Author: Jonathan

Joe Stiglitz this time.

The Dismal Economist’s Joyless Triumph

… The point of reciting these challenges facing the world is to suggest that, even if Obama and other world leaders do everything right, the US and the global economy are in for a difficult period. The question is not only how long the recession will last, but what the economy will look like when it emerges.

Will it return to robust growth, or will we have an anemic recovery, à la Japan in the 1990’s? Right now, I cast my vote for the latter, especially since the huge debt legacy is likely to dampen enthusiasm for the big stimulus that is required. Without a sufficiently large stimulus (in excess of 2 percent of GDP), we will have a vicious negative spiral: a weak economy will mean more bankruptcies, which will push stock prices down and interest rates up, undermine consumer confidence, and weaken banks. Consumption and investment will be cut back further.

Many Wall Street financiers, having received their gobs of cash, are returning to their fiscal religion of low deficits. It is remarkable how, having proven their incompetence, they are still revered in some quarters. What matters more than deficits is what we do with money; borrowing to finance high-productivity investments in education, technology, or infrastructure strengthens a nation’s balance sheet.

The financiers, however, will argue for caution: let’s see how the economy does, and if it needs more money, we can give it. But a firm that is forced into bankruptcy is not un-bankrupted when a course is reversed. The damage is long-lasting. 

If Obama follows his instinct, pays attention to Main Street rather than Wall Street, and acts boldly, then there is a prospect that the economy will start to emerge from the downturn by late 2009. If not, the short-term prospects for America, and the world, are bleak.

Paul Krugman argues that mortgage rates should be (and have generally been) about a point and a half above 10-year Treasuries.

Mortgage rates are still too high

The persistence of the spread offers one opportunity for quick economic stimulus: declare that Fannie and Freddie are backed by full faith and credit, and if that doesn’t work, have the Treasury borrow on their behalf. This can bring mortgage rates down by more than 100 basis points. By itself, that’s not nearly enough to turn the economy around, but it could really help the economic recovery package.

The 10-year rate was 2.85% on Christmas Eve, down from 3.45% at the beginning of the month.

Matthew Yglesias explains compensation economics to Dean Baker.

Nice Work if You Can Get It

The Washington Post takes a look at Fannie Mae’s new board. Dean Baker takes a look at the Post’s skewed priorities:

The remarkable part of this story is that the Washington Post reporter could not find a single person who thought that paying part-time workers $160,000 a year was a bad idea. There is absolutely no one cited in this piece who raised a question about the compensation levels for the board.

Keep in mind that this is a newspaper that is absolutely apoplectic over autoworkers getting $27 an hour. If we assume that the board members on average will devote 500 hours a year to their board duties, this puts their pay rate at $320 an hour.

Look, super-high salaries for the already wealthy equal necessary incentives for prosperity. Relatively high wages for the working class equals productivity destroying union malfeasance. That’s not really so hard to understand, is it?

The price of oil that is; thus Dave Cohen. I won’t try to summarize; the argument isn’t hard to follow, though.

The price is not right

Today’s NYMEX WTI oil price, about $45/barrel, is dangerously, outrageously low. Crude oil is not some “inconsequential penny stock” as Clive Maund pointed out, but that’s how it’s been priced (321Energy, November 19, 2008). I am going to talk about how oil prices get set in a futile attempt to understand what future prices might look like. I find little reason for optimism regarding the market’s ability to provide a coherent oil price signal reflecting future scarcity of this precious non-renewable resource.

Figure 1 is taken from James Hamilton’s Understanding Crude Oil Prices (UCSD Department of Economics, November  7, 2008); updated (in blue) to reflect the current price.

… The issue discussed in this essay is whether the price does or does not tell us about Our Oil Future. It does not. We know the $45 oil price is not right as we look down the road to a time when the global economy rises like a Phoenix from the ashes. Because of the nature of oil pricing, I find it likely that we revisit the 2008 nightmare over and over again in future years.

via James Hamilton

Should UAW wages be reduced to the industry average? Then what about CEOs? Yves Smith:

Have You Bought Into the Pay Double Standard?

So with this mechanism in place, any CEO who has fallen below median pay who is targeted to be in a higher group will have his pay ratcheted up, independent of performance, merely to keep up with his peers, This increase raises the average and creates new laggards. The comp consultants have institutionalized a leapfrogging process that keeps them busy surveying competitor reward levels and keeps top-level pay rising relentlessly.

The Fed’s Trade-off Is Inflation Versus Unemployment

The Fed doesn’t like to ever say that it is deliberately throwing people out of work, nor do economists who support the Fed’s actions when it deliberately throws people out of work. Therefore they talk about a trade-off between “growth” and inflation, not unemployment and inflation.

The Washington Post is helping to conceal the Fed’s actions today in an article where it refers to the view of Greenspan and other Fed members in the 90s that the economy could grow more rapidly without triggering inflation. In fact, the debate was over how low the unemployment rate could fall before inflation began to accelerate. The conventional view at the time was that “non-accelerating inflation rate of unemployment” or NAIRU was near 6.0 percent. The unemployment rate eventually fell to a year-round average of 4.0 percent without any substantial uptick in the inflation rate.

It is important to note that the conventional economic theory is called the non-accelerating inflation rate of “unemployment,” not the non-accelerating inflation rate of “growth.”

—Dean Baker

There’s been an argument floating around the econoblogs over the desirability of the Feds pushing down mortgage rates. Felix Salmon here makes the case against, and links to a couple of arguments on the other side.

Felix Salmon: Against Lower Mortgage Rates

Glenn Hubbard and Charlie Mayer have a WSJ op-ed saying, in the clear words of their headline, that "Low-Interest Mortgages Are the Answer"; Brad DeLong agrees, and yes, he’s more astonished than anybody else that he’s siding with Hubbard.

I, however, find the argument unconvincing.

First, Hubbard and Mayer imply that the house-price decline is now in overshooting territory: "while fundamental factors clearly played a role in driving down house prices that were at excessive levels two years ago," they write, "house values are today lower than what is consistent with the average level of affordability in the past 20 years".

This is an argument which basically says that nominal house prices don’t matter — all that matters is "affordability", which is code for low interest rates. In other words, they’re assuming their conclusion. Of course nominal interest rates matter: house-price declines, as we’ve seen, can cause massive delinquency and default. As a result, no one wants to live in a world where house prices would plunge if and when interest rates rise substantially.

Indeed, the authors’ own research, which shows relatively low levels of affordability 20 years ago when interest rates were high, only proves that nominal prices do matter. And as a glance at the Case-Shiller indices will show you, nominal house prices are still very high by historical standards.

There’s really no fundamental reason why Americans could and did become so comfortable with the concept of the million-dollar house, even while the average household income remained stubbornly in the five-digit range. And there’s no fundamental reason either why most families should essentially have to use one full-time salary just to pay the mortgage, and rely on a second full-time salary to actually spend and live on. If you’re looking at affordability in terms of household income, you’re missing the fact that many households have had to take on extra jobs just to afford their homes.

The op-ed continues:

A 4.5% mortgage rate is not too low. The 10-year U.S. Treasury yield closed at 2.3% on Dec. 12, 2008. Hence a 4.5% mortgage rate is 2.2% above the Treasury yield, above the 1.6% spread that would prevail in a normally functioning mortgage market.

But a 4.5% mortgage rate is too low, and as someone who sits on the board of a credit union which does a lot of real estate lending, I’m very aware of the fact.

Hubbard and Mayer, here, are careful again to ignore nominal levels: they look instead only at spreads over the bubblicious Treasury market. Yes, when Treasury yields are artificially low, then spreads over Treasuries are going to look wider than normal. But a 4.5% mortgage rate is unprecedented in modern times, if ever, and for good reason.

If banks could originate to distribute, like they did during the bubble, then they could happily lend out at 4.5% and not worry about the consequences of having an asset yielding 4.5% sitting on their books for 30 years. But as we’ve seen, the originate-to-distribute is a recipe for fraud and lax underwriting. Private-sector investors are now sensibly wary of it, and Frannie should be too.

On the other hand, if banks are really lending out 30-year funds at 4.5%, they’re taking an enormous amount of interest rate risk, which is not at all easy to hedge. Remember that the first round of Frannie scandals centered on the agencies’ inability to effectively hedge their interest-rate risk; there’s no reason to believe that private-sector mortgage lenders will be any better. When Fed funds goes back over 5% — which it’s bound to do at some point in the next 30 years –and banks have a whole bunch of 4.5% loans on their books, we’ll just have yet another banking crisis on our hands.

Hubbard and Mayer go on to calculate that lowering mortgate rates to 4.5% could lead to 2.4 million additional owner-occupied homes in 2009. That’s an enormous number, and it worries me greatly. We have too many owner-occupied homes already — one of the reasons we had a housing bubble in the first place was that a lot of people who had no business buying property went ahead and did so anyway.

In order for buying a home to be sensible, you basically need a predictably steady income and you need to expect to stay in the same place for the next 5-10 years. Are there 2.4 million non-homeowners who really fit that bill and who are remotely willing to buy a house in the next 12 months? Of course not. So if that many people do end up buying houses, a lot of them will end up either losing money — because they have to sell when they move and they’ll get hit with all the attendant fees and costs — or else missing out on opportunities which are too far from where they are stuck because they own a home somewhere. Or, of course, they’ll simply default.

The authors even go into a reverie about a $100-billion-a-year "housing wealth effect" — haven’t we learned anything from the bubble? The housing wealth effect is a by-product of home equity lines of credit and cash-out refinancings — the very instruments which caused the bubble and burdened Americans with far more debt than they could afford. There’s no housing wealth effect if you can’t borrow against your housing wealth — and, frankly, people shouldn’t be able to borrow against their housing wealth, certainly not as easily as they did over the past few years.

Hubbard and Mayer do have one good argument:

The 4.5% mortgage rate that the Treasury is considering also should be available for present homeowners who want to refinance, because of the benefits for the economy as a whole. We calculate that up to 34 million households would be able to do so, at an average monthly savings of $428 — or a total reduction in mortgage payments of $174 billion. This is a permanent reduction in payments and is thus likely to spur appreciable increases in consumption.

Moreover, trillions of dollars of refinancings would retire a large number of the existing mortgage-backed securities. This would reduce uncertainty about the value of existing mortgage-backed securities. It would flood the market with additional liquidity that the private sector could deploy to other uses such as auto loans, credit cards, commercial mortgages and general business lending.

The multiplier here, however, is tiny: the cost to the government of reducing mortgage payments by $174 billion would be a good three times that sum.

There are much more effective ways for the government to spend half a trillion dollars than buying up mortgage-backed securities. Throwing it all at homeowners and leaving everybody else out in the cold is neither fair nor sensible.