Chickens coming Home to Roost

Posted: October 18, 2011 | Author: | Filed under: Austerity, Global Financial Crisis | Tags: , , , | 6 Comments

What happens to your bank when you overlook due diligence in lending, borrow money from the Fed at near zero interest rates but lend it out to very few people at  10 to 20 times the inflation rate, slack off on renegotiating loans,  charge customers fees on everything, and engage in practices that basically drain resources from your clientele?  Well, your customers eventually suffer so much economic destress they start bringing you down with them by defaulting.  Big US banks are suffering because their customers are suffering.  Kind’ve Karmic isn’t it?  Well, it’s karmic in the sense that that’s what you get from engaging in really short-sighted bad business practices made to enrich your executives and prop your stock prices up over actually doing your core business intelligently.

Fears about the health of US consumer balance sheets grew on Monday as Citigroup and Wells Fargo joined JPMorgan Chase in reporting new signs that homeowners and credit-card borrowers are falling behind on their payments.

The banks’ third-quarter results were hit by expected declines in investment banking, reflecting turbulence in global markets. But the reports also revealed weakness in the consumer side of their businesses – with mortgage delinquency numbers suggesting that record low mortgage rates and government loan modification programmes are failing to help a large swathe of homeowners.

Overall revenues fell 8 per cent at Citigroup year-on-year and 6 per cent at Wells, sending their shares down 1.7 per cent and 8.4 per cent, respectively. The S&P 500 index fell 1.9 per cent.

Wells said delinquencies of more than 90 days in its main portfolio of consumer loans – including mortgages and credit cards – rose 4 per cent to $1.5bn, the first increase since 2009. Early stage delinquencies in its retail business remained flat at 6.13 per cent after falling for three quarters. The bank increased its provision for consumer-banking losses for the first time in two years.

“The economic recovery has been more sluggish and uneven than anyone anticipated,” said John Stumpf, Wells chief executive

Federal policy that emphasizes bailing out failing businesses while leaving their customers high and dry with extremely high unemployment rates and costs of borrowing and living is having ongoing effects. Here’s some more info on banks beefing up their loan loss reserves from that FT article.

JPMorgan last week increased its provision for losses on consumer loans to $2.3bn from $1.9bn in the previous quarter. JPMorgan said delinquencies on goverment-insured mortgages hit $9.5bn, up from $9.1bn in the second quarter and $9.2bn a year ago.

“The residential mortgage problems are unprecedented,” said Gerard Cassidy, analyst at RBC Capital. “The rate of improvement in the delinquencies has slowed down dramatically in the last two years and even over the more recent quarters.” He said the problems were no longer in “subprime” but “prime” mortgages.

Capital One, among the top six US card issuers, reported rising 30-day delinquencies in June and July. “Defaults on credit card debt are certain to rise from here,” said James Friedman at Susquehanna Capital Group.

So, what’s not to be surprised about given that the unemployment rate has been sitting around 9% now for three years in a row?   All of these really bad metrics on consumer finances should be signalling policymakers to act.  But, that’s not happening.  Well, not unless you count all the finger pointing at Ben Bernanke.  I am continually flummoxed by the inability of every one in policy circles to get the basic economics right. The obsession with austerity is killing this country and it’s doing the same in others. The data just screams ongoing murder.

Here’s some thoughts on the absolute disconnect of policy from reality from Josh Bivens at the Economic Policy Institute Blog who also can’t figure out why nuts and bolts economics has suddenly been termed radical.  If we’d have done something differently about three years ago, these  statistics that indicate horrible stress on US households could’ve been dealt with by now.  It’s odd that the very policymakers that were so concerned about Banks and Businesses have no problem slowly killing their customers.

There is nothing inherent in the economics of financial crises that makes slow recovery inevitable – they just require that policymakers figure out how to engineer more spending in their wake, same as in response to all other recessions.

Rather, the real problem they pose to policymakers is that engineering such spending increases in the wake of financial crises often requires policy responses that seem unorthodox or radical relative to the very narrow range of macroeconomic stabilization tools that enjoy support across the ideological spectrum. To put this more simply – they require policymakers do more than watch the Federal Reserve pull down short-term interest rates. For decades, all recession-fighting was outsourced to the Fed’s control of short-term “policy” interest rates – this despite the fact that in the U.S. this recession-fighting tool hasn’t actually been all that successful since the 1980s (see Table 2 in this paper).

The best response to a recession that is either so deep or so infected by debt-overhangs that conventional monetary policy is not sufficient, is simply to engage in lots of fiscal support – think the American Recovery and Reinvestment Act (ARRA) – but (as Ezra notes) much, much bigger in the case of the Great Recession.

But, this kind of discretionary fiscal policy response to recession-fighting (and jobless-recovery fighting) had fallen deeply out of favor in the same decades that saw increasing reliance on conventional monetary policy[1]. In fact, advocating fiscal policy that was up to the task of providing a full recovery in the wake of crises that defanged conventional monetary policy somewhere along the way got labeled radical, rather than simply nuts-and-bolts economics.

Further, this rejection of discretionary fiscal policy was done on very thin analytical reeds – essentially the fear was that it took too long to debate, pass, and see an effect from fiscal policy – and that if the recession was “missed” in real-time by policymakers, we would end up providing lots of fiscal support to an already-recovered economy – and might even cause economic overheating that would lead to runaway inflation and interest rate spikes.

This fear led to the strange mantra in the debate over fiscal stimulus in 2008 that policy had to be targeted, temporary and timely – which basically ruled out most things but tax cuts. But, given that the last three recessions have seen extraordinarily sluggish return to job-creation in their wake, this timely obsession was clearly misplaced (and, plenty argued so in real-time).

What we’ve been experiencing the last three years is the fall out of a financial crisis exacerbated by extremely bad policy.  It’s easy to pin the blame on the recalcitrant republicans who are willing to tank all of us to regain the White House, but there’s definitely some blame to pin on the Obama White House. It’s clear that the White House  simply did not manage the situation well at all.  The question that keeps me up nights is this.  Has the Obama administration learned its lessons?  I’m not certain on that.  But, I am certain that if some one like a Herman Cain gets in, there will be more hell to pay in terms of inexperience and bad policy than if we muddle through with more Obama incompetency.  I’m not sure if Romney will be about as inept as we’ve seen the current occupant or will be lead to worse policies of the sort put forth by the Cains and Bachmanns.

Bivens wonders who the Democrats are that suddenly decided that that nothing could be done about recessions except to dither and hope for the best efforts by the FED. Hoping for miracles from the Fed at the zero bound is delusional.  There is no historical or theoretical argument for any of this silly behavior.  We continue to see the deficit hawk arguments on all sides to the point that one can only assume that there’s very little difference between Republican and Democratic orthodoxy on voodoo economics any more.  This includes shilling for useless tax cuts.

But, I would also want to make sure to include much of the policymaking apparatus of the Democratic Party, who became far too enamored of the unalloyed virtues of deficit-cutting in the past two decades. The excellent labor market performance of the late 1990s, for example, is labeled a pure result rather than an important cause of substantially lower budget deficits during that time. And the regressive and stupid tax cuts pursued under the Bush Administration were generally not fought on the grounds that they were regressive and stupid, but that they would lead to intolerably large deficits – deficits so large they might even lead to Greek-like financial crises when, in fact, deficits as a share of GDP averaged less than 2 percent in 2006 and 2007. To be clear – the Bush tax cuts were expensive as well as regressive and stupid, and letting them (or at the very least the most regressive set of them) expire would be a real policy victory, freeing up public resources for much more valuable ends. But they did not cause deficits in the 2000s to reach terrifying levels.

Sadly, this same Democratic policy apparatus seems to be repeating many of these mistakes, by continually insisting that aggressive maneuvers to help alleviate the jobs-crisis must be done simultaneously with efforts to close what are actually pretty non-scary medium term deficits. Would the “very-big-stimulus-now-cum-progressive-measures-to-bring-medium/long-term-spending-and-revenues -in-balance-when-we-get-back-to-full-employment” plan be the best of all worlds? Sure.

So, what changed between the Reagan legacy of huge deficits “as far as the eye can see” or the “deficits don’t matter” mantra of old Dick Cheney to the mantra now that only deficits matter?  What’s caused this idea that you can spend hugely on unjustifiable wars, bailing out failing banks and businesses, and giving tax cuts and credits to every one under the sun with no real rationale but you have to say no now to stopping macroeconomic seppuku?  To a certain extent, we have Robert Rubin to thank for that.  Many of Rubin’s acolytes are still planted in the Treasury and were sent to the Obama White House early on.  Here’s a brief bit on that from an Allan Blinder Working Paper at Princeton that gives a good overview on how our approach to fiscal policy went completely off the track.

The fact that the Clinton boom started almost immediately after Congress passed a budget reduction package gave rise to some rethinking—some of it serious, some of it muddled—of even the sign of the fiscal-policy multiplier. Among politicians and media types, the notion that raising taxes and/or cutting spending would expand (rather than contract) the economy took hold rapidly and uncritically—with seemingly little thought about exactly how this was supposed to happen. Quicker than you can say “Robert Rubin,” the idea that reducing the budget deficit (or increasing the surplus) is the way to “grow” the U.S. economy—even in the short run—came to dominate thinking in Washington. This thinking was, of course, profoundly anti-Keynesian.

Is this why no longer seem to be able to get our act together and just do the basic right thing when it comes to helping US consumers deal with the Great Recession and its ongoing aftermath?   That would seem feasible except that right after 2001, George W Bush and and Allan Greenspan went right back on the stimulation on steroids policy of previous administrations. Both parties want happily along with that.   So, I continue not to get it and the policy continues not to get it right and if you look measurements of economic health like defaults and unemployment, it’s pretty clear that US Households aren’t going to get any thing either.  It’s no wonder people are starting to take to the streets.

Balanced Budget Amendments are Bad Policy

Posted: August 3, 2011 | Author: | Filed under: U.S. Economy, U.S. Politics, voodoo economics | Tags: , , , , , , , , , , , , , | 9 Comments

I always have to cover this topic in any introductory macroeconomics class I teach because usually one nutjob or another running for office always brings this up and people fall for it.  The arguments are usually based on complete fallacies and misunderstanding of the math of economics, but hey, for some reason balanced budgets sound ‘reasonable’ when they are anything but.

I used to talk theoretically about how balanced budget amendments will kill state economies when the next real recession hits.  Well, it hit a few years ago and we’re there.  States continue to make their own economies worse day in and day out but there’s still those people that insist that if a family has to balance its budget, then so should the country.  That’s even stupid considering most families have mortgages and car payments and probably student loans. Take Michele Bachmann as an example. She’s got all of the above plus farm subsidies and government grants.  Even the President is guilty of that false equivalency.  No person or family exists in perpetuity.  No person or family can print money.  No person or family has the power of taxation.  Because of these three things, you cannot compare government to a family.  Nor can you compare government to a business.  Businesses exist to make a profit.  Government exists to provide services and goods that the private sector will not provide or provides at an outrageous cost.  It exists to administer justice and ensure level playing fields and fair play exists.  Everything about a government is unique and is no way comparable to either businesses or households.

Macroeconomists know from years of study that the federal government can influence the economy at large.  It does so through its spending and taxing priorities and policies.  This is called fiscal policy.  We have found several economic laws that guide the relationship between taxes and government spending and the behavior of Gross Domestic Product (GDP) which roughly measures all the legal and reported spending by households, governments, foreigners, and businesses.  In our economy, household spending comprises about 68% of all GDP.

Investment or purchases by businesses is the smallest and most erratic component of GDP.  Keynes said that it is easily spooked and subject to animistic spirits.  Because it’s an unreliable source of growth, Keynes argued that in down turns, government should use its power to spend.  Business investment usually only does fine in good economies. Please note,  Keynes said deficit spend in recessions.  Keynes’ prescription also said that Federal governments should run balanced budgets during times when the economy is fully employed and surpluses during bubble or boom times to relieve inflationary pressure.  As usual, conservative politicians completely lie about the nature of Keynes and his highly proven and credible theories on fiscal policy.  A lot of what we know about Monetary Policy comes from Milton Friedman, however, that is not the subject today.  What I want to emphasize is that both men spent a lot of time analyzing panics and the Great Depression and are very much at the heart of accepted theory.  We are seeing a classical lack of aggregate demand today.  It is what’s driving the budget deficit.  It is what’s driving the joblessness. It is what’s driving the slow recovery.  Government must and will by automatic stabilizers be in a deficit position during downturns.  It is simple math.  More revenues come in during good times than bad.  More safety net spending increases during bad times than good.  We naturally run towards deficit in bad economies and towards surplus in good.

However, show me an economy that’s booming with high revenues and lower safety net spending and I will show you a group of politicians spending wildly.  This tends to create inflation and can lead to bubbles.  However, you never hear them complain at that point in time.   That’s because it should be relatively easy to balance a budget then, but they do not do so or if they do its by expanding programs that cannot be sustained without borrowing during bad economies.

With that short explanation, let me cite you some folks that tell you why balanced budget amendments are bad policy.  This first quote is from Simon Johnson who is the former chief economist for the IMF.  He asks us to keep in mind that GDP is a measurement that is fraught with problems.   He also mentions the fact that a balanced budget amendment makes the government make recessions worse.

Second and more seriously, imagine that this constitutional amendment were in place and that federal spending were roughly at its limit relative to the size of the economy. Then, what happens should the financial sector blow up again — either through no fault of its own (which, believe it or not, is the current prevailing myth on Wall Street about 2007-9) or because of some toxic combination of malfeasance and malpractice (the current predominant view of 2007-9 among many other people)?

The blame game is irrelevant when G.D.P. drops 10 percent; the issue is how to prevent a Great Depression. But note that with such a decline in G.D.P., a level of nominal spending that was 18 percent of G.D.P. is suddenly 20 percent, and now a constitutional crisis awaits – even before we get to the question of whether tax cuts or other forms of stimulus might be appropriate.

It makes no sense to take aim, as a matter of constitutional process, at two numbers that are both outcomes of deeper economic processes.

And to be frank, sometimes it makes a great deal of sense to apply an economic stimulus to an economy in free fall. One such moment was 1930 (and 1931 and 1932), when no stimulus was applied. Other moments were 2008 and 2009; both President Bush and President Obama initiated stimulus packages. When credit for and confidence in the private sector evaporates, do you really want the government sector to be forced to make quick cuts — or to raise taxes?

James Ledbetter at Reuters argues that even conservatives should oppose a balanced budget amendment (BBA).  His reasons are more pragmatic.  He argues that it won’t work.

Historically, conservatives have opposed extending government authority in places where it is not effective. You can find all the evidence you need to conclude that balanced budget requirements are useless by simply investigating the oft-repeated claim that 49 states have laws requiring a balanced budget. Leave aside the falsity of the claim and just consider the logic: if so many states are required to balance their budgets, why are so many states in the red?

The answer is that requiring state governments to annually balance their books simply encourages them to find clever ways to disguise debt and deficits. For example: California has both a Constitutional and a statutory requirement that its budgets be balanced. Would any sane person maintain that the state’s books have been anything resembling healthy for at least a decade? This year, after some brutal spending cuts, the governor’s office found that the state still had a short-term deficit of more than $9 billion and $35 billion in long-term debt. The governor’s budget report noted that California’s “massive budget deficits for most of the past decade…have been largely the result of a reliance on one-time solutions, borrowing, accounting maneuvers, and cuts or revenues that were illusory and therefore did not materialize.”

If that sounds familiar, it may be because, as Richard Quest pointed out on CNN Sunday evening, we’ve witnessed numerous Congressional attempts in recent decades to rein in federal deficits—including Gramm-Rudman in 1985 and the Budget Enforcement Act of 1990—all of which fell victim to legislative legerdemain. Why would a federal balanced budget amendment be any different?

Here’s something from The Economist on “Fiscal Rules”.  Some fiscal rule–rather than a balanced budget amendment–would better stop congress from spending during booms and full employment cycles rather than balancing its budget via a BBA. This would be a rule that attaches the spending mandates to what’s going on in the economy.  But again, I doubt they’d follow it since they’ve ignored a good portion of the Keynesian prescription for years any way.

It is difficult for Congress to tie its own hands. Any law that can pass Congress can later be undone or changed. In the rare cases that Congress puts together a near-perfect piece of legislation, that’s a bad thing. In the vastly more common occurrence that Congress passes highly imperfect legislation in need of significant future tweaks, that’s a very good thing. Support for an amendment to the constitution is a spectacular vote of confidence in the ability of a legislature to design near-perfect legislation, because the only thing rarer than an amendment to the constitution is a subsequent amendment undoing or clarifying a previous amendment.

I see the argument for a well-designed, over-the-business-cycle balanced-budget amendment. But the idea of enshrining this Congress’ pathologies into the constitution is terrifying. Let’s see Congress design some quality fiscal rules using the normal legislative process first, and then we can talk about adding those to the constitution.

Bruce Bartlett has some excellent analysis up for the current go round of balanced budget amendments.  Mark Thoma explains how a BBA is a very bad idea. His analysis includes looking at the destabilizing effects that states’ BBAs have had on their economies. There’s a nifty graph that I did not include here if you’d like to go view it.

I’ve argued on many occasions that one of the big lessons we need to learn from this recession is that state-level balanced budget requirements are highly destabilizing. When a recession hits, spending goes up for social services and taxes fall as income, sales, property values, and other sources of revenue for state and local governments decline.

The result is a big hole in state and local government budgets, and that forces either increases in taxes or cuts in spending both of which make things even worse. And though some state and local governments were an exception to this, far and away the choice is to cut spending. We can see this in the state and local government employment statistics:

That’s not what we want to have happening when we are trying to recover from a recession. It would be much better if states had rainy day funds to rely upon, and if the rainy day funds fall short, the federal government could backfill the budget holes to prevent the destabilizing downsizing.

So have we learned the lesson? Nope, at least not if you are a Republican. They’d like to impose the same destabilizing rules on the federal government:

You really would have to search high and low for an economist that actually supports a BBA.  The more conservative ones go for the fiscal rule that attaches spending to business cycles but even they believe that it would be unenforceable and easy to avoid. Can you imagine some District Judge trying to look over a complex macroeconomic model and figure out if the government forecast was correct or not?

A group of leading economists, including five Nobel Laureates in economics, today publicly released a letter to President Obama and Congress opposing a constitutional balanced budget amendment. The letter outlines the reasons why writing a balanced budget requirement into the Constitution would be “very unsound policy” that would adversely affect the economy. Adding arbitrary caps on federal expenditures would make the balanced budget amendment even more problematic, the letter says. The Economic Policy Institute and the Center on Budget and Policy Priorities organized the letter.

“A balanced budget amendment would mandate perverse actions in the face of recessions,” the letter notes. By requiring large budget cuts when the economy is weakest, the amendment “would aggravate recessions.”

The signatories of the letter are Nobel Laureates Kenneth Arrow, Peter Diamond, Eric Maskin, Charles Schultze, William Sharpe and Robert Solow; Alan Blinder, former Vice Chair of the Federal Reserve System’s Board of Governors and former member of the Council of Economic Advisors; and Laura Tyson, former Chair of the Council of Economic Advisors and former Director of the National Economic Council.

I’ll let former Reagan economist Bruce Bartlett have the last word here. He looks at the recent debate in Congress on the BBA.

Next week, House Republicans plan to debate a balanced budget amendment to the Constitution. Although polls show overwhelming public support, it is doubtful that many Americans realize that the measure to be debated is not, in fact, a workable blueprint to enforce a balanced budget. In fact, it’s just more political theater designed to delight the Tea Party.

We really need improved economic literacy in this country.  I genuinely can’t get over what some of the morons in congress can get away with saying.  Economists call them on it but it appears no one every listens.