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

Debt, Recession, and That Ol’ Devil Denominator

Krugman recently presented this graph, showing household debt as a percentage of GDP.

and made this comment.

Second, a dramatic rise in household debt, which many of us now believe lies at the heart of our continuing depression.

There are those who seem to believe that if Krugman says it, it must be wrong.   Here is Scott Sumner’s reaction.

What do you see?  I suppose it’s in the eye of the beholder, but I see three big debt surges:  1952-64, 1984-91, and 2000-08.  The first debt surge was followed by a golden age in American history; the boom of 1965-73.  The second debt surge was followed by another golden age, the boom of 1991-2007.  And the third was followed by a severe recession.  What was different with the third case?  The Fed adopted a tight money policy that caused NGDP growth to crash, which in turn sharply raised the W/NGDP ratio.  Krugman has another recent post that shows further evidence of the importance of sticky wages.  Forget about debt and focus on NGDP.  It’s NGDP instability that creates problems, not debt surges.

Bold emphasis is provided by Marcus Nunes, who goes on to say:

Why does the share of debt rise? I believe it reflects peoples “optimism” about future prospects. In the chart below I break down Krugman´s chart and separate mortgage and non-mortgage household debt as a share of NGDP. I also add the behavior of the stock market (here represented by the Dow-Jones Index).

[See the linked Nunes post for his chart.]

Eye of the beholder, indeed.  Nunes makes an expectations-based argument, and adds:

Non-mortgage debt remains relatively stable after 1965, fluctuating in the range of 17% to 22% of NGDP. No problem there.

But the reality is that non-mortgage debt has grown quasi-exponentially in the post WW II period.

Sumner, as always, beats the NGDP drum. 

My friend Art takes a jaundiced view of the Sumner-Nunes interpretation.  He gets it exactly right.  To see why, let’s go back and have a look at the data.  Here is straight CMDEBT (Household Credit Market Debt Outstanding,) presented as YoY percent change – not distorted by a GDP divisor.

Sumner sees a debt surge from 1952 to 1964.  I see a secular decrease in the YoY rate of debt growth from over 15% to under 5% by about 1966.

Sumner sees a debt surge from 1984 to 1991.  I see a decrease in the YoY rate of debt growth from over 15% to about 5% over that same span.

Sumner sees a debt surge from 2000 to 2008.  I see a modest rise into a broad peak between 2003 and 2006, with a net decrease in the rate of debt growth over the 2000 to 2007 period.  In CY 2008 debt growth goes negative.  Here’s a close-up view.

So much for optimism-fueled debt growth. 

Between the non-existent debt surges Sumner sees a golden age from 1965 to 1973.  I’m a bit puzzled by a golden age boom that straddles one recession and leads directly into another; though I will admit that average GDP growth then looks impressive compared to the GDP growth of the last decade.  But the thing that Sumner misses within his “golden age” is the big debt surge from 1971 to 1974. 

By my reckoning, Sumner is incapable of identifying either a debt surge or an economic boom.  

So what is going on here?  Sumner and Nunes either fail to realize or deliberately ignore that the quantity CMDEBT/GDP has a denominator.  Let’s look at GDP.  Here is YoY GDP growth over the post WW II period.  And, of course, this is NGDP – not inflation adjusted – the very quantity to which Sumner ascribes so much gravitas.

The average GDP growth over the period 1948 to 2007 is 7.04%
The average over the “debt surge” period 1952 to 1964 is 5.35%
The average over the “debt surge” period 1984 to 1991 is 6.85%
The average over the “debt surge” period 2000 to 2007 is 5.24%

What we have are three periods of below average GDP growth, two of them substantially so.  The middle one is only slightly below average, but that is misleading since there is a steep decline in GDP growth over the period.

Consider C = A/B.  If B is small or decreasing, it will tend to make C large or increasing.  To ascribe all of the changes in C to changes in A is to ignore that Ol’ Devil Denominator.  

Sumner does bring up NGDP growth late in the passage quoted above, but I don’t get his point.  If I’m reading him correctly, he claims that NGDP growth crashed between 2000 and 2008, and that caused the Debt/GDP ratio to rise.  But NGDP growth was sharply up from 2001 to 2003, relatively steady through 2006, and never crashed until 2008.  If there is any sense in his argument, somebody will have to explain it to me.   

What actually happened was a real debt surge – but it was between 1997 and 2004.  Meanwhile, GDP growth both before and after the 2000-2003 dip was around 6 to 7%.  Then, in 2006, household debt growth and GDP growth both started to slump, and in 2008 took a nose dive together.

Sumner and Nunes have made a very fundamental error – not so much in the math itself as in the application of logic.  This is sloppy thinking, and any conclusions drawn from it must be highly suspect.

To get a handle on what is really going on, let’s look at debt growth and GDP growth together.

They don’t move in lock-step, but the similarity is striking.  Specifically, every recession except 2001 corresponds exactly to a minimum in debt growth.  So Sumner’s advice to “forget about debt” looks like it’s missing something very important – specifically that the household component of spending [aka GDP growth] has been debt financed.  To put it in context, have a look at Krugman’s first graph in the article linked above.   It shows what we all know, but some chose to ignore – that median wages have stagnated for 40 years.

In my narrative, the reason household debt grew to almost 100% of GDP is that stagnating incomes have not been able to support the cost of the American life style – due to decades of inflation, but probably largely driven by the costs of health care and education.  Remember – contra the prevailing view of economists today – spending, and therefore GDP growth, is directly dependent on income, not on wealth

Debt is a useful tool that develops into a problem when it becomes too burdensome to service.  Looking at debt as a percentage of GDP provides a clue as to how serviceable the debt is.  When you also consider that all of the GDP growth over several decades has gone to the top income earners, you can see that the debt servicing problem is made that much worse for the average person. 

Nunes thinks debt rises when people are optimistic about the future, and he weaves a narrative based on that idea.  He then blames the 2008 collapse on bad policy, including a contractionary Fed.   He appears to want spending growth, but refuses to recognize the exhausted ability of ordinary people to spend.

In my view – and I think the data supports it – Krugman and Art have this exactly right.  And, as is nearly always the case, those who disagree with PK on what is happening in the real word have to invent a fantasy-world explanation – or, if I can borrow an especially tortured metaphor from Nunes,  pull a red herring out of a hat.

Cross-posted at Retirement Blues.

Tags: , , , , , Comments (25) | |

Unethical Commentary, Newsweek Edition

 I don’t usually pass along a Krugman piece, but the ACA is familiar territory for AB.

By Paul Krugman, The New York Times
21 August 12
here are multiple errors and misrepresentations in Niall Ferguson’s cover story in Newsweek – I guess they don’t do fact-checking – but this is the one that jumped out at me. Ferguson says:

The president pledged that health-care reform would not add a cent to the deficit. But the CBO and the Joint Committee on Taxation now estimate that the insurance-coverage provisions of the ACA will have a net cost of close to $1.2 trillion over the 2012-22 period.

Readers are no doubt meant to interpret this as saying that CBO found that the Act will increase the deficit. But anyone who actually read, or even skimmed, the CBO report (pdf) knows that it found that the ACA would reduce, not increase, the deficit – because the insurance subsidies were fully paid for.

Now, people on the right like to argue that the CBO was wrong. But that’s not the argument Ferguson is making – he is deliberately misleading readers, conveying the impression that the CBO had actually rejected Obama’s claim that health reform is deficit-neutral, when in fact the opposite is true.

We’re not talking about ideology or even economic analysis here – just a plain misrepresentation of the facts, with an august publication letting itself be used to misinform readers. The Times would require an abject correction if something like that slipped through. Will Newsweek?

See Also: Niall Ferguson Publishes Embarrassing Defense Of Newsweek Article

Tags: , , Comments (5) | |

Tax cuts and economic growth

Of course see Mike Kimel’s Presimetrics, familiar to most AB readers, and posts at Angry Bear can be listed here

Paul Krugman write on the meme:

Dooh Nibor

Update: And the Romney people respond with deep voodoo, invoking the supposed fabulous growth effects from his tax cuts. And who could argue? Remember how the economy tanked after Clinton raised taxes? Remember how great things were after Bush cut them? Oh, wait.
More seriously, we have lots of empirical work on the effects of tax changes at the top — and none of it supports the Romney camp’s claims. What we’ve just learned is that they were faking it all along. There is no plan to offset the tax cuts; Romney is just intending to blow up the deficit to lavish favors on the wealthy, then use it as an excuse to savage Social Security and Medicare.

Tags: , Comments (1) | |

Romney’s VERY Private Equity (with UPDATE)

By now there’s been a lot of discussion in the media about the Vanity Fair and Associated Press exposés of Romney’s and his wife’s offshore bank accounts, to the limited extent that information about them is publicly available.  Romney is now likening overseas bank accounts and shell/money-laundering corporations to investing in real overseas companies—as if investments in overseas companies guarantee profit rather than loss in the same way that Bain and its executives usually were guaranteed profits, through financial-transaction fees and “consulting” fees they arranged for themselves irrespective of whether the acquisitioned company made money or instead collapsed under the weight of the debt Bain forced it to incur, in large part, in order to pay Bain those fees.  And as if personal profits from overseas investments aren’t taxable here in the United States unless those profits are stored in bank accounts elsewhere. 

Romney’s refusal to disclose enough specifics about these foreign bank accounts, where the money actually came from and under what circumstances, and how it has been invested gives new meaning to the term “private equity,” at least in Romney’s case.  And this refusal, too, has been and will continue to be widely discussed.

But there’s one aspect of the investigative reports that I think has not been given enough attention and analysis: that Romney’s IRA account from his 15 years as CEO of Bain Capital—a period of time when annual IRA investments could be no more than $2,000—now has assets of more than $100 million.  The Vanity Fair article quotes an expert that the author consulted as saying he believes that they only way that this could have happened would be if Romney significantly undervalued the actual value of the assets he was placing into that account.  Paul Krugman in his New York Times column on Monday discussed the IRA and said there were conceivable legal ways to accomplish this but, because of the secrecy, no way for the public to know whether these wealth was accumulated legally or not. 

Krugman didn’t discuss how this could have happened legally, so I’m wondering: what kinds of investments would there have to have been for this money to have so wildly metastasized?  Apple stock?  If so, how much Apple stock?  Precious-metal funds?  A quiet Louvre heist? 

But there’s another issue concerning Romney’s and Bain’s peculiar brand of investment—this one involving the realdefinition of private equity, not the pun one I used in the title of this post—that also hasn’t received enough media attention: the difference between Bain-style private equity and Silicon Valley-style venture capital.  That difference being the one I alluded to above regarding the investor’s forcing the invested-in company to borrow large sums from banks and use some of the borrowed money or some of its profits to pay huge fees to the investor.  Or, in Bain’s case, apparently, not to all the investors, just to the investment company itself and to its executives—thus eliminating, for them, the usual risk inherent in capitalist investment.  You know; the risk so vaunted by uber-capitalist-advocates like Romney.  Not to mention Romney himself. 
Slate writer Will Oremus has an article there today in which he argues that the real difference between the federal government as an angel investor in startups such as Solyndra and private venture capitalists is that the former can only recoup its investment, while the latter can make substantial—sometimes huge—profits.

But venture capitalists, unlike Bain and its executives, also can lose all or some of their investment, just as the government can.  ((Does Andreesson Horwitz load up the startups it invests in with huge bank debt and use some of the loan money to pay the venture capitalist firm huge financial-transaction and consulting fees?)*  Just as there’s a difference between Silicon Valley-type venture capitalism and Bain-style private equity—something that Obama should point out—there’s a difference between making off like a bandit and being one.


UPDATE: Well, as implied in my reply to a comment below, I was unaware that Romney was the sole owner of Bain; I thought Bain was a closely-held corporation in which Romney was the main, but not the sole, shareholder.  But a jaw-dropping Boston Globe investigative report today, titled “Mitt Romney stayed at Bain 3 years longer than he stated,” makes clear—among, um, other things—that Romney was the sole owner of Bain.

ALSO: On the subject of what types of investments Romney would have to have placed in his Bain-years IRA in order for it to have gained so much wealth, I just emailed Paul Krugman at his Princeton email address, told him about my post and about the speculation in the comments by Mike and Kaleberg, and asked whether he could write on his blog or even in his column about the various possibilities.  So … we’ll see ….

*Parenthetical added on 7/12 at 11:15 a.m.  Should have included it in the original yesterday.  Couldn’t resist adding it now.

Tags: , , , , , Comments (7) | |

Paul Krugman speaks Monday night…

From the Boston Globe comes this interview with Paul Krugman on what he does in between writing and speaking. Just for fun.

From the bully pulpit of his New York Times column, Paul Krugman has been explaining why numbers matters since 1999. The unabashed liberal took the Bush administration to task, but he hasn’t exactly let the Obama administration off the hook, as his new book, “End This Depression Now” makes clear. The Nobel laureate is in town Monday night for a sold-out event sponsored by the Harvard Book Store

The event will be held at First Parish in Cambridge, MA Unitarian-Universalist church. I will be there…if I get the chance to say hello before the event, what do you recommend I ask or say?

Tags: Comments (45) | |

They Also Serve Who Only Stand and Graph: A Graphical Response to Paul Krugman on the Effect QE1 and QE2

by Mike Kimel

They Also Serve Who Only Stand and Graph: A Graphical Response to Paul Krugman on the Effect QE1 and QE2

I’ve taken a lot of flak for critiquing two posts by Paul Krugman in two posts of my own (the second one is here).

To summarize the point where people keep telling me I’m wrong, it has to do with quotes from Prof. Krugman’s pieces, and whether or not I’m misinterpreting those quotes. So I’m going to try this again… I’m going to put up the quotes and tell you how I’ve been told I should be interpreting those quotes. Then I’m going to put up a graph.

Before I get started, I want to be clear: Prof. Krugman is often the only voice of reason, particularly on issues like austerity and taxes, among those allowed up onto the platform to speak. What follows is not a polemic against Prof. Krugman. All of us are wrong sometimes. But I’m focusing on this issue precisely because it seems to be one of the factors leading one of the few voices of reason out there astray on an important issue. Anyway, enough with the editorial comment. First, a quote from Prof. Krugman’s first post.

Furthermore, Fed efforts to do this probably tend on average to hurt, not help, bankers. Banks are largely in the business of borrowing short and lending long; anything that compresses the spread between short rates and long rates is likely to be bad for their profits. And the things the Fed is trying to do are in fact largely about compressing that spread, either by persuading investors that it will keep short rates at zero for a longer time or by going out and buying long-term assets. These are actions you would expect to make bankers angry, not happy — and that’s what has actually happened.

Now, from Prof. Krugman’s second post in which he responds directly to me :

Ordinary monetary policy involves cutting short-term rates to fight a slump; it’s not what we’re talking about here, since it’s hard up against the zero lower bound. But the large-scale conventional expansion the Fed engaged in by getting to the zero bound has, of course, widened the spread between short and long term rates, since markets expect short rates to rise above zero eventually. So looking at the raw data on the short-long spread tells you nothing.

The bolding, in both cases, is mine. Now, I’ve had people writing to tell me I’ve interpreted these two paragraphs the wrong way. The way to interpret them, I’m told (and now that it has been pointed out, I can see the logic) is this:

1. The Fed engaged in conventional expansion at the beginning of the financial meltdown, and that widened the spread between the short term rate at which the banks borrow and the long term rates at which the banks lend.

2. During the nonconventional expansions (i.e., QE1 and QE2), the spread narrowed).

3. Banks prefer wider spreads, and thus, we have evidence that banks are actually unhappy with the things the Fed is (or was) trying to do.

Point number 1 is partly consistent with the graph shown in my first post on the topic, or at least kind of. The graph shows the spread between the FF rate and the 30 year mortgage rate. (i.e., the spread between the shortest rate at which banks borrow and the longest rate at which they regularly lend.) As the graph shows, the spreads widened… but best I can tell, they hit a local bottom in December of 2006. That big process of widening of spreads began in early December 2006.

If you think of monetary policy in terms of interest rates, which most people (and not to speak for Prof. Krugman, but based on reading his posts on a daily basis for many years, it is evident he does), there is nothing magical about early December 2006. The Fed Funds rate was about 6.11% at the time. It rose (not quite continuously) through mid June of 2007, but remained above 6.11%. But from early Dec 2006 to mid June of 2007, the spread increased from 0.86 to 1.48, a jump of 72%. Yes, as interest rates tightened, the spread continued rising, but the whole big rise got jumpstarted not with conventional monetary expansion, but rather with conventional monetary tightening, and this happened before anyone was thinking slump.  

Here’s a second graph. It shows the FF rate, the spread between the FF and the 30 year mortgage rate, QE1 and QE2. The QEx periods are represented by the Gray bars. I’ve also labeled the non-QEx periods as C1, C2 and C3 for “conventional 1,” “conventional 2,” and “conventional 3” – not that any of what we’ve seen in this time has been conventional.

As I noted already, the C1 period is not entirely consistent with how I’ve been told I should be interpreting Prof. Krugman’s quotes, though it isn’t inconsistent with the quotes either. Call it a wash.

What about QE1? Well, the spread peaked the weak of Nov 6 2008 (spread of 5.96), and QE1 began on Nov 26 (spread of 5.41). During QE1, the spread got as low as 4.59 in Dec 2009, and then widened out. The spread was at 4.92 at the end of March 2010 when QE1 ended.

I don’t know what to make of this. Was QE1 telegraphed? It sure doesn’t look like it if you at the FF, but I don’t know enough about that market. I will only say that from where I’m standing, it sure likes the compression Prof. Krugman was talking about is due to something other than QE1. I say this because the narrowing of the spread was actually about the same (actually, a smidge greater) over a three week period leading up to the start of QE1 as it was from the beginning of QE1 to the end of QE1. Worse, it seems that the last four months of QE1 show a widening, not a compression of the spread.

Where the story begins coming apart completely, though, comes in period C2. Somehow the spread begins to narrow precisely, and I do mean precisely, at the point where QE1 ends. From March 31, 2010, to November, 2010, we see a narrowing of the spread that looks more like a straight line than anything else in the graph.

And then…. the spreads begin to widen again beginning in early November 2010. But QE2 began November 3, 2010, and, according to what people tell me, QE2 should have led to a narrowing of the spread, not the end of the narrowing of the spread.

In sum, the evidence is neutral when it comes to what Prof. Krugman believes happened to the spread during QE1, and it contradicts his views on QE2. None of this is to knock anyone, not Prof. Krugman, nor any of the folks who wrote me. We’re living in unconventional times, and the old rules don’t apply. I would merely suggest that in the light of this information, people re-evaluate whether unconventional monetary policy really is hurting the banks. As I suggested in my previous two posts, I believe the evidence shows quite the opposite.

  (As always, if anyone wants my spreadsheet, just drop me a line. I’m at my first name (mike), my last name (kimel with one m), at gmail.)

Tags: Comments (21) | |

What is the Question? Responding to Paul Krugman

by Mike Kimel

What is the Question? Responding to Paul Krugman

Paul Krugman has been kind enough to respond to my post which in turn was commenting on an earlier post he had written.

As I noted in my previous post, I’m very leery about writing this, given Prof. Krugman is usually a very perceptive individual and I’ve noticed that Prof. Krugman is usually right when he is in a disagreement with someone. My trepidation is increased quite a bit by the fact that we’re treading on ground that is so much closer to his area of expertise than the two topics I normally write about. That said, I still believe he is wrong, and I will try to make my point a bit more explicit.

Prof. Krugman’s response comes in four paragraphs. The first is merely an introduction. In the second paragraph, Prof. Krugman states:

Ordinary monetary policy involves cutting short-term rates to fight a slump; it’s not what we’re talking about here, since it’s hard up against the zero lower bound. But the large-scale conventional expansion the Fed engaged in by getting to the zero bound has, of course, widened the spread between short and long term rates, since markets expect short rates to rise above zero eventually. So looking at the raw data on the short-long spread tells you nothing.

Now note this from Krugman’s earlier piece (bolding also mine):

Furthermore, Fed efforts to do this probably tend on average to hurt, not help, bankers. Banks are largely in the business of borrowing short and lending long; anything that compresses the spread between short rates and long rates is likely to be bad for their profits. And the things the Fed is trying to do are in fact largely about compressing that spread, either by persuading investors that it will keep short rates at zero for a longer time or by going out and buying long-term assets. These are actions you would expect to make bankers angry, not happy — and that’s what has actually happened.

Notice… in Prof Krugman’s second post, the spread widened. In his first, post, the one to which I objected (and in response to which I showed a graph of the spread), the spread compressed. As I understand it, on that issue to which I objected, we are now on the same page – we both agree the spread widened. But then what Krugman wrote in his first post about banks being made worse off is not correct, all else being equal. 

What I don’t understand in Prof. Krugman’s second post is the last sentence of the paragraph shown above – why does looking at the short long spread tell us nothing? I could be wrong, but I am assuming Prof. Krugman is stating that it wasn’t the Fed’s intent to widen the spread. the widening of the spread was not the intent of the Fed. That may well be correct – Prof. Krugman knows the key players personally and I do not, so he enjoys both greater access to and greater insights into the behavior of the people involved.

In his next paragraph, Prof. Krugman writes:

QE is an attempt to get traction despite those zero short-term rates by buying long-term debt, hopefully narrowing the spread and thereby boosting the economy. I don’t think it’s had a large effect, but that’s the goal.

Again, I don’t dispute what Krugman believes the Fed was trying to do with QE. I also don’t dispute his opinion that it didn’t have much of an effect. Personally, I suspect the positive effect on the economy of QE was very close to zero and I wrote about my expectation that the effect would be very close to zero at the time.

As I recall, Prof. Krugman was also stating the same thing in real time, albeit more rigorously. In fact, I would say Prof. Krugman made the point better than anyone of whom I was aware. He also was, to my knowledge, the first person with a big platform to make the point that the “bond vigilantes” were wrong as QE would not result in inflation. All of which is to say, not only am I in agreement with him on this issue, I have been one of the small voices supporting him on the issue since 2008.

So let us move on to my other objection to Prof. Krugman’s post (the first being the non-existent compression of short and long term interest rates, and how that was negatively impacting banks). My problem, and the one that I share with many others, is with this statement from Prof. Krugman’s earlier post:

The naive (or deliberately misleading) version of Fed policy is the claim that Ben Bernanke is “giving money” to the banks. What it actually does, of course, is buy stuff, usually short-term government debt but nowadays sometimes other stuff. It’s not a gift. 

To claim that it’s effectively a gift you have to claim that the prices the Fed is paying are artificially high, or equivalently that interest rates are being pushed artificially low. And you do in fact see assertions to that effect all the time. But if you think about it for even a minute, that claim is truly bizarre.

Now let me be 100% clear. I do claim it’s a gift. And did so without mentioning interest rates at all (except in the context of checking whether interest rates compressed or not). Regular readers know I virtually never mention interest rates as I don’t think they are particularly important when it comes to the outcomes of monetary policy. (What is important? Well, it is called monetary policy and not interest rate policy for a reason.)

My claim that the Fed gave a gift to a certain very specific subset of banks and similar entities is based on the following:

1. the housing market was tanking, driving down home prices and driving up foreclosures

2. the expectation was that the situation in the housing market was becoming worse and foreclosures were going up with no end in sight

3. the perceptions described 1. and 2. was that derivatives based on mortgages would continue losing value and nobody knew where the process would end

4. as a result of 1., 2., and 3., nobody wanted derivatives based on mortgages… those who had such derivatives on their books wanted them gone, and nobody else would buy them at any price

Whether the perception of the risk associated with holding those assets was correct or not, it was what everyone believed. The Fed stepped in and paid a price that only made sense in a world where there were no such perceptions of risk. And it wasn’t willing to help everyone that had been blindsided by these perceptions of risk, but rather just one group that had made some very poor decisions.

Put another way – the Fed was willing to relieve some (but not all entities) of assets they didn’t want at a price much higher than those entities could have received from anyone else. That is a gift.

Prof Krugman closes his new piece with this:

And as for the other thing: Kimel apparently thinks the Fed is buying privately issued MBS, aka toxic waste; actually it’s only buying agency debt, which already has an implicit federal guarantee and is functionally not much different from long-term Treasuries.

This is sort of correct, but not in a helpful way. First, a quibble – leaving aside principal reinvestment the Fed no longer is buying agency debt. Now, some substance – yes, the agency debt had an implicit federal guarantee. But… let us be very precise about our definition.

Agency debt means debt issued by a US gov’t sponsored agency. A US government sponsored agency is an agency created by the Federal government to engage in particular commercial activities. Fannie Mae, for example, was created by the Federal government to securitize mortgages and thus help increase the size and scope of the secondary mortgage market, which in turn would make mortgages easier for most people to get.

But Fannie Mae became a publicly traded corporation in 1968. It was no longer owned by the Federal government, and it started acting in the best interest of its shareholders. The Federal government no longer backed the debt Fannie Mae issued, but it was in Fannie Mae’s interest to imply that its debt and its operations were, in fact, guaranteed by the Federal government as that allowed it to borrow for less. If that sounds like the same reason why some charlatan goes around pretending be an heir to the Rockefeller fortune, well, it is, and it puts precisely the same obligation on the Rockefeller family as Fannie Mae put on the Federal government.

So, Fannie Mae’s “implicit guarantee” only began to have any real world value at the point where the Federal government took the company over and that really did happen before the Fed started picking up MBS. But if the Treasury was willing to guarantee MBS debt, why had the market for the debt dried up?

The answer has to do with the size of the Treasury’s guarantee. Remember, the size of the MBS problem was, at the time un-knowable, Hank Paulson’s bazooka had $700 billion in it, was rapidly being seen as inadequate to the task, and there was a big fight over increasing the debt ceiling going on. There was no certainty over whether Congress was going to pony up money to keep the Federal government going, much less pay off some recently acquired private obligations run up by a group of companies suddenly being given the gimlet eye.

Even if you forget about the existence of that uncertainty, the mere fact that the Fed had to step in should remind you that uncertainty was there and was big. If the markets believed the Federal government was providing a full and credible guarantee, the markets for the MBSs would have unfrozen. There has been a lot of money sloshing around earning zero in the last few years – why wouldn’t investors on the sidelines take a positive return guaranteed by the Federal government… unless they didn’t believe the guarantee.

All of which is to say, the gift came not just from the Fed. The Federal government, in the form of the Treasury department, took the first crack, but what was sitting in that particular corner of the financial kitty litter box was too big for the Treasury’s scoop alone. That just goes to show how big of a gift public entities gave to a small group of miscreants.

In closing, I’d like to address a final point… something from Paul Krugman’s post that I originally responded to, namely (and I’m paraphrasing) how are these policies are supposed to hurt the rest of us?

The answer is simple… moral hazard. Most of us were pretty sure that when push came to shove, certain entities would be saved from their folly. Now, any doubts are gone. We know with absolute certainty that it’s true. We have seen the lengths to which our government has gone to save these favored few. Those entities, going forward, have the magic guarantee. So not only has competing against them gotten more costly, it has gotten more costly simply not to be them. Because those entities know they can take bigger risks with no penalty, so they will.

There were other, better ways to proceed. None of them are perfect, but I’ll mention three better options that I wrote about back in 2008.

One would be for the Treasury and the Fed to guarantee that during the crisis, a) any financial entities that couldn’t meet their obligations would be taken over the moment they failed to make a payment and b) the moment a financial entity was taken over by the Treasury + Fed, those two would guarantee that entity’s debts. There would still be moral hazard but it wouldn’t be nearly as bad. We wouldn’t be treated to quite the same spectacle of companies on taxpayer life-support giving themselves huge bonuses while mocking the hoi polloi with drivel about the importance of their place in society. More importantly, we the people would be getting a lot more bang for our collective buck.

Another option would be to allow the public to bank with the Federal Reserve. Things have changed in the past 100 years, after all. Financial intermediaries aren’t all that necessary these days, except to the intermediaries themselves. Besides, the Fed can misread someone’s FICO scores just as easily as Bank of America can, and Ben B is paid orders of magnitude less than his counterpart at B of A. If people could bank directly with the Fed, there wouldn’t be a need to save a bunch of entities whose bad decisions periodically “require” some sort of bail-out.

A third option (one I noted at the time was ludicrous, but was less ludicrous than what would eventually transpire) would be for the Fed & Treasury to have simply recognized at the time that a process that relied on banks loaning money to the public to get the economy hopping had no hope of working because there wasn’t a mechanism to get banks to loan money to the public. The Fed could simply have handed each American a menu and said: “pick $X worth of stuff from this menu.”

This gets back to my statement that from where I’m standing, interest rates aren’t something on which monetary policy should focus. Money, and where that money goes, should be the focus. To quote a comment left by a reader called Mark at Professor Krugman’s blog the other day:

If the Fed printed one trillion in cash and gave each American $3000, I have a pretty good understand what the result would be. But purchasing one trillion in long term treasuries seems to just make an already large pile of unused, uncirculated money even larger. I’m not sure how this qualifies as quantitative easing any more than Bill Gates walking into soup kitchen qualifies as quantitative easing.

Tags: Comments (37) | |

Panel Discussion with: Krugman, Sachs, Phelps, Soros

Just wanted to let everyone know about a presentation that aired on Cspan’s Book TV.  It is a 2 hour panel discussion titles: Global Economy: Crisis Without End.  It was held 2/17/12.   Click hereto bring up the show.
What I found most interesting was the different perspectives between Krugman and Sachs. I’m not sure, but I don’t think either realized they were talking about the “crisis” from 2 different perspectives which leads to 2 different answers to what needs to be done. Thus, they come across as if the other is wrong, when in my opinion, they are both correct. Krugman says we need to do more now. Yes we do. Sach’s says we need to take the long view and start changing the direction we are going, namely calling for higher revenue raising by the government to be spent on the nation’s infrastructure, and he did not just mean physical infrastructure. I guess you would say he was calling for the government folks to get real about raising capital and then doing capital expenditures. Not exactly the thinking I would have expected from Sach’s considering his start in economic life: Shock Therapy.
Maybe I was just seeing the difference in Keynes vs Neoclassic Econ meets Bono?  So as much as Sach’s appears to be calling for the correct long term solution, I don’t trust him as the one to lead the charge.
It was a very good discussion and there is more there than what I have keyed on.

Tags: , , , , , , Comments (2) | |

Krugman, Roubini, and the Eurozone

Krugman highlights but provides no link to Nouriel Roubini’s address to the 2006 Davos meeting (direct link to Economonitors here).

What I would say is that this incident exemplified something that was going on all along the march to the eurodebacle. Serious discussion of the risks and possible downsides was simply not allowed. If you were an independent economist expressing even mild concerns about the project, you were labeled an enemy and shut out of the discussion.

and in the same op ed It’s Not About Welfare States (via truthout) reviews election rhetoric and disinformation on the economic crisis in Europe being mainly welfare oriented countries:

Whenever a disaster happens, people rush to claim it as vindication for whatever they believed before. And so it is with the euro.

As an aside, the interesting thing about the introduction of the euro from a political point of view is the way it cut across the ideological spectrum. It was hailed by the Wall Street Journal crowd, who saw it as a sort of milestone on the way back to gold, and by many on the British left, who saw it as a way to create an alliance of social democracies. It was criticized by Thatcherites, who wanted to be free to move Britain in an American direction, and by American liberals, who believed in the importance of discretionary monetary and fiscal policy.

But now that the thing is in trouble, people on the right are spinning this as a demonstration that … strong welfare states can’t work.

Tags: , , Comments (6) | |

Random Notes on Economics, Music, and Death–and a Bleg

  1. Excess Rents Datapoint of the Day: Since the NYT doesn’t pay Paul Krugman for his blog posts, why should reading those count as part of the “20 free articles” non-subscribers are allowed?
  2. I want the Grapelli track, but not enough to pay for a six-CD set.
  3. This—built by government employees—is the greatest accomplishment in music since Alan Lomax.
  4. And, for fun, via my buddy Tom, the best obituary you’ll read today.
  5. Bleg of the Day: Anyone have a good source or sources on the structures, organizations, and operations of the old “Tea Companies”? Have been thinking about bubbles, and Tea Companies seems to be the Goldman Sachs of the pre-20th century: always in the middle of the problems, but treated reverentially in the histories.

    And, in the Posts I Plan to Write Soon category:

  6. This book is making me wonder if we’re asking the wrong question. Maybe it’s not “Is Economics a Science,” but rather “Is Economics a Discipline.” More to come on this.

Tags: , , , Comments (3) | |