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

Causation and the Financial Crisis

Robert Waldmann

Matthew Yglesias discusses the financial crisis and the idea of causation. He shows that he was a philosophy major. I’m delighted. The question is whether the answer to the question “What caused the financial crisis?” is of the form “A, because if A had not been true, then there wouldn’t have been a financial crisis.” Yglesias notes potential problems with that approach. I critique after the jump.

OK jumpers, here I admit that, while I am delighted to have philosophy applied to finance, I think that among other things Yglesias made up some pseudo problems. He is commenting on an excerpt from a post by Barry Ritholtz

Understand that this is a theoretical discussion based on counter-factuals — what is likely to have occurred if various elements leading up to the crisis were different. We are trying to discern the differences between primary and secondary factors, separating the causes from the exacerbators.

Whenever someone asserts as a cause an event or force relative to a particular outcome, you should always ask: “Is this a “BUT FOR cause of that outcome?” In terms of a specific result or outcome, “But for” this factor, how would the outcome have changed? Would the result have been the same or different?

I will comment on the passage quoted by Yglesias (note I have not read the post).
That little passage is vulnerable to a serious practical critique. It relies a lot on the word “likely.” Now one thing we have learned from the crisis is that it is a bad mistake to look at the most likely outcome and assume it is certain. In practice, the sort of result we can get from trying to understand the causes of the crisis is that it probably wouldn’t have occurred without those causes. That’s not good enough for financial regulation.

More to the point, we can figure out that a crisis in 2007-8-9 would have been unlikely but for the following factors, but we can’t conclude that without those factors another crisis is unlikely to ever occur. Obviously different crises can have different causes. If the same factors exacerbate crises with different causes, it might be better to address the exacerbators and not the causes of the current crisis.

This is not the criticism Yglesias makes. I’m going to try to be relatively brief for now and focus on two issues. First he notes that but for causation and legal liability are different. He has examples in which people are, and should be, punished for damage they didn’t cause in the sense that it wouldn’t have happened but for their actions.

Then he writes “One is that when something very large-scale and bad happens, we probably have a few different interests. One is in punishing perpetrators and one is in preventing recurrence.” Huh ?!?! Matthew Yglesias and I are inclined to be consequentialists (in my case at least it means I was inclined to be a utilitarian — was exposed to convincing arguments against utilitarianism and watered down my beliefs to something vague enough to be unrefuted).

I at least absolutely believe that the only possible justification for a punishment is to prevent a recurrence. I definitely do not think that we have an legitimate interest in punishing perpetrators except to the extent that it prevents an occurrence. I had thought that Yglesias agreed with me on this. He certainly has repeatedly described himself as mostly consequentialist.

This implies that I oppose vengeance for the purpose of vengeance. That, in turn, doesn’t imply much in practice. I think one effective way to prevent a recurrence of the crisis would be to tar and feather 10% of bankers chosen at random as collective punishment. I do not advocate this course of action, because tarring and feathering is torture and because there are costs of having terrified bankers which are even worse than the occasional financial crisis due to excessive risk taking.

Then Yglesias comes up with an abstract example.

The second is that when something complicated happens, it’s plausible that you’ll see confusing webs of preemption that defy simple counterfactual analysis. Imagine that A, B, C, D, E, F, and G all happened. And suppose that to produce a crisis you need A, plus either B or C, plus any two of E, F, and G. If you try to do a “but-for” analysis on all seven factors, you’re going to reach the conclusion that “A caused the crisis” while B, C, D, E, F, and G all may have contributed in some way but didn’t actually cause it. But it’s not clear that that’s the right thing to say. And it’s definitely not clear that the correct policy response is to focus on A. Maybe A had lots of really beneficial effects, while B and C are both useless.

Here he is probably making a correct analysis of how attempted “but for” causal analysis will mislead us. However, the shorthand of referring to factors with letters is key. This is one case in which language influences causal analysis (in a way in which id doesn’t influence logical inference). Let’s say there is another language in which the same word is used with two English meanings B and C. In Italian the same word “fare” means “to make” or “to do” and the same word “forza” means “strength” and “force.” On the other hand there are two translations of “to be” “essere” and “stare” and of “to love”If they do the but for analysis they will conclude that both A and “B or C” are causes.

This means that we can make a mistake if we take the division of entities into categories to be either a known truth or a harmless convenience. Here Yglesias doesn’t say that understanding what caused something is unimportant. He notes that it is hard. I tend to share his belief that analysis of causation by English speaking lawyers and judges is invalid, because they take the English language as know to be right and true (unlike all other languages) or, more exactly, because they assume that the decision to reason in English is harmless, innocent and doesn’t matter.

Philosophers know that arguments which seem valid are proven to rest on unexamined conventions. They do this by inventing new words. I agree with Yglesias that one problem with legal efforts to find causation is that they rely to much on plain English and are too suspicious of neologisms and jargon.

I am not joking.

OK that was the punchline but we are after the jump so I go on.

In the simple case of A, B, C, D and E, where each can be true or false it is possible to construct the whole set of possibilities (there are 32) and say which imply a crisis. This means that the same long boring report is written whether we think that “A or B” is an elementary category and saying “A but not B” a pointless quibble or if we think that “A” and “B” are elementary categories and “A or B” is derived from them.

In the real world, it is absolutely impossible to get anywhere without risking having been lead there by the irrelevant history of the evolution of language. The innocent language in which every possible state of the world has it’s own name has an infinite vocabulary and no one can learn it. IIUC philosophers have long since given up on finding a language such that using that language can’t lead us astray.

Just to go on and on some of Yglesias’s other examples are interestingly irrelevant.

After the Ritholtz passage he continues

I’m broadly sympathetic to that account, but it’s worth emphasizing that there are a lot of complications. Consider this example from L.A. Paul and Ned Hall, “Causation and Preemption”:

Suzy and Billy, two friends, both throw rocks at a bottle. Suzy is quicker, and consequently it is her rock, and not Billy’s, that breaks the bottle. But Billy, though not as fast, is just as accurate: Had Suzy not thrown, or had her rock somehow been interrupted mid-flight, Billy’s rock would have broken the bottle moments later.

So you can’t say that the “but for Suzy’s toss, the bottle wouldn’t have broken.” But I think a normal person would want to say that Suzy broke the bottle. There’s a lot of work done on this and other philosophical topics. But I would note that in a politics/policy context it often just depends on what we care about.

Yes and, in this case, what we care about is preventing a recurrence so, for our purposes, Billy’s and Suzy’s actions are the same. They are like B and C in the abstract example.

In plain English, “Sally broke the bottle” is true and “Bill broke the bottle”. The example shows how we can’t completely describe the events usefully with two sentences of only 4 words each. This is not a surprise.

OK this is the example which caused me to write this post.

Imagine I’m in the elephant house at the zoo on a crowded day. A couple of elephants get loose and start stampeding through the crowd. I have a gun on me, and spot some dude I don’t like and decide to take advantage of the chaos by shooting him in the end. Eventually, it turns out that 80 percent of the people who were in the elephant house that day wind up dead as a result of the stampede. From a “but-for” perspective, it’s not clear that I actually caused the dude’s death. But from a legal perspective, it’s clear that I’m a murderer. The point of the statute is precisely to punish people who shoot other people in the head. But from a policy perspective, the bigger issue here is arguably elephant stampedes rather than guns at the zoo. At a minimum, elephant stampedes are killing more people.

Again huh ?!?!? I would say that the purpose of the murder statute is to prevent murder and the purpose of preventing murder is to keep people alive. To mean, punishing murderers is a means to an end not an end in itself. So I think the character named “I” should be jailed. We jail for 2 reasons and both have to do with intention and not “but for” causation. We want to deter murderers. Punishing someone for killing someone who would have died anyway but he didn’t know it works just as well. Deterrence depends on what people think will happen to them and people generally don’t kill other people if they know the other person is about to get stomped by an elephant (some bloodthirsty person might and there is no point in deterring him but no harm either so punishing people for killing people who are going to die anyway is just as useful as a deterrent (also we are all going to die sooner or later)).

Another purpose of jail is to incapacitate. We lock people up because the crime they have committed convinces us that they are likely to commit more crimes. In theory if we could determine who would commit crimes in the future consequentalism tells us we should lock them up before they have committed a crime. The rule that people are to be locked up only after they have committed a crime is needed, because the alternative is to grant some person or group arbitrary power to lock others up if they say they think the others will commit a crime.

Our forecast of future murder depends again on intent.

Now I will argue that I am really really fanatically consequentialist and have been for a long long time. When I was in 4th grade, I said that the prison sentence for attempted murder should be longer than the prison sentence for murder. My logic was based on incapacitation (I’m pretty sure I didn’t believe in deterrence at all then). The prediction of future murders depends on the intent I argued (as I argued above). Plus if the attempted murder is unsuccessful we know that there is someone that the defendant wants to kill. If the murder had been successful, maybe the murderer would be satisfied.

This is very consequentialist thinking. It totally freaked out my classmates and teacher.

Years later, I understood what was wrong with my reasoning. I was assuming that we knew for sure that an act was an attempted murder. In the real world, severe punishment for attempted murder would lead to locking up people whose aim was assault not murder. Indeed the word lead me astray. There are many degrees of intent from trying and seeing if it works to absolute determination to make it work. The difference between a murder and an attempted murder may be partly chance, but it can also be partly based on determination.

My proposal was like locking up people who will commit crimes but haven’t yet. Under absurd assumptions about what we know, it makes consequentialist sense, but in the real world, we can’t know that much or trust people who claim to know that much.

Tags: , Comments (13) | |

Japan to increase holding of US assets

by Rebecca Wilder

Japan to increase holding of US assets

Here’s one that was tucked away in the Financial Times, Japan Post Bank urged to diversify holdings. With all of the talk about China, its currency, and the question of the Chinese “financing the U.S. deficit”, the media always forgets about Japan!

From the FT:

One of the largest buyers of Japanese government bonds is under pressure to diversify its holdings in a move that will reverberate throughout the huge JGB market.

Shizuka Kamei, Japanese financial services minister, said on Monday that Japan Post Bank should diversify its investments into US Treasuries and corporate bonds in an effort to reduce the risks of over-concentration in JGBs.

and later..

A big shift by the postal bank away from JGBs could have unsettling implications for the market. Japan Post helped digest 45 per cent of the increase in outstanding JGBs between 2001 and 2007 and already holds about 24 per cent of outstanding JGBs, according to Ruixue Xu, rates strategist at Royal Bank of Scotland in Tokyo.

However, analysts do not expect Japan Post to shift away from JGBs immediately.

Although it has attempted to expand lending since it was privatised in 2007, Japan Post has largely failed to make inroads in new businesses and remains dependent on buying JGBs.

Japan Post Bank – one of four government companies that was scheduled for an IPO offer, but to my knowledge that has been stalled – holds ¥176,990.8bn in deposits, or $US1.96tn, and the equivalent of $US2.2tn in total assets. That rivals Bank of America, the US’ largest bank holding company by assets.

Who’s going to purchase Treasury bonds? That’s right, Japan (at least the very large Japan Post Bank, in this case): the largest foreign holder of US assets at 12.11% of the total (see above chart).

The disclaimer at the end of the FT article (in bold) is important – banks are sitting on quite a bit of reserves, and purchasing JGB’s creates a very safe and clean balance sheet on which to sit. However, it is very interesting that the government is pushing US bonds. Why not German?

And the chart of the day: Japan’s 5-yr CDS is 113% higher than in Q4 2009. In fact, the G3, Japan, the US, and Germany, are all seeing heightened CDS spreads.

Debt is on the mind. Rebecca Wilder with Newsneconomics

Comments (2) | |

Heavy Flow (not an iPad post)

Was 2009 a great year to be a bank? The headlines all say so. (The 140 U.S. banks that were closed by the FDIC last year may disagree some.) But, as Isabelle Kaminska of Alphaville notes, very little of the gains posted for last year came from anything related to talent:

Deutsche Bank reported net income of €5bn for the year 2009 on Thursday, compared to a €3.9bn loss in 2008.

This, we would say, is a pretty impressive turnaround in anyone’s business….

Deutsche attributes much of that growth to the successful re-orientation of its business towards customer business and liquid, ‘flow’ products. While it’s not broken out within the results, we’re willing to bet that a large slice of that re-orientation was therefore focused on managing flow emanating from the group’s ever growing synthetic exchange-traded-product and foreign exchange businesses — both of which happen to do very well when spreads are wide, and volatility is high.

When I first started working in the investment side of the banking industry, 20-some years ago, the traders and marketers were especially careful to distinguish themselves from the “retail” side of banking. Indeed, the retail bankers were described as “9-6-3” people: lend at 9%, take deposits at 6%, and be on the golf course by 3:00.

Now that that same type of effort is producing all those record profits, is it time to decide that the legendary “management skills” of Jimmy Cayne, Vikram Pandit, and Neutron Jack (who turned GE from a products company into a finance company) might not have been all that different from that of a polyester-suited small-town bank manager?

Tags: , , , , , Comments (1) | |

Real GDP per Capita and Tax Cuts, Top Marginal Income Tax Rate Edition

by cactus

Real GDP per Capita and Tax Cuts, Top Marginal Income Tax Rate Edition

One often hears that cutting marginal income tax rates, particularly on high individuals, leads to faster economic growth. Let’s dispense with argumentification, opinionizing and pontificatulationizing and graph us some data. Data for this post – top marginal rates from the IRS and real GDP per capita from the Bureau of Economic Analysis.

The first graph shows the annual change in real GDP per capita from one year to the next. I took a few liberties with the graph, namely:
1. I color coded each bar – black means the devil raised taxes, white is for the sweetness and light of a tax cut, and gray means no change to top marginal rates.
2. I included a couple of text boxes. The first shows the average growth in real GDP per capita when you have tax cuts, tax hikes, and no change, and it does so for two periods – 1930 to 2009 and 1952 – 2009.
3. The second text box shows the number of instances of tax cuts, tax hikes, and no change to the tax burden over the two periods.

The graph goes back to 1930 because data on real GDP per capita only goes back to 1929. Here’s what it looks like:

(Graph 1)

Faster economic economic growth occurs in years when you have tax hikes than tax cuts. Wait, that can’t be right. This graph is not showing the Truth! So how do we salvage it? Well, maybe the problem is that it takes awhile for the American public to react to a tax cut. After all, it has to be a huge surprise when a person who has talked about the virtues of tax cuts for thirty years actually (get this!) cuts taxes when he becomes President. I still remember the shock we were all in back when GW cut taxes in 2003 – who could possibly have expected tax cuts from a guy who had cut taxes in 01 and 02 and had been promoting tax cuts as the solution to everything from gout to bad haircuts? So maybe we have to assume that it can take a while for tax cuts to have their glorious effect, allowing us to soar into growthy nirvana.

So the next graph is color coded differently – black means the devil raised taxes, either this year, last year, the year before that, or two, three, or four years before that. White means the same look-back, except this time we’re talking tax cuts. Gray is a situation in which either there’s been no change in the tax rate rate (this year or in the previous four), or both tax cut(s) and tax hike(s) occurred during that period. For instance, from 1939 to 1940, the top rate was raised from 79.0% to 81.1%. It feel to 81.0% in 1941, and then rose to 88% in 1942 and again to 94% in 1944. Because of the tax cut (however infinitesimal) in 1941, 1941 through 1945 are colored gray.

I note that once again, I threw in a couple of text boxes. So here it is:

(Graph 2)

Well, this still cannot possibly be right. Why is the data hiding the True Facts? This is clearly gonna take more digging. So let’s be a bit more systematic and cut to the chase.

The next graph shows the average annual growth rate in real GDP per capita within 0, 1, 2, … and 9 years of a tax cut (with no intervening tax hike) from 1930 to 2009. It also shows the average annual growth rate within 0, 1, 2, … and 9 years of a tax hike (with no intervening tax cut). And of course, it shows the same for periods in which there was no change in the top tax bracket and/or in which there were both tax cuts and tax hikes. Thus, at year 0, growth rates are the one shown in Graph 1. At year 0 to 4, growth rates are the shown in Graph 2. And so on and so forth.

Here’s what that looks like:

(Graph 3)

Well, nine years out and there’s no situation in which tax cuts beat tax hikes.

So one last time to the well… this next graph is similar to Graph 3, but it only includes data for the period from 1952 to 2009.

(Graph 4)

Finally. Some evidence. All of this allows us to state that “carefully selecting data allows one to show that that tax cuts are correlated with rapid growth in the first and second year after the cut, but even that degree of cherry picking indicates that the year of the tax cut, as well as 3 or more years out, growth is faster when taxes are hiked than when they are cut.”

Or we can simply go the Fox News route and say: “Behold the Truth as passed down in the Gospel of St. Ronnie. Tax cuts lead to faster growth.”

I have a few possible explanations for these four graphs. One – the best one – I’m not going to mention since it requires some number crunching to confirm and I simply don’t have the time right now. Maybe in the coming weeks. But here are a few more for the two year positive window on tax cuts:

1. Some of those “going Galt” folks are actually serious. Some of them really do make business decisions based on taxes. But people who make business decisions based on reductions of the income tax don’t know how to run a business. Their initial foray into the business world (or initial expansion) frees up some capital and makes things look good for a while, and then they flop.
2. Similar to 1., except that the business decisions are actually accounting conveniences at first which grow to have real effects a couple years down the road.
3. Those anticipating tax cuts put off converting paper earnings into real taxable earnings until after the tax cuts have gone into effect. Thus, for a few years you have “pent up” profits coming out which disappear after a while.

So why, except for a cherry-picked window, are tax cuts not as good for growth as tax hikes are? A few thoughts:
1. At the margin, given the relative size of the gov’t and private sector, and given that both are made up mostly of very inept and/or corrupt people, the gov’t is not less efficient than the private sector.
2. Less money in the public sector constrains the gov’t at those times when it needs to act and when the private sector won’t or can’t? (E.g., how much less freedom of movement does the gov’t have now than it would had the supluses of the late 90s continued through 2008?)
3. The Megan McArdle hypothesis – if the data shows something different from what we know the truth must be, well, something is wrong with the data and anyone who believes what the data seems to show is craaaazy. Call it a poor man’s version of Maier’s Law, with the entire Austrian school way ahead of the second corollary to that law.

Questions, comments, contributions, donations?
by cactus

Comments (112) | |

While Rome Burns, Nero Fiddles – Health Care Edition

by Tom aka Rusty Rustbelt

While Rome Burns, Nero Fiddles – Health Care Edition

While the House and Senate were trying to overhaul the entire health care system, key Medicare regulations were left in limbo. Those provisions are still in limbo.

Medicare physician reimbursement based on Sustainable Growth Rate (SGR) have been controversial and generally considered unworkable since being passed. The solution has been an annual fix rather than a permanent fix. The House bill had a permanent fix, but went nowhere.

As a result of not being fixed, some physicians will see draconian cuts in Medicare reimbursements as of March 1. Primary care docs will see a small increase in rates. Or there may be a fix, or maybe not.

Physical therapists who provide Medicare services are now subject to a cap, amounting to rationing, for elderly patients. This capping system was instituted in 1997 but an annual fix has prevented implementation. Now that too is in limbo, and therapists may be “donating” services in 2010, while waiting on an answer. If the cap remains, services will have to be rationed..

Seniors are very dependent on various forms of therapy to regain mobility and self-sufficiency after fractures, surgeries and strokes. Would we prefer nursing home placement instead?

If health care reform enlarges the role of the federal government, and this is how the feds do business, this could prove interesting.

Newsflash: Apparently Obama’s 2011 budget assumes a fix for physician SGR. 2010? In limbo.
Tom aka Rusty Rustbelt

Comments (20) | |

Eagles Update

For those who missed it yesterday, Palace defeated the Wolves at Selhurst Park last night, 3-1 (only a goal in the 90th minute breaking the shutout) behind a hat trick from defenseman-moved-forward Danny Butterfield, who played a similar role in Saturday’s 2-0 win over Peterborough.

Most interesting is this observation from Palace manager Neil Warnock:

“Transfer deadline day was a long day for me. I think Fulham offered £30,000 for three of our academy players, and Chelsea came in for some too. That’s disgusting. And everybody knows that [the full-back Nathaniel] Clyne almost went to Wolves yesterday, and I was disappointed with the offer we accepted for him. But he turned them down and the money we would have got for him we’ll get from this Cup run now.”

Fire sales rarely make economic sense if you’re caretaking a Going Concern and willing to provide bridge financing. That the latter was secured the day after the Transfer Deadline may not be coincident.

Tags: , , Comments (2) | |

Social Security and Deficit Reduction: Some Fun with Numbers

by Bruce Webb

Well it looks like we are going to get a Deficit Commission and one way or another Social Security will be on the table. But what exactly does that mean for either Social Security or the total deficit picture? Before answering that lets review a couple of basics.

In talking deficit reduction we need to distinguish between ‘deficit’ and ‘debt’. A ‘deficit’ is basically an accounting convention, it is worthwhile to calculate various gaps between income and cost. But not everything labeled ‘income’ actually represents cash extracted from the economy, in particular interest on Intragovernmental Holdings is not in fact financed by such dollars, although it is real as real in the long run, in the immediate term it is simply a bookkeeping entry. Which leads to some really odd results. In order to keep things straight the CBO maintains two different measures for deficits: ‘primary deficit’ which measures actual cash flow and ‘deficit’ which includes that interest. Now in general newspapers report the deficit and not the primary deficit, when we talk about an Obama $1.6 trillion deficit for FY2010 that figure silently includes interest on the Intragovernmental Holdings as a positive number, whereas a calculation of primary deficit wouldn’t include it at all.

Turning to ‘debt’. Last week Congress raised the debt ceiling from $12 trillion to close to $15 trillion. But this does not mean Treasury is free to borrow up to $3 trillion in cash prior to going back to Congress, because there are two different components of debt subject to the ceiling. You can check out both the total debt and its two components via a web application maintained by Treasury called Debt to the Penny which would tell you that as of Monday ‘Debt held by the Public’ was $7.849 trillion while ‘Intragovernmental Holdings’ were $4.499 trillion for a total of ‘Public Debt’ of $12.349 trillion, which is the number you normally see reported in the newspapers.

Mostly when people talk ‘deficit reduction’ they do so not in the context of opening borrowing room in the current year or its effects on interest rates, those those are pretty important things indeed. Instead they tend to think of it in terms of debt reduction or perhaps just a slowing in the growth rate of Public Debt. And one way to accomplish that is to cut spending. Or so you would think, once you start factoring in the curious treatment of interest on Intragovernmental Holdings things start getting strange. Follow me below the fold if you dare.

More than half of the $4.499 trillion in Intragovernmental Holdings are held by the two Social Security Trust Funds, in fact they have $2.5 trillion in Treasury obligations that score as part of Public Debt. But for the sake of this argument I want to simplify that a little:

Suppose you have a Trust Fund with a balance of $2 trillion in notes earning 5% a year which operates along side a benefits program with its own dedicated revenue stream that either will or will not pay all costs in any give year. Now imagine three different scenarios:

A1: the benefits program self-funds with non-interest income equalling cost
B1: the benefits program runs with an operating loss of $100 billion
C1: the benefits program runs with an operating surplus of $100 billion
What are the subsequent impacts on total Public Debt?

Under A1 there is no call on funds from Treasury nor is there any cash flow to it. But Treasury does have to create $100 billion in the form of new Special Treasuries to credit to the Trust Fund to account for interest. This $100 billion adds to Intragovernmental Holdings which in turn adds to Public Debt for a net increase in that debt of $100 billion.

Under B1 there is a call on $100 billion in funds from Treasury to meet costs. To meet that call Treasury has to borrow (or find revenue, same thing for our purposes) $100 billion in Debt held by the Public. In turn it offsets that by not giving any credit to the Trust Fund for accrued interest, instead ‘taking’ it in exchange for that other dept. The end result is that $100 billion is added to Debt held by the Public and so to Public Debt while nothing is added to Intragovernmental Holdings with a net increase in total Public Debt of $100 billion, i.e. the same amount as A1.

Under C1 the operating surplus of $100 billion flows to Treasury and in principle pays down that same amount in Debt Held by the Public (or reduces borrowing by that amount, same thing) which reduces Debt Held by the Public and hence Public Debt by that amount. But under the rules in play Treasury is required to issue $100 billion in Special Treasuries to ‘pay’ for that borrowing and another $100 billion in such Treasuries to account for the interest which increases Intragovernmental Holdings and so Public Debt by that amount for a total net increase in total Public Debt of $100 billion. Same as A1 and B1.

So for the specific purpose of calculating Public Debt A1=B1=C1. I suggest this result is pretty damn counter-intuitive but absent some mechanism I am missing that is how the numbers run.

Okay now say in the interest of deficit and debt reduction we cut our benefits program by $100 billion a year while leaving its revenue constant.

A2. The benefits program, previously revenue neutral, now provides a $100 billion cash surplus to Treasury reducing Debt Held by the Public by that amount. In turn Treasury issues $200 billion in Special Treasuries to account for the borrowing and the accrued interest. Net increase in the Public Debt is still $100 billion.
B2: The benefits program, previously running at a $100 billion loss, is no revenue neutral with no cash effect on Treasury meaning that Treasury only has to issue a Special Treasury for $100 billion meaning a net increase in Public Debt of $100 billion.
B3: The benefits program, previously running a $100 billion surplus now is running a $200 billion one, reducing Debt Held by the Public and hence Public Debt by that same amount. But Treasury has to issue $300 billion in Special Treasuries for a net increase in Public Debt of $100 billion.

Now this is getting kind of spooky, not only does A1=B1=C1 for the purposes of the number on the Debt Clock, they are also precisely equal to A2=B2=C2. That is no matter whether the current system is running cash surpluses, cash deficits or is cash neutral cutting $100 billion in spending doesn’t move the Debt Clock at all.

Does this mean there is no real world effect? Well of course not, between the six scenarios we have impacts on Debt Held by the Public from up $100 billion to down $200 billion depending on the before and after states, that is real money. But all it really is is a transfer from Social Security beneficiaries to holders of Debt Held by the Public, it is just robbing Grandma so as to make it easier to pay off the Chinese Central Bank.

Making the attempt to attach at least this component of Entitlements Reform to raising the Debt Ceiling kind of a sham. Because for the specific purpose of calculating total Public Debt subject to the limit it is a wash.

Now lets turn to Deficits. Under Unified Budget scoring any surplus to Social Security including accrued interest counts as a positive meaning a $100 billion annual cut in Benefits will yield a $1 trillion ten year score plus any additional interest effects on the Trust Funds which actually would be substantial. Because every $100 billion added to or not subtracted from the Trust Fund will be generating 5% compound interest. But those same interest dollars which score as a positive on a 10 year deficit total actually score as an equal increase in Public Debt. This too is pretty damn counterintuitive, we have the same factor driving deficit and debt in opposite directions.

And just to insert some final confusion what does $100 billion in cost cuts per annum do for our old friend Unfunded Liability. Well it wipes it out, the problem being that it is simply replaced by Public Debt in the form of Special Treasuries even as the dollars used to build that fund were spent long since. Given all this I can’t see why any worker would support cuts to Social Security, all that does it cut current obligations while replacing them with Public Debt in the future, a debt that we can’t expect the capitalists of the future to be any more willing to pay back than the capitalists of today. As long as the Social Security Trust Funds are throwing off enough interest dollars to cover the gap between Income excluding Interest and Cost there is absolutely no reason why workers should simply sacrifice their own interests here. In this scenario all of the benefit simply flows to the bond market. Now theoretically there would be positive impacts on interest rates which might create some indirect benefits for consumers, and if we were experiencing Carter/Reagan double digit interest rates then maybe a case could be made. But under current conditions I just don’t see it.

Anyway the next time some one comes waving that $12 trillion figure as a reason to cut Social Security be sure to ask him to show his work, in this particular case cutting spending actually serves to increase debt. And weirdly enough so does increasing revenue. Such are the weirdities of Trust Fund accounting.

Final bonus nugget. What would a perfectly balanced Social Security system look like?
One it would run a small cash flow deficit, Treasury would be transferring some money to SS each and every year.
Two still Social Security would overall score as being in surplus for Unified Budget purposes.
Three beyond whatever borrowing was needed for One, Social Security would be adding to Public Debt every year.

Yep a system that is cash flow negative, in permanent surplus AND adding to debt. Perfect! Wrap your head around that for awhile.

Tags: , Comments (55) | |

Ending Stimulus and the Shape of the Recovery

by Tom Bozzo

Brad DeLong observes that the FY2011 budget features “big, very big” tightening on the revenue and spending sides (2.5% of GDP “from 2010 to 2011”) for the prevailing labor market conditions. DeLong wants his “morning in America” (don’t we all?), and is understandably alarmed at the pessimistic forecast of the rate of labor market improvement. Paul Krugman echoes the sentiment on “near-term” fiscal tightening.

As is always the case, the tightening question has to be “relative to what?” [1] Receipts as a fraction of GDP are expected to increase fairly substantially, for example, but that’s largely a consequence of expected economic growth.

Compared to the current-policy baseline, the FY 2011 (10/2010-9/2011) budget increases the FY 2011 deficit by around 0.8 percent of GDP. In FY 2012, the budget would subtract around 0.7 percent of GDP from the current-policy deficit. Krugman is correct to attribute this to the winding-down of ARRA stimulus and of our “overseas contingency operations” better known as the wars in Iraq and Afghanistan. Go see Table S-2 here [PDF]. Additionally, current policy has some stimulus on top of current law. Allowing most of the Bush tax cuts to become permanent reduces FY 2011 receipts by around 0.9 percent of GDP. (See Table 14-2, here.)

As for the timing, the budget assumes (see Table 2-1) that real GDP in quarter 4 of calendar year 2010 will be 3 percent higher year-over-year; in Q4 of 2011 (a/k/a Q1 of FY 2012), real GDP is expected to increase another 4.3 percent. Even with the tightening, Q4 2012 real GDP would increase another 4.3 percent y/y. So the FY 2012 tightening only arrives after two years of modest growth.

If measures labeled as such are actually to be temporary economic stimulus measures, they obviously must end sometime. Ending them after the expansion ends is stupid — the tightening would reinforce the subsequent downturn — so it’s going to take some steam out of the expansion one way or another. The most pressing timing concern would be not to take away the stimulus before it’s clear that the recent GDP growth is sustainable; I’d argue that after two years of growth, should we get there, the case that measured GDP growth is a matter of one-time shots and/or statistical glitches will be fairly weak.

The slow assumed labor market recovery Brad DeLong notes might be seen as a mirror-image of the GDP recovery assumed in the budget baseline:

The budget’s baseline economy (with the triangle marks) isn’t as pessimistic as OMB is willing to imagine in public (and if you’re Ken Houghton, you might see all of these as irrationally exuberant), but the ‘output gap’ opened by the recession is assumed to close very slowly. While higher-frequency data are not equally optimistic, there’s building evidence (so far, outside of employment) for a reasonably strong recovery. And as Maynard explains at Creative Destruction, it’s arguably in the administration’s interest to err on the pessimistic side since people (again, even including some economists) don’t understand counterfactuals and thus tend to inappropriately place blame (or credit) for surprises.

[1] Every economics professor who disparages the “jobs created or saved” concept should be immediately stripped of tenure and exposed to the current labor market for forgetting that all economic analysis is counterfactual.

Tags: , , Comments (33) | |


by Dale Coberly
an Op-Ed


A few weeks ago Bruce Krasting published on his own blog an essay claiming that Social Security was going broke and that it would cause the economy to collapse, and the only possible remedy was to means test Social Security.

I replied on Angry Bear that Social Security was not going broke and could never go broke. I pointed out that the Trust Fund was created exactly for the purpose of covering temporary periods of negative cash flow in the regular pay as you go structure of Social Security. That negative cash flow is normally a matter of month to month irregularities in collecting the money and paying it out. A sufficient reserve is kept to bridge extended periods of lower collections and higher payouts caused by, for example, the current recession. And a very large reserve has been allowed to grow in order to effectively allow the baby boomers to pre pay their own retirement.

Because of the demographic “bulge” of the baby boom, the absence of the enhanced Trust Fund, would have allowed a “generational inequity” where the Boomers paid a lower payroll tax to “pay as you go” for the smaller number of retirees in the generation ahead of them; and then the smaller number of workers in the generation behind them would have had to pay a higher tax rate because of the greater number of boomers. The current large Trust Fund is big enough to take care of the retiring baby boomers even during a recession with a ten percent unemployment rate that lasts ten years.

In a private exchange (since published) Krasting seemed to concede this. But he insisted that whatever the justice of the case, the lack of a surplus in Social Security would require Congress to go to the bond market and attempt to borrow money there to make up for the money they have been “borrowing” from Social Security. Krasting predicted that THIS would cause the economy to collapse and the only possible remedy was to means test Social Security.

In my reply to him I said that I was not impressed with claims that the sky was falling, having heard them before, and that the honest way for Congress to make up for the money it could no longer “borrow” from Social Security, if it could not borrow on the bond market, would be for it to raise taxes on the people who had benefitted from the tax cuts that had led to the deficits.

Krasting did not hear this, and instead writes that we are “thick headed” because I at least don’t care very much about his calculation of the looming death of the Trust Fund based his very own assumptions about interest rates. His letter is reproduced below. I can’t see that it has any merit at all. Perhaps someone who can write more clearly than Krasting can help him make his case.

What Krasting does have on his side is that apparently all the advisors to the President and the Congress agree with him that it is better to destroy the workers retirement security… that they pay for themselves… than to cause the least discomfort to bond traders or the high income folks whose tax cuts have allowed them to get even richer “in the markets.” Apparently the rich don’t have to pay their bills. Or even repay the money they borrowed that helped them get richer.

What I sometimes like to point out is that even if the Congress steals the Trust Fund, it would not result in material harm to the workers…. as long as they are allowed to raise their own tax a small amount so they can continue to pay for their own retirement on a “pay as you go” basis. This would be an injustice to them, but it would do far, far, less harm than turning Social Security into a means-tested welfare-as-we-knew-it. And far less harm than raising the retirement age… a perennial favorite among the folks who have jobs they like, and enough money to retire in their forties when their taxes are too high for their sense of what they are owed for their labor.

Conclusion: Krasting apparently wants me to endorse his numbers for interest rates and the death of the Trust Fund. I can’t do that. I prefer to let the Social Security Trustees do all the hard forecasting. All I can do is point out what their numbers mean. In this case Krastings numbers mean precisely nothing: Even if his numbers were right… and I don’t think they are, they have no important significance for Social Security.

When Social Security goes cash-flow negative, or what day the Trust Fund “goes broke” does not matter. Social Security can continue to pay for itself forever, with a modest tax rate that pays for the taxpayers own expected costs of retirement.

This may involve a very modest departure from a kind of “generational equity” that simply does not exist in the real world for any other aspect of life. Only an insane person, or one with evil intent would argue to destroy Social Security because one generation might pay or get a percent more or less. It would be like forcing people to give up farming because the price of bread varied from one generation to the next. Even the stock market does not deliver that kind of intergenerational “equity.”

It has always been understood that the Trust Fund would go cash flow negative. That is what it was created to be used for. If that is now a problem for the Treasury or the bond market, there are honest ways to deal with that problem. Stealing from Social Security is not honest. And destroying Social Security in the name of deficit reduction or shoring up the bond market is not only dishonest, it is maliciously evil.
by Dale Coberly

Comments (60) | |