Ickman's blog

Energy Security vs Water Security

2011-05-28T05:48:00.000-07:00

Interesting article in NYTimes on using fracking to unlock oil supplies. Although fracking uses up valuable water supplies,

The oil industry says any environmental concerns are far outweighed by the economic benefits of pumping previously inaccessible oil from fields that could collectively hold two or three times as much oil as Prudhoe Bay, the Alaskan field that was the last great onshore discovery. The companies estimate that the boom will create more than two million new jobs, directly or indirectly, and bring tens of billions of dollars to the states where the fields are located, which include traditional oil sites like Texas and Oklahoma, industrial stalwarts like Ohio and Michigan and even farm states like Kansas.
“It’s the one thing we have seen in our adult lives that could take us away from imported oil,” said Aubrey McClendon, chief executive of Chesapeake Energy, one of the most aggressive drillers. “What if we have found three of the world’s biggest oil fields in the last three years right here in the U.S.? How transformative could that be for the U.S. economy?”

But I wonder how much gain there is if switch from importing oil to importing water? Not that we can ever insulate ourselves from imported oil, there is not that much to frack. But even if there was, aren't supplies of water also important? Would politicians be so happy to have our water consumption decided by an Organization of Water Exporting Countries?

Don't Knock the Ryan Plan?

2011-05-28T05:25:00.001-07:00

Joe Nocera tells us not to knock Paul Ryan. Not that he likes the plan itself:

The Ryan plan, which would give seniors a fixed amount they can use to buy health insurance, would undoubtedly shift the cost burden over time from the government to seniors themselves, making health care far less affordable for millions of people. Ryan says that “empowering” health care consumers will help control costs, but that’s absurd: Medicare itself has far more pricing power than the people who actually need treatment.

The first part of Nocera's critique is correct, the cost of health care is shifted to seniors themselves, but the second part makes no sense (though I have seen this before, see here). I wonder how people can hold such contradictory ideas in their heads at the same time? If you shift more of the costs to seniors, who have limited budgets, they will get less health care. If they pay less for health care, costs will fall. Of course so will the amount of health care provided. But you cannot deny that if people cannot afford healthcare they will buy less of it.

Indeed, that seems to be the biggest problem with the Ryan plan. It controls the costs of healthcare by forcing people to buy less than they need.

But then the confused Nocera argues that we should not scorn Paul Ryan. Because the costs of health care are real he argues that:

It would be nice if we could treat the Ryan plan not as an object of derision but as a launching off point for a serious debate. That way, maybe for once we could avert a crisis instead of acting shocked when it finally arrives.

But this seems odd to me. Why not let the Obama Plan be the start of a discussion to control Medicare costs? You don't want to scorn Ryan who argues that Obamacare destroys Medicare. But we should start the discussion with Paul Ryan?

Nocera is really confused.

Supermarkets and Schools

2011-05-06T07:57:00.000-07:00

Greg Mankiw connects to this Don Boudreaux article in the WSJ asking what supermarkets would be like if they were run like public schools. Mankiw thinks the article is thought-provoking, so do I, but for opposite reasons I think. Have you ever seen what supermarkets are like in poor neighborhoods? Compare groceries and school in South-Central Los Angeles. The schools are better, much better, and that is saying something. They are even safer. For a study of groceries in South Central you can go here.

Of course there are plenty of good groceries stores in Brentwood and Beverly Hills. So what is the point that Boudreaux and Mankiw want to make. That we can have school choice and the affluent will get good choice and good schools, and the poor will get their education from bodegas and liquor stores? Do they think that the crime and violence, let alone lack of purchasing power, that inhibits supermarkets from moving to poor neighborhoods will not deter schools?

Playing with Fire

2011-05-05T04:40:00.000-07:00

Pennsylvania Senator Pat Toomey puts in his two cents as dumbest legislator early in his term. With Congress playing fire over a debt ceiling bill, he calls for legislation to only pay interest on the debt. As this article in the NYTimes notes:

“I think the important thing to do would be to make it clear to markets that the government is not going to default on its debt,” said Senator Patrick Toomey, Republican of Pennsylvania, whose bill assigns priority to interest payments. “It would be easy, I think, to make it clear to the markets that they don’t have to worry about this.”

Toomey's plan to pay interest payments but not other government obligations -- such as wages -- seems as dumb politically as economically. After all, much of the debt is held by foreigners, so Toomey would pay off the Chinese before American citizens who toil for the public. I guess this fits with the basic Republican idea that interest recipients are more important than average Americans, but it is certainly playing with fire to do so. This would convert the government into a debt junkie who chooses each month whether to pay utilities or the rent and which creditors to hide from. Does Toomey really believe financial markets will still trust US debt under such behavior?

Greeks are Angry

2011-04-18T10:35:00.000-07:00

Greeks are angry over the costs of reform. See this article in the Guardian.

A growing chorus of voices is urging the Greek government to restructure its debt as fears grow that a €110bn bailout has failed to rescue the country from the financial abyss and is forcing ordinary people into an era of futile austerity.
"It's better to have a restructuring now … since the situation is going nowhere," said Vasso Papandreou, whose views might be easier to discount were she not head of the Greek parliament's economic affairs committee.

Given the scale of protests to minor adjustments it is hard to see how Greece can make the big adjustments necessary to adjust their fiscal situation:

Tomorrow, in a clear sop to the thousands who have signed up to the "can't pay, won't pay" movement, the ruling socialists will announce reductions of up to 50% in road toll fees. As the nation struggles to rein in a debt of €340bn, the logic of appeasing protesters – an estimated 8,000 Greeks a day were refusing to pay tolls – has outweighed antagonising them further. "Our hope is that this will calm things down," the deputy transport minister Spyros Vougias said.
Last week, a man shot a bus inspector hired to crack down on fare dodgers after protesters stormed a police station, snatched hundreds of confiscated number plates and set light to thousands of fines. Days later thugs attacked Antonis Loverdos, the health minister, as he visited a hospital in Athens. In Patras, James Watson, the 83-year-old Nobel Prize-winning geneticist was also attacked as he prepared to give a speech at the city's university.

It is hard to see how Greece can adjust without haircuts from bondholders. Some trade between haircuts and real reforms might make it palatable. But that opens up a complex political economy problem for Europe, since there are other economies, notably Portugal and Ireland with similar, though right now more manageable, problems.

Natural Gas Nonsense

2011-04-16T06:38:00.000-07:00

Joe Nocera has an article in today NYTimes arguing in favor of tapping the Marcellus Shale. The main point he makes:

The truth is, every problem associated with drilling for natural gas is solvable. The technology exists to prevent most methane from escaping, for instance. Strong state regulation will help ensure environmentally safe wells. And so on. Somewhat to my surprise, this view was seconded by Abrahm Lustgarten, a reporter for ProPublica who has probably written more stories about the dangers of fracking than anyone. In a comment posted online to my Tuesday column, he wrote that while the environmental issues were real, they “can be readily addressed by the employment of best drilling practices, technological investment, and rigorous regulatory oversight.”

Ironically, the NYTimes also has a front page article today arguing that GOP Pushes to Deregulate Environment at State Level. And this does not even deal with our PA Governor Tom Corbett who has ordered that "the Secretary of Environmental Protection must personally approve all enforcement actions and notices of violation. But only for natural gas drillers." Moreover the Governor will not allow any severance tax to cover any social costs associated with removing the gas.

Nocera argues that all his opponents are NIMBYs. But he ignores any discussion of the high cost of getting the gas out. We are told how abundant the natural gas is, but that any severance tax will lead to a drastic cut in production. Which must mean that most wells are marginal -- that only with very high prices is it profitable to produce the gas.

I am not against drilling but I think one should not ignore the costs. I suppose the problem is that bankers do not drill for natural gas. If they did Joe Nocera would be telling us that we should never take one cubic foot out of the ground -- you cannot trust anything a banker says. But no problem with gas drillers. And environmental regulators, so much better than bank regulators.

Thanks Paul Ryan

2011-04-06T11:07:00.000-07:00

Like most Republican initiatives, Paul Ryan's budget proposal is designed for me. Tax cuts for the well-off (which extend to the moderately well off), burden placed on future generations. For example, all the burden of Medicare reforms go to those 54 and younger. I'm 55, so I get off okay. Just like Republican tax policy or environmental policy all the costs are on future generations and I don't have any.

The reason is straightforward as David Leonhart notes in the NYTimes:

Yet there is at least one big way in which the plan isn’t daring at all. It asks for a whole lot of sacrifice from everyone under the age of 55 and little from everyone 55 and over. Representative Paul Ryan, the Wisconsin Republican who wrote the plan, calls the budget deficit an “existential threat” to the United States. Then he absolves more than one-third of all adults from responsibility in dealing with that threat...
The reason is partly political. Older people vote in larger numbers than younger adults. Children, of course, can’t vote at all.

This is the basic issue. All the young Obama voters did not vote in the midterm elections, so the Republicans won. Ryan rewards his constituency. Taxes will be cut. Spending for the poor will be cut. The deficit, well it will be cut if unemployment magically can fall to 2.8%, and if unicorns can fly.

Like all good Republican policies, the benefits go to me and the sacrifice goes to the future -- the young who will be left with the cost of the environmental cleanup and a huge federal debt -- and the poor who live elsewhere. I really don't understand why I should be so lucky.

Wisconsin Uprising and All That

2011-02-21T14:26:00.000-08:00

The uproar in Wisconsin has awaken my desire to blog.

The fight over the right of public sector unions to collectively bargain is an interesting question. In principle, I would tend to be on the side of ending this right. Unlike unions in the private sector, public sector unions are bargaining with elected officials who have little incentive to hold the line since these unions are major voting interests.

On the other hand, it is pretty transparent that this is an attempt to break a key voting block on the Democratic side of the spectrum at the same time that the Supreme Court has opened up the spigots for corporate donations with their Citizens United Decision.

In this case it is hard not to agree with Krugman:

In principle, every American citizen has an equal say in our political process. In practice, of course, some of us are more equal than others. Billionaires can field armies of lobbyists; they can finance think tanks that put the desired spin on policy issues; they can funnel cash to politicians with sympathetic views (as the Koch brothers did in the case of Mr. Walker). On paper, we’re a one-person-one-vote nation; in reality, we’re more than a bit of an oligarchy, in which a handful of wealthy people dominate.
Given this reality, it’s important to have institutions that can act as counterweights to the power of big money. And unions are among the most important of these institutions.
You don’t have to love unions, you don’t have to believe that their policy positions are always right, to recognize that they’re among the few influential players in our political system representing the interests of middle- and working-class Americans, as opposed to the wealthy. Indeed, if America has become more oligarchic and less democratic over the last 30 years — which it has — that’s to an important extent due to the decline of private-sector unions.

The irony, however, is that what the unions and right thinking people should be fighting is not for public sector union fighting power but a consensus that will cut subsidies for heating for low-income households so that the estate tax can be reduced and taxes can be cut for the super-rich.

Why doesn't anybody protest that? The contrived budget crisis caused by excessive tax cuts is the real shame.

End all Energy Subsidies

2011-01-05T14:10:00.001-08:00

An interesting article that discusses ending all energy subsidies. The argument is that since most subsidies actually go to fossil fuels, this will help green possibilities. And with cap and trade dead, it may be the only politically feasible way to encourage green alternatives.

If President Obama wants to set us on a path to a sustainable energy future—and a green one, too—he should propose a very simple solution to the current mess: eliminate all energy subsidies. Yes, eliminate them all—for oil, coal, gas, nuclear, ethanol, even for wind and solar. It will be better for national security, the balance of payments, the budget deficit, and even, believe it or not, the environment. Indeed, because wind, solar, and other green energy sources get only the tiniest sliver of the overall subsidy pie, they’ll have a competitive advantage in the long term if all subsidies, including the huge ones for fossil fuels, are eliminated. And with anti-pork Tea Partiers loose in Washington and deficit cutting in the air, it’s not as politically inconceivable as you might think.

In any event, it certainly would eliminate wasteful subsidies.

Voter Preferences

2010-12-09T07:15:00.000-08:00

This column in Slate collects the American voters views, according to polls, on economic policy. No wonder that policy is stalemated. Two snippets:

But the polled American is not sure whether the government should be doing so much to aid the economy in the first place. And, for her, all bets are off if the tax compromise becomes known as Stimulus 3.0 (or 2.0). She barely liked the 2009 stimulus when Congress passed it, and she certainly does not like it now. (The financial regulatory reform bill? She's made her peace with that.) Yet, in an enduring example of the polled American's propensity for containing multitudes, she likes virtually all of the elements of stimulus, such as the tax breaks, unemployment insurance, infrastructure investment, and bolstered food stamps—a case of the parts besting the sum, apparently. And she thinks the country needs more of those provisions. She also supports an increase in the minimum wage.

and

So how does the polled American think we should tackle the deficit issue? He knows that programs need cuts—tax hikes alone can't, and shouldn't, pull the country out of this mess. But he wants Washington to leave Social Security and Medicare well enough alone. And he hesitates to bring the ax to energy, health, or education programs. That said, he supports several provisions proposed by the president's debt commission—like shrinking the federal workforce, cutting federal salaries, closing overseas bases, and ending the tax deduction on home mortgage interest. And one program to really trim is America's generous foreign aid. The polled American thinks the government ships a quarter of our budget overseas, and thinks we should spend only $1 of every $10 helping out other nations. (In reality, the foreign aid amounts to less than 1 percent of the federal budget.)

This last part is great. Voters want to reduce the amount of foreign aid the government gives to a level ten times higher than we do! I don't think this can be done even standing on a chair.

Note also this article from Bloomberg that reports polling on the deficit. Americans want the deficit reduced. But the public also wants

...Congress to keep its hands off entitlements such as Medicare, Medicaid and Social Security, a Bloomberg National Poll shows. They oppose cuts in most other major domestic programs and defense. They want to maintain subsidies for farmers and tax breaks like the mortgage-interest deduction. And they’re against an increase in the gasoline tax.

I want to lose weight without cutting down my caloric intake. Not having great success with that program either.

No wonder policymakers can get nothing done. We would be better off, perhaps, if policy could be made in secret and then we voted after the fact based on results. I think that leads basically to dictatorship.

I Agree with Krugman

2010-12-06T07:55:00.001-08:00

Paul Krugman argues that President Obama should just let the tax cuts expire and I agree.

Democrats have tried to push a compromise: let tax cuts for the wealthy expire, but extend tax cuts for the middle class. Republicans, however, are having none of it. They have been filibustering Democratic attempts to separate tax cuts that mainly benefit a tiny group of wealthy Americans from those that mainly help the middle class. It’s all or nothing, they say: all the Bush tax cuts must be extended. What should Democrats do?
The answer is that they should just say no. If G.O.P. intransigence means that taxes rise at the end of this month, so be it.

Krugman thinks it is a bad deal. I think they should just let them expire based on budget realities. What would be best would be to couple this with a cut in payroll taxes. That would lower the cost of employing people and would mitigate any effect on unemployment.

But I expect the President will give in to satisfy his campaign pledge about not raising taxes on the middle class.

The Next Crisis?

2010-12-05T05:43:00.000-08:00

I hate to be alarmist, but the prospects of a crisis in state and local finance seems almost inevitable. "Creative" efforts to avoid taxing to cover current expenditures have created a looming debt crisis. And politics seems to militate against any efforts to deal with the crisis. As this New York Times article reports:

The State of Illinois is still paying off billions in bills that it got from schools and social service providers last year. Arizona recentlystopped paying for certain organ transplants for people in its Medicaidprogram. States are releasing prisoners early, more to cut expenses than to reward good behavior. And in Newark, the city laid off 13 percent of its police officers last week. While next year could be even worse, there are bigger, longer-term risks, financial analysts say. Their fear is that even when the economy recovers, the shortfalls will not disappear, because many state and local governments have so much debt — several trillion dollars’ worth, with much of it off the books and largely hidden from view — that it could overwhelm them in the next few years.

This is another instance of placing the burden of current expenditure on future taxpayers. But the states and localities have less leeway to continue borrowing, and the federal government seems unlikely to bail them out.

Consider:

Illinois, which has been failing to make the required annual payments to its pension funds for years, is doing. It borrowed $10 billion in 2003 and used the money to invest in its pension funds. The recession sent their investment returns below their target, but the state must repay the bonds, with interest. The solution? Illinois sold an additional $3.5 billion worth of pension bonds this year and is planning to borrow $3.7 billion more for its pension funds.

or:

Arizona, hobbled by the bursting housing bubble, turned to a real estate deal for relief, essentially selling off several state buildings — including the tower where the governor has her office — for a $735 million upfront payment. But leasing back the buildings over the next 20 years will ultimately cost taxpayers an extra $400 million in interest.

and then the most transparent kicking of the can:

New York balanced its budget this year by shortchanging its pension fund. And in New Jersey, Gov. Chris Christiedeferred paying the $3.1 billion that was due to the pension funds this year.
It is these growing hidden debts that make many analysts nervous. States and municipalities currently have around $2.8 trillion worth of outstanding bonds, but that number is dwarfed by the debts that many are carrying off their books.

The problem is not so much the magnitude -- the economy will recover -- but the structural problems of our politics. There is no political gain to dealing with current problems.

Unemployment Extension versus Bush Tax Cuts

2010-12-02T07:31:00.000-08:00

Can the Republican position on tax cuts be any more cynical? Compare their argument for extension with their refusal to extend unemployment insurance unless it is paid for. Here is Representative John Shadegg of Arizona speaking with Mike Barnicle on MSNBC (from Slate):

He's fine with unemployment benefits as long as they do not add to the deficit. Then Barnicle questioned the validity of the position, given that Shadegg supports giving a $700 billion tax break to the wealthiest Americans without paying for it. Barnicle also argued that unemployment insurance provides an "immediate benefit" to the economy, unlike tax cuts for the rich.

"No!" Shadegg said. "Unemployed people hire people? Really? I didn't know that." He continued: "The truth is the unemployed will spend as little of that money as they possibly can."

Any argument, no matter how stupid, is acceptable to make sure that the very rich get their tax cut.

Meanwhile, Diane Rogers makes the sensible wish:

So I make one open wish today, regardless of how politically-unrealistic I’m told this wish is: that policymakers could consider doing at least the “non-crazy” thing with the Bush tax cuts and stop proposing that any of them be permanently extended. Instead of frantically trying to “decouple” the high-end Bush tax cuts from the “middle-class” ones, we should be thinking about the best way to eventually “decouple” ourselves from all of them.

Unfortunately, I do not think our politics will allow this to happen. We suffer from a simple basic problem. Old people vote, young people do not. So the political system, responsive as it is, transfers wealth from the future to the present. It is not just budgets. Think about climate policy. We pollute now to maintain high consumption at the expense of the future climate. Politicians refuse to impose a carbon tax. Why? Because the beneficiaries of saving the earth, younger people, don't vote (I know that future generations cannot vote, but if young people voted at even half the rate of old people, we would have climate legislation).

I doubt we can fix any of our problems until young people vote.

Eichengreen on the Irish Bailout

2010-12-01T15:11:00.001-08:00

Barry Eichengreen has an important, and terrifying, article on the Irish bailout.

The Irish “rescue package” finalized over the weekend is a disaster. You can say one thing for the European Commission, the ECB and the German government: they never miss an opportunity to make things worse.

The big problem is the unwillingness of anyone to force bondholders to take a haircut. But if the debt is not restructured, the problem is not solved, just postponed.

One can interpret the intransigence of the German government and its EU allies in two ways. First, they understand neither economics nor politics. As Tallyrand said of the Bourbons, “They have learned nothing, and they have forgotten nothing.”

Alternatively, policy makers in Germany – and in France and Britain – are scared to death over what Ireland restructuring its bank debt would do to their own banking systems. If so, the appropriate response is not to lend to Ireland – to pile yet more debt on the country’s existing debt – but to properly capitalize their own banking systems so that the latter can withstand the inevitable Irish restructuring.

And so it goes.

Political Preference and the Economy

2010-11-13T05:21:00.001-08:00

How is the economy doing? According to recent research (see this article) your answer to this question may depend on your political party preferences. Not because economic benefits are doled out to people based on how they voted. Rather, that how people judge the state of the economy can be predicted by their political preferences:

"Partisan predispositions exerted a powerful impact on perceptions of 'objective' economic events," wrote Bartels, "not only in the extreme categories of 'strong' Democrats and Republicans but over the whole range of the party identification scale."

...These aren't idle bluffs. Gerber and Huber have also shown that retail spending is strongly correlated with whether there is alignment between partisanship and who holds the presidency. Democratic-leaning counties spend more after a Democrat is elected president and less after a Republican is (and vice versa for Republicans). Nor is partisan-tinged economic evaluation unique to Americans. Researchers studying British politics in the '90s found the same phenomenon.

It would be interesting to see if economists opinions shared this bias.

QEII and the Carry Trade

2010-11-10T04:17:00.000-08:00

The Fed is engaged in a second round of quantitative easing. This seems necessary given the low probability of any future fiscal stimulus. But what if the increase in liquidity just further fuels the carry trade? Interest rates are so low that investors are borrowing dollars and investing in emerging market economies to earn higher rates. As Japan used to be the borrowing center for the carry trade, now it is us.

Of course, the carry trade is more profitable if the dollar depreciates relative to other currencies. If QEII is effective in generating some extra inflation, and if investors expect this, this will induce carry traders even further, unless nominal interest rise right away. The Fisher effect would predict an immediate rise in nominal interest rates to compensate for expected inflation. But we are not seeing that. But if investors expect future dollar depreciation even without a current interest rate response we get a super environment of the carry trade.

That may be why so many emerging market economies are mad. They are getting the brunt of the carry trade impact.

That Pledge Lasted Long

2010-11-09T09:46:00.000-08:00

This pledge lasted a long time.

In a bigger shift from his campaign pledge to end earmarks, he tells me that they are a bad “symbol” of easy spending but that he will fight for Kentucky’s share of earmarks and federal pork, as long as it’s doled out transparently at the committee level and not parachuted in in the dead of night. “I will advocate for Kentucky’s interests,” he says.

For more, see here.

Should we applaud Senator Paul for realizing that his pledge was relatively stupid, and honestly indicating that he will renege? Earmarks do not add to spending, they just substitute legislator for administrator decisions on how to spend. Or should we castigate him for taking so little time to renege?

Hat tip to Marginal Revolution.

Who Balances their Budget?

2010-11-03T07:09:00.001-07:00

This part of Rand Paul's acceptance speech caught my attention:

Putting a special emphasis on the word "respectfully," Paul told the crowd he would "respectfully" ask the U.S. Senate to deliberate on why the American people are unhappy with what's going on in Washington: "The American people want to know why we have to balance our budget and they don't?" Paul also said he would "respectfully" ask the Senate to deliberate this issue: "Do we wish to live free or be enslaved by debt?"

Am I missing something? Aren't we suffering from the collapse of a housing bubble brought on by people borrowing more than they could afford? Aren't we suffering from a foreclosure crisis now? Isn't foreclosure the result of homeowners defaulting on their debt? Since when do US households balance their budgets?

Is this the realism we have to look forward to? At least Jim Bunning pitched no-hitters in both leagues (one a perfect game) and was the only person to strike out Ted Williams three times in a game. You could cut that kind of guy slack for moronic comments.

Is Obama a Keynesian?

2010-11-03T07:04:00.000-07:00

Everybody is linking to this great video questioning Obama's Keynesian "heritage" from the March for Sanity. Worth another view.

We should have listened to Keynes

2010-10-22T08:13:00.001-07:00

I meant to blog about Keynes' idea of the bancor and taxing surpluses, but Felix Salmon beat me to it.
He borrows "George Monbiot’s lucid summary of John Maynard Keynes’ proposal":

He proposed a global bank, which he called the International Clearing Union. The bank would issue its own currency – the bancor – which was exchangeable with national currencies at fixed rates of exchange. The bancor would become the unit of account between nations, which means it would be used to measure a country’s trade deficit or trade surplus.

Every country would have an overdraft facility in its bancor account at the International Clearing Union, equivalent to half the average value of its trade over a five-year period. To make the system work, the members of the union would need a powerful incentive to clear their bancor accounts by the end of the year: to end up with neither a trade deficit nor a trade surplus. But what would the incentive be?

Keynes proposed that any country racking up a large trade deficit (equating to more than half of its bancor overdraft allowance) would be charged interest on its account. It would also be obliged to reduce the value of its currency and to prevent the export of capital. But – and this was the key to his system – he insisted that the nations with a trade surplus would be subject to similar pressures. Any country with a bancor credit balance that was more than half the size of its overdraft facility would be charged interest, at a rate of 10%. It would also be obliged to increase the value of its currency and to permit the export of capital. If, by the end of the year, its credit balance exceeded the total value of its permitted overdraft, the surplus would be confiscated. The nations with a surplus would have a powerful incentive to get rid of it. In doing so, they would automatically clear other nations’ deficits.

Would have been a hell of a good idea. The whole problem with global economic adjustment is the asymmetry between surplus and deficit countries.

Reform of Financial Architecture

2010-10-15T07:52:00.000-07:00

Simon Johnson has a very good column on the problems of the international financial system. His point is that the currency wars that are attracting so much attention are just a prelude to a bigger problem:

The “currency wars” themselves are merely a skirmish. The big problem is that the core of the world’s financial system has become unstable, and reckless risk-taking will once again lead to great collateral damage.

The key problem is that the international financial system has not been reformed significantly since 1944, but the global pattern of current account surpluses and deficits have changed dramatically. In addition to the risk aversion on the part of emerging market economies that Johnson talks about we also have the surpluses of the petro states. Meanwhile, the industrialized countries are net borrowers owing to political equilibria that make it difficult to pay for their spending.

The system needs reform. Attention has to be paid to the structural changes that have occurred. This is actually one of the key research areas of our CRIFES center at PSU.

Elizabeth Warren's Fallacy

2010-10-02T04:49:00.000-07:00

The title says it all.

Democratizing Development Research?

2010-10-01T12:10:00.000-07:00

A brawl has broken out over the call by World Bank President Robert Zoellick to democratize development research.

World Bank President Robert Zoellick challenged economists to take on tougher challenges in development economics and to consult a wider range of professionals in developing countries, opening a debate about how effectively economists have attacked problems in global poverty.

Dani Rodrik is happy but Bill Easterly is not:

"The speech hits all the right notes: the need for economists to demonstrate humility, eschew blueprints...and focus on evaluation but not at the expense of the big questions," Mr. Rodrik said.

But the reaction wasn't unanimous. New York University economist William Easterly, a former World Bank economist who is skeptical about the value of foreign aid, called Mr. Zoellick's comments "amazingly presumptuous." He says the current system of economic research, where ideas are picked apart by other economists, works well. If anything, he says World Bank economists are often the exception because their bosses pressure them "to reach the 'right' conclusions," Mr. Easterly said—meaning that World Bank loans are useful and foreign aid is productive.

This has led to a debate between Bill Easterly and World Bank Chief Economist Martin Ravallion on Bank censorship of research. The debate is kind of unfair. How can you really be taken seriously in a defense of bank propriety if you are employed currently by the Bank?

The Cost of Health Care

2010-10-01T12:03:00.000-07:00

This is an important series on the cost of health care by Aaron Caroll. It is especially good at debunking conventional wisdom on why our health care is so expensive.

Rajan's Reply

2010-09-17T12:01:00.000-07:00

Ragu Rajan replies to Krugman and Wells attack on his book Fault Lines. The book is excellent, no time to discuss it now. The reply is devastating and valuable.

Here is a small taste (but important point):

Krugman starts with a diatribe on why so many economists are “asking how we got into this mess rather than telling us how to get out of it.” Krugman apparently believes that his standard response of more stimulus applies regardless of the reasons why we are in the economic downturn. Yet it is precisely because I think the policy response to the last crisis contributed to getting us into this one that it is worthwhile examining how we got into this mess, and to resist the unreflective policies that Krugman advocates.

Read the whole thing.

Historians versus Economists?

2010-09-13T10:23:00.000-07:00

Gideon Rachman had a really abominable article in the FT. It is not his call for economists to become less vain that I have trouble with:

The vanity of economists needs to be challenged. Above all, their claim to scientific rigour – buttressed by models and equations – must be treated much more sceptically.

I am not really sure who is so vain. But the use of models and equations is of course misunderstood here. Models and equations are used to make arguments understandable, not to pretend. But this is not the worst. Rachman quotes Stiglitz calling for new paradigms in economics, and then argues:

For somebody educated as a historian, there is an obvious alternative conclusion to draw from Prof Stiglitz’s opening observation. And that is to conclude that the entire attempt to treat economics as a “science ... defined by its ability to forecast the future” is misconceived.

Economics is not about predicting the future. That is a straw man. It shows how little Rachman understands about economics. Fortunately, his FT colleague, Tim Harford has a good column that deals with this. Here is the money shot:

Historians deal in hindsight. It is a wonderful thing. But it is not the only thing. I wonder whether Gideon, intoxicated with a heady brew of Niall Ferguson and Herodotus, has forgotten that.

Tom Sargent Interview

2010-09-02T11:29:00.000-07:00

Tom Sargent is interviewed by Art Rolnick on the state of modern macro. Very nice read. But the best part is this exchange:

Rolnick: I’ll come back to that in a second, but you haven’t said anything yet about what is to be gained in terms of understanding financial crises from importing insights of behavioral economics into macroeconomics.

Sargent: No, I haven’t.

Read the whole thing.

A New Macroeconomics Paradigm

2010-08-20T10:15:00.000-07:00

Joseph Stiglitz calls for a paradigm shift in macroeconomics:

The blame game continues over who is responsible for the worst recession since the Great Depression – the financiers who did such a bad job of managing risk or the regulators who failed to stop them. But the economics profession bears more than a little culpability. It provided the models that gave comfort to regulators that markets could be self-regulated; that they were efficient and self-correcting. The efficient markets hypothesis – the notion that market prices fully revealed all the relevant information – ruled the day. Today, not only is our economy in a shambles but so too is the economic paradigm that predominated in the years before the crisis – or at least it should be.

There follows the typical litany of complaints against modern macroeconomics: equilibrium assumptions, representative agent models, no room for finance. Some of these points make some sense, but there is no alternative approach that shows the way to go. Stiglitz talks about success in economic theory that has not gotten into macroeconomics.

Fortunately, while much of the mainstream focused on these flawed models, numerous researchers were engaged in developing alternative approaches. Economic theory had already shown that many of the central conclusions of the standard model were not robust – that is, small changes in assumptions led to large changes in conclusions. Even small information asymmetries, or imperfections in risk markets, meant that markets were not efficient.

The problem is not to recognize that a model is just a model, but how to incorporate frictions into usable models. This is really hard. The most likely reason it has not been done yet is that nobody has figured it out, not that economists are ostriches.

Stiglitz also takes the typical potshot at market efficiency. Economists assumed markets were efficient so nobody stopped people from taking too much risk. I just don't get this argument. If people thought markets were efficient they would not have believed that extra return could arise with extra risk. The problem is that too many in the financial world, including regulators, did not really believe in efficient markets. Otherwise, they would have known that risks were being seriously piled up.

Fiscal Stimulus

2010-08-19T10:44:00.001-07:00

An interesting piece by Jim Manzi in the New Republic argues that uncertainty about the impact of fiscal stimulus is inevitable because of the difficulties of doing counterfactual exercises. Of course to do a credible counterfactual you have to specify a model and you need agreement about which is the correct model. This is complicated especially with a topic like fiscal stimulus.

But I wonder if there is also another problem. What if the relationship between fiscal stimulus and growth is non-linear? Is it implausible that a credible fiscal retrenchment might lead to an investment boom? There is considerable evidence that fiscal consolidation can be expansionary, according to Albert Alesina. It may also be the case that conventional Keynesian remedies can work, especially in countries that do not have too much government debt already.

But if both fiscal stimulus and fiscal consolidation are expansionary it may be hard to isolate the effect in standard econometric exercises. It may also explain why each side in the debate can point to evidence that supports their view.

The Bankers and the Producers

2010-08-18T07:51:00.000-07:00

Over at Vox-Eu, Thorvaldur Gylafson compares banking scandals with plot of Mel Brooks' The Producers. Like modern day Biayalstock and Blooms the bankers make bad loans and hope to loot the bank before anybody notices how much they have earned:

Not all the CEOs running the fraudulent savings and loans (S&Ls) in California and Texas in the 1980s and 1990s saw The Producers, but all of them could have played Max’s role convincingly. They shared Mr. Brooks’ insight into why the massive frauds use accounting as their “weapon of choice”, structure their efforts to fail, and recruit an accountant as their most valuable fraud ally. The fraudulent CEOs and their accounting allies were the real-life Bialystocks and Blooms. They bankrupted the S&Ls, enriching themselves and their friends along the way, at the expense of stockholders, creditors, and taxpayers.

This explanation is then applied to the recent financial crisis.

During the ongoing subprime mortgage loan crisis, the rating agencies and the top tier audit firms played the real life role equivalent to the critic that Max pretended to try to bribe to make sure that Springtime for Hitler received a terrible review. Unlike the critics, who Max realised he could not succeed in bribing, the rating agencies and the top tier audit firms gave rave reviews to toxic subprime mortgage paper. The rating agencies claimed the toxic waste was pristine “AAA” – the safest of the safe. The elites that we count on to advise us on quality in the real world are more corruptible than the elites in the fictional world that Max and Leo inhabited.

One important element of this crisis was that the big banks kept too much toxic debt on their own books. This is why the banks had such big losses. They did not just sell off the worst debt. They kept it too.

How does this fit with the Biayalstock and Bloom theory? Holding all that toxic waste on the books is kind of like producing a really bad play. But is it credible that Richard Fuld and James Cayne wanted Lehman and Bear Stearns to fail? Did Stanley O'Neal believe he as dooming Merrill Lynch while he earned his big bonuses? This seems unlikely. The CEO's of these companies were more like the old ladies seduced by Max than they were like Max. They did get rich while the play looked like it was a hit, but they were highly compensated because people actually thought they produced hits.

The problem in this crisis was that risks were underpriced. Executives got overly compensated for taking risks because investors believed that markets were inefficient and these guys were brilliant.

Blown Wind

2010-08-17T09:32:00.000-07:00

Is Windpower the solution to our energy needs? This article in Slate suggests that is not. Recently when Texas experienced a heat wave very little of its windpower capacity was of any use:

Put another way, only about 5 percent of the state's installed wind capacity was available when Texans needed it most. Texans may brag about the size of their wind sector, but for all of that hot air, the wind business could only provide about 0.8 percent of the state's electricity needs when demand was peaking.

The problem with windpower is not simply reliability (the wind does not always blow), but the relationship between wind and peak loads. When it is very hot the wind is less likely to be blowing and that is when the demand for electricity is at its highest. Windpower adds to non peak capacity, but then you still need coal and nuclear or whatever for peak loads.

I think the only green thing about the green jobs created by windpower is the currency we waste in the process.

Krugman, Maddow Smackdown

2010-08-17T06:50:00.000-07:00

Jack Shafer takes down Paul Krugman and Rachel Maddow for their alarmist warnings of the unpaving of American highways. What Krugman and Maddow see as the decline of western civilization may just be a rational response to lack of use and alternative routes:

A strong case can be made that North Dakota and maybe a few other states are now paying the price—or not paying the price, as it were—for having overbuilt their road systems. The most recent federal numbers show that North Dakota has 86,842 miles of road, compared with next-door-neighbor Montana's 73,202 miles. Montana is similarly rural, but it's twice the size of North Dakota and has a 50 percent greater population. If Montana can function with 13,000 fewer miles of road than North Dakota, then North Dakota can unpave or abandon several thousands of miles of road without disintegrating. Montanans even drive more rural miles (PDF) than North Dakotans. South Dakota, which has about 25 percent more people than North Dakota, gets by with just 83,744 miles of road!

Fannie and Freddie

2010-08-17T04:24:00.001-07:00

There is renewed discussion about what to do with Fannie and Freddie. In today's NYTimes Andrew Sorkin channels Barney Frank to explain why reform will be difficult.

More important, shutting down Fannie and Freddie and having the private market step in, as politically popular a sound-bite as that may be, is economically unfeasible. For better or worse, Fannie, Freddie and Ginnie Mae were behind 98 percent of all mortgages in this country so far this year, according to the Mortgage Service News. Pulling the rug out from under them would be pulling the rug from under the entire housing market as it continues to struggle.

The GSE's may have repackaged 98 percent of all mortgages in the country, but they did not finance them. That still came from savers. The GSE's, after all, still need funds just to survive. The real question is why the private market cannot package and sell bundles of mortgages in the absence of the GSEs? We know they did this before the financial crisis.

Presumably, the private markets are less willing now to refinance mortgages with very low down payments. They probably have learned from their mistakes. The pressure to keep the GSE's derives from the desire to continue to make risky loans that the private markets won't make.

So the question is who did not learn from the crisis, private markets or the government?

Sachs, Building Booms and Reforms

2010-08-16T10:56:00.001-07:00

Jeff Sachs comments on the reforms in Poland and Russia in Scientific American. He writes of the contrast between Warsaw and St. Petersburg.

Warsaw has enjoyed a building boom, with impressive new business towers going up despite the economic slowdown in western Europe. St. Petersburg glories in the architectural treasures of the past but with much less evidence of current dynamism.

This is because Poland has had successful reforms and Russia has not:

In Russia, on the other hand, corruption has run rampant during the past 20 years, and the public shows little capacity to rein it in. The institutions of civil society, suppressed by centuries of tsarism and obliterated by Soviet-era state brutality, remain weak. Because the constraints on corruption were so toothless, vast state wealth—especially oil, gas and mineral wealth—was transferred in the mid-1990s into private hands, creating the so-called oligarchs of the new Russia. A few years later powerful bureaucrats wrested back control of many of these assets. The rise and fall of the oligarchs was murky, without the transparency needed for a healthy market economy. Russia, not surprisingly, lands at a dismal 146th on the Transparency International corruption list.

But the comparison is contrived. As anyone who has visited Moscow in the last ten years knows, it has experienced a tremendous building boom. Indeed, all one reads about in Moscow is how building is trampling on its architectural heritage. There are skyscrapers and apartment buildings everywhere. Outside the home of the New Economic School in Moscow we are surrounded by huge apartment blocks, obscuring what used to be great views of southwestern Moscow.

So if Sachs had visited Moscow would he have written that corruption has no effect on economic performance? Of course there are reasons why Moscow benefits more than St. Petersburg, primarily because it is the capital and business wants to be close to officials. Is this also the explanation for Warsaw? I do not know enough to answer. But it is an odd comparison.

Really Bad Idea

2010-08-12T10:40:00.000-07:00

Considering really bad ideas, how about regulating food markets. That is the call made by Joachim von Braun in the Financial Times.

The setting of prices at the main international commodity exchanges was significantly influenced by speculation that boosted prices. Not only are food and energy markets linked, but also food and financial markets have become intertwined – in short, the “financialisation” of food trade. There are increasing indications that some financial capital is shifting from speculation on housing and complex derivatives to commodities, including food. While the financial markets have recently been regulated to curb excessive speculation, commodity markets have remained largely untouched and are the open flank of the system attracting speculation.

Most food riots occur because governments suppress food prices and then under the press of shortages are forced to raise them. Most famines occur because governments regulate the transport of food.

What market imperfection requires food regulation?

Rajan on Economic Security

2010-08-10T09:49:00.000-07:00

Raguram Rajan has a good post on energy security. His main point is that most policies to ensure security reduce welfare, and that perhaps what really guides such policies is the fear of a total breakdown of markets. So countries do things to insure against tail events.

Illustrated Guide to a PhD

2010-08-10T08:44:00.000-07:00

From Chris Blattman, the illustrated guide to a PhD.

Exotic Municipal Finance

2010-08-06T07:55:00.001-07:00

The New York Times has an article on the problems of the Denver school system. Needing to plug a $400 million hole in their pension system they turned to JP Morgan.

The bankers said that the school system could raise $750 million in an exotic transaction that would eliminate the pension gap and save tens of millions of dollars annually in debt costs — money that could be plowed back into Denver’s classrooms, starved in recent years for funds...

Rather than issue a plain-vanilla bond with a fixed interest rate, Denver followed its bankers’ suggestions and issued so-called pension certificates with a derivative attached; the debt carried a lower rate but it could also fluctuate if economic conditions changed.

The contract was signed just as the financial crisis was getting underway. So interest rates fell. Now, of course, the contract has turned against them and it is paying much more interest than planned, and to terminate the contract it will cost an additional $81 million.

It will be argued that the problem is derivatives. But the real issue is simpler. Should municipal agencies use exotic finance to cover their expenses. It comes down to two simple questions:

Is the agency well-suited to speculating on the course of interest rates? Is it better able to forecast interest rates than those selling the derivatives?
Is the agency well-suited to coping with the risks associated with such speculation?

It is hard to believe a school board could answer yes to either of these questions.

This is another example of where the lack of belief in market efficiency let somebody down. One could argue, in fact, that there is a normative reason to believe in market efficiency. Forget the positive evidence. Just believe markets are efficient, then you won't believe JP Morgan bankers can save you money without increasing your risk. If you do so, you are not going to be suckered into bad bets.

Ego and Politicians

2010-06-09T14:24:00.000-07:00

Politicians have great egos. They think they can make a difference. They are willing to go through a lot to prove or disprove the point. Some spend huge amounts of their own fortunes to get elected. What does this say about politicians? We can use Meg Whitman as an example to illustrate (we could have used Michael Bloomberg as well).

Now we read that Meg Whitman spent at least $85 million to win the Republican nomination for Governor in California. She presumably will spend even more in the general election campaign.

Now Whitman is a billionaire supposedly, so I suppose that this is not much to her. But the question I want to ask is can she not find a better use for this money? What about charity? She could give this to the Gates Foundation, for example, and improve health around the world. Or if she is only concerned with California, then to some California charities.

To choose spending this on her campaign, she has to believe that she is better for California than the next best candidate by more than the value of the charitable contributions. Now most politicians hardly ever make a difference. So she must have a really, really, big ego.

The question then is whether you really want as a Governor someone who is so sure they are great. It seems to me that politicians who self-finance their campaigns are super egotists. The fact that they spend their own money demonstrates their confidence, but it also demonstrates something about them.

Or it could be that they do it just to show off. They want to be powerful in and of itself.

Larry Summers was Correct

2010-06-09T13:45:00.000-07:00

Turns out Larry Summers was correct about the variance of math scores across gender. See this article in the NYTimes by John Tierny. Recall that Summers conjectured that one reason whey there are fewer women in science at Harvard was that the greater variation in math scores among men meant more in the extreme upper tail, and that Harvard physicists came from the extreme upper tail. This has nothing to do with average scores across gender, the point is about variance.

Now some researchers have looked at this by studying students who took College Admissions tests while in the seventh grade -- obviously high achievers.

The Duke researchers — Jonathan Wai, Megan Cacchio, Martha Putallaz and Matthew C. Makel — focused on the extreme right tail of the distribution curve: people ranking in the top 0.01 percent of the general population, which for a seventh grader means scoring above 700 on the SAT math test. In the early 1980s, there were 13 boys for every girl in that group, but by 1991 the gender gap had narrowed to four to one, presumably because of sociocultural factors like encouragement and instruction in math offered to girls.
Since then, however, the math gender gap hasn’t narrowed, despite the continuing programs to encourage girls. The Duke researchers report that there are still four boys for every girl at the extreme right tail of the scores for the SAT math test. The boy-girl ratio has also remained fairly constant, at about three to one, at the right tail of the ACT tests of both math and science reasoning. Among the 19 students who got a perfect score on the ACT science test in the past two decades, 18 were boys.
Meanwhile, the seventh-grade girls outnumbered the boys at the right tail of tests measuring verbal reasoning and writing ability. The Duke researchers report in Intelligence, “Our data clearly show that there are sex differences in cognitive abilities in the extreme right tail, with some favoring males and some favoring females.”

So it is possible for men and women to achieve the same mean scores on math tests yet persistent differences to appear when one looks at the variance. But Harvard presumably only hires scientists from the upper tail, not the lower one.

Wonder if any of Summers' critics will apologize?

Public Sector Pensions and non-Ricardian Voters

2010-05-21T10:46:00.001-07:00

The question of whether the US will become Greece is surely too pessimistic. But the article in today's NYTimes on public pensions does take away one's breath.

In Yonkers, more than 100 retired police officers and firefighters are collecting pensions greater than their pay when they were working. One of the youngest, Hugo Tassone, retired at 44 with a base pay of about $74,000 a year. His pension is now $101,333 a year.

Apparently police officers perform overtime to jack up their payments. Some of this overtime is actually paid work for Con Ed, and according to State Law should not count as overtime.

The city has even arranged for its police to put in overtime as flagmen on Consolidated Edison construction sites. Though a company is paying the bill, the city is actually reporting the work as city overtime to the New York State pension fund, padding future payouts — an arrangement at odds with the spirit of public employment, if not the law.
A spokesman for the New York State comptroller’s office said that the city was in error and pointed to a 1986 decision by the Supreme Court of New York that found that hours worked by police for outside businesses could not be included in their state-paid pensions.
“It has long been established that such overtime from private special duty cannot be included,” said the spokesman, Mark Johnson.

Of course the problem is not special to New York. Roger Lowenstein wrote about this in his book, While America Aged.

The problem is one of political economy. Public sector unions are important vote machines, and pensions impose future costs not present one. Of course if voters were Ricardian this would not work. The Ricardian Equivalence Theorem (which Ricardo did not believe in) says that what matters is the present value of taxation not its timing. So the fact that votes are bought by promising future pensions that are not funded should be completely understood by voters who would consider current taxes to be an equivalent burden. But clearly voters are not Ricardian since they vote for politicians who impose these future burdens all the time.

Structural Rigidities and Financial Crisis

2010-05-17T09:02:00.000-07:00

Sometimes it is hard to understand the connection between structural rigidities and financial crises. The connection between excessive regulation and government deficits is not exactly direct. Financial crises tend to be due to problems with banks or with government borrowing. But this article in the NYTimes on Portugal does a good job of clarifying the point.

The specific example is rent control. This is quite severe in Portugal:

José Gago da Graça owns a Portuguese real estate company and has two identical apartments in the same building in the heart of Lisbon. One rents for €2,750 a month, the other for almost 40 times less, €75.

The discrepancy is a result of 100-year-old tenancy rules, which have frozen the rent of hundreds of thousands of tenants and protected them against eviction in Portugal.

What is the connection to the financial crisis? Well, these rules limit production of rental housing, and thus force people to purchase rather than rent housing.

The post-revolution rules helped protect tenants, but also led to a chronic shortage of rental housing. This, in turn, persuaded a new generation of Portuguese to tap recently into low interest rates and buy instead — often in new suburbs — thereby exacerbating the country’s mortgage debt and leaving Portugal with one of Europe’s lowest savings rates, of 7.5 percent.

When the opportunities to borrow at low rates -- due to the euro -- presented themselves, Portuguese households took advantage. Rather than rent and save, households were pushed, by rent control, to borrow and purchase. That would not be so bad if the price of housing was not experiencing a bubble. But the borrowing took place precisely when housing prices departed from rents.

Of course we know that rent control is bad. We just now see how it is bad in other unintended ways.

Negative Equity

2010-05-17T07:31:00.000-07:00

Felix Salmon points to this post on Calculated Risk on homeowners' negative equity. Key highlight:

CoreLogic reported today that more than 11.2 million, or 24 percent, of all residential properties with mortgages, were in negative equity at the end of the f irst quarter of 2010, down slightly from 11.3 million and 24 percent from the fourth quarter of 2009. An additional 2.3 million borrowers had less than five percent equity. Together, negative equity and near-negative equity mortgages accounted for over 28 percent of all residential properties with a mortgage nationwide.

In addition there are two noteworthy graphs. One shows negative equity by state. Fortunately, Pennsylvania is 48th. Finally, being near the bottom of the rankings is good. The second graph shows the distribution of negative equity. A rising proportion of such homes have more than 25% negative equity, a level at which it is hard to believe any rational person will not walk away. So more defaults may be imminent. And from the first graph we know that these are likely to be concentrated in a few states.

Greek Tragedy

2010-05-07T04:35:00.000-07:00

I loved Cornelius Ryan's book, "A Bridge Too Far," and the movie too. Today, Paul Krugman likens the Maastricht treaty creating the euro as "A Money Too Far." An apt analogy. The resources (rather institutions) necessary to make a currency union effective were unavailable to those behind the treaty, just as Montgomery's plan to take Arnhem Bridge was too ambitious given the reality on the ground in Holland. And in both cases, naysayers were ignored.

The extent of Krugman's pessimism is evident:

Many observers now expect the Greek tragedy to end in default; I’m increasingly convinced that they’re too optimistic, that default will be accompanied or followed by departure from the euro.

Hard to see how this ends in a non-tragic way.

Common Sense on Goldman Sachs

2010-05-04T04:24:00.000-07:00

Warren Buffett has provided a throated common sense defense of Goldman Sachs behavior in the Abacus deal. According to the NYTimes, Buffett commented:

“I don’t have a problem with the Abacus transaction at all, and I think I understand it better than most...”
His comments echoed the strong view he had offered just the day before: “For the life of me, I don’t see whether it makes any difference whether it was John Paulson on the other side of the deal, or whether it was Goldman Sachs on the other side of the deal, or whether it was Berkshire Hathaway on the other side of the deal,” Mr. Buffett said.

Buffett argues that the quality of an investment depends on the facts involved, not the identity of who is on the other side:

“I don’t care if John Paulson is shorting these bonds. I’m going to have no worries that he has superior knowledge,” he said, adding: “It’s our job to assess the credit.” The assets are the assets. The math either works or it doesn’t.

I guess it is not surprising that the world's most successful investor would not want to support the view that if an investment proves successful it must be illegal. Since market trades must reflect a divergence of views somebody is going to end up losing on a deal.

Paulson and Goldman

2010-04-21T12:41:00.001-07:00

Brad DeLong has a great post (by an anonymous commentator) about why Goldman might really be innocent.

Consider the view from Goldman Sachs. Paulson shows up, says he thinks the subprime market is going to crash and is going to crash hard and is going to crash soon and wants to start laying big bets to that effect. GS goes out, runs the numbers, tests the market, and decides that yes, they can create a great deal of AAA securities plus an equity tranche out of the long side.

The AAA securities will really be AAA securities: minimal risk. Thus they can be sold off at a healthy price to those who want AAA securities. This will burnish the reputation of the firm--look! we made some more AAA securities for you!--in a market that really likes AAA securities and is short of them. And the buyers will be happy because they will get Treasury+5 or Treasury+10 basis points on their cash without risk.

The equity tranche--well, there is a healthy carry trade associated with it in the short run. The short-term earnings from that carry trade will mount up over time, and will more than offset the losses even if the subprime market crashes. Only if the market crashes and not only crashes but crashes hard and crashes soon and moreover crashes freakishly hard and freakishly soon will the equity tranche be a loser.

The overwhelming probability, GS thought, is that Paulson will be the loser--but because his expectations are irrational he's willing to take the short side. So the important thing is to keep this big fish who promises to give us lots of money on the hook. Let him pick the underlying securities--it really doesn't matter, and it gives him the illusion of an edge. Don't bother telling Paulson's role to IBX and company--it really doesn't matter, and it might spook them off and then we might lose the real pigeon while we hunt for more counterparties to take the long side.

Clearly at the time most thought Paulson was out of his elements. This is quite clear in Zuckerman's The Greatest Trade Ever. Maybe Goldman thought that Paulson was the sucker. Somebody has to be wrong in these bets.

Cowen reviews 13 Bankers

2010-04-20T18:53:00.001-07:00

Tyler Cowen has an interesting review on the Johnson-Kwak book, 13 Bankers.

Synthetic CDO's and Bubbles

2010-04-20T07:58:00.000-07:00

There has been a chorus lately arguing that synthetic CDO's fueled the bubble and made the subprime debacle much worse. For example, Felix Salmon writes:

Then, after AIG exited the market, everything should have ground to a halt. But it didn’t, because banks continued to build synthetic subprime CDOs out of the credit default swaps which were being bought by Greg Lippmann and others. The demand for those CDOs from investors like Wing Chau was enormous, and helped to ratify the valuations that everybody else was placing on their own subprime assets. Remember that this is a market with almost no pricing transparency in the secondary market: because all securitization deals are unique, the only way to get a feel for the health of the market is by looking at where primary deals are pricing. Whenever anybody said that the marks being put on subprime assets by banks and hedge funds were delusional, it was easy to point to the booming market in synthetic subprime CDOs to prove them wrong. No one, of course, remarked on the irony that the synthetic subprime CDO market was only booming because John Paulson and others were providing a huge amount of demand for bearish bets.

Or Roger Lowenstein in the NYTimes,

While such investments added nothing of value to the mortgage industry, they weren’t harmless. They were one reason the housing bust turned out to be more destructive than anyone predicted. Initially, remember, the Federal Reserve chairman, Ben Bernanke, and others insisted that the damage would be confined largely to subprime loans, which made up only a small part of the mortgage market. But credit default swaps greatly multiplied the subprime bet. In some cases, a single mortgage bond was referenced in dozens of synthetic securities. The net effect: investments like Abacus raised society’s risk for no productive gain.

And the famous ProPublica article on the Magnetar trade makes the same point too. Yves Smith at Naked Capitalism I think is the originator of this argument, or at least heralded as so. I presume one can also find it at Baseline Scenario, since it follows that bankers are evil. Or Felix Salmon again.

But I cannot understand the argument. When CDO's are created that finance mortgages and other asset purchases one gets price appreciation in the underlying asset that creates a bubble. When the asset price collapses there is a destruction of wealth. With a synthetic CDO, on the other hand, there is no underlying asset appreciation. The accusers all claim that synthetic CDO's are just bets. But if they are just bets then they lead to a transfer of wealth, not a destruction of wealth. Those on the long side who lost transferred wealth to those on the short side who won. But no amount of betting like that can cause a financial crisis.

If betting on the Kentucky Derby multiplied ten-fold would that cause a financial crisis? Hard to see how. Then how does the proliferation of synthetic CDO's make the underlying losses any bigger? I cannot see that. Perhaps the losses were concentrated in some banks that were too big to fail, but that is not what caused the crisis.

I don't understand why this argument has taken off, except that it makes banks look evil I suppose.

Greek Tragedy Spreading

2010-04-15T09:44:00.001-07:00

Peter Boone and Simon Johnson reflect on the implications of the Greek bailout for Portugal and the EU. Key highligh:

The bailout of Greece, while still not fully consummated, has brought an eerie calm in European financial markets. It is, for sure, a massive bailout by historical standards. With the planned addition of IMF money, the Greeks will receive 18% of their GDP in one year at preferential interest rates. This equals 4,000 euros per person, and will be spent in roughly 11 months.

Despite this eye-popping sum, the bailout does nothing to resolve the many problems that persist. Indeed, it probably makes the euro zone a much more dangerous place for the next few years.

The key problem now is how to control fiscal profligacy. There seems to be no restraint, especially if the EU will bailout anyone who gets in trouble. As Boone and Johnson note:

Pity the serious Portuguese politician who argues that fiscal probity calls for early belt tightening. The EU, the ECB, and the Greeks have all proven that the euro zone nations have no threshold for pain, and EU money will be there for anyone who wants it. The Portuguese politicians can do nothing but wait for the situation to get worse, and then demand their bailout package too. No doubt Greece will be back next year for more. And, the nations that “foolishly” already started their austerity, such as Ireland and Italy, must surely be wondering whether they too should take the less austere path.

The question is how long with Germany be willing to live with this system.

Reviewing the Shorts

2010-03-30T11:39:00.000-07:00

David Warsh reviews three recent books on the role of credit default swaps in the financial crisis:

I enjoyed the first two. Tett tells the story of the rise of the credit default swap, and Zuckerman explains how John Paulson (among others) used them to profit by selling the housing bubble short. Michael Lewis tells the same story, less effectively, and ignores Paulson. I think this is so he can treat those who saw what was happening as weirdos. This may be because, as Warsh point out, Lewis sure considered them so in 2007. As Michael Osinski wrote in Business Week (hat tip to Warsh):

It wasn't until Jan. 31, 2007, that the index of subprime bonds suffered its first ever one-point drop. According to Lewis, that was the day "the market cracked." What Lewis fails to note is that the day prior, Lewis himself had filed a column for Bloomberg News from Davos mocking Nouriel Roubini's warning "that the risk of a crisis happening is rising." Such forecasts of doom came from "people with no talent for risk-taking gather[ed] to imagine what actual risk takers might do," Lewis wrote. The headline described them as "Wimps, Ninnies, and Pointless Skeptics." In The Big Short, Lewis recognizes he was wrong. The ninnies have inherited the earth.

Lewis's book is of course the best read. He is a great writer. But his book seems less like reporting than storytelling. He never questions or analyzes what his heroes tell him. And there ought to be some reward for depth.

I plan to write a longer post comparing Zuckerman and Lewis since they address the same subject but write different books. But for now, Warsh's review is very good.

Health Care Incentives

2010-03-29T05:38:00.000-07:00

John Cassidy looks at the size of the subsidies and penalties that face individuals and firms under the Health Care plan. His analysis shows that

The so-called “individual mandate” isn’t really a mandate at all. Under the new system, many young and healthy people will still have a strong incentive to go uninsured.
Once the reforms are up and running, some employers will have a big incentive to end their group coverage plans and dump their employees onto the taxpayer-subsidized individual plans, greatly adding to their cost.

The penalties for individuals are not large enough to induce health people to buy insurance, and the subsidies for individuals dropped from group insurance are too high to not be taken up. This suggests that the estimated reduction in uninsured is overstated and that the subsidies that will be required under the plan are underestimated.

Tyler Cowan also discusses this issue.

Brooks on Economics

2010-03-26T14:53:00.000-07:00

David Brooks had an article in the New York Times today on the future of economics. It is the usual stuff about how economics was too narrow but the financial crisis will make it better as economists become humanists:

Economics achieved coherence as a science by amputating most of human nature. Now economists are starting with those parts of emotional life that they can count and model (the activities that make them economists). But once they’re in this terrain, they’ll surely find that the processes that make up the inner life are not amenable to the methodologies of social science. The moral and social yearnings of fully realized human beings are not reducible to universal laws and cannot be studied like physics.
Once this is accepted, economics would again become a subsection of history and moral philosophy. It will be a powerful language for analyzing certain sorts of activity. Economists will be able to describe how some people acted in some specific contexts. They will be able to draw out some suggestive lessons to keep in mind while thinking about other people and other contexts — just as historians, psychologists and novelists do.
At the end of Act V, economics will be realistic, but it will be an art, not a science.

Greg Mankiw explains some of the flaws of the article.

I could nitpick this article forever, but one important point I think is that Brooks confuses what sells in the wider market for what economists will be doing. Thus, he writes:

One gets the sense, at least from the outside, that the intellectual energy is no longer with the economists who construct abstract and elaborate models. Instead, the field seems to be moving in a humanist direction. Many economists are now trying to absorb lessons learned by psychologists, neuroscientists and sociologists. They’re producing books with titles like “Animal Spirits,” “The Irrational Economist,” and “Identity Economics,” about subjects such as how social identities shape economic choices.

What sells in the wider audience, however, is not what economists are actually doing. It is a good market response to write a popular book saying economists are stupid, or whatever. But the professional work is getting more technical not less. Despite the impressions of Brooks or Skidelsky economists for the most part do not see the financial crisis as a repudiation of their efforts. So there is no reason to re-evaluate what economists do. I think that is how this is viewed internally. And that is what governs the dynamics of the profession.

Consumer Financial Protection Agency

2010-03-25T04:12:00.000-07:00

The main reason why I have opposed the idea of a Consumer Financial Protection Agency is the fact that Elizabeth Warren would be chosen to head it. I thought my fear was paranoia, but the New York Times has an article today articulating just that premonition. So let's hope that somehow this idea can die.

Kinsley vs Krugman on Inflation

2010-03-23T11:37:00.000-07:00

I enjoyed this debate between Kinsley and Krugman. I confess to the same puritanical views that Kinsley has regarding inflation.

Krugman and China

2010-03-17T14:59:00.000-07:00

Paul Krugman has been calling for a surcharge on Chinese imports of 25% as a response to currency manipulation. He wants a tough policy because he believes they will not respond otherwise. Scott Sumner does a pretty nice job dealing with the hubris part of this argument. In a second column Krugman does a better job of explaining the economics:

Let me start with a proposition: the right way to think about China’s exchange rate is, initially, not to think about the exchange rate. Instead, you should focus on China’s currency intervention, in which the government buys foreign assets and sells domestic assets, on a massive scale.

Although people don’t always think of it this way, what the Chinese government is doing here is engaging in massive capital export – artificially creating a huge deficit in China’s capital account. It’s able to do this in part because capital controls inhibit offsetting private capital inflows; but the key point is that China has a de facto policy of forcing capital flows out of the country.

Now, bear in mind the two basic balance of payments accounting identities:

Capital account + Current account = 0

Current account = Domestic savings – Domestic investment

By creating an artificial capital account deficit, China is, as a matter of arithmetic necessity, creating an artificial current account surplus. And by doing that, it is exporting savings to the rest of the world.

This is a good way to think about the problem, but it does not necessarily support Krugman's policy preference. He argues that if China appreciated the yuan or if the US slapped a tariff on Chinese exports these would reduce the current account surplus of China. He starts from the macro balances but then comes back to the currency value being the exogenous driving force. He is reading his two equations from the top down. Why does it not work from the bottom up?

Suppose that China stopped purchasing foreign assets and let the yuan appreciate. Then we are to suppose that Chinese savings will necessarily fall. Presumably this arises because the movement in the exchange rate makes imports more expensive.

But why do we believe that the current account will adjust in this manner. Can't we read the CA equation the opposite way? If Chinese households and corporations want to save over 50% of GDP there will still be an excess of savings over investment (see this article for some evidence on the distribution of Chinese savings by type). So something else must give. What? Presumably the price level. Since net exports fall due to the currency intervention aggregate demand is lower. This puts downward pressure on the price level. This offsets the impact of the currency change on the real exchange rate. China is just as competitive as before.

For a currency surcharge or revaluation to reduce the Chinese current account surplus it has to change the savings/investment balance. It is not clear how that will happen until something changes the desires of Chinese corporations to hoard savings and Chinese households to save. There may be government policies that China can pursue to achieve this, and they would likely improve welfare (for example a retirement system), but it is not at all clear that they will be implemented in response to tough talk from US Congressman about the yuan.

More Naked CDS

2010-03-08T19:27:00.000-08:00

According to Rajiv Sethi the prohibition of naked credit default swaps can be supported on the grounds of Diamond and Dybvig's financial instability model:

"In this case, expectations of default can become self-fulfilling even when solvency would not be a concern if expectations were less pessimistic. What does this have to do with naked credit default swaps? As John Geanakoplos notes in his paper on The Leverage Cycle, such contracts allow pessimists to leverage (much more so than they could if they were to short bonds instead). The resulting increase in the cost of borrowing, which will rise in tandem with higher CDS spreads, can make the difference between solvency and insolvency. And recognition of this process can tempt those who are not otherwise pessimistic to bet on default, as long as they are confident that enough of their peers will also do so. This clearly creates an incentive for coordinated manipulation."

I don't understand this argument for (at least) two reasons. First, unlike bank runs there is no sequential service constraint with sovereign bonds. If people try to exit the price falls, which prevents runs. Bank runs happen because of the advantage to rush to the head of the line.

Second, and more important, Sethi seems to forget that with naked CDS the purchaser is out money, the seller is receiving income. It is negative carry for the buyer. Thus there is a bias already against shorting in this fashion. The naked CDS holders are putting their money where their mouth is. Hard to see why they would do this based on some expectation that others will also do it, thus raising the cost of their play. Most traders would want to keep quiet to buy the insurance at a lower cost, and hope that others do not follow.

See The Money Demand for more interesting critiques of the Sethy argument.

Naked CDS and Greece

2010-03-03T11:34:00.000-08:00

Sam Jones has a nice column on the benefit of naked CDS and the Greek crisis. It is a critique of the argument of Munchau that:

A naked CDS purchase means that you take out insurance on bonds without actually owning them. It is a purely speculative gamble. There is not one social or economic benefit. Even hardened speculators agree on this point. Especially because naked CDSs constitute a large part of all CDS transactions, the case for banning them is about as a strong as that for banning bank robberies.

Jones shows how hedge funds that were naked CDS are now likely to be buyers of Greek bonds. His argument is twofold:

Firstly, any naked CDS buying – as slated by Mr Münchau – occurred, by hedge funds at least, well before the current crisis. Hedge funds have not been the most significant buyers of CDS in recent weeks. (Banks, stuffed to the gills with sovereign debt thanks to the ECB, have)

Ergo, there is no speculative, opportunistic “attack” underway to try and push Greece further into catastrophe (as Mr Münchau notes, Greece seems content to do this all on its own anyway).

Secondly, and more importantly, however, hedge funds, completing their clever trade, have been buyers of Greek government debt, or else insurers of other holders as CDS writers.

In a market where one of Greece’s principal market makers -– Deutsche Bank –- says it will not buy Greek bonds, and where European politicians are having to force their own national banks to do so in order to try and avert the threat of a Greek bond auction failing, the boon from hedge funds looking to hoover-up Greek debt is undeniable.

And the only reason they are in the market to buy is because of naked CDS positions they laid on many months -– and in some cases years -– ago.

What I don't understand is why his argument is not even stronger and simpler. Hedge funds buy naked CDS when prices are low speculating that a crisis may occur. When the crisis occurs and spreads rise, the hedge funds sell the swaps to those in dire need -- those who are lenders to Greece.

Indeed, isn't this just like any argument for short selling -- that it is providing more market information about what might happen? Suppose that enough hedge funds bought CDS on Greek debt years ago and that spreads rose significantly then. Lending to Greece would have been reduced and the extent of Greece's debt woes today would be smaller. Wouldn't more naked CDS have been better?

Right On

2010-03-02T09:25:00.000-08:00

Felix Salmon had a nice post today about politicians and their nonsense regarding Greece and credit default swaps. Carolyn Maloney, Chair of Joint Economic Committee, is quoted in the FT:

Ms Maloney compared the use of credit default swaps in the Greek situation to the “activities that brought down American International Group”, referring to the US insurer that collapsed and was bailed out in September 2008. “These reports, if true, are a shocking echo of the financial crisis that faced the US in 2008 – whose reverberations are still being felt today, in the worst recession in decades.”

This is nonsense, as Salmon notes. AIG sold CDS and then could not cover claims, Greece is not selling any CDS, it is the subject of insurance. People are buying insurance against their default. The comparison is daft.

Salmon also points to the German financial watchdog which apparently is worried that German bailout funds will go to speculators, even though the speculators seem to be betting on a Greek default. It is crazy.

But as Salmon notes:

it’s all a big Kabuki, wherein anybody bashing banks in general, and Goldman Sachs in particular, gets automatic political brownie points. And there are no points at all, it seems, for basic financial literacy.

Is Reich Dishonest or Uninformed?

2010-02-24T06:50:00.000-08:00

Robert Reich's opinion piece in today's NYTimes is either intellectually dishonest or plain ill-informed. This does not detract from the lack of analysis.

The intellectually dishonest part refers to his argument that health insurers that are raising rates are earning super-profits:

This can’t be the whole story, because big health insurers are making boatloads of money. America’s five largest health insurers made a total profit of $12.2 billion last year; that was 56 percent higher than in 2008, according to a report from Health Care for America Now.

Surely, Reich knows that health insurance is not all that profitable a business. As noted opponent of the health insurance industry Tim Noah argued in Slate:

But the profits weren't across the board; Aetna saw an 8 percent decline. The huge combined increase was driven mostly by Cigna, whose 356 percent increase appears to be unrelated to its core health insurance business. As for declining private coverage: Health insurers argue (not implausibly) that it's largely driven by the tendency of young, healthy people to drop nongroup health insurance in tough economic times.

Or as Princeton economist Uwe Reinhardt argued in the NYTimes, looking at WellPoint's income statement:

As a percentage of total assets of $48,403.2 million deployed by the company (measured at the reported book value on the firm’s balance sheet), WellPoint’s profits in 2008 amounted to 5.14 percent in 2008 and 6.42 percent in 2007.

As a percentage of the equity shareholders had in WellPoint (also measured at the book values reported by accountants), WellPoint’s profits in were 11.62 percent in 2008 and 14.55 percent in 2007.

Relative to other industries, these are not particularly high numbers, nor are they particularly low.

So Reich clearly knows that health insurers profits vary and that they are not that high. But he must argue that they are so he can argue for removing their anti-trust exemption:

Anthem’s parent is WellPoint, one of the largest publicly traded health insurers in America, which runs Blue Cross and Blue Shield plans in 14 states and Unicare plans in several others. WellPoint, through Anthem, is the largest for-profit health insurer here in California, as it is in Maine, where it controls 78 percent of the market. In Missouri, WellPoint owns 68 percent of the market; in its home state, Indiana, 60 percent. With 35 million customers, WellPoint counts one out of every nine Americans as a member of one of its plans.

No discussion of course of the restriction against competing across state lines. So we have an industry with not very high profits, regulated by state insurance regulators, and Reich believes that competition will drive down rates!! Who would enter the market under the conditions he argues for?

If profits are high one might expect removing entry barriers to reduce prices. But the antitrust exemption is not the entry barrier, it is state regulation that is the entry barrier. The antitrust exemption is what allows insurers to share demographic information. But given that profits are not that high, insurance rates must be high because of the cost of health care, not the insurers. Certainly Reich must understand that.

So is he intellectually dishonest or uninformed? You decide.

This time is no different

2010-01-28T08:42:00.001-08:00

Carmen Reihhart and Ken Rogoff explain why we are likely to face a wave of fiscal crises in the wake of the banking crises. This stems from the research in their magisterial book. Their point is simple, but important:

In previous cycles, international banking crises have often led to a wave of sovereign defaults a few years later. The dynamic is hardly surprising, since public debt soars after a financial crisis, rising by an average of over 80 per cent within three years. Public debt burdens soar owing to bail-outs, fiscal stimulus and the collapse in tax revenues. Not every banking crisis ends in default, but whenever there is a huge international wave of crises as we have just seen, some governments choose this route.

What will complicate the response is not only the short-term political focus on employment, but also the fact that many emerging economies (which are not in such bad shape) still rely on the US as a market for goods. It is still not clear how the world will re-balance to smaller US external deficits.

While our institutions our better now -- better Central Banks and the IMF -- it is still not clear if governments will respond to this challenge. But beware Reinhart and Rogoff's warning:

Markets are already adjusting to the financial regulation that must follow in the wake of unprecedented taxpayer largesse. Soon they will also wake up to the fiscal tsunami that is following. Governments who have convinced themselves that they have done things so much better than their predecessors had better wake up first. This time is not different.

Geithner and his critics

2010-01-28T04:36:00.000-08:00

Treasury Secretary Tim Geithner faced his critics in Congress yesterday and they were angry. There was bipartisan agreement in attacking the AIG bailout. It is a complicated issue, of course. But given the quality of these critics I cannot help feeling support for Geithner. Where was Congress then? Have they agreed on a mechanism to shut down large financial institutions? Do they remember how close we were to meltdown last year?

Elitists and Populists

2010-01-26T04:24:00.000-08:00

I admit it. I really liked David Brooks' column today. His fundamental point is that elitists and populists really reflect the same type of thinkings:

These two attitudes — populism and elitism — seem different, but they’re really mirror images of one another. They both assume a country fundamentally divided. They both describe politics as a class struggle between the enlightened and the corrupt, the pure and the betrayers.

These attitudes appeal to people because they simplify, kind of like conspiracy theories. Life is more complex. But complexity is not viable political platform. Better to attack the villains.

Brooks description of the competing fantasies is very good:

Ever since I started covering politics, the Democratic ruling class has been driven by one fantasy: that voters will get so furious at people with M.B.A.’s that they will hand power to people with Ph.D.’s. The Republican ruling class has been driven by the fantasy that voters will get so furious at people with Ph.D.’s that they will hand power to people with M.B.A.’s. Members of the ruling class love populism because they think it will help their section of the elite gain power.

This is close to an old theory of mine about the attraction of Marxism. I have always thought that adherents view themselves as planners in the socialist commonwealth. No member of the socialist vanguard envisions herself as a worker realizes her self worth through labor in a workers's state. The theory appeals to elite requirements, because what else would intellectuals do in a workers' paradise where there is no need to criticize society? Must have to run society.

This is a good idea

2010-01-20T07:29:00.001-08:00

Douglas Diamond and Anil Kayshap have a good idea relating to the proposed tax on Wall Street.

Obama and Golf

2009-12-31T18:06:00.000-08:00

Michele Cottle criticizes the President for playing golf, and Paul Kruman approves. This is one of the stupidest articles one can read. For example,

As a senator, John F. Kennedy scored political points on Eisenhower by mocking Ike’s golf obsession--while taking pains to keep his own golfing gifts under wraps. (As Van Natta recounts, JFK forbade the media from photographing him at play.) Bushes 41 and 43 were both slammed for golfing during wartime. It has been posited that W. quit the game in part because of the stinging coverage of comments he made on the golf course in August 2002, following a suicide bombing in Israel. “There are a few killers who want to stop the peace process that we have started, and we must not let them,” Bush told the assembled journalists. “I call upon all nations to do everything they can to stop these terrorist killers. Thank you. Now watch this drive.” The tone-deaf clip eventually made its way into Michael Moore’s Fahrenheit 9/11. It was not one of golf’s finer moments.

So JFK hypocritically criticized Ike for playing golf even though he was a golfer (don't even get me started on JFK sending Pierre Salinger to buy all the Cuban Cigars he could find before announcing his boycott of Cuban imports). And George W. Bush made stupid comments on a golf course. Obama should thus quit golf because he can be falsely accused by some hypocrite? Or because a stupid President made stupid comments on a golf course?

This is what happens to liberals when they consider golf. Their minds go numb. Then there must be the ritual comment that golf is a white elitist pastime. This can only be said by a non-golfer. I played today at Wilson Golf Course in LA. The course is a United Nations meeting. I doubt there is a place in America -- except on other public golf courses -- where you get Blacks, Whites, Jews, Hispanics, and Korean Americans interacting in such a friendly, equal, manner. Obama's natural constituency plays golf at public courses all over America.

Derman on Regulators

2009-12-31T18:04:00.000-08:00

Emmanuel Derman dreams about the TSA and the FED trading places.

If a bank failed at 9 a.m. one morning and shut its doors, the TSA would announce that all banks henceforth begin their business day at 10 a.m.
And, if a terrorist managed to get on board a plane between Stockholm and Washington, the Fed would increase the number of flights between the cities.

That does sum it up pretty well.

Hamilton Channels Shiller

2009-12-28T19:04:00.000-08:00

Jim Hamilton channels some Bob Shiller to explain why stocks have performed so poorly for the last decade. Worth reading.

Goldman Scandal?

2009-12-27T09:37:00.001-08:00

Felix Salmon has a good discussion on NYT’s 3000-word story on Goldman and synthetic CDOs.

Great Article

2009-12-25T07:47:00.001-08:00

I had not noticed this parody about our health care system by Jonathan Rauch until today (when David Brooks mentioned it here). Here is a bit of the flavor of it:

"Hello! Thank you for calling Air Health Care, the airline that works like the health care system. My name is Cynthia. How can I give you travel care today?"

"Hi. My name is Jonathan Rauch. I need to fly from Washington, D.C., to Eugene, Oregon, on October 23."

"Yes, I'd be happy to assist you with that. It does look like we can get you on a flight on January 23 at 1 p.m. or February 8 at 3 p.m. Which would you prefer?"

"Neither. I need to be in Eugene on October 23. As in, the 23rd of October."

"I'm sorry, we have nothing open on that date. You might try another carrier."

"I suppose I'd better. Who has availability?"

"I'm afraid I have no way to know that. I have no way to look into their systems."

"Who would know?"

"You can call them individually and ask. I'm sure you can find one."

"Look, I don't have time to call two dozen airlines. It's important that I get to Eugene on the 23rd. There must be something you can do."

"Well, it looks like maybe we could squeeze you in on October 26, if you don't mind departing Washington Dulles at 5:35 a.m."

"Good grief. All right, I suppose it will do."

It just keeps getting better.

Of course one reason for the difference between airlines and health care is that consumers pay directly for the former. So the airlines try to attract us. But insurers make decisions for consumers regarding health care. Of course we all pay for health care too, but we don't make choices and we don't individually pocket the savings. Not sure that health reform will fix this.

Health Bill

2009-12-25T06:54:00.000-08:00

Paul Krugman criticizes those who are unhappy about the Senate's passage of health care. In the spirit of the holidays he updates Dickens:

It begins with sad news: young Timothy Cratchit, a k a Tiny Tim, is sick. And his treatment will cost far more than his parents can pay out of pocket.
Fortunately, our story is set in 2014, and the Cratchits have health insurance. Not from their employer: Ebenezer Scrooge doesn’t do employee benefits. And just a few years earlier they wouldn’t have been able to buy insurance on their own because Tiny Tim has a pre-existing condition, and, anyway, the premiums would have been out of their reach.
But reform legislation enacted in 2010 banned insurance discrimination on the basis of medical history and also created a system of subsidies to help families pay for coverage. Even so, insurance doesn’t come cheap — but the Cratchits do have it, and they’re grateful. God bless us, everyone.

Of course, one might also note that somebody must pay for the increased coverage. Perhaps as the tale proceeds, Cratchit loses his job as Scrooge goes out of business.

Krugman does not consider that because he has his own straw men to consider. He divides opposition to the health bill to three groups: irrational tea baggers; "Bah Humbug" fiscal scolds; and disappointed progressives. Obviously the only sensible reason to be unhappy is if you are disappointed that we are not enacting a single payer system, but you have to be realistic.

There are reasons to be unhappy with the bill that does not fall into his three categories. The fiscal impact of the bill that Krugman is so happy about depends on Congress carrying out commitments that all know they won't follow. Even supporters like Ezra Klein believe that the individual mandate in this bill is a sweetheart deal. The penalty for not buying insurance is so small that for many the best option will be to just pay the penalty and sign up for insurance only after you need it. But someone will have to pay the cost of this, will they not?

The most pressing problem, perhaps, is that the bill does not allow competition across state lines. Krugman never discusses this issue. The exchanges are set up on a state level, and private insurers cannot compete. Given that the bill limits administrative costs, small insurers will likely go out of business -- they cannot spread the fixed costs sufficiently -- so in some states the number of options will decrease under this bill. As Richard Epstein argues, the current bill turns health insurance into a regulated public utility.

I suppose that Krugman really approves of this but he never discusses it. He cannot. This argument does not fall into any of his straw man categories.

CO2 Emissions and Taxes

2009-12-22T07:08:00.000-08:00

The big problem at Copenhagen was the difficulty in getting the US and China to agree on sharing the burden of reducing CO2 emissions. The problem is the difference between size of country and size of income. China produces slightly more CO2 than the US (data is for 2006), perhaps 9%, but in per-capita terms the US produces 4 times as much. But the US is also ten times wealthier in per-capita terms. So if we calculate tons of CO2 emitted per unit of per-capita GDP, the figure for the US is 133,680 and for China it is 1,358,217. That is, we emit about one-tenth that of China per unit of per-capita income. This means that if the US and China were to reduce emissions by one million tons, and if the efficiency of production is unchanged, then US per-capita income would fall by about 13 cents, and Chinese per-capita income would fall by $1.36. So the incidence of the "tax" on emissions would be ten times higher on the average Chinese person than on the average American.

If we think of this as taxation then a fair way to share the burden might be to have a flat tax per unit of per-capita income. Then we ought to face an emission target ten times higher than China. Of course, if we believe in progressive taxation our tax rate ought to be even higher.

Before setting tax rates one ought to consider where are the greatest gains for reducing emissions -- that is efficiency gains that do not reduce GDP. Is that in China or the US? This could go either way, I suppose. One could argue that China has less efficient plants, so easy fixes are available since they have regulated less. But it may also be the case that it is easier to implement many technological fixes in the US than in China. My guess is that the efficiency differences are unlikely to be of the same order of magnitude as these income differences.

Samuelson Appreciations

2009-12-21T12:02:00.000-08:00

Here are three good Samuelson appreciations: Dixit, Krugman, and Warsh.

How Sausage is Made

2009-12-21T06:59:00.001-08:00

The Health Bill passed the Senate, and this article in the NYTimes illustrates how legislation is passed, with all sorts of special deals for key Senators. Some highlights:

Another item in the package would increase Medicare payments to hospitals and doctors in any state where at least 50 percent of the counties are “frontier counties,” defined as those having a population density less than six people per square mile.
And which are the lucky states? The bill gives no clue. But the Congressional Budget Office has determined that Montana, North Dakota, South Dakota, Utah and Wyoming meet the criteria.
Another provision would give $100 million to an unnamed “health care facility” affiliated with an academic health center at a public research university in a state where there is only one public medical and dental school.

The latter may be in PA, though nobody seems to be sure. I wonder if the PSU Hershey Medical
Center qualifies as a public medical school?

This reminds me of a bill (in the 80's) that provided a certain tax break only to cities with an American League Baseball team and a population of more than one million people. This still left two candidates (pretty obvious), so another provision in the bill limited the tax break to States that had a Republican Governor in 1980. The two provisions were several hundred pages apart in the bill. Guess which city won?

More on Credit

2009-12-14T18:26:00.001-08:00

The President told the bankers they have to start lending to help us get out of the recession, and that they owe us this:

“America’s banks received extraordinary assistance from American taxpayers to rebuild their industry,” Mr. Obama said. “Now that they’re back on their feet, we expect an extraordinary commitment from them to help rebuild our economy.”

The President argues that credit difficulties are hurting small business:

President Obama reiterated his call Monday for the nation's banks to increase lending, saying that he was getting too many letters from small businesses unable to borrow money.

The story seems to be that the recovery is now held back because of a lack of credit. It is hard to understand what model might suggest this. The normal story is that we suffer from a lack of demand. Many observers, like Paul Krugman, have been arguing that we need more stimulus to fuel the recovery. That seems like what we need is more demand. In a recession the demand for loans declines. That is why the yield curve steepens. The quantity of credit extended depends on supply and demand. Given how low interest rates are, it is hard to believe that the recovery is really being stifled by a lack of credit supply.

Sure, we hear a lot about the troubles small businessmen are having obtaining credit. And surely banks are busy improving their balance sheets. But it must primarily be a lack of demand which hinders credit from flowing. Banking is a competitive industry. If there were companies with good collateral that were trying to borrow it is hard to believe they could not get credit.

More likely, the problem is that the quality of collateral is quite poor right now. Banks don't need more real assets. What kind of paper can companies pledge in a recession? Given that bank regulators want banks to improve their balance sheets this pressure must be what is limiting loans.

Credit and the Bankers

2009-12-14T14:32:00.001-08:00

President Obama called the big Bankers to DC today to tell them to make more loans. See here and this article from Bloomberg. The purpose of the meeting was to "to ratchet up pressure on banks to extend more credit to small businesses and ease opposition to his regulatory overhaul."

Meanwhile,

Federal Deposit Insurance Corp. Chairman Sheila Bair said she’s “concerned” that U.S. banks are making only the safest loans. “There needs to be well-managed risk-taking to get the economy going again,” Bair said today in a Bloomberg Television interview at the White House.

Now it seems clear that credit for small business is a problem. But does it really make sense for regulators to call on banks to make more risky loans when the financial crisis arose because of excessive lending and an asset bubble?

Moreover, the whole process seems backwards to me. It was only six months ago that the Treasury was assessing the health of individual banks because we were worried about their solvency. In the wake of the financial crisis prudence would suggest that they should be worried about the quality of their balance sheets.

But the questions arise why the banks don't lend given that we bailed them out. We helped them, why don't they help Main Street? Well, one problem might be the restrictions put on those banks that took TARP money. They are paying a large price to get out of TARP, as this article in the NYTimes about Citibank suggests.

The moves will result in a $10.1 billion hit to Citigroup’s fourth quarter results, because of accounting charges taken on the value of the repaid preferred shares and the cancellation of loss-sharing agreement. The new stock offering, meanwhile, will severely dilute the value of existing Citigroup shares.

Why do it then? Clearly to get out from under the Pay Czar. It is better for the big banks to raise capital costly and pay back Uncle Sam than to be subject to the restrictions mandated by Congress. And if you are raising money to pay back Uncle Sam it must be harder to lend to Aunt Main Street. Nobody wants to mention that connection, however.

Addendum: Wells Fargo has announced that it too will repay TARP funds.

Paul Samuelson passes away

2009-12-13T19:39:00.000-08:00

Paul Samuelson, the father of modern economics, passed away. Here is the NYTimes obit. Samuelson is clearly the most influential economist of the last century, even including Keynes. While the Keynes may have made a revolution, Samuelson made contributions to so many basic areas of economics that it is hard to enumerate them all. Clearly, he could have won several additional Nobel Prizes if these were given for specific contributions rather than lifetime achievements in the early days.

Tobin Taxes

2009-11-27T09:28:00.000-08:00

Paul Krugman argues for extending Tobin taxes not just to currency transactions but also to repo transactions as well:

As Gary Gorton and Andrew Metrick of Yale have shown, by 2007 the United States banking system had become crucially dependent on “repo” transactions, in which financial institutions sell assets to investors while promising to buy them back after a short period — often a single day. Losses in subprime and other assets triggered a banking crisis because they undermined this system — there was a “run on repo.”
And a financial transactions tax, by discouraging reliance on ultra-short-run financing, would have made such a run much less likely. So contrary to what the skeptics say, such a tax would have helped prevent the current crisis — and could help us avoid a future replay.
Would a Tobin tax solve all our problems? Of course not. But it could be part of the process of shrinking our bloated financial sector. On this, as on other issues, the Obama administration needs to free its mind from Wall Street’s thrall.

Tyler Cowan argues against Krugman and makes several good points, most notably, that capital requirements are more effective than a Tobin tax to deal with excessive risk taking.

It seems to me that one big problem with a Tobin tax is that it is a tax on arbitrage transactions, and in particular, on short selling. It seems to me that asset bubbles are caused by the difficulties of arbitrage and short selling. If we had more of it then skepticism about bubbles could be priced and this would be valuable. Taxing financial transactions raises the cost of an already costly activity. So the unintended consequence could be severe.

Ethanol Woes

2009-11-27T07:00:00.001-08:00

The NYTimes reports about the projected excess of ethanol mandated by Congress. Two years ago Congress mandated more use of ethanol for obvious political reasons:

To please the farm lobby and to help wean the nation off oil, Congress mandated that refiners blend a rising volume of ethanol and other biofuels into gasoline. They are supposed to use at least 15 billion gallons of biofuels by 2012, up from less than seven billion gallons in 2007.

But the recession and reductions in fuel consumption make these targets hard to fulfill:

At the maximum allowable blend, in which gasoline at the pump contains 10 percent ethanol, updated projections suggest that the country is unlikely to be able to use all the ethanol that Congress has ordered up. So something has to give.

When Congress wrote the rules, in 2007, gasoline consumption had been growing for years, and it looked as if the nation would be able to use considerably more ethanol in the future. Gasoline consumption hit a peak of 3.4 billion barrels that year.
But gasoline demand fell in 2008, after soaring gas prices early in the year were followed by the economic crisis. Consumption was slightly less than 3.3 billion barrels last year, and it could end 2009 at about the same level.

Congress could lower the targets but this would anger farmers. It could raise the amount of ethanol blended in gasoline, but this would ruin catalytic converters.

Perhaps the best solution would be for Congress to just buy the excess ethanol and store it. Cars would be saved and the subsidies would be maintained. But this would make transparent the fact that ethanol is a political subsidy to farmers, not a beneficial program to deal with global warming or energy needs. And making this transparent would make the subsidy program less sustainable over time. So this is unlikely. So more of our cars are likely to be rendered clunkers, but the cash will only be for the farmers this time.

Makes you kind of wonder what Congressional created health care will be like.

Reserve Currency

2009-11-11T10:20:00.000-08:00

The Economist has an article that makes sense discussing the role of the dollar as a world currency. The basic point is that there is no good alternative right now. A very nice discussion of this issue also appeared in the Economic Report of the President, which had this graph:

This appendix made the important point that although the Euro zone is large, there is no unified European debt, only the debt of individual countries. This makes it harder to hold reserves in euros than in dollars. Depth of our capital markets is what makes the dollar a reserve currency.

Strong Dollar

2009-11-11T07:52:00.001-08:00

Once again a US Treasury Secretary has affirmed support for the strong dollar.

U.S. Treasury Secretary Timothy Geithner said a strong dollar is in the nation’s interest and the government recognizes the importance it plays in the global financial system.
“I believe deeply that it’s very important to the United States, to the economic health of the United States, that we maintain a strong dollar,” Geithner told reporters in Tokyo today.

This despite the fact that the dollar fell to a 15-month low against major counterparts (click here for a picture of the DXY index) and will continue to slide as the US adjustment to our large current account deficits continues. This ignores any slide due to fears of inflation from large budget deficits. As the economy recovers imports will rise and thus we will need more dollar depreciation for the current account to adjust. If those who fear that deficits will lead to future inflation are correct then the dollar's slide will be even larger.

But at least we love that strong dollar!

Protection Rackets

2009-11-10T10:50:00.000-08:00

The NYTimes reports about Oleg Deripaska suing Vedomosti over disclosure of financial information. The key points:

Rusal, the world’s largest aluminum company, is closely held by wealthy Russian businessmen, including Oleg Deripaska, once Russia’s richest man. As a private company, few details of its business are public.
The company hopes to raise $2.5 billion in an initial public offering in Hong Kong that will be an important test of international investor interest in Russian equities.
A series of articles in the business newspaper Vedomosti at the end of October detailed Rusal’s dismal financial results for 2008 and included other facts about the company. The articles cited documents given to bankers at a conference closed to the public.
That scoop is evolving into a legal test for business publications in Russia, a country where the political press is already kept on a tight rein.

Something appears to be missing in this story. Why is Deripaska doing this? Clearly, this lawsuit threat can have nothing to do with RUSAL’s impending IPO. The information that Vedomosti published is already published! A lawsuit, even if successful, is not going to put that genie back in the bottle. Moreover, Deripaska’s hypersensitivity about this can only serve to heighten suspicions that RUSAL really does have something to hide. In short, threatening a lawsuit is not in Deripaska’s immediate interest at all. So why is he making the threat?

The answer is that Deripaska is acting here not primarily on his own behalf but on behalf of all the members of the small club of oligarchs in Russia who – like Deripaska - participate in Vladimir Putin’s “protection racket.” Clifford Gaddy and I are writing in detail about this scheme in our new book, Russia’s Addiction. Beginning in the year 2000, when he entered office as Russia’s president, Putin has had a deal with the most powerful business owners. In that deal, the oligarchs agreed to abide by a few clear rules about their behavior inside and outside Russia; in return, Putin guaranteed them not only protection against expropriation by the state but also, and even more important, protection against each other. To be able to deliver on that latter guarantee, Putin has since 1999 at the latest preserved a monopoly on damaging financial information about the oligarch-controlled companies. That is, he and only he (along with one or two key associates) possesses the information, and he protects it from any leaks. Financial information is the nuclear weapons of Russia’s thoroughly opaque corporate elite. When Putin took over, the oligarchs were on the verge of all-out and all-destructive war against one another using such information. He ended the era of proliferation and brinksmanship and enforced a peace that has lasted to this day.

But if Putin’s power over the oligarchs rests on a monopoly of financial information, what could be more threatening to him and his system than independent collection – and release – of financial information? If independent media seek out the goods on the oligarchs, Putin's authority is dissipated. Ending internecine warfare among the oligarchs was the key event in the formation of the protection racket. The main terrain on which that war had been fought was ... the "independent media." Independent in quotes because, of course, the oligarchs owned the media and used it as weapons against each other. That is how kompromat was disseminated prior to Putin's accession. Putin took the media over to insure the oligarchs against each other. Deripaska’s threat against Vedomosti is intended to send the message to the press today not to upset the system Putin established a decade ago.

Craziest Quote of the Day

2009-11-09T14:50:00.000-08:00

This would count for the year and probably the decade too. It is from Dick Armey, former House Majority Leader from Texas, and former Department Chair at North Texas State University:

“I don’t consider Larry Summers a serious economist,” Armey said. “You can get a Ph.D. from Harvard without ever having seriously considered the subject.”

I wonder if you can get the John Bates Clark Medal without seriously considering the subject? Here is the article it came from.

Summers list of publications is at least 10 pages long (his cv is here).

Links for today

2009-11-03T10:11:00.000-08:00

Ned Phelps has an interesting article in the FT that criticizes both Keynesians and neoclassicals. He blames speculation for the housing crisis, not incentives.

The WSJ has an article (subscription required) on John Geanokopolos's work on leverage. I think that theorists will be interested to learn that they were on the margins:

Mr. Geanakoplos is among a small band of academics offering new thinking about those cycles. A varied group ranging from finance specialists to abstract theorists, they are moving to economic center stage after years on the margins.

Hard to see what margins they were on, but then we also learn that traditional macroeconomics had been relegated to second class status:

Traditional macroeconomics, such as practiced by John Maynard Keynes and Milton Friedman, was relegated to second-class status.

So I guess any comment about economics is possible in the WSJ. But despite these complaints, the article is interesting.

Everyone wants to make their work seem more revolutionary than it was, and reporters need it to be so, else why report it.

Mortgage Finance

2009-10-28T09:36:00.000-07:00

This article by John Krainer of the San Francisco Fed has lots of information about the evolution of mortgage finance. This is important for thinking about the financial crisis of course. This is especially relevant for thinking about the relative importance of Government Sponsored Enterprises (GSE's) like Fannie Mae and Freddie Mac versus the non-agency securitizers. We can see, for example, that as the housing bubble proceeded the share of mortgages supplied by the GSE's declined:

We can also see that the non-agency lenders were more highly represented in the more risky types of mortgages at the height of the boom. For 2006 we have this picture:

Thus:

Compared with mortgages purchased by the GSEs, non-agency securitizations were much more likely to involve adjustable-rate mortgages, including option ARMs, to be rated as subprime, and to have less-than-full documentation of borrower income and assets. The median FICO credit score for the non-agency securitizations was about 30 points lower than for the mortgages held or guaranteed by Fannie Mae or Freddie Mac and much closer to the credit scores typically associated with loans guaranteed by Ginnie Mae.

These pictures are not consistent with the view that the housing bubble was the fault of the GSE's alone. Deteriorating standards seemed to accelerate as the GSE share fell.

Real Costs

2009-10-27T12:32:00.000-07:00

The Brazilian Real has been appreciating significantly since last March. This rally has pushed the price of Big Mac up dramatically, according to this story in Bloomberg:

Buying McDonald’s Corp.’s flagship hamburger costs 8 reais in Sao Paulo, or $4.62, compared with $3.99 in New York and 2.29 pounds in the U.K. capital, or $3.74.

This is the counterpart to the dollar's weakening of course. But Brazil's President has not taken this lying down. As the Economist reports:

Brazil has gone for the direct approach. Foreign capital has flooded in, attracted by the healthy prospects for economic growth and high short-term interest rates. That has pushed up local stock prices, as well as the real, Brazil’s currency. To stem the tide, the government this week reintroduced a tax on foreign purchases of equities and bonds. Though many doubt the long-term efficacy of such measures, it had an immediate effect. The real, which had risen by more than one-third since March, fell by 2% (before regaining some ground). Brazil’s main stockmarket dropped by almost 3%.

This seems like quite a costly way to prevent currency appreciation -- cause your own stock market to fall. Perhaps a useful move to prick a bubble, but Brazil's appreciation versus the dollar does not seem to be driven by much other than fundamentals.

It's the fault of smart guys

2009-10-16T08:46:00.000-07:00

Calvin Trillin explains how the financial crisis was caused by the migration of smart guys to Wall Street. Wall Street used to be populated by the lower third of the class. Then smart guys started going too. That is what caused the invention of complex securities:

“Did you ever hear the word ‘derivatives’?” he said. “Do you think our guys could have invented, say, credit default swaps? Give me a break! They couldn’t have done the math.”

“When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness.”

Maskin on the Crisis

2009-10-16T08:32:00.001-07:00

Nobel Laureate Eric Maskin discusses what he sees as essential reading on the financial crisis. Here is one tidbit:

I don’t accept the criticism that economic theory failed to provide a framework for understanding this crisis. Indeed, the papers we’re discussing today show pretty clearly why the crisis occurred and what we can do about it. The sort of economics that deserves attack is Alan Greenspan’s idealized world, in which financial markets work perfectly well on their own and don’t require government action. There are, of course, still economists – probably fewer than before – who believe in that world. But it is an extreme position and not one likely to be held by those who understand the papers we’re talking about.

Nobel Prize

2009-10-13T10:16:00.000-07:00

Okay, so everybody now knows that Elinor Ostrom and Oliver Williamson won the Nobel Prize. A good day for Berkeley Economics! Williamson paid 82-1 in our pool, and nobody bet on Ostrom. here is the Nobel Prize committee announcement. Michael Spence talks about it here. And here and here are discussions at Marginal Revolution.

Nobel Update

2009-10-08T15:00:00.000-07:00

Here are the latest odds for our lottery:

Economist	Payoff to a Dollar Bet

Diamond	5.2222222	to	1
Mortensen	7.6153846	to	1
Sims	7.6153846	to	2
Pissarides	10.2	to	1
Hansen	13	to	1
Nordaus	17.666667	to	1
Shiller	17.666667	to	1
White	27	to	1
Fehr	36.333333	to	1
Dreze	55	to	1
Feldstein	55	to	1
Hausman	55	to	1
Hendry	55	to	1
Jorgensen	55	to	1
The Field	55	to	1
Tirole	55	to	1
Williamson	55	to	1
Arthur	111	to	1
Barro	111	to	1
Broom, John	111	to	1
Dasgupa	111	to	1
Fama	111	to	1
Hart	111	to	1
Holmstrom	111	to	1
Kornai	111	to	1
Krueger	111	to	1
Nelson	111	to	1
Romer	111	to	1
Sachs	111	to	1
Sargent	111	to	1
Wilson	111	to	1
Winter	111	to	1

Strong Dollar

2009-10-08T10:39:00.000-07:00

Treasury Secretary Geithner said, as recently as October 3, that “it is very important to the United States that we continue to have a strong dollar,” as reported by Bloomberg. Yet, the dollar continues to slide: 12 percentfrom its peak this year in March as measured by the Federal Reserve’s trade- weighted Real Major Currencies Dollar Index.

As of this point, investors no longer believe this rhetoric, which is standard for Treasury Secretaries:

“Since the dollar has been weak and weakening for years, Geithner was using a code phrase, a carry-over from the Bush administration,” said David Malpass, president of research firm Encima Global in New York. “It means that the U.S. approves of a constantly weakening dollar but doesn’t want a disruptive collapse,” said Malpass, the former chief economist at Bear Stearns Cos. and deputy assistant Treasury secretary from 1986 to 1989.

The government has used the phrase for so long that “I don’t think it has much meaning left for the markets,” said Vassili Serebriakov, a currency strategist at Wells Fargo Bank in New York. “Once you have this policy in place I don’t think there’s any possible choice but for the Treasury to stick to what it’s been saying all this time.”

The problem is that the desire for the dollar to be strong is in conflict with the need to adjust to the large current account deficit. US economic recovery requires an increase in exports, and current account adjustment requires that plus reduced imports, and that requires a weak, rather than a strong dollar. Economic policies pursued to combat the recession do not induce expectations of a stronger dollar in the future.

The problem, of course, is the fundamental conflict between internal and external objectives of economic policy. To be the world's reserve currency requires sacrificing internal concerns for external ones, so that confidence in the currency is maintained. This is hard to do when we are in a deep recession.

Nobel Prize

2009-10-07T08:12:00.000-07:00

The Nobel Prize in economics will be announced on Monday. Our annual lottery (which tends to be more accurate than all other pools and lotteries in the profession) is underway. Here are the latest odds.

Economist	Payoff to a Dollar Bet

Diamond	5.5	to	1
Mortensen	7.6666667	to	1
Pissarides	7.6666667	to	1
Shiller	12	to	1
Sims	12	to	2
Nordaus	18.5	to	1
Fehr	25	to	1
Hansen	25	to	1
Dreze	38	to	1
Hausman	38	to	1
Hendry	38	to	1
The Field	38	to	1
White	38	to	1
Williamson	38	to	1
Arthur	77	to	1
Barro	77	to	1
Broom, John	77	to	1
Feldstein	77	to	1
Hart	77	to	1
Holmstrom	77	to	1
Jorgensen	77	to	1
Kornai	77	to	1
Krueger	77	to	1
Nelson	77	to	1
Sachs	77	to	1
Sargent	77	to	1
Wilson	77	to	1
Winter	77	to	1

Lehman Again

2009-10-04T19:45:00.001-07:00

Richard Robb has an interesting counter to the argument that the impact of Lehman's failure was overblown. His main point is that the looking only at Libor and the overnight swap market was misleading at that time:

The latest contribution by John Cochrane and Luigi Zingales, like others before them, rests partly on misunderstanding of the data. The authors deduce that Lehman wasn’t the main cause of last autumn’s turmoil by inspecting the daily movements in the spread between Overnight Interest Rate Swaps and three-month Libor, which they define as “the rate at which banks can borrow unsecured for three months.”
But a better definition of Libor under the circumstances was “the rate at which banks said they can borrow”. Libor is the result of a survey, not a measure of actual transactions. In the week of September 15 last year, big banks refused to settle foreign exchange with each other. They were not lending interbank for three month terms, so Libor during that week tells us little.

We could say the same thing for OIS. Volume was light to nonexistent in the week of September 15 last year. What we do know is that three-month T-bills traded at 0.04 per cent on September 17, down from 1.47 per cent on Friday September 12. These are real data that ought to impress the professors that the market was breaking down as fast as it knows how.

In addition to this argument there is the additional point that Lehman's collapse led to the run on money markets because the Reserve Primary Fund held lots of Lehman debt. This cause them to break the buck, and this led to a run on other money market funds. Since money market funds are the main purchasers of commercial paper, this spread the crisis to the rest of the economy. This is the amplification mechanism that was crucial in generating such a large impact from the failure of a relatively small bank failure.

Fiscal Multipliers

2009-10-04T19:38:00.000-07:00

Here are some links, courtesy of Mark Thoma and Econbrowser, for discussion on the size of fiscal multipliers.

New Summers Profile

2009-10-04T19:22:00.000-07:00

The New Yorker has a profile of Larry Summers. The focus in on how the Obama team dealt with the economic crisis, and how Summers has evolved.

Securitization and Beef

2009-10-04T05:17:00.001-07:00

One argument against regulation is that private companies have an incentive to conform to the highest standards to maintain their reputation. They won't shift risks even when the opportunity arises because this will hurt them in the future. Yet, this argument does not always work, as this article in the New York Times on E Coli in ground beef explains.

Ground beef is combined together from different suppliers, much like a collateralized debt obligation. This makes it very hard to identify the source of an outbreak.

Ground beef is usually not simply a chunk of meat run through a grinder. Instead, records and interviews show, a single portion of hamburger meat is often an amalgam of various grades of meat from different parts of cows and even from different slaughterhouses. These cuts of meat are particularly vulnerable to E. coli contamination, food experts and officials say. Despite this, there is no federal requirement for grinders to test their ingredients for the pathogen.

Self regulation does not work here very well:

Unwritten agreements between some companies appear to stand in the way of ingredient testing. Many big slaughterhouses will sell only to grinders who agree not to test their shipments for E. coli, according to officials at two large grinding companies. Slaughterhouses fear that one grinder’s discovery of E. coli will set off a recall of ingredients they sold to others.

Given how often I eat hamburgers this is a most important story. It seems incentives for self-regulation here are much worse than in the financial industry. Notice that with securitization the problem is that it is very difficult to disentangle the loans that make up the security. But in hamburgers it is impossible to distinguish which producers supplied the tainted meat. This is due to the lack of testing at the source, a result of an inadequate regulatory structure and the failure of self-regulation in this industry.

Goolsbee: funniest DC celebrity

2009-10-01T15:33:00.001-07:00

Austan Goolsbee is the funniest celebrity in Washington according to Politico. See his standup routine here.

Executive Compensation and the Crisis

2009-09-27T07:36:00.000-07:00

Rene Stulz has a new working paper which studies the impact of CEO pay on the economic crisis. Studying CEO. The conclusions are interesting:

There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity. Further, option compensation did not have an adverse impact on bank performance during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; further, there is no evidence that they hedged their equity exposure. Consequently, they suffered extremely large wealth losses as a result of the crisis.

This is an important study. Perhaps it is not all that surprising, since competition across banks in an asset bubble leads to herding behavior.

This article in the New York Times discusses the controversy. This study is not going to head off reforms on CEO pay. Still, it is important to think about unintended consequences:

“neither bank C.E.O.’s nor regulators thought that banks were taking excessive risks.” So if the risks were viewed as small, he adds, “compensation incentives would not induce them to avoid those risks.”
He points out that in 2006, a collateralized-debt obligation with a triple-A rating didn’t look like a huge risk. “On the contrary, it looked like an extremely low-risk asset,” he says. “Yet, banks incurred extremely large losses on such C.D.O.’s.”
Regulations that would have encouraged executives to take on less risk, he adds, might have made matters worse because executives “might well have chosen to invest even more in AAA-rated C.D.O.’s and other asset-backed securities.”

One could argue, I suppose, that if CEO pay has a common structure, then differences in CEO schemes may not show up in differences in importance, yet the structure is still problematic. That is, all CEO incentive packages could induce risk taking, the differences being less important than the structure itself.

The Financial Bailout will not Impoverish America

2009-09-25T07:10:00.000-07:00

Last night I participated in a debate here at PSU on the subject of bailouts. The motion was that bailouts will impoverish America, and I argued against. Here are my remarks (I only had five minutes for the presentation).

Meanwhile, Daniel Gross at Slate makes some important similar points, especially that many of the bailed out banks have actually paid income back to the government, and that the expenditures actually made are very small compared with the commitments. For example,

After the failure of Lehman Bros., the Treasury Department agreed to guarantee the $3.8 trillion industry for money-market funds. In so doing, taxpayers assumed a massive liability. Managers of money-market funds were charged a tiny fee for this insurance. On Sept. 18, the government lifted the guarantee, reporting that it had collected $1.2 billion in fees without having made any payments.

This seems to be the experience with most of the bailouts. Large commitments, much smaller expenditures, programs being wound down. Emergency actions paid off, at least so far.

Mundell calls for fixed dollar-euro rate

2009-09-24T15:03:00.000-07:00

Robert Mundell, Nobel Laureate and intellectual father of the euro, calls for a fixed exchange rate between the dollar and the euro. See this article.

Posner becomes a Keynesian

2009-09-23T12:21:00.000-07:00

Richard Posner writes in the New Republic about how he became a Keynesian. Worth reading, despite his confusion over the difference between savings and investment. Perhaps the problem is Posner's inability to use the word equilibrium condition. For Keynes point was that savings equals investment in equilibrium and that changes in income bring this about. Without this the article is confusing about passive and active investment and so on.

I need to write more about the contribution of Keynes to understanding this crisis.

Global Public Debt

2009-09-22T09:32:00.000-07:00

The Economist has a nice interactive tool for looking at public debt across countries.