The frame has been set, the dye cast. Treasury Secretary Hank Paulson, presumably representing the Bush administration but indirectly representing Wall Street, and Fed Chief Ben Bernanke, want a blank check from Congress for $700 billion or possibly a trillion dollars or more to take bad debt off Wall Street’s balance sheets. Never before in the history of American capitalism has so much been asked of so many for (at least in the first instance) so few.
Put yourself in the shoes of a member of Congress, including our two presidential candidates. The Treasury Secretary and Fed Chair have told you this is necessary to save the economy. If you don’t agree, you risk a meltdown of the entire global financial system. Your own constituents’ savings could go down with it. An election is six weeks away. Besides, in the last two days of trading, since rumors spread that the Treasury and the Fed were planning something of this sort, stock prices revived.
Now – quick -- what do you do? You have no choice but to say yes.
But you might also set some conditions on Wall Street.
The public doesn’t like a blank check. They think this whole bailout idea is nuts. They see fat cats on Wall Street who have raked in zillions for years, now extorting in effect $2,000 to $5,000 from every American family to make up for their own nonfeasance, malfeasance, greed, and just plain stupidity. Wall Street’s request for a blank check comes at the same time most of the public is worried about their jobs and declining wages, and having enough money to pay for gas and food and health insurance, meet their car payments and mortgage payments, and save for their retirement and childrens’ college education. And so the public is asking: Why should Wall Street get bailed out by me when I’m getting screwed?
So if you are a member of Congress, you just might be in a position to demand from Wall Street certain conditions in return for the blank check.
My five nominees:
1. The government (i.e. taxpayers) gets an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.
2. Wall Street executives and directors of Wall Street firms relinquish their current stock options and this year’s other forms of compensation, and agree to future compensation linked to a rolling five-year average of firm profitability. Why should taxpayers feather their already amply-feathered nests?
3. All Wall Street executives immediately cease making campaign contributions to any candidate for public office in this election cycle or next, all Wall Street PACs be closed, and Wall Street lobbyists curtail their activities unless specifically asked for information by policymakers. Why should taxpayers finance Wall Street’s outsized political power – especially when that power is being exercised to get favorable terms from taxpayers?
4. Wall Street firms agree to comply with new regulations over disclosure, capital requirements, conflicts of interest, and market manipulation. The regulations will emerge in ninety days from a bi-partisan working group, to be convened immediately. After all, inadequate regulation and lack of oversight got us into this mess.
5. Wall Street agrees to give bankruptcy judges the authority to modify the terms of primary mortgages, so homeowners have a fighting chance to keep their homes. Why should distressed homeowners lose their homes when Wall Streeters receive taxpayer money that helps them keep their fancy ones?
Wall Streeters may not like these conditions. Well, you should tell them that the public doesn’t like the idea of bailing out Wall Street. So if Wall Street doesn’t accept these conditions, it doesn’t get the blank check.
Sunday, November 30, 2008
Saturday, November 29, 2008
What Wall Street Should Be Required to Do, to Get A Blank Check From Taxpayers
The frame has been set, the dye cast. Treasury Secretary Hank Paulson, presumably representing the Bush administration but indirectly representing Wall Street, and Fed Chief Ben Bernanke, want a blank check from Congress for $700 billion or possibly a trillion dollars or more to take bad debt off Wall Street’s balance sheets. Never before in the history of American capitalism has so much been asked of so many for (at least in the first instance) so few.
Put yourself in the shoes of a member of Congress, including our two presidential candidates. The Treasury Secretary and Fed Chair have told you this is necessary to save the economy. If you don’t agree, you risk a meltdown of the entire global financial system. Your own constituents’ savings could go down with it. An election is six weeks away. Besides, in the last two days of trading, since rumors spread that the Treasury and the Fed were planning something of this sort, stock prices revived.
Now – quick -- what do you do? You have no choice but to say yes.
But you might also set some conditions on Wall Street.
The public doesn’t like a blank check. They think this whole bailout idea is nuts. They see fat cats on Wall Street who have raked in zillions for years, now extorting in effect $2,000 to $5,000 from every American family to make up for their own nonfeasance, malfeasance, greed, and just plain stupidity. Wall Street’s request for a blank check comes at the same time most of the public is worried about their jobs and declining wages, and having enough money to pay for gas and food and health insurance, meet their car payments and mortgage payments, and save for their retirement and childrens’ college education. And so the public is asking: Why should Wall Street get bailed out by me when I’m getting screwed?
So if you are a member of Congress, you just might be in a position to demand from Wall Street certain conditions in return for the blank check.
My five nominees:
1. The government (i.e. taxpayers) gets an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.
2. Wall Street executives and directors of Wall Street firms relinquish their current stock options and this year’s other forms of compensation, and agree to future compensation linked to a rolling five-year average of firm profitability. Why should taxpayers feather their already amply-feathered nests?
3. All Wall Street executives immediately cease making campaign contributions to any candidate for public office in this election cycle or next, all Wall Street PACs be closed, and Wall Street lobbyists curtail their activities unless specifically asked for information by policymakers. Why should taxpayers finance Wall Street’s outsized political power – especially when that power is being exercised to get favorable terms from taxpayers?
4. Wall Street firms agree to comply with new regulations over disclosure, capital requirements, conflicts of interest, and market manipulation. The regulations will emerge in ninety days from a bi-partisan working group, to be convened immediately. After all, inadequate regulation and lack of oversight got us into this mess.
5. Wall Street agrees to give bankruptcy judges the authority to modify the terms of primary mortgages, so homeowners have a fighting chance to keep their homes. Why should distressed homeowners lose their homes when Wall Streeters receive taxpayer money that helps them keep their fancy ones?
Wall Streeters may not like these conditions. Well, you should tell them that the public doesn’t like the idea of bailing out Wall Street. So if Wall Street doesn’t accept these conditions, it doesn’t get the blank check.
Put yourself in the shoes of a member of Congress, including our two presidential candidates. The Treasury Secretary and Fed Chair have told you this is necessary to save the economy. If you don’t agree, you risk a meltdown of the entire global financial system. Your own constituents’ savings could go down with it. An election is six weeks away. Besides, in the last two days of trading, since rumors spread that the Treasury and the Fed were planning something of this sort, stock prices revived.
Now – quick -- what do you do? You have no choice but to say yes.
But you might also set some conditions on Wall Street.
The public doesn’t like a blank check. They think this whole bailout idea is nuts. They see fat cats on Wall Street who have raked in zillions for years, now extorting in effect $2,000 to $5,000 from every American family to make up for their own nonfeasance, malfeasance, greed, and just plain stupidity. Wall Street’s request for a blank check comes at the same time most of the public is worried about their jobs and declining wages, and having enough money to pay for gas and food and health insurance, meet their car payments and mortgage payments, and save for their retirement and childrens’ college education. And so the public is asking: Why should Wall Street get bailed out by me when I’m getting screwed?
So if you are a member of Congress, you just might be in a position to demand from Wall Street certain conditions in return for the blank check.
My five nominees:
1. The government (i.e. taxpayers) gets an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.
2. Wall Street executives and directors of Wall Street firms relinquish their current stock options and this year’s other forms of compensation, and agree to future compensation linked to a rolling five-year average of firm profitability. Why should taxpayers feather their already amply-feathered nests?
3. All Wall Street executives immediately cease making campaign contributions to any candidate for public office in this election cycle or next, all Wall Street PACs be closed, and Wall Street lobbyists curtail their activities unless specifically asked for information by policymakers. Why should taxpayers finance Wall Street’s outsized political power – especially when that power is being exercised to get favorable terms from taxpayers?
4. Wall Street firms agree to comply with new regulations over disclosure, capital requirements, conflicts of interest, and market manipulation. The regulations will emerge in ninety days from a bi-partisan working group, to be convened immediately. After all, inadequate regulation and lack of oversight got us into this mess.
5. Wall Street agrees to give bankruptcy judges the authority to modify the terms of primary mortgages, so homeowners have a fighting chance to keep their homes. Why should distressed homeowners lose their homes when Wall Streeters receive taxpayer money that helps them keep their fancy ones?
Wall Streeters may not like these conditions. Well, you should tell them that the public doesn’t like the idea of bailing out Wall Street. So if Wall Street doesn’t accept these conditions, it doesn’t get the blank check.
Friday, November 28, 2008
What Wall Street Should Be Required to Do, to Get A Blank Check From Taxpayers
The frame has been set, the dye cast. Treasury Secretary Hank Paulson, presumably representing the Bush administration but indirectly representing Wall Street, and Fed Chief Ben Bernanke, want a blank check from Congress for $700 billion or possibly a trillion dollars or more to take bad debt off Wall Street’s balance sheets. Never before in the history of American capitalism has so much been asked of so many for (at least in the first instance) so few.
Put yourself in the shoes of a member of Congress, including our two presidential candidates. The Treasury Secretary and Fed Chair have told you this is necessary to save the economy. If you don’t agree, you risk a meltdown of the entire global financial system. Your own constituents’ savings could go down with it. An election is six weeks away. Besides, in the last two days of trading, since rumors spread that the Treasury and the Fed were planning something of this sort, stock prices revived.
Now – quick -- what do you do? You have no choice but to say yes.
But you might also set some conditions on Wall Street.
The public doesn’t like a blank check. They think this whole bailout idea is nuts. They see fat cats on Wall Street who have raked in zillions for years, now extorting in effect $2,000 to $5,000 from every American family to make up for their own nonfeasance, malfeasance, greed, and just plain stupidity. Wall Street’s request for a blank check comes at the same time most of the public is worried about their jobs and declining wages, and having enough money to pay for gas and food and health insurance, meet their car payments and mortgage payments, and save for their retirement and childrens’ college education. And so the public is asking: Why should Wall Street get bailed out by me when I’m getting screwed?
So if you are a member of Congress, you just might be in a position to demand from Wall Street certain conditions in return for the blank check.
My five nominees:
1. The government (i.e. taxpayers) gets an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.
2. Wall Street executives and directors of Wall Street firms relinquish their current stock options and this year’s other forms of compensation, and agree to future compensation linked to a rolling five-year average of firm profitability. Why should taxpayers feather their already amply-feathered nests?
3. All Wall Street executives immediately cease making campaign contributions to any candidate for public office in this election cycle or next, all Wall Street PACs be closed, and Wall Street lobbyists curtail their activities unless specifically asked for information by policymakers. Why should taxpayers finance Wall Street’s outsized political power – especially when that power is being exercised to get favorable terms from taxpayers?
4. Wall Street firms agree to comply with new regulations over disclosure, capital requirements, conflicts of interest, and market manipulation. The regulations will emerge in ninety days from a bi-partisan working group, to be convened immediately. After all, inadequate regulation and lack of oversight got us into this mess.
5. Wall Street agrees to give bankruptcy judges the authority to modify the terms of primary mortgages, so homeowners have a fighting chance to keep their homes. Why should distressed homeowners lose their homes when Wall Streeters receive taxpayer money that helps them keep their fancy ones?
Wall Streeters may not like these conditions. Well, you should tell them that the public doesn’t like the idea of bailing out Wall Street. So if Wall Street doesn’t accept these conditions, it doesn’t get the blank check.
Put yourself in the shoes of a member of Congress, including our two presidential candidates. The Treasury Secretary and Fed Chair have told you this is necessary to save the economy. If you don’t agree, you risk a meltdown of the entire global financial system. Your own constituents’ savings could go down with it. An election is six weeks away. Besides, in the last two days of trading, since rumors spread that the Treasury and the Fed were planning something of this sort, stock prices revived.
Now – quick -- what do you do? You have no choice but to say yes.
But you might also set some conditions on Wall Street.
The public doesn’t like a blank check. They think this whole bailout idea is nuts. They see fat cats on Wall Street who have raked in zillions for years, now extorting in effect $2,000 to $5,000 from every American family to make up for their own nonfeasance, malfeasance, greed, and just plain stupidity. Wall Street’s request for a blank check comes at the same time most of the public is worried about their jobs and declining wages, and having enough money to pay for gas and food and health insurance, meet their car payments and mortgage payments, and save for their retirement and childrens’ college education. And so the public is asking: Why should Wall Street get bailed out by me when I’m getting screwed?
So if you are a member of Congress, you just might be in a position to demand from Wall Street certain conditions in return for the blank check.
My five nominees:
1. The government (i.e. taxpayers) gets an equity stake in every Wall Street financial company proportional to the amount of bad debt that company shoves onto the public. So when and if Wall Street shares rise, taxpayers are rewarded for accepting so much risk.
2. Wall Street executives and directors of Wall Street firms relinquish their current stock options and this year’s other forms of compensation, and agree to future compensation linked to a rolling five-year average of firm profitability. Why should taxpayers feather their already amply-feathered nests?
3. All Wall Street executives immediately cease making campaign contributions to any candidate for public office in this election cycle or next, all Wall Street PACs be closed, and Wall Street lobbyists curtail their activities unless specifically asked for information by policymakers. Why should taxpayers finance Wall Street’s outsized political power – especially when that power is being exercised to get favorable terms from taxpayers?
4. Wall Street firms agree to comply with new regulations over disclosure, capital requirements, conflicts of interest, and market manipulation. The regulations will emerge in ninety days from a bi-partisan working group, to be convened immediately. After all, inadequate regulation and lack of oversight got us into this mess.
5. Wall Street agrees to give bankruptcy judges the authority to modify the terms of primary mortgages, so homeowners have a fighting chance to keep their homes. Why should distressed homeowners lose their homes when Wall Streeters receive taxpayer money that helps them keep their fancy ones?
Wall Streeters may not like these conditions. Well, you should tell them that the public doesn’t like the idea of bailing out Wall Street. So if Wall Street doesn’t accept these conditions, it doesn’t get the blank check.
Thursday, November 27, 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]
Wednesday, November 26, 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
Tuesday, November 25, 2008
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.
Monday, November 24, 2008
The Coming Bailout of All Bailouts Bill: A Better Alternative
If you think the Bailout of All Bailouts (whose details will be worked out over the coming week) won't saddle American taxpayers with billions, if not trillions, of risky obligations, you don't know politics -- especially in an election year when members of Congress are eager to get home to campaign; when the incumbent lame-duck president (who was he?) has all but vanished, leaving his hapless Treasury Secretary, a former investment banker, to take the lead and the heat; when voters are in high anxiety over the economy and Wall Street is melting down; when the executives of every financial powerhouse in America have staked lots of money on campaigns in both parties and have indundated Washington with lobbyists.
In other words, watch your wallets. The tab here could be very high. If everything goes extremely well, markets move upward, and the risky loans become far less risky, it's possible that taxpayers (that is, the Treasury) might actually make money. But if the bottom falls out, American taxpayers could be on the hook for trillions of dollars. What then? The federal debt soars. What then? Interest rates go out of sight. What then? Foreigners lend us less money. What then? We're cooked.
Some Democrats will try to make the best of the emerging Bailout of All Bailouts Bill, seeking to tack a stimulus package on it. In my view, they'd be better advised to hold out for a different approach.
Paulson is right that it makes sense to allow the big banks to wipe their balance sheets clean of as many bad loans as they can identify, and put them into a special agency that then sells them for as much as possible. The agency would bundle or unbundle the risky loans, slice and dice them as needed, with the goal of getting the most for them on world markets by creating a market for them.
But there's no reason taxpayers need to be involved in this.
Whether you call it a reorganization under bankruptcy or just a hellova fire sale, the process should resemble chapter 11 under bankruptcy. Any big financial institution that wants to clear its books can opt in. But the price for opting in is this: Investors in these institutions lose the value of their equity. Executives lose the value of their options, and their pay (and the pay of their directors) is sharply limited. All the money from the fire sale goes to making creditors as whole as possible.
Meanwhile, policymakers work on a new set of regulations to ensure transparency on Wall Street -- governing disclosures, minimum capital requirements, avoidance of conflicts of interest, and better ensurance against stock manipulation -- so that, once the bad debts are off the books, the new numbers can be trusted.
I repeat: This isn't a crisis of solvency or liquidity; it's a crisis of trust.
In other words, watch your wallets. The tab here could be very high. If everything goes extremely well, markets move upward, and the risky loans become far less risky, it's possible that taxpayers (that is, the Treasury) might actually make money. But if the bottom falls out, American taxpayers could be on the hook for trillions of dollars. What then? The federal debt soars. What then? Interest rates go out of sight. What then? Foreigners lend us less money. What then? We're cooked.
Some Democrats will try to make the best of the emerging Bailout of All Bailouts Bill, seeking to tack a stimulus package on it. In my view, they'd be better advised to hold out for a different approach.
Paulson is right that it makes sense to allow the big banks to wipe their balance sheets clean of as many bad loans as they can identify, and put them into a special agency that then sells them for as much as possible. The agency would bundle or unbundle the risky loans, slice and dice them as needed, with the goal of getting the most for them on world markets by creating a market for them.
But there's no reason taxpayers need to be involved in this.
Whether you call it a reorganization under bankruptcy or just a hellova fire sale, the process should resemble chapter 11 under bankruptcy. Any big financial institution that wants to clear its books can opt in. But the price for opting in is this: Investors in these institutions lose the value of their equity. Executives lose the value of their options, and their pay (and the pay of their directors) is sharply limited. All the money from the fire sale goes to making creditors as whole as possible.
Meanwhile, policymakers work on a new set of regulations to ensure transparency on Wall Street -- governing disclosures, minimum capital requirements, avoidance of conflicts of interest, and better ensurance against stock manipulation -- so that, once the bad debts are off the books, the new numbers can be trusted.
I repeat: This isn't a crisis of solvency or liquidity; it's a crisis of trust.
Sunday, November 23, 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]
Saturday, November 22, 2008
The fiscal stimulus: ineffective or wrong?
The latest economic data show that output growth has weakened and unemployment is creeping up. The government is worried, with good reason, that the economy is going through a pronounced slowdown, perhaps even a recession. To limit the damage, Congress yesterday approved a battery of fiscal measures. By my reckoning, however, the plan will at best provide a short-lived nudge to consumption, but not employment; at worst, it’ll do nothing.
Starting in May, the government will send $600 checks to individuals ($1,200 for couples and an extra $300 for each child). People who earn too little to pay income taxes, but make more than $3,000, will receive a $300 payment. Payments will total $106 billion and will add to the budget deficit.
Cash outlays are supposed to boost private consumption expenditures and accelerate overall growth. $106b may seem a small stimulus for a $14 trillion economy, but the payments are expected to have a “multiplier effect”: higher demand will prompt businesses to hire more workers, and increased employment will further stimulate private consumption, which in turn will induce more hiring. The process continues ad infinitum. The outlays, therefore, can have a final effect on aggregate demand that is many times bigger than the initial stimulus —hence the name “multiplier.”
The effectiveness of the measure hinges on two factors. First, the fraction of the government outlays that will be spent immediately. According to Bruce Bartlett, previous experiences with tax rebates in 1975 and 2001 indicate that it's small. The recent study by Elmendorf and Furman indicates that it's a 50 percent.
The second requirement, which has received less attention, is that businesses will respond to the initial surge in demand by hiring new workers. If they don’t, then the fiscal package will have no second-round impact on demand, and the stimulus to consumption will total just $50b.
Because the first two quarters of 2008 will be marked by considerable uncertainty about the course of the economy in the medium term, the announcement of the fiscal plan will not have an immediate effect on hiring. Manufacturers may ratchet up their inventories, in anticipation of the small jolt of demand in May, but they will do so by using overtime and temp workers, rather than hiring permanent employees. In the services sector, we won’t see any change in employment until the late spring, and even then employers will similarly meet spikes in demand with overtime hours and temp workers, at least initially. If, come June, forecasts have improved, we may see employment pick up over the fall. But by then the effect of the government checks will have played out. In conclusion, the fiscal package won’t provide any significant boost to employment.
A less obvious reason to reject the stimulus is that the slowdown in aggregate demand is necessary, even healthy. Most of the growth experienced between 2002 and 2006 was based on low interest rates, over-valued real estate, and loose lending standards.
Chart 1, from a story by Michael Mandel at BusinessWeek, tells it all. Mandel estimates that, “if consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001.” That extra spending was financed with debt. Quite literally, Americans were borrowing their prosperity from the future —not exactly a sustainable growth path.
Chart 1 (left) and 2 (right). Click to enlarge.
The growth of productivity, the value of output per hour worked, confirms the hypothesis that consumer expenditures were out of line with real income gains, at least over the last five years. Robert Gordon of Northwestern University estimates that trend productivity growth peaked in 2002, and has slowed down ever since (see Chart 2, via Michael Mandel’s blog). The gap between long-term growth of GDP and consumption, on the other hand, has widened over the same period.
So, if the recent growth rate of expenditures was excessive, why is Congress rushing to prop it up? More importantly given that the stimulus will be financed with future tax increases: why are legislators borrowing even more from future prosperity? The answers to these questions have a lot to do with politics and very little with economics.
Notice the hodgepodge of enigmatic measures included in the fiscal package. Congress grants payments of $300 to low-income seniors and disabled veterans, but not to other disabled people. It allows federal housing agencies to insure jumbo mortgages, as if subsidies to the purchase of expensive homes was going to parachute the economy. And it includes specific provisions to prevent illegal immigrants from claiming payments, precluding illegals from contributing to the consumption surge, however small that may be. So, if you think about it for a minute, what Congress did is give itself a votes-buying package, which does stimulate something: re-election.
Technorati tags:
economics, macroeconomics, fiscal policy, fiscal stimulus, stabilization policy
Starting in May, the government will send $600 checks to individuals ($1,200 for couples and an extra $300 for each child). People who earn too little to pay income taxes, but make more than $3,000, will receive a $300 payment. Payments will total $106 billion and will add to the budget deficit.
Cash outlays are supposed to boost private consumption expenditures and accelerate overall growth. $106b may seem a small stimulus for a $14 trillion economy, but the payments are expected to have a “multiplier effect”: higher demand will prompt businesses to hire more workers, and increased employment will further stimulate private consumption, which in turn will induce more hiring. The process continues ad infinitum. The outlays, therefore, can have a final effect on aggregate demand that is many times bigger than the initial stimulus —hence the name “multiplier.”
The effectiveness of the measure hinges on two factors. First, the fraction of the government outlays that will be spent immediately. According to Bruce Bartlett, previous experiences with tax rebates in 1975 and 2001 indicate that it's small. The recent study by Elmendorf and Furman indicates that it's a 50 percent.
The second requirement, which has received less attention, is that businesses will respond to the initial surge in demand by hiring new workers. If they don’t, then the fiscal package will have no second-round impact on demand, and the stimulus to consumption will total just $50b.
Because the first two quarters of 2008 will be marked by considerable uncertainty about the course of the economy in the medium term, the announcement of the fiscal plan will not have an immediate effect on hiring. Manufacturers may ratchet up their inventories, in anticipation of the small jolt of demand in May, but they will do so by using overtime and temp workers, rather than hiring permanent employees. In the services sector, we won’t see any change in employment until the late spring, and even then employers will similarly meet spikes in demand with overtime hours and temp workers, at least initially. If, come June, forecasts have improved, we may see employment pick up over the fall. But by then the effect of the government checks will have played out. In conclusion, the fiscal package won’t provide any significant boost to employment.
A less obvious reason to reject the stimulus is that the slowdown in aggregate demand is necessary, even healthy. Most of the growth experienced between 2002 and 2006 was based on low interest rates, over-valued real estate, and loose lending standards.
Chart 1, from a story by Michael Mandel at BusinessWeek, tells it all. Mandel estimates that, “if consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001.” That extra spending was financed with debt. Quite literally, Americans were borrowing their prosperity from the future —not exactly a sustainable growth path.
Chart 1 (left) and 2 (right). Click to enlarge.
The growth of productivity, the value of output per hour worked, confirms the hypothesis that consumer expenditures were out of line with real income gains, at least over the last five years. Robert Gordon of Northwestern University estimates that trend productivity growth peaked in 2002, and has slowed down ever since (see Chart 2, via Michael Mandel’s blog). The gap between long-term growth of GDP and consumption, on the other hand, has widened over the same period.So, if the recent growth rate of expenditures was excessive, why is Congress rushing to prop it up? More importantly given that the stimulus will be financed with future tax increases: why are legislators borrowing even more from future prosperity? The answers to these questions have a lot to do with politics and very little with economics.
Notice the hodgepodge of enigmatic measures included in the fiscal package. Congress grants payments of $300 to low-income seniors and disabled veterans, but not to other disabled people. It allows federal housing agencies to insure jumbo mortgages, as if subsidies to the purchase of expensive homes was going to parachute the economy. And it includes specific provisions to prevent illegal immigrants from claiming payments, precluding illegals from contributing to the consumption surge, however small that may be. So, if you think about it for a minute, what Congress did is give itself a votes-buying package, which does stimulate something: re-election.
Technorati tags:
economics, macroeconomics, fiscal policy, fiscal stimulus, stabilization policy
Friday, November 21, 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."
Thursday, November 20, 2008
Why Wall Street is Melting Down, and What to Do About It
Hank Paulson didn't blink, so Lehman Brothers went down the tubes. The end of socialized capitalism? Don't bet on it. The Treasury and the Fed are scrambling to enlarge the government's authority to exchange securities of unknown value for guaranteed securities in an effort to stave off the biggest financial meltdown since the 1930s.
Ironically, a free-market-loving Republican administration is presiding over the most ambitious intrusion of government into the market in almost anyone's memory. But to what end? Bailouts, subsidies, and government insurance won't help Wall Street because the Street's fundamental problem isn't lack of capital. It's lack of trust.
The sub-prime mortgage mess triggered it, but the problem lies much deeper. Financial markets trade in promises -- that assets have a certain value, that numbers on a balance sheet are accurate, that a loan carries a limited risk. If investors stop trusting the promises, Wall Street can't function.
But it's turned out that many promises like these weren't worth the paper they were written on.
That's because, when the market was roaring a few years back, many financial players had no idea what they were buying or selling. Worse, they didn't care. Derivatives on derivatives, SIVs, credit default swaps (watch this one!), and of course securities backed by home loans. There seemed no limit to the leverage, the off-balance sheet liabilities, and what credit rating agencies would approve by issuers who paid them to.
Two years ago I asked a hedge fund manager to describe the assets in his fund. He laughed and said he had no idea.
This meant almost no limit to what was promised. Regulators -- Alan Greenspan in particular -- looked the other way.
It worked great as long as everyone kept trusting and the market kept roaring. But all it took was a few broken promises for the whole system to break down.
What to do? Not to socialize capitalism with bailouts and subsidies that put taxpayers at risk. If what's lacking is trust rather than capital, the most important steps policymakers can take are to rebuild trust. And the best way to rebuild trust is through regulations that require financial players to stand behind their promises and tell the truth, along with strict oversight to make sure they do.
We tell poor nations they have to make their financial markets transparent before capital will flow to them. Now it's our turn. Lacking adequate regulation or oversight, our financial markets have become a snare and a delusion. Government only has two choices now: Either continue to bail them out, or regulate them in order to keep them honest. I vote for the latter.
Ironically, a free-market-loving Republican administration is presiding over the most ambitious intrusion of government into the market in almost anyone's memory. But to what end? Bailouts, subsidies, and government insurance won't help Wall Street because the Street's fundamental problem isn't lack of capital. It's lack of trust.
The sub-prime mortgage mess triggered it, but the problem lies much deeper. Financial markets trade in promises -- that assets have a certain value, that numbers on a balance sheet are accurate, that a loan carries a limited risk. If investors stop trusting the promises, Wall Street can't function.
But it's turned out that many promises like these weren't worth the paper they were written on.
That's because, when the market was roaring a few years back, many financial players had no idea what they were buying or selling. Worse, they didn't care. Derivatives on derivatives, SIVs, credit default swaps (watch this one!), and of course securities backed by home loans. There seemed no limit to the leverage, the off-balance sheet liabilities, and what credit rating agencies would approve by issuers who paid them to.
Two years ago I asked a hedge fund manager to describe the assets in his fund. He laughed and said he had no idea.
This meant almost no limit to what was promised. Regulators -- Alan Greenspan in particular -- looked the other way.
It worked great as long as everyone kept trusting and the market kept roaring. But all it took was a few broken promises for the whole system to break down.
What to do? Not to socialize capitalism with bailouts and subsidies that put taxpayers at risk. If what's lacking is trust rather than capital, the most important steps policymakers can take are to rebuild trust. And the best way to rebuild trust is through regulations that require financial players to stand behind their promises and tell the truth, along with strict oversight to make sure they do.
We tell poor nations they have to make their financial markets transparent before capital will flow to them. Now it's our turn. Lacking adequate regulation or oversight, our financial markets have become a snare and a delusion. Government only has two choices now: Either continue to bail them out, or regulate them in order to keep them honest. I vote for the latter.
Wednesday, November 19, 2008
Tuesday, November 18, 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, November 17, 2008
Sunday, November 16, 2008
Global Warming, Retiring Boomers, and Who's to Pay the Damages?
As I write this, Hurricane Ike is heading to the Gulf coast.
Even if you don’t believe in global warming, a lot of insurance companies do. Ever since eight costly hurricanes struck Florida and the Gulf Coast in 2004 and 2005, large national insurers have been dropping customers whose homes are located on or near coastlines, and refusing new ones.
It’s not only flooding that has insurers worried. It’s wind damage, mud slides, and coastal erosion. We’re talking tens of billions of dollars of potential damage. Right now there’s only a patchwork of state insurance funds which may not be up to the task, coupled with federal flood insurance that already went $17 billion into the hole after Katrina.
If you believe in global warming – and just about every expert does – hurricanes are going to become even more violent and the oceans will rise even faster over the next decade or two, even if we figure out some way to control climate change over the longer term.
To make matters worse, developers are planning even more homes and commercial properties in vulnerable areas. You see, 77 million boomers will be retiring over the next fifteen to twenty years, and many want to go to coastal areas where the weather is milder and the beaches beautiful – Florida, the Carolinas, coastal Virginia, Cape Cod.
So who’s going to insure against all the likely damage? There’s mounting pressure on Washington to come to the rescue with federally-subsidized insurance. Once again, this means the rest of us taxpayers will be left holding the bag.
Here’s a better idea. Get private insurers back into the business of insuring homeowners against flooding, wind damage, and erosion. Do this by having the federal government offer to sell the companies reinsurance against catastrophic loss. This wouldn't be a handout. Insurance companies would have to buy the reinsurance. But because the federal government can spread the risk far more broadly than can any individual company, the price of reinsurance is likely to be low enough to make it profitable for individual insurance companies to get back in the market. Essentially, the government would back up insurance companies in much the same way it does for possible losses associated with terrorism.
But there’s no reason to extend this back-up to future development in vulnerable coastal areas. Federal reinsurance shouldn't be available for policies on new homes or commercial properties there. We now know too much about global warming to encourage this.
Sorry boomers. You’ll have to retire to safer ground.
Even if you don’t believe in global warming, a lot of insurance companies do. Ever since eight costly hurricanes struck Florida and the Gulf Coast in 2004 and 2005, large national insurers have been dropping customers whose homes are located on or near coastlines, and refusing new ones.
It’s not only flooding that has insurers worried. It’s wind damage, mud slides, and coastal erosion. We’re talking tens of billions of dollars of potential damage. Right now there’s only a patchwork of state insurance funds which may not be up to the task, coupled with federal flood insurance that already went $17 billion into the hole after Katrina.
If you believe in global warming – and just about every expert does – hurricanes are going to become even more violent and the oceans will rise even faster over the next decade or two, even if we figure out some way to control climate change over the longer term.
To make matters worse, developers are planning even more homes and commercial properties in vulnerable areas. You see, 77 million boomers will be retiring over the next fifteen to twenty years, and many want to go to coastal areas where the weather is milder and the beaches beautiful – Florida, the Carolinas, coastal Virginia, Cape Cod.
So who’s going to insure against all the likely damage? There’s mounting pressure on Washington to come to the rescue with federally-subsidized insurance. Once again, this means the rest of us taxpayers will be left holding the bag.
Here’s a better idea. Get private insurers back into the business of insuring homeowners against flooding, wind damage, and erosion. Do this by having the federal government offer to sell the companies reinsurance against catastrophic loss. This wouldn't be a handout. Insurance companies would have to buy the reinsurance. But because the federal government can spread the risk far more broadly than can any individual company, the price of reinsurance is likely to be low enough to make it profitable for individual insurance companies to get back in the market. Essentially, the government would back up insurance companies in much the same way it does for possible losses associated with terrorism.
But there’s no reason to extend this back-up to future development in vulnerable coastal areas. Federal reinsurance shouldn't be available for policies on new homes or commercial properties there. We now know too much about global warming to encourage this.
Sorry boomers. You’ll have to retire to safer ground.
Saturday, November 15, 2008
Friday, November 14, 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, November 13, 2008
Economy Slowing Says Calculated Risk
Great Blogger, Calculated Risk "Clearly the economy is slowing sharply"
Wednesday, November 12, 2008
Fannie and Freddie, and Why the Accounting Gimmicks Continued
Accounting gimmicks first came to light at Fannie and Freddie in 2003, at which time Fannie's and Freddie's former CEOs were sacked. Why, then, did they continue for another five years, even under new CEOs, even after policymakers first learned of them? Three reasons: (1) Top executives and shareholders continued to profit from them so there was no incentive to stop them, (2) everyone involved kept expecting home values to continue to rise -- or, when they fell, rise again soon enough -- to make up for the accounting shortfalls, and (3) Fannie and Freddie continued to be in bed with Congress and the administration. Democrats and Republicans alike have been complicit in this outrage.
Tuesday, November 11, 2008
Monday, November 10, 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, November 9, 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, November 8, 2008
Fannie and Freddie, as Predicted
A reprise of what I wrote August 25: Any day now -- perhaps any hour -- the plug will be pulled on Fannie Mae and Freddie Mac, and a massive government bailout will ensue. Together, they'll become the largest government-owned entities in American history, and, once again, taxpayers will pay the bill, which could come to $25 billion or more.
One question is how did we ever get to this? The Savings and Loan Bailout of the late 1980s should have taught us that when government guarantees the downside of risks and private investors reap the upside gains, there's hell to pay. The risks Fannie and Freddie took on weren't officially guaranteed by the government -- that is, by you and me -- but investors assumed they were. And so did Fannie's and Freddie's executives, who reaped a bonanza with bonuses in the tens of millions each year.
Apologists will say that Fannie and Freddie exist to make housing loans to low-income Americans, so it was inevitable that the two giants would get caught in the quagmire of the housing burst. But the fact is, Fannie and Freddie -- and the executives who ran them and still run them -- have been out to maximize profits. Period. Just the same as every other mortgage and investment bank. High-risk sub-prime loans offered a higher rate of return, so Fannie and Freddie went into them big time. And because of the implicit government guarantee, Fannie and Freddie could take on even more risks and make even more money. Until now.
It's another case of socialized capitalism, folks. The largest, yet. Along with making lots of money for investors and their executives, Fannie and Freddie corrupted our political process. They blocked any attempt to reign in the risks. Their lobbyists were and are the most sophisticated and among the most ubiquitous in Washington.
What to do now? Hope that, like the S&L fiasco, taxpayers can get back a fair portion of our dollars. But unlike the S&L fiasco, this time we should make sure we bury socialized capitalism for good.
One question is how did we ever get to this? The Savings and Loan Bailout of the late 1980s should have taught us that when government guarantees the downside of risks and private investors reap the upside gains, there's hell to pay. The risks Fannie and Freddie took on weren't officially guaranteed by the government -- that is, by you and me -- but investors assumed they were. And so did Fannie's and Freddie's executives, who reaped a bonanza with bonuses in the tens of millions each year.
Apologists will say that Fannie and Freddie exist to make housing loans to low-income Americans, so it was inevitable that the two giants would get caught in the quagmire of the housing burst. But the fact is, Fannie and Freddie -- and the executives who ran them and still run them -- have been out to maximize profits. Period. Just the same as every other mortgage and investment bank. High-risk sub-prime loans offered a higher rate of return, so Fannie and Freddie went into them big time. And because of the implicit government guarantee, Fannie and Freddie could take on even more risks and make even more money. Until now.
It's another case of socialized capitalism, folks. The largest, yet. Along with making lots of money for investors and their executives, Fannie and Freddie corrupted our political process. They blocked any attempt to reign in the risks. Their lobbyists were and are the most sophisticated and among the most ubiquitous in Washington.
What to do now? Hope that, like the S&L fiasco, taxpayers can get back a fair portion of our dollars. But unlike the S&L fiasco, this time we should make sure we bury socialized capitalism for good.
Friday, November 7, 2008
Thursday, November 6, 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
Wednesday, November 5, 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
Tuesday, November 4, 2008
Today's Jobs Report, and What it Means
Today's jobs report confirms not only how badly the economy is doing, but how badly working families are doing -- and why it's not possible to revive the economy unless and until working families have more purchasing power.
84,000 jobs were lost in August -- the 8th month of job declines. Since January, more than 600,000 jobs have been lost. Remember that at least 125,000 new jobs need to be added to the economy each month merely in order to keep up with an expanding population. So the loss of 600,000 jobs actually means a larger portion of the population without work than today's household survey (6.1 percent unemployment) reveals.
In the short term, the economy needs a powerful fiscal stimulus. Longer term, it needs policies (such as I mentioned yesterday) that will continue to put more money into the pockets of average working families.
84,000 jobs were lost in August -- the 8th month of job declines. Since January, more than 600,000 jobs have been lost. Remember that at least 125,000 new jobs need to be added to the economy each month merely in order to keep up with an expanding population. So the loss of 600,000 jobs actually means a larger portion of the population without work than today's household survey (6.1 percent unemployment) reveals.
In the short term, the economy needs a powerful fiscal stimulus. Longer term, it needs policies (such as I mentioned yesterday) that will continue to put more money into the pockets of average working families.
Monday, November 3, 2008
Sunday, November 2, 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
Saturday, November 1, 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 recession
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