Relevant and even prescient commentary on news, politics and the economy.

A Regulatory Substitute to Burst Housing Bubble?

During the late stages of the NASDAQ bubble, several commentators suggested raising margin requirements to dampen stock speculation. Senior FED Economist Simon Kwan responded with an Economic Letter concluding:

“…the effectiveness of using margin requirements as a policy tool is questionable. Investors can use financial derivatives to obtain exposure to equities without owning stocks, and they also can substitute margin credit with other types of credit. Finally, the bulk of the research on margin requirements indicates that changes in the requirements do not have a significant permanent effect on the behavior of stock prices.”

Bruce Bartlett, Senior Fellow at the National Center for Policy Analysis agreed with Kwan, while noting:

“… advocates of higher margin requirements, such as economist Robert Shiller of Yale, argue that they are an significant weapon in the Fed’s arsenal. He feels that higher margin requirements can be an important signal that the Fed is serious about cooling an overheated market.”

Despite the excellent arguments of Kwan and Bartlett, I found myself agreeing with Shiller; the purpose of raising margin requirements wasn’t to attack asset prices directly, rather to cool the speculative fervor. Of course, by March/April 2000 when Kwan and Bartlett responded, it was already too late for the NASDAQ.

Regulatory Substitutes for Housing Bubble

Once again some commentators are suggesting using “regulatory substitutes”, as opposed to monetary policy, to cool speculation in the housing market. In May, an interagency Credit Risk Management Guidance for Home Equity Lending was released. Many commentators (including me) saw this as an attempt to deflate the housing bubble. Apparently I was wrong about the intention of the Guidance.

Responding to questions from Congressman Jim Saxton (R-NJ), Chairman Greenspan recently wrote (note: this Q&A is worth reading in its entirety and addresses the yield curve and oil in addition to housing):

Congressman Jim Saxton:

A consensus view among monetary policy makers is that monetary policy should not be used to respond to, manage, or attempt to “burst” and asset price “bubble”.

Q: Given this view, is there any regulatory policy tool that can be used to moderate lending in “frothy” sectors that fuel asset price inflation?

Q: Is there a “regulatory substitute” that can minimize asset bubbles?

Q: Is the recent Interagency Credit Risk Management Guidance for Home Equity Lending such an attempt?

Greenspan responded:

Bank Regulatory policies are neither designed nor used to influence asset prices in particular sectors of the economy. Rather, there purpose is to ensure adequate bank risk management …

With respect to regulatory options or “regulatory substitutes” to address asset price bubbles, some observers have suggested increasing margin requirements to counter perceived speculation in equities markets. Even if one presumes that a bubble in this market can be identified before in bursts, however, such an approach is unlikely to succeed. Only a small fraction of equity is purchased using credit. Moreover, money is fungible, so that if an attempt were make to limit the amount of credit that could be used for a particular purpose, say, the purchase of securities, it is highly likely that some investors who would be constrained by such a regulation would find ways to channel credit from other sources to effect the desired purchases – for example, by funding more of the security purchase with funds ostensibly borrowed for other purposes, such as mortgage or consumer loans.

The recent Interagency Credit Risk Management Guidance for Home Equity Lending was not a regulatory effort to combat a housing price bubble, nor was it an example of regulatory suasion aimed at asset prices. Rather, it was a response to indications that some banks were not appropriately managing risks in the home equity area.

First, Greenspan is using Kwan’s “money is fungible” argument against raising margin requirements with respect to the housing bubble. The argument seems inappropriate here. With equities, I agree speculators can obtain funds from other sources, but it is much more difficult for marginal homebuyers to obtain the necessary funds for a down payment from other sources.

The stronger arguments are that the FED cannot tell when assets are in a bubble and that they can cause harm to the economy by “tampering”. In 2000, Bartlett made this argument with respect to the NASDAQ bubble writing that the greater risk was “associated with market tampering by the Fed” as opposed to the risk of the bubble bursting.

However, I don’t see tighter lending requirements as “tampering” with the market. The following graph shows the trend toward riskier products. ARMs and Interest Only (IO) loans are increasing (with a slight dip for IOs in ’05) and the use of negatively amortizing loans (not shown) is also increasing. At the same time, the requirements for “full documentation” is decreasing.

Click on graph for larger image.
Source: Fitch Ratings newsletter “RMBS Mortgage Principles and Interest”. (RMBS: Residential Mortgage Backed Securities)

So is appears lending requirements are getting looser. The agencies could tighten these requirements a little. Also the FED doesn’t have to recognize an “asset bubble”, just excessive speculation, something they have already acknowledged.

But, just like with the NASDAQ, I’m afraid it is already too late for the housing bubble.

Best Regards, CR Calculated Risk

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PlameGate: Blaming the Press

Kate O’Beirne was one of Russert’s guests this morning. At first she whined that the special prosecutor has been at this investigation for two years (actually he should have been at this two years ago) – and then she suggested it was someone else who first leaked Valerie Plame’s identity as a CIA agent. Her NRO colleague John Podhoretz writes:

Karl Rove and others learned that Joseph Wilson was married to a CIA operative from the media.

His source for this claim was this story:

Sources indicate that Rove may have learned Valerie Plame’s identity from within the Administration rather than from media contacts

That was the headline that Podhoretz dismisses the headline and accuses Massimo Calabresi of bizarre spin. It would seem Podhoretz is the master of bizarre spin.

Of course – it does not matter who within the Administration let Karl Rove know that Ms. Plame was a CIA agent. He should not have leaked this information to various reporters including one that was all too willing to publish this information.

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Economics, Politics, and Sausage

If you are a young worker worried about all those deferred taxes being built up by the Bush Administration and the GOP led Congress, I guess the good news is that Congress has left town. Before they left, they passed a pork-filled energy bill as well as added all sorts of pork to the highway bill even if this bill fails to meet certain priorities. Passing CAFTA required all sorts of log-rolling but the best that David Altig can do to defend Bush’s departures from his free trade mantra is remind us that political decisions are like making sausage.

As I read David’s post, I had to ask: who’s the conservative here. As David tries to blame the legislative process, he fails to meet Doha. David does try to excuse the 2000 steel tariffs as the price breaking down resistance to the “fast-track” trade authority appealing to the usual excuse making from Lawrence Kudlow. But even Kudlow got the point that the 2002 steel tariffs were more the political calculus of Karl Rove than some trade-off in an incremental moving towards free trade. Let’s recall that the same political calculus was present during the Clinton White House discussions of a steel tariff proposal that could have given Al Gore the Presidency. Yet, President Clinton rejected the advice of the political hacks in favor of the advice from his economic advisors.

I’m surprised that we do not hear more conservatives asking our policymakers to “just say no”. No to diversions from free trade cloaked in the language of trade agreements. No to the pork in the highway bill. And no to a give away to the shareholders of oil companies (which happens to include me in a wee way) financed by deferred tax bills on the kids.

President Bush loves to say he “gets things done” without any apparent regard for what thing got done. Fred Barnes loves to talk about Bush being a “big government conservative”, which is the oxymoron of all time. Since David brought up Mr. Kudlow, let me suggest that Lawrence likely does not understand that rising debt = deferred tax increases. David does understand this simple point. Might I plea with him and other conservative economists in joining pro-growth liberals in telling this White House and Congress to cease with such pork paid for by future taxes on the kids?

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Employment Compensation as a Share of Domestic Income: 1960 to 2004

I owe our readers a follow-up to this post. While Chad accused me of cherry picking the time frame with the suggestion the labor compensation to national income ratio for the late 1990’s was somehow an anomaly, Liberal was kind enough to suggest I provide a chart starting around 1960. It seems Brad DeLong has already provided this chart as well as a chart showing Wages and Salaries as a Share of Net Domestic Product. Take a look at Brad’s graphs as they show the late 1990’s was not an anomaly. While you are there – take a look at his discussion as well.

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CAFTA: Trade Diversion

With hat tip to Brad Setser, Edmund Andrews reports:

Mr. Hayes, a Republican whose district in North Carolina has lost thousands of textile jobs in the last four years, had defied President Bush and House Republican leaders by voting against the Central American Free Trade Agreement, or Cafta. But the House speaker, J. Dennis Hastert, told him they needed his vote anyway. If he switched from “nay” to “aye,” Mr. Hayes recounted, Mr. Hastert promised to push for whatever steps he felt were necessary to restrict imports of Chinese clothing, which has been flooding into the United States in recent months.

Let’s imagine that Speaker Hastert delivers on this implied promise to retain high tariffs on Chinese textile imports as we lower tariffs on imports from Central America. If so, we may have a case of what Jacob Viner called trade-diverting effects. While I am an advocate of free trade, there were lots of reasons to oppose the log-rolling that was just passed in the House.

Update: Brad DeLong has more on why we should stop saying George W. Bush is for free trade.

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Strong Fixed Investment Demand Growth

The preliminary estimate for 2005QII indicates that real GDP is growing at a 3.4% per year. With consumption demand growing at a 3.3% rate and government purchases growing at a 2.0% rate, one might react to his news with a big ho-hum.

As one that has been hoping for a reversal of the bad news that we saw for export and investment demand, however, I see some good news in these numbers. Export demand growth was reported at 12.6% per year and imports fell. Fixed investment growth was reported at 9.3% with both business fixed investment and residential investment reporting strong growth rates.

Final sales of domestic product grew at a 5.8% annualized rate with the difference between growth in sales and the growth in production coming from a “negative contribution from private inventory investment”. Could this news be a harbinger of an export and investment led recovery, which would might increase the employment to population ratio to 63% by year end? One can only hope!

Update: John Podhoretz gives the standard NRO Cornerite reaction to the fact that real GDP growth was just enough to keep the output gap from increasing:

Americans who don’t know anything about macroeconomics not knowing that they’re living in a miraculously good economic period presided over by President Bush and the Republican Congress.

Americans who learn their economics from the National Review certainly don’t know anything about macroeconomics.

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A Legitimate Rightwing Concern with AmeriSave

Kipesquire inquires about the impact on national savings and is concerned that AmeriSave is not fiscally neutral. His Broken Windows Fallacy raises an important point: if the government lowers my net taxes but not does cut government purchases, there will be an increase in someone else’s net taxes either now or later.

Kip, however, makes a few gaffes in his critique. First of all, AmeriSave requires me to cut my consumption by $1000 (save the funds instead) to get the $1000 transfer payment. But Kip fails to acknowledge this important point. Kip then goes onto to endorse certain tax breaks for the well to do without applying the same standard of fiscal neutrality.

While some of his suggestions have merit, this statement shows what is really bothering Kip:

This program would only apply to the middle-class and working poor. Which means of course that the overall federal tax system will become even more progressive than it already is, “tax cuts for the wealthy” notwithstanding.

Shame on us liberals for not jumping on the Reverse Robin Hood bandwagon!

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Social Security: The Club for Growth Claims Americans Can’t Save

Did Jonathan Swanson read Kash’s post? He replies with some odd logic:

Too bad the solution does not address the Social Security shortfall, nor does it provide a feasible investment strategy for the demographic group it targets … one can benefit from the wonder of compound interest only when one has disposable income to invest. The demographic group AmeriSave accounts target can’t afford to save in this manner; the glaring deficiency in the Democrats’ proposal is that if low-income Americans could afford to invest in retirement programs like 401(k)s and IRAs, they already would doing so … AmeriSave accounts presuppose that 1) Social Security benefits are “guaranteed” benefits, and 2) investing a portion of payroll taxes through Personal Retirement Accounts destabilizes the current Social Security system. This logic is faulty for two reasons. First, Social Security benefits are anything but guaranteed … Secondly, voluntary Personal Retirement Accounts offer retirees a better return on their payroll taxes that the government can never take away.

Swanson’s first premise is that after-tax income for some Americans is so low that they choose not to save for retirement. While this suggestion might be true for some households, the GOP fiscal agenda – including their Social Security agenda – would likely lower the after-tax income of these households.

Swanson’s claim that Social Security benefits are not guaranteed might be a concern if the U.S. Treasury will one day default on its obligations because of the Bush fiscal agenda or never tax, always borrow. While Donald Luskin often makes this claim, his latest on the yuan issue (also see Mark Thoma) makes this claim:

What Krugman won’t see is that China has chosen to hold U.S. bonds as collateral because they are the highest-quality and lowest-risk securities in the world. That’s why they make such excellent collateral. The fact that China chooses to hold our bonds is proof of our strength and their need to hang on to a piece of it.

What the Club for Growth does not seem to understand is that the Trust Fund is also holding Federal bonds, which pay the same interest rate as the bonds held by the Chinese Central Bank and the same rate that would be paid to bonds in those DeMint personal lock boxes. As I noted in a comment under Mark’s post – Luskin must think the Trust Fund is holding corporate bonds issued by U.S. airline companies.

Addendum: Luskin’s use of the word “collateral” is extremely odd. Consider this definition:

Collateral is a word used for assets that secure a loan. For example, in the case of a mortgage the house serves as the collateral for the mortgage-loan. This way, the bank is secured against the default risk of the borrower not being able to meet the interest payments. In case of default the bank can sell the house and get its money back.

The U.S. government wishes to borrow and the Chinese government becomes the lendor. The Federal bond is the financial instrument that we see as the loan. It would be odd that the same financial instrument that was the instrument of the loan was also used as the collateral. Now one could suggest that collateral was not needed as the probability of default was nil.

While we are on the topic of odd use of financial terminology, consider Luskin’s mentee: Roland Patrick (we know him as Patrick R. Sullivan) and his critique of Krugman:

Second, it doesn’t appear that Krugman grasps the difference between buying dollars and buying bonds.

Of course, Krugman was clearly referring to dollar-denominated bonds. What was Patrick’s first “point”:

First, it’s an open question what China’s spending its dollars on oil, Napa Valley wine, Washington state cherries, Boeing airplanes …

Of course, most of us know that China is buying oil from other nations but they are not buying very much in the way of wine, cherries, or even airplanes from our West Coast relative to the amount of goods we buy from China. A Luskin wannabe should sharpen his knowledge of the data and his ability to understand simple financial terminology before he decides to take on the writings of Dr. Paul Krugman.

But let’s hope the Chinese decide to purchase more planes from Boeing. But then as economists advocate a yuan revaluation, we are relying on changes in relative prices to increase Chinese demand for our goods. Most economists understand this simple point – even if the econopundits at the National Review do not.

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Did Nancy Skinner Question Karl Rove’s Patriotism?

Cliff May thinks so:

On Fox a moment ago, liberal radio talk show host Nancy Skinner said that Karl Rove “is endangering our national security” – her short-hand reference to the Wilson/Plame brouhaha. So the left, which is always shouting: “How dare you question my patriotism!” to people who are not questioning their patriotism is now questioning the patriotism of Karl Rove and President Bush. Nice twist. This has become the left’s new refrain and a useful one it is since the left has long been seen by many Americans as not trustworthy on national security.

Of course, Mr. May questions the patriotism of liberals when there is no basis for doing so. It would seem that he and John Podhoretz want to give us ample reason to question their commitment to national security when it conflicts with their partisan garbage. I only regret that I was not watching FNC for their reaction to Ms. Skinner’s comment.

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