inflation has disappeared and we are wondering if and when it will come back

TO BE NOTED: From Supply and Demand (in that order):

"Inflation, We Need You

When his mom would leave the house shopping for a few hours, my toddler son used to go the window and yell out "Mommy, I need you!"

That's pretty much where our economy is right now: inflation has disappeared and we are wondering if and when it will come back. This morning the BLS released the April CPI, which (seasonally adjusted) was lower than March. The seasonally adjusted CPI has fallen month-to-month five out of the last seven months.

The chart below shows the seasonally adjusted CPI (blue) for 2008-9 and the seasonally unadjusted CPI (red) for the 1929-30 (sorry, no seasonal adjustment is available for 1929-30).

Posted by Casey B. Mulligan "

based on a different methodology than the OFHEO index

TO BE NOTED: From Supply and Demand (in that order):

"NAR Suggests that Housing Prices Stopped Falling in 2009

See the chart below, which is based on a different methodology than the OFHEO index I showed yesterday, and goes through March.

Posted by Casey B. Mulligan at 10:19 AM

I believe that there were at least some fundamentals other than income and population driving the housing boom

TO BE NOTED: From Supply and Demand (in that order):

"Update to the Best Graph in 6 months

[An update from here.]

As compared to the same quarter in the prior year, 2009 Q1 payroll tax collections fell 8 percent.

TO BE NOTED: From Supply and Demand (in that order)

"Payroll Tax Collections Through 2009 Q1

The chart below shows payroll tax collections through March 2009. They are expressed as a percentage change from the same month in the prior year.

As compared to the same quarter in the prior year, 2008 Q4 payroll tax collections fell 4 percent. As compared to the same quarter in the prior year, 2009 Q1 payroll tax collections fell 8 percent. This is one indicator that the contraction of payroll spending in Q4 continued at about same pace in Q1.

Posted by Casey B. Mulligan at 4:22 AM

come forth quickly with its subsidy, or make it clear from the beginning that no subsidy was coming

TO BE NOTED: From the NY Times:

"Waiting for the Subsidy

By Casey B. Mulligan

Casey B. Mulligan is an economics professor at the University of Chicago.

Subsidies can have a perverse effect on activity if they are debated too long. The banking sector bailout is one example; the purchase of hybrid automobiles by Chicago cab drivers is another.

Hybrid automobiles can save gas, especially in urban driving conditions when the automobile is moving slowly or idling, where alternative power sources have a bigger advantage. A problem is that the purchase price of hybrid vehicles is often higher, and many are less spacious than the more ubiquitous sport utility vehicles.

A significant fraction of the taxicab fleet may be well suited for hybrids, because many of the miles driven are in urban conditions, and often the vehicles have only one passenger. Thus I have been surprised to notice so few hybrid taxis in Chicago, where less than 1 percent of cabs are hybrids.

by Ray Tsang

[via Apture]

In an admittedly unscientific survey, I watched for Toyota taxis with about 100,000 miles. I assumed that many drivers of Toyotas would be likely to buy a Toyota for their next taxi, and that the Prius — the company’s hybrid model — would get their consideration. I asked the drivers about buying a Prius.

The drivers told me about the Chicago City Council’s debates about transforming the city’s taxi fleet.

The council has debated mandating hybrid purchases. But the rumor among taxi drivers is that in addition, or perhaps instead, the city or another government agency will eventually subsidize the purchase of a hybrid. Drivers have decided that they should not purchase a Prius or another hybrid until the subsidy arrived. Buying one now would mean overpaying.

Regardless of whether it is realistic to expect Chicago to someday subsidize purchases of hybrid taxis, the fact is that some cab drivers are considering the possibility. If taxi drivers consider future subsidies in their industry, then so must bank executives.

Last fall the public learned that banks were not selling many of their legacy mortgages and mortgage-backed securities, despite the impression that ownership of the assets was hindering the banks’ lending. A variety of theories have been put forward to explain this failure, and to suggest what the government might do to fix it.

But the lack of trade in mortgage-backed securities may have something in common with the lack of trade in hybrid Chicago taxicabs. The secondary market for legacy mortgages may have stagnated largely because of the (ultimately correct) anticipation of a huge government subsidy. As I wrote last week, banks were not “unable” to sell their legacy mortgages; they were prudently unwilling to sell because they expected the government to step in eventually and help push the prices of the assets higher.

There would have been two preferable possibilities: for the government to come forth quickly with its subsidy, or make it clear from the beginning that no subsidy was coming. With both Chicago taxis and the secondary market for mortgages, the government did neither. Instead, it only fueled rumors that subsidies were on the way, and froze the same markets it intended to stimulate."

they were prudently unwilling to sell because they expected the government to eventually step in and help push the prices of those assets higher.

TO BE NOTED: From the NY Times:

"Encouraging the Sellers, Not the Buyers, of ‘Toxic Assets’

By Casey B. Mulligan

Casey B. Mulligan is an economics professor at the University of Chicago.

Last week the Obama administration released what has become known as the “Geithner plan”: an administration policy to reorganize asset ownership in the banking sector. The plan may have its desired effect of loosening up the market for “legacy assets,” but probably not for the reasons the Obama administration has stated.

Banks own mortgages (either directly, or through ownership of mortgage-back securities) whose values plummeted in 2008, because the mortgages are collateralized with real estate whose value crashed.

Conventional wisdom about the banking crisis says that bank lending to the wider economy cannot occur because banks have been unable to sell these assets, which adds to their difficulties in making new loans.

As Treasury Secretary Timothy F. Geithner says, a secondary market for mortgages “does not now exist” because there is a “ lack of clarity about the value of these legacy assets [which makes] it difficult for some financial institutions to raise new private capital on their own.”

I agree that (to a good approximation) a secondary market for legacy mortgages does not exist. But the biggest reason is not lack of clarity, but rather the lack of a viable government policy to deal with the banking crisis. Until now, perhaps.

But let’s stick with the conventional wisdom for a moment more. According to that wisdom, it does not help for the Treasury and the F.D.I.C. to subsidize and leverage the purchase of legacy mortgages from banks as Secretary Geithner proposes, because the plan does nothing to (a) create clarity in legacy asset value or (b) ensure that banks no longer have significant direct or indirect holdings of mortgages on their balance sheets.

As Professors Paul Krugman and Joseph Stiglitz have explained, the Geithner plan does increase the value of legacy mortgages to its owners, because it subsidizes the purchase of them. But it does not increase the clarity of those values, and in fact reduces clarity.

Consider an example, again from the conventional wisdom. Market participants are not sure whether a pool of mortgages will be worth $30 million or $50 million, and are concerned that the current owner knows a bit better and thus will offer for sale only the weakest of the weak. This $20 million worth of uncertainty, according to Secretary Geithner and the conventional wisdom, stops the secondary market from operating.

Thanks to the emergence of the Geithner plan’s subsidy and its leverage, the pool of legacy mortgages last week suddenly became worth $40 to $90 million (the Geithner subsidy raises private investors’ value of all types of bad mortgages, and its leverage increases the gap between the value of the best and the value of the worst). Yes, the legacy mortgages are worth more, but the profit of owning them is now less certain.

To make matters worse, the Geithner plan has no provision to stop banks from financing some of the ventures that will purchase the banks’ own legacy assets. The result may be bank ownership of mortgages that is less direct, but is bank ownership nonetheless.

Thus, if the conventional wisdom is right, this plan will fail because it creates no clarity, and it does little to separate banking from legacy mortgage ownership.

But I believe that the conventional wisdom is highly exaggerated. Instead, the secondary market for legacy mortgages has stagnated largely because of the (ultimately correct) anticipation of a huge government subsidy. Banks were not “unable” to sell their legacy mortgages; they were prudently unwilling to sell because they expected the government to eventually step in and help push the prices of those assets higher.

We all witnessed last week the big capital gains to banks that came with the unveiling of the Geithner plan. A bank would have been foolish to sell off its legacy mortgages during the fall or winter, before such a plan was unveiled and executed, because a fall or winter non-bank buyer of legacy mortgages would likely be ineligible for the ultimate subsidy.

Thus, the secondary market for legacy mortgages has failed so far because of the lack of a plan rather than a lack of clarity. To get the market operating again, the Geithner plan does not need to alleviate the market weakness improperly identified by its authors, but needs only to stay on the path to execution."

Me:

Your comment is awaiting moderation.

“Banks were not “unable” to sell their legacy mortgages; they were prudently unwilling to sell because they expected the government to eventually step in and help push the prices of those assets higher.”

I agree. Many Toxic Assets have, in fact, been sold. However, the fact that the government has been bailing everyone out has led to the belief that it was worth holding on to many of the TAs to see if the government could induce a better price. As well, money to banks has lessened the need for a fire sale of TAs.

Thus, having given incentives and subsidies to the sellers, it must do this for the buyers as well. Also, the large banks are counting on the government not being able to seize them for some time.

One other point: although many people are complaining that the buyers are getting a very good deal, they should remember that the buyers know that the government can always get some of that money back, through taxes.

— Don the libertarian Democrat

OFHEO suggests we hit bottom and CS suggests that we're still going down?

TO BE NOTED: From Supply And Demand:

"Case-Shiller OFHEO faceoff

Two readers generously offered their valuable insights on the Case-Shiller OFHEO gap I noted earlier this morning.

Professor Nunes says that the CS index puts too much weight on particular regions. He has a paper showing how Case-Shiller and OFHEO agree much more region-by-region.

It looks like he has an important and very useful point. (I must also confess that he sent me the paper last fall, and I failed to remember his contribution).

Does the regional aggregation issue explain whether which series is right about January: OFHEO suggests we hit bottom and CS suggests that we're still going down? (Note: Professor Nunes does not like national (as opposed to regional) analysis of housing, so he may be understandably unwilling to answer). Note that OFHEO said that nearly all regions (the West being a notable exception) increased in January.

Sean MacLeod of Metacapital Management emails that "those in the mortgage finance market believe the OFHEO data to be c#$p." He prefers Case-Shiller and a third series, RadarLogic.

I am not sure CS is so much better. In particular, CS says that national housing prices almost doubled (relative to construction costs!) during the boom, which seems reasonable for a couple of regions, but a huge exaggeration for most of America. On the other hand, the OFHEO index was late in showing the bust (see the chart below, which measures both relative to the residential construction PPI). That's why I look at both, and support the Employment for Economists Act!

Many thanks to Mr. MacLeod and Professor Nunes! Housing prices are an incredibly important economic indicator these days, so their insights are worth many times more what I and the readers of this blog are paying for them!

Posted by Casey B. Mulligan at 9:05 AM

This adds to the growing list of reasons why the housing market is turning around in early 2009.

TO BE NOTED: From Supply And Demand:

"Housing Market Evidence Continues to Pile Up

The AP reports:

"The Commerce Department says sales rose 4.7 percent in February to a seasonally adjusted annual rate of 337,000 from an upwardly revised January figure of 322,000."

This adds to the growing list of reasons why the housing market is turning around in early 2009.

Oh yeah, we have to add that building permits increased in February too.

Posted by Casey B. Mulligan at 11:24 AM

The CPI and PPI both increased in February, for the second month in a row.

TO BE NOTED: From Supply And Demand:

"Deflation May be Done

The CPI and PPI both increased in February, for the second month in a row.

That may break a pattern that, prior to February, was all too similar to 1929-30. The chart below displays the (seasonally unadjusted) CPI for 2008-9 and 1929-30.

Posted by Casey B. Mulligan at 5:50 AM

During most of our lifetimes, the prices of things we buy have generally increased over time.

From Casey Mulligan:

"Deflation – Let’s Not Try That Again!

Copyright, The New York Times Company

The Great Depression years 1929-33 featured a large and prolonged deflation. January 2009 reversed a deflation pattern for 2008 that was ominously similar to 1929’s.

During most of our lifetimes, the prices of things we buy have generally increased over time. We can name some exceptions, such as toys over the last decade and computer equipment over the last couple of decades, but otherwise most items (even houses) have prices that are higher now than they were ten, twenty, or thirty years ago.

This general increase in consumer prices – often called inflation – has become familiar. Employees expect regular pay raises, and employers can normally afford them because they are increasing the prices of the products they sell.

Just as important, familiarity with inflation comforts lenders who offer loans to consumers and businesses under assumption that those borrowers will tend have incomes that rise together with all other prices. That is, lenders typically arrange for repayment at regular intervals in specific dollar amounts – such as the regular monthly payment on a home mortgage – and inflation helps borrowers “grow into” their loan payments.

On rare occasions, consumer price trends suddenly change directions.

Nineteen twenty-nine was one of those occasions. Consumer prices were pretty constant during the 1920s. The chart below picks up the story in January 1929 with the red line. That line measures the (seasonally unadjusted) consumer price index in each month through July 1930, normalized so that October 1929 is 100 (for example, the value of 97.9 in April 1929 means that prices then were 2.1 percent lower than they would be in October).



Prices were heading up in the spring and summer of 1929, during which time lenders might have expected that the typical home owner would obtain a pay raise and the typical farmer would someday fetch more for his crops – in both cases making it easy to pay back their respective mortgages.

In the fall of 1929, the inflation stopped (incidentally, the stock market crashed in late October of that year) and prices headed down, falling almost every month for almost four years. By the spring of 1933, this deflation brought prices down almost 50 percent from their 1929 peak. It was difficult for homeowners and farmers to make their mortgage payments when their paychecks had been cut in half.

The blue series in the chart shows the consumer price index for 2008 and 2009. Like the 1929 series, the 2008 series is normalized so that October is 100.

The chart shows how consumer prices also rose in the spring and early summer of 2008. Inflation had stopped by the fall (there was a stock market crash in October 2008, too), and consumer prices headed down. In fact, the deflation at the end of 2008 brought prices down more than four percent in a couple of months, as compared to the one percent drop at the end of 1929.

Price reductions since the summer of 2008 have been credited to declines in prices of commodity– such as fuel and food. That’s not the whole story, because other prices (notably housing prices) were falling in 2008. Moreover, the role of commodity prices adds to the similarity between 1929 and 2008, because commodity prices were falling in 1929-33 too.

If the Great Depression consumer price parallel were to continue beyond 2008, we would be in for a sustained deflation until the year 2012. At that point, with most borrowers earning less than half of what they were when they applied for the loan, today’s mortgage problems would seem minor. Thus, January’s C.P.I. report released on Friday was a welcome return to something familiar: inflation.

Posted by Casey B. Mulligan at 5:06 AM "

Me:

Don said...

You're correct. One of the main reasons that Deflation is a disaster is that it's disorienting, and causes people to panic, as if they're in a foreign and unfriendly landscape with no way out. It's a panic magnifier.

Don the libertarian Democrat

February 25, 2009 8:14 AM

I am skeptical that this prediction will turn out right.

From Casey Mulligan:

"134 million floor

In October I predicted that employment would not drop below 134 million. It hasn't yet -- but it got close enough in January that I am skeptical that this prediction will turn out right.

Posted by Casey B. Mulligan at 6:18 AM

Me:

Don said...

In October, it was not clear that employers would begin proactively shedding workers. Beginning in the middle of November, they did. Also, it was not written in stone. Policy actions have made things worse.

Don the libertarian Democrat

February 6, 2009 7:34 AM

Wow, in dollar terms, I was close on each of the spending categories

From Casey Mulligan:

"Wow I was close on Nominal GDP

Wow, in dollar terms, I was close on each of the spending categories (see below)!

I expected the GDP deflator to fall a lot more, and the experts thought it would rise. I wonder how much GDP deflator revision is possible.

Posted by Casey B. Mulligan at 6:13 AM

Don said...

I believe that Bob Murphy is correct. I believe that is has to do with the way you view the Productivity Numbers. You say that workers are holding out. I say that Employers are Proactively laying workers off in anticipation of the depth of the downturn. In other words, the layoffs are exceeding the fall in demand. Hence, a temporary rise in productivity. My evidence amounts to quite a few posts showing that this is exactly what employers and employment experts are now saying is happening. Remember, I said that this would happen months ago. A Proactivity Run is a consequence of a Calling Run. These are my own terms for Fisher's Debt-Deflation, which I think is turning out to be a very useful model for what's happening. Based on Fisher, I also predicted a Savings Spree which is now occurring as well.
The current numbers are in line with what I said, only worse. I too thought that GDP would only go down 1%. The real fall is very worrying, because for me it means things are moving faster than Fisher's view would indicate. This is more like falling dominoes. If the projections were using unemployment numbers, then I see that the real drop is less than the drop expected given unemployment. Hence, more evidence that jobs are being shed far ahead of the actual amount of the downturn. Having said all this, I ,quite frankly, find these numbers more dubious than most as a general rule. They are useful, but no more. I admit to not being an economist. I'm just a citizen trying to understand the world. I have to admit that your productivity point does seem important, even though I disagree on what it means.
By the way, I enjoy any comments that help me understand these issues.

January 30, 2009 8:55 AM

In hindsight, we readily see that at least one of the purported pathways to depression was never followed.

Here's something Casey Mulligan should get right, since he understands that the financial sector is not exactly wedded to the rest of the economy, but doesn't:

"October Hysteria in Hindsight

Copyright, The New York Times Company

After Lehman failed and “credit markets froze” in the second half of September 2008, many people proclaimed that a second Great Depression( I DIDN'T ) would unfold. In hindsight, we readily see that at least one of the purported pathways to depression was never followed.

During the first days of October 2008, it was claimed that businesses would not be able to borrow from banks even for basic operational expenses, such as making their payrolls. As employees had to work without pay (so the story goes), the businesses patronized by those employees would suffer, and the downward spiral would continue. Then presidential-candidate Barack Obama said that “the credit market is seized up and businesses, for instance, can't get loans to meet payroll.” It was even suggested that “recession proof” employers such as colleges and municipalities would not be able to pay their employees.

Now that a couple of months have passed, let’s look at payroll spending measured by the Bureau of Economic Analysis. The chart below shows payroll spending (measured in billions of dollars) for each of the months of second half of 2008 (December data not yet available), including contributions to pension and health funds for employees. Aggregate payroll spending was highest in August, and has remained within 0.1 percent of the August high ever since.



The Lehman Brothers investment bank failed on September 15. The bank was deeply intertwined with other financial institutions – its failure to pay its obligations put its creditors at risk – and brought the credit crisis to its crescendo. By the end of the month, the intense financial chaos motivated Mr. Obama and others to warn that banks needed lots of money from taxpayers, or else the banks’ business customers would not be able to pay their employees.

Because the bailout bill took time to pass, and then additional time for the Treasury to design and execute its $700 billion Capital Purchase Program (CPP), no bank received any money from the Treasury pursuant to the CPP until the last couple of days of October. Thus, if the warnings were right, payroll spending should have been precipitously lower in October than in the previous months. Instead, payroll spending was almost $1 billion dollars higher in October than in September – not exactly the collapse that we feared.

Some of the details of the CPP became known earlier in October. Anticipation of the CPP expenditures cannot explain why payroll spending did not collapse in October, because the purported pathway to depression was about the day-to-day cash needs of otherwise strong businesses. Even the United States Treasury admitted last week that “capital [from its CPP] needs to get into the system before it can have the desired effect.”

Even when some (but by no means all) of the CPP funds finally got “into the system” in the last days of October and the full month of November, Congress was dismayed to see that banks were not using the funds to lend. Nevertheless, payroll spending did not collapse in November, either.

It is true that payroll employment fell by about 850,000 in October and November – and that’s serious as compared to the last couple of recessions – but the payroll spending data show that the employment loss was small compared to the spending collapse forecasted in early October. The fact is that more than 136,000,000 workers received their paychecks – more than $1.3 trillion worth in October and November combined – essentially the same aggregate payroll that was paid out in the two months prior to Obama’s warning.

None of the above denies or confirms that our economy is headed for economic depression, because there are multiple pathways for getting there. Nor does it deny that the Treasury CPP might help in some way. But it does refute one of the scariest pathways to Depression – a collapse of payroll spending – that politicians from both parties alarmingly described to the American public in order to justify spending $700 billion of taxpayer funds on a bailout of United States banks."

Now, we have been dealing with two distinct events:
1) A Calling Run, followed by:
2) A Proactivity Run.

The Calling Run involved a panicked scramble to get out of declining assets and into cash, or guaranteed investments. The reason that this could effect lending was because many of the assets and investments that were being fled were loans, or other financial assets and investments held by banks. Quite naturally, if your lending practices and loans are leading you to a mad scramble to unload and untangle them, losing you an unknown sum of money, it is only natural that your lending would be curtailed. The fact that Mulligan doubts this defies belief. He only has to ask himself whether he would keep lending normally if his normal lending had led to enormous losses. Apparently he would. One explanation of the lending going on is the fact that many people had preexisting lines of credit and they accessed them. That's what these lines of credit were there for. As well, the government did intervene enough to keep some lending going on. Finally, there are small banks, for instance, who have been able to keep lending through this crisis. In any case, this run does not automatically lead to a Proactivity Run, because the financial sector is somewhat separate from the general economy. In any event, employment would certainly lag the Calling Run, at least until the extent of the Calling Run becomes clear.

In this crisis, the Proactivity Run, as opposed to simply some prudent downsizing, quite obviously began in the second half of November. It wouldn't be dramatic even here immediately, because some workers would be kept on until after the end of the holidays. By now it is obvious in both employment and consumption. In my opinion, the dithering about these bailouts, including the Automotive Bailout, have led to an Uncertainty Shock as to the level of government support. Now that the government has guaranteed more and more businesses, leading to the belief that the government will do whatever it takes to stop these runs, we are beginning to see a diminution in the fear and aversion to risk, as evidenced by the TED and VIX. My evidence for my position is the actual flow of investments.

One final thing. I don't know what is included in that compensation figure above, but, having run a business, I can tell you that if you let people off, you pay UI for them for a while. As well, if business stays higher than the employer estimates, he might have to pay more wages than he anticipates to the remaining workers. I have often found, after trimming my staff, that my payroll expenses remained the same for some time. A very annoying occurrence, but a real world one.

Finally, let me state the following: The Calling Run was not inevitable, and, even after it hit, the Proactivity Run was not inevitable. A system based on Bagehot's Principle's, I contend, would have stopped both. The handling of this crisis by the government, while better than nothing, has been a mess. That's how I see it.

Companies are cutting back so aggressively, they actually might be increasing their productivity even in the face of a wrenching economic shock.

Contra Casey Mulligan, the WSJ comes out in favor of the Productivity and Proactivity Theory of Yours Truly. In fact, I'm having a great week, as James Surowiecki and William Gross, two of my list of sages, both agreed that our Investor Class( DON'T CALL THEM FREE MARKET FANATICS) wants a Bailout Run. From Real Time Economics:

"Jobs Data’s Possible Silver Lining: Productivity

There may have been a little silver lining in the horrific December job losses reported by the Labor Department Friday. Companies are cutting back so aggressively( A PROACTIVITY RUN ), they actually might be increasing their productivity even in the face of a wrenching economic shock.( THAT'S MY THEORY )

In the final three months of 2008, employers reduced the number of hours that workers logged at a 7.7% annual rate, through a combination of layoffs and cutbacks in things like overtime and manufacturing production shifts. It was the largest quarterly contraction in hours worked since 1975, according to Macroeconomic Advisers LLC.( A PROACTIVITY RUN )

The hours worked contraction might have been greater than the contraction in overall economic output for the quarter, which will be reported later this month( THAT'S THE FIGURE THAT I'M WAITING FOR. ). In other words, businesses might have been able to squeeze more out of the workers they kept on staff, increasing business productivity, even though the economy was going through its most severe contraction in decades.( THAT'S IT. )

The government’s estimate of productivity growth — a measure of the nation’s output per hour worked by the work force — comes out in early February. Most economists focus on productivity growth among non-farm businesses — excluding agriculture, government and certain parts of housing. Macroeconomic Advisers estimates that output in the nonfarm business sector contracted at an 8.25% rate for the quarter, while hours worked during the quarter contracted at an 8.6% annual rate.

What’s so good about companies laying off workers, cutting overtime hours and eliminating production shifts, as happened during the quarter? Clearly, it means workers are suffering. But it also means the economy is adjusting to the shock of the financial crisis, and the crisis can’t end until an adjustment has taken place.( YES )

U.S. productivity trends have changed dramatically in the past decade. The U.S. experienced a productivity boom in the late 1990s and it has proven surprisingly enduring. Productivity hasn’t declined on a year-over-year basis since 1995. In the 1970s and 1980s, it experienced long contractions around recessions.

Chris Varvares, a Macroadvisers economist, says many companies entered this downturn with inventories relatively lean, meaning companies have not been caught on their heels by the collapse in consumer demand. The expanded use of temporary workers also has made it easier for business to adjust its workforce as the environment changes. Technology, the source of the 1990s boom, has made it easier to manage both inventories and employment levels.

This certainly isn’t going to make the financial crisis go away quietly. It won’t fix huge losses on dumb loans made by banks. It doesn’t solve the crisis faced by millions of Americans left without work. And its possible that even this good news could be revised away by statisticians.( TRUE )

But if it persists, it could be a source of some long-term optimism. At least here’s some evidence that the economy is making the adjustments it needs to make to eventually get back on track. In the long run, productivity is an economy’s primary driver of growth and wealth( YES. THAT'S MY THEORY. TAKE THAT CASEY. ). – Jon Hilsenrath

Wilbur Ross Will Buy A Bank. So He's Been Saying For Eight Months

Casey Mulligan gets ecstatic over one quote:

"Flashback: Another Example of How Washington Helped Decapitalize the Banking Industry

A billionaire venture capitalist explains how he has not yet bought a distressed bank because the Treasury is doing all the buying these days.

Thanks Alberto for the tip. "

Here's Wilbur Ross:

"NEW YORK (CNNMoney.com) -- Billionaire investor Wilbur Ross, known for his investments in distressed companies in the steel, automotive industries, said it is only a matter of time before his firm acquires a bank.

"We will end up with a bank, there is no doubt about that," Ross, the chairman and CEO of WL Ross & Co., said in an interview Tuesday.

Ross, a major player in the private equity industry, said that his plans to purchase a depository institution were delayed last year after the government moved to inject capital into the nation's banking system as part of a broader effort to halt the financial crisis.( WHY? )

He estimated that the rescue package delayed his investment anywhere between six to twelve months( WHY? ), and suggested that his firm might look to buy a commercial bank or thrift institution.

Ross made a string of investments across the financial services sector last year, including the purchase of H&R Block's (HRB) subprime mortgage servicing unit last spring for $1.3 billion and the acquisition of bankrupt American Home Mortgage Investment Corp.

But some of those bets have backfired. Last February he plowed $250 million into the bond insurer Assured Guaranty (AGO) at around $21 a share. The company's market value has been nearly cut in half since then.

Still, acquiring sources of deposits has become a top priority for banks and other financial institutions in the past few months since credit has gotten harder to come by as a result of the ongoing crisis. Private equity investors like Ross have also expressed a desire to buy banks as well.

"What is important is to get access to a stable, low-cost source of funding," Ross said. "That is what we are interested in."

Faced with a quickly rising tide of bank failures, banking regulators have relaxed restrictions about who can buy a depository institution in the hopes of coaxing outside investors to take part in the bidding.( THAT'S TRUE. I'VE POSTED ON THIS.)

Last Friday, a group of private investment firms, including buyout shop J.C. Flowers & Co and hedge fund Paulson & Co.( APPARENTLY PAULSON CAN DO WHAT ROSS CAN'T ), struck a deal with the Federal Deposit Insurance Corp. to buy failed mortgage lender IndyMac for $13.9 billion.

As part of the deal, the buyers will take responsibility for the first 20% of losses, and the FDIC will cover the majority of additional losses.

Last week's IndyMac announcement is particularly noteworthy since there have only been a few investments made in banks by private equity firms and other distressed investors in recent months -- and many of those deals have quickly soured.

Most notably, private equity firm TPG made a disastrous investment in Washington Mutual, the savings and loan that collapsed in September. It was the largest bank failure in history. WaMu was subsequently sold( WHERE WAS ROSS? ) to JPMorgan Chase (JPM, Fortune 500).

But Ross said it would make more sense if private equity firms are allowed to take full ownership of a bank instead of just a small stake.

"Private equity is not passive. We are not minority investors. We are control investors. That is the whole theory of private equity - adding value through better management," he said.

And here's Wilbur Ross on CNBC:

"Wilbur Ross: Possibly a Thousand Banks Will Close( WERE ACTUALLY AT ABOUT 20 NOW )

WILBUR ROSS, LEHMAN BROTHERS, FINANCIAL INSTITUTIONS, MERRILL LYNCH, BANK OF AMERICA

CNBC.com

| 15 Sep 2008 | 02:12 AM ET

In an exclusive interview with CNBC.com, Wilbur Ross, chairman and CEO of WL Ross & Co., says he sees possibly as many as a thousand bank closures in the coming months. And this will create opportunities for investors.

"I do think a lot of the regional ones will (close), just as they did in the last savings and loan crisis in the 1990s," Ross said. (Watch the full CNBC.com exclusive interview with Wilbur Ross on the left)

Ross says he will be looking to pick up smaller distressed institutions. "There will be opportunities, but we will need federal assistance in them( WILL YOU WILBUR? ), because what we're mainly looking for is stable sources of deposits( FDIC ), not so much the loan portfolio."

Ross feels that there will be too many people willing to provide capital to the large financials, which makes them less of a bargain than smaller banks.

When asked about his views on Bank of America's purchase of Merrill Lynch , Ross said that he didn't think that Merrill was in that dire a position.

"I think people in general felt better about Merrill's situation than about Lehman. I think ever since John Thain came in, he's done a wonderful job trying to fix what was a very difficult situation," Ross said.

He also noted that this was really now the second successful turnaround for Thain. "He (Thain)saved Merrill, went into BoFA ... Temasek, for example, went into something like a $5 a share profit out of this. So it's not a tragic ending."

"It will be very interesting to see where Thain ends up in the Bank of America hierarchy," Ross added.

© 2009 CNBC.com"

And here's Wilbur Ross:

"By Will McSheehy

April 16 (Bloomberg) -- Billionaire financier Wilbur Ross Jr., who made his fortune turning around distressed steel and textile companies, plans to seek about $4 billion from investors including Arab sovereign funds to buy U.S. depositary banks.

Ross, 70, will talk with Gulf investors in Abu Dhabi next week about 100 to 200 so-called thrift banks, he said in a phone interview from New York today. He said some of the lenders are good investments, even after a mortgage-market slump led to $245 billion of asset writedowns and credit losses at the world's biggest banks.

Regional depositary banks have ``more narrowly defined'' problems and ``a more stable base of deposits'' than cross-border lenders such as Citigroup Inc. and UBS AG, Ross said. He plans to package U.S. thrift bank acquisitions ``as a finished product'' to sovereign wealth funds( THEY'RE DOING WELL NOW ), he said.

Flush with cash from record oil income, Gulf funds are among investors that committed at least $59 billion in the past year to shore up banks including Citigroup and Merrill Lynch & Co. Abu Dhabi's sovereign fund, the world's richest with estimated assets of $875 billion, agreed to invest $7.5 billion in Citigroup in November. Qatar's fund will spend as much as $15 billion on bank stakes, the Gulf state's prime minister said in February.

Thrifts Are `Vulnerable'

Thrifts are ``particularly vulnerable because their portfolios tend to be so real estate-oriented,'' and so can be bought ``at a very attractive price,'' Ross said today. Acquired banks could be combined with a mortgage business to provide stable funding for home loans that are ``essential'' to the U.S. economy even if ``singularly unprofitable'' right now.

Depositary banks are regulated by the Federal Deposit Insurance Corp. and can accept consumer deposits. The FDIC insures deposits at 8,534 banks and savings associations in the U.S., more than 90 percent of which are community-based banks. Thrifts can be savings and loans, credit unions or savings banks.

Each thrift acquisition would probably be valued at around $500 million, Ross said. His buyout company, WL Ross & Co., may invest about $2 billion of its own money in the acquisitions. The firm has ``relations and existing investments'' with some Gulf sovereign wealth funds, he said, without providing names.

Washington Mutual Inc., the biggest U.S. savings and loan institution, on April 8 said it got $7 billion from a group of investors led by David Bonderman's TPG Inc. after losses on subprime loans erased 74 percent of its market value.

`Less Than Satisfactory'

Citigroup stock has slumped 24 percent since it announced Abu Dhabi's investment on Nov. 26. Merrill Lynch is down 16 percent since Kuwait's fund said it bought $2 billion of convertible securities Jan. 15.

``Some of the initial forays have been less than satisfactory, at least on a temporary trading basis, so there is obviously a degree of caution,'' by Gulf funds, Ross said.

Investors like Ross can profit from a decline in value of financial-services companies amid the U.S. subprime crisis, said Steven Kaplan, a professor of finance at the University of Chicago's business school.

``Financial companies have declined in value a lot,'' Kaplan said in a phone interview today. ``I'm sure many of them deserve to have declined. But some of them probably haven't, and those are the ones he's going after.''

Ross is already betting on the mortgage-servicing industry, which processes loan payments and forecloses on bad mortgages. Servicing companies can gain value during housing slumps because borrowers are less likely to move or refinance, making the stream of fees paid by a mortgage owner last longer.

Acquisitions

Ross is seeking to acquire H&R Block Inc.'s mortgage- servicing unit for $1.1 billion. His AH Mortgage Acquisition Co. this week closed its purchase of an American Home Mortgage Investment Corp. subsidiary. That transaction was valued at about $500 million last year.

Ross's firm joined with Richard Branson's London-based Virgin Group Ltd. earlier this year to bid for U.K. lender Northern Rock Plc. The bank was taken over by the U.K. government instead. The collapse of the U.S. subprime mortgage market lifted the cost of credit around the globe and led to a run on Northern Rock last year.

Ross said today that the Northern Rock bid provided ``knowledge we'd like to put back to work'' if the right opportunity arises in the U.K. mortgage market.

Ross is scheduled to speak at a conference in Abu Dhabi April 21 organized by the Asian Venture Capital Journal."

So, since April of last year, Wilbur Ross has been looking into buying a bank. Since then, a number of banks have been sold. Others have failed. What he's looking for is a total collapse of the market. He sees 1000 banks failing. Whenever an investor telegraphs his intentions like this, please take it with a grain of salt. He might buy a bank next week, or never.

Finally, I have posted a fairly large number of quotes now, from billionaires to some of the best investors in the world, who have said that investors are waiting on and want government intervention, even though some of these sources don't. Yet, that doesn't qualify as evidence, but one blowhard investor trumpeting on in public for eight months about his buying a bank constitutes proof. Really?

"In fact, the investment/net worth ratio is currently at a postwar low."

Bad news for another of my proposals. Namely, targeted tax cuts for investment. From Macroblog:

"Will tax stimulus stimulate investment?

On Monday, the form of potential fiscal stimulus, 2009-style, took a step forward detail-wise. From the Wall Street Journal:

“President-elect Barack Obama and congressional Democrats are crafting a plan to offer about $300 billion of tax cuts to individuals and businesses(ODDLY, THAT'S THE SAME AMOUNT AS MY PROPOSAL FOR THESE TWO TAX CUTS ), a move aimed at attracting Republican support for an economic-stimulus package and prodding companies to create jobs( I WANT TO USE IT AS AN INCENTIVE TO ATTACK THE FEAR AND AVERSION TO RISK, WHICH I BELIEVE TO BE THE MAIN PROBLEM NOW.).

“The size of the proposed tax cuts—which would account for about 40% of a stimulus package that could reach $775 billion over two years( MY FIGURE IS $700 Billion )—is greater than many on both sides of the aisle in Congress had anticipated.”

The plan appears to make concessions to both economic theory—which suggests that consumers will save a relatively large fraction of temporary increases in disposable income—and recent experience—which seems to suggest that what works in theory sometimes works in practice. Again, from the Wall Street Journal:

“Economists of all political stripes widely agree the checks sent out last spring were ineffective in stemming the economic slide, partly because many strapped consumers paid bills( ISN'T THAT SPENDING? ) or saved the cash( I HOPE SOME PEOPLE DO. JUST NOT EVERYBODY. ) rather than spend it. But Obama aides wanted a provision that could get money into consumers’ hands fast, and hope they will be persuaded to spend money this time if the credit is made a permanent feature of the tax code.”( I THINK THAT THE TAX HAS TO BE PHASED OUT TO ENCOURAGE SPENDING SOONER RATHER THAN LATER.)

As for the business tax package:

“… a key provision would allow companies to write off huge losses incurred last year, as well as any losses from 2009, to retroactively reduce tax bills dating back five years. Obama aides note that businesses would have been able to claim most of the tax write-offs on future tax returns, and the proposal simply accelerates those write-offs to make them available in the current tax season, when a lack of available credit is leaving many companies short of cash.

“A second provision would entice firms to plow that money back into new investment( THIS IS WHAT I WOULD FAVOR ). The write-offs would be retroactive to expenditures made as of Jan. 1, 2009, to ensure that companies don’t sit on their money until after Congress passes the measure.”

A relevant question here is really quite similar to the one we ask when the tax cuts are aimed at households: Will the extra cash be spent? This graph provides some interesting perspective:

Relative to net worth (of nonfarm nonfinancial corporate businesses), private fixed investment has been in consistent decline since the second quarter of 2006. (The level of fixed investment has declined in each quarter, save one.) In fact, the investment/net worth ratio is currently at a postwar low. ( IS HOUSING INCLUDED? )

Why? A couple of hypotheses come to mind. (1) Firms are extremely pessimistic about the outlook and see relatively few worthwhile projects in which to commit funds.( TRUE ) (2) Credit markets are so impaired that the net worth of firms—a critical variable in mainstream models of the so-called “credit channel” of monetary policy—is supporting increasingly smaller levels of lending.( TRUE ) (3) Nonfinancial firms, like financial firms, are deleveraging and hence not expanding( TRUE ). ALL OF THESE ARE PROBABLY TRUE TO SOME EXTENT, BUT WHEN I LOOK AT THE GRAPH, IT SEEMS THAT INVESTMENT STARTED GOING DOWN DURING THE TECH BUBBLE YEARS AND CONTINUED IN THE HOUSING BUBBLE YEARS. I'M WONDERING IF THERE HASN'T BEEN A MASSIVE AMOUNT OF MONEY INVESTED IN STOCKS AND HOUSING AS OPPOSED TO, SAY, MANUFACTURING. SEE BELOW.

Of course, even if one of these hypotheses is true, it need not be the case that marginal dollars sent in the direction of businesses will go uninvested. But it makes you wonder.( I STILL FAVOR MY IDEA. THE GRAPH ISN'T CONCLUSIVE. )

By David Altig, senior vice president and research director at the Atlanta Fed"

Here's Casey Mulligan:

"TESTING THE THEORY WITH DATA FROM 2008

Another application of this logic is to the residential sector: does residential spending increase or decrease nonresidential spending? Here it is easy to see the importance of supply -- see the figure below.

When housing boomed, nonresidential construction spending fell (despite the fact that the housing boom was increasing the prices of construction labor and materials) -- almost dollar for dollar!

When housing crashed, nonresidential construction spending ROSE (despite the fact that the housing crash was reducing the prices of construction labor and materials), about 15 cents on the dollar. Note that, according to the NBER, some of the nonresidential increase occur ed during a recession.

Another fascinating property of this episode is that the shocks to spending are on the order of magnitude (100s of billions of dollars) of the kinds of fiscal stimuli being recommended by some economists.

When interpreting what is above, we need to recognize that a large sector is omitted -- the non-construction sector. For this reason, the calculations above underestimate of the aggegate supply effect of housing spending on nonresidential spending (Take, for example, accountants. A housing boom pulls accountants into work for construction businesses, which leaves fewer accountants to work for non-construction businesses.). But they also underestimate the aggregate demand effect, because the housing construction workers are taking their paychecks and spending some of it on non-construction items. In any case, the supply effect is easy to see -- the housing construction boom did not take place with resources that would have otherwise been unemployed and the housing bust did not release resources entirely into unemployment."

So, I'm wondering if the Tech and Housing Bubbles diverted money away from other types of investment. If so, we might want to rethink subsidizing the purchases of houses ( I'm for a general housing subsidy for low-income people. ) It would seem to me, interpreting Mulligan's points for my own purposes, that now would be an especially felicitous time to encourage investment in sectors that have been recently shunned.

"Maybe the housing crash and mortgage modification that followed have something to do the recession of 2008."

Casey Mulligan got a lot of grief for this post:

"Want to Cut Your Debt? Work Less

Copyright, The New York Times Company

Mortgage modification programs create terrible work incentives and are ubiquitous these days, and this is one reason why this recession is so different from previous ones.

In most cases, a homebuyer takes out a mortgage that covers only part of the value of the house he’s buying. In other words, the house a person buys is worth more than the mortgage he owes on it. This means that in the event of borrower delinquency, the lender can, in most cases, obtain his full principal by foreclosing on the house and selling it to a new purchaser.

However, housing prices have fallen dramatically since 2006. By 2008, about 12 million mortgages were “under water” – meaning that market value of the house had fallen below the amount owed on the mortgage. Because of the low resale values, foreclosing on any of those homes will not yield lenders their entire principal; lenders in those cases must rely on the good behavior of the borrowers.

Officials at the Federal Reserve, the United States Treasury, the F.D.I.C., Fannie Mae (most recently, its “Early Workout” program) and Freddie Mac have encouraged lenders in such cases to “modify” mortgages – that is, to accept a stream of payments from the borrowers that is different from the amounts promised when the mortgages were initially signed. In particular, these “modification programs” encourage lenders to reduce mortgage payments so that each borrower’s housing payments (including principal, interest, taxes and insurance) are 38 percent of the borrower’s gross income( THEN THEY'RE PROPORTIONAL. THERE'S NO INCENTIVE TO MAKE LESS. ). The payments are to be reduced for the next five years, or when the mortgage is paid off (whichever comes first).

Of course, a borrower cannot be harmed by the opportunity to have his mortgage payment reduced. But what is economically noteworthy is that the amount of the payment reduction depends on the borrower’s income – the less he or she earns, the more the payment is reduced. ( I'M NOT SURE I UNDERSTAND THE CONCERN. SURELY IT'S BETTER TO EARN MORE AND PAY MORE THAN TO EARN LESS AND PAY LESS. FOR ONE THING, YOU WILL HAVE MORE MONEY AFTER YOU'VE MADE THE HOUSING PAYMENT. ) For example, a borrower whose annual family income is $100,000 can have her housing payments reduced to $38,000 per year, whereas a borrower whose annual income is $50,000 can have his payments reduced to $19,000 per year.( THAT ISN'T A GOOD REASON TO EARN LESS. I DON'T UNDERSTAND THIS. )

One implication of the mortgage modification rules is that a family that earns $50,000 less in the year prior to their modification stands to save $19,000 per year for the following five years – or a total of $95,000 on its housing payments! Those are 95,000 reasons to hesitate when looking for a new job, when wrapping up a maternity or paternity leave, or when confronting other job transition situations. ( NOT IF YOU CAN EARN MORE. IS ALL THE EXTRA MONEY GOING TO HOUSING PAYMENTS? )

I do not expect every adult among those in the 12 million underwater households to be without a job because of the modification rules( ARE YOU SAYING THAT THEY QUIT THEIR JOB? THEN THEY DO NOT RECEIVE UNEMPLOYMENT BENEFITS. ). Although modification professionals have specialized in educating homeowners about their modification options, many homeowners probably do not fully understand the mortgage consequences of their earning decisions. Nobody knows the exact numbers, but, even if 90 percent of homeowners were oblivious or uninterested in their modification options, that would leave over a million households that were aware. One million plus workers would make a large dent in the employment statistics.

My previous post reminded readers that productivity has been rising and employment falling in this recession. If approximately one million workers realized that earning income in 2008 was not in their financial interest – and acted on this realization – their actions would have the effect of significantly reducing aggregate employment and hours. As businesses operated with less labor, labor productivity would rise. Maybe the housing crash and mortgage modification that followed have something to do the recession of 2008."

I don't see the incentive at all. Quitting your job will make you much poorer, since you won't have any income, and if you're fired or let off, that has nothing to do with your housing payments. Once fired or let off, your payments are proportional to what you earn. There's no incentive to stay out of a job if you can get one for mortgage payments. For one thing, you have to look for a job for UI, and any fool knows that you should take a decent job if you're offered one. You never know when you'll be offered another. I must have missed something.

My explanation is that employers have been laying off workers proactively due to the fear and aversion to risk. In other words, they have been letting workers go even though demand hasn't fallen enough to justify the layoffs. That's why productivity is rising. I'm putting the fear and aversion to risk now rampant in the economy up against loan modifications as an explanation of rising productivity, and readers can decide which explanation is more probable.

"Once the boom was over, it became time to invest in the nonresidential sector again."

From EconomPic Data:

"Construction Spending November

Per Interest Rate Roundup:

The latest figures show construction spending was down, but not out, in the month of November. Total spending declined 0.6% against market expectations for a decline of 1.4%. October's decline was also revised to just -0.4% from a previously reported drop of -1.2%.

The residential market continues to be a lead anchor, with private residential spending down 4.2% -- the biggest decline since July's -6.2% reading. Private nonresidential spending, on the other hand, increased 0.7% after a 0.4% decline in October. Within the private nonresidential sector, spending on lodging was up 0.7%, spending on office property rose 0.9%, spending on transportation projects jumped 3.2% and spending on power facilities climbed 5.3%.

Looking at the longer trend (year over year rather than month over month), residential construction has gotten absolutely crushed. One area of huge growth has been manufacturing, which I have no explanation for. It looks like the media is confused as well. See if this commentary by Zacks makes any sense:

Construction in manufacturing also increased by 61.5% over the past year, as the manufacturing sector had been struggling during this economic recession, as evidenced by the ISM Manufacturing announcement on Friday, a 28 year low.

Source: Census

Posted by Jake at 10:15 AM "

Here's Casey Mulligan's explanation of the Manufacturing Construction increase, which makes sense to me:

"Flashback: Nonresidential Investment Boom

I have consistently explained (eg., here and here) how the housing boom was diverting resources away from nonresidential investment. Once the boom was over, it became time to invest in the nonresidential sector again. ( I AGREE )

I was told that the latter couldn't happen, because banks were (supposedly) not lending.

Well, November showed yet another INCREASE in nonresidential construction spending:

"The Commerce Department reported Monday that construction spending dropped by 0.6 percent in November, less than half of the 1.3 percent decline economists expected. A 4.2 percent fall in housing construction was partially offset by a surprisingly strong 0.7 percent rise in nonresidential activity."

This was no surprise to readers of this blog!!

Construction spending is measured in dollars -- so it is an even bigger real increase (recall that investment goods prices have been falling these days).

Posted by Casey B. Mulligan at 9:55 AM "