Citigroup was once the biggest U.S. bank. General Motors was once the biggest automaker in the world. Now, both are on the brink. Yet Citigroup is likely to be rescued within days. General Motors may not be rescued at all.
Why the difference? Viewed from Wall Street, Citi is too big and important to be allowed to fail while GM is simply a big, clunky old manufacturing company that can go into chapter 11 and reorganize itself. The newly conventional wisdom on the Street is that the failure of the Treasury and the Fed to save Lehman Brothers was a grave mistake because Lehman's demise caused creditors and investors to panic, which turned the sub-prime loan mess into a financial catastrophe -- a mistake that must not occur again. But GM? GM is only jobs and communities. Citi is money.
The Street's view of the world is fundamentally flawed. Banks are important to the economy because they're financial intermediaries. They connect savers with investors and borrowers. This is a vital function, but there's nothing magical about it. At any given time the world contains a vast pool of money that can be put to all sorts of uses. Financial intermediaries simply link the pool to the uses.
To be sure, savers need to believe that intermediaries are trustworthy; otherwise, savers will prefer the underside of their mattresses. That's why governments regulate intermediaries, insure deposits, and do whatever else needs to be done to make savers feel safe. What governments and societies fear most are "runs" on banks -- panicked efforts by depositors to pull their money out all at once, before banks can possibly collect the money from all those who have used it to borrow or invest. That's what happened in the 1930s.
But the current panic on Wall Street is not a "run" in this sense. It has almost nothing to do with banks' roles as financial intermediaries. It's about money that's been lent to or invested in the banks themselves, in order to profit off of the banks' profits. Lehman's demise cost many investors and creditors lots of money, to be sure, but they were investors and creditors in Lehman, not in the real economy.
Before the asset bubbles burst, financial institutions were generating whopping profits, so naturally they attracted many investors and creditors. After the burst, the profits disappeared. These days, you'd be hard pressed to find many people who want to invest in or lend to financial institutions. Citigroup had a market value of $274 billion at the end of 2006. Now its value is about $21 billion. That's awful news for Citi, its executives and traders, and its investors and creditors. But it's not necessarily awful news for the economy as a whole. Even if Citigroup were to go belly up, the real economy would not be seriously harmed. The mutual funds, pension funds, and deposits overseen by Citi would be safe; fund managers would find their way to other banks.
In other words, Citigroup is not much different from General Motors. It's a company that once made lots of money but, through a series of management blunders, is now losing money hand over fist. Just like the shareholders and creditors of GM, Citi's shareholders and creditors are taking a beating.
So why save Citi and not GM? It's not clear. In fact, there may be more reason to do the reverse. GM has a far greater impact on jobs and communities. Add parts suppliers and their employees, and the number of middle-class and blue-collar jobs dependent on GM is many multiples that of Citi. And the potential social costs of GM's demise, or even major shrinkage, is much larger than Citi's -- including everything from unemployment insurance to lost tax revenues to families suddenly without health insurance to entire communities whose infrastructure and housing may become nearly worthless. I'm not arguing that GM should be bailed out; as I've noted elsewhere, GM's creditors, shareholders, executives, and workers should have to make substantial sacrifices before taxpayers should be expected to sacrifice as well.
Nonetheless, Citi is about to be bailed out while GM is allowed to languish. That's because Wall Street's self-serving view of the unique role of financial institutions is mirrored in the two agencies that run the American economy -- the Treasury and the Fed. Their job, as they see it, is to keep the financial economy "sound," by which they mean keeping Wall Street's own investors and creditors happy.
Because the public doesn't understand the intricacies of finance, it's easily persuaded that this is the same thing as keeping credit flowing to Main Street. That's why the public and its representatives have committed $700 billion of taxpayer money to Wall Street and another $500 to $600 billion of subsidized loans to the Street from the Fed -- bailing out the investors and creditors of every major bank, including , momentarily, Citi -- only to discover, at the end of this frantic and unbelievably expensive exercise, that American jobs and communities are more endangered than they were at the start.
Tuesday, December 30, 2008
Monday, December 29, 2008
Sugar Giants Shove Their Sweetener
by Chris Tenove
Jul/Aug 2003 Issue
What does anybody know about the sugar industry? The people who put the frosting on the frosted flakes keep a low profile and are happy when folks are too busy eating to ask a lot of questions. Now, though, a dust-up with the World Health Organization (WHO) has flushed them into the limelight, where they're pitting profits against public health.
The conflict was inflamed by a new set of dietary guidelines drawn from two years of research by the WHO and the UN Food and Agricultural Organization. The guidelines are part of a worldwide strategy to tame the swelling epidemic of obesity, diabetes, osteoporosis and cardiovascular diseases. One recommendation is that free sugars (i.e. sugar added to foods) should make up no more than 10 percent of our daily caloric intake. The sugar lobby reacted to that suggestion like a toddler asked to hand back his Halloween booty...
'It was particularly stupid for them to put in writing that they're going to try to get Congress to take away WHO's money,' says Michael Jacobsen, executive director of the Center for Science in the Public Interest. 'It gave consumers a chance to see the kind of bullying that is usually done behind closed doors.' [Adbusters]
Sunday, December 28, 2008
The burden of spending
Over the 12 months to October 2007, home prices in the 20 largest metropolitan areas declined by 6.1 percent. And they have fallen every month since January. With less equity to borrow from, homeowners could cut their spending. As a second whammy, a large volume of adjustable rate mortgages are scheduled to reset to higher interest rates between 2008 and 2012. The burden of higher monthly payments could force households to reduce their expenditures too.
Economic growth and consumer debt are inextricably connected in the U.S. And it’s been that way for so long that it’s easy to forget why and what that implies.
Spending has outpaced personal income since the mid 1980s. Households saved ten percent of disposable income in 1985, five percent in the mid 1990s, and then nothing in 2005. (See chart 1, maroon series, scale on the left axis.)
Chart 1 (click to enlarge)
Economic growth and consumer debt are inextricably connected in the U.S. And it’s been that way for so long that it’s easy to forget why and what that implies.
Spending has outpaced personal income since the mid 1980s. Households saved ten percent of disposable income in 1985, five percent in the mid 1990s, and then nothing in 2005. (See chart 1, maroon series, scale on the left axis.)
Chart 1 (click to enlarge)
Low interest rates motivated the consumption ramp-up. Loose monetary policy played its part, but it would be incorrect to blame it all on the Fed. The massive accumulation of wealth by developing countries lowered the opportunity cost of spending, as Alan Greenspan has explained.
Interest rates motivated it, but the borrowing spree was made possible by innovations in the financial sector that increased the supply of debt. The introduction of the FICO score in the early 1990s improved the assessment of a borrower’s creditworthiness – or at least lenders believe so. By pegging interest rates to an index, instead of offering fixed rates, lenders transferred some financial risk to borrowers. Securitization of debt balances shifted some more of that risk off the lenders’ balance sheets.
The problem with a growth path based on borrowing and spending is that it has a natural end. An individual’s debt limit is determined by her creditworthiness, income capacity and collateral. That limit may be high relative to current income, and it may even be unknown to the borrower — after all, it’s up to the lender to draw the line. But once debt balances reach that limit, spending can grow only as fast as income (minus debt payments). Consumption is pinned to the vagaries of income. At the aggregate level, that means that economic growth is more vulnerable to unemployment and to the swings of the stock and real estate markets.
For instance, back in 2001 unemployment was rising, investment fell sharply, and share prices crashed. But overall the economy held up better than expected. Why? One explanation lies in real estate wealth. That year house prices rose by nine percent and consumers borrowed against home equity.
As a gauge of the current level of indebtedness, households now spend almost 15 percent of their disposable income on interest payments, including mortgages. (See chart 1, blue series, scale on the right axis.) If you include repayment of principal, the fraction of debt payments is much larger. Debt repayments are linked to interest rates, and hence subject to unforeseeable increases. Hence the worry about mortgage resets.
The main variables that determine spending and access to debt are outside the policymaker’s control. The cost of borrowing depends on the world level and distribution of savings. Lenders will continue to improve their assessment and management of risk, thus reducing the cost of credit. And central banks are capable of controlling inflation, but not of preventing asset bubbles or stimulating long-run growth.
But don’t despair: tax policy can mend our spending ways. First of all, do no harm. Tax laws can distort the cost of borrowing. The Tax Reform Act of 1986 partially addressed this issue by getting rid of the deduction for interest paid on consumer debt (credit card and uncollateralized loans). The deduction for mortgage interest should go next. I concede that there’s a (weak) case for subsidizing home ownership. But these days a house is much more than a place to live: it’s a piggy bank to draw from. There is no reason why the government should subsidize that.
Second, replace the personal income tax with a tax on consumption. A basic tenet of economics is that if you tax something you get less of it. An income tax punishes work. Instead, the government could levy a tax on the difference between income and contributions to savings. The new tax could be progressive, rather than flat, and could include personal deductions, just like the current personal income tax.
The main obstacle to those tax policies is political. The mortgage interest deduction is popular, and a consumption tax is still regarded as an oddity. No presidential candidate who actually cares about being elected would make such proposals. Perhaps in 2012, if the then incumbent president can afford it. Changing the nature of American economic growth is a cause worthy of spending political capital on.
Technorati tags: economics, consumption, consumer debt, consumer expenditures, economic growth
Saturday, December 27, 2008
Nouriel Roubini: "clear by now that a severe U.S. recession is inevitable in next few months."
Nouriel Roubini, a leading economist at New York University, is now saying that a US Recession is almost here:
"It is increasingly clear by now that a severe U.S. recession is inevitable in next few months. Those of us who warned for the last 12 months about a combination of a worsening housing recession, a severe credit crunch and financial meltdown, high oil prices and a saving-less and debt-burdened consumers being on the ropes causing an economy-wide recession were repeatedly rebuffed the consensus view about a soft landing given the presumed resilience of the US consumer."Roubini is a smart economist who often goes against the consensus view."But the evidence is now building that an ugly recession is inevitable."
Friday, December 26, 2008
The Real Difference Between Bankruptcy and Bailout
When a big company that gets into trouble is more valuable living than dead, there used to be a well-established legal process for reorganizing it - called chapter 11 of the bankruptcy code. Under it, creditors took some losses, shareholders even bigger ones, some managers' heads rolled. Companies cleaned up their books and got a fresh start. And taxpayers didn't pay a penny.
So why, exactly, is the Treasury substituting government bailouts for chapter 11? Even if you assume Wall Street's major banks and insurance giant AIG are so important to the national and global economy that they can't be allowed to fail, that doesn't mean they have to be bailed out. They could be reorganized under bankruptcy protection. True, their creditors, shareholders, and executives would take bigger hits than they're taking now that taxpayers are bailing them out. But they're the ones who took the risk. We didn't.
The Treasury seems to have lost sight of its real client. Its client is not the creditors, shareholders, or executives of any of these firms. Its sole client is the American people.
It would be different if Main Street was getting something out of all this. But credit still isn't flowing to small businesses or distressed homeowners, and unemployment is skyrocketing.
There's more at stake for Main Street when it comes to General Motors and other automakers now teetering on the edge of bankruptcy, because two and a half million households depend directly or indirectly on them for their paychecks. But the best way to protect all these people is not to pay off the automakers' creditors, shareholders, and executives, with no strings attached. Recall that when the government bailed out Chrysler in the early 1980s, a third of its employees lost their jobs.
In exchange for government aid, the Big Three's creditors, shareholders, and executives should be required to accept losses as large as they'd endure under chapter 11, and the UAW should agree to some across-the-board wage and benefit cuts. The resulting savings, combined with the bailout, should be enough to allow the Big Three to shift production to more fuel efficient cars while keeping almost all its current workforce employed. Ideally, major parts suppliers would adhere to the same conditions.
Remember: The underlying goal is to help Americans through this crisis and come out of it with a stronger economy.
And what a tragedy it would be if the government spends so much on these bailouts there isn't enough money left for the next administration to help average people get affordable health insurance, send their kids to good schools, and find good jobs -- including jobs rebuilding the nation's crumbling infrastructure and finding alternative sources of energy.
It's not the big guys who need rescuing. It's the small. Right now, the government has its priorities upside down.
So why, exactly, is the Treasury substituting government bailouts for chapter 11? Even if you assume Wall Street's major banks and insurance giant AIG are so important to the national and global economy that they can't be allowed to fail, that doesn't mean they have to be bailed out. They could be reorganized under bankruptcy protection. True, their creditors, shareholders, and executives would take bigger hits than they're taking now that taxpayers are bailing them out. But they're the ones who took the risk. We didn't.
The Treasury seems to have lost sight of its real client. Its client is not the creditors, shareholders, or executives of any of these firms. Its sole client is the American people.
It would be different if Main Street was getting something out of all this. But credit still isn't flowing to small businesses or distressed homeowners, and unemployment is skyrocketing.
There's more at stake for Main Street when it comes to General Motors and other automakers now teetering on the edge of bankruptcy, because two and a half million households depend directly or indirectly on them for their paychecks. But the best way to protect all these people is not to pay off the automakers' creditors, shareholders, and executives, with no strings attached. Recall that when the government bailed out Chrysler in the early 1980s, a third of its employees lost their jobs.
In exchange for government aid, the Big Three's creditors, shareholders, and executives should be required to accept losses as large as they'd endure under chapter 11, and the UAW should agree to some across-the-board wage and benefit cuts. The resulting savings, combined with the bailout, should be enough to allow the Big Three to shift production to more fuel efficient cars while keeping almost all its current workforce employed. Ideally, major parts suppliers would adhere to the same conditions.
Remember: The underlying goal is to help Americans through this crisis and come out of it with a stronger economy.
And what a tragedy it would be if the government spends so much on these bailouts there isn't enough money left for the next administration to help average people get affordable health insurance, send their kids to good schools, and find good jobs -- including jobs rebuilding the nation's crumbling infrastructure and finding alternative sources of energy.
It's not the big guys who need rescuing. It's the small. Right now, the government has its priorities upside down.
Thursday, December 25, 2008
There Was a Reason They Called It... The Casino Economy
by Thomas Croft
02 Jul 03
In the last three years, a 'perfect storm' of rising energy costs, record consumer and corporate debt and massive trade and current account deficits joined with unsustainable investment practices, and resulted in an economic collapse. The first recession since 1929 to be primarily caused by over-investment, these 'collateral damage' investing schemes-in overseas boondoggles and sweatshops, extreme mergers, absurd dot-coms and derivative scams-all came home to roost. Enron used all of these investment tricks and more. The corruption scandals of 2001-2 completed the melt-down. Now, the world is probably in a double-dip recession, thanks partly to the scandal and continuing international disruptions.
The problem with casino bets and Russian Roulette is that somebody always loses. [CounterPunch]
Wednesday, December 24, 2008
Recession buzz
Chart 1 (click to enlarge)
It’s been hard for news readers to avoid the word “recession” this January. The number of newspaper stories mentioning it has certainly been overwhelming (see Chart 1). Weak economic data might seem to justify the gloom. Growth has slowed down and the labor market has weakened. Still, we haven’t seen a single quarter of negative growth, and the employment figures have been equivocal, and certainly not recessionary. So, given what we know about the state of the economy, is all this recession chatter justified, or are journalists getting carried away?
To answer that question, I have put together data on the tone of economic reporting in the newspapers, as well as on indicators of the health of the real economy. Then I have estimated a statistical model and compared the level of pessimism of the newspapers with the actual mood that one would expect based on the known state of the economy. The results are pretty exciting. So exciting, in fact, that I plan on updating and reporting my calculations every month, here on EconWeekly.
My measure of usage of the word “recession” is The Economist’s R-word index: the number of stories containing that word in the New York Times and the Washington Post. The index is a surprisingly good indicator of economic slowdowns. It never fails to rise sharply at the beginning of recessions. (See Chart 2.) And in spite of its simplicity, it captures the sentiment of the newspapers pretty well. Mark Doms and Norman Morin, of the Federal Reserve Board, constructed a much fancier recession index for a research project on the subject, containing dozens of media sources and carefully filtering the search terms. And yet, the difference between their measure and The Economist’s R-word index is almost always small. (See Figure 4.1 in Doms and Morin’s paper.)
Chart 2 (click to enlarge)
To gauge the present and immediate future of the economy, I include the following variables in my statistical model: the unemployment rate, the growth of the S&P500 index, the growth of the price of oil, the growth of personal consumption expenditures, and the spread between the ten-year bond and the one-year Treasury bill. (Econometrics jocks can find the details of the statistical model below.)
My model shows that newspapers have indeed been too gloomy this past month. In January, known economic conditions would have justified about 200 stories mentioning the word “recession”; the actual count was around 300. Up until December, however, newspaper mood was approximately in line with the actual state of the economy. (See Chart 3.) Why did newspaper sentiment diverge from economic fundamentals last month?
Chart 3 (click to enlarge)
In January we witnessed a sequence of unusual events. There was ongoing talk about the fiscal stimulus package, which is being introduced precisely to avoid an economic slowdown. The President sketched a plan on January 18, then the House of Representatives announced theirs a week later, and then the Senate considered changing it. Then there was a mini crash in the stock market, followed by the surprise cut of the Federal Reserve’s target interest rate on January 22, and then another cut at the Fed’s scheduled meeting on the 30th. Every newspaper story that reported any of these events most likely included the word “recession.”
But, at least in part, I believe that the buzz has to do with incentives in the news industry. Even when reporting facts, every media outlet strives to agree with the views of its audience. Fox News would lose its parish if it started “showing” that the Iraq surge was wrong and ineffective, and the Wall Street Journal would clash against the opinions of its readers if it started “proving” that the Bush tax cuts were a bad idea. Maintaining an audience depends vitally on conforming to their prior expectations. (Note to self: what do EconWeekly readers expect?)
Economics reporting is a bit different because the state of the economy can be measured and verified more objectively. As a result, views are more homogeneous across audiences. Still, media outlets need to take into account three factors which determine the views news consumers, and therefore the choice of tone and volume of economic reports: intrinsic pessimism, past reports on the state of the economy, and reports from other media outlets.
Bryan Caplan of George Mason University has identified pessimism as one of the four capital biases of the average Joe. (Read this summary.) People routinely see negative trends in long-term living standards, wages, inequality, etc. The gloom extends to the state of the economy at any given moment. About half of Americans have been thinking that we are in a recession, or on the brink of one, since October! Where that pessimism comes from, I have no idea. David Hume, Caplan says, thought that “the humour of blaming the present, and admiring the past, is strongly rooted in human nature.” It sounds appealing. But whichever the reason, the media recognize the appeal of worrying reports about the economy —and deliver.
Inherent pessimism influences the interpretation that the media put on any given piece of hard data. But once the newspapers set clouds in the horizon, their incentives to deliver negative news become stronger, because they need to conform to the readers’ expectations. A newspaper that changed its view on the state of the economy would go against the prior views —plus, it would be accused of the horrible crime of flip-flopping. A newspaper has therefore an incentive to keep a certain mood even on something as relatively objective as the state of the economy. Past negative reports will lead to more negative reports in the future, feeding a cycle of pessimism, unless new hard data against such views are so strong that the paper is forced to tone it down over time.
Finally, people are exposed to reports from more than one source of information, even if it’s secondhand. Any newspaper that strayed from the average mood of all other newspapers would conflict with the established view, alienating itself. Any given outlet has thus an incentive to stay in line with the tone of all the major media, resulting in “herd behavior”: the tendency to base decisions (in this case the tone of the news) on the behavior of the rest of the community (other media outlets).
The combination of natural pessimism and the need to conform to the public’s views, therefore, explains why sometimes reporting on the economy is not consistent with actual events, as is the case now. Only policymakers, animal spirits and time can determine whether we’ll see a recession in 2008. For now, skip the editorials on economics.
Statistical model:
VAR, with monthly data, from January of 1976 through the latest month available. Each equation includes six lags. The variables are: the R-word index, the unemployment rate, the change in nonfarm payrolls, the slope of the yield curve (10-year minus 1-year), the growth of personal consumption expenditures on durable goods accumulated over the current and previous two months, and the growth of the industrial production index, also accumulated over the same period. I also include a set of monthly dummies and a dummy variable that equals 1 if the NBER announced a decline in real GDP. The unemployment rate is the first release reported by the BLS. The change in payrolls mimics the one reported by the BLS, that is, it is equal to the first estimate of payrolls for month t, minus the revised (first update) figure for month t-1. Both unemployment and payroll figures come from ALFRED. The yields on the ten-year bond and the one-year Treasury bill are monthly averages, from FRED. Durable expenditures come from the NIPA accounts, via FRED, and the industrial production index is from the Federal Reserve, also via FRED.
Technorati tags:
economics, news, media bias, recession, media
Tuesday, December 23, 2008
Recession buzz
Chart 1 (click to enlarge)
It’s been hard for news readers to avoid the word “recession” this January. The number of newspaper stories mentioning it has certainly been overwhelming (see Chart 1). Weak economic data might seem to justify the gloom. Growth has slowed down and the labor market has weakened. Still, we haven’t seen a single quarter of negative growth, and the employment figures have been equivocal, and certainly not recessionary. So, given what we know about the state of the economy, is all this recession chatter justified, or are journalists getting carried away?
To answer that question, I have put together data on the tone of economic reporting in the newspapers, as well as on indicators of the health of the real economy. Then I have estimated a statistical model and compared the level of pessimism of the newspapers with the actual mood that one would expect based on the known state of the economy. The results are pretty exciting. So exciting, in fact, that I plan on updating and reporting my calculations every month, here on EconWeekly.
My measure of usage of the word “recession” is The Economist’s R-word index: the number of stories containing that word in the New York Times and the Washington Post. The index is a surprisingly good indicator of economic slowdowns. It never fails to rise sharply at the beginning of recessions. (See Chart 2.) And in spite of its simplicity, it captures the sentiment of the newspapers pretty well. Mark Doms and Norman Morin, of the Federal Reserve Board, constructed a much fancier recession index for a research project on the subject, containing dozens of media sources and carefully filtering the search terms. And yet, the difference between their measure and The Economist’s R-word index is almost always small. (See Figure 4.1 in Doms and Morin’s paper.)
Chart 2 (click to enlarge)
To gauge the present and immediate future of the economy, I include the following variables in my statistical model: the unemployment rate, the growth of the S&P500 index, the growth of the price of oil, the growth of personal consumption expenditures, and the spread between the ten-year bond and the one-year Treasury bill. (Econometrics jocks can find the details of the statistical model below.)
My model shows that newspapers have indeed been too gloomy this past month. In January, known economic conditions would have justified about 200 stories mentioning the word “recession”; the actual count was around 300. Up until December, however, newspaper mood was approximately in line with the actual state of the economy. (See Chart 3.) Why did newspaper sentiment diverge from economic fundamentals last month?
Chart 3 (click to enlarge)
In January we witnessed a sequence of unusual events. There was ongoing talk about the fiscal stimulus package, which is being introduced precisely to avoid an economic slowdown. The President sketched a plan on January 18, then the House of Representatives announced theirs a week later, and then the Senate considered changing it. Then there was a mini crash in the stock market, followed by the surprise cut of the Federal Reserve’s target interest rate on January 22, and then another cut at the Fed’s scheduled meeting on the 30th. Every newspaper story that reported any of these events most likely included the word “recession.”
But, at least in part, I believe that the buzz has to do with incentives in the news industry. Even when reporting facts, every media outlet strives to agree with the views of its audience. Fox News would lose its parish if it started “showing” that the Iraq surge was wrong and ineffective, and the Wall Street Journal would clash against the opinions of its readers if it started “proving” that the Bush tax cuts were a bad idea. Maintaining an audience depends vitally on conforming to their prior expectations. (Note to self: what do EconWeekly readers expect?)
Economics reporting is a bit different because the state of the economy can be measured and verified more objectively. As a result, views are more homogeneous across audiences. Still, media outlets need to take into account three factors which determine the views news consumers, and therefore the choice of tone and volume of economic reports: intrinsic pessimism, past reports on the state of the economy, and reports from other media outlets.
Bryan Caplan of George Mason University has identified pessimism as one of the four capital biases of the average Joe. (Read this summary.) People routinely see negative trends in long-term living standards, wages, inequality, etc. The gloom extends to the state of the economy at any given moment. About half of Americans have been thinking that we are in a recession, or on the brink of one, since October! Where that pessimism comes from, I have no idea. David Hume, Caplan says, thought that “the humour of blaming the present, and admiring the past, is strongly rooted in human nature.” It sounds appealing. But whichever the reason, the media recognize the appeal of worrying reports about the economy —and deliver.
Inherent pessimism influences the interpretation that the media put on any given piece of hard data. But once the newspapers set clouds in the horizon, their incentives to deliver negative news become stronger, because they need to conform to the readers’ expectations. A newspaper that changed its view on the state of the economy would go against the prior views —plus, it would be accused of the horrible crime of flip-flopping. A newspaper has therefore an incentive to keep a certain mood even on something as relatively objective as the state of the economy. Past negative reports will lead to more negative reports in the future, feeding a cycle of pessimism, unless new hard data against such views are so strong that the paper is forced to tone it down over time.
Finally, people are exposed to reports from more than one source of information, even if it’s secondhand. Any newspaper that strayed from the average mood of all other newspapers would conflict with the established view, alienating itself. Any given outlet has thus an incentive to stay in line with the tone of all the major media, resulting in “herd behavior”: the tendency to base decisions (in this case the tone of the news) on the behavior of the rest of the community (other media outlets).
The combination of natural pessimism and the need to conform to the public’s views, therefore, explains why sometimes reporting on the economy is not consistent with actual events, as is the case now. Only policymakers, animal spirits and time can determine whether we’ll see a recession in 2008. For now, skip the editorials on economics.
Statistical model:
VAR, with monthly data, from January of 1976 through the latest month available. Each equation includes six lags. The variables are: the R-word index, the unemployment rate, the change in nonfarm payrolls, the slope of the yield curve (10-year minus 1-year), the growth of personal consumption expenditures on durable goods accumulated over the current and previous two months, and the growth of the industrial production index, also accumulated over the same period. I also include a set of monthly dummies and a dummy variable that equals 1 if the NBER announced a decline in real GDP. The unemployment rate is the first release reported by the BLS. The change in payrolls mimics the one reported by the BLS, that is, it is equal to the first estimate of payrolls for month t, minus the revised (first update) figure for month t-1. Both unemployment and payroll figures come from ALFRED. The yields on the ten-year bond and the one-year Treasury bill are monthly averages, from FRED. Durable expenditures come from the NIPA accounts, via FRED, and the industrial production index is from the Federal Reserve, also via FRED.
Technorati tags:
economics, news, media bias, recession, media
Monday, December 22, 2008
Sunday, December 21, 2008
Saturday, December 20, 2008
Friday, December 19, 2008
On college endowments
According to a study released yesterday by the National Association of College and University Business Officers (NACUBO), the endowment fund of Harvard University is worth $34.6 billion, a 19.8% percent higher than a year ago. 76 colleges and universities sit on endowments over $1b. Even more impressively, almost every one of the 733 institutions analyzed reports a double-digit increase in the value of its fund. (Look up the endowment of your alma mater here.)
Chart 1 (click to enlarge)
The increase in the value of the endowments has been the result of at least two factors: risk taking and stock market bonanza. First, higher-education institutions invest large portions of their wealth on high-risk, high-return securities. On a dollar-weighted average, in 2007 they held a 47.4% of their funds in equities, an 18.2% in hedge funds, a 5.4% in private equity, and a 3.6% on venture capital investments. Wealthier universities hold riskier portfolios than the average. (See Chart 1.)
Second, average stock prices have increased almost every single year for over 25 years. In spite of the burst of the dot-com bubble in 2000, the inflation-adjusted Dow Jones Industrial Average Index ended 2007 at a level five times higher than in 1982. Even the most passive portfolio manager would have achieved high returns in this stock market.
Chart 2 (click to enlarge)
No surprise then that most universities have performed so well. Over the last ten years, the return on most endowments beats the S&P 500 index, which grew at a healthy 7.1% annual rate itself. (See Chart 2.) In the case of the largest portfolios, universities beat the market by a long shot.
News of these fabulous riches has prompted some sectors to demand that universities share more of their wealth. Lawmakers remind them that, as tax-exempt institutions, “they’re supposed to offer public benefit in return for (that) exemption.” Private foundations, which are also tax-exempt, are required by law to spend 5% each year; the average for colleges is 4.6%, with little variation across levels of wealth (see data). Parents, on the other hand, don’t understand why tuition keeps going up while universities continue to amass wealth. Little do they suspect that the cost of college is stoked by the self-interest of parents and students themselves, not that of universities.
The classic explanation for the rise of tuition is that the college premium —the positive gap between the earnings of college graduates and high school graduates— has increased the demand for college education, thereby raising its equilibrium price.
More interestingly, the stock market has also made tuition rates go up, according to a paper* by my former colleague at the University of Chicago Pablo Peña (pdf). Rises in asset prices increase the amount of resources available to universities. Part of that wealth is spent on inputs that improve the quality of education: more and better qualified professors, and newer and more sophisticated facilities, such as labs, computers and libraries, for instance. Higher quality, in turn, increases the amount of human capital accumulated in college, and ultimately affects life-time earnings, i.e. the returns to education. Prestige considerations may be at work too: celebrity professors and state-of-the-art facilities increase the reputation of the institution, adding to the value of the diploma. Therefore, larger endowments spur the demand for college education, and drive up tuition rates.
Differences in the value of endowments across universities are vast: the combined value of the top ten colleges represents 35% of total endowment assets. In light of Pablo’s theory, the implications of this inequality depend on what universities and colleges spend their money on.
If they continue to use their wealth to improve the quality of the service they provide, demand for college education and tuition levels will continue to rise. Differences in tuition rates and education quality between top-notch and second-tier institutions will continue to widen too, since endowments and asset returns are highly concentrated. Also, because the ablest students —those with highest SAT scores or best records of achievement in high school— benefit the most from the quality of college education, the matching of the best students with the best institutions will intensify. Differences in the quality of students across colleges will increase.
On the other hand, universities could start using their endowments to increase capacity or subsidize the cost of college. In this unlikely scenario, the equilibrium price of higher education will probably decline, the quality of college education will drop, and the college premium —the earnings of college graduates vis-Ã -vis high-school graduates— will drop.
Selected institutions have recently been announcing that they will increase financial aid. Recent announcements might suggest that this could actually happen among selected institutions. Harvard and Dartmouth have eliminated loans from their aid packages and will be giving grants instead; and Yale has followed in their footsteps. These de facto cuts in average tuition rates are not going to change the system. First, they won’t change the quality of education at top universities, for which the foregone tuition revenue is peanuts. Second, they won’t reduce the cost of attendance of the average college student, because the number of institutions that can afford foregoing tuition revenues is small.
But improved aid packages at top schools will make their programs affordable to the brightest students, regardless of their financial situation. If the newfound altruism of the Harvards and Yales has any effect, that will be an even more pronounced assortative matching of colleges and applicants by quality. The scope of these developments is very limited, but it’s good news —at least for believers, like myself, in a free, merit-based education system.
More data:
Tuition rates: table of nominal rates (html), graph of real rates (pdf, Figure 1)
Technorati tags: economics, education, college, endowments, college tuition
Chart 1 (click to enlarge)
The increase in the value of the endowments has been the result of at least two factors: risk taking and stock market bonanza. First, higher-education institutions invest large portions of their wealth on high-risk, high-return securities. On a dollar-weighted average, in 2007 they held a 47.4% of their funds in equities, an 18.2% in hedge funds, a 5.4% in private equity, and a 3.6% on venture capital investments. Wealthier universities hold riskier portfolios than the average. (See Chart 1.)
Second, average stock prices have increased almost every single year for over 25 years. In spite of the burst of the dot-com bubble in 2000, the inflation-adjusted Dow Jones Industrial Average Index ended 2007 at a level five times higher than in 1982. Even the most passive portfolio manager would have achieved high returns in this stock market.
Chart 2 (click to enlarge)
No surprise then that most universities have performed so well. Over the last ten years, the return on most endowments beats the S&P 500 index, which grew at a healthy 7.1% annual rate itself. (See Chart 2.) In the case of the largest portfolios, universities beat the market by a long shot.
News of these fabulous riches has prompted some sectors to demand that universities share more of their wealth. Lawmakers remind them that, as tax-exempt institutions, “they’re supposed to offer public benefit in return for (that) exemption.” Private foundations, which are also tax-exempt, are required by law to spend 5% each year; the average for colleges is 4.6%, with little variation across levels of wealth (see data). Parents, on the other hand, don’t understand why tuition keeps going up while universities continue to amass wealth. Little do they suspect that the cost of college is stoked by the self-interest of parents and students themselves, not that of universities.
The classic explanation for the rise of tuition is that the college premium —the positive gap between the earnings of college graduates and high school graduates— has increased the demand for college education, thereby raising its equilibrium price.
More interestingly, the stock market has also made tuition rates go up, according to a paper* by my former colleague at the University of Chicago Pablo Peña (pdf). Rises in asset prices increase the amount of resources available to universities. Part of that wealth is spent on inputs that improve the quality of education: more and better qualified professors, and newer and more sophisticated facilities, such as labs, computers and libraries, for instance. Higher quality, in turn, increases the amount of human capital accumulated in college, and ultimately affects life-time earnings, i.e. the returns to education. Prestige considerations may be at work too: celebrity professors and state-of-the-art facilities increase the reputation of the institution, adding to the value of the diploma. Therefore, larger endowments spur the demand for college education, and drive up tuition rates.
Differences in the value of endowments across universities are vast: the combined value of the top ten colleges represents 35% of total endowment assets. In light of Pablo’s theory, the implications of this inequality depend on what universities and colleges spend their money on.
If they continue to use their wealth to improve the quality of the service they provide, demand for college education and tuition levels will continue to rise. Differences in tuition rates and education quality between top-notch and second-tier institutions will continue to widen too, since endowments and asset returns are highly concentrated. Also, because the ablest students —those with highest SAT scores or best records of achievement in high school— benefit the most from the quality of college education, the matching of the best students with the best institutions will intensify. Differences in the quality of students across colleges will increase.
On the other hand, universities could start using their endowments to increase capacity or subsidize the cost of college. In this unlikely scenario, the equilibrium price of higher education will probably decline, the quality of college education will drop, and the college premium —the earnings of college graduates vis-Ã -vis high-school graduates— will drop.
Selected institutions have recently been announcing that they will increase financial aid. Recent announcements might suggest that this could actually happen among selected institutions. Harvard and Dartmouth have eliminated loans from their aid packages and will be giving grants instead; and Yale has followed in their footsteps. These de facto cuts in average tuition rates are not going to change the system. First, they won’t change the quality of education at top universities, for which the foregone tuition revenue is peanuts. Second, they won’t reduce the cost of attendance of the average college student, because the number of institutions that can afford foregoing tuition revenues is small.
But improved aid packages at top schools will make their programs affordable to the brightest students, regardless of their financial situation. If the newfound altruism of the Harvards and Yales has any effect, that will be an even more pronounced assortative matching of colleges and applicants by quality. The scope of these developments is very limited, but it’s good news —at least for believers, like myself, in a free, merit-based education system.
More data:
Tuition rates: table of nominal rates (html), graph of real rates (pdf, Figure 1)
Technorati tags: economics, education, college, endowments, college tuition
Thursday, December 18, 2008
Economy Slowing Says Calculated Risk
Great Blogger, Calculated Risk "Clearly the economy is slowing sharply"
Wednesday, December 17, 2008
Amend the Bailout of all Bailouts
Paulson's taxpayer-financed bailout continues to put money into the wrong pockets. So another item Congress should get to as soon as it returns: amend the Bailout of All Bailouts (the so-called "Troubled Asset Recovery Program") to force big banks to loan out at least 50 percent of the amounts they receive in cash from the government. In addition, because dollars are fungible -- that is, a dollar received from the government functions the same as any other dollar of bank assets -- the big bank beneficiaries of the bailout should be barred from (1) paying lobbyists who have anything whatever to do with administration or implementation of the bailout; (2) buying up other financial institutions; (3) paying dividends to shareholders; or (4) paying any bonuses or severance packages to any executives -- as long as the bailout continues. There's simply no excuse for using taxpayer dollars for any of these purposes.
Tuesday, December 16, 2008
Monday, December 15, 2008
On inflation expectations
With Federal Reserve and government doing their best to stimulate demand, people have started looking at inflation. The worry is that the economy is not as sick as our policymakers think, and so the fiscal and monetary medicines are excessive. Markets disagree.
Expected inflation is an important determinant of future inflation. If the public expects higher inflation, workers demand higher wages, prompting employers to raise the price of their goods, which results in higher actual inflation.
Markets in fixed-income securities provide timely information about inflation expectations. Treasury inflation-protected securities (TIPS) deliver interest and principal payments that are tied to inflation. Payments from regular Treasury notes, on the other hand, are not indexed to inflation. The difference between the yield rates of the two types of securities must be equal to the inflation rate expected by the markets—otherwise there would be an arbitrage opportunity. In practice, because of technical issues, the yield spread is only an approximation to expected inflation, and people call it the break-even inflation (BEI) instead. (More on this below.) From here on I use BEI and “expected inflation” interchangeably.
Because the Treasury has created notes with different maturities, we can use the spread between nominal and TIPS securities to gauge inflation expectations for different horizons. For example, today’s difference between the yield of five-year TIPS and that of five-year nominal notes is approximately equal to the inflation rate expected over the five years starting now (2008-2012).
The Fed is interested in long-term inflation expectations, because in the short term prices are affected by transitory or volatile factors, such as commodity prices. One measure of long-term expectations, which we can also derive from yields, is the five-year, five-year forward rate. That is an approximation to the rate of inflation expected for the five years starting five years from now. Today, that would be the period from 2013 through 2017.
Chart 1 (click to enlarge)
Earlier this month Greg Ip of the Wall Street Journal posted a graph showing the five-year, five-year forward BEI, which generated some discussion in the econ blogosphere. Felix Salmon and Greg Mankiw worried over signs of increasing inflation coming from that graph. Mankiw went as far as saying that the rise in expected inflation is “consistent with the hypothesis that policymakers are overreacting to some economic news with excessive monetary and fiscal stimulus.” Following up on knzn’s analysis (Feb. 3), I find that the worries about inflation in the far-future are overstated—and that inflation expectations over the near-future have been overlooked.
Using knzn’s back-of-the-envelope method, I have produced my own time series of forward BEI, which matches the one posted by Ip quite closely (see chart 1). The graph shows that starting on January 15, the rate of inflation expected for the far future (2013-2017) started increasing abruptly. By the time Ip’s graph was produced, January 30, the forward BEI had increased by 16 basis points.
That is not unusual. We have seen increases of similar or larger size in 2007: between March 9 and March 27 (15 b.p.), May 26 to June 13 (25 b.p.), and between September 11 and September 20 (16 b.p.). But each of those spikes partially reversed over time. In fact, after September 20, the time series began a protracted downward trend that left expectations at the end of 2007 below their level at the end of the summer.
Chart 2 (click to enlarge)
Let’s zoom in on the picture (chart 2). Expected inflation for the far future, the forward rate, did rise in the second half of January. Interestingly, most of the rise happened between January 16 and January 22, perhaps fueled by discussion of the fiscal stimulus package (the President made a call for tax relief on January 18). I guess markets don’t have much faith on the fiscal discipline of the government.
More relevant to the immediate future of the economy: over the second half of January the spot BEI—the rate of expected inflation for 2008-2012—went down. Inflation expectations briefly increased after the January 22 rate cut. But overall, between the 15th and the 30th, expected inflation for the near future fell slightly.
On January 30th and subsequent days the spot BEI fell, which is quite exceptional, because it tends to increase every time the Fed eases—just look at the record in chart 2. In February inflation expectations for the near-future have continued to abate.
Chart 3 (click to enlarge)
Just in case the leaves don't let me see the tree, let me now zoom out and smooth out the time series (see chart 3). The recent rise in inflation expectations for the far future (the forward rate) to which Mankiw and Salmon referred, barely registers. In fact, those expectations have remained quite stable throughout 2007. On the other hand, expected inflation for the near future (the spot rate) started a downward trend in mid-2006. And January certainly didn’t put an end to that trend.
What do we make of this? Worries about an economic slowdown have been simmering ever since house prices began falling, back in 2006. They have intensified as the credit crisis unfolds. Much like knzn, I think that markets expect a deceleration of demand, and hence of prices. Generally speaking, monetary policy has not convinced the public that the slowdown can be avoided, and neither has the fiscal stimulus package. Regarding the far future, inflation expectations are contained.
Addendum: why isn’t the break-even inflation (BEI) equal to expected inflation?
Earlier I wrote that the spread between TIPS and nominal notes is only an approximation to expected inflation. Here I include a list of reasons why the equality doesn’t hold exactly. Please let me know if I miss something.
1. Compound bias
From the Fisher identity
i – r = pi + pi*r
By taking the spread between nominal (i) and real (r) interest rates, we ignore the interaction term pi*r. The BEI rate therefore overestimates expected inflation. If we take the yield on TIPS as an estimate of r, it’s easy to correct for this (just divide the spread by (1+r)). This bias, however, is tiny in the US nowadays, since interest rates are in the one to five percent range most of the time.
2. Inflation lag
Every day, the principal of TIPS is adjusted using the change in the Consumer Price Index. In principle, since the CPI is published only once a month, and with some delay, the adjusted principal would be updated using a lagged measure of inflation. Investors would require compensation for the difference between current and lagged CPI, and the BEI would overestimate (underestimate) expected inflation if lagged inflation were higher (lower) than current inflation.
In practice, we need not worry about this bias in the US, since the Treasury seems to have come up with daily inflation adjustments—I suppose by extrapolation of past CPI figures. Also, the bias is tiny, since monthly CPI increases are small, and not systematic, since the rate of inflation is not consistently increasing or decreasing month-to-month over long periods of time.
3. Protection against deflation
The principal of a TIPS is protected from deflation. At maturity, the investor receives the greatest between the original principal or the inflation-adjusted principal. Because this protection is valuable, the yield on TIPS is lower than otherwise, and the BEI overestimates expected inflation. In practice this bias is negligible, because the probability of deflation is extremely low.
4. Inflation risk
TIPS offer protection against inflation volatility. If investors are risk averse and inflation changes over time, TIPS are more valuable than securities whose value suffers from inflation risk. The yield will be lower, and the BEI will overestimate inflation expectations.
5. Liquidity premium
TIPS are less liquid than nominal notes. Because liquidity is valuable, the price of TIPS is lower and their yield is higher than if these securities were as liquid as nominal notes. For this reason the BEI underestimates expected inflation.
At times of high market volatility, some investors “fly” to liquid securities, in this case nominal Treasury notes, driving yields on those securities down, and introducing a negative bias to BEI as an estimator of inflation expectations.
6. Differences in the duration of the securities
In real terms, the payments from TIPS are constant, whereas the payments from a nominal note decline. The inflation-protected security has therefore a longer duration—sensitivity to interest rate changes—than the nominal security, with respect to the real interest rate.
Technorati tags:
economics, inflation expectations, expected inflation, inflation, TIPS
Expected inflation is an important determinant of future inflation. If the public expects higher inflation, workers demand higher wages, prompting employers to raise the price of their goods, which results in higher actual inflation.
Markets in fixed-income securities provide timely information about inflation expectations. Treasury inflation-protected securities (TIPS) deliver interest and principal payments that are tied to inflation. Payments from regular Treasury notes, on the other hand, are not indexed to inflation. The difference between the yield rates of the two types of securities must be equal to the inflation rate expected by the markets—otherwise there would be an arbitrage opportunity. In practice, because of technical issues, the yield spread is only an approximation to expected inflation, and people call it the break-even inflation (BEI) instead. (More on this below.) From here on I use BEI and “expected inflation” interchangeably.
Because the Treasury has created notes with different maturities, we can use the spread between nominal and TIPS securities to gauge inflation expectations for different horizons. For example, today’s difference between the yield of five-year TIPS and that of five-year nominal notes is approximately equal to the inflation rate expected over the five years starting now (2008-2012).
The Fed is interested in long-term inflation expectations, because in the short term prices are affected by transitory or volatile factors, such as commodity prices. One measure of long-term expectations, which we can also derive from yields, is the five-year, five-year forward rate. That is an approximation to the rate of inflation expected for the five years starting five years from now. Today, that would be the period from 2013 through 2017.
* * *
Chart 1 (click to enlarge)
Earlier this month Greg Ip of the Wall Street Journal posted a graph showing the five-year, five-year forward BEI, which generated some discussion in the econ blogosphere. Felix Salmon and Greg Mankiw worried over signs of increasing inflation coming from that graph. Mankiw went as far as saying that the rise in expected inflation is “consistent with the hypothesis that policymakers are overreacting to some economic news with excessive monetary and fiscal stimulus.” Following up on knzn’s analysis (Feb. 3), I find that the worries about inflation in the far-future are overstated—and that inflation expectations over the near-future have been overlooked. Using knzn’s back-of-the-envelope method, I have produced my own time series of forward BEI, which matches the one posted by Ip quite closely (see chart 1). The graph shows that starting on January 15, the rate of inflation expected for the far future (2013-2017) started increasing abruptly. By the time Ip’s graph was produced, January 30, the forward BEI had increased by 16 basis points.
That is not unusual. We have seen increases of similar or larger size in 2007: between March 9 and March 27 (15 b.p.), May 26 to June 13 (25 b.p.), and between September 11 and September 20 (16 b.p.). But each of those spikes partially reversed over time. In fact, after September 20, the time series began a protracted downward trend that left expectations at the end of 2007 below their level at the end of the summer.
Chart 2 (click to enlarge)
Let’s zoom in on the picture (chart 2). Expected inflation for the far future, the forward rate, did rise in the second half of January. Interestingly, most of the rise happened between January 16 and January 22, perhaps fueled by discussion of the fiscal stimulus package (the President made a call for tax relief on January 18). I guess markets don’t have much faith on the fiscal discipline of the government.
More relevant to the immediate future of the economy: over the second half of January the spot BEI—the rate of expected inflation for 2008-2012—went down. Inflation expectations briefly increased after the January 22 rate cut. But overall, between the 15th and the 30th, expected inflation for the near future fell slightly.
On January 30th and subsequent days the spot BEI fell, which is quite exceptional, because it tends to increase every time the Fed eases—just look at the record in chart 2. In February inflation expectations for the near-future have continued to abate.
Chart 3 (click to enlarge)
Just in case the leaves don't let me see the tree, let me now zoom out and smooth out the time series (see chart 3). The recent rise in inflation expectations for the far future (the forward rate) to which Mankiw and Salmon referred, barely registers. In fact, those expectations have remained quite stable throughout 2007. On the other hand, expected inflation for the near future (the spot rate) started a downward trend in mid-2006. And January certainly didn’t put an end to that trend.What do we make of this? Worries about an economic slowdown have been simmering ever since house prices began falling, back in 2006. They have intensified as the credit crisis unfolds. Much like knzn, I think that markets expect a deceleration of demand, and hence of prices. Generally speaking, monetary policy has not convinced the public that the slowdown can be avoided, and neither has the fiscal stimulus package. Regarding the far future, inflation expectations are contained.
Addendum: why isn’t the break-even inflation (BEI) equal to expected inflation?
Earlier I wrote that the spread between TIPS and nominal notes is only an approximation to expected inflation. Here I include a list of reasons why the equality doesn’t hold exactly. Please let me know if I miss something.
1. Compound bias
From the Fisher identity
i – r = pi + pi*r
By taking the spread between nominal (i) and real (r) interest rates, we ignore the interaction term pi*r. The BEI rate therefore overestimates expected inflation. If we take the yield on TIPS as an estimate of r, it’s easy to correct for this (just divide the spread by (1+r)). This bias, however, is tiny in the US nowadays, since interest rates are in the one to five percent range most of the time.
2. Inflation lag
Every day, the principal of TIPS is adjusted using the change in the Consumer Price Index. In principle, since the CPI is published only once a month, and with some delay, the adjusted principal would be updated using a lagged measure of inflation. Investors would require compensation for the difference between current and lagged CPI, and the BEI would overestimate (underestimate) expected inflation if lagged inflation were higher (lower) than current inflation.
In practice, we need not worry about this bias in the US, since the Treasury seems to have come up with daily inflation adjustments—I suppose by extrapolation of past CPI figures. Also, the bias is tiny, since monthly CPI increases are small, and not systematic, since the rate of inflation is not consistently increasing or decreasing month-to-month over long periods of time.
3. Protection against deflation
The principal of a TIPS is protected from deflation. At maturity, the investor receives the greatest between the original principal or the inflation-adjusted principal. Because this protection is valuable, the yield on TIPS is lower than otherwise, and the BEI overestimates expected inflation. In practice this bias is negligible, because the probability of deflation is extremely low.
4. Inflation risk
TIPS offer protection against inflation volatility. If investors are risk averse and inflation changes over time, TIPS are more valuable than securities whose value suffers from inflation risk. The yield will be lower, and the BEI will overestimate inflation expectations.
5. Liquidity premium
TIPS are less liquid than nominal notes. Because liquidity is valuable, the price of TIPS is lower and their yield is higher than if these securities were as liquid as nominal notes. For this reason the BEI underestimates expected inflation.
At times of high market volatility, some investors “fly” to liquid securities, in this case nominal Treasury notes, driving yields on those securities down, and introducing a negative bias to BEI as an estimator of inflation expectations.
6. Differences in the duration of the securities
In real terms, the payments from TIPS are constant, whereas the payments from a nominal note decline. The inflation-protected security has therefore a longer duration—sensitivity to interest rate changes—than the nominal security, with respect to the real interest rate.
Technorati tags:
economics, inflation expectations, expected inflation, inflation, TIPS
Sunday, December 14, 2008
More Americans Expecting Recession in The Next Year
More Americans are expecting a recession in the next year. Consumers are waking up to the reality that the economy has a significant chance of recession next year.
Recession times are increasingly being expected. The coming holiday spending season will likely provide important clues to where consumer spending is headed. Consumer spending is about 70% of the US's GDP. Consumer spending is a key factor in a forecasting a recession.
The economic mood took a sharp turn for the worse over the past month, with 40 percent of Americans expecting a recession in the next year, according to a Reuters / Zogby poll released Wednesday.
That was a big rise from a month earlier, when 31 percent of the likely voters polled predicted a recession. The darker mood came as mounting concerns about housing and credit markets pounded Wall Street, and oil prices approached $100 per barrel.
That was a big rise from a month earlier, when 31 percent of the likely voters polled predicted a recession. The darker mood came as mounting concerns about housing and credit markets pounded Wall Street, and oil prices approached $100 per barrel. (CNBC 1/21/07)
Recession times are increasingly being expected. The coming holiday spending season will likely provide important clues to where consumer spending is headed. Consumer spending is about 70% of the US's GDP. Consumer spending is a key factor in a forecasting a recession.
Saturday, December 13, 2008
Housing Bubble Sites
National Sites
Regional Sites
- The Housing Bubble
- The House Bubble
- Housing Panic
- Paper Economy a US Real Estate Bubble Blog
- Housing Doom Housing Bubble
- Doctor Housing Bubble
- Bubble Markets Inventory Tracking
- Priced Out Fovever
- HousingTracker
- Matrix
- The Real Estate Bloggers
- The Mortgage Lender Implode-O-Meter
- Housing Bubble Casualty
- Housing Bubble Bust
- Bubble Pictures
- Bubble News Network
- Lawrence Yun Watch
- Is There a Housing Bubble
- Real Estate Comments
Regional Sites
- DC Home Prices
- Greater Northern VA Housing Bubble Fallout
- Frankly Realty (Virginia)
- Baltimore Metro Area Housing Blog
- Baltimore Housing Bubble
- Chicago Bubble Blog
- Irvine Housing Bubble
- The Jersey Shore RE Bubble
- New Jersey Real Estate Report
- Socket Site (San Francisco)
- Patrick.net (San Francisco)
- Bay Area Real Estate Blog
- Burbed (San Francisco)
- Marin Real Estate Bubble
- Sonoma Housing Bubble
- Seattle Bubble
- Calgary Contrarian
- Vancouver Housing Market Blog
- SoCal Real Estate Bubble Blog
- Flippers in Trouble (Sacramento)
- Portland Housing
- Proffesor Piggington (San Deigo)
- Pacific Beach Bubble
- Boston Bubble
- California Housing Forecast
- Massachusetts Housing Market
- Vancouver Condo Info
- New York City Housing Bubble
Friday, December 12, 2008
The Meltdown (Part IV)
The Dow is see-sawing but the reality is that the Bailout of All Bailouts isn't working. Credit markets are largely still frozen. Despite all the money going directly to the big banks, despite all the government guarantees and loans and special tax breaks, despite the shot-gun weddings and bank mergers, despite the willingness of the Treasury and the Fed to do almost whatever the banks have asked, the reality is that credit is not flowing. It's not flowing to distressed homeowners. It's not flowing to small businesses. It's not flowing to would-be homeowners with good credit ratings. Students are having a harder time borrowing for their tuition. Auto loans are drying up.
Why? Because the underlying problem isn't a liquidity problem. As I've noted elsewhere, the problem is that lenders and investors don't trust they'll get their money back because no one trusts that the numbers that purport to value securities are anything but wishful thinking. The trouble, in a nutshell, is that the financial entrepreneurship of recent years -- the derivatives, credit default swaps, collateralized debt instruments, and so on -- has undermined all notion of true value.
Many of these fancy instruments became popular over recent years precisely because they circumvented financial regulations, especially rules on banks' capital adequacy. Big banks created all these off-balance-sheet vehicles because they allowed the big banks to carry less capital.
Paulson is recapitalizing the banks -- giving them money directly rather than relying on reverse auctions -- largely because he's come to understand that the banks have taken on so much debt that the reverse auction system he told Congress he would use(designed to place a market value on these fancy-dance instruments) will leave too many banks insolvent.
But pouring money into these banks, expecting they'll turn around and lend to small businesses and Main Streets, is like pouring water into a dry sponge. Nothing will come out of it because Wall Street is so deep in debt that the banks are using the extra money to improve their balance sheets. They're hoarding it because their true balance sheets -- considering the off-balance sheet vehicles they created over the past several years -- are in such rotten shape.
In other words, taxpayers are financing a massive effort to save Wall Street's balance sheets from Wall Street's previous off-balance-sheet excesses. It won't work. It can't work. The entire effort is merely saving the asses of lots of executives and traders who got us into this mess in the first place, and whose asses should not be saved at taxpayer risk and expense.
What to do? Immediately require the Treasury to stop the broad Wall Street recapitalization, and require Wall Street to lend the money directly to Main Street. At the same time, force Wall Street to write down its true balance sheets: Let the executives and traders take the hit. Let their shareholders and even their creditors take the hit for Wall Street's collosal irresponsibility. This is the only true way to restore trust. It's also the only way to save Main Street's small businesses, homeowners, students, and everyone else.
Why? Because the underlying problem isn't a liquidity problem. As I've noted elsewhere, the problem is that lenders and investors don't trust they'll get their money back because no one trusts that the numbers that purport to value securities are anything but wishful thinking. The trouble, in a nutshell, is that the financial entrepreneurship of recent years -- the derivatives, credit default swaps, collateralized debt instruments, and so on -- has undermined all notion of true value.
Many of these fancy instruments became popular over recent years precisely because they circumvented financial regulations, especially rules on banks' capital adequacy. Big banks created all these off-balance-sheet vehicles because they allowed the big banks to carry less capital.
Paulson is recapitalizing the banks -- giving them money directly rather than relying on reverse auctions -- largely because he's come to understand that the banks have taken on so much debt that the reverse auction system he told Congress he would use(designed to place a market value on these fancy-dance instruments) will leave too many banks insolvent.
But pouring money into these banks, expecting they'll turn around and lend to small businesses and Main Streets, is like pouring water into a dry sponge. Nothing will come out of it because Wall Street is so deep in debt that the banks are using the extra money to improve their balance sheets. They're hoarding it because their true balance sheets -- considering the off-balance sheet vehicles they created over the past several years -- are in such rotten shape.
In other words, taxpayers are financing a massive effort to save Wall Street's balance sheets from Wall Street's previous off-balance-sheet excesses. It won't work. It can't work. The entire effort is merely saving the asses of lots of executives and traders who got us into this mess in the first place, and whose asses should not be saved at taxpayer risk and expense.
What to do? Immediately require the Treasury to stop the broad Wall Street recapitalization, and require Wall Street to lend the money directly to Main Street. At the same time, force Wall Street to write down its true balance sheets: Let the executives and traders take the hit. Let their shareholders and even their creditors take the hit for Wall Street's collosal irresponsibility. This is the only true way to restore trust. It's also the only way to save Main Street's small businesses, homeowners, students, and everyone else.
Thursday, December 11, 2008
Wednesday, December 10, 2008
Income mobility and education
As goats on a tree, reaching for the best leaves, we all strive to be the ones at the top. But even in America, the land of opportunity, only good climbers make it. And lately even the fittest seem to be having a hard time.
The table below shows the percentage of people who moved from a given group in the income distribution to any other one, between 1994 and 2004. (The data come from the Panel Study of Income Dynamics, and the income measure is household taxable earnings.) The lowest degree of income mobility occurs among the poorest and the wealthiest: 58% of households in the bottom 20% of the distribution stay there, and 60% of those in the wealthiest quintile don’t move either.
Pooling people from all ages together, however, can be misleading. The typical earnings profile over a lifetime is hump-shaped: earnings start low, rise up until the individual is in her 50s, then begin a slow decline, and fall sharply with retirement. Because of this non-monotonicity, movements up and down the earnings distribution may have little to do with climbing the social ladder.
As an example: suppose the economy is populated by two individuals, one of whom is 35 and earns $45,000, and the other one is 55 and makes $75,000. So the older person is at the top of the distribution. Ten years later, the young individual has accumulated experience and earns $65,000, whereas the older person, now 65, has retired and doesn’t earn any labor income. The younger individual is at the top of the earnings distribution now. If we were oblivious to the age of these individuals, this two-person society would look remarkably mobile: the poorer person moved to the top and vice versa. In reality, the observed mobility is the product of the normal course of earnings over peoples’ lives.
The fortunes of a person are more likely to change early in life. Twentysomethings are less likely to be attached to a house, a family, or a job. They job-hop, experiment, go back to school. Over time, some people land a dream job —or a “comfort job”— and stay there. And some others simply grow roots: they have mortgages to pay, and spouses and kids to drag along. We also become more risk averse with age.
The data bear these intuitions: 67% of households whose head was between 22 and 29 in 1994 had switched quintiles ten years later; 54% of those between 30 and 39 did so, about the same as among the 40-49 age group.
Things get much more interesting when I look at mobility within education groups. Schooling is probably the single most important factor determining a person’s chance to “make it.” People with less education are less employable. They also experience smaller changes in productivity, so their earnings curve is less steep. And they have fewer opportunities to fill high-powered positions —the sort that provide a pay boost if one is successful. In this, however, the evidence doesn't support my expectations.
Between 1975 and 1985, and within the group of college graduates, 61% of households moved to a different economic class, whereas 59% of high school graduates were mobile -barely a difference. And twenty years later, 54% of college grads and 60% of people with a high school degree were mobile. (See chart.)
Click to enlarge
What made the economic ladder more slippery for college grads? Following the reasoning above, maybe people have less appetite for risk, and are taking jobs that are safer but also offer fewer opportunities to leap-frog over income classes. Starting up a business, for instance, is one of the riskiest endeavors one could pursue. But statistics show that animal spirits have not subdued —the fraction of entrepreneurs and self-employed has risen over the last 30 years.
A second explanation is that unobserved ability, not education, is behind opportunity. A couple of decades ago earning a college degree was a major feat. Only the well-off, highly-motivated and bright ever put their feet in a University. Nowadays going to college is almost a given. As a result a college degree has become a weaker signal of one’s competence. Highly capable individuals still get ahead, but the vast majority of college graduates do not belong to that breed.
Finally, but not less importantly, it might be a problem of too many grads chasing too few jobs with incentive-based pay. In spite of all the talk about stock options, the number of positions with (significant) variable compensation has grown more slowly than the body of individuals with a University diploma. More well-educated people land jobs without the power or the incentives to rise fast on the pay scale.
This calcification of the white-collar society is worrying. More and more individuals go to graduate school in order to earn that M.B.A., M.A., or even Ph.D., that will give them an edge over their peers. That behavior is perfectly rational, and yet self-defeating. The latest batches of college grads remind me of hamsters on a wheel rather than goats.
Technorati tags: economics, income mobility, inequality, income inequality, upward mobility
Tuesday, December 9, 2008
Risk Factors For A 2008 Recession
Here are the top risk factors for 2008 US Recession:
- Continuing Housing Bust
- High Oil Prices
- Security Issues
- Credit Crunch
- High Consumer Debt
- Large Trade Deficit
- Consumer Spending is slowing (it makes up 70% of the US GDP)
- Commercial Construction decline
Monday, December 8, 2008
The Meltdown (Part I)
Global capital markets have seized up. Confidence is evaporating. Put simply, no lender trusts any borrower to repay, fearing that that borrower won't be able to rely on anyone else to honor obligations. Even banks are hoarding cash, unwilling to lend to other banks. Everyone with any savings is heading for the hills -- for gold, for under the mattress, for wherever savings can be watched. We're witnessing a huge international bank run. We have not seen a global financial crisis on this scale since the 1930s.
What's happened? Put simply, the Bailout of All Bailouts has been a dud, at least so far. Most obviously, it hasn't done what it was intended to do -- reassure financial markets that the Treasury and the Fed would have enough money to handle any financial crisis.
So it's everyone and every institution -- and every country -- for itself. Several nations (Ireland, Greece, Germany) have basically guaranteed all deposits. As a result, global capital is moving their way. They're also thereby creating a new form of socialized capitalism. At the rate they're going, these nations will soon own and run their financial markets, and maybe a big chunk of the world's.
I fault Hank Paulson, first and foremost. He never succeeded in explaining to anyone what exactly he'll do with the bailout money -- how, for example, an auction to acquire mortgage-backed bad debt would work, and whether and to what extent he's planning to recapitalize the banking system. Even now, the American public has no idea what he's up to. Nor, for that matter, do many insiders.
Leadership isn't just about passing a big piece of legislation. It's about explaining and thereby gaining trust and confidence from a public -- including a global public -- that's otherwise afraid and confused. A credible and powerful explanation is necessary right now -- about where we've been, how we got into this mess, and how a particular plan (in this case, the bailout), will get us out of it. Yet Paulson has proven himself uniquely unable to explain anything to anyone. George W. Bush, for his part, is hopeless and hapless. Worse than a lame duck, he's a seriously disabled parakeet, with no remaining store of public trust. Ben Bernanke seems like an able fellow but his capacity to communicate is almost as bad as his predecessor's. Congressional leaders are too busy pointing fingers of blame to be capable of explaining much of anything and summoning confidence. And fewer than three weeks before a national election, both candidates are inevitably caught up in partisan wrangling. Obama does understand what's happening, and could calm global capital markets if he were already president. But he is not president as yet, nor even president-elect.
The leadership vacuum could not happen at a worse time. If credit markets remain frozen, we'll soon witness a huge round of business bankruptcies. We're in completely uncharted terrain.
What's happened? Put simply, the Bailout of All Bailouts has been a dud, at least so far. Most obviously, it hasn't done what it was intended to do -- reassure financial markets that the Treasury and the Fed would have enough money to handle any financial crisis.
So it's everyone and every institution -- and every country -- for itself. Several nations (Ireland, Greece, Germany) have basically guaranteed all deposits. As a result, global capital is moving their way. They're also thereby creating a new form of socialized capitalism. At the rate they're going, these nations will soon own and run their financial markets, and maybe a big chunk of the world's.
I fault Hank Paulson, first and foremost. He never succeeded in explaining to anyone what exactly he'll do with the bailout money -- how, for example, an auction to acquire mortgage-backed bad debt would work, and whether and to what extent he's planning to recapitalize the banking system. Even now, the American public has no idea what he's up to. Nor, for that matter, do many insiders.
Leadership isn't just about passing a big piece of legislation. It's about explaining and thereby gaining trust and confidence from a public -- including a global public -- that's otherwise afraid and confused. A credible and powerful explanation is necessary right now -- about where we've been, how we got into this mess, and how a particular plan (in this case, the bailout), will get us out of it. Yet Paulson has proven himself uniquely unable to explain anything to anyone. George W. Bush, for his part, is hopeless and hapless. Worse than a lame duck, he's a seriously disabled parakeet, with no remaining store of public trust. Ben Bernanke seems like an able fellow but his capacity to communicate is almost as bad as his predecessor's. Congressional leaders are too busy pointing fingers of blame to be capable of explaining much of anything and summoning confidence. And fewer than three weeks before a national election, both candidates are inevitably caught up in partisan wrangling. Obama does understand what's happening, and could calm global capital markets if he were already president. But he is not president as yet, nor even president-elect.
The leadership vacuum could not happen at a worse time. If credit markets remain frozen, we'll soon witness a huge round of business bankruptcies. We're in completely uncharted terrain.
Sunday, December 7, 2008
Saturday, December 6, 2008
Personal bankruptcy and consumption smoothing
The welfare effects of bankruptcy legislation are not correctly understood. Policymakers and the general public think, for the most part, that laws that protect borrowers in the event of default are beneficial to consumers. In practice, however, those laws have negative effects on the households that need credit most — and, ironically, those whom the legislation was intended to protect.
Traditionally, Chapter 7 has been the most popular type of bankruptcy filing. Under that section of the Bankruptcy Code, a filer relinquishes her assets, minus a certain exempted amount, and in return is discharged from her unsecured debt (credit card debt, personal loans, student loans, etc.).
State law sets those exempted amounts. In Illinois, for instance, exemptions are: $7,500 for home equity, $1,200 for motor vehicles, $750 for tools of the trade, and $2,000 for any other generic property. So suppose that you file for bankruptcy in the “Land of Lincoln,” and that you have $20,000 worth of home equity, and a car with a market value of $600. Then you can sell the house and keep $7,500 of the proceeds, and sell your car and keep the $600 (since that’s below the $1,200 limit).
Since 1978, with the passage of the Bankruptcy Reform Act (BRA), there’s also a federal exemption. Some states allow filers to choose between the state and the federal amounts. Obviously, if given the opportunity, filers use whichever is highest.
There is an enormous disparity of bankruptcy exemptions across states, even after accounting for the existence of the federal limits. For example, in 2006 the states of Texas, Florida, Oklahoma, Iowa, Kansas, South Dakota, and the District of Columbia, all allowed for an unlimited homestead exemption. In the states of Ohio and Virginia, at the other extreme, the limit is set at $5,000 (and those states don’t allow for the application of the federal exemption). The map below shows the maximum exemption that a married homeowner could claim in 2003, after combining homestead and non-homestead amounts, and taking the highest of the state and federal limit (where the federal limit is available). The limits also vary over time, although high-exemption states tend to remain the same over the years.
The amount of the exemption provides insurance for the debtor’s consumption. Suppose that a debtor suffers a setback, such as illness or unemployment, and that she is forced to default on her credit card debt and student loans. In the absence of any exemption, creditors would take a blanket security interest in all of the debtor’s possessions. The existence of an exemption means that she is left with at least a small amount of assets after filing for bankruptcy. Legislators see it as a way to provide a “fresh start.” An alternative view is that a certain amount of assets, and hence consumption, are insured against negative events.
On the other side of the coin, lenders are hurt by this form of consumer protection. Higher exemptions reduce the payments received by the lender in the event of default, and increase the probability of bankruptcy, since the borrower’s punishment for doing so becomes smaller. Creditors rationally respond to higher exemptions by raising interest rates and rationing credit. This rationing may take the form of fewer households with access to debt, smaller loans, or both. Fewer and smaller loans reduce the amount of consumption that households can finance with debt in times of low income.
In theory, then, bankruptcy exemptions have an ambiguous effect on consumption smoothing. Higher exemptions allow bankrupt households to keep more assets; but those same higher exemptions reduce the supply of credit. It is, therefore, an empirical matter whether higher limits enhance or detract from the role of debt as a consumption insurance mechanism.
To answer that question, I put together data on consumption and lay-offs of American households (from the Panel Study of Income Dynamics), as well as bankruptcy exemptions, for as many years as I could get consistent data for. (In practice, that is 1976 through 2003, with the exception of 1994-1997.) The idea is to estimate by how much a family’s consumption is reduced when its main income earner gets laid off, and see how much the hit to consumption changes with the bankruptcy exemption.
As a warm-up and point of reference, I estimate that, without taking into account the exemptions, a household whose breadwinner gets laid off reduces its consumption by five to six percent. Once I include bankruptcy laws in the econometric analysis, I find that households that live in states with unlimited exemptions reduce their consumption by 16 to 18 percent. Households in the top third of the distribution of (limited) exemptions reduce their consumption by nine to ten percent. For households with lower exemptions the effect of unemployment on consumption is low and statistically insignificant. (See chart.)
Click to enlarge
My interpretation of the results is that consumer debt is an important mechanism of consumption insurance. People use loans and credit card debt not only to finance big-ticket items, but also to make ends meet when disaster strikes. Legislation that makes it harder to obtain debt, such as bankruptcy exemptions or interest rate caps, ends up punishing the weakest: people with low wealth, who could make the most use of credit as an insurance device.
Don’t get me wrong: this is not a call to eliminate bankruptcy exemptions. There is a place for them as a means to provide safety to people who have been struck by unexpected events. A zero-exemption policy would probably expand credit supply — at the cost of leaving thousands of families destitute and without a chance to recover. But exorbitant homestead exemptions go way beyond providing a chance for a “fresh start.” Likewise, there’s no reason why people should be allowed to keep $60,000 worth of personal property, as they can do in Texas.
Surely, medical expenses can easily run into the hundreds of thousands of dollars. But that’s a reason to reform health insurance. Limiting the enforceability of credit contracts is a bad way to lay out safety nets.
This post was based on my own research. The write-up of the paper is still in the making. It will be available on my website by January 28. In the meantime, you can have a look at the slides I prepared for a presentation this Friday.
Technorati tags: economics, personal bankruptcy, consumption, bankruptcy exemption, consumption smoothing
Traditionally, Chapter 7 has been the most popular type of bankruptcy filing. Under that section of the Bankruptcy Code, a filer relinquishes her assets, minus a certain exempted amount, and in return is discharged from her unsecured debt (credit card debt, personal loans, student loans, etc.).
State law sets those exempted amounts. In Illinois, for instance, exemptions are: $7,500 for home equity, $1,200 for motor vehicles, $750 for tools of the trade, and $2,000 for any other generic property. So suppose that you file for bankruptcy in the “Land of Lincoln,” and that you have $20,000 worth of home equity, and a car with a market value of $600. Then you can sell the house and keep $7,500 of the proceeds, and sell your car and keep the $600 (since that’s below the $1,200 limit).
Since 1978, with the passage of the Bankruptcy Reform Act (BRA), there’s also a federal exemption. Some states allow filers to choose between the state and the federal amounts. Obviously, if given the opportunity, filers use whichever is highest.
There is an enormous disparity of bankruptcy exemptions across states, even after accounting for the existence of the federal limits. For example, in 2006 the states of Texas, Florida, Oklahoma, Iowa, Kansas, South Dakota, and the District of Columbia, all allowed for an unlimited homestead exemption. In the states of Ohio and Virginia, at the other extreme, the limit is set at $5,000 (and those states don’t allow for the application of the federal exemption). The map below shows the maximum exemption that a married homeowner could claim in 2003, after combining homestead and non-homestead amounts, and taking the highest of the state and federal limit (where the federal limit is available). The limits also vary over time, although high-exemption states tend to remain the same over the years.
Bankruptcy exemptions under Chapter 7 of the Bankruptcy Code
(in 2003, for a home owner)
Click to enlarge
(in 2003, for a home owner)
Click to enlarge
The amount of the exemption provides insurance for the debtor’s consumption. Suppose that a debtor suffers a setback, such as illness or unemployment, and that she is forced to default on her credit card debt and student loans. In the absence of any exemption, creditors would take a blanket security interest in all of the debtor’s possessions. The existence of an exemption means that she is left with at least a small amount of assets after filing for bankruptcy. Legislators see it as a way to provide a “fresh start.” An alternative view is that a certain amount of assets, and hence consumption, are insured against negative events.
On the other side of the coin, lenders are hurt by this form of consumer protection. Higher exemptions reduce the payments received by the lender in the event of default, and increase the probability of bankruptcy, since the borrower’s punishment for doing so becomes smaller. Creditors rationally respond to higher exemptions by raising interest rates and rationing credit. This rationing may take the form of fewer households with access to debt, smaller loans, or both. Fewer and smaller loans reduce the amount of consumption that households can finance with debt in times of low income.
In theory, then, bankruptcy exemptions have an ambiguous effect on consumption smoothing. Higher exemptions allow bankrupt households to keep more assets; but those same higher exemptions reduce the supply of credit. It is, therefore, an empirical matter whether higher limits enhance or detract from the role of debt as a consumption insurance mechanism.
To answer that question, I put together data on consumption and lay-offs of American households (from the Panel Study of Income Dynamics), as well as bankruptcy exemptions, for as many years as I could get consistent data for. (In practice, that is 1976 through 2003, with the exception of 1994-1997.) The idea is to estimate by how much a family’s consumption is reduced when its main income earner gets laid off, and see how much the hit to consumption changes with the bankruptcy exemption.
As a warm-up and point of reference, I estimate that, without taking into account the exemptions, a household whose breadwinner gets laid off reduces its consumption by five to six percent. Once I include bankruptcy laws in the econometric analysis, I find that households that live in states with unlimited exemptions reduce their consumption by 16 to 18 percent. Households in the top third of the distribution of (limited) exemptions reduce their consumption by nine to ten percent. For households with lower exemptions the effect of unemployment on consumption is low and statistically insignificant. (See chart.)
Click to enlarge
My interpretation of the results is that consumer debt is an important mechanism of consumption insurance. People use loans and credit card debt not only to finance big-ticket items, but also to make ends meet when disaster strikes. Legislation that makes it harder to obtain debt, such as bankruptcy exemptions or interest rate caps, ends up punishing the weakest: people with low wealth, who could make the most use of credit as an insurance device.
Don’t get me wrong: this is not a call to eliminate bankruptcy exemptions. There is a place for them as a means to provide safety to people who have been struck by unexpected events. A zero-exemption policy would probably expand credit supply — at the cost of leaving thousands of families destitute and without a chance to recover. But exorbitant homestead exemptions go way beyond providing a chance for a “fresh start.” Likewise, there’s no reason why people should be allowed to keep $60,000 worth of personal property, as they can do in Texas.
Surely, medical expenses can easily run into the hundreds of thousands of dollars. But that’s a reason to reform health insurance. Limiting the enforceability of credit contracts is a bad way to lay out safety nets.
This post was based on my own research. The write-up of the paper is still in the making. It will be available on my website by January 28. In the meantime, you can have a look at the slides I prepared for a presentation this Friday.
Technorati tags: economics, personal bankruptcy, consumption, bankruptcy exemption, consumption smoothing
Friday, December 5, 2008
Recession Fears Grow
Reuters reports that "Unsold goods are piling up in warehouses as the housing meltdown and soaring oil prices strain consumers, raising fears that already glum fourth-quarter growth prospects may tip toward recession."
"The sluggishness is apparent in the retail sector, where 70 percent of chain stores posted weaker-than-expected October sales results, according to research firm Retail Metrics.
"The sluggishness is apparent in the retail sector, where 70 percent of chain stores posted weaker-than-expected October sales results, according to research firm Retail Metrics.
"We expect the challenging retail environment to continue for the foreseeable future," Mike Ullman, chairman and chief executive officer of department store chain J.C. Penney (JCP.N: Quote, Profile, Research), said last week. He added that the company would keep inventory levels tight through 2008."
Respected economist Nouriel Roubini writes "Any recession call for the U.S. is clearly dependent on US consumption faltering. Since residential investment is only 5% of even a worsening housing recession cannot – by itself – trigger an economy-wide recession. Rather, since private consumption is over 70% of aggregate demand a sharp and persistent slowdown in consumption growth – below 1% or even negative - is necessary to trigger a full blown recessionThursday, December 4, 2008
Bailout Redux: The Real Choice Ahead
If the choice is between a lousy bailout bill and economic Armageddon, I'd vote for the lousy bailout bill.
But make no mistake: This is a lousy bill. It doesn't do the most important thing -- help distressed homeowners avoid foreclosure (that role is given to the Treasury Department, which is the equivalent of putting it into the permanent circular file). It doesn't make Wall Street more transparent (there's almost no word in it about improved transparency and capital requirements, or avoiding conflicts of interest and market manipulation). It doesn't control the most egregious aspects of executive salaries (the bill contains a contorted detour for controlling certain golden parachutes when the government has made direct equity purchases of financial companies rather than taken their bad paper through an auction). It does have provisions designed to protect taxpayers should the bad securities continue to be bad, but the responsibility for acting on this is left up to the next President. And the Senate version has lots of additional stuff -- some good (extending deposit insurance), some unnecessary (extending certain tax credits), but most of which should never have been added.
And while the bailout bill may avoid economic Armageddon, it won't avoid a severe deterioration of the American economy in the months ahead. The bailout will help keep credit markets functioning. But ask yourself: what's the point of keeping credit markets functioning if most Americans can't afford to go deeper into debt anyway? And why does anyone suppose that businesses will continue to borrow from credit markets when their customers have stopped buying?
Wall Street and its creditors are not at the core of the American economy. Main Street and consumers are at the core. So even if the bailout bill keeps Wall Street going and prevents the sort of massive defaults that would freeze global credit markets, it does virtually nothing to help the vast majority of American consumers who are already at the end of their ropes -- who right now need extended unemployment insurance, affordable health coverage, and assistance in meeting their mortgage payments and fuel bills. And as long as Americans remain at the end of their ropes, the American economy will continue to decline.
So the real choice isn't between a lousy bailout bill or economic Armageddon. It's between taking prompt action to help average Americans or watching the nation fall into a deeper and deeper recession. Wall Street will be bailed out. The bigger question is whether Congress and the next administration do what's needed to rescue the rest of America, and the overall economy.
But make no mistake: This is a lousy bill. It doesn't do the most important thing -- help distressed homeowners avoid foreclosure (that role is given to the Treasury Department, which is the equivalent of putting it into the permanent circular file). It doesn't make Wall Street more transparent (there's almost no word in it about improved transparency and capital requirements, or avoiding conflicts of interest and market manipulation). It doesn't control the most egregious aspects of executive salaries (the bill contains a contorted detour for controlling certain golden parachutes when the government has made direct equity purchases of financial companies rather than taken their bad paper through an auction). It does have provisions designed to protect taxpayers should the bad securities continue to be bad, but the responsibility for acting on this is left up to the next President. And the Senate version has lots of additional stuff -- some good (extending deposit insurance), some unnecessary (extending certain tax credits), but most of which should never have been added.
And while the bailout bill may avoid economic Armageddon, it won't avoid a severe deterioration of the American economy in the months ahead. The bailout will help keep credit markets functioning. But ask yourself: what's the point of keeping credit markets functioning if most Americans can't afford to go deeper into debt anyway? And why does anyone suppose that businesses will continue to borrow from credit markets when their customers have stopped buying?
Wall Street and its creditors are not at the core of the American economy. Main Street and consumers are at the core. So even if the bailout bill keeps Wall Street going and prevents the sort of massive defaults that would freeze global credit markets, it does virtually nothing to help the vast majority of American consumers who are already at the end of their ropes -- who right now need extended unemployment insurance, affordable health coverage, and assistance in meeting their mortgage payments and fuel bills. And as long as Americans remain at the end of their ropes, the American economy will continue to decline.
So the real choice isn't between a lousy bailout bill or economic Armageddon. It's between taking prompt action to help average Americans or watching the nation fall into a deeper and deeper recession. Wall Street will be bailed out. The bigger question is whether Congress and the next administration do what's needed to rescue the rest of America, and the overall economy.
Wednesday, December 3, 2008
Who's Paying For Your Fix?
by Kate Duncan
May/Jun 2003 Issue
Unless your morning latte was a fair trade blend, it probably cost more than what the farmer who picked the beans earns in a day.
Conventional coffee prices are at their lowest in a century, even below the cost of production. Farmers have been leaving the fruit to rot on the tree, pulling the kids out of school, abandoning the family land and pouring into the cities to find non-existent work. That’s why, as the most heavily traded commodity after oil, and the most common beverage after water, coffee is a major focus of the fair trade movement.
If your morning latte was a fair trade brew, it means the person who farmed the beans is earning enough to support his family. This is all well and good, but the way fair trade is usually explained - with prices, numbers and statistics - ignores it’s lasting benefits. The true point of fair trade is the cultural, communal, and environmental stability it bolsters.
A farmer who sells through fair trade is a member of a cooperative that is a vehicle for community empowerment. And not just a neighborhood watch: The people typically organized via fair trade are those whom the free market has filtered to the lowest economic stratum. Rather than maneuvering them into a position where they’re forced to take what they can get, fair trade recognizes farmers as equal partners, a platform from which they can command more control over their business and lives.
'Fair trade is a different kind of business relationship between the producer and buyer, which has been an inspiration to help these communities pull together instead of caving to the pressure of all the things trying to blow them apart,' says Monika Firl. Monika heads up producer relations for Cooperative Coffees, and as such, led half a dozen coffee roasters and me (as a grateful representative of Idyll Development Foundation, one of Cooperative Coffee’s funders) on a buying trip to farmers’ co-ops in Nicaragua, Guatemala, and Mexico in February, where we were able to see the effect for ourselves. [Clamor]
Tuesday, December 2, 2008
A bash for confidence indexes
Every month the University of Michigan and the Conference Board conduct a survey of households’ confidence on the state of the economy. Each pollster asks several questions and summarizes the results with an index, which is closely watched for signs of consumer distress. Last November, the Michigan index fell by 4.8 points from October; the Conference Board Index dipped by 7.9 points. Supposedly this is bad news because worried consumers are thrifty consumers. Don’t let the surveys fool you: they are almost complete rubbish — unless you know how to use them.
At first glance, both the Michigan index (MI) and the Conference Board index (CI) are correlated with the business cycle: they sink around the beginning of a recession and rebound near the end (see chart nearby, originally published by the Wall Street Journal). They even seem to track the quarter-to-quarter growth of consumption expenditures. Look a bit closer, however, and you’ll see that confidence and reality get out of synch sometimes. For instance, both the MI and the CI were abnormally low relative to consumption growth in 1992-1993, and again during 2002 and 2003. The indices dipped during the Asian crisis of 1998, but consumption growth didn’t budge; conversely, expenditure growth fell dramatically in early 1995 even though sentiment didn’t change.
Formal statistical analyses have found that consumer sentiment says very little that forecasters don’t know already. That is, once this quarter’s spending, interest rates, etc. are known, it does not help much to predict future spending growth. Confidence and expectations matter. The issue, I reckon, is that these particular indices fail to capture them.
A cursory look at the guts of the MI and the CI will convince you that they are literally meaningless. Each of them is a mishmash of five opinions — which, by the way, are not the same for both surveys (see table below). The questionnaires represent but the pollster’s guess of what determines spending. There’s no guarantee that the questions are the ones that actually matter.
For instance, the MI doesn’t include questions on job security, whereas the CI doesn’t ask about present personal finances. The potential irrelevance of the surveys becomes painfully clear when one examines the first question of the MI: “Do you think now is a good or bad time for people to buy major household items?” With such a specific wording, that question should predict expenditures on cars, appliances, furniture and such, i.e. durable goods. But once past purchases are included into the forecasting model, confidence and expenditures are barely correlated. [1]
Even if one of the indexes had the right composition, there’s no reason why all the questions should be given equal weights. Personal finances and availability of jobs, for example, may influence a consumer’s expenditures more than overall business conditions; short-term prospects should matter more than distant ones. In both the MI and the CI, however, every question counts the same.
Despite my bashing of the indexes, the surveys are worth keeping. Each of them contains some question that can help predict one or other component of expenditures. More specifically, the Conference Board’s questions about job prospects help forecast expenditures on durable goods: sentiment about the current job situation (question number two in the table) significantly predicts purchases of vehicles and other durables; expectations about future jobs (question four) predicts expenditures on vehicles only. [1] The Michigan survey, on the other hand, contains questions which are not used in the indexes. It would be worth exploring whether they are useful for forecasters.
Unfortunately, the component questions are not accessible to most people. If they are, it’s only with significant delay. And even if they were published timely, most people wouldn’t be able to use them because they can’t handle the number crunching. So here’s my advice for the everyday news consumer. First, don’t draw any conclusions from month-to-month changes of the indexes, no matter how large they are. Start believing them only after several months of consecutive rises or declines. Second, the Conference Board index is a better predictor than the Michigan index, because the latter doesn’t include any question about jobs. Third, rather than sentiment indicators, pay attention to data on the labor market: the unemployment rate and the payroll numbers, for example, averaged over at least three months. Not only do they gauge consumers’ confidence more accurately than the confidence indexes themselves: they influence spending decisions directly (the more unemployment, the less disposable income).
In all fairness, the intention of the MI and the CI was never to forecast any specific variable. They were designed over 40 years ago as a rough measure of the households’ view of the state of the economy. Even if the surveys captured expectations correctly, it should be up to economists, not statisticians, pollsters or newspapers, to figure out how those expectations translate into realized outcomes. Some day we’ll know how to do it. I’m pretty confident.
References and further reading:
[1] Bram and Ludvigson (1998) Does consumer confidence forecast household expenditure? A sentiment index horserace (pdf)
[2] Carroll, Fuhrer and Wilcox (1994) Does consumer sentiment forecast household spending? If so, why? (pdf)
[3] Croushore (2006) Consumer confidence surveys: can they help us forecast consumer spending in real time? (pdf)
Technorati tags: economics, consumer confidence, consumer sentiment, forecasting, expectations
At first glance, both the Michigan index (MI) and the Conference Board index (CI) are correlated with the business cycle: they sink around the beginning of a recession and rebound near the end (see chart nearby, originally published by the Wall Street Journal). They even seem to track the quarter-to-quarter growth of consumption expenditures. Look a bit closer, however, and you’ll see that confidence and reality get out of synch sometimes. For instance, both the MI and the CI were abnormally low relative to consumption growth in 1992-1993, and again during 2002 and 2003. The indices dipped during the Asian crisis of 1998, but consumption growth didn’t budge; conversely, expenditure growth fell dramatically in early 1995 even though sentiment didn’t change.
Formal statistical analyses have found that consumer sentiment says very little that forecasters don’t know already. That is, once this quarter’s spending, interest rates, etc. are known, it does not help much to predict future spending growth. Confidence and expectations matter. The issue, I reckon, is that these particular indices fail to capture them.
A cursory look at the guts of the MI and the CI will convince you that they are literally meaningless. Each of them is a mishmash of five opinions — which, by the way, are not the same for both surveys (see table below). The questionnaires represent but the pollster’s guess of what determines spending. There’s no guarantee that the questions are the ones that actually matter.
Click to enlarge
For instance, the MI doesn’t include questions on job security, whereas the CI doesn’t ask about present personal finances. The potential irrelevance of the surveys becomes painfully clear when one examines the first question of the MI: “Do you think now is a good or bad time for people to buy major household items?” With such a specific wording, that question should predict expenditures on cars, appliances, furniture and such, i.e. durable goods. But once past purchases are included into the forecasting model, confidence and expenditures are barely correlated. [1]
Even if one of the indexes had the right composition, there’s no reason why all the questions should be given equal weights. Personal finances and availability of jobs, for example, may influence a consumer’s expenditures more than overall business conditions; short-term prospects should matter more than distant ones. In both the MI and the CI, however, every question counts the same.
Despite my bashing of the indexes, the surveys are worth keeping. Each of them contains some question that can help predict one or other component of expenditures. More specifically, the Conference Board’s questions about job prospects help forecast expenditures on durable goods: sentiment about the current job situation (question number two in the table) significantly predicts purchases of vehicles and other durables; expectations about future jobs (question four) predicts expenditures on vehicles only. [1] The Michigan survey, on the other hand, contains questions which are not used in the indexes. It would be worth exploring whether they are useful for forecasters.
Unfortunately, the component questions are not accessible to most people. If they are, it’s only with significant delay. And even if they were published timely, most people wouldn’t be able to use them because they can’t handle the number crunching. So here’s my advice for the everyday news consumer. First, don’t draw any conclusions from month-to-month changes of the indexes, no matter how large they are. Start believing them only after several months of consecutive rises or declines. Second, the Conference Board index is a better predictor than the Michigan index, because the latter doesn’t include any question about jobs. Third, rather than sentiment indicators, pay attention to data on the labor market: the unemployment rate and the payroll numbers, for example, averaged over at least three months. Not only do they gauge consumers’ confidence more accurately than the confidence indexes themselves: they influence spending decisions directly (the more unemployment, the less disposable income).
In all fairness, the intention of the MI and the CI was never to forecast any specific variable. They were designed over 40 years ago as a rough measure of the households’ view of the state of the economy. Even if the surveys captured expectations correctly, it should be up to economists, not statisticians, pollsters or newspapers, to figure out how those expectations translate into realized outcomes. Some day we’ll know how to do it. I’m pretty confident.
References and further reading:
[1] Bram and Ludvigson (1998) Does consumer confidence forecast household expenditure? A sentiment index horserace (pdf)
[2] Carroll, Fuhrer and Wilcox (1994) Does consumer sentiment forecast household spending? If so, why? (pdf)
[3] Croushore (2006) Consumer confidence surveys: can they help us forecast consumer spending in real time? (pdf)
Technorati tags: economics, consumer confidence, consumer sentiment, forecasting, expectations
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