Category: Economics

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.

I don’t generally post on these conversations (or even read them very much, really), but this one has a particularly good cast. I’ll be following it closely.

Book Clubbing With Paul Krugman

This week at Cafe, Paul Krugman is joining us to talk about his new book The Return Of Depression Era Economics And The Crisis of 2008 — a revised version of his 1999 book. The first version focused on Asia and Latin America– this one turns its gaze on our current economic troubles and America.

Paul’s first post will be up shortly, and he’ll introduce the discussion. In the meantime, check out his Nobel Prize lecture, which he recently delivered in Stockholm on December 8th.

We’ve roped in a great group of economists to discuss with Paul all week: Dean Baker, co-director of the Center for Economic and Policy Research, and assistant professor of economics at Bucknell University; Brad DeLong, professor of economics at UC Berkeley, and former Deputy Assistant Secretary of Treasury in the Clinton Administration; Robert Reich, professor at UC Berkeley’s Goldman School of Public Policy, and former U.S. Secretary of Labor from 1993 to 1997; Dana Chasin, Senior Policy Advisor at OMB Watch; Jo-Ann Mort, the founder and CEO of ChangeCommunications, Randall Wray, professor of economics and research director at the Center for Full Employment and Price Stability at the University of Missouri-Kansas City; Mark Thoma, associate professor of economics at the University of Oregon; and Susan Feiner, professor of economics and women’s and gender Studies at the University of Southern Maine.

Update: the first installment.

NYT Informs Readers of Forecaster’s Track Record

Yes, it can be done. The NYT headline read, “Goldman, Once Warning Of $200 Oil, Sees $45 In 2009.”

This is exactly what the media should be doing when they present forecasts from various experts. For example, when they share the views of people like Alan Greenspan on the economy, they can preface them with a comment like, “Alan Greenspan, who insisted there was no housing bubble.” In fact, the media should preface the predictions of almost all their economic experts with this comment.

With some experts this assertion would be especially important information. For example, predictions from Frederick Mishkin, a New York University professor and a former governor of the Federal Reserve Board, should carry the preface “who recently praised Iceland’s economy for its effective inflation targeting.” Statements from Frank Nodthrift, the former chief economist with Freddie Mac, should include the phrase, “who asserted that house prices never fall.”

Reporters should be familiar with the track record of the experts they rely upon and they should share this information with the public.

—Dean Baker

Stimulus Is for Suckers

…
The historical role of a stimulus is to kick things off, to grease the wheels of credit, to get things “moving again.” But the effect ends when the stimulus does, when the sugar shock wears off. Compulsive budget balancers who prescribe a “targeted and temporary” policy followed by long-term cuts to entitlements don’t understand the patient. This is a chronic illness. Swift action is definitely needed. But we also need recovery policies that will continue for years.

First, we must fix housing. We need, as in the 1930s, a Home Owners’ Loan Corporation to restructure failed mortgages on sustainable terms. The basic objective should be to keep people in their homes by all necessary means …

Second, we must backstop state and local governments with federal funds. Otherwise falling property (and other) tax revenues will implode their budgets, forcing destructive cuts in public services and layoffs for teachers, firefighters, and police. …

Third, we should support the incomes of the elderly, whose nest eggs have been hit hard by the stock market collapse. … The best way is to increase Social Security benefits. …

Fourth, we should cut taxes on working Americans. Obama proposes to effectively offset the first $500 of Social Security taxes with a refundable credit. It’s a good idea, but can be expanded. …

Finally, we must change how we produce energy, how we consume it, and above all how much greenhouse gas we emit. …

What a dollar of stimulus puts back into the economy when spent on…

Chapter 11 is the right road for US carmakers

The debate about whether or not to bail out the Big Three carmakers has been mischaracterised. It has been described as a package to help the undeserving dinosaurs of Detroit. In fact, a plan to bail out the carmakers would benefit shareholders and bondholders as much as anybody else. These are not the people that need help right now. In fact they contributed to the problem.

Financial markets are supposed to allocate capital and monitor that it is used to good effect. They are supposed to be rewarded when they do that job well, but bear the consequences when they fail. The markets failed. Wall Street’s focus on quarterly returns encouraged the short-sighted behaviour that contributed to their own demise and that of America’s manufacturing, including the automotive industry. Today, they are asking to escape accountability. We should not allow it.

What needs to be done is to help the automakers get a fresh start and allow them to focus on producing good cars rather than trying to juggle their books to meet past obligations.

The US car industry will not be shut down, but it does need to be restructured. That is what Chapter 11 of America’s bankruptcy code is supposed to do. …

Barry Ritholtz.

More CRA Idiocy

Howard Husock has an exercise in cognitive dissonance in today’s NYT Op-Ed pages titled Housing Goals We Can’t Afford, and it begins:

“The national wave of home foreclosures, many concentrated in lower-income and minority neighborhoods, has created a strong temptation to find the villains responsible.”

What can you say about an Op-Ed whose very first sentence is a giant pile of steaming bullshit? That statement is demonstrably false. As the prior post on foreclosures shows, the concentration is mostly middle class and upper middle class white suburban neighborhoods.

…

Let’s put some context around what the CRA  is and isn’t.

In the 1960s and 70s, banks would redline neighborhoods. They would literally put a map on a wall, and with a red magic marker, draw a redline enveloping certain neighborhoods. If you lived within the redlined areas, regardless of your income, credit score, assets, debt servicing ability, if you were in the redlined area you could not qualify for a mortgage.

Although Redlining was made illegal by the Fair Housing Act of 1968, the practice still surreptitiously continued. The Community Reinvestment Act of 1977 was the next attempt to stop redlining. There were two main aspects of the CRA: First, it required banks to apply the same lending criteria in all communities. Credit Score, Loan-to-value, percentage of monthly take home, etc. had to be the same across different areas.

Second, the Community Reinvestment Act required banks to make good faith attempts to loan the money back to its own depositors. If you open up a branch in Harlem, you cannot suck up all the local business and residents’ cash, and then turn around and only lend it out to Tribeca condo buyers. You must make a fair attempt to loan the money locally. Banks have no obligation to open branches in Harlem, but if they did, they are required to at least try to lend the locals back their own money.

Note that there are no quotas, minimums or mandates. This is a very soft rating system.

The rest of Husock’s article is filled with the usual dissembling and half-truths. He mentions “in 1995 the Clinton administration added tough new regulations,” but omits any mentions that the Bush administration substantially watering down the act in 2004.

…

And of course, vast numbers of sub-prime mortgages were written by non-CRA banks. Indeed, none of the 300+ mortgage originators that imploded were depository banks covered by the CRA.

This is a an intellectually silly argument from other perspectives also. Why was there no credit/housing meltdown from 1977 to 2005? Why did 30 other countries, none of which have are covered by the CRA, have a remarkably similar housing boom and bust to the USA? Husock’s arguments not only fail legally and factually, they also fail in terms of time and space …

via The Big Picture

Quelle Surprise! Banks Increase “Mark to Make-Believe” Assets to $610 Billion

Banks are, if nothing else, entirely predictable. If there is a way to game the system, they will avail themselves of it.

Curious? Go read Yves Smith.

#4 of Foreign Policy magazine’s 10 Worst Predictions for 2008:

“[A]nyone who says we’re in a recession, or heading into one—especially the worst one since the Great Depression—is making up his own private definition of ‘recession.’” —Donald Luskin, The Washington Post, Sept. 14, 2008

(aka “The Stupidest Man Alive“)

Collect them all!

John Mauldin quotes (famous pessimist) Nouriel Roubini:

A severe global recession will lead to deflationary pressures. Falling demand will lead to lower inflation as companies cut prices to reduce excess inventory. Slack in labour markets from rising unemployment will control labor costs and wage growth. Further slack in commodity markets as prices fall will lead to sharply lower inflation. Thus inflation in advanced economies will fall towards the 1 per cent level that leads to concerns about deflation.

Deflation is dangerous as it leads to a liquidity trap, a deflation trap and a debt deflation trap: nominal policy rates cannot fall below zero and thus monetary policy becomes ineffective. We are already in this liquidity trap since the Fed funds target rate is still 1 per cent but the effective one is close to zero as the Federal Reserve has flooded the financial system with liquidity; and by early 2009 the target Fed funds rate will formally hit 0 per cent. Also, in deflation the fall in prices means the real cost of capital is high – despite policy rates close to zero — leading to further falls in consumption and investment. This fall in demand and prices leads to a vicious circle: incomes and jobs are cut, leading to further falls in demand and prices (a deflation trap); and the real value of nominal debts rises (a debt deflation trap) making debtors’ problems more severe and leading to a rising risk of corporate and household defaults that will exacerbate credit losses of financial institutions.

— Professor Nouriel Roubini of New York University

I keep seeing graphs that suggest that something exceptional is going on. Here’s one from Mauldin’s post:

That’s percentage growth. Here’s the result:

I guess we can conclude that the Fed is working pretty hard to prevent deflation. But maybe not; it’s apparently more complicated, and even more complicated on top of that.

Figures. Go read Mauldin. (Any relation?)

Lots of graphs today via Barry Ritholtz. Click the link for all of ’em, but here’s one. Is it bad news that the index is in the toilet? Good news that it’s ticked up?

Beats me.

Credit Crisis Watch (December 8, 2008)

Another indicator worth keeping an eye on is the Barron’s Confidence Index. This Index is calculated by dividing the average yield on high-grade bonds by the average yield on intermediate-grade bonds. The discrepancy between the yields is indicative of investor confidence. A declining ratio indicates that investors are demanding a higher premium in yield for increased risk. A slight improvement has taken place over the past week, but hardly of the magnitude to indicate restored confidence in the economy.

Is it premature to be this cynical?

Nah…

Joseph Stiglitz: Keynesian economics finds new relevancy in the 21st century global economy

… Today, the risk is that the new Keynesian doctrines will be used and abused to serve some of the same interests. Have those who pushed deregulation 10 years ago learned their lesson? Or will they simply push for cosmetic reforms — the minimum required to justify the mega-trillion dollar bail-outs? Has there been a change of heart, or only a change in strategy? After all, in today’s context, the pursuit of Keynesian policies looks even more profitable than the pursuit of market fundamentalism! …

Blaming Moody’s

“We obviously cannot ask payment for rating a bond. To do so would attach a price to the process, and we could not escape the charge, which would undoubtedly come, that our ratings are for sale.”

— Edmund Vogelius, a Moody’s vice president, explained the company’s business model in a 1957 article in The Christian Science Monitor

via Barry Ritholtz; graphic via NY TImes