Macro slack

This month will mark the sixth anniversary of the current economic cycle in the United States. Although it might be too early for an obituary –the chances of a recession by year-end are slim— a mid-life review of the expansion is surely due. The story, I warn you, may strike you as uninspiring: “The 21st century economy: A solid slacker” would make a fitting title.

Most people hold the notion that expansions are times of normal or fast growth. A few economists would say that they are periods when the primary factor limiting how much the economy produces is its physical capabilities --how many people are willing to work, the quality of their skills and technology, and the physical capital available for them to use. (Read this blog post by professor James Hamilton on Econbrowser.) On the flip side, a recession is an episode of slow or no growth, and slack capacity. By historical standards, the economy has been in a grey area between recession and “normal times” since 2001.

Chart 1 (click to enlarge)
Exhibit number one: The Labor Participation Rate –the ratio of employed people to the potential labor force— is low and out of course. Normally, the rate goes up during times of expansion as better job prospects entice students to get a job, fifty- and sixty-somethings are kept in the payrolls until their normal retirement age, and stay-at-home mommies and daddies find it harder to pass up job opportunities. This time around, however, more and more people have stayed away from the labor market throughout the recovery and the expansion (chart 1).

Chart 2 (click to enlarge)
Exhibit number two: Total Capacity Utilization –a ratio of actual to potential production in the industrial sector– has recovered all the ground that it lost during the 2001 recession, but it has failed to increase after that (chart 2). At one point or another during each of the three previous expansions, capacity utilization topped the 85 percent mark; now, after 23 quarters of expansion, it hovers around 81-82 percent.

Chart 3 (click to enlarge)
Exhibit number three: For too long has the Gross Domestic Product (GDP) stayed below its potential, defined as the maximum level of output the economy can produce without increasing inflation. The output gap has stayed between one and two percent, instead of falling to zero and beyond, as it always has done in the past (chart 3).

Since the three statistics discussed reflect the same reality, I have taken the liberty of merging them into a single indicator. The Slack Index, as I have called the cocktail, is the average of the output gap, unused industrial capacity (100 minus Total Capacity Utilization), and the non-participation rate (100 minus the Labor Participation Rate). I normalize the series to be equal to 100 in 1992. A higher value of the index indicates more spare productive capacity.

The index has remained for quite some time around a value of 96, which would be fine for a recovering economy, but too high for an expanding one (chart 4).

Chart 4 (click to enlarge)

Turning to evidence on growth, GDP has averaged an annualized growth rate of 2.8 percent, lower than in any other expansion in the post-war era. For example, in the 23 quarters following the 1991 recession, the average growth rate was 3.3 percent, and 4.9 percent in the same period after the 1981-82 recession.

It seems pretty clear that the economy is unusually far below its possibility frontier. The good news is that if we are able to shake off the threats from the housing slump, the sub-prime mortgage crisis, and soaring oil prices, the economy should be able to grow much faster without stoking inflation.

The job market appears to be tight. The unemployment rate, at 4.7 percent, remains low. But this time around we have a large pool of potential workers who so far have chosen to stay off the payrolls. If the macroeconomic threats evaporate, those people may return to the market, increasing the supply of labor and pushing wages down.

So if the economy comes out of the slums and you’re looking for a job you’d better not play hard-to-get; if you already have one, don’t bug your boss to cut you some slack.

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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.

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.

Stimulus Shtimulus

Let's get real. Even if a stimulus package could get through Congress and signed into law soon, even if directed at lower-income Americans who are far more likely than higher-income to spend any extra money, even if a cash supplement doled out within sixty days rather than a tax rebate or refund that won’t be out until next summer, even if in the range of five hundred dollars a household, which is the most anyone is talking about – even if all these conditions were met, the stimulus would still be too little and too late.

Falling home prices are eating into household wealth far more, and more quickly. Homes are the biggest assets Americans own – their golden gooses for retirement and piggy banks for home equity loans and refinancing. So as home prices fall, people not only feel poorer but are poorer. That means they can’t spend nearly as much, even if the government drops an extra five hundred dollars in their laps. Which in turn almost guarantees a recession or worse, because as consumption lags, companies have to reduce production and cut payrolls.

According to a recent estimate by Merrill-Lynch, the hit to consumer spending this year and next will be three hundred sixty billion dollars. That’s more than double the size of the stimulus package the President or any leading Democrat is talking about.

How much worse can it get? The housing bubble drove home prices up 20 to 40 percent above historic averages relative to earnings and rents, and pushed up new home construction. Now that the bubble is bursting, expect prices to drop by roughly the same amount, and new home construction to contract. It plunged last month to its lowest point in more than sixteen years.

As a practical matter, our only real hope for avoiding a deep recession or worse depends on loans and investments from abroad, combined with export earnings as the dollar continues to weaken. In other words, no stimulus package from Washington will be enough. We need the rest of the world to bail us out.

When the heat is not in the core

Prices rose 2.4 percent in the year to September 2007, using the monthly price index for personal consumption expenditures (PCE); the reading was 0.6 percentage points higher than in August. Core inflation on the other hand, which doesn’t include the prices of food and energy, was 1.8 percent in the year to September 2007, and the reading stayed unchanged from the previous month.

Over the entire history of the two time series, the average difference between core and overall inflation has been close to nil (0.12 percentage points between 1960 and 2007). But the gap between the two does not necessarily have to be small and indeed has not been small for prolonged periods, sometimes lasting several years. (See chart 1.)


Most recently, between November of 2002 and August of 2006, overall inflation stayed above core inflation for 46 consecutive months. The average (and median) difference was 0.7 percentage points, a large one considering that core inflation ranged between 1.3 and 2.5 percent. (See chart 2.)


Most central banks including the Federal Reserve follow core prices, which means that many times their gauge of inflation is below the increase in the cost of living. Whether the Fed likes the prices of food and energy or not, wages are implicitly pegged to overall, not core inflation.

Suppose that the Fed has a target core inflation rate of two percent. If the public expects an overall inflation of, say, three percent next year, wages will increase accordingly, and so will nominal consumption expenditures. Monetary theory tells us that this will push actual overall inflation up to around three percent. Unless the prices of food and energy change relative to the rest of the prices, core inflation will also be around 3 percent, above the Fed’s target.


Conducting monetary policy by tracking core inflation is tantamount to assuming that the average gap between core and overall prices won’t get too far for too long (and that workers and employers have the same expectations). The US experience between 2002 and 2007 indicates otherwise (see chart 2). Given that economic conditions during those years have been “normal” --as opposed to the extraordinary oil shocks of the 1970s and early 1980s-- the premise that food and energy prices won’t stray too far from core prices doesn’t seem adequate as the default hypothesis for the rest of the century (barred a major technological breakthrough).

The main reason why central banks track core inflation, rather than overall inflation, is that the prices of foodstuffs and energy are notoriously volatile. Short-run changes in the price of those goods reflect variations in weather conditions, geopolitical climate, commodity markets, and discoveries of new oil reserves, for example. Central banks assume that those phenomena have a zero-mean effect on inflation in the long-run, so their effect on prices in the short-run can be safely ignored.

There is no question that inflation should be stripped out of its most volatile components. But it’s worth exploring alternatives to what we now know as core inflation. One possibility would be to use the prices of all goods and services, but then adjust their weights to reflect their volatility –prices with high volatility and low correlation with overall inflation would receive low weights. Those weights would evolve as new data are incorporated to the time series.

Another possibility is to leave out all goods and services with volatilities above a certain threshold. Those goods would not necessarily be food and energy, and would not necessarily be the same every month or every quarter. The Federal Reserve banks in Dallas and Cleveland have been calculating a trimmed index of inflation for a while. (Robert Rich and Charles Steindel of the Federal Reserve Bank of New York explore three alternatives to “ex-food-and-energy” inflation.)

A more radical approach would consist of targeting wages or labor costs directly, instead of the price of goods. (Knzn, over at “Economics and…” has been advocating this policy. Start by reading this post and this one.)

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Googling "recession" from United States has Tripled in the Past Year

Graph of the number of times the word "recession" was googled from United States over the last year. As one can tell it has triple in the past year.

Democrats Should Stop Squabbling Over Healthcare Mandates

Democrats should be celebrating. Their three major candidates have put health insurance front and center on the domestic agenda, and with plans that are remarkably similar. They've done so at a time when the public seems readier than ever before to embrace universal health insurance, and readier to trust a Democratic president to put it into effect.

But instead of celebrating, the candidates and left-leaning pundits are squabbling over whether the plans should include so-called mandates that require everyone to purchase health insurance. Talk about self-inflicted wounds. Mandates are a sideshow, and fighting over them risks turning away voters from the main event.

In almost every important respect, all major Democratic plans are the same. They require employers to "play or pay" -- either provide coverage to their employees or contribute to the cost of coverage. They create purchasing pools that will offer insurance to anyone who doesn't get it from an employer. They offer a public heath-insurance option. The plans preserve freedom of choice of doctors. They aim to save money through more preventive care, better management of chronic disease, and standardized information technology. All of them subsidize lower-income families.

Despite some skirmishing over whose subsidies are most generous, the subsidies are about the same. The major Democratic plans would spend nearly an identical amount of money helping low- and middle-income families because they rely on the same source of general revenue, derived from allowing the Bush tax cuts to expire. Given the myriad ways universal health insurance might otherwise be organized -- single payer, employer mandate, health-insurance vouchers, tax credits -- this Democratic consensus is striking. It also highlights the abject failure of Republicans to come up with any coherent plan.

Take a closer look and even the candidates' positions on mandates aren't all that different. John Edwards has proposed to automatically enroll people in health insurance on their tax returns, but has said this mandate won't apply until premiums are affordable. Hillary Clinton says she favors mandates, but isn't sure there should be a penalty for noncompliance. Barack Obama favors an immediate mandate for children, but doesn't include one for adults. He says he's willing to revisit the issue after making health insurance more affordable and enrollment easier, and is also considering an automatic enrollment with an opt-out for those who don't want to be included.

As a practical matter, the difference between Sen. Clinton's and Sen. Obama's approaches come down to timing and sequencing. Mrs. Clinton wants a mandate first, believing that enrolling the younger and healthier will help reduce costs for everyone else. Mr. Obama thinks forcing people to buy health insurance before it's affordable isn't realistic. He wants to lower health costs first, and is willing to consider a mandate only if necessary.

This fight is little more than a distraction, given that a mandate would matter only to a tiny portion of Americans. All major Democratic candidates and virtually all experts agree that the combination of purchasing pools, subsidies, easy enrollment and mandatory coverage of children will cover a large majority of those who currently lack insurance -- even without a mandate that adults purchase it. A big chunk of the remainder are undocumented immigrants, who aren't covered by any of the plans.

Who's left? Only around 3% of the population. So the question they're really battling over is whether it's better to require this 3% to buy insurance, or lure them into buying it with low rates and subsidies.

The answer depends on who's in this 3%. Mrs. Clinton thinks they're mostly younger and healthier than the general population so they should be required to buy health insurance. That way, they'll bring costs down for everyone else because their payments will subsidize the others.

Mr. Obama thinks a lot of them are people who won't be able to afford even the subsidized premiums, so they'd either ignore a mandate or wouldn't be able to pay for it. He says if his plan gets 97% coverage without a mandate and he finds that the remaining 3% are mostly young and healthy, he'll go along with a mandate.

Who's correct? It's hard to know. So far, the Massachusetts experiment suggests Mr. Obama. Massachusetts is the only state to require that every resident purchase health insurance. The penalty for failing to do so could reach $4,000 next year, but the state has already exempted almost 20% of its current uninsured from the requirement. Massachusetts is concerned they can't afford a policy, even with subsidies similar to those in all the Democratic plans. So far, about 50% of Massachusetts's uninsured have complied with the mandate.

A mandate may not make much difference anyway. Columbia University professor Sherry Glied and her colleagues investigated health-insurance mandates now in place in Switzerland and the Netherlands. They report in the November-December issue of Health Affairs that mandates can, but don't always, increase coverage. Whether they do depends on the cost of complying with them and the penalties for not doing so. Overall, they found, the effects of mandates largely reinforced existing high levels of coverage. Switzerland now enjoys near-universal coverage, but this reflects only a tiny increase over the rate of coverage before it was mandated, when over 98% of population had mostly voluntary coverage.

It's expected that gloves will come off in the last months of a primary campaign. But by warring over mandates, Democrats are leading with their chins. It's the least important aspect of what they're offering. It's also, to many Americans, the least attractive because it conjures up a big government bullying people into doing what they'd rather not do.

The public is ready for universal health insurance, but getting any plan through Congress will still be tricky. To get it enacted after January 2009, Democrats need to start building a movement in support of the big and important reforms universal health insurance requires -- and on which they happen to agree.

facevalue

The Economist gets it wrong when claiming that “social networks lose value once they go beyond a certain size.” (Social graph-iti, October 20th.) The British weekly says that the large scale of the networks makes it difficult to restrict one’s contacts to a select group.

But Facebook consists precisely of a web of small overlapping communities. Users only befriend the people they choose. Increasing the size of the overall network does not necessarily affect the composition of any given community. And if people are “spammed by random friend-requests,” an infrequent event by my reckoning, they only need to decline.

The “snob” effect to which The Economist refers occurs only in venues where individuals can’t avoid some form of interaction with the rest of the users. Examples of this would be upscale restaurants or clubs, where increased patronage is bad for everyone: the business loses its exclusive image, and patrons are annoyed by the presence of riffraff.

On the contrary, Facebook becomes more useful as it grows. The larger the network, the more likely it is to find a welcome addition to one’s exclusive circle of friends.

Andreas Kluth, the author of that article in the weekly newspaper, was kind enough to reply to my comments:

I agree with you about the web of small overlapping communities, although my point was that other platforms, such as Ning, are more explicitly built to enable those. But my bigger point, which I could not fit into my word-count, is this: Facebook can choose to become a money machine by aggregating its communities to turn them into valuable audiences, but then it would become like those restaurants you mention. Or it could restrict itself to enabling micro-communities, but then it would be much less valuable as a business.

Oh, so Mr. Kluth’s point is that businesses will not pay much for advertising unless their ads can reach lots of eyeballs. With its current structure of small communities, Facebook is bound to never make much money. I don’t completely disagree with Mr. Kluth. But the value of the company doesn’t reside as much in its sheer size as it does in the closeness among the members of its communities.

The key difference between Facebook and, say, MySpace, is that on Facebook most people actually know and, to some extent, trust their friends -which makes it an ideal venue to implement the internet version of word-of-mouth advertising. This is how it would work. Companies would pitch their products and services to Facebook users who have lots of friends, and then would ask those users to let them place an ad on their home page. (The ads could take the form of a message on a public wall, or some other “cool” widget, to prevent the social network from becoming “too commercial.”) The idea is that the user is personally endorsing the product or service, not selling it. Because of the mutual trust, her friends would be likely to check out those ads. Moreover, most Facebook friends share common interests, backgrounds or socio-economic characteristics, which would make the ads highly targeted. Ads with a high “click-on” rate and a targeted audience would sell at a premium over ads on other internet sites.


On the other hand, as Mr. Kluth points out, the audience of those ads would be much smaller than, say, on Yahoo, since they would reach relatively small communities. So I don’t know whether this strategy would be enough to turn Facebook into a money-making machine.

The Palo Alto start-up seems to be taking steps to boost its revenues. It will soon unveil a new system that “will let advertisers visit an automated Web site to place targeted ads on Facebook and elsewhere,” reports the Wall Street Journal. It remains to be seen whether this new system or its partnership with Microsoft will turn out to be the company’s particular goose of the golden eggs.

In the meantime, everybody is in the dark regarding how much Mr. Zuckerberg’s brainchild is worth. At a conference on “Graphing social patterns,” reports The Economist, panelists valued the Palo Alto start-up at $100 billion. Microsoft places its value at just $15 billion -the software giant bought yesterday a 1.6 percent stake in Facebook for $240 million. That’s still more than 100 times its projected revenues for 2007 –a lot for a company that has not returned a profit in three years. I wouldn’t take any of those estimates at face value.

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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."

"But the evidence is now building that an ugly recession is inevitable."

Roubini is a smart economist who often goes against the consensus view.

We Need a Stimulus Now, But What Kind?

As I've noted several times over the past year, a fiscal stimulus is necessary if the economy is to avoid recession. We may be in recession already. We can't rely soly on monetary policy. A bold fiscal stimulus is necessary, and must be done quickly in order to prevent millions of people from losing their jobs -- and catapulting us into a deeper recession.

What sort of stimulus? Since 80 percent of Americans pay more in payroll taxes than they do in income taxes, and because middle and lower-income people are far more likely to spend whatever tax relief they get than higher-income people, the best stimulus would offset the payroll tax. And the easiest way to do this is through a refundable tax credit, effective as soon as possible. I've looked at what the candidates are offering. Obama's stimulus package seems to me to be the most reasonable. It would give a direct, immediate boost to the economy. In my view, its tax cuts for workers and extra social security payments for seniors offer the fastest and most efficient way to get more purchasing power into the economy.

Unfair trade?

I’ve gotten used to hearing things like this: “Country X (insert the name of your favorite developing country here) doesn’t care about the labor rights of its workers, so US products can’t compete with Country X's.” Ditto about environmental or product safety standards. American manufacturers are being wiped out by hordes of third-world factories that exploit children and slave-workers; produce unsafe goods; and dump their untreated filth into the air and water. The situation is often described as “unfair.”


That some countries have lower standards than the US is undeniable. That competition from those countries is unfair, though, defies logic. It doesn’t make sense to complain that the behavior of our competitors is not fair play, given that the American tough rules are self-imposed.

Differences in social standards reflect heterogeneity in preferences across countries, and preferences are neither fair nor unfair. Is it unfair to French employers that, unlike their American counterparts, they must give their workers five weeks of paid vacation a year? Is it unfair to Canada that the minimum wage in Alberta is CAD$8.00, but only $6.15 across the border in Montana? Is it unfair to Saudi Arabia that its women are not allowed to participate in market activities, thus effectively wasting a vast pool of human capital? Is it unfair to American carmakers that their cars won’t pass emission standards in Europe?

Laws vary across countries and over time, but they simply mirror the values of the constituencies that chose those laws.

I know what you’re thinking: you’re revolted at the thought that developing countries base their comparative advantage on their utter disregard of nature and their own people. But not every person feels the same way. Imposing your standards, or even worse, banning trade with those countries, would amount to imposing your rules in your own house, your neighbor’s, and in the entire neighborhood.

Accommodating disparate values is not difficult: we only need to label products to reflect the social standards of the producers. So we could have T-shirts with little labels that certify that they were made in factories that don’t use children, don’t dump their toxic dyes into the river, and let their workers go home every day; and regular T-shirts. Studies have shown that American consumers are willing to pay substantial premiums for “socially responsible” products. See here and here; hat tip to Dani Rodrik.

Moreover, as much as we cry foul over the barbarism of other countries, America hasn’t always been a green pasture. Scientists have observed that, as countries develop, domestic pollution rises and then falls; the relationship between income and contamination displays an inverted-U shape, the so-called environmental Kuznets curve (see chart, which shows the estimated relationship between ambient sulfur dioxide concentrations and income per capita).

A dirt-poor country (no pun intended) doesn’t produce much of anything, not even pollution. As it industrializes, its pollution rises, both in absolute terms and relative to its output. Beyond a certain point in development, however, its inhabitants will put more weight on the environment and less on growth, and will spend more resources abating pollution and enforcing tougher standards. I haven’t read about Kuznets curves in the fields of product safety or labor standards, but I wouldn’t be surprised if they existed.

In the future, China, India and Mexico, to name a few, will become cleaner, more respectful places. The sorry state of those countries regarding social matters is just a necessary stage in their development. In the meantime, it’s only fair that they do what they want, just as the US does now and has done in the past.

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Economist: America's Vulnerable Economy

America's Vulnerable Economy

Prediction

The nominees for president in 2008 will be John McCain and Barack Obama. I can’t, as yet, see far enough into the future to know which of them will win. I'll report back just as soon as I do.

Apparent "oops"

In my previous post I wrote "For borrowers in a pinch, mortgage payments probably take priority over credit card payments." Somebody called my attention to a study by Experian that seems to contradict my assertion. The credit-reporting agency finds that people with bad credit are less likely to skip a credit card payment than a mortgage payment. I couldn't find the study online, but here's a review.

But if you interpret the finding by Experian carefully, you'll see that the contradiction is only apparent, and I already touched on this argument in my post. Borrowers have the option to make small payments on their credit card debt. Because minimum payments are minute and late payment fees hefty, borrowers have the incentive and the ability to "not skip" card payments. In a way, however, making just the minimum payment is skipping your card payment. Mortgage amortization schemes, on the other hand, are seldom flexible, so people either make their monthly payments in full, or not at all.

Economy Slowing Says Calculated Risk

Great Blogger, Calculated Risk "Clearly the economy is slowing sharply"

Thank Me For My Patience

After what seemed like an interminable wait on the phone the other day for a service representative to help me fix a holiday gift that wouldn't work, I heard the dreaded words: "Thank you for your patience." I heard them again after sitting on a plane that was stuck on a runway for over an hour. "Thank you foryour patience." Again, at a hotel that had misplaced my luggage. "Thank you for your patience." A few days ago at a restaurant where I thought I had made areservation but somehow didn't have a table. "Thank you for your patience."

Again and again -- it seems more this past holiday season than ever before -- I'm being thanked for giving something I did not give and I don't have, especially at that particular moment, and that's patience. What's galling is that the thankers know I have no choice in the matter. Whether it's on the phone or on a runway or in a lobby or in a restaurant, I'm stuck because I've already committed myself to their service, flight, hotel room, or table for two. What I'm really being thanked for is not going ballistic.

The old saw says time is money. But now that most of us are working and commuting longer hours than ever, our time is worth more than money. Time is the most precious thing we have. And if the market worked like it does in textbooks, we'd penalize companies for costing us time. We'd pay them for their product and we'd bill them for our time. That way, they'd have an incentive to staff up when they need to, or devise backup systems for when something goes wrong, or give customers better notice of delays -- even though these steps might cost them more.

But the market isn't working because we rarely connect the price we pay for something with the time we lose waiting for it. Maybe there should be a truth-in-labeling law requiring companies to disclose not just prices but also average waiting times. Of course, given how backed up Congress is, we'll wait years. In the meantime, I'd settle for a law banning the use of the phrase "thank you for your patience."

The other sub-prime debt

Pop quiz: What am I? Banks give me to people with weak credit histories. I get securitized off the lender’s balance sheet. And I carry a variable interest rate. Nope, I’m not a sub-prime mortgage.

Credit card companies wrote off 4.58 percent of distressed debt balances in the first half of 2007, 30 percent more than in the same part of 2006. Outstanding revolving debt –the lion’s share of which consists of credit card debt- amounted to about $915 billion at the end of August. With a default rate of, say, 4.5 percent, we’re talking about $41.2 billion worth of non-performing credit lines. Could credit card debt bring about another liquidity crisis?

The current level of credit card balances in distress is relatively small. The default rate for sub-prime mortgages is about 20 percent, and aggregate outstanding balances of that type of loans come to about $1.2 trillion. The level of non-performing sub-prime mortgage balances is thus $240 billion, or about 6 times as large as its credit card counterpart. This is the end of the good news.

The relative low rate of credit card defaults is a bit misleading. Mortgages are classified as bad as soon as the borrower is late for a few monthly payments in a row. On the other hand, the 4.58 percent of bad revolving credit I mentioned above does not include the balances that borrowers roll over indefinitely by making only the minimum payment. Many of those balances will eventually be in default, but that may take months or years.


Moreover, the fortunes of credit card balances and mortgages may go hand in hand. For borrowers in a pinch, mortgage payments probably take priority over credit card payments. Debtors can always postpone the latter by rolling them over. If enough people do that, cash flows from credit card balances will fall too far below projections and a liquidity problem may ensue. The investors who buy securitized pools of receivables will have a problem too as the value of their bonds drops.

Credit card debt is also more or less linked to the value of real estate. Part of the reason why the sub-prime mortgage market got out of hand is that the size of loans was implicitly linked not to the current value of housing but to its expected future value -both borrowers and lenders were expecting the price of housing to go up, and were planning to refinance the loans before higher interest rates kicked in. Alas, the real estate soufflé collapsed and borrowers got stranded with outsized mortgages that they could neither pay off nor roll over.

Likewise, credit card issuers probably extended generous credit lines to homeowners in the expectation that, if need be, borrowers would tap into their home equity to finance their card balances. In the face of falling real estate prices, credit card issuers will become stingier.

The Wall Street Journal reported in August that some lenders are tightening credit standards for auto loans, credit cards and personal loans. “We used to offer frequent, automatic line increases, and now, we’ve pulled back a little bit,” Barbara Johnson of the USAA Federal Savings Bank told the Journal. The growth of revolving consumer debt has stopped accelerating since the spring (see chart, from the same article in the WSJ).


By some accounts, the economy is tiptoeing around a recession. Reining in credit would bring consumption growth to a halt, as well as Gross Domestic Product to a large extent. Is there anything we can do?

The simplest thing that state and federal governments should do is lower or eliminate bankruptcy limits. The bankruptcy limit is the amount of wealth that a borrower is allowed to keep when she files for bankruptcy. More than one academic study (see this one and this one, for example) show that higher bankruptcy limits make lenders decrease the amount of credit they give, especially to low-wealth borrowers. And those are precisely the debtors who are most likely to be caught in sub-prime debt with adjustable rates. Lower limits would increase the amount of credit available, lower its cost, and foster responsible borrowing.

Here’s a more difficult quiz: who is going to convince the government and consumer associations that less consumer protection is better for borrowers?

How likely is a credit card meltdown? Could it set off a recession? Who is to blame for the high default rates in the sub-prime and credit card markets? Leave your answers in the comments.

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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
  

Benazir Bhutto and What's to Come

Benazir Bhutto was a courageous and articulate woman who was deeply dedicated to her nation and to democracy. I met her several times in the 1990s. Each time she talked with great passion and eloquence about returning to Pakistan, regardless of the risks entailed, to help that nation build a firm democracy.

Today, Pakistan is a tinder box containing a nuclear bomb. If it should drift into civil war, the world will be greatly endangered. Afghanistan and Iran border Pakistan on the West; India (with its own nuclear bomb) on the East.

Republicans will try to use any ensuing instability and violence to make their case for a “strong” foreign policy backed by military force, reminding voters that the world is a dangerous place and that Republican militarism is therefore necessary. And they will once again try to brand Democrats as “soft” on terrorism. But they do so at their peril. It is the Bush administration, after all, that has placed a huge and risky bet on President Pervez Musharraf – staking him billions of dollars we now know was used to build up the Pakistani military, presumably against India, rather than to fight terrorists on its northwest frontier. The Bushies also allowed India to expand its nuclear arsenal, raising the stakes further. When Musharraf’s hold on power grew precarious, the Bushies facilitated Bhotto’s return to Pakistan. When Musharraf banned political rallies – both to preserve his own power but also to avoid widespread violence – it was the Bush administration that urged him to allow them and allow Bhutto to speak at them. In short, at every step along the way the Bush administration has gambled wildly, with no backup in case its gambles fail. If Republicans want to celebrate and politicize this sort of mindless foreign policy – analogous to the mindlessness we’ve seen in Iraq – they will pay politically.

In the meantime, let us pray that Pakistan does not disintegrate into violence and civil war.

Temporary marriages

“German politician suggests temporary marriages” was a recent news story . Gabriele Pauli, the member of the conservative CSU who launched the proposal, believes that anyone wanting to stay married more than seven years would have to apply for an extension. Otherwise, the union would automatically expire.

Brilliant! Why should spouses have to stick together forever? Life takes many twists and turns that might make you want to part ways with your one-time sweetheart. Besides, couples could always chain fixed-term marriages and remain together for as long as they liked. In fact, given the high rate of failed unions, temporary marriage is a necessary institution. Is it?

After thinking about this for a while, here’s my conclusion. If you believe that people are perfectly rational and far-sighted, then temporary marriage is a redundant arrangement. Modern, secular societies have accepted four behaviors or institutions that accomplish the same goals. Those institutions are: cohabitation, divorce, pre-nuptial agreements and pre-marital sex. On the other hand, if you think that humans are inattentive creatures that postpone inevitable losses, then temp marriages can be useful.

Temp marriages are redundant

Taking your partner for a test drive sounds like a great idea. You don’t want to get stuck with a lemon on a coast-to-coast ride. And I don’t mean learning about your partner’s sense of humor, income, or intelligence -you figure that out in the first couple of dates. I’m thinking about experience traits such as earnings growth potential, resilience in the face of job or family setbacks, or health.


But the importance of learning about your partner is one of the reasons why society allows and practices cohabitation. Even in relatively conservative America, 41 percent of women ages 15 to 44 have lived with an unmarried man, according to the 2000 Census.

In spite of all that learning before tying the knot, people still misjudge their partners. And some harmful habits, such as domestic abuse, alcoholism, drugs, or snoring, appear only after years of life in common. Other people develop the proverbial “seven-year itch.”

But this is why societies have sanctioned divorce. Committing to a fixed-term marriage, while retaining the possibility to get a divorce, is meaningless. The divorce option can be defined as “I can quit anytime”; the temp marriage with a divorce option goes “I can quite at the end of the contract, or any time.”

Temporary marriages also ease the splitting process. Presumably, distribution of assets, custody of the children, alimony and child support, etc. would be stipulated on the contract. But spouses who are concerned about the financial consequences of a separation sign pre-nuptial agreements. Since the divorce option, with the attached pre-nuptial distribution of assets, can be executed any time, it is superior to temp marriages.


Finally, temporary marriages allow people to get in intimate relationships without having to commit for life. But modern, secular societies consent sex between unmarried people.

In fact, some religious groups have allowed fixed-term marriages in order to substitute for consented pre-marital sex. The Muslim Shiites allow the “Nikah Mut’ah” or “sigheh”, which is a marriage with a preset duration and, in practice, a way around the official ban on pre-marital sex. The institution is an exercise in hypocrisy, since “sigheh” can last for as little as a few hours and the spouses don’t even need a cleric. (Another motivation for the sigheh is to allow prostitution –some women will accept to “get married” for hours or days in exchange for a dowry.) But the point is that secular societies have accommodated people’s urges by authorizing pre-marital sex, instead of adopting temp marriages.

Temp marriages can be useful

Humans are pretty inattentive creatures. We don’t reconsider the decision to have cable TV every day. Likewise, we typically do not re-evaluate the optimality of our wedlock state very often, even though divorce is an available option every single day. Temporary marriages force us to do that re-evaluation at least once each term, near the end of the contract. This forced re-evaluation would stop relationships that would have withered away for too long otherwise.

Another way to understand the same phenomenon is procrastination. The process of splitting up comes with costs, both subjective and real: the fear of and stress from separation, the attorney’s fees, moving costs, etc. It is perfectly rational to postpone losses, since we apply a discount factor to future events. But when eventual divorce becomes a certainty, postponing it is never optimal: the more you wait, the more difficult it will be to find another spouse, and the larger the foregone happiness from remaining in a bad marriage. Temp marriages cap those losses.

So the evaluation of temporary marriages depends on how rational people are. Which view is more accurate? That’s up to you: I muse, you decide.

Can you think of other reasons why temporary marriages are a valuable option? Is there some other "irrational behavior" that leads people to prolong their (failed) marriages? Why have societies chosen divorce, pre-marital sex and cohabitation as alternatives to fixed-term marriages? Leave your answers in the comments.

Technorati tags:
economics, marriage, temporary marriage, divorce, family

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.

"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 recession

On Immigration

The biggest split in America today isn’t over social issues like abortion or gay marriage. It’s not even over the war in Iraq, or taxes. The biggest divide is over immigration.

Demagogues on the right and left are telling Americans our jobs are threatened, our social services overwhelmed, and their streets unsafe because of immigrants. Fear and prejudice are on the rise. According to a recent Pew survey, more than half of Hispanic adults in America today worry they or someone close to them could face deportation. Earlier this year, when Congress tried to enact a bipartisan bill that would better secure the borders and also try to regularize the plight of undocumented immigrants – giving them a path to become regular citizens and avoid the constant fear of deportation – the bill was killed by these agents of fear and intolerance.

Well, I have some news for those fear-mongers. If they think this country or this economy can succeed in coming decades without tens of millions of additional immigrants, they’re not thinking straight. The huge baby boom generation – 77 million Americans born between 1946 and 1964 – will be retiring, and there aren’t nearly enough native-born Americans after them to keep this economy going, let alone keep money flowing into the boomers’ Social Security and Medicare trust funds. The graying of America means we need this new wave of immigrants.

Remember also that most of us born here are descended from immigrants. What we’ve learned is that people with the guts and gumption to leave their country of birth and come to America are almost by definition ambitious. And we also know something else: The single most important asset of this economy and society is ambition.

I’m not arguing that we throw our borders open. No, we need better border security. But to think immigrants are our enemies, or to believe that they’re taking more out of the economy more than they putting into it, is pure baloney.

At this time of year especially, we need to remind ourselves of the tolerance and generosity that built this country by allowing our immigrant ancestors to become full-fledged Americans.

News and the economy

You must have noticed how downbeat the tone of economic news has become recently. In August, reporters sounded concerned, then became gloomy, and now they’re definitely fretful. At this pace, by the end of October we’ll have a depression.

Housing prices are collapsing like a soufflé and, according to the news, they’re taking private spending and employment with them. We’ve been pounded with this story for weeks. Check out this headline on the front page of Wednesday’s Wall Street Journal: “Housing chill grows worse, bites consumers.” The rest of the article doesn’t get any warmer.

And yet I don’t think anybody, basing their conclusions exclusively on the available data, would be that pessimistic. Robert Lucas had soothing words for us a few days ago. (Read them here, via Mark Thoma.) Consumer spending in August, reported today, rose by 0.6 percent, the highest increase in the last four months. Can journalists foresee things that the rest of us can’t? Or could they just be dragging us into a recession with their rash predictions, one headline at a time?

A popular way to gauge the influence of the newspapers is to check how the number of stories that contain the word “recession” correlate with the business cycle. The Economist’s R-word index must have been the first of its kind.

Click on the chart to enlarge.


Current macroeconomic statistics are only known with months of delay. The news, on the other hand, are available instantly. They even seem to provide a glimpse of the future. Look at the chart above. My own R-word index shoots up right before the beginning of recessions and peaks near the end of such episodes. It also leads changes in the unemployment rate.

The contribution of the media to public opinion, however, is not to provide more accurate or more timely forecasts -journalists don’t have clearer crystal balls than economists, and they use the same hard data as the rest of us. Their effect comes from interpreting and opining, and choosing the tone of their writing. And they tend to be a trigger-happy bunch –big splashes of bad news sell better than timid guesswork.

The question of whether the media have some influence on economic ups and downs has worried politicians before. When Alfred Kahn was President Carter’s economic advisor, the White House got upset because he mentioned the possibility of a recession. So Kahn said, “OK, I’ll call it a ‘banana’ instead. There’s a possibility we’re going to have a big banana.”

Academics have caught up with the idea only recently, perhaps because the internet has made newspaper searches much faster. The most impressive paper I’ve found in this line of research is the one by Mark Doms and Norman Morin of the Federal Reserve of San Francisco and the Fed’s Board of Governors, respectively. Doms and Morin measure news sentiment using a fancier version of the R-word index of The Economist –one that includes news from 30 newspapers and uses words other than “recession,” such as “layoffs” and “economic recovery”, among other improvements.

They find that the media can make the state of the economy look worse than it really is. In fact, they have done it in the past. Look at my chart above: during the mild recession of 1990-91 the New York Times was more downbeat than during the huge oil crises of the 1970s and 1980s. Doms and Morin also find that people give credit to those alarming headlines, as reflected by the correlation between the tone of the news and the Michigan index of consumer sentiment. Because spending is affected by consumer sentiment, the media do aggravate recessions.

Right now the press is actually not as jittery as it was in 1990, or even in 2001, in spite of my gloomy observations at the beginning of this post (talk about shaping the opinion of your readers?). During the month of September the New York Times has run an average of 2.2 articles per day with the R word. That’s much lower than the 4.2 average we saw in the four months preceding the 2001 recession. (See chart.)

Click on the chart to enlarge.


But Doms and Morin’s most fascinating conclusion is that “consumers update their expectations about the economy much more frequently during periods of high news coverage than in periods of low news coverage.” They also confirm what I ventured above: “high news coverage of the economy is concentrated during recessions and immediately after recessions.” So, aside from shaping public opinion directly, the intensity and tone of news coverage determines how much attention people pay to economic news.

We have two hypotheses to explain the combination of those findings. The first one is that people are pessimistic about economic news by nature. Bryan Caplan, blogger at EconLog, has written a book where he analyzes what he calls “pessimistic bias”, among other economic misconceptions. So people only believe bad news because those conform to their (dismal) prior expectations.

The second hypothesis, my favorite, is the notion that people display "optimal inattention”–they update their information only sometimes, on purpose. So, for example, you ignore the evening newscast when it sounds like “business as usual”, but you really open your eyes when you see a headline reading “Recession likely.”


There are several rationales behind optimal inattention. One is that individuals think that bad news, but not good ones, may have an impact on their financial futures. For example, "Citigroup to lay off 3K" makes you worry about keeping your job; but "Citigroup's profit up 32%" does not make you think about a bigger bonus.

Another explanation is that people solve a signal extraction problem. On any given day the news combine truth and noise, so the evidence needs to pile up over weeks or months before the individual is convinced that something is truly happening. Because newspapers insist more on bad economic news than on good ones, it takes a shorter time for individuals to extract the truth in bad times.

I don’t think that we can tell apart these stories using aggregate data. Economists will need to use controlled experiments instead, such as this one, mentioned a while ago by Freakonomics.

But the effort will be worth it. Monetary policy for one could benefit from that research. The task of central bankers depends critically on "anchoring expectations". If we understood how those expectations are shaped by what people read, the Fed's messages could become capable of directing the course of inflation or the economy.

The role of the blogosphere in all this is uncertain. There is some sketchy reasoning out there, and a lot of parroting. My sense is that high-quality posts get more coverage from the parrots than the bad ones, so the blogosphere offers a healthy counterpoint to the mainstream media. But that's only my view. Just in case, I’m going to stop using the word reces… I mean… banana.

Why do you think economic news coverage is higher during bad times? Do you know of estimates of the effect of news bias on the real economy, not just on consumer sentiment? What's the most likely explanation why consumers are "rationally inattentive"? Leave your answers in the comments.

Technorati tags:
economics, news, media bias, recession, consumer sentiment

Housing Bubble Sites

National 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

Pizza and beer now cost an arm and a leg

Sure sign economy is headed for trouble: Even cheap eats are hard to find

If you’re looking for a sure sign the U.S. economy is headed in the wrong direction, all you need to do is look at the skyrocketing price of “recession-proof” foods: pizza, hot dogs, bagels and beer.

For many Americans, the credit crunch and the mortgage mess have left their pocketbooks – and their cupboards – bare. These same consumers, many living paycheck to paycheck, have relied on these cheaper foods to keep their expenditures down. Not anymore.

In the past few months, the news has gone from bad to worse:

Pizza makers have seen their cheese costs soar this year from $1.30 a pound to $1.76 a pound. Even worse, the flour used to make the dough has gone from $3-$7 dollars a bushel to $25 a bushel in less than a year.

Beer makers have been forced to raise their prices because of the skyrocketing price of hops – one of the principle ingredients. The price of hops has gone from about $4 a pound in September to $40 a pound. The price of barley, beer’s other main ingredient, has nearly doubled.

Bagel shops have struggled to hold the line on prices and keep their customers. The exploding wheat prices have made the $1 bagel a fact of life in big cities such as New York. Donuts are averaging $1.50. And many shop owners fear a wheat shortage will drive prices even higher.

Even the lowly hot dog is getting more expensive. Gray’s Papaya, a New York hot dog institution, will be jacking up the price for its $3.50 “Recession Special” – two hot dogs and a 14-ounce drink. Nicholas Gray, owner of the frankfurter chain, has yet to set the price increase, but he indicated it is coming soon.
Overall, retail food prices rose 4 percent last year – the biggest jump in 17 years. The USDA officials predicted another 3 percent to 4 percent increase this year and continuing price hikes, faster than the pace of inflation going into 2010. And the price pinch has hit the lower-income shoppers hardest.

Why is this happening? Call it the perfect storm of inflationary pressures.

Bob Goldin, executive vice president of Technomic Inc., a food industry consulting firm, described the cost increases as a "disaster scenario," with no real end in sight and limited ability for most to pass on the bulk of the costs to consumers.

Surging energy costs have driven up the price of transporting goods from farm to storefront. The national average for a gallon of gas jumped to $3.164, creeping closer to last May's record of $3.227, according to AAA and the Oil Price Information Service. Diesel prices jumped 1.5 cents to a new record national average of $3.642 a gallon.

While most Americans fuel their cars with gasoline, most of the products they buy are transported by trucks, trains and ships that burn diesel. While gas prices are unlikely to rise as high as $4 a gallon, diesel may well pass that psychologically important level this spring, boosting prices of virtually every consumer product, said Tom Kloza, publisher and chief oil analyst at the Oil Price Information Service in Wall, New Jersey.

"It's everything that gets shipped," Kloza said of diesel fuel's impact on the economy. "That is the one that is much scarier."

Another reason for the sharp hike in food prices is the increasing demand for ethanol, which has driven up the price of corn – and at the same time created a shortage of wheat as farmers shift their crop to the more lucrative corn.

“There are several reasons [for higher food prices], but at the core is corn, the largest and most important of agricultural commodities,” said Bill Lapp, president of Advanced Economic Solutions.

Which brings us back to the price of flour — and the pricier pizza. Jimmy Ferrell, owner of the four Fat Jimmy's pizza restaurants in Louisville, Ky., said the price of flour has forced him to pass the cost onto his customers. "You have to raise (prices) a couple times a year just to keep up," he said.

Ferrell thinks the rising flour prices have hurt small operators more than national chains.

"The national chains have a lot more pull and they can negotiate prices. I don't think we have the same buying power that a Papa John's or a Domino's obviously has."

Food industry consultant Goldin doesn’t see a light at the end of the tunnel. "There are no simple solutions," he said. "The trend will be to reduce product costs, and some of that may very well affect quality.”

So, how can budget-conscious consumers stretch their dollar? There is one – albeit artery-clogging — alternative.

Fast food companies, looking for a way to attract budget-conscious customers, are increasingly offering more food for less money. The “dollar-menu” option is growing at chains such as McDonald’s, Burger King and Quiznos.

That's good news for diners like Boston resident Shekia Scott. While lunching with friends at a Burger King, Scott said higher prices for food and gas were hurting her budget. But, she added, "the dollar menu's been a help."

So there you have it. Your best option for cheap eats is a gut-busting McDonald’s double cheeseburger for a buck. Makes you want to cry in your beer … if you can afford it.

The Associated Press and CNBC contributed to this report.

The Wall Street Journal Gets it Wrong Again

The editorial board of the Wall Street Journal is at it again. In today's lead editorial, the Journal noted that new numbers from the Congressional Budget Office show that the richest 1 percent of Americans together paid about 39 percent of all income taxes in 2005 (the latest year for which such data are available); the richest 5 percent paid almost 60 percent; the richest 10 percent, 70 percent. Americans with incomes below the median (half of all households) paid a total of 3 percent of all income taxes.

Hence, the Journal reasons, it would be unfair and foolhardy for anyone to suggest a higher marginal income tax on the rich.

Once again, the Journal distorts reality by ducking two important issues. The first is the total tax burden – including sales, property, and payroll taxes, as well as fees, tolls, so-called “sin” taxes (alcohol and tobacco) and lotteries. These are, by most measures, regressive in that they take a larger bite out of the earnings of lower-income households than they do upper-income households. (Those who continue to claim that Social Security is a progressive system fail to acknowledge that poor people don’t live as long as richer people; those who say “sin” taxes and lotteries aren’t compulsive and therefore shouldn’t really be considered regressive are living on another planet. Tragically, poorer Americans consume on a per capita basis more alcohol and tobacco and are lured into buying more lottery tickets than richer Americans.)

The second issue is that of individual, rather than group or class, responsibility. Whatever is deemed a “fair” rate of taxation presumably is “fair” relative to the rate an individual or household pays – not the total revenue generated from his or her economic class. The rich have become so very rich that even if they were paying a lower marginal income tax rate than they are, the revenues coming from the “richest 1 percent” or “richest 5 percent” would still constitute a large percentage of total revenues. The real question, from the standpoint of ethics or social responsibility, is what individuals or households pay. And there is no question that the marginal income tax rates of the very rich are very low by historic standards. Some of them are paying at a lower tax rate than working-class Americans. Does anyone seriously believe that a hedge fund manager, venture capitalist, or private-equity mogul paying at a 15 percent rate (because his earnings are considered capital gains rather than ordinary income) is paying a fair share?

Conservatives cannot have it both ways – embracing the idea of individual responsibility when it comes to the poor; forgetting it when it comes to the rich.