Monday Reads

Good Morning!

Nobel Prize winning economists continue to warn against “Destructive Austerity”. Here’s Paul Krugman on a Jared Bernstein post.

That is, we’re sacrificing the future as well as the present. Oh, and the cuts that aren’t falling on investment in physical capital are largely falling on human capital, that is, education.

It’s hard to overstate just how wrong all this is. We have a situation in which resources are sitting idle looking for uses — massive unemployment of workers, especially construction workers, capital so bereft of good investment opportunities that it’s available to the federal government at negative real interest rates. Never mind multipliers and all that (although they exist too); this is a time when government investment should be pushed very hard. Instead, it’s being slashed.

From Davos, we have this from Joseph Stiglitz on the austerity forced on Irleand.

NOBEL PRIZE-winning economist Joseph Stiglitz has described the continued payments by the Government to unsecured bondholders as “unconscionable”.

Ireland’s chances of cutting its way back to health were negligible he said, and its prospects were being compounded by German chancellor Angela Merkel’s austerity rhetoric.

“Why should Irish taxpayers have to give up health and education to make good on a loan from a private bank when the previous government failed to do an adequate job of regulation?” asked Prof Stiglitz in an interview with The Irish Times .

There were cases where austerity programmes led to quick recovery, he said, but there were so few and in circumstances so different to Ireland’s that they weren’t applicable.

“The only instances in which they worked tended to be when there was a weak country with a strong trading partner and typically with a flexible exchange rate. You have a fixed exchange rate and a Europe in recession.”

In the complexity of the discussion over bondholders, Prof Stiglitz said simple facts were being overlooked: the unsecured bondholders were paid a normal interest rate for bearing a risk by investing in Irish banks, which was and is the nature of the market economy.

In addition the process of internal devaluation – a drop in salaries and other costs– would, he said, only fan the flames of recession.

“Your ability to make mortgage and other debt payments is diminished and you already have a problem in your real estate market,” he said. “In that sense the suffering, the bankruptcies and the foreclosures are going to only increase.”

David Cay Johnston says austerity  has a “siren call”.

This message of austerity is like the call of the ancient Sirens, whose music lured sailors to shipwreck.
We should take a lesson from Odysseus, who poured wax into the ears of his crew and had himself lashed to the mast of his ship to resist the Siren call.

Austerity supporters are selling the idea that governments, like families, must cut back when income shrinks. But economically, governments are not like families.

Firing teachers, cops and government clerks will, for sure, reduce public spending. But budgets, like the song of the Sirens, are only part of the story. Listen only to the alluring lyrics and, like the many voyagers before Odysseus, we will suffer disastrous consequences – in our case falling incomes and worsening economies.

The full economic story begins with this principle taught to every economics student: spending equals income and income equals spending. Cut spending and incomes must fall; cut incomes and spending must fall.

Those who disagree with this say that only private spending can create wealth and that government spending is inefficient. I think the first argument is wrong, but the second is often true, which is why citizens need to pay close attention to their government.

When private spending shrinks, then either government spending must grow to make up for it or the other side of the equation, income, must shrink.

If we increase spending today by borrowing, we create a claim on future income. Families with debt must divert part of their future income to interest and principal to service that debt or go bankrupt. Governments are different, provided they have monopoly control of their currency. By definition, no sovereign government can ever go broke in its own currency.

Krugman’s NYT editorial today calls the entire austerity agenda a “debacle”.

True, the federal government has avoided all-out austerity. But state and local governments, which must run more or less balanced budgets, have slashed spending and employment as federal aid runs out — and this has been a major drag on the overall economy. Without those spending cuts, we might already have been on the road to self-sustaining growth; as it is, recovery still hangs in the balance.

And we may get tipped in the wrong direction by Continental Europe, where austerity policies are having the same effect as in Britain, with many signs pointing to recession this year.

The infuriating thing about this tragedy is that it was completely unnecessary. Half a century ago, any economist — or for that matter any undergraduate who had read Paul Samuelson’s textbook “Economics” — could have told you that austerity in the face of depression was a very bad idea. But policy makers, pundits and, I’m sorry to say, many economists decided, largely for political reasons, to forget what they used to know. And millions of workers are paying the price for their willful amnesia.

The Florida Primary is tomorrow and Romney is regaining the lead in polls.

Mitt Romney may be on his way to a decisive victory in the Florida GOP primary Tuesday, according to a new NBC/Marist poll.

Romney leads Newt Gingrich by 15 points, 42 percent to 27 percent in the crucial state. Rick Santorum is third with 16 percent, followed by Ron Paul with 11 percent. Just 4 percent said they were undecided.

“The bottom line in all this is Romney’s sitting in the driver’s seat going into Tuesday,” said Lee Miringoff, director of the Marist Institute for Public Opinion at Marist College, who conducted the poll.

If Romney pulls off a victory of that magnitude, he could be on a glide path to the nomination. But there are warning signs for the Republican Party that the primary has taken a toll on Romney and the rest of the GOP field. Each of the candidates struggles in a general-election matchup with President Barack Obama in this swing state, especially with independents.

Goerge Monbiot suggests that the UK and other countries consider a “maximum wage”.

The successful bank robber no longer covers his face and leaps over the counter with a sawn-off shotgun. He arrives in a chauffeur-driven car, glides into the lift then saunters into an office at the top of the building. No one stops him. No one, even when the scale of the heist is revealed, issues a warrant for his arrest. The modern robber obtains prior approval from the institution he is fleecing.

The income of corporate executives, which the business secretary Vince Cable has just failed to address(1), is a form of institutionalised theft, arranged by a kleptocratic class for the benefit of its members. The wealth which was once spread more evenly among the staff of a company, or distributed as lower prices or higher taxes, is now siphoned off by people who have neither earned nor generated it.

Over the past ten years, chief executives’ pay has risen nine times faster than that of the median earner(2). Some bosses (British Gas, Xstrata and Barclays for example) are now being paid over 1000 times the national median wage(3). The share of national income captured by the top 0.1% rose from 1.3% in 1979 to 6.5% by 2007(4).

These rewards bear no relationship to risk. The bosses of big companies, though they call themselves risk-takers, are 13 times less likely to be sacked than the lowest paid workers(5). Even if they lose their jobs and never work again, they will have invested so much and secured such generous pensions and severance packages that they’ll live in luxury for the rest of their lives(6). The risks are carried by other people.

The problem of executive pay is characterised by Cable and many others as a gap between reward and performance. But it runs deeper than that, for three reasons.

As the writer Dan Pink has shown, high pay actually reduces performance(7). Material rewards incentivise simple mechanistic jobs, such as working on an assembly line. But they lead to the poorer execution of tasks which require problem solving and cognitive skills. As studies for the US Federal Reserve and other such bolsheviks show(8), cash incentives narrow people’s focus and restrict the range of their thinking. By contrast, intrinsic motivators — such as a sense of autonomy, of enhancing your skills and pursuing a higher purpose — tend to improve performance.

Even the 0.1% concede that money is not what drives them. Bernie Ecclestone says “I doubt if any successful business person works for money … money is a by-product of success. It’s not the main aim.”(9) Jeroen van der Veer, formerly the chief executive of Shell, recalls, “if I had been paid 50 per cent more, I would not have done it better. If I had been paid 50 per cent less, then I would not have done it worse”(10). High pay is both counterproductive and unnecessary.

The second reason is that, as the psychologist Daniel Kahneman has shown, performance in the financial sector is random, and the belief of traders and fund managers that they are using skill to beat the market is a cognitive illusion(11). A link between pay and results is a reward for blind luck.

Most importantly, the wider consequences of grotesque inequality bear no relationship to entitlement. Obscene rewards for success are as socially corrosive as obscene rewards for failure. They reduce social mobility, enhance plutocratic power and allow the elite to inflict astonishing levels of damage on the environment(12). They create resentment and reduce the motivation of other workers, who see the greedy bosses as the personification of the company(13).

Interesting idea isn’t it?  What’s on your reading and blogging list today?


Some times being Right doesn’t always make you Feel Good

wayne-stayskal-30-septemberYou may remember back in January that I was not happy and very outspoken about the size of the Obama Stimulus plan. I was not impressed by the content or with the mix between tax cuts and direct government spending. You may recall that the Blue Dogs interminable resistance to do anything that might wake their sleeping Republican voters and the desire on the part of POTUS to appease the unappeasable remnants of the Republican party led to a very watered down plan. At the time, all that I could hope was that it might be enough to get the ball rolling. However, I felt that the historical multiplier –especially for taxes– was not going to kick in the way it had in the past.

The release of the miserable unemployment data yesterday (not all that unexpected as you’ll recall) as well as an estimate of our output gap now clearly squares with my earlier view as well as the earlier views of Brad deLong, Paul Krugman, Mark Thoma and Joseph Stiglitz among others. The stimulus was clearly not the blue pill the economy needed. (That last link is from me saying this same thing in July.)

The Washington Monthly says the decision to appease centrists and Republicans looks even worse in retrospect. Now, the media gets it. Color me completely unsurprised because I told you so back then that it wasn’t going to be enough. I even mentioned it recently when it appeared the stimulus plans of German, France, and Japan had already lifted those economies from the worst of it last spring. These countries emphasized direct government spending. We mostly shuffled a few funds as stop gaps and the created a bunch of tax cuts that no one really needs right now.

In February, when the debate over the economic stimulus package was at its height, a handful of “centrist” Senate Republicans said they’d block a vote on recovery efforts unless the majority agreed to slash over $100 billion from the bill.

The group, which didn’t have any specific policy goals in mind and simply liked the idea of a small bill, specifically targeted $40 billion in proposed aid to states. Helping rescue states, Sen. Collins & Co. said, does not stimulate the economy, and as such doesn’t belong in the legislation. Democratic leaders reluctantly went along — they weren’t given a choice since Republicans refused to give the bill an up-or-down vote — and the $40 billion in state aid was eliminated.

At the time, it seemed like a very bad idea. That’s because it was a very bad idea.

In the past, government hiring had managed to somewhat offset losses in the private sector, but government jobs declined by 53,000, with the biggest number of cuts on the local and state levels. Even the Postal Service, which is included in the public-sector job statistics, dropped 5,300 jobs.

“The major surprise came from the public sector, where every level of government cut back,” Naroff said. “The budget crises at the state and local levels have caused an awful lot of belt-tightening.”

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He’s no FDR

DeLong skewers the the Stimulus Plan Claim via the Unemployment rate

DeLong skewers the the Stimulus Plan Claim via the Unemployment rate with stylized facts

With the release of financial regulation reform and healthcare reform that has Wall Street breaking open the bubbly, I just want to join the chorus of highly skeptical economists. The tune of the last few days is hard to miss. Take this piece from the NY Time’s Dealbook as an example: Only a Hint of Roosevelt in Financial Overhaul. There’s also Paul Krugman’s Op-Ed Column today Out of the Shadows which is the typical on-the-one-hand-on-the-other hand economist behavior. (Could I just mention in passing that I like the OLD Paul better? The one that was an out spoken advocate for liberal economists? I’m not sure what happened at that White House Dinner, but I’m beginning to think we now have a Manchurian economist at Princeton. Oh, where is our Shrill One?) Oh, and you can still read my first impressions here. I’m going to start with Financial Reform but don’t leave me yet. Brad deLong takes on Christine Romer’s The Lessons of 1937 at The Economist and since he still hasn’t been invited to dinner at the White House, it’s classic Brad.

So what does Krugman think about the Alphabet Soup Agency reheat slugging its way through that perpetual Hall of Wall Street minions we know as our Congress? He believes that it throws some light on the shadow banking industry in that the Alphabet Soup gang at the FED get to see more balance sheets and books. There is also a stab at standardizing the process, but custom fitted Credit Default Swaps remain. The essential riskiness remains. Let’s examine the Krugman critique.

But what about the broader problem of financial excess?

President Obama’s speech outlining the financial plan described the underlying problem very well. Wall Street developed a “culture of irresponsibility,” the president said. Lenders didn’t hold on to their loans, but instead sold them off to be repackaged into securities, which in turn were sold to investors who didn’t understand what they were buying. “Meanwhile,” he said, “executive compensation — unmoored from long-term performance or even reality — rewarded recklessness rather than responsibility.”

Unfortunately, the plan as released doesn’t live up to the diagnosis.

Well, maybe the White House Pastry chef did not completely overwhelm the shrill one.

Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen.

Furthermore, the plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.

In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators.

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Is this ANY way to run an Economy?

bank-holidayThe US economy is in a fragile state right now which begs the question: Why do our policy makers seem oblivious to lessons from the great meltdowns of the past?  Adam Posner of the Daily Beast asks the question out right: Does Obama Have a Plan B? Posner asserts that the administration appears to be hellbent on recreating the Japanese Lost Decade.  This is something that I’ve been harping on for months as has Paul Krugman and Joseph Stiglitz–two big brained economists with Nobel prizes.

So it is with some irony if not humility that we should approach Treasury Secretary Geithner’s Public Private Investment Plan presented on March 23. A number of major American banks have lost huge amounts of money, and clearly have insufficient capital if they are not literally insolvent. Why else would they be pushing so hard to change the accounting rules to avoid showing what they really have on their books instead of raising private capital? Why else is the U.S. government taking so long to perform “stress tests” and trying to get expectations of overpayment for some of the bad assets on the banks’ books before the test results are out? In short, the U.S. government is looking to shovel capital into the banks without sufficient conditions, hiding rather than confronting the actual situation.

That is just like the Japanese government in their lost decade, or the U.S. officials during the 1980s before they really tackled the savings-and-loan crisis. In those cases, the delay simply made the problem worse over time and in the end the government had to put more money into the troubled banks directly, taking over or shutting down the weakest of them. Whatever the political culture, it would seem we have not learned from experience. Or perhaps we cannot act on our learning. The universal barrier would appear to be the political difficulty of recapitalizing banks. That seems obvious, but the constraint it puts on good policy is enormous.

That is why the Geithner plan is so complex and jury-rigged, to avoid the need for public requests for more money for banks. Unfortunately, it is unlikely to succeed absent additional public money and more-intrusive government action. The plan will buy some time and certainly some appreciation in bank share prices. Current shareholders will be getting a new lease on life with subsidies from taxpayers. For that reason alone, the plan certainly will cost the taxpayer more in the end than a more direct recapitalization with public control would have.

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Zombie Banks must DIE!

zombie-road-signWell, the Obama administration has decided to take the Zombie route which is something I’ve repeatedly argued against.  But why just take my word for it?  Let’s start with Nobel prize winning  economist Paul Krugman reporting  on his NY Times blog today in a thread aptly titled Despair over Financial Policy.

The Geithner plan has now been leaked in detail. It’s exactly the plan that was widely analyzed — and found wanting — a couple of weeks ago. The zombie ideas have won.

The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.

Just about every economist and financial blog on the web, especially the progressive ones, have warned against this option since similar plans put Japan into its lost decade of recession, high deficits, unemployment, and financial malaise.  This is worse than I even expected of the Obama administration.  This basically means more BIG subsidies for BIG investors.  It is nothing less than a massive transfer of wealth to the people and institutions most responsible for this mess from those of us that will suffer the most and have the most to lose. This threatens our jobs, our children’s future, and our country’s standing as the world’s largest single country economy.  This is THE single worst possible decision.

This from Calculated Risk:

With almost no skin in the game, these investors can pay a higher than market price for the toxic assets (since there is little downside risk). This amounts to a direct subsidy from the taxpayers to the banks.

From Yves Smith  Naked Capitalism:

The New York Times seems to have the inside skinny on the emerging private public partnership abortion program. And it appears to be consistent with (low) expectations: a lot of bells and whistles to finesse the fact that the government will wind up paying well above market for crappy paper.

Key points:

The three-pronged approach is perhaps the most central component of President Obama’s plan to rescue the nation’s banking system from the money-losing assets weighing down bank balance sheets, crippling their ability to make new loans and deepening the recession….

The plan to be announced next week involves three separate approaches. In one, the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell.
Yves here. If the money committed to this program is less than the book value of the assets the banks want to unload (or the banks are worried about that possibility), the banks have an incentive to try to ditch their worst dreck first.

In addition, it has been said in comments more than once that the banks own some paper that is truly worthless. This program won’t solve that problem. Back to the piece:

In the second, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.

Yves here. Hiring asset managers to do what? Some investors get 85% support (more as is revealed later), others get dollar for dollar? This makes no sense unless very different roles are envisaged (but how will the price for assets given to the asset managers be determined? Or are these for the off balance sheet entities that should be but are still not yet consolidated, like the trillion dollar problem hanging around at Citi?) Back to the article:

In the third piece, the Treasury plans to expand lending through the Term Asset-Backed Secure Lending Facility, a joint venture with the Federal Reserve.

Yves again. While the first TALF deal got off well, Tyler Durden points out its capacity is 2.7 times pre-credit mania annual issuance levels, which means the $1 trillion considerably overstates its near term impact. And credit demand by all accounts is far from robust. Cheap credit is not enticing in an environment of weak to falling asset prices and job uncertainty.

And notice the utter dishonesty: a competitive bidding process will protect taxpayers. Huh? A competitive bidding process will elicit a higher price which is BAD for taxpayers!

Dear God, the Administration really thinks the public is full of idiots. But there are so many components to the program, and a lot of moving parts in each, they no doubt expect everyone’s eyes to glaze over.

Later in the article, there is language that intimates that the banks will put up assets and take what they get. However, the failure to mention a reserve (a standard feature in auctions) does not mean one does not exist. Or the alternative may be, since bidding will almost certainly be anonymous, is to let the banks submit a bid, which would serve as a reserve. That is the common procedure at foreclosure auctions, when the bank puts in a bid equal to the mortgage value (so either a foreclosure buyer takes the bank out or the bank winds up owning the property).

From Financial Armageddon:

No Surprise to Anyone

If there is anything to be learned from the current crisis, it is the fact that Washington has a habit of screwing things up.

From setting up corrupt and self-serving government-sponsored enterprises that fail to accomplish their stated goals, to ill-conceived and underfunded insurance schemes, guarantee programs, and safety nets that don’t provide the benefits claimed, to rules and regulations that leave those who are “protected” high and dry, it’s amazing how often good intentions go wrong when the politicians are in charge.

From George Washington’s Blog:

Does a Single Independent Economist Buy the Geithner-Summers-Bernanke Approach?

Does a single independent economist buy the Geithner-Summers-Bernanke approach?

On the left, you have:

  • Nobel economist Joseph Stiglitz saying that they have failed to address the structural and regulatory flaws at the heart of the financial crisis that stand in the way of economic recovery, and that they have confused saving the banks with saving the bankers
  • Nobel economist Paul Krugman saying their plan to prop up asset prices “isn’t going to fly”. He also said:

    At every stage, Geithner et al have made it clear that they still have faith in the people who created the financial crisis — that they believe that all we have is a liquidity crisis that can be undone with a bit of financial engineering, that “governments do a bad job of running banks” (as opposed, presumably, to the wonderful job the private bankers have done), that financial bailouts and guarantees should come with no strings attached. This was bad analysis, bad policy, and terrible politics. This administration, elected on the promise of change, has already managed, in an astonishingly short time, to create the impression that it’s owned by the wheeler-dealers.

On the right, you have:

  • Leading monetary economist Anna Schwartz saying that they are fighting the last war and doing it all wrong
  • Former Assistant Secretary of the Treasury and former editor of the Wall Street Journal Paul Craig Roberts lambasting their approach
  • Economist John Williams saying “the federal government is bankrupt … If the federal government were a corporation … the president and senior treasury officers would be in federal penitentiary.”
  • Prominent economist Marc Faber and many others tearing their approach to shreds.

Of course, other Nobel economists, high-level fed officials, former White House economist, and numerous others have slammed their approach as well.

Sure, the economists for the banks and other financial giants which are receiving billions at the government trough think that the Geithner-Summers-Bernanke approach is swell.

And perhaps a couple of economists for investment funds which use their giant interventions into the free market to make some quick money.

But other than them, no one seems to be buying it.

I may be one of the few in the chorus singing soprano, but I’m in a very huge chorus singing sfz! that this is the worst possible of ALL choices.  This is nothing more than a wealth transfer that will accomplish nothing other than keeping banks and financial institutions that are basically bankrupt on live support long enough to drain the daylight out of any recovery.  This President is AWOL from his job. Not only is he AWOL, but he is incompetent.  He can go on Leno, he can go on sixty minutes, he can give lavish St Patrick’s Day parties and he can hold town meetings in California but he is totally incapable of staying in Washington and doing his job.  By allowing this, he will have stolen more from every single honest taxpayer in this country than even Darth Cheney and the Texas Village idiot did with their adventures in nation building and subsidy of the oil and gas industries and the military industrial sectors.  If somebody in Congress doesn’t act to stop this, I say we start calling them to demand impeachment proceedings.  We’ll be lucky if we come out of recession by the time my daughters reach retirement.

There I said it.  If President Obama doesn’t stop this nonsense now he should be impeached for criminal misuse of  tax payer’s money.


How Low Can We Go?

caution

The Financial media and economics blogosphere is full of wonky goodness this week  with all kinds of forecasts of the economy.  The big question is how bad will it get?  The secondary questions deal with economic forecast assumptions built into the Obama Budget.  Are they overly rosy or realistic?  I’ll save the wonkiest battle for last even though it is the most interesting.   It is between Mankiw and Krugman (with me agreeing with Mankiw for a change on a technicality) but it’s based on some pretty high level math so let’s start with the the least technical shot across the bow of  the good ship Hopey Changey.

Robert Barro has the most blunt assessment of the big question in this week’s WSJ.  His opinion piece just asks the question out right.  What Are the Odds of U.S. Depression? Barro is a member of what you could possibly call the elite team of economists in the country.  His credentials and CV are impeccable.  His record of academic publishing is unassailable.  He teaches at Harvard.  He also tends to be a voice from the right.   However, he’s presenting research in this opinion piece so this isn’t based on dogma, but some high level number krunching.   He’s actually put the probability of a ‘great’ depression at 20%.dtd04

The bottom line is that there is ample reason to worry about slipping into a depression. There is a roughly one-in-five chance that U.S. GDP and consumption will fall by 10% or more, something not seen since the early 1930s.

Our research classifies just two such U.S. events since 1870: the Great Depression from 1929 to 1933, with a macroeconomic decline by 25%, and the post-World War I years from 1917 to 1921, with a fall by 16%. We also assembled long-term data on GDP, consumption and stock-market returns for 33 other countries, sometimes going back as far as 1870. Our conjecture was that depressions would be closely connected to stock-market crashes (at least in the sense that a crash would signal a substantially increased chance of a depression).

I’d really suggest you buck up and actually read his story line about his data because it is very interesting.  He basically looks back at periods when there were severe stock market crashes (like now) and looks at trends.  His database is not restricted to US history but includes severe recessions and depressions from 34 different countries.

His assessment of forecasts is based on looking at the Fed scenarios.  He tips his conservative bent at the end of this quote by basically saying none of the policies we’ve seen to date are going to do much.  I highlighted his proposed time line.  He does think we’re going into a situation that will be worse than the 1980s recession but most likely not as bad as the Great Depression of the 1930s.

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