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

AIG bailout not a free lunch

James Tilson and Robert E. Prasch follow the money at New Economic Perspectives regarding the AIG bailout and a more accurate sense of costs.

“If it’s too good to be true, it probably is.” This old adage came to mind on December 11, 2012 when the U.S. Treasury made the announcement, reiterated unthinkingly by the press, that the AIG bailout was coming to an end with American taxpayers making a tidy profit on the deal. In an effort to capitalize on the news, AIG has spent millions of dollars on a primetime ad campaign thanking America for the bailout, highlighting its success: “We’ve repaid every dollar America lent us. Everything, plus a profit of more than 22 billion.” Unfortunately, this cleverly designed public relations maneuver deceives the taxpayer by distorting the perception of what has been a contentious use of government funds.


Among the shares the Treasury sold were 562,868,096 gifted to them from the Credit Facility Trust. This trust had previously been established by thehtFederal Reserve Bank of New York for the sole benefit of the Treasury Department. When these shares are taken into account, only 65.99% of the total returns from the Treasury’s sale of AIG common stock can be attributed to its original TARP investment, and the remainder should be credited to the FRBNY. The Treasury’s calculation, however, does not adjust for this transfer of shares. The effect is to artificially boost the returns on its politically contentious TARP investment at the expense of the Federal Reserve. Not counting these gifted shares, the Treasury assumes a break-even price of $28.73, but if we examine its investment in isolation, the true break-even is $45.53. After adjusting all cash flows associated with sale of stock, the Treasury’s profit of $5 billion becomes a loss of $12.7 billion.

An accurate evaluation of the Treasury’s investment in AIG should incorporate the effects of this tax advantage. So, rather than an average sale price of $31.18, a more telling number would be the share price controlling for this preferential tax treatment. According to estimates by analysts at Bank of America and JPMorgan Chase, doing so would reduce AIG’s share price by $5 to $6 dollars a share. ( ) If we were to adjust the sale price by $6 per share, the Treasury’s return is reduced from nearly $5 billion to a loss of more than $5 billion. Compounding this adjustment with that from the shares gifted by the Federal Reserve described above, the Treasury’s return is further reduced to become more than a $19 billion loss.

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Calculating the Cost of Bailouts

by Linda Beale

Calculating the Cost of Bailouts

A recent New York Times includes a piece on the Treasury’s study of the various bailouts or “rescues” of distressed financial and other institutions. Gretchen Morgenson, Seeing Bailouts Through Rose-Colored Glasses, New York Times (May 19, 2012).

The Treasury study, The Financial Crisis Response–in charts (April 13, 2012), is positive about the way that government handled the bailouts.

Collectively, these programs –carried out by both a Republican and a Democratic administration–were effective in preventing the collapse of the financial system, in restarting economic growth, and in restoring access to credit and capital. They were well-designed and carefully managed. Because of this, we were able to limit the broader economic and financial damage. Although this crisis was caused by a shock larger than that which caused the Great Depression, we were able to put out the financial fires at much lower cost and with much less overall economic damage than occurred during a broad mix of financial crises over the last few decades.

Reading that, one might conclude that everybody now is sitting fairly pretty, and that it was all done in a very upfront, fair and damage-free way. That ignores the fact that the bank bailouts treated the banksters with kid gloves–letting managers continue to receive their customary overcompensation and allowing banks generally to continue their predatory practices even while the taxpayers were providing them extraordinarily low-cost financing with practically no strings attached. Meanwhile, ordinary Americans–especially those in the lower half of the income distribution–suffered enormously. Congress–at the behest of the banksters–refused to enact mortgage clawback provisions in bankruptcy, the one law that would have done wonders at saving families and neighborhoods from unprecedented deterioration and blight.

To be fair, the report does include a bevy of charts that attempt to show how the crisis played out for the banks, the economy in general, and ordinary Americans (unemployment, depressed home sales market, etc.). But then the Treasury goes on to claim the following:

[T]he latest available estimates indicate the financial stability programs are likely to result in an overall positive financial return for taxpayers in terms of direct fiscal cost. These estimates are based on gains already realized and on a range of different measures of cost and return for the remaining investments outstanding. These estimates do not include the full impact of the crisis on our fiscal position. And they do not include the cost of the tax cuts and the emergency spending programs passed by Congress.

Now, it is good to know that at least the “direct fiscal cost” of the bailouts is likely to be positive. But note the gaping hole between that amount and the overall true cost of the bailouts–the “impact of the crisis on our fiscal position” and “the cost of the tax cuts” and “the emergency spending programs.” Now, at least the emergency spending programs generated economic activity and made real differences for individual people a good number of whom one can assume weren’t in the top 1%.

The tax cuts are a big cost item and one that may well not have had the benefits assumed, except for those that went to the lower and lower-middle income working classes (such as the payroll tax relief). And the impact on our fiscal position is ongoing and still strongly felt, as we struggle to rebalance an economy that already consumed too much from outside and produced too little here at home. So how much comfort can we take from the idea that the direct fiscal cost may be significantly less than some had initially expected it to be?


Here’s where the Times story comes in. Morgenson notes that “As the battles over financial regulation rage in Washington, it’s crucial that American taxpayers understand the costs associated with rescuing behemoth institutions.” We cannot take wise action for or against reduction in size of banks or other issues unless we are dealing with full information about the crisis and its aftermath. That won’t be easy in the politicized environment in which the Obama administration understandably wants to showcase how its efforts have helped the economy and the GOP seens intent on a “my way or the highway” approach to governance that cares more about winning a race than about doing what’s good for the people.

Morgenson reports on an interview with Edward Kane, Boston College finance professor and economist, who thinks that the public needs to see a more thorough cost-benefit analysis of the TARP and other expenditures. Kane calls the analysis “deficient” (one might even say misleading) for counting as gains the interest income the Fed made from holding Treasuries (this is like money passed from mom to dad to put in the allowance jar for the kids–in other words, Treasury interest is paid by the US fisc to the Fed, and the Fed’s profits are paid into the US fisc, so it’s all the same pot). But the bigger deal is a genuine evaluation of the opportunity cost of the subsidy provided to bailout recipients.

The programs provided enormous amounts of money at below-market terms for extended periods, he said. Had those guarantees been priced at their true market value — what a private investor would have charged to lend during those dire days — taxpayers should have received far higher returns. Morgenson, Seeing Bailouts Through Rose-Colored Glasses

Charles Calomaris, a Colombia Business School prof and NBER research associate who worked with Kane on the study, noted the cost-benefit concern.

“We are not saying that the benefits weren’t there,” Mr. Calomiris said. “We’re not saying that it wasn’t worthwhile to create these programs. Maybe it was, maybe it wasn’t. But it requires a fuller analysis of what the benefits were.” Morgenson, Seeing Bailouts Through Rose-Colored Glasses

crossposted with ataxingmatter

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Define Rich V: Looking at the historical labor economy

We are taking a little side trip inthis series of defining rich based on the prior tax rate schedulesbut, this post is keeping with the process of looking at history formarkers as to the definition of rich. For any new readers, I believeas a society we knew and had definite boundaries as to what definedrich. I believe we knew how to say the word “when” as the incomeand wealth was pouring into one’s glass These boundaries producedspecific public policy that resulted in a more equal and justsociety.
In our local city there is anothertextile mill going to the grave. We have lost a couple of huge millsto fire in the last decade.  The local paper did an article on thismill known as the French Worsted Mill. It was built in two stages,1906 and then 1906. It was part of the revival of the mill industryvia specific targeting of French industrialists, post water power forthe city. A local person who was eventually governor of the state iscredited with bring $6,000,000 of foreign investment into the cityearly turn of the century. At one point they had a Uniroyal rubberplant that made soles for shoes The last pair of Keds (sneakers) went out thedoor in 1970. Nine hundred and fifty people out of work due to “FarEaster Producers”.  (See the article: Pressure growsrapidly for Congress to to clamp tariffs on foreign goods, 5/19/1970)  This was a city as industrial asanything Detroit or Pittsburgh were. This was a cultural center forthe region with 6 theaters and I don’t mean just movies. We aretalking blue collar all the way. We’re talking jobs that we considerthrow away jobs to the far east today. We’re talking jobs that are notconsidered “good” jobs anymore.
So, now that you have the picture, hereis what this mill and the jobs within it were able to do for theworkers. I think this bit of history also adds to my position thatwe have continually pushed the cost of the American Dream up theincome line such that the middle class can not afford it…even with2 college educated people in one house. This is the sub-context tothe discussion regarding the decline of the middle class or the lossof the middle class. When people say the middle class does notexist, what is being stated is that the American Dream is no longerfinancially possible for this groups of citizens. The Dream is notdead or gone, it is over priced relative to the income of the middleclass. It is just as we are not drowning in debt, we are dehydratingfrom lack of income.

The article in the paper talked about aMr. Bacon. He worked in the mill in 1956 along with 700 to 800 otherresidents. The job was not as a machine tool maker (the mill as mosthad their own machine shop) or a special machine operator thatrequired special skill. He was a laborer. The tasks mentioned werestuffing waste wool into burlap sacks or “picking up the yarn” orfetching parts from the machine shop. We’re talking menial labortasks. Starter jobs.
For this work Mr. Bacon was paid $1.80per hour. The minimum wage was $1.00 per hour. At some point he wasearning $80 per week for 40 hours work. This is $4160 per year. With this income Mr. Bacon was able to put himself through collegeand became a teacher in the local school system. It was not just anyold college he went to. It was Providence College with a tuition of$500 per year. Yes, a private college that cost only 1/8thof his annual income.
Mr. Bacon’s story is the story that notonly are the Republican presidential candidates promoting as to whatwe need to “get back” to, but the democrats are saying we needto go forward to. Mr. Bacon’s story with this mill is the proof thatthe 2 parties are not talking about a fantasy time in our history. It did exist.
Here’s the problem though with both of their directions. I’m justgoing to list them.
  1. $40,000 is the annual tuition at Providence College today.
  2. $1.80 per hour is equivalent to the following: $14.40/hour standard of living, $17.80 real value, $18.20 unskilled labor and $22.00/hour production labor.
  3. Tuition of $500 is equivalent to the following: $4010.00 standard of living, $4960 real value, $5050 unskilled labor and $6120.00 production labor
Are you seeing the problem here? It’snot just the difference of tuition going up 80 times. It’s that the wage equivalent today for what amounts to stacking shelves in Walmartis not being paid at Walmart. Not only is this Walmart job notpaying such wages, this is what the current autoworker is earning. The autoworker was one of the best compensated citizens we had. Lookup the definition of  middle class in the dictionary, and you would have seen anautoworker!
How bad is this? Considered
Thelow-wage benchmark set by the UAW has already set off a competitivestruggle in the global auto industry, with Fiat-Chrysler boss SergioMarchionne telling Italian workers they must accept American-styleconcessions or he will move production to North America for cheaperlabor.
I have read that the German automakersare here in the US for the same reason. We are now the stop for outsourcing.
Here is the other more important aspectof the story of the French Worsted Mill and it’s relationship to theAmerican Dream. All those candidates, all those legislators, allthose governors proposing programs they say will encourage people toget off welfare and join the “productive” class, programs thatwill spur job creation, programs that will grow the economy such thatwe can cut taxes JUST LIKE THE GOOD OLD DAYS have no answer for thelack of pay of $14.00 per hour for the Walmart shelf stocker. Theyhave no answer as to how they are going to return the ratio betweenthe hourly wage and the cost of college education to that of the1950’s such that an individual can accomplish what Mr. Bacon andothers from the same mill accomplished. Not only do they have noanswer, they don’t even want to consider this aspect of theirsolution.
Mr. Bacon’s story is also telling uswhy we think the public sector is so over paid. If a Walmart shelfstocker should be earning $14.00 hour comparatively but are not, ifan autoworker earning $14.00 per hour is underpaid comparatively,then certainly the higher hourly wages of the public sector lookexcessive. Everyone used to know that the public sector was alwayspaid less compared to the private sector. They did not have morebenefits than the autoworker, but they do now. The slowdeterioration of the autoworkers and all the other laborers pay andbenefits has hidden the reality of the finger pointing at the publicsector. It’s not that they are paid so much, and thus look “rich”by comparison, it’s that the autoworker has lost so much over such along time that the loss is not recognized as a loss. Instead, thepublic sector’s economic position is looked at as an unjust gain. Not only is this presented as an unjust gain, it is an injusticeperpetrated via taxation. And the stage is now set for all thearguments such as those we hear coming from governors such as Walkerand Kasich.
This is where the Keds hit the road. We, and I have to say “We” because We voted in those who made thepolicy changes, have decided that a good job is not one which allowsthe experience of Mr. Bacon or the autoworker. We upped it to be onethat required academic education. No longer would trade education orapprenticeship education be of such value that it would define themiddle class. Unfortunately, as I had suggested in 2007, evenacademic education is being defined down as to not resulting in a “goodjob”.
“The dream seems to now only be adefinite with a 2 person, college educated and working household. That combination is not far from being in the 10% group. Thus, wehave raised the dream to something beyond which a large portion ofthe population will not reach considering only 28% have a 4 yeardegree even though 64% of high school students are entering college. It looks even worse with people suggesting that you need an IQ of 110to succeed in college. I mean, can we push the dream any further outor be anymore aristocratic in our arguments? “

In 2003, the homeownership rate for upper-income families withchildren was 90.8 percent, while the rate for their low- tomoderate-income counterparts was significantly lower at 59.6 percent– yet in 1978 some 62.5 percent of low-to moderate-income workingfamilies with children owned their homes. Ultimately, had the 1978homeownership rates for working families with children prevailed in2003, an additional 2.3 million children would now be living inowner-occupied homes.

How’s this little bit of history change your ideas about what toblame for the current housing/mortgage mess? I suppose if you areall for a future that is less than what was accomplished in the pastthen blaming government for promoting housing and people for spendingbeyond there means is all right by you.

No one in the middle class of yore was rich by any means. But,what they had was a life much freer of risk than today. What theylived in was an environment that provided the means to manage therisk of life and living. When we are told by those running for or inoffice that Americans need to be more…(fill in the blank) they aresuggesting such from within their own experience of having grown upin a socially constructed via government environment that was devoidof certain risks of living based on one’s income. In other words,you would not be told that the requirement for food stamps would meanyou had to have less than $2000 in savings.

The removal of these risks allowed one to take what theypersonally had (natural ability and otherwise) and grow it into alife where economically more of life’s risks could be taken onindividually.   It was an environment which removed the concept ofluck from the social justice equation.

This environment was not all welfare. It was an environment thatassured a person of common acuity could live a life free from therisk of weather, malnourishment, illness and aging. It was anenvironment that produced an economy such that the vast majority ofthe 72% without a college education were living this minimal risklife. We had an environment which supported the economic life journeyof the autoworker, simultaneously supporting the economic life journey of Mr.Bacon’s experience, simultaneous supporting the economic life journey of anindividual such as President Obama.

It was an economic environment which produced a directrelationship between income/wealth and risk absorption. As incomeand wealth went up, so did the absorption of risk and vice versa. Today we

have a system that is completely theopposite such that we have arrived at place where the relationship iscompletely reversed. We spare those who as a group can purchase agovernment which insulates them from any risk while pushing all therisks of living on to those who can not afford any risk and then tellthose people “oh well”. The bank bailouts and theausterity plan is the realization of the reversal of the risk/income-wealth relationship.

Our past economic environment also produced a direct relationshipbetween income-wealth and luck. Again, as income-wealth increased,your success was more dependent on luck and vice versa. This too hasbeen reversed as we see with the Washington revolving door and evergreater capture of the nations wealth as one’s income-wealthincreases. The environment produces an ever stronger assurance thatincome and wealth will increase as they both increase. This isunlike the experience of the middle class including all the highly educatedpeople who find themselves under employed or unemployed do to theshear luck of having chosen wrong. Today the closer you are to zeroon the line of income-wealth, the luckier you need to be.

I’ll leave you with this, the class warfare. There is classwarfare. It has always been with us, since the writing of theConstitution. However, I believe the current theater is the mostdevious the vast majority of the US population has ever faced. Thisis because of the two parties in this seemingly perpetual human quest,one has successfully cloaked themselves in the costume worn of athird party observer effectively immunizing themselves from the pain of the fight via camouflageof a messenger.  I even suspect some aregaining a wee bit of entertainment in their ability to manipulate theircounterparts into fighting among themselves. I speak of the laborclass successfully being divided such that those who labor in theprivate sector of the economy accuses those who labor in the publicsector of the economy for their poor economic position and the publicsector laborer does not recognizing themselves in the private laborworld. I tell you, the false messenger is recognized in that theirlabor is money. It is not in their mind or body. Warren Buffet maywant to be taxed more, but Warren Buffet is not working his money asthe Kock Brothers are working theirs…and Warren Buffet isbenefiting from the productivity of the Kock’s Brother’s money.

Next up is 1936’s tax table.

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Hank Paulson and Some Animals Are More Equal than Others

byMike Kimel

Barry Ritholtz points us to a Bloomberg article showing, once again, that when it came to measures to prop up the economy in 2008, some animals are more equal than others:

Paulson explained that under this scenario, the common stock of the two government-sponsored enterprises, or GSEs, would be effectively wiped out. So too would the various classes of preferred stock, he said.

The fund manager says he was shocked that Paulson would furnish such specific information — to his mind, leaving little doubt that the Treasury Department would carry out the plan. The managers attending the meeting were thus given a choice opportunity to trade on that information.

There’s no evidence that they did so after the meeting; tracking firm-specific short stock sales isn’t possible using public documents.

And law professors say that Paulson himself broke no law by disclosing what amounted to inside information.

The article goes on:

At the time Paulson privately addressed the fund managers at Eton Park, he had given the market some positive signals — and the GSEs’ shares were rallying, with Fannie Mae’s nearly doubling in four days.

William Black, associate professor of economics and law at the University of Missouri-Kansas City, can’t understand why Paulson felt impelled to share the Treasury Department’s plan with the fund managers.

“You just never ever do that as a government regulator — transmit nonpublic market information to market participants,” says Black, who’s a former general counsel at the Federal Home Loan Bank of San Francisco. “There were no legitimate reasons for those disclosures.”

Janet Tavakoli, founder of Chicago-based financial consulting firm Tavakoli Structured Finance Inc., says the meeting fits a pattern.

“What is this but crony capitalism?” she asks. “Most people have had their fill of it.”

The Bloomberg article is worth reading in its entirety.

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Notes toward A Blog Post on Chrystia Freeland’s Interview of GE CEO Jeff Immelt

UPDATE NOTE: The following isn’t complete. Many of my notes from the latter part of today’s interview can be found on Twitter, hashtagged #Immelt. At the moment, I both (1) don’t have easy access to them and (2) have other things that need to be done. Feel free to look there, and/or mention anything you want discussed here.)

The fake “news” of the day will be Immelt’s disparaging of America and Americans.

The semi-real news of the day will be that Immelt threw President Obama under the bus four or five times before finally saying that he “respects the President and respects the Presidency.” While this is progress from Jack Welch thinking that Buying George W. Bush the office meant that his firm would be exempted from cleaning up the PCBs GE dropped into the Hudson River (it did result in a nine-year delay and the likelihood that taxpayers, not GE, will foot the large majority of the bill), it’s not exactly a ringing endorsement of the man who gave us the Unforced Error of Simpson-Bowles.

Jeff Immelt, unlike Henry Aaron, believes that Simpson-Bowles is what we need for “growth.”

Jeff Immelt admits that, while the Board of Directors has some input, CEO pay is all about “getting what you believe you deserve.”

Jeff Immelt declares that if unemployment gets back down to 6%, no one will care about his being paid $21.5 million last year (about 40% of which appears to be an increase in his pension benefits; other GE pension contributors haven’t been so fortunate) to continue running GE into the ground to a standstill.

Jeff Immelt says that the US is 25th in math and 26th in science. (He’s wrong on the latter; we’re 17th.) He then spewed some horseshit about the “crisis” of Germans believing that it’s easier to find skilled workers in Mexico than it is in the United States.

Why do I call this horseshit? Well, let’s look at the two countries compared by Immeltian standards (link is PDF):

There are two three possibly-reasonable explanations. Either (1) there are a lot of Stupid Germans or (2) the places where Germans trying to hire are Significant Laggard or “Business Friendly, School Crappy” States.

Oops, or (3) the Germans pwnd Jeff Immelt, who then didn’t check the data.

And that’s without noting that, if you adjust for demographic issues such as poverty or consider racial inequalities, the U.S. is right at the top, no matter what Jeff Immelt says.

Otherwise, mostly, Jeff Immelt lies through his teeth, and Chrystia Freeland—who was tougher on George Soros last year—lets him get away with saying it.

It is left as an exercise whether this is because her boss openly declaring this was going to be a powder-puff interview (“I’m a big fan” of a man who has lost 60% of shareholder value for his investors over the past ten years) or because she decided to let Immelt hang himself. (I know which way I’m betting.)

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Too Big to Fail? Wall Street and Main Street: How Big Are They

Guest post by Steve Roth
crossposted at Asymptosis

Too Big to Fail? Wall Street and Main Street: How Big Are They

People are forever talking about banks that are too big to fail. But you rarely hear about the larger issue: The financial industry is too big to fail. Click for larger graphic.)

Note that “Main Street” here includes government expenditures — 20% of the total. Remove those, and Wall Street money flow is 58 times the size of Main Street.

I haven’t pulled these numbers for past years,* but it’s clear that this disparity has grown hugely since the 80s, driven by credit issued by the financial industry, to the financial industry, with the money circulating in the financial industry. From Dirk Bezemer:


(FIRE is finance, insurance, and real estate.) The financial industry has spent the last 30 years inflating its own bubble.

So much for the flows. What about the stocks? This is harder to compile, and it’s also difficult to compare Wall Street and Main Street. I’ll explore this in future posts. But here are two numbers worth pondering:

The red bar on the left is the one I’m concentrating on here. (It’s probably a big understatement, because it doesn’t include assets held by financial corporations; see “tally stick,” below.) Divvy these financial assets between every household in America, and each one gets half a million dollars. Yow.

Think of that pool of financial assets as stored money. While they couldn’t all be turned into actual “money” at one time, they constitute the pool of money held by people and businesses, which money flows into (from personal savings and undistributed profits) and out of (for consumption, fixed investment, and tax-paying). This pool is also expanded by new credit/money creation, and increases in asset values. It is shrunk by loan payoffs and declines in asset values.

Now here’s the key point to understand: everything of value to humans is created by the people and businesses on Main Street producing, buying, selling, and investing (in productive assets and housing). Yes, Wall Street produces and sells some of that value: vehicles for investing business and personal savings in a variety of real assets (“intermediation”), safe storage (compared to your mattress), convenience, bookkeeping, advice, etc. That’s all paid for via fees and commissions, and those Wall Street fees and commissions are counted as part of GDP (aka Main Street). As they should be.

But you have to ask: did Wall Street deliver 35% or 45% of the human value of all American businesses in the 2000s? That was the “financial services” share of business profits — the reward received for value created. (I’ve seen some variance in this number, but 34% is the lowest number I’ve seen.)

Whereas the financial sector claimed less than 15 percent of total U.S. corporate profits in the 1950s and 1960s, its share grew to 25 percent in the 1990s and 34 percent in the most recent decade through 2008. Testimony by Sheila Bair, January 14, 2010.

Here’s a picture:

You don’t have to imagine “evil actors” (though there is some proportion of those on Wall Street) to understand why a massive financial sector could be really, really bad for the real economy.

Imagine one of those super-hot racing sailboats that let you pump water from side to side as you switch tacks, to keep the boat upright, stiff, and stable. Now imagine all that water leaks out into the bottom of the boat, so it’s sloshing around with the wind and wave action. Every time you run into a big wave, all the water flows to the front of the boat. A big gust of wind heels you over, and all the water flows over in the same direction. It makes the boat really unstable.

That water is the money swirling and sloshing around in the financial economy. In the short term, those flows are are driven largely by people trying to predict what other people are going to do, so they can go in the same direction. Sound like our sailboat? With $55 trillion of financial assets in the U.S (4 x GDP), and those assets trading hands maybe twelve times a year, that’s a lot of sloshing.

It’s no wonder the sailboat gets knocked over periodically.

Now imagine that a whole bunch of your best and brightest crew members are spending their time with buckets pouring more water into the boat, and moving the water around from place to place (while furiously collecting as much as they can in little bottles in their pockets). Do you think you’re gonna win the race?

But here’s what’s weird: neoclassical economics basically ignores the motive effects of financial sector, treating it like a transparent, frictionless, and inert tally stick or bookkeeping system — like the bank in Monopoly. As Dirk Bezemer has pointed out, the model that the Fed uses to predict our economic future does not include the financial sector as an active entity.

The boxes indicate the variables included in the model. In the present context, the important observation is that all are real-sector variables except the money supply and interest rates, the values of which are in turn fully determined by real-sector variables. In contrast to accounting models, the financial sector is thus absent (not explicitly modelled) in the model.

Paper (pdf). A very nice summary here. You may take issue with Bezemer’s statements, but it’s certain that the Fed’s model does not consider the spectacularly large and highly variable flows within the financial economy, or model their effect on the real economy beyond the rather static notions of money supply and interest rates.

This is especially strange since the Fed is explicitly tasked with compensating for the business cycle. And the business cycle is largely driven by … the financial sector. (Main-street businesses’ cash flows, profits, and losses don’t display anything like the volatility of financial assets.)

Aside from those destabilizing money flows, which are pretty much inherent to financial economies (though their effects on the real economy depend crucially on plain old quantity), what other pernicious effects might we expect to see when a self-inflating financial sector does a very good job of inflating itself?

Moral Hazard. Because the financial economy is so massive, government has no choice but to bail it out if it gets in trouble. Financial-industry players know that, and they act accordingly.

Stagnant Growth in the Real Economy. As the pool of new financial assets (many of which are fabricated using finance-industry-issued credit) increases in value (in a boom or bubble), we see:

rising commitments for the real sector to finance asset transaction out of wages and profit, and rising actual debt levels. When the asset was sold at a profit, someone else bought the asset at the new, higher price. He or she financed this either by diverting liquidity away from real-sector transactions, or by borrowing – at higher levels than did the first buyer. Therefore asset price booms are accompanied by rising debt and by a slowdown in real-sector nominal growth.

Government Capture. Unlike welfare payments, for instance, which distribute money widely and hence are difficult to bring to bear on lobbying etc., the financial sector concentrates wealth, so it can be effectively used to capture government — which further benefits the financial sector, in a self-perpetuating cycle.

Misallocation of Resources. Since the financial industry provides rewards to employees and shareholders that are well in excess of the human value it produces (even considering its role as an intermediary delivering financial capital to the real economy, and its resulting second-hand contribution to delivering things that humans value), both financial and human capital are diverted away from the real economy that produces stuff we want.

I can think of several others (without even starting on things like fairness), but I’ll leave it to my gentle readers to fill out the whole set.

Supply siders, conservative politicians, and freshwater economists are fond of referring to financial capital as the “fuel” of the real economy. But if anything, labor, sales, innovation, or maybe natural resources constitute the real economy’s “fuel.”

Financial investments in business — whether in the form of equity or credit or some weird hybrid — are more like lubrication. A flow of financial capital is crucial to keep the machine running, but you don’t need all that much flow relative to output (43x? 58x??). (And Fama and French showed us long ago that it takes very few traders or trades to create an efficient market with reasonably accurate price signals.) This especially as business owners consistently tell us that investment is dead last on their list of business constraints.

Too much lubrication, in fact (I’m repeating my own line here), and the shop floor starts to get very, very slippery.

Truth told: we have truly oceanic quantities (both flows and stocks) of money, credit, liquidity — whatever you want to call it — far in excess of what’s necessary to lubricate the real economy. When somebody tells you that we need more savings to augment those quantities (and that we should, for instance, tax the rich less so they can provide those savings), I suggest that you go directly to Go, and look at the first three graphics in this post.

If I am correct, the financial sector is much larger than is necessary to lubricate the real economy, and as a result delivers far greater downsides than are necessary to fulfill its valuable purposes.

Is there anything we can do about that? Monsieur Pigou gave us the solution long ago: If you want less of something, tax it.

* It amazes me that these Wall Street figures are so hard to compile, and in fact are never compiled. (Google “financial industry profits” site:wsj.com. One useless hit.) The ratio between the financial economy and the real economy is not part of the everyday language of economic discourse. A kudos to Dean Baker and the folks at CEPR for putting these Wall Street numbers together.

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Mark Thoma has a Future in Stand-Up Comedy

The readers of the Fiscal Times learn what everyone looking at the alphabet-soup of back-door taxpayer theft (or, as Ben Bernanke calls them, facilities) knows:

There are many ways policy could have been improved; providing more help for state and local governments is high on the list, but I’ll focus on another way: using fiscal policy to help households make up for losses from the recession. This is an important, but too often ignored aspect of recovering from what are known as “balance sheet recessions.”…

The effect on bank balance sheets also varies with the type of recession, and a financial collapse brought about by bad loans is particularly severe. The present recession is an example of this, and policy has done a good job of preventing even worse problems from developing by rebuilding financial sector balance sheets through the bank bailout and other means.

But household balance sheets have not received as much attention. We could have helped households rebuild their balance sheets, and this would have helped banks by lowering the default rate on loans. Instead, we left households to mostly solve their problems on their own, and then helped banks when households could not repay what they owed. [emphasis mine; link his]

At his own blog, Professor Thoma ends—as one should—with one of his better jokes, with a perfect Steven Wright delivery:

[W]e can still learn something and improve policy the next time a balance sheet recession hits the economy.

Policy created and maintained as badly as it has been for the past three years must view that summary as a feature, not a bug.

UPDATE: I see RDan mentioned this earlier today. Is the term “balance sheet recession” not so common as I believe it is?

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TARP Cost estimate lowered again

LA Times (via John Chait).

The projected cost of the $700-billion financial bailout fund — initially feared to be a huge hit to taxpayers — continues to drop, with the nonpartisan Congressional Budget Office estimating Monday that losses would amount to just $25 billion.

That’s a sharp drop from the CBO’s last estimate, in August, of a $66-billion loss for the Troubled Asset Relief Program, known as TARP. Going back to March, the budget office estimated that the program would cost taxpayers $109 billion.


No one could have predicted.
And no I don’t get tired of being right all the time.

Rude intrusion:Ken here. For a perspective closer to mine than Robert’s, Donald Marron—who also drank the CBO kool-aid initially—looks at the wider picture of “TARP cost” here.

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He Gave at the Office

What Treasury under Geither does, according to the Washington Post:

“I think we are known as the front line,” said [Michael] Pedroni, 38, a former International Monetary Fund economist and Federal Reserve Bank of New York employee who has spent time at a Wall Street research firm. “Our analysis is meant to be very candid, very quick, very unvarnished.”

Fortunately, he left the FRB NY before Geithner did, so it’s not a question of nepotism, just the finance perspective.

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