. Shapiro says, “Wage and salary growth has evaporated, credit is very tight, home prices continue to decline, financial asset values have been decimated and household balance sheets are extremely stressed.”

But the difference between a bad economy and a depression is real. We’ve taken a few steps away from depression lately. If Friday’s jobs report shows more progress, it will suggest that Mr. Bernanke’s optimism is legitimate.

•

Wall Street has a notoriously bad forecasting record. It almost always predicts that the economy will grow by something like 3 percent a year, which happens to be correct most of the time. But when a forecast would most be useful — when the economy is turning — Wall Street doesn’t offer much guidance. Amazingly enough, Wall Street’s consensus forecast has failed to predict a single recession in the last 30 years.

A small firm in New York called the Economic Cycle Research Institute has a much better record. It was founded by Geoffrey Moore, an economist who helped invent the idea of leading indicators. He used historical patterns to predict the economy’s direction, and unlike most Wall Street forecasters, he wasn’t afraid to stand apart from the crowd. In 2006, while most forecasters were still talking about 3 percent growth, Mr. Moore’s protégés were issuing warnings (though they were still too optimistic).

Today, they think the economy is on the verge of turning. “We’re in the worst recession since World War II,” says Lakshman Achuthan, the managing director of the Economic Cycle Research Institute. “However, the days of this recession are limited.”

The main reason, he says, is the economy’s normal self-correcting mechanism. That mechanism, I realize, is somewhat counterintuitive. You often hear — and we in the news media often write — about the vicious cycle of job cuts, spending cuts and yet more job cuts. Eventually, though, the cycle always ends, and momentum reverses.

How? Prices fall by enough to tempt households to spend. Businesses cut their costs, become profitable again, and begin to expand. Spending begets more spending. This is what’s happening now, Mr. Achuthan argues. The stimulus plan is also making a difference, he says, and so are the government’s efforts to reduce the cost of borrowing.

Obama administration officials have been a bit more circumspect. They have said, as you would expect them to, that more disappointments are likely. But Lawrence Summers, the top economic adviser, has also been talking lately about the economy’s tendency to self-correct.

To replace worn-out vehicles and accommodate a growing population, Americans need to buy roughly 14 million vehicles a year, Mr. Summers says. Recently, they have been selling at an annual pace of only nine million. At some point, more people will have to start buying.

The Economic Cycle Research Institute’s data show that, in every previous downturn in the last 75 years, the economy has started to grow no more than four months after its pace of deterioration has unquestionably slowed. So that’s what the institute is forecasting: the Great Recession will most likely be over by Labor Day.

Friday’s jobs report, covering April, will support this case if, at the very least, it shows job losses of no more than 650,000 a month. The average forecast among economists is roughly 610,000. The Labor Department’s revisions to its February and March numbers will also be worth watching.

Still, even most optimists, including Mr. Achuthan, are not predicting a fabulous recovery. The forces weighing on the economy are too strong.

Stock prices, despite their dizzying fall, are only slightly below their historical average, relative to long-term earnings, which suggests that a true bull market is unlikely. Home prices still have some way to fall. Eventually, the government will need to bring down the budget deficit, and doing so will hold back economic growth.

Morgan Stanley’s economists put out a thoughtful report this week, pointing out that the aggressive steps taken by the government have so far muted the impact of “deleveraging” — the paying down of debt by households and Wall Street. But this debt repayment is still happening, and it will be a drag on growth for a long time. The debt and the severity of this recession also raise the risk that the recent signs will turn out to be a false dawn, much as the economy slipped back into a deep downturn in the mid-1930s.

And whenever the economy begins growing again, it won’t feel good for a while. Slowing job losses aren’t the same as job gains. The unemployment rate may continue to rise into 2010 — and not come down to a healthy level until even later.

As a point of reference, the recession of the early 1990s ended in March 1991, but Americans were still so dissatisfied that they removed George H. W. Bush from office a year and a half later.

So the situation is not as dark as it was a few months ago. Maybe Friday’s jobs report will bring more reason for hope. But the Great Recession, or at least its impact, still has a way to go.

E-mail: leonhardt@nytimes.com"

having held off while waiting to find out which homeowners would be eligible for the Obama administration’s assistance program

TO BE NOTED: From the NY Times:

Economic Scene

For Housing Crisis, the End Probably Isn’t Near

By DAVID LEONHARDT

The closest thing to a real estate crystal ball in the last few years has been the house auctions that are regularly held around the country.

In 2006 and early 2007, the official housing statistics were still showing that house prices were holding up. But that was largely because so many sellers were refusing to sell. Themade up mostly of foreclosed homes, showed the truth: house values were starting to plummet in many places.

So a few weeks ago, I decided to go to an auction at a hotel ballroom in Washington — and to study the results of several others elsewhere — with an eye to figuring out whether prices may now be close to bottoming out.

That’s clearly a huge economic question. Last week, JPMorgan’s chief financial officer told Eric Dash of The New York Times that JPMorgan, and presumably other banks, would be under pressure “until home prices stabilize and unemployment peaks.” As long as home prices are falling, foreclosures are likely to keep rising and the toxic assets polluting bank balance sheets are likely to stay toxic.

There are reasons, though, to think that prices may be on the verge of stabilizing. Relative to fundamentals, like household incomes and rents, houses nationwide now appear to be overvalued by only about 5 percent. You can make an argument that the end of the housing crash is near.

But that’s not what I found at the auctions.

•

“This is a perfect storm of opportunity,” Bob Michaelis, goateed with a shaved head, told the 300 or so people who had come to downtown Washington for the auction.

Mr. Michaelis, the auction manager, spoke from a lectern on stage, and his goal seemed to be to persuade people that they might never see a buyers’ market as good as this one. Prices have plunged, and interest rates, he said, are at “generational lows.” (The National Association of Realtors has been running a radio commercial this spring making a similar case.)

“Look around to your left and your right, and you’ll see someone who sees an opportunity just like you do,” Mr. Michaelis said. “We’re approaching the bottom of the market, I think. We’re approaching the bottom of the market, if we’re not there already.”

He then told the audience that, in the last 100 years, house prices have recovered from every downturn and gone on to reach record highs. Oh, and Wells Fargo and Countrywide were standing by, ready to offer financing to qualified auction buyers.

If nothing else, this sales pitch certainly had chutzpah. It combined the old bubble-era notion that house prices always rise over time (ignoring the fact that incomes, stock values and the price of bread do, too) with the new postcrash idea that houses must be a bargain because they’re a lot cheaper than they used to be. Even Countrywide, which was taken over by Bank of America after so many of its subprime mortgages went bad, is still part of the housing pitch.

Yet as soon as the auction began, it was clear that the pitch wasn’t working.

The winning bid on the first home auctioned off, a two-bedroom townhouse in Virginia Beach, was $115,000. Just last July, it sold for $182,000, according to property records. A four-bedroom brick house with a two-car garage in Upper Marlboro, Md., went for $375,000. Last year, it sold for $563,000.

Throughout the evening, such low-ball prices continued to win the bidding. At one point, the auctioneer, Wayne Wheat, interrupted his sing-song auction call to cheerfully ask, “Where are my investors?”

The tables that had been set up around the edges of the ballroom, reserved for people planning to buy multiple houses, were mostly empty. Many audience members, like the man in a camouflage baseball cap just in front of me, were attending their first auction.

On Sunday, my colleague Carmen Gentile went to a larger auction, in Miami, to see if my experience had been unusual. It wasn’t. The homes there also sold for just a fraction of what they would have even a year ago. The rate of decline in Miami hasn’t even slowed noticeably in recent months, according to data kept by Real Estate Disposition Corporation, known as R.E.D.C., which runs the auctions.

A recently transplanted New Yorker named Michael Houtkin won the bidding on a one-bedroom condominium on the outskirts of Boca Raton, a few blocks from three golf courses, for the incredible price of $30,000. “Things were almost being given away,” he said later.

As is often the case at these auctions, the seller of the condo — Fannie Mae — retained the right to refuse the winning bid and keep the property. But Mr. Houtkin told me he was optimistic his bid would be accepted. An R.E.D.C. employee suggested to him that $30,000 wasn’t much below the minimum price that Fannie Mae had hoped to receive.

How could that be? Because Fannie Mae, like many banks, is inundated with foreclosed properties. In recent weeks, banks have begun accelerating foreclosures again, after having held off while waiting to find out which homeowners would be eligible for the Obama administration’s assistance program.

The glut of foreclosed homes creates a self-reinforcing cycle. Falling prices lead to more foreclosures. Foreclosures lead to an excess supply of homes for sale. The excess supply then leads to further price declines. Jan Hatzius, the chief economist at Goldman Sachs, says that the “massive amount of excess supply” means that home prices nationwide will probably fall an additional 15 percent.

This estimate hides a lot of variation, too. In Miami, Goldman forecasts, prices could drop an additional 33 percent, which is pretty amazing since they’ve already fallen 50 percent from their 2006 peak.

Nor is excess supply the only reason prices still have a way to fall. Nationwide, homes may not be overvalued by much. But in some cities, including New York, San Francisco, Los Angeles, Boston, Chicago and Miami, they remain very expensive.

So while Mr. Hatzius and his Goldman colleagues are somewhat more pessimistic than most forecasters, but the difference isn’t enormous.

I’ll confess that this bearish picture isn’t exactly what I had hoped to find. A year ago, as part of a move from New York to Washington, my wife and I bought our first house.

We did so fully expecting prices to continue falling (though perhaps not as much as they ultimately will, given the severity of the financial crisis). But we decided they had fallen enough for us to take the plunge. We preferred buying before the bottom of the market instead of renting and having to move again in a year or two.

Still, when I wrote about that decision last spring, I argued that anyone who didn’t have to probably should not buy yet. Prices still had a way to fall.

They don’t have as far to fall today, but the great real estate crash is not over, either. So if you are part of the 30 percent of American households who rent and you’re trying to decide when to buy, relax.

The market is still coming your way.

E-mail: Leonhardt@nytimes.com"

For Housing Crisis, the End Probably Isn’t Near

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but that's not the point

From Felix Salmon:

"Taxing the $5 Million-a-Year Brigade

David Leonhardt wants to hike taxes on the very highest earners:

Today's tax code makes no distinction between income above $373,000 and income above, say, $5 million. Both are taxed at 35 percent.
That is a legacy of the tax changes of the early 1990s, when far less of the nation's income went to millionaires. Today, you can make a good argument for a new, higher tax bracket on the very largest incomes. In the past, the economist Thomas Piketty says, higher marginal tax rates tended to hold down salaries and bonuses, because executives had less incentive to angle for multimillion-dollar pay.
Do these ideas stem in part from anger and bitterness? Of course they do. How can you not be a little angry and bitter about the role that huge, unjustified pay played in causing the worst recession in a generation?
In fact, that's sort of the point. Given the damage that's been caused by our decidedly unmeritocratic system of paying executives, the most irrational course of all would be the status quo.

Creating a new tax bracket for people making more than $5 million a year wouldn't raise a huge amount of money for the government, but that's not the point -- just as the reason that people like me want to claw back bonuses from AIG has nothing to do with recouping any significant portion of the money that the government has poured into the insurer.

The point is that incentives matter, and that if you skew people's incentives with horribly-designed winner-takes-all pay structures, you're liable to get extremely nasty consequences.

I'm reminded of Dan Ariely's TED talk on cheating: if you create an atmosphere where large sums of money start to lose all meaning, people are going to cheat more. And when pay soars past the $5 million-a-year mark, it no longer has any connection to expenditures: it's just a race, really, to see who can make the most money.

One person infected by such a mindset is Evan Newmark, who's nicely stilettoed by Ryan Chittum:

Think about your own behavior in the giddy pre-Crash years. Did you bully a raise from your boss when one of your colleagues left? Did you buy a little condo in Miami to cash in on the boom? Did you throw more money into brokerage stocks as they rose higher and higher?

Well, outside the bubble the answers for 99 percent of us are : No, no, and no.

Is it the job of fiscal policy to create a tax regime which mitigates against the formation of devastating bubbles? I don't see why not; it might even fit in with the behavioral-economics bent of the Obama team. But still, I doubt this is going to happen: it's quite un-American. Many people work very hard, in this country, because they dream of one day pulling down a spectacular seven-or eight-figure income. Does Obama really want to kill that highly-motivating dream?"

Me:

I've never understood this. I care very much that people not be destitute, which is why I favor a guaranteed income with health care. I also believe that we need a real middle class that feels middle class in order to ever have smaller government, and for real social stability. But, other than that, I couldn't care less what people make. To me, it's as much luck as skill or talent, but so what? It seems to be a focus on envy rather than on helping the less fortunate, and divert our attention on the real problem, poverty. I feel the same way about these AIG bonuses. It shows a preference for symbolism over substance. If the bonuses are illegal, fine. Otherwise, pay them and move on. The fact that these bonuses are the tipping point strikes me as strange. It's like swinging at the pitch when the ball is already in the mitt, and then trying to figure out a way to call a balk.

By DonthelibertarianDemocrat Posted: Mar 18 2009 5:30pm ET

As long as the Too Big To Fail doctrine holds, the banks’ implicit government guarantee is more explicit than it ever has been.

From The Baseline Scenario:

"Looting Goes Mainstream (Media)

with 3 comments

A week ago, Simon wrote his “Confusion, Tunneling, and Looting” post, which argued that the confusion created by crises helps the powerful and well-positioned siphon assets out of institutions and out of the government. The revelations that much of the AIG bailout money has gone straight to its large bank counterparties in the form of collateral could fall under this heading.

The looting theme has gone mainstream, with David Leonhardt in The New York Times. I think Leonhardt’s article is good, but it describes looting (taking advantage of implicit government guarantees to take excessive risks) as a cause of the mess we are now in - and as something we’ll need to worry about in preventing crises in the future. But, as Simon argued, it’s also something to worry about right now. As long as the Too Big To Fail doctrine holds, the banks’ implicit government guarantee is more explicit than it ever has been. So whatever perverse incentives helped bring on the crisis are even stronger today.

Written by James Kwak

March 12, 2009 at 8:15 am"

Me:

From Bloomberg:

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aKqHkkFlnvfM

“Most U.S. bank debt is held by insurers and foreign investors, with a small portion owned by mutual funds, said FTN’s Darst. The Investment Company Institute, a trade group representing mutual funds, doesn’t keep statistics on fund ownership of bank debt, spokeswoman Ianthe Zabel said.

Investors shouldn’t increase holdings that lack explicit government guarantees because “extreme losses” could force senior creditors to share in bailout costs, JPMorgan Chase & Co. said in a March 6 report by Srini Ramaswamy. While the scenario remains remote, owning the banks’ senior debt isn’t attractive when there’s concern about systemic risk, Ramaswamy wrote.

“We’re seeing the start of the next leg of the crisis and that’s going to be financial bondholders taking a haircut as lenders default,” Mehernosh Engineer, a London-based strategist at BNP Paribas SA, said this week. “There’s been a perception that banks’ senior bondholders are untouchable, but that’s going to change.”

Look at who owns this debt: Insurers, Foreign Investors.

Let’s say we allow defaults on this. Who are the insurers? Will we simply have to then prop them up instead? Have you seen any recent headlines about insurers being the next big problem?

Foreign investors? Try this:

http://blogs.cfr.org/setser/2009/01/29/read-dean-areddy-and-ng-on-the-management-of-chinas-reserves-during-the-crisis/

“It turns out that one of China’s main criticism of US policy is simple: the government didn’t stand by institutions that China expected the US to support. Lehman. Wamu. And the Reserve Primary Fund. Dean, Areddy and Ng:

“Leaders in China, the world’s third-largest economy, have been surprised and upset over how much the problems of the U.S. financial sector have hurt China’s holdings. In response, Beijing is re-examining its U.S. investments, say people familiar with the government’s thinking. …

Chinese leaders have felt burned by a series of bad experiences with U.S. investments they had believed were safe, say people familiar with their thinking, including holdings in Morgan Stanley, the collapsed Reserve Primary Fund and mortgage giants Fannie Mae and Freddie Mac.”

….. The Reserve issue “is causing a lot of concern with a lot of financial institutions in China,” said the Chinese official. Some officials expected that the U.S. and its financial institutions would better protect China from loss. “If the U.S. is treating us this way, eventually that will be enough cause for concern in the stability of the [U.S.] system,” the official said.”

Why does this bother me? Because this shifts the focus to Treasuries. From Buiter:

“In addition to (1) and (2) being met, there must be sufficient ‘fiscal spare capacity’ - confidence and trust in the financial markets and among permanent-income consumers, that the government will raise future taxes or cut future public spending by the same amount, in present discounted value terms, that they want to boost spending or cut taxes today. Without this confidence and trust, financial markets and forward-looking consumers will be spooked by the spectre of unsustainable fiscal deficits. Fear of future monetisation of public debt and deficits, or of future sovereign default will cause nominal and real long-term interest rates to rise. Ultimately, the sovereign will be rationed out of its own debt market. The US government (and the US economy as a whole) will encounter a ’sudden stop’.

These are not tales to frighten the children. I am deeply concerned that, when the US Federal government starts to run Federal budget deficits of 14 percent of GDP or over, the markets will get spooked and will simply refuse to fund the US authorities at any interest rate. Summers’ naive proposal for expansion now, virtue later, is simply not credible given the political economy of the US budget, now and in the foreseeable future.”

We’re in a bind. Either we default on these bonds, leading foreign investors to suspect that we’re default happy, or we guarantee the bonds, possibly adding to our debt. In all honesty, it might be better to guarantee the debt, and pray we don’t have to honor it.

Since I consider looting ( govt guarantees ) and fraud, negligence, collusion, and fiduciary mismanagement, as the main causes of this crisis, I don’t like giving in. But it’s important to consider that, in this case, we’re giving in to foreign investors who we need, and insurers who will probably come calling as well with lobbying debts in tow. The one benefit is that it would make seizure easier.

So, let’s guarantee the bondholders, and seize the big banks, and remember that this isn’t going to be a battle quickly won.

Just one view.

The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.

From the WSJ:

"Secondary Sources: Greenspan’s Defense, Depression, Looting

A roundup of economic news from around the Web.

• Greenspan Defense: On the Journal’s opinion pages, former Federal Reserve Chairman Alan Greenspan says the central bank wasn’t responsible for the housing bubble. “There are at least two broad and competing explanations of the origins of this crisis. The first is that the “easy money” policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today’s financial mess. The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages. Between 2002 and 2005, home mortgage rates led U.S. home price change by 11 months. This correlation between home prices and mortgage rates was highly significant, and a far better indicator of rising home prices than the fed-funds rate.”
• What Is Depression?: Calculated Risk looks at what would need to happen for this recession to become a depression. “Some people argue the duration of the economic slump defines a depression - and the current recession is already 15 months old. That is longer than the recessions of ‘90/’91 and ‘01. The ‘73-’75 recession lasted 16 months peak to trough, and the early ’80s recession (a double dip) was classified as a 6 month recession followed by a 16 month recession (22 months total). Those earlier periods weren’t “depressions”, so if duration is the key measure, the current recession still has a ways to go… Even though the current recession is already one of the worst since 1947, it is only about 1/3 of the way to a depression (assuming a terrible Q1). To reach a depression, the economy would have to decline at about a 6.6% annual rate each quarter for the next year… I still think a depression is very unlikely. More likely the economy will bottom later this year or at least the rate of economic decline will slow sharply. I also still believe that the eventual recovery will be very sluggish, and it will take some time to return to normal growth.”
• Looting: David Leonhardt of the New York Times looks at a 1993 paper titled “Looting” by George Akerlof and Paul Romer, and he sees parallels to the current crisis. ““Looting” provides a really useful framework. The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem. Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame. But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem. Do you remember the mea culpa that Alan Greenspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess. He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all.”

Compiled by Phil Izzo"

Me:
11:26 am March 11, 2009

• • • Don the libertarian Democrat wrote:

    “The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.”

    You’ve got it. This is the main cause of the crisis, even though it’s practically impossible to get people to see this. Maybe this post will help.

In layman’s terms, he was asking for a clearer legal path to nationalization.

From the NY Times:

"Banks Counted on Looting America’s Coffers

By DAVID LEONHARDT

Sixteen years ago, two economists published a research paper with a delightfully simple title: “Looting.”

The economists were George Akerlof, who would later win a Nobel Prize, and Paul Romer, the renowned expert on economic growth. In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.

In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

On Tuesday morning in Washington, Ben Bernanke, the Federal Reserve chairman, gave a speech that read like a sad coda to the “Looting” paper. Because the government is unwilling to let big, interconnected financial firms fail — and because people at those firms knew it — they engaged in what Mr. Bernanke called “excessive risk-taking.” To prevent such problems in the future, he called for tougher regulation.

Now, it would have been nice if the Fed had shown some of this regulatory zeal before the worst financial crisis since the Great Depression. But that day has passed. So people are rightly starting to think about building a new, less vulnerable financial system.

And “Looting” provides a really useful framework. The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.

Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.

But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.

Do you remember the mea culpa that Alan Greenspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.

He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all.

•

The term that’s used to describe this general problem, of course, is moral hazard. When people are protected from the consequences of risky behavior, they behave in a pretty risky fashion. Bankers can make long-shot investments, knowing that they will keep the profits if they succeed, while the taxpayers will cover the losses.

This form of moral hazard — when profits are privatized and losses are socialized — certainly played a role in creating the current mess. But when I spoke with Mr. Romer on Tuesday, he was careful to make a distinction between classic moral hazard and looting. It’s an important distinction.

With moral hazard, bankers are making real wagers. If those wagers pay off, the government has no role in the transaction. With looting, the government’s involvement is crucial to the whole enterprise.

Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains. As Gretchen Morgenson has reported, Merrill Lynch’s losses from the last two years wiped out its profits from the previous decade.

What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.

In effect, the bankers had siphoned off this bailout money in advance, years before the government had spent it.

I understand this chain of events sounds a bit like a conspiracy. And in some cases, it surely was. Some A.I.G. employees, to take one example, had to have understood what their credit derivative division in London was doing. But more innocent optimism probably played a role, too. The human mind has a tremendous ability to rationalize, and the possibility of making millions of dollars invites some hard-core rationalization.

Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”

Unfortunately, we can’t very well stop the flow of that money now. The bankers have already walked away with their profits (though many more of them deserve a subpoena to a Congressional hearing room). Allowing A.I.G. to collapse, out of spite, could cause a financial shock bigger than the one that followed the collapse of Lehman Brothers. Modern economies can’t function without credit, which means the financial system needs to be bailed out.

But the future also requires the kind of overhaul that Mr. Bernanke has begun to sketch out. Firms will have to be monitored much more seriously than they were during the Greenspan era. They can’t be allowed to shop around for the regulatory agency that least understands what they’re doing. The biggest Wall Street paydays should be held in escrow until it’s clear they weren’t based on fictional profits.

Above all, as Mr. Romer says, the federal government needs the power and the will to take over a firm as soon as its potential losses exceed its assets. Anything short of that is an invitation to loot.

Mr. Bernanke actually took a step in this direction on Tuesday. He said the government “needs improved tools to allow the orderly resolution of a systemically important nonbank financial firm.” In layman’s terms, he was asking for a clearer legal path to nationalization.

At a time like this, when trust in financial markets is so scant, it may be hard to imagine that looting will ever be a problem again. But it will be. If we don’t get rid of the incentive to loot, the only question is what form the next round of looting will take.

Mr. Akerlof and Mr. Romer finished writing their paper in the early 1990s, when the economy was still suffering a hangover from the excesses of the 1980s. But Mr. Akerlof told Mr. Romer — a skeptical Mr. Romer, as he acknowledged with a laugh on Tuesday — that the next candidate for looting already seemed to be taking shape.

It was an obscure little market called credit derivatives."

Me:

"With moral hazard, bankers are making real wagers. If those wagers pay off, the government has no role in the transaction. With looting, the government’s involvement is crucial to the whole enterprise."

"Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”

Thank you for this post. I believe that looting was the main cause of this crisis. At least now, some people will finally see its importance.

I'd like to add this quote:

WHY BANKS FAILED THE STRESS TEST
Andrew G Haldane*
Executive Director for Financial Stability
Bank of England
13 February 2009

http://www.bankofengland.co.uk...

"No. There was a much simpler explanation according to one of those present. There was absolutely no incentive for individuals or teams to run severe stress tests and
show these to management. First, because if there were such a severe shock, they would very likely lose their bonus and possibly their jobs. Second, because in that
event the authorities would have to step-in anyway to save a bank and others suffering a similar plight.
All of the other assembled bankers began subjecting their shoes to intense scrutiny. The unspoken words had been spoken. The officials in the room were aghast. Did
banks not understand that the official sector would not underwrite banks mismanaging their risks? Yet history now tells us that the unnamed banker was spot-on. His was a brilliant articulation of the internal and external incentive problem within banks. When the big
one came, his bonus went and the government duly rode to the rescue. The timeconsistency problem, and its associated negative consequences for risk management, was real ahead of crisis. Events since will have done nothing to lessen this problem, as successively larger waves of institutions have been supported by the authorities"

Don the libertarian Democrat

— Don, Tacoma, WA

"So far, at least, this recession can only be said to be the worst since 1982."

I agree with Justin Fox here:

"In today's NYT, David Leonhardt digs up some obscure Labor Department statistics to document something I've been touching on in this blog: So far, at least, this recession can only be said to be the worst since 1982.

Including discouraged workers ... the unemployment rate was 7.6 percent last month. Another 5.2 percent of the labor force was involuntarily working part time. These two groups bring the combined rate to 12.8 percent. ... And there appear to be several hundred thousand people — mostly men — who stopped looking for work more than a year ago but would gladly take a good-paying job if one came along. They would lift the rate above 13 percent.

As bad as the number is, it is still not that close to its 1982 peak of 16.3 percent (or anywhere near its Depression levels, which were probably above 30 percent).

Now this recession isn't over yet. By the time that it is, I wouldn't be shocked if unemployment had surpassed its 1982 levels—making this the worst economic downturn since the Great Depression. Still, all indications are that it's much closer in severity to the deep recessions of the mid-1970s and early 1980s than to the complete disaster that was the early 1930s.

The financial crisis of the past couple years has been more like that of the 1930s than anything since. But the government response—however bungled and expensive it's been—seems to have kept the economic damage within bounds. So far."

I agree.

Are Sticky Wages Stickier Than Sticky Buns?

Felix Salmon posts about the idea that employers don't like to reduce wages in a recession or economic downturn:

"David Leonhardt on deflation, Wednesday:

The drop in prices, which isn't over yet, will make life easier on millions of people. It's possible, in fact, that the current recession will do less harm to the typical family's income than it does to many other parts of the economy.
The reason is something called the sticky-wage theory. Economists have long been puzzled by the fact that most businesses simply will not cut their workers' pay, even in a downturn. Businesses routinely lay off 10 percent of their workers to cut costs. They almost never cut pay by 10 percent across the board.

Fedex press release, Thursday:

FedEx is now implementing a number of additional cost reduction initiatives to mitigate the effects of deteriorating business conditions, including:
Base salary decreases, effective January 1, 2009:
* 20% reduction for FedEx Corp. CEO Frederick W. Smith
* 7.5%-10.0% reduction for other senior FedEx executives
* 5.0% reduction for remaining U.S. salaried exempt personnel

Fedex is largely non-union, which means that most workers are taking a pay cut. I'm not sure this is necessarily a bad thing, if it avoids layoffs and reductions in service quality, instead spreading the pain around more thinly. But it does point to the possibility that this recession will indeed be different, and that it might mark the beginning of the end of sticky wages.( COULD BE. PROACTIVE FEAR OVERRIDING EVERYTHING ELSE )

There's been a huge shift in power in recent years from labor to capital: corporate profits have been rising much faster than wages for some time now ( DON'T TELL THAT TO PEOPLE WHO BELIEVE THAT ORGANIZED LABOR IS TOO POWERFUL ). It makes sense that capital would make use of its newfound power to reduce labor costs in a deflationary environment of rising unemployment. During the boom, companies laid off workers because those workers demanded, and cost, too much money. Now that workers have lost their negotiating leverage, we might start seeing more across-the-board pay cuts." ( COULD BE )

I would say that, in the case of FedEx, my understanding is that they are fighting for their life. In a possible bankruptcy situation, cutting wages is much easier. It might well be that in this current situation many businesses will end up near bankruptcy and that wage cuts could be higher than usual. It might also be that the fear and aversion to risk has effected workers to the point that lower wages in exchange for a job seems a good deal.

However, let me raise a few points:
1) Productivity is still rising
2) Worker's morale is not something you want to help depress in an already downbeat situation
3) As I pointed out in " I Don't Work In AIG Crap", workers who have made money for the company are not going to be happy taking a pay cut for other people's losses. It is possible that such treatment will lead them to look for another job, leading to the possible loss of the best employees of the business.

It might well turn out that wages aren't as sticky as they used to be, and it might also turn out to be a very bad thing for businesses and the economy, as well as the workers.

"the current recession will do less harm to the typical family’s income than it does to many other parts of the economy."

I've started calling these "Silver Lining Stories", but to me, again, there is a difference between falling prices and deflation. Yet, even in deflation, some people would turn out to be better off. Not everyone loses in deflation. This is not a new point. I've already posted about the possible benefits of falling commodities prices. From the NY Times, David Leonhardt:

"Very few Americans alive today can remember a time when prices across the economy were falling. But they’re falling now.

Multimedia

Graphic

Deflation Rears Its Head

"The cost of fruits, vegetables, clothing and vehicles are all dropping. Housing prices have been falling for more than two years, and a barrel of oil costs about $45, down from $145 in July.

The inflation report released by the government on Tuesday showed that the Consumer Price Index was 3 percent lower last month than it had been three months earlier. It was the steepest such drop since 1933.

These declines have raised fears of a deflationary spiral — fears that help explain the Federal Reserve’s surprisingly large interest rate reduction on Tuesday. And there is good reason to fear deflation. Once prices start to fall, many consumers may decide to reduce their spending even more than they already have. Why buy a minivan today, after all, if it’s going to be cheaper in a few months? Multiplied by millions, such decisions weaken the economy further, forcing companies to reduce prices even more. ( THAT'S THE WORRY )

But a truly destructive cycle of deflation is still not the most likely outcome. For one thing, the price of oil cannot fall by another $100 in the next few months. For another, the federal government will soon, finally, be fully engaged in trying to stimulate the economy.( TRUE )

In mechanical terms, the Fed’s rate cut is actually a decision to pump more money into the economy (which will cause short-term interest rates to fall) ( QUANTITATIVE EASING, PRINTING MONEY, DEBASING THE COINAGE ). Starting next year, the Obama administration is planning to spend hundreds of billions of dollars on public works and other programs. ( STIMULUS, KEYNESIAN )

All else being equal, more money sloshing around an economy causes prices to rise. In this case, it will probably keep them from falling as much as they otherwise would have. ( TRUE. GRANT BELIEVES THAT THEY SHOULD BE ALLOWED TO FALL )

So amid all the legitimate worries about deflation, it’s worth considering what may be the one silver lining in the incredibly bad run of recent economic news: The cost of living is falling. ( TRUE )

Jobs are disappearing, bonuses are shrinking and raises will be hard to come by. But the drop in prices, which isn’t over yet, will make life easier on millions of people. It’s possible, in fact, that the current recession will do less harm to the typical family’s income than it does to many other parts of the economy. ( TRUE )

The reason is something called the sticky-wage theory. Economists have long been puzzled by the fact that most businesses simply will not cut their workers’ pay, even in a downturn. Businesses routinely lay off 10 percent of their workers to cut costs. They almost never cut pay by 10 percent across the board.

Traditional economic theory doesn’t do a good job of explaining this. During a recession, the price of hamburgers, shirts, cars and airline tickets falls. But the price of labor does not. It’s sticky.

In the 1990s, a Yale economist named Truman Bewley set out to solve this riddle by interviewing hundreds of executives, union officials and consultants. He emerged believing there was only one good explanation.

“Reducing the pay of existing employees was nearly unthinkable because of the impact of worker attitudes,” he wrote in his book “Why Wages Don’t Fall During a Recession,” summarizing the view of a typical executive he interviewed. “The advantage of layoffs over pay reduction was that they ‘get the misery out the door.’ ” ( I AGREE WITH ATTITUDES BEING THE CAUSE )

Companies resort to cutting jobs and giving only meager pay increases, increases that are even smaller than the low rate of inflation that’s typical during a recession. This recession may well be the worst in a generation — but thanks to the stickiness of wages, the pay drop for most families may not be much worse than that of a typical recession.( TRUE )

The forecasting firm IHS Global Insight predicts that prices will fall by an additional 1 percent in 2009. That would bring the total drop, from the summer of 2008 to the end of 2009, to roughly 4 percent. But you can be sure that most executives will not force their workers to take a 4 percent cut in their paychecks. The fears about morale will be too great.( TRUE. MORALE IS IMPORTANT )

Strange as it sounds, the drop in prices will keep real incomes — inflation-adjusted incomes — from dropping too much. ( TRUE )

I don’t mean to make things sound better than they are. The economy is bad and getting worse. A deflationary spiral remains a real threat, even if it’s not the most likely result. No matter what, unemployment is headed much higher.

People who keep their jobs, meanwhile, will suffer through some stealth pay cuts — higher health insurance premiums, for instance. Raises will also remain meager in 2010, even if prices start rising again. Like every other recent recession, this one will force families to take an effective pay cut, and a significant one.

But the drop in prices will still soften the blow. And at this point, American families can use any bit of economic help that they can get."

It's all true, but, remember, we don't know exactly what Deflation would actually lead to. It might well change the terms on which a lot of these silver lining stories are based upon.

"Gladwell’s hit upon a politically charged topic and reached conclusions that are discomfiting to the very successful"

Matt Yglesias on Malcolm Gladwell and the reception in the media to his new book:

"I’ve really been taken aback by a lot of the hostile response to Malcolm Gladwell’s Outliers that I’ve read. This isn’t a book without flaws. But the flaws in the book are flaws that have long been present in Gladwell’s writing. And at the same time, Gladwell has long been one of America’s most successful and celebrated non-fiction writers. And that’s because the flaws in his work are, frankly, pretty darn forgivable. Nothing he writes is up to the standard of a peer reviewed scientific journal, and everything he writes is about a million times more readable than anything you’d find in a journal. Yes, some of the stuff in Outliers (in particular, the bit about airplane crashes) doesn’t really seem relevant to the main point, but that’s true of The Tipping Point and Blink as well and folks didn’t seem to mind too much. Nor should they mind too much — the bit about plane crashes is fascinating."

I tend to enjoy this kind of writing of non-fiction, but I also often end up just thumbing through the book instead of reading it carefully all the way through. One problem I often find now, and Gladwell's previous books fit into this category, is that, once I've gotten what I believe is the main argument, I start to lose interest in the book, even if well written. I will probably take it out from the library at some point, and thumb through it or maybe even read it all way through, but I'm in no hurry. I will probably have read a number of reviews of it by then, so I'll be somewhat prepared, depending on the quality of the reviewers of course, for what the main argument of the book will be.

"At the end of the day, it’s hard for me not to reach the conclusion that the backlash is, not coincidentally, coming just as Gladwell’s hit upon a politically charged topic and reached conclusions that are discomfiting to the very successful. I’ve seen a few people express the notion that Gladwell’s conclusion — that success is determined largely by luck rather than one’s powers of awesomeness — is somehow too banal to waste one’s time with. I think those people need to open their eyes and pay a bit more attention to the society we’re living in. It’s a society that not only seems to believe that the successful are entitled to unlimited monetary rewards for their trouble, but massive and wide-ranging deference."

Well, Gladwell's book is going to be like Taleb's for me. If what Yglesias says is true, I can already say that I agree with the main thesis and will probably feel slightly stronger about it than he does. I don't immediately see the political point that Yglesias is making. One can make such an argument, that the wealthier are more deserving than lucky, and so they should be left to their riches. Nozick makes such an argument, but it's in the context of setting up a system that works for other reasons than simply wealth, as I remember. But Hayek pointed out that the value that wages determined doesn't necessarily equate with what jobs or careers we most value in a sense not determined by supply and demand, or the ability to tie the value to wages or profit. We can certainly value priests and teachers more than investors, based on our own personal morality.

"Beyond that, it’s a society in which the old-fashioned concept of noblesse oblige has largely gone out the window. The elite feel not only a sense of entitlement, but also a unique sense of arrogance that only an elite that firmly believes itself to be a meritocracy can muster. Gladwell not only shows that this is wrong, but he does an excellent job of showing why it feels right. He explains that success does, in fact, require hard work — lots of it — and that people who think they got where they are through effort rather than good fortune are at least half right. The issue is that in some ways the best luck of all is the luck to be in a position to do hard work at a time when it pays off. Bill Gates, Gladwell explains, put in vast hours programming computers at a very young age at a time when almost nobody in the United States even had the opportunity to put in that kind of time in front of a computer screen."

Hard work and talent are necessary, but not sufficient inputs into wealth in many cases. Yes.

"It’s a discomfiting thought. And an important one. So I hope people read Outliers. Or at least David Leonhardt’s review rather than Michiko Kakutani’s. And could someone tell me what the deal is with The New York Times reviewing some books twice?"

Well, one deal is that the reviews might differ, and so provoke debate among the paper's readers. I might follow this book more, but, again, since I tend to agree with it, I'm more likely to read something else first.

"That is, if you really want to boost growth, then the infrastructure spending does actually have to be a good investment"

Here's an interesting idea which combines three things:

1) Fighting Urban Sprawl
2) The Current Stimulus Plan
3) What To Spend It On

"David Altig, research director at the Atlanta Fed and a blogger at macroblog, has a post up on the question of infrastructure spending as stimulus. He agrees that timing issues are not, at this point, important, but after examining the impact of public works spending on growth he concludes:

More than most of the currently popular stimulus ideas, the benefits of increased infrastructure spending really do seem to depend critically on the specifics. Best to think about those specifics sooner rather than later.

That is, if you really want to boost growth, then the infrastructure spending does actually have to be a good investment, rather than building for the sake of building (which would be consumption). In the Times, David Leonhardt agrees, writing:

And yet when it comes to the nation’s infrastructure, money isn’t the main problem.

A lack of adequate financing is part of the problem, without doubt. But the bigger problem has been an utter lack of seriousness in deciding how that money gets spent. And as long as we’re going to stimulate the economy by spending money on roads, bridges and the like, we may as well do it right."

Here's my comment on Paul Krugman's blog on Nov. 12th:

"I mean, surely on what and where you spend the money is as relevant as the total number? Or are you simply assuming that the money goes out and that’s it? Is this organic or mechanical?"

The post continues:

"We do a pitiful job of determining how to spend our money. Leonhardt suggests that we need to take a broad view of the contributions of any given project. Planners should have to prove that road construction will reduce traffic (good luck!), and transit projects should take into account things like emissions and energy consumption. He gets points for mentioning that congestion pricing is a useful tool to limit congestion and provide information about transportation demand (and demerits for excessiving lauding of Ma Pete). But what he doesn’t mention, but what is pretty critical, is that infrastructure projects ought to take into account their effect on land-use."

This seems correct.