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A Few Relationships Between Expansions and the Recessions that Follow Them

A Few Relationships Between Expansions and the Recessions that Follow Them

by cactus

Good evening, and welcome. Last week I had a post looking at the recessions since 1929 (i.e., since the BEA began computing GDP data). Each recession was ranked according to its length and severity, and by the political party of the President under which the recession began.

This week I’d like to take a slightly different tack. This week we will look at how the length and severity of a recession are affected by the length and “growthiness” of the expansion that preceded it. Before we go on… data on real GDP per capita comes from BEA, which is available annually from 1929 to 1946 and quarterly thereafter. I did no smoothing – that is to say… for an event that occurred in January, February, or March of 2001, as an example, I used figures for Q1 of 2001. Recession cycle dates came from the NBER. OK. The preliminaries are out of the way, so ready, set and go.

The first graph shows the median annualized reduction in real GDP per capita as compared to the median length of the earlier expansion. Assuming I didn’t make a mistake (its 3AM as I write this) – the graph shows that in general, the longer the previous expansion, the less severe the shrinkage during the recession.

There isn’t nearly as strong a relationship between the speed of economic growth during the expansion and the speed of the decline during the recession.

(BTW… if you’re wondering, yes, count of previous expansion lengths = count of previous expansion rates + 1. This is because we do not have data on real GDP per capita prior to 1929, but we do know how many months there are in the expansion prior to the Great Depression.)

What about the length of the previous recovery. The following graph shows us that longer expansions typically result in shorter recessions.

There does not, however, seem to be a clear relationship between the speed of the expansion and the length of the recession.

So… the speed of the expansion isn’t clearly related to the severity or length of the recession. However, the length of time between recessions does affect both the severity of the recession and how long it lasts.

Next week… the relationship between the recessions and subsequent expansion.

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The Deficit Commission

by Linda Beale

The Deficit Commission

Ever since Alice Rivlin spoke here at Wayne about her role on the upcoming Deficit Commission and her belief that we must cut entitlements, I have been worried. This seems like the same center-right coalition to undo the New Deal that has been rampaging in the country for four decades now–reaganomics, and with no heart.

Digby, reprinted in the Huffington Post, commiserates, at We (meaning you) Must Tighten Our Belts“. It is “interesting” to see that many millionaires feel quite at ease talking about the need to cut back on wages (blaming unions for the fact that owners have taken their businesses overseas where they can pay slave wages), delay social security benefits, tighten medicare requirements. But if you talk about taxing the rich, the response is always that this will “kill competitiveness” and “make the country poorer because there will be less investment.”

Funny, the bigger businesses get, the less competitive they seem to be–they become more like monopolies able to extract whatever they want from the consumer. Have you tried to order flowers for Mother’s Day? Every florist in a small town in Texas where my mother lives has the same national flower sales arrangements and pricing–so you can get an $8.00 azalea for $50 (plus $15 delivery). What a scam. It’s the thought that counts, but that thought costs more and more every year. Then look at the banks. I have a savings account with not a little cash in it at one of the big national banks: it pays so little interest that the bank probably spends more on tracking the interest than it does in paid interest. But their spreads are good–we lend money to them for practically nothing, but they charge an arm and a leg to lend it to the community. And Comcast–don’t get me started on them.

My problem, you see, is that I watched the movie Wall Street for the first time tonight. Made in 1987, the Wall Street of Gordon Gekko’s “greed is good” was full of evil blokes who broke up companies because they felt like it and could make more millions doing it, no matter what it did to the workers. But that Wall Street, with the LBO guys tearing up firms, was tame compared to the Wall Street during the Bush regime where groups of smart traders lived to suck the lifeblood out of their customers to make themselves rich.

I have a friend who married a Goldman banker. When the crisis broke, she was terribly offended that people thought the bankers shouldn’t get their huge bonuses. “We earned it” she practically screamed in her email to me. “Why shouldn’t we get it when we worked for it.” I remember thinking then, that something different had happened on Wall Street when even the relatively little fish in the big banks had that absolute sense of entitlement, but were quite ready to heap piles of scorn on the “welfare queens” and all those ordinary little people who had some sense of being “entitled” to Social Security in their old age.

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No one could have predicted

Jacob Weisberg wrote

The assumption that the rating agencies knew their business, a key enabler of the subprime meltdown, is analogous to the view before the Iraq war that Saddam Hussein had WMD. There are a lot of people now who scoff about what an obvious fallacy that was and not many who can point to doubts expressed at the time. But even if Rubin had better understood the risks Citi traders were taking and been in a position to do something about it, he almost certainly would not have said, “sell the AAA-rated CDOs.” Nor would anyone else have.

When Weisberg writes “not many” he means “none of the guys I hang out with” which means “no one who counts” or “none of the cool kids.”
Via Brad DeLong who wrote “in addition to Robert Shiller and Dean Baker, three people who can point to doubts expressed at the time come to mind: Raghuram Rajan, Alan Greenspan, and me.
What are we, chopped liver?”

But that’s not 2 % of it. The set of nobodies who don’t count included majorities in the House and the Senate and George W Bush Jr.

In September 2006, Congress passed the Credit Rating Agency Reform Act, after hearings and investigations that began in the wake of the Enron meltdown. The measure gave authority to the Securities and Exchange Commission to designate, regulate and investigate rating companies.

The law also prohibits notching, the threat of unsolicited bad ratings unless an agency is hired to assess a security. It also requires the rating companies to disclose any potential conflicts of interest.

That is a law passed in congress tightening regulation of ratings agencies, because congress was concerned about conflicts of interests. Weisberg may have assumed that the ratings agencies knew what they were doing. Actually congress seems to have agreed, and decided that the ratings agencies knew they were cashing in their reputations as quick as they could.

But I mean who can keep track of every little bill signed into law.

Notice he is talking about any time when AAA CDOs still had yields close to treasuries, that is not just the 1990s, when Rubin was at Treasury, but most of the period (including September 2006) when he was at Citibank.

That oversight isn’t even the grossest intellectual error in the brief passage I quoted. From one sentence to the next “not many” becomes not “anyone.” Obviously there were people effectively shorting AAA CDOs by investing heavily in CDSs on AAA CDOs. One is named John Paulson who has been in the news a bit lately. Andrew Lahde and Michael Burry are two others. Weisberg’s claim “not have said, “sell the AAA-rated CDOs.” Nor would anyone else have.” Is false and anyone who has been paying any attention knows it.

Weisberg sees no difference between saying a probability is low and that it is zero. So if the probability that a financier picked at random sys “sell the AAA-rated CDOs” is low then it is zero. I have one bit of financial advice – don’t take financial advice from Jacob Weisberg. When talking about the financial crisis he assumes that low probability events never happen.

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Is it hedging or casino betting when banks go short on products they have created/sold to customers?

by Linda Beale
published on ataxingmatter April 28

Financial reform–the GOP’s “chicken game”; and is it hedging or casino betting when banks go short on products they have created/sold to customers?
Edited to add additional links 4/28/10 at 5:35pm

As the GOP blocked progress on the Senate finance bill for a third time (56-42) in their foolish game of “financial reform chicken”, hearings yesterday with Goldman executives raised many important questions and got lots of rambling answers. See, Senate Hearing on Goldman Sachs & the Financial Crisis. Why rambling?–the ABA online journal today notes that one of the principal Goldman lawyers advises that those responding at Congressional hearings take long pauses before answering and give rambling responses to questions–to use up the time of the questioner without advancing the ball in terms of information provided. See Goldman Sachs Lawyer Advises Long Pauses, Rambling Answers, ABA Journal, Apr. 27, 2010.

Re the game of chicken:

The Dems will lose if they blink first in this chicken game. In fact, the best response to the GOP chicken play is to toughen the financial reform rules: legislate a fiduciary duty of broker-dealers to their clients (since they don’t seem to believe they have even quasi duties at this point–see below and see Gerding, The Senate Goldman Hearing: Fiduciary Duties for broker-dealers? and Ribstein’s response that duties just create litigation costs); add a permanent financial institution tax on leverage and assets that will essentially force banks to downsize while appropriately charging them for the cost-of-funds advantage that they enjoy because of their size and the implicit federal guarantee–see, e.g., Leonhardt, A Bank Tax As Insurance for Us All, NY Times, Apr. 27, 2010; add a tough proprietary trading ban that wil return banks to the boring business of being bankers rather than day-traders; remove the “mark-to-model” version of fair value accounting that lets banks invent their own valuations and force them to use market quotes/actual trades for all valuations even in “disrupted” markets–and surely do not allow the FDIC to determine valuations during crisis as the Dodd bill currently does, since that is an invitation to distorted values that are adopted to enhance balance sheets; eliminate tax-free reorganizations for financial institutions; create rules as proposed by Senators Kaufman and Brown that will shrink the banks to manageable size rather than “TBTF” size, through limits on share of deposits (10% of total at insured depository institutions) and nondeposit liabilities (2% of GDP for bank holding companies, 3% of GDP for shadow banks) (the Kaufman April 21, 2010 speech on the proposed legislation is available with summary of bill on, here). On the reasons that downsizing banks makes sense, see Alford, Why dismantling too big to fail financial firms makes economic sense, Naked Capitalism, Apr. 27, 2010; Zamarripa, Big Banks Can’t Be Reformed With Small Ideas, Roll Call, Apr. 28, 2010.

Every day that the GOP votes no, add one more tough provision.

re the Goldman hearings and hedging/casino gambling:

The Senate questioners recognized the problem of a bank whose assets and liabilities are sufficiently large that its failure could derail world economies and that has (and uses) ability to create innovative financial products that amount to nothing more than casino bets in which the bank is likely the only party with all the information (e.g., synthetic CDOs, where one said thinks referenced mortgages will fail, so buys the synthetic cDO credit default swap “insurance” pay-out on the failure of the referenced mortgages; the other side thinks mortgages will continue to pay out, so “insures” the mortgages (or may not understand the product sufficiently to know that it is providing the swap insurance guaranteeing the referenced mortgages)). The concern here is that these investment banks are performing quasi-public functions (serving as middlemen in the sales of stocks and bonds, helping deals between corporations take place, etc.) but are acting with purely private greed (treating sales as a search for suckers, creating products that are toxic from the start and pawning them off on unsuspecting buyers, using flash trading schemes that permit the bank to make money off its own clients’ trade information).

The banks, of course, see themselves as merely profit-making businesses. It’s “caveat emptor” from day one. And if their risk-taking leads the economy into chaos, they don’t care as long as they come out with profits–they claim no fiduciary duties to customers, no obligations to the public (other than mandated by securities laws, and even there they have a bank-friendly reading of disclosure requirements), only the rationale of making the most bucks possible in whatever way possible. According to the bankers, their shorts are just reasonable “hedges” against loss.

This issue is central to the financialization of our economy and the need for substantive financial reform even beyond what is currently being proposed in the Senate amid the Republicans’ game of chicken.

End users of wheat are legitimately hedging when they buy futures. Issuers of corporate bonds that pay a floating rate of interest are legitimately hedging when they buy an interest rate swap under which the counterparty accepts a fixed rate of interest and pays the issuer a floating rate that it can then pay over to its bond holders.

But if we allow investment banks to create synthetic CDOS and other complex financial products that are purely casino bets (I would urge that we should just not, but it is not clear Congress has the guts to implement the kinds of severe changes that are needed here), should we allow them to claim that shorting their own products is merely a “hedge” like other end users purchase? I don’t think so. One way to disincentivize the creation of complex financial products and the endless financialization of the economy that ultimately adds no jobs and does nothing for quality of life (except for the wealthy traders and quants that create the products) is to change the risk appetite of banks. No bank should be permitted to be net short on any product it creates or any product that it sells to customers. But not being short is not enough. Banks need to be bear sufficient risk for the products they create . So we might also require banks that create and sell financial products to 1) retain a sufficient share of the interests issued to provide a reasonable equity cushion below the products sold –around 15-20% and 2) not be permitted to “hedge” those products by shifting the risk of loss off to another bank or financial entity. Odds are their appetites for creating risky would diminish significantly if they bore the risk they created and there was no prospect for bailout (another item that needs to be strengthened in the current bill and that the GOP “no” vote makes possible to do).

By the way, a letter to the editor in the Times Friedberg, Goldman Deal and the Financial Market, Apr. 27, 2010, suggests that such naked bets are “good” for the market because they help pricing. Would you claim that a bunch of people laying down a bet on “red 21” helped one know whether red 21 was a good bet and accurately priced? Certainly not. The naked credit default swap is probably not much better at predicting real value–for years, the CDS prices on even the worst subprime deal were really really low (that’s why John Paulson could make so much money off his short). Irrational bets on the long or short don’t do anything except increase volatility and increase the size of the bubble market. Pricing information gained is either too insignificant in that mix or misinformation that adds to the problem.

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Real GDP in recoveries

In all the discussions of the real GDP release I did not see this comparison, and I thought it should be made. So far real GDP has increased 2.7% as compared to an average of 4.3% in recoveries since 1950. The range is from a high of 6.8% in 1958 to a low of 1.5% in 1991.

Someone in comments asked for a comparison to the preceding recession.

P.S. If anyone knows how to shift the dates on a bar chart with negative values down to the bottom of the chart please use the comments to explain how.

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