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

Barry Ritholz responds to one narrative of the 2007 financial collapse

Barry Ritholz writes in his column in the Washington Post:

To many people, the 2008-09 financial crisis was a complex, fast-
moving news story and an anagram-laden, horrifying collapse. Such events often give rise to false histories, myths and ideologically driven narratives.

It is vitally important that we understand what really happened. Let’s put to rest some of the sillier ideological narratives that have been pushed by partisans. And let’s start here: Five years on, it’s clear that the collapse of Lehman Brothers signaled a deep and enduring global financial crisis. Lehman’s failure did not, however, cause the crisis.

The low rates had sent bond managers scrambling for higher-yielding fixed-income paper. They found that yield in securitized subprime mortgages, a novel financial product. Three elements made this possible:

Dan here…these are three elements discussed…worth a look:

  • The first was ultra-low yields.
  • The second was a new class of lenders — Greenspan called them “financial innovators” — that were not traditional depository banks but were mortgage originators only.
  • The third element was the corruption of the ratings agencies.

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by Dale Coberly



In the open thread section last night constant reader B*uce K*asting reported:

“CBO changed some variables, the result was an increase in the unfunded numbers. In 2012 CBO concluded that the shortfall was 1.9% of payrolls. In 2013 they increased that to 3.4% – A 70% increase.

Question; How big does this shortfall have to be before anything is done about it??”

I assume that the report is accurate and that CBO is making an honest prediction.

But B*K* is vastly over reacting.  It is true that 3.4% is 70% bigger than 1.9%.  But this is a meaningless, or misleading, comparison.

If one were to compare the new projection to the old projection for the tax rate needed to put Social Security into “actuarial balance” for the next seventy five years, it would look like this:  Old projection 12.4% (current rate) plus 1.9% equals 14.3%.  New projection 12.4% plus 3.4% equals 15.8%.  So the new projection 1s 15.8/14.3 or about 10.4% bigger than the old projection.

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McCutchen vs. Federal Trade Commission

In response to my e-mail on an Oct. 8th  decision on McCutchen vs Federal Election Commission by the Supreme Court that could expand the role of money in elections, Beverly Mann writes:
  … the argument in McCutchen is that it makes no sense to have this artificial divide between “issue” advocacy and candidate advocacy—that is, to allow unlimited donations for “issue” advocacy (e.g., PACs) while retaining the limitation on donations directly to parties or candidates.  Everyone, including me, expects that the 5-4 majority will strike down that distinction and say that the so-called First Amendment grounds for striking down McCain-Feingold in Citizens United—speech is money—regarding limitations on “issues” advocacy pertains equally to the limitations on donations directly to parties and candidates.  (bolding mine)

The LA Times adds:

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Obamacare Defunding and the Mandate

This is pure political fantasy. I will pretend to take Republicans seriously. They claim that Obamacare is unpopular (true) and tha the people want them to defund Obamacare. It is clear that the most unpopular part of Obamacare is the mandate (the Medicare entitlement reform which is included in House budget resolutions and of which they demand much more is also unpopula). The mandate is also the best known part. People worry about it. I worry about what will happen when people realize ust how toothless it is (it’s a voluntdate not a mandate) People who don’t have insurance and who aren’t exempt because insurance would cost too high a fraction of their income are supposed to pay a penalty (or tax according to the Roberts Court). If they don’t, they will get a firmly worded letter and will not get a tax refund. The normal IRS enforcement mechanisms are forbidden (this means no tax leins not just no arrests).

OK so let’s pretend that Republicans get their way and Obamacare is defunded so no money may be spent implementing or enforcing Obamacare. Does this mean that people who owe and don’t pay the penalty get their refunds ? Well no, money may be disbursed from the Treasury only as appropriated by law by Congress. The IRS can’t send people money if, according to the ACA which is still the law of the land, they aren’t owed money. The defunding just means the IRS can’t pay some poor paper pusher to decide if someone owes the penalty. It doesn’t allow the IRS to send out checks to people who are, according to the law, owed nothing just because it hasn’t checked.

In fact, I don’t think the IRS would be allowed to send anyone refund checks. People with health insurance don’t have to pay the penalty and get a refund (or owe the “amount you owe”) according to the plain old garden variety tax code. But to check the documents that prove that the tax return filer has insurance the IRS would have to spend money implementing and enforcing Obamacare.

I think the Republican proposal is to leave the tax code as it is (including the penalty) and forbid any implementation.

Everyone who would suffer from the mandate would, as far as I can tell, suffer equally from defuning. Also AFAIK everyone who wouldn’t suffer from the mandate would suffer from defunding.

I think they are counting on losing this one. They couldn’t possiblu afford to win it.

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Balkanization of the Internet: Brazil’s Response to the NSA

“To extricate” Brazil from the reach of the NSA and American technology giants, Dilma Rousseff, President of Brazil, has proposed doing the following:

constructing submarine cables that do not route through the US, building internet exchange points in Brazil, creating an encrypted email service through the state postal service and having Facebook, Google and other companies store data by Brazilians on servers in Brazil.

To protect its population and its government, all countries may have no choice but to follow Brazil’s lead: control all points of Internet entry and exit, as well as insist that any data stored by any foreign company be under its control.

What Brazil is doing makes perfect sense.  But how can Brazil protect its inter-country communications, if those communications must, of necessity, pass through NSA hands? A giant Brazilian company runs a mine in Sudbury, ONT.  (Sometimes, the relationship between Canadians and Vale, the Brazilian company, are a bit…rocky.  If that relationship becomes too dicey, Canada, which is very cozy with the NSA, may well take a peek at any Vale communications leaving Canada for Brazil. Or maybe a competitor with NSA connections wants to take a peak.)

If the answer is a Brazilian mail carrier, say goodbye to any global mailing system. Microsoft Outlook? Gone.  Google’s Gmail? Gone. Every country will have its own mail carrier.  China will have its mail server.  Russia will have its mail server.  We will have to work out how those hundreds of mail servers communicate. 

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Has hourly self-employment income stayed relatively constant to hourly payroll income?

The Brookings Institute has just come out with a new paper seeking to explain the decline in labor’s share of national income. The paper is titled, The Decline of the U.S. Labor Share. It was written by Michael W. L. Elsby, Bart Hobijn, and Ayşegül Şahin. Here is a video of Justin Wolfers explaining the basics of the paper.

The Brookings Institute paper says that the decline in labor share is over-stated because self-employed people are earning less in labor income. And the decline in self-employment income explains part of the decline in labor share.

They say that one third of the decline in labor share can be accounted for by a decrease in self-employment income. The idea is part of understanding what part of self-employment income is labor income and what part is capital income… but I question their basic assumption.

In the paper, they make an assumption.

“Self-employment income in this headline measure is imputed under the assumption that average hourly compensation for the self-employed is the same as for those on payroll. That is, hourly self-employment income = hourly payroll income for all quarters in the postwar period.”

They then say that the hours of self-employed people as a share of total labor hours (self-employment hours + payroll hours) have decreased from 14% in 1948 to 8.5% in 2012. When you multiply hours by hourly wage, you must then conclude that self-employed people are earning less as a share of national income over time. Thus they conclude that the labor share of self-employed people has declined over the years and accounts for one third of the total decline in labor share.

It all rests on the assumption that the relative ratio between hourly compensation between self-employed people and those on payroll has not changed over the years.

Can that really be a true assumption when productivity from employee work has grown much faster than their hourly compensation? Hasn’t the increased income from increased hourly productivity gone to the “owners” of labor’s work? The self-employed still hire employees who are more productive but not receiving compensation equal to their increased productivity. Aren’t the self-employed reaping increasing benefits from their more productive employees?

It would seem to follow that employers, even if they are self-employed, are getting more income from increased productivity of their workers.

And if the self-employed are working less hours, wouldn’t it might be because they have more leisure time now from increased pay per hour? Are they earning more per hour and now find they can afford more leisure time off?

I think of a cleaning cooperative in Humboldt County, California, called Restif Cleaning Services. The company is 100% employee owned. I talked with them by phone. They tell me that the employee owners receive on average $20 to $24 per hour of work. Now all of their competitors employ workers at a wage rate from $8 to $12 per hour. The self-employed owners at the other companies must be making quite a profit for themselves, especially if we assume those owners are working less hours.

I know a lady who cleans houses. She charges $45 per hour. And then pays workers $10 to $12 per hour to do the work. Needless to say, she does not like doing the work herself because she makes much less per hour. If she does a job of 5 hours by herself, she makes $225 at $45 per hour. If she has a worker do 3 of those hours, and she works 2 hours, she makes $200 ($225 – $25), at a rate of $100 per hour of work. In this case, she is making 8x the hourly wage of her employee. She says it is hard to find good dependable employees. And she is a nice religious person who wants to do missionary work in Africa to help poor children.

What about employers that are not so nice?

Side thought: I think about for a moment how supply-side schools teach that lower wages would shift the LRAS curve to the right. My research into effective demand says that lower labor share would shift the LRAS curve to the left.

We can see that the cleaning lady has an incentive to work less hours, but only because she progressively receives more per hour than the employee on payroll. Thus, the more she can get workers to do the work, the more she makes per hour. Thus, we have an explanation of why self-employed people are working comparatively less hours. It is not because they earn the same or relatively the same over time as those on payroll. It is because they are increasingly earning more per hour than those on payroll. This refutes the apparently casual assumption in the Brookings Institute’s paper.

One of the keys to saying that self-employed people are earning relatively much more than employed people is based on employee productivity gains over the decades.

If I then was to assume that self-employed hourly income had risen against payroll hourly income, I would not have reached the same conclusion as the Brookings Institute paper. I would not have said that a third of the decline in labor share is attributed to a relative decrease in self-employment labor income. It would then follow that a decline in labor’s share of income is more a result of payroll income declining than the Brookings Institute would have us believe.

However, on page 13 of the paper, it is noted…

“Moreover, rises in compensation at the very top of the distribution of proprietors have been even more extreme than among employees, suggesting that the average hourly compensation of the self-employed has soared in recent decades relative to the payroll employed, violating a key assumption underlying the headline measure.”

So they recognize a problem with the assumption. I suggest they not be so sure of saying that a third of the decline is due to lower self-employment income.

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For the Record, No: A Review Too Late

Were Lawrence Summers what his critics say he is—a political hack with an inflated sense of his own skills that is matched only by his sense of entitlement, accompanied by a grotesquely non-realistic view of his accomplishments—this is precisely the letter he would write.

Felix, who was The Voice of Reason on this  before and after, has more.

(h/t DeLong; subtitle blatantly “borrowed” from WalterJon)

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Nick Rowe explores interest rates & aggregate demand… What about profit rates, optimism & effective demand?

Nick Rowe at Worthwhile Canadian Initiative asks a question

“What happened in 2008? Why didn’t the cut in interest rates prevent Aggregate Demand from falling? Was it just that the cut in interest rates wasn’t big enough? Or is the rate of interest the wrong thing to look at? Because it’s only a relative price, and relative prices only matter for relative demand?”

There is a lot to explore here, and I am going to go down the road of profit rates and effective demand. The issue involves the dynamics at the onset of a recession. But let’s start exploring with Keynes and go from there. Here is Keynes in Chapter 22 of General Theory

“Thus the remedy for the boom is not a higher rate of interest but a lower rate of interest! For that may enable the so-called boom to last. The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.”

The boom which is destined to end in a slump is caused, therefore, by the combination of a rate of interest, which in a correct state of expectation would be too high for full employment, with a misguided state of expectation which, so long as it lasts, prevents this rate of interest from being in fact deterrent. A boom is a situation in which over-optimism triumphs over a rate of interest which, in a cooler light, would be seen to be excessive.” (source)

Keynes says with an exclamation point that a lower rate of interest is the solution to a boom; just keep the boom going by lowering interest rates. Nick Rowe is then asking why a drop in interest rates during 2008 didn’t stop aggregate demand from crashing. The Fed rate did almost reach the zero lower bound by the end of 2008.

Friap 1

Line to graph #1.

Back at the beginning of 2004, inflation started to appear. Soon after the Fed started to raise the Fed interest rate. The Fed rate kept rising until the Fed felt inflation was under control around a 2% target.

We can see that profit rates took a hit when the Fed rate started to rise back in 2004. But they soon got right back on track. Optimism overcame the Fed rate hike. (more on optimism below) The aggregate profit rate leveled out at the beginning of 2006 and then fell by the end of 2006.

Real GDP was growing and eventually hit the effective demand limit in the 3rd quarter of 2007. The recession officially started in December of 2007.

2008 recession 1

Link to graph #2. Real GDP stopped increasing after reaching effective demand limit. (note: area shaded red in LRAS zone, but area shaded red in graph #1 is recession.)

Once real GDP hit the effective demand limit, real GDP came to a stop. And we can see in graph #1 that the Fed then started to drop the Fed rate.

So the question is… Was the grinding to a halt of real GDP (and by association aggregate demand) due to high interest rates from 2004 to 2008 and then interest rates not going down fast enough in 2008? or Did real GDP grind to halt primarily because of the effective demand limit upon real GDP? In all recessions prior to 2007, except the Volcker induced recession, real GDP slowed down and stopped once reaching the effective demand limit.

What does Keynes say about the effective demand limit in Chapter 3 of General Theory?

“Thus the volume of employment is given by the point of intersection between the aggregate demand function and the aggregate supply function; for it is at this point that the entrepreneurs’ expectation of profits will be maximised. The value of D at the point of the aggregate demand function, where it is intersected by the aggregate supply function, will be called the effective demand.” (source)

We can see in graph #1 that aggregate profit rates started falling a year before real GDP reached the effective demand limit and kept falling for at least a year after. I would generally say that profit rates had been maximized before and after the effective demand limit.

If interest rates had dropped faster and farther in 2008 as the recession was starting, would the profit rate have started heading up? Would the expectation of more profit by entrepreneurs been resuscitated? 

Or was the true problem having the Fed rate too high in 2006 and 2007?

As Keynes said in the first quote above from chapter 22, optimism can overcome a high interest rate. And when real GDP had room to grow in 2005 before hitting the effective demand limit, there was reason for optimism. Profit rates continued to increase. And in a certain light, the Fed rate was inconsequential to the growth of real GDP through 2005. But as profit rates began to maximize in 2006 approaching the “constraining dynamics” of the effective demand limit, the Fed rate became a problem. And when real GDP started grinding to a halt from the effective demand limit, the Fed quickly tried to bring down their interest rate.

Getting back to Nick Rowe’s question… “Why didn’t the cut in interest rates prevent Aggregate Demand from falling?”

In light of Keynes’ quote from chapter 22, the Fed rate should have dropped in mid-2006, when profit rates were declining and as real GDP was approaching the effective demand limit. The party of the boom would have been extended by optimism. The demotivating dynamic of the effective demand limit upon optimism would have been overcome. Unemployment and capital utilization would have stayed steady as real GDP kept growing from increasing productive capacity through optimistic investment. Profit rates would have stayed steady, but the sense of optimism to continue enjoying those profit rates would have continued. And the profit rates would not have started downward.

If one had wanted to avoid the crisis, one could say that the Fed kept their interest rate too high after 2005. But personally, I am glad the bubble burst. Eventually we will get back to a normal sustainable economy once economists realize that we need to fix where we are, and not try to return to the bubble years before the crisis.

Don’t economists realize how unsustainable the economy was back then? Like Keynes says in chapter 22, “The boom which is destined to end in a slump…”

We must avoid booms like the last one, and it appears that one is developing again but with labor in a much weaker position. The Fed decided yesterday to keep supporting the “quasi-boom” and the optimism behind it. But the pessimism is still waiting its moment to crash the party… the Fed cannot avoid the eventual pessimism that will develop once real GDP hits the effective demand limit sometime toward the end of 2014. The Fed rate will be somewhat inconsequential once the dynamics of the effective demand limit start to bite.

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Disingenuous? or heading toward defiant and impudent

Disingenuous? or heading toward defiant and impudent.

Yves Smith says:

One of the aggravating facts of life in bureaucracies is having to contend regularly with misrepresentation. And I don’t mean faux friendly corporate bromides like “We’re here to help,” but weasely, technically accurate but substantively misleading statements. A Treasury reply to some questions from Elizabeth Warren is a classic in this genre.

Read more at Naked Capitalism

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