Saturday, December 4, 2010

Naked Capitalism: Marshall Auerback: Bankers Gone Wild in Ireland AND Germany

Marshall Auerback: Bankers Gone Wild in Ireland AND Germany

By Marshall Auerback, a hedge fund manager and portfolio strategist who writes for New Deal 2.0.

Despite a blame-a-thon on Ireleand, Germans banks are really at the core of the eurozone catastrophe.

Much ink has been spilled in the press over the Irish problem and the laxity of the country’s southern Mediterranean counterparts in contrast to the highly “disciplined” Germans. But perhaps we have to revisit that caricature. Not only has the Irish crisis blown apart the myth of the virtues of fiscal austerity during rapidly declining economic activity, but it has also illustrated that Germany’s bankers were every bit as culpable as their Irish counterparts in helping to stoke the credit bubble.

One of the traditional rationales for the creation of the euro was that a single currency and strict Maastricht criteria would keep the profligate Mediterraneans and their Celtic equivalents in line. Instead, critics, particularly in Germany, increasingly see the European Monetary Union as a means for freeloading nations to offload their liabilities onto fitter neighbors.

Not surprisingly, this has engendered much discussion that perhaps it would serve Germany’s interests to leave the euro, rather than booting one of the Mediterranean “scroungers” out. But as Simon Johnson has pointed out, this comforting narrative of German prudence matched up against Irish profligacy doesn’t really stack up:

German banks in particular lost their composure with regard to lending to Ireland — although British, American, French and Belgian banks were not so far behind. Hypo Real Estate — now taken over by the German government — has what is likely to be the highest exposure to Irish debt.

But look at loans outstanding relative to the size of their domestic economies (using the BIS data on what they call an “ultimate risk basis”).

German banks are owed $139 billion, which is 4.2 percent of German G.D.P. [my emphasis]

Where were the German regulators? As my colleague Bill Black has noted:

They seem to have believed that ‘What happens in Vegas (Dublin) stays in Vegas (Dublin).’ Instead, their German banks came back from their riotous holidays in the PIIGS with BTDs (bank transmitted diseases). The German banks’ regulators continue to let them hide the embarrassing losses they picked up on holiday, but that cover up will collapse if any of the PIIGS default. The PIIGS will default if the EU does not bail them out, so there will be a bail out even though the German taxpayers hate to fund bailouts.

German banks’ relatively high exposure to Ireland does pose the question as to whether there is some wild, Weimar-style hyperinflationista lurking deep in the heart of every German, only able to express itself fully when away from the prying eyes of fellow citizens.

All of the rescue plans that have been introduced in Ireland or Greece thus far rest on the assumption that, with more time, the eurozone’s problem children could get their fiscal houses in order — and Europe could somehow grow its way out of trouble. But the fiscal austerity being offered as the “medicine” is turning out to be worse than the disease. It has exacerbated the downturn and unleashed a horrible debt deflation dynamic in all of the areas where it was reluctantly implemented.

But here’s the thing: these fiscal straitjackets obscure the history of how we came to today’s horrible impasse and, more specifically, the German banks’ role in helping to fuel the credit binge. Also lost is the reason why this has metastasized into a far greater crisis: as part of the eurozone, Ireland does not have the fiscal freedom to come up with a sufficiently robust government response. The UK had a comparable real estate bubble in the late 1980s, which culminated with the Soros attack on the pound in 1992 and the ejection of sterling from Exchange Rate Mechanism (the precursor to the EMU). This was a blessing in disguise. Withdrawal from the ERM saved the UK because it allowed the country sufficient latitude to reflate. Yes, the country had a major recession (in many ways a consequence of the surrender of fiscal freedom as a result of joining the ERM in the first place), but there was never a systemic risk that posed a threat to the country’s overall solvency as is the case in Ireland today. And this is exacerbating the problem in Ireland because it persists in chasing its tail repeatedly with futile fiscal austerity measures.

The truth of the matter is this: the eurozone seems rotten to the core, literally. Germany represents that core. The Germans might occupy the penthouse suite, but it is the suite of a roach motel. And we know what happens to those who enter such “establishments.”

Yes, longer term the problems currently afflicting the eurozone could be sorted via the creation of a supranational fiscal authority — a “United States of Europe”. But with each crisis (Ireland today; Portugal and Spain tomorrow; Italy and then France next?), the political forces are coalescing in a radically different direction. The Germans are becoming increasingly resentful as they perceive their country as the bailout mechanism of last resort (even though the Irish experience suggests that their bankers are also guilty of many of the same excesses as the “Celtic Tiger”). The PIIGS themselves are seeing that the benefits of euro membership have been vastly overstated and in fact now act as a cancerous influence through the Germanic embrace of austerity. (Paradoxically, it has been the “profligate” behavior of those so-called lazy Mediterraneans that has enabled Germany to retain its export-driven model, as well as allowing it to run lower budget deficits than most other countries.)

The eurozone could ultimately end up like Yugoslavia writ large. Prior to the break up of that country, the relatively rich republics, Slovenia and Croatia, resented policies that transferred wealth to the poorer republics like Serbia, Macedonia, Montenegro, or the autonomous region of Kosovo. Once Tito’s organizing genius disappeared, the links stitching the country together became frayed and eventually snapped as old grievances manifested themselves in newer forms. The same could happen to the Europe Union if it underwent a supranational fiscal union — the beginnings of which are already in evidence. I think the Germans are beginning to recognize that, which is why there is discussion about leaving the euro.

But let’s first be clear: German Chancellor Angela Merkel has persistently argued that it is essential that private investors, notably the bond holders, begin to suffer losses so that they will have the proper incentives to provide effective “private market discipline” going forward. She has further argued that it is fair that they suffer losses, given the premium yields they received and their lack of due diligence. That’s an honorable policy. But it’s like the old Irish joke of the driver who gets lost, asks for directions, and is told, “Well, I wouldn’t be starting from here.” By the same token, Ireland clearly illustrates that German banks, as well as their Mediterranean counterparts, would be big losers under the Merkel proposal. Ironically, German financial institutions could find themselves subject to the same kinds of bailouts that Chancellor Merkel and many of her counterparts in Berlin are urging on the Irish and Greeks.

As always, leave it to the Irish to come up with the most poetic response to the crisis. True, W.B. Yeats did not live to see this disaster, but his passionate “September 1913” does evoke the tragedy of today’s Ireland and the futility of the current policy responses for their people (and beyond):

Was it for this the wild geese spread
The grey wing upon every tide;
For this that all that blood was shed,
For this Edward Fitzgerald died,
And Robert Emmet and Wolfe Tone,
All that delirium of the brave?
Romantic Ireland’s dead and gone,
It’s with O’Leary in the grave.

Graves that might soon include not only the O’Learys, but also the Garcias, Texeiras, Moreaus, and Schmidts if a more rational course of action throughout the euro zone is not adopted soon.

Thursday, November 18, 2010

Paul Krugman: Bowles-Simpson deficit plan is regressive

Yep, It’s Regressive

Jon Chait takes another look at Bowles-Simpson, this time with numbers from the Tax Policy Center, and is disillusioned. As I surmised, it redistributes income upward: the bottom 80 percent of families would pay higher taxes than they did in the Clinton years, while the top 20 percent — and especially the top 5 percent — would pay less; not what you’d call shared sacrifice.

The only twist here is that the ultra-rich, the top 0.1 percent, who get a lot of their income from dividends and capital gains, would be hit by having these gains taxed as ordinary income. Even so, they would face a smaller tax increase than the bottom 60 percent.

This wasn’t the plan we’ve been looking for; on taxes, what on earth were they thinking?

Tuesday, November 16, 2010

Why QE2 and reserves dont matter.

Auerback: Amateur Hour at the Federal Reserve

By Marshall Auerback, a portfolio strategist and Roosevelt Institute Fellow

As any student of Economics 101 realises, you can control the price of something, or the quantity, but not both simultaneously. In announcing its decision to purchase an additional $600bn of treasuries last week, the Federal Reserve presumably intended to create additional stimulus to an economy, since tepid growth has failed to make a dent in unemployment. Even Friday’s “good” unemployment numbers, where the US economy added 151,000 jobs, were not enough to reduce the current jobless rate of 9.6%.

So is a new round of “QE2” going to do the trick? It would be interesting to figure out how the Fed came to the magic number of $600 billion. Why not a trillion? Why not $250bn? Why $75bn a month? There’s an element of sticking one’s finger in the air and hoping for the best. The Bernanke Fed is slowly reaching Greenspan-like levels of incompetence.

Let’s go back to first principles: Quantitative easing involves the central bank buying financial assets from the private sector – government bonds and maybe high quality corporate debt. In this particular instance, the Fed has announced it will buy $75bn of treasuries a month. So what the central bank is doing is swapping financial assets with the banks – they sell their financial assets and receive back in return extra reserve balances. So the central bank is buying one type of financial asset (private holdings of bonds, company paper) and exchanging it for another (reserve balances at the central bank). The net financial assets in the private sector are in fact unchanged although the portfolio composition of those assets is altered (maturity substitution) which changes yields and returns.

Central bank demand for “long maturity” assets held in the private sector reduces interest rates at the longer end of the yield curve. These are traditionally thought of as the investment rates. This might increase aggregate demand given the cost of investment funds are likely to drop. But on the other hand, the low rates reduce the interest-income of savers who will reduce consumption (demand) accordingly.

Essentially, then, you have a supply side response to a problem of aggregate demand. The cost of investment funds might well drop, although that’s not 100 percent clear. Consider the following example: Let’s say the Fed simply targeted the 10 year treasury at 2.25%. The central bank would have a bid at that level and buy all the securities the market didn’t want to buy at that level. They may in fact buy a lot or a very few, and possibly none at all, depending on Treasury issuance, investor demand, and market expectations.

But the FOMC has announced a limit to the Fed purchase program, both in terms of the monthly amounts and the total quantity. How high will 10 year notes trade with the billions free to trade at market levels?

It could be at much higher yields, which presumably defeats the whole purpose of the program. Of course, if the Fed bought every single 10 year treasury, then for sure they could maintain that rate indefinitely; but then they would have to preclude announcing a specific amount that they wished to purchase. Of course, if the Fed did this, people would undoubtedly squawk about “printing money” and “creating inflation” but again, QE does not actually create new net financial assets.

In fact, the Fed has done nothing but TALK about its plans over the past several months, but has yet to initiate the program. There has been no widespread “money printing” or “currency debasement”. The Federal Reserve announced an INTENTION to do something and private portfolio investors took their cue from that. But as any Asian central banker can tell you, private portfolio preference shifts are notoriously fickle, with conflicting motives. The term structure of rates in Japan would imply a comparable intent to make holding yen unattractive, yet 10 year government bonds in Japan yield less than one percent and the yen remains resolutely strong against the dollar.

Is there another method by which the Fed could influence the long term structure of interest rates? Why not just stop issuing 10 year government paper? If the Treasury had announced they were eliminating everything longer than 2 year notes for new issues there would hardly be any screams of “money printing”?

And how low would the 10 year go?

If the objective is to allow the banks to earn their way out of insolvency, then QE2 is also an ineffective means of doing this, since it flattens the yield curve, but still engenders interest rate risk on the part of the banks which persist in “playing the yield curve”, especially via leverage. There is a more effective means of doing promoting bank profitability in a comparatively risk free way, as my colleague, Randy Wray, has noted:

[T]here is nothing wrong with offering longer-maturity CDs to replace overnight reserve deposits held by banks at the Fed. Banks are content to hold deposits at the Fed—safe assets that earn a little interest. They are hoping to play the yield curve to get some positive earnings in order to rebuild capital. If they can issue liabilities at an even lower interest rate so that earnings on deposits at the Fed cover interest and other costs of financing their positions in assets, this strategy might work. That is what they did in the early 1990s, allowing banks that were insolvent to work their way back to profitability. The Fed could even lend to banks at 25 basis points (0.25% interest) so that they could buy the CDs, then pay them, say, 100 or 200 basis points (1% or 2% interest) on their longer maturity CDs. The net interest earned could tide them over until it becomes appropriate for them to resume lending to households and firms.

To be clear, we are not necessarily advocating banks play the yield curve to restore profitability (far better to have a payroll tax cut for that), or that they get such an arbitrage from the Fed, only that it would work with less risk both to the bank and the financial system than what will result from QE. Ultimately, if the objective is to allow banks to restore profitability via traditional lending activities, then there are far more obvious ways to do so. Let’s first recall that BANKS DO NOT LEND THEIR RESERVES, as is always depicted in the economics textbooks via so-called “fractional reserve lending”. The Federal Reserve Bank is a bank, just like Citibank or Wells Fargo. The Treasury has an account at the bank, just as you or I have a checking account at our local bank. Other banks, like BofA and Wells Fargo have accounts at the Fed as well, and they are called reserve accounts (for more see here).

Reserve accounts are not made up of money held in reserve in case a loan goes bad, they are money held at the Federal Reserve for payment settlement. The reserves of money held in case loans go bad are capital. They are not lent out. The way banks actually operate is to seek to attract credit-worthy customers to which they can loan funds to and thereby make profit. What constitutes credit-worthiness varies over the business cycle and so lending standards become more lax at boom times as banks chase market share. But that’s a function of credit analysis (or the lack of it, as the cycle matures), NOT the bank’s reserve positions.

These loans are made independent of their reserve positions. At the individual bank level, certainly the “price of reserves” will play some role in the credit department’s decision to loan funds. But the reserve position per se will not matter. So as long as the margin between the return on the loan and the bank’s marginal cost of funds is sufficient, the bank will lend

So as long as the margin between the return on the loan and the rate they would have to borrow from the central bank through the discount window is sufficient, the bank will lend (for more explanation, see here).

Consequently, the idea that reserve balances are required initially to “finance” bank balance sheet expansion via rising excess reserves is inapplicable. A bank’s ability to expand its balance sheet is ultimately dictated by the presence of creditworthy borrowers, which is a function of FISCAL POLICY. Instead of expending political capital on pointless accounting shuffles and financial guarantees, or programs such as TALF, TARP, Term Auction Credit, or the Commercial Paper Lending Facility, one could simply implement a $2 trillion tax cut (or spend it via the government, or do revenue sharing with the states), thereby generating increased spending power in the economy, providing significantly higher multiplier effects and ultimately shifting the economy back to self-sustaining growth. This would be far more effective than continuing an endless array of silly Fed programs, which do nothing but diminish the central bank’s credibility and have had minimal impact in terms of economic growth.

In many respects, the markets are already implicitly conceding the ineffectiveness of “QE2”. Within hours of the program being announced, there were stories of “QE3”. Instead of having a situation where the markets “buy the rumor, sell on the news”, it appears to have been more a case of buy the rumor and then double up on the news.

We’ve truly hit amateur hour at the Fed. We’re inciting speculation and the Federal Reserve is acting like the kid in his car seat who keeps turning his toy steering wheel as much as it takes to turn the car. Toy cars, however, won’t get you very far if you plan a long journey, and likewise QE2 is a pretty ineffective vehicle if one wishes to engender genuine economic growth. Eventually, investors will realize they’ve been conned (yet again) by the Fed and the end result won’t be pretty.

Don’t Fear the Rise in the Fed’s Reserve Balances

By Scott Fullwiler

Many in the financial press have noted the rise since September 2008 in the Fed's reserve balances from about $20 billion to more than $800 billion today. A number of well-known economists have expressed concern that this will be inflationary.

However, fears that these are inflationary are misplaced, even inapplicable, as they apply only to a monetary system operating under a gold standard, currency board, or similar arrangement, not the flexible exchange rate system of the U. S.

Under a gold standard, for instance, banks must be careful when creating loans that they have sufficient gold or central bank reserves to meet depositor outflows or legal reserve requirements. This is the fractional banking, money multiplier system standard in the economics textbooks. If there is an inflow of gold, then bank deposit creation can increase and prices can rise. The same can occur if the central bank raises the quantity of reserves circulating relative to its own gold reserves.

But that's not the case under modern monetary systems with flexible exchange rates.

In the U. S., when a bank makes a loan, this loan creates a deposit for the borrower. If the bank then ends up with a reserve requirement that it cannot meet by borrowing from other banks, it receives an overdraft at the Fed automatically (at the Fed's stated penalty rate), which the bank then clears by borrowing from other banks or by posting collateral for an overnight loan from the Fed. Similarly, if the borrower withdraws the deposit to make a purchase and the bank does not have sufficient reserve balances to cover the withdrawal, the Fed provides an overdraft automatically, which again the bank then clears either by borrowing from other banks or by posting collateral for an overnight loan from the Fed.

The point of all this is that the bank clearly does not have to be holding prior reserve balances before it creates a loan. In fact, the bank's ability to create a new loan and along with it a new deposit has NOTHING to do with how many or how few reserve balances it is holding.

In other words, there is no loan officer at any bank that checks with the bank's liquidity officer to see if the bank has reserves before it makes a loan.

What constrains a bank in the creation of new loans and deposits, then? First, there is the fact that there must be a willing borrower . . . one whom the bank deems to be creditworthy. Second, the loan must be perceived as profitable . . . in this case, the bank's ability to raise deposits does matter, since it probably expects the borrower to withdraw the deposit it will create, and finding new deposits is much cheaper for the bank than borrowing from other banks or from the Fed. Third, the loan must be on the regulator's approved list of assets, and if the loan results in an expansion of the bank's balance sheet, the bank must be aware of the impact on its capital requirements and other financial ratios with which the regulator is concerned.

But, how many reserve balances the bank is holding does NOT affect its operational ability to make the loan.

Most fears expressed by economists, policymakers, and the financial press regarding the rise in reserve balances since September presume—like the inapplicable money multiplier model—this will necessarily lead to excessive creation of loans and deposits by banks and thus rising inflation.

But this cannot possibly be true. Banks have the same ability to create loans with $800 billion in reserve balances that they had with $20 billion. The difference now is mostly that they do not see as many creditworthy borrowers coming through their doors, given the deep recession, which has led them to create fewer loans.

Admonishments of banks by members of Congress for "not lending out the TARP funds" make the same mistake. Banks don't lend out TARP funds or any other funds. They create loans and deposits out of thin air, then use reserve balances to settle payments or meet reserve requirements.

For further evidence, consider two recent extreme cases:

In Canada, reserve balances have been effectively zero for over a decade now, and bank lending continues as it does anywhere else. Canada's inflation also has been similar to that of the U. S.

In Japan, under the so-called quantitative easing regime of 2001-2005, reserve balances reached around 15% of GDP, and the monetary base (reserve balances plus currency in circulation . . . often termed "high powered money") reached 23% of GDP. But Japan has, if anything, experienced deflation during and since this period, which is not surprising, since—again—the rising quantity of reserve balances did not enhance Japanese banks' abilities to create loans.

In the U. S., by comparison, reserve balances have reached about 6% of GDP, with the monetary base rising from about 6% to about 12% of GDP since September 2008. Those fearing rising Fed reserve balances apparently haven't noticed that an increase in reserve balances about three times the size in terms of GDP already happened in Japan, with none of the effects that have been predicted for the U. S.

In short, don't fear the rise in the Fed's reserve balances. It is not inflationary because the money multiplier view, found in the textbooks, doesn't apply to the flexible exchange rate monetary system of the U. S. The U. S. may indeed experience rising inflation in the future (or it may not), but it won't have anything to do with the quantity of reserve balances banks are holding.

Thursday, October 28, 2010


Both Econ 215 (8:00 - 9:15) and Econ 1010 (9:25-10:40) are cenceled today, Oct 28th. See you next Tuesday.

Wednesday, October 6, 2010

Data sets for dissertation

Fed state level data

Mason and Calomiris:

FDIC member bank data:

Brief explanation of housing in NIPA:

Monday, October 4, 2010

Required Assginment: "How Four Drinking Buddies Saved Brazil"


Since I think this podcast about inflation in Brazil is more likely to make an impression on you than my lectures I am assigning it as a required text. There will be a question on the midterm.

You can listen to it here: Planet Money.

Or you can get it from ITunes (it is free).

Monday, September 20, 2010

Stuff to talk about in class. Week of Sept 21st edition.

Two things to discuss in class:

NBER announces that July 2009 was the "trough" of the Great Recession:
The Press Release is here

Core CPI does not change in August. Is not news good news?
The Press release is here

Stuff to know (short version):

From the WSJ:

From EconSpeak:

As AP reports the National Bureau of Economic Research has deemed that the Great Recession ended in June 2009. While it is true that real GDP has inched upwards over the past 4 quarters, real GDP as of 2010QII was only $13,191.5 billion per year as compared to $13,363.5 billion as of 2007QIV. With 2007 witnessing a growth rate that was less than 2 percent and with negative cumulative growth since then – we are far below full employment today. AP also reports that the President isn’t exactly celebrating this NBER announcement:


How is the CPI market basket determined?

The CPI market basket is developed from detailed expenditure information provided by families and individuals on what they actually bought. For the current CPI, this information was collected from the Consumer Expenditure Surveys for 2007 and 2008. In each of those years, about 7,000 families from around the country provided information each quarter on their spending habits in the interview survey. To collect information on frequently purchased items, such as food and personal care products, another 7,000 families in each of these years kept diaries listing everything they bought during a 2-week period.

Over the 2 year period, then, expenditure information came from approximately 28,000 weekly diaries and 60,000 quarterly interviews used to determine the importance, or weight, of the more than 200 item categories in the CPI index structure.

How are CPI prices collected and reviewed?

Each month, BLS data collectors called economic assistants visit or call thousands of retail stores, service establishments, rental units, and doctors' offices, all over the United States, to obtain information on the prices of the thousands of items used to track and measure price changes in the CPI. These economic assistants record the prices of about 80,000 items each month, representing a scientifically selected sample of the prices paid by consumers for goods and services purchased.

What is an index?

An index is a tool that simplifies the measurement of movements in a numerical series. Most of the specific CPI indexes have a 1982-84 reference base. That is, BLS sets the average index level (representing the average price level)-for the 36-month period covering the years 1982, 1983, and 1984-equal to 100. BLS then measures changes in relation to that figure. An index of 110, for example, means there has been a 10-percent increase in price since the reference period; similarly, an index of 90 means a 10-percent decrease. Movements of the index from one date to another can be expressed as changes in index points (simply, the difference between index levels), but it is more useful to express the movements as percent changes. This is because index points are affected by the level of the index in relation to its reference period, while percent changes are not.

Here is the full FAQ answer to "what is an index?" from the BLS

This is mostly so I remember to print it out tomorrow morning:

Relative weights of the components of the CPI

Wednesday, September 15, 2010

EPI: State and Local Public Employees Undercompensated

I wonder how much adjunct faculty factored into this (By way of Economist's View):

EPI: State and Local Public Employees Undercompensated

A new study from the EPI says that once you control for differences between public and private sector employees, public sector employees are, on average, undercompensated:

State and local public employees undercompensated, EPI study finds: State and local public employees are undercompensated, according to a new Economic Policy Institute analysis. The report, Debunking the Myth of the Overcompensated Public Employee: The Evidence by Labor and Employment Relations Professor Jeffrey Keefe of Rutgers University, finds that, on average, state and local government workers are compensated 3.75% less than workers in the private sector.
The study analyzes workers with similar human capital. It controls for education, experience, hours of work, organizational size, gender, race, ethnicity and disability and finds that, compared to workers in the private sector, state government employees are undercompensated by 7.55% and local government employees are undercompensated by 1.84%. The study also finds that the benefits that state and local government workers receive do not offset the lower wages they are paid.
The public/private earnings differential is greatest for doctors, lawyers and professional employees, the study finds. High school-educated public workers, on the other hand, are more highly compensated than private sector employees, because the public sector sets a floor on compensation. The earnings floor has collapsed in the private sector.
The Political Economy Research Institute (PERI) at the University of Massachusetts, Amherst and the DC-based Center for Economic Policy Research are also releasing a study today, which echoes the national findings of Debunking the Myth of the Overcompensated Public Employee at a regional level. PERI’s report, The Wage Penalty for State and Local Government Employees in New England finds a "wage penalty" for state and local government workers in New England of almost 3%.

Wednesday, September 8, 2010

Pictures of Unemployment

From J. Bradford DeLong:

Jobless Recovery Watch

Q: How long do jobless recoveries in the post-WWII U.S. typically last?

A: We have only had two. One lasted two and a half years. The other lasted four years. This one has, so far, lasted ten months.

From Calculated Risk:

Here is a graph you should all find interesting

Again from Calculated Risk:

From Calculated Risk:

Spiegel Online: Tensions Rise in Greece as Austerity Measures Backfire

Tensions Rise in Greece as Austerity Measures Backfire

Tensions Rise in Greece as Austerity Measures Backfire

By Corinna Jessen in Athens

The austerity measures that were supposed to fix Greece's problems are dragging down the country's economy. Stores are closing, tax revenues are falling and unemployment has hit an unbelievable 70 percent in some places. Frustrated workers are threatening to strike back.

The feast of the Assumption of Mary on Aug. 15 is the high point of summer in the Greek Orthodox world. Here in one of the country's many churches, believers pray to the Virgin for mercy, with many of them falling to their knees.

The newspaper Ta Nea has recommended that the Greek government adopt the very same approach -- the country's leaders have to hope that Mary comes up with a miracle to save Greece from a serious crisis, the paper writes. Without divine intervention, the newspaper suggested, it will be a difficult autumn for the Mediterranean state.

This dire prognosis comes even despite Athens' massive efforts to sort out the country's finances. The government's draconian austerity measures have managed to reduce the country's budget deficit by an almost unbelievable 39.7 percent, after previous governments had squandered tax money and falsified statistics for years. The measures have reduced government spending by a total of 10 percent, 4.5 percent more than the EU and International Monetary Fund (IMF) had required.

The problem is that the austerity measures have in the meantime affected every aspect of the country's economy. Purchasing power is dropping, consumption is taking a nosedive and the number of bankruptcies and unemployed are on the rise. The country's gross domestic product shrank by 1.5 percent in the second quarter of this year. Tax revenue, desperately needed in order to consolidate the national finances, has dropped off. A mixture of fear, hopelessness and anger is brewing in Greek society.

Unemployment Rates of up to 70 Percent

Nikos Meletis is neatly dressed, and his mid-range car is clean and tidy. Meletis used to earn a good living at a shipbuilding company in Perama, a port opposite the island of Salamis. "At the moment, I'm living off my savings," the 54-year-old welder says, standing in front of a silent harbor full of moored ships.

Meletis is a day laborer who used to work up to 300 days a year; this year he has only managed to scrape together 25 days' work so far. That gives him 25 health insurance stamps, when he needs 100 in order to insure himself and his family -- including his wife, who has cancer. "How am I supposed to pay for the hospital?" Meletis asks. Unemployment benefits of at most €460 ($590) per month are available for a maximum of one year -- and only if he can produce at least 150 stamps from the past 15 months.

There's hardly a worker in the shipbuilding district of Perama who could still manage that. Unemployment in the city hovers between 60 and 70 percent, according to a study conducted by the University of Piraeus. While 77 percent of Greek shipping companies indicate they are satisfied with the quality of work done in Perama, nearly 50 percent still send their ships to be repaired in Turkey, Korea or China. Costs are too high in Greece, they say. The country, they argue, has too much bureaucracy and too many strikes, with labor disputes often delaying delivery times.

Perama is certainly an unusually extreme case. But the shipyards' decline provides a telling example of the Greek economy's increasing inability to compete. Barely any of the country's industries can keep up with international competition in terms of productivity, and experts expect the country's gross domestic product to fall by 4 percent over the course of the entire year. Germany, by way of comparison, is hoping for growth of up to 3 percent.

Sales Figures Dropping Everywhere

Prime Minister George Papandreou's austerity package has seriously shaken the Greek economy. The package included reducing civil servants' salaries by up to 20 percent and slashing retirement benefits, while raising numerous taxes. The result is that Greeks have less and less money to spend and sales figures everywhere are dropping, spelling catastrophe for a country where 70 percent of economic output is based on private consumption.

A short jaunt through Athens' shopping streets reveals the scale of the decline. Fully a quarter of the store windows on Stadiou Street bear red signs reading "Enoikiazetai" -- for rent. The National Confederation of Hellenic Commerce (ESEE) calculates that 17 percent of all shops in Athens have had to file for bankruptcy.

Things aren't any better in the smaller towns. Chalkidona was, until just a few years ago, a hub for trucking traffic in the area around Thessaloniki. Two main streets, lined with fast food restaurants and stores catering to truckers, intersect in the small, dismal town. Maria Lialiambidou's house sits directly on the main trucking route. Rent from a pastry shop on the ground floor of the building used to provide her with €350 per month, an amount that helped considerably in supplementing her widow's pension of €320.

These days, though, Kostas, the man who ran the pastry shop, who people used to call a "penny-pincher," can no longer afford the rent. Here too, a huge "Enoikiazetai" banner stretches across the shopfront. No one wants to rent the store. Neither are there any takers for an empty butcher's shop a few meters further on.

A sign on the other side of the street advertises "Sakis' Restaurant." The owner, Sakis, is still hanging on, with customers filling one or two of the restaurant's tables now and then. "There's really no work for me here anymore," says one Albanian employee, who goes by the name Eleni in Greece. "Many others have already gone back to Albania, where it's not any worse than here. We'll see when I have to go too."

No Way Out

The entire country is in the grip of a depression. Everything seems to be going downhill. The spiral is continuing unabated, and there is no clear way out. The worse part, however, is the fact that hardly anyone still hopes that things will improve one day.

The country's unemployment rate makes this trend particularly clear. In 2009, it was 9.5 percent. This year it may rise to 12.1 percent and economists expect it to reach 14.3 percent in 2011. Those, though, are only the official numbers, which were provided by Angel GurrĂ­a, secretary general of the Organisation for Economic Co-operation and Development (OECD). The Greek trade union association GSEE considers those numbers far too optimistic. It considers 20 percent to be a more likely figure for 2011. This would put the unemployment rate as high as it was in 1960, when hundreds of thousands of Greeks were forced to emigrate. Meanwhile, purchasing power has fallen to its 1984 level, according to the GSEE.

'Things Are Starting to Simmer'

Menelaos Givalos, a professor of political science at Athens University, has appeared on television, warning viewers that the worst times are still to come. He predicts a large wave of layoffs starting in September, with "extreme social consequences."

"Everything is getting more expensive, I'm hardly earning any money, and then I'm supposed to pay more taxes to help save the country? How is that supposed to work?" asks Nikos Meletis, the shipbuilder. His friends, gathered in a small cafeteria on the pier in Perama, are gradually growing more vocal. They are all unemployed, desperate and angry at the politicians who got them into this mess. There is no sympathy here for any of the political parties and no longer any for the unions either.

"They only organize strikes to serve their own interests!" shouts one man, whose name is Panayiotis Peretridis. "The only thing that interests me anymore is my daily wage. A loaf of bread is my political party. I want to help my country -- give me work and I'll pay taxes! But our honor as first-class skilled workers, as heads of families, as Greeks, is being dragged through the dirt!"

"If you take away my family's bread, I'll take you down -- the government needs to know that," Meletis says. "And don't call us anarchists if that happens! We're heads of our families and we're desperate."

He predicts the situation will only become more heated. "Things are starting to simmer here," he says. "And at some point they're going to explode."

Monday, August 30, 2010

Naked Capitalism: Japan’s Experience Suggests Quantitative Easing Helps Financial Institutions, Not Real Economy

Japan’s Experience Suggests Quantitative Easing Helps Financial Institutions, Not Real Economy

A few days ago, we noted:

When an economy is very slack, cheaper money is not going to induce much in the way of real economy activity.

Unless you are a financial firm, the level of interest rates is a secondary or tertiary consideration in your decision to borrow. You will be interested in borrowing only if you first, perceive a business need (usually an opportunity). The next question is whether it can be addressed profitably, and the cost of funds is almost always not a significant % of total project costs (although availability of funding can be a big constraint)…..

So cheaper money will operate primarily via their impact on asset values. That of course helps financial firms, and perhaps the Fed hopes the wealth effect will induce more spending. But that’s been the movie of the last 20+ years, and Japan pre its crisis, of having the officialdom rely on asset price inflation to induce more consumer spending, and we know how both ended.

Tyler Cowen points to a Bank of Japan paper by Hiroshi Ugai, which looks at Japan’s experience with quantitative easing from 2001 to 2006. Key findings:

….these macroeconomic analyses verify that because of the QEP, the premiums on market funds raised by financial institutions carrying substantial non-performing loans (NPLs) shrank to the extent that they no longer reflected credit rating differentials. This observation implies that the QEP was effective in maintaining financial system stability and an accommodative monetary environment by removing financial institutions’ funding uncertainties, and by averting further deterioration of economic and price developments resulting from corporations’ uncertainty about future funding.

Granted the positive above effects of preventing further deterioration of the economy reviewed above, many of the macroeconomic analyses conclude that the QEP’s effects in raising aggregate demand and prices were limited. In particular, when verified empirically taking into account the fact that the monetary policy regime changed under the zero bound constraint of interest rates, the effects from increasing the monetary base were not detected or smaller, if anything, than during periods when there was no zero bound constraint.

Yves here This is an important conclusion, and is consistent with the warnings the Japanese gave to the US during the financial crisis, which were uncharacteristically blunt. Conventional wisdom here is that Japan’s fiscal and monetary stimulus during the bust was too slow in coming and not sufficiently large. The Japanese instead believe, strongly, that their policy mistake was not cleaning up the banks. As we’ve noted, that’s also consistent with an IMF study of 124 banking crises:

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.

Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.5 Of course, the caveat to these findings is that a counterfactual to the crisis resolution cannot be observed and therefore it is difficult to speculate how a crisis would unfold in absence of such policies. Better institutions are, however, uniformly positively associated with faster recovery.

But (to put it charitably) the Fed sees the world through a bank-centric lens, so surely what is good for its charges must be good for the rest of us, right? So if the economy continues to weaken, the odds that the Fed will resort to it as a remedy will rise, despite the evidence that it at best treats symptoms rather than the underlying pathology.

ProPublica: Banks’ Self-Dealing Super-Charged Financial Crisis

Banks’ Self-Dealing Super-Charged Financial Crisis

Short/no reading version of the story:
Planet Money

Over the last two years of the housing bubble, Wall Street bankers perpetrated one of the greatest episodes of self-dealing in financial history.

Faced with increasing difficulty in selling the mortgage-backed securities that had been among their most lucrative products, the banks hit on a solution that preserved their quarterly earnings and huge bonuses:

They created fake demand.

A ProPublica analysis shows for the first time the extent to which banks -- primarily Merrill Lynch, but also Citigroup, UBS and others -- bought their own products and cranked up an assembly line that otherwise should have flagged.

The products they were buying and selling were at the heart of the 2008 meltdown -- collections of mortgage bonds known as collateralized debt obligations, or CDOs.

As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created -- and ultimately provided most of the money for -- new CDOs. Those new CDOs bought the hard-to-sell pieces of the original CDOs. The result was a daisy chain [1] that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those.

Saturday, August 21, 2010

Econ 101: Macroeconomics Fall 2010

I will be posting course material here. As you probably noticed there is a direct link to this post on the right hand side of the blog.

The material posted here is for:
Econ 101: Macroeconomics
T-TH 9:25-10:40 Section: 9T3RA

I can be reached at:

Office Hours:
Tuesday and Thursday: 7:00 to 8:00 and 10:40-11:00
If I am not in the classroom (PH154) I will be in the adjunct office in the economics department: PH300B

Final Grades

Final Grade Roster Explained:
The most you can score for your homework grade is 1 (100%). Homework total grades that have been bolded had scored higher than a 1 (100%).

Two students earned a full letter grade higher on the second midterm than the first, their whole entry has been bolded.


Required "Reading":

Planet Money: How Four Drinking Buddies Saved Brazil"



1. Must be handed in during class.

2. Must be stapled. Assignments not stapled will lose a letter grade

3. You must answer all questions. Failure to answer one question will result in a check minus. Failure to answer more than one question will result in a zero.

4. Rules for Emailing homework assignments (emrgencies only)
a. Must be a single, legible pdf or word document.
b. Must be time stamped before the begining of class on the day it is due.

Homework Assignment #1: Due 10/5
Homework Assignment #2: Due 10/14
Homework Assignment #3: Due 11/23

Old Exams:

Midterm #1
Midterm #2

Sample Final*

An answer sheet was requested for the sample homework. I have not included graphs, I have only explained what will happen to the graphs.
The answers to the sample final are here.

*A word of caution. This is last semesters final, do not simply take it for granted that this semesters final will look exactly like the one I gave this spring. Certain topics were covered differently.

Final Grades

Final Grade Roster Explained:
The most you can score for your homework grade is 1 (100%). Homework total grades that have been bolded had scored higher than a 1 (100%).

Two students earned a full letter grade higher on the second midterm than the first, their whole entry has been bolded.

Econ 215: Money and Banking; T-TH 8:00-915

I will be posting course material here. As you probably noticed there is a direct link to this post on the right hand side of the blog.

The material posted here is for:
Econ 215: Money and Banking
T-TH 8:00-9:15 Section: 8T3RA

Final Grades

Final Grade Roster Explained:

1. The most you can score for your homework grade is 1 (100%). Homework total grades that have been bolded had scored higher than a 1 (100%).

2. If you received a zero by either not handing something in or not taking a test the space was left blank. if you did hand something in or took a test and still received a zero it was marked as a zero.

3. Students who earned a full letter grade higher on the second midterm have had their whole entries bolded. There were quite a few.

4. The average grade for the semester was a 33 and the median grade was a 36. Students who scored within a few points of 33 or 36 got a C (which means average) and the rest of the curve was based around that.

I can be reached at:

Office Hours:
Tuesday and Thursday: 7:00 to 8:00 and 10:40-11:00
If I am not in the classroom (PH154) I will be in the adjunct office in the economics department: PH300B



You must read and listen to Gary Gorton and Charles Calomiris before the final.

Gary Gorton on the Financial Crisis

Calomiris on the Financial Crisis
The above link is a direct link to the October 29, 2009 EconTalk podcast. You can play the podcast directly from the site or download it. If you prefer, you can also subscribe to the podcast through the ITunes Store

Homework Assignments:


1. Must be handed in during class.

2. Must be stapled. Assignments not stapled will lose a letter grade

3. You must answer all questions. Failure to answer one question will result in a check minus. Failure to answer more than one question will result in a zero.

4. Rules for Emailing homework assignments (emrgencies only)
a. Must be a single, legible pdf or word document.
b. Must be time stamped before the begining of class on the day it is due.

Homework #1 Due 10/14
Edit of Homework #1 Due 10/19

Homework #2 Due 11/16

Homework #3 Due 11/23

Final Grades

Final Grade Roster Explained:

1. The most you can score for your homework grade is 1 (100%). Homework total grades that have been bolded had scored higher than a 1 (100%).

2. If you received a zero by either not handing something in or not taking a test the space was left blank. if you did hand something in or took a test and still received a zero it was marked as a zero.

3. Students who earned a full letter grade higher on the second midterm have had their whole entries bolded. There were quite a few.

4. The average grade for the semester was a 33 and the median grade was a 36. Students who scored within a few points of 33 or 36 got a C (which means average) and the rest of the curve was based around that.

Monday, July 12, 2010

Dean Baker: The IMF Black Helicopter Gang Wants Your Social Security

Dean Baker
Co-director, Center for Economic and Policy Research :

The IMF Black Helicopter Gang Wants Your Social Security

A few years back there was a fear in some parts about black UN helicopters that were supposedly taking part in the planning of an invasion of the United States. While there was no foundation for this fear, there is basis for concern about another international organization, the International Monetary Fund (IMF).

This week the IMF told the United States that it needs to start getting its deficit down and put cutting Social Security at the top of its “to do” list. This one is more than a bit outrageous for two reasons.

First, the IMF can take a substantial share of the blame for economic crisis that gave us big deficits in the first place. The IMF is supposed to oversee the operations of the international financial system. According to standard economic theory, capital is supposed to flow from rich countries like the United States to poor countries to finance their development. In other words, the United States should be having a trade surplus, which would correspond to the money that we are lending to poor countries to finance their development.

However, the IMF messed up its management of financial crises so badly in the last decade that poor countries decided that they had to accumulate huge amounts of reserves in order to avoid ever being forced
to deal with the IMF. This meant that capital was flowing in huge amounts in the wrong direction. One result of this reverse flow was that the United States ran a huge trade deficit instead of a trade surplus. Another result was the $8 trillion housing bubble, the collapse of that crashed the U.S. economy.

The other reason that the IMF advice is infuriating is the incredible hypocrisy involved. The average Social Security benefit is just under $1,200 a month. No one can collect benefits until they reach the age of
62. By contrast, many IMF economists first qualify for benefits in their early 50s. They can begin drawing pensions at age 51 or 52 of more than $100,000 a year.

This means that we have IMF economists, who failed disastrously at their jobs, who can draw six-figure pensions at age 52, telling ordinary workers that they have to take a cut in their $14,000 a year Social
Security benefits that they can’t start getting until age 62. Now that is black helicopter!

Saturday, July 10, 2010

Some Blog Posts about New-Keynsianism

Sunday, June 27, 2010

Naked Capitaism: Deficit Doves, the Gift that Keeps on Giving

Deficit Doves, the Gift that Keeps on Giving

The first section of this post is by Warren Mosler, the President of Valance Co. who writes for New Deal 2.0

Deficit doves are doing more harm than the hawks — here’s what they need to know.

The deficit hawks are prevailing. The economy remains an economic and social disaster. Medicare has already been cut by the Democratic majority in the new health care bill. Social security is now under attack by the new bipartisan Congressional Commission on Fiscal Sustainability and Reform. Meanwhile, the media tries to present a balanced approach, pairing deficit hawks with deficit doves.

But the deficit hawks aren’t the problem. They do the best they can with arguments that feature empty rhetoric supported by the underlying assumption that deficits are ‘bad.’

Actually, it’s the well-intentioned but misinformed deficit doves featured by the media that may be doing the most harm. They don’t understand actual monetary operations and reserve accounting, and therefore incorporate the same fundamentally incorrect assumptions as the deficit hawks. They agree deficits are ‘bad,’ but try to argue that’s the case only in the long term. They agree that deficits can be too high, but try to argue they have been higher, particularly in World War II, and therefore larger deficits should be easily manageable, while agreeing there is a level that could not be manageable. They agree markets could be ‘unfriendly’ and a lack of confidence could translate into far higher interest rates, but argue that the current low rates for Treasury securities are the markets telling us that at least for now confidence is high indicating markets are eager to fund current deficits. And they agree that ‘bang for the buck’ matters and support tax cuts and spending increases based on higher multipliers.

The problem is that the two sides of the story are in fact fundamentally on the same side. The media does not feature the true deficit dove story. Nor do any of the true doves have even a small piece of the administration’s ear, or the ear of anyone in Congress willing to speak out. There are maybe a hundred true doves, including many senior economics professors. The problem is this professional, highly educated, highly experienced collection of true doves does not get a fair hearing.

The true deficit dove positions include:

1. Since government spending is merely a matter of changing numbers in bank accounts on its own spread sheet, there is no solvency issue or sustainability issue
2. The right size deficit is the one that coincides with our stated goals of full employment and price stability.
3. Interest rates for government are set by the government, and not by the market place.
4. Bang for the buck considerations are moot as the size of the deficit per se is not an issue.

The answer to why the true doves capable of articulating the above points don’t’ get a fair hearing may be credentials. My BA in Economics from the University of Connecticut in 1971 doesn’t cut it, nor the fact that the very large fund I managed was the highest rated firm for the time I ran it. And my net worth never getting anywhere near a billion hasn’t helped either. Seems billionaires get celebrity status and lots of airtime for just about anything they want to say.

The same is true of the economics professors who’ve got it right. Without being from and at the usual ‘top tier’ schools, none can even get published in main stream economics journals, where submissions featuring obvious accounting realities are routinely rejected. In fact, any economist who states accounting identities and operational realities such as ‘deficits = savings’ or ‘loans create deposits’ or ‘Federal spending is not constrained by revenues’ is immediately labeled ‘heterodox’ and unworthy of serious mainstream consideration. Even the late Wynne Godley, who did have reasonable credentials as head of Cambridge Economics, and was the number one UK economics forecaster, was labeled ‘unorthodox’ because his mathematical models featured the deficits = savings accounting identity.

My three proposals that can immediately turn the tide and get us back to full employment and prosperity remain:

1. A full payroll tax (fica) holiday
2. $150 billion of Federal revenue sharing to the States on a per capita basis
3. An $8/hr Federally funded job for anyone willing and able to work to facilitate the transition from unemployment to private sector employment.

The only thing between today’s state of the economy and unimagined prosperity is the space between the ears of policy makers that’s filled with the deficit hawk rhetoric, and unfortunately further supported by the rhetoric of the deficit doves the media selects to present the ‘opposing view.’

Yves here. Mosler wrote this piece to address the debate over the federal budget deficits in the US, which meant he could skip over some important caveats.

Modern Monetary Theory does describe how the world works in a fiat currency regime, meaning the “government” is the issuer of sovereign currency. Despite all the hyperventilating about default, governments that issue their own currency will never be forced to default (note that Greece, Spain, Ireland, and California are not in this position). They can create a lot of inflation, but that is a separate issue.

The times in the modern era when sovereign states have defaulted is:

1. Under a gold standard

2. When they either are not currency issuers OR have adopted a currency they do not control (eg. countries like Argentina that dollarized their economies)

3. Countries that have overly large banking sectors relative to GDP AND those banks have large liabilities in foreign currencies AND those banks have major solvency problems (Iceland, this would also be the reason for a UK default)

The lone exception is the Russia default of 1998, which remains a bizarre, opportunistic incident. Russia’s sovereign debt was under 20% of GDP, and there was no reason for it to have defaulted, even if its debt levels had been higher.

Now to a general point about MMT. The negative responses to it are almost reflexive, shoot the messenger: deficit = bad, we aren’t prepared to listen to anyone who says otherwise.

Sorry, gang, it IS more complicated than that. We’ve provided this formula before:

Domestic Private Sector Financial Balance + Fiscal Balance – Current Account Balance = 0

Now let’s consider what has happened in the US, and some other advanced economies. Our corporations, in their infinite wisdom, have decided increasingly to offshore and outsource, which means move operations outside the US and to turn big chunks of their operations over to other companies, again often foreign ones.

Let’s go back to the formula. First result is that we have a current account deficit. So that means that the sum of the other two parts of the economy, the private sector plus the public sector will run deficits, as in borrow more than they spend. Maybe one is a net saver, the other a bigger net borrower, or both are net borrowers. But at least one sector will be a net borrower.

But let’s consider another set of issues. The fixation of public companies on quarterly earnings plus the offshoring/outsourcing phenomena have led them to become net savers, even in expansions (see here for a long-form discussion). Normally, the household sector is a net saver (households generally try to save for retirement and for emergencies). Most readers appear to implicitly assume that those funds should be used by business, that government borrowing crowds out private sector borrowing. But while INDIVIDUAL businesses do borrow, recall they also generate cash. The trend, even in periods of growth, when businesses as a whole ought to be borrowing and investing in growth, is instead that they are net savers.

In that scenario, even if the US had no trade deficit, the government would need to run a deficit to accommodate the desire of the private sector to save. The alternative would be that the US would need to go from its assumed trade balance to a trade surplus. That would happen through a fall in prices and wages in its tradeable goods sector (which can happen via domestic deflation, which will make debt burdens worse in real terms, or a fall in the dollar) and/or an increase in productivity so that our exports gained market share.

Now the private sector in the US is deleveraging, which and reducing debt is tantamount to saving. We have pointed out that the euro would likely have to fall to 60 to 80 cents to the dollar to prevent the eurozone from falling into deflation (which will make debt levels in real terms worse and almost certainly precipitate the defaults that the austerity programs being implemented are meant to avoid.

The certain continued fall in the euro (the trajectory is a given, the open questions are how far and how fast), and China’s signaling that it is likely to devalue its currency if the euro falls materially means the dollar is likely to remain strong, Right now, every country with overly high debt levels wants to break glass, weaken currency, and use exports to provide it with some lift to offset the contractionary impact of deleveraging. It appears unlikely that the US will be able to play that game. Odds are high that we will continue to be a net importer.

So, if we decide to run government surpluses now, the result is almost certain to be deflation, at best a Japan-type stagnation with high unemployment (and the US has far less social cohesion than Japan does), at worst a deflationary downspiral. But in either case, austerity becomes self-defeating. The value of outstanding debt rises as prices fall and GDP contracts. Default becomes more likely, and as defaults rise, banks become more impaired, investors more cautious, and the downturn can easily accelerate and become self-reinforcing.

Now some readers are correctly concerned about the wisdom of letting the cohort in DC spend more, given our misadventures in the Middle East, and healthcare “reform” serving as a Trojan horse for further entrenchment and enrichment of Big Pharma and the heath insurers. I am certainly not keen about handing a blank check to the likes of Geithner (oh wait, we did that already, it was called the TARP). We also need to keep pressure high on the need to reform governing structures.

As much as the logic of continued government spending is unpalatable to many, be careful what you wish for. If you think the economy now is not so hot, just wait to see what happens if deflation takes hold.

Saturday, June 5, 2010

This recent post from Peter Droman at the EconSpeak blog: A political Economy Moment reminded me that I have wanted to make a post about a philosophical problem with the debate about fiscal policy and the role of government.

I think it is in some ways unfortunate that economics is caught in a Keynesian/Monetarist (or classical) binary. Broadly speaking the debate is about whether government can have a positive effect on the workings of the economy. The problem is that this binary does not capture the full spectrum of attitudes towards government and it causes some philosophical problems for any leftists cum economists. Tiny, tiny, minority they may be.

Simplistically speaking, I subscribe to the Marxian point that the state is a "committee for the management of the affairs of the bourgeois". Oddly, I think there is a lot of overlap in the way I see the world as your walk-a-day libertarian who similarly sees governments as constraining the potential of the world. In fact, the idea that governments are simply the tools of corporations is a large component of libertarian ideology. After all such things as bailouts, "regulatory capture", and even the Fed are all seen as distorting the playing field in favor of the politically connected few. I find myself more often than not nodding in agreement with libertarian or Hayekian critiques of how the current system is managed.

Libertarians, however, lose me when they start prescribing solutions. In a nutshell their solution to the problems with capitalism is simply more capitalism. The intellectual work is simple, governments distort the natural process of the market and once the market is set free from government control manna will rain from heaven.

But what if you don't believe that the solution is more capitalism? Solutions become very messy. The problem is that, in a universe of atomistic firms and households (the world of the economist) the only point of conscious intervention in the economy is government. So we are stuck putting lipstick on a pig so long as we are forced to defend the efficacy of government. I, personally, am willing to hold my nose and pull the lever. A defense of government intervention is--baring some kind of miracle of theory or reality--a defense of conscious intervention into our own history.

However--and I want to point out I'm not entirely cynical about this--there is always an endless stream of caveats. For instance, from the EconSpeak post above after talking about the "center-to-left prescription for the recession Mr Dorman goes on to point out:

In a sense yes: those who make the decisions summon economic arguments to justify their actions. But who gets to make the decisions and what arguments they find appealing is not the outcome of academic seminars. What got us into this mess in the first place, and what now threatens to throw us back into the maelstrom, is the political hegemony of the “finance perspective”, the interests and outlook of those whose main concern is maximizing (and now simply protecting) the value of their financial assets.

Within the world of elite interests, this is almost a mass constituency. While the bulk of such assets are held by an infinitesimal few, perhaps the top 10-20% of the population in the industrialized countries have significant financial wealth and actively monitor their returns. Their understanding of how economies work and what priorities policy-makers should adhere to follow from their personal position. Inflation is a constant threat to asset-holders. They fear the laxity of central banks as well as the buildup of government debt, which can serve as an incentive to future inflation. They want their portfolios to have a component of absolutely risk-free government securities, and the very whisper of sovereign default chills them to the core. They believe in the inherent reasonableness of financial markets and believe that anyone who wishes to borrow from them should demonstrate their prudence and fiscal rectitude. They were willing to relax their principles temporarily during the panic, but now that they have caught their breath they want to see a return to “sound” practices. Governments will bend to their wishes not because they have better arguments, but because they hold power.

How do you get business done in such an environment? I have found myself disagreeing with Paul Krugman's call for a larger stimulus. It seems that within a democratic system the nature of compromise necessarily means any kind of stimulus would be too small. Whats more, the mishmash of the stimulus bill was qualitatively inadequate. So why should we insist that congress mismanage more stimulus? Here, though, it is not just my politics but my professional chauvinism that finds the process aggravating. As a side bar, I'm fairly certain that the last generation of economists have been preoccupied with monetary policy not only because the stagflation of the 70s was their founding trauma but because monetary policy is largely the sole technocratic purview of economists. Anyway, disagreeing with the call for more stimulus then means retreating into a weaker position that "in theory this would work."

The real solution to this impasse is not intellectual. It's political, for those of us who desperately do not want to be cynical about the role of government also have to assume that it is possible for political life to operate properly. What we ultimately need is a government--while not perfect--is something that can be believed in and trusted. I feel a great nostalgia for the immediate post war era when governments had proven they could respond to a crisis and there was--even in the US--a consensus about the legitimate role of government in economic life.

The 70s of course changed all that. The documentary filmmaker Adam Curtis' four part "The Century of the Self" traces the individualism of the baby boomer generation from its political expression to its transformation into "lifestyle consumerism" in which individualism get channeled and expressed through differentiated consumption goods. Curtis contends that Ronald Reagan's declaration that "Government is the problem" spoke precisely to this individualism which had been shaped over the turbulent and dysfunctional national politics of the 60s and 70s but had become cynical and satiated. I think, in a way, that process has been repeating itself or I suppose it is the new political reality. The new rise of libertarianism seems to be siphoning off significant proportion of people who should be properly left leaning. The critique is the same either way you go but but leaning right offers a simple and consistent prescription. Unfortunately, in the absence of something simple and coherent a functioning left requires some kind of demonstrable proof. That proof has been fairly short in coming over the last 30 years as Reagan's prophecy fulfills itself.

How I would deal with the European debt crisis.

If I were Emperor of Europe here is what I would do: I would have the European Central Bank (ECB) implicitly guarantee Greek debt by offering to buy Greek debt at some particular interest rate and then pay for the purchase of Greek debt by issuing a "Eurozone Bond" backed by the full faith and credit of all the countries in the Eurozone.

The buying of Greek debt would not be inflationary since the ECB would effectively be sterilizing the purchase of Greek debt with the issuance of Eurozone debt. It would also relieve the fiscal pressure on the countries who are putting up government funds to help shore up the Eurozone. These countries could still--in partnership with the ECB--exercise control and impose all the austerity conditions they want.

This would also help push the Euro ever so slightly toward its full potential as a competitor currency of the dollar since it would finally create a true Eurozone debt instrument. Obviously, though, the market would not be very large or liquid but perhaps this market could be opened up to other countries. While the EU does not seem overly concerned with the problem of moral hazard it would be relatively easy to limit countries from taking advantage of this market if the EU actually started to enforce their rules governing debt to gdp ratios.

I am double minded about what interest rate to charge the Greeks. A penalty rate seems appropriate, but obviously that may only make it more difficult for Greece to pay down it's debts. At any rate, some kind of risk premium above what the ECB would get on the Eurozone instrument seems appropriate and would be profitable for the ECB. And if the Greeks finally do default? Well, then the Germans can put their real money to work.

Perhaps unfortunately, I do not run Europe and the ECB seems like a profoundly conservative and unimaginative institution. That may be a necessary thing in Europe, it may also be a major liability for Europe to have monetary policy nonexistent at the national level and unhelpful at the supra-national level. While the ECB has been engaged in what the Wall Street Journal calls a "stealth bailout" of Europeans banks holding Greek debt they may do well to push things further. Legal and political realities notwithstanding.

Don't Blame Fannie, Freddie, CRA or poor people

I'm going to use this blog post (my first in a while) to aggregate all of the arguments against blaming poor people and/or the government for the sub prime meltdown.

In the interest of being fair, the most compelling arguments for blaming fannie and freddie come from Charles Calomiris:

Charles Calomiris onEconTalk October 26th, 2009

and the paper By Edward Pinto they reference:

I think that Calomiris is right to point out that Krugman's claim (talked about in the last article posted) that Fannie and Freddie did not make subprime loans because they were legally prohibited doesn't hold water, but who knows.

Anyway, below are a couple of old blog posts, all by way of or from the Economist's View blog. The final post, directly from Economist's View is the best one.

Kroszner: CRA & the Mortgage Crisis
By Barry Ritholtz - December 3rd, 2008, 11:53AM

Sayeth the man:

“Some critics of the CRA contend that by encouraging banking institutions to help meet the credit needs of lower-income borrowers and areas, the law pushed banking institutions to undertake high-risk mortgage lending. We have not yet seen empirical evidence to support these claims, nor has it been our experience in implementing the law over the past 30 years that the CRA has contributed to the erosion of safe and sound lending practices. In the remainder of my remarks, I will discuss some of our experiences with the CRA. I will also discuss the findings of a recent analysis of mortgage-related data by Federal Reserve staff that runs counter to the charge that the CRA was at the root of, or otherwise contributed in any substantive way, to the current subprime crisis . . .

“This result undermines the assertion by critics of the potential for a substantial role for the CRA in the subprime crisis. In other words, the very small share of all higher-priced loan originations that can reasonably be attributed to the CRA makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis.”

Be sure to read the entire speech by the Fed Governor here. He discusses the result of an exhaustive data analysis performed by the various Fed Banks looking into the CRA issue and sub-prime

Of course, now that the election is over, the usual parade of reality challenged nitwits won’t be interested in any hard data or professional analyses. The full 233 page report is available here.

Things Everyone In Chicago Knows...

Paul Krugman
June 3, 2010

Which happen not to be true.

It was deeply depressing to see Raguram Rajan write this:

The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans.

That’s a claim that has been refuted over and over again. But what happens, I believe, is that in Chicago they don’t listen at all to what the unbelievers say and write; and so the fact that those libruls in Congress caused the bubble is just part of what everyone knows, even though it’s not true.

Just to repeat the basic facts here:

1. The Community Reinvestment Act of 1977 was irrelevant to the subprime boom, which was overwhelmingly driven by loan originators not subject to the Act.

2. The housing bubble reached its point of maximum inflation in the middle years of the naughties:

Robert Shiller

3. During those same years, Fannie and Freddie were sidelined by Congressional pressure, and saw a sharp drop in their share of securitization:


while securitization by private players surged:


Of course, I imagine that this post, like everything else, will fail to penetrate the cone of silence. It’s convenient to believe that somehow, this is all Barney Frank’s fault; and so that belief will continue.

Once Again, It Wasn't Fannie and Freddie

Russ Roberts:

Krugman gets the facts wrong, by Russell Roberts: Back in July, as Fannie and Freddie were starting to implode, Krugman concluded that Fannie and Freddie weren't part of the subprime crisis:

But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.

Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t: the definition of a subprime loan is precisely a loan that doesn’t meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.

So whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.

His conclusion is quoted approvingly by Economist's View, a couple of days ago.

Alas, Krugman has his facts wrong. As the Washington Post has reported:

In 2004, as regulators warned that subprime lenders were saddling borrowers with mortgages they could not afford, the U.S. Department of Housing and Urban Development helped fuel more of that risky lending.

Eager to put more low-income and minority families into their own homes, the agency required that two government-chartered mortgage finance firms purchase far more "affordable" loans made to these borrowers. HUD stuck with an outdated policy that allowed Freddie Mac and Fannie Mae to count billions of dollars they invested in subprime loans as a public good that would foster affordable housing.

Housing experts and some congressional leaders now view those decisions as mistakes that contributed to an escalation of subprime lending that is roiling the U.S. economy.

The agency neglected to examine whether borrowers could make the payments on the loans that Freddie and Fannie classified as affordable. From 2004 to 2006, the two purchased $434 billion in securities backed by subprime loans, creating a market for more such lending.

$434 billion isn't zero, and that's just from 2004 to 2006.

I'm a bit confused about the part pointing to this blog. I don't quote that passage. In fact, I don't quote that column. In fact, I don't even link that column myself - it's only linked within a post from Jim Hamilton that I echo, and that's a post disagreeing with Krugman. So, saying I "quoted approvingly" is not exactly accurate.

The title of the post was "It Wasn't Fannie and Freddie." The point from Krugman I was referring to is (and yes, I do approve of it, and I'll explain why):

...I stand by my view that Fannie and Freddie aren’t the big story in this crisis.

Fannie and Freddie did not cause the credit crisis and nothing in the article quoted by Cafe Hayek, or anything since the article came out last June changes that.

There are two questions that are being confused in the debate over the source of the financial crisis:

1. What caused Fannie and Freddie to fail?

2. What caused the financial crisis?

Answering the first question does not necessarily answer the second. Showing that some politician, some policy, some legislation, lack of effective regulation, whatever, caused Fannie and Freddie to fail is important, we need to know why they were vulnerable when the system got in trouble, but Fannie and Freddie did not cause the crisis, they were a consequence of it.

How do we know this?

Fannie and Freddie became fairly large players in the subprime market, and they got that way by following the rest of the market down in lowering lending standards, etc. But they did not lead it down. Their actions came in response to a significant loss of market share, and it is this loss of market share that motivated them to take on more subprime loans.

We need to understand why the overall market - the part outside of Fannie and Freddie's domain - was able to lower lending standards (and increase their risk exposure in other ways as well), and how regulation which had worked up to that point failed to keep Fannie and Freddie from dutifully responding to the market pressures on behalf of shareholders by duplicating the strategy themselves, but again, they were followers, not leaders.

Tanta (via econbrowser) describes the downward plunge of the GSEs:

Fannie and Freddie .... didn't like losing their market share, and they pushed the envelope on credit quality as far as they could inside the constraints of their charter: they got into "near prime" programs (Fannie's "Expanded Approval," Freddie's "A Minus") that, at the bottom tier, were hard to distinguish from regular old "subprime" except-- again-- that they were overwhelmingly fixed-rate "non-toxic" loan structures. They got into "documentation relief" in a big way through their automated underwriting systems, offering "low doc" loans that had a few key differences from the really wretched "stated" and "NINA" crap of the last several years, but occasionally the line between the two was rather thin. Again, though, whatever they bought in the low-doc world was overwhelmingly fixed rate (or at least longer-term hybrid amortizing ARMs), lower-LTV, and, of course, back in the day, of "conforming" loan balance, which kept the worst of the outright fraudulent loans out of the pile. Lots of people lied about their income (with or without collusion by their lender) in order to borrow $500,000 to buy an overpriced house in a bubble market. They weren't borrowing $500,000 from the GSEs.

Michael Carliner continues, explaining how Fannie and Freddie took on the extra subprime debt:

Fannie and Freddie are ... subject to regulation by HUD under mandates to serve low- and moderate income households and neighborhoods. As originators and investors with more energy than brains expanded their (subprime) lending to those borrowers and neighborhoods, it was difficult for Fannie and Freddie to increase their shares. They didn't want to buy or guarantee subprime loans, correctly perceiving them to be insanely risky. Instead they purchased securities created by subprime lenders, taking only the supposedly-safe tranches. Those portfolio purchases were counted toward their obligations to lend to lower-income home buyers, but are now part of the write-downs.

Until Republicans started trying to claim that Fannie and Freddie caused the financial meltdown as a means of tying Obama to the crisis - a strategy that backfired badly when all of the embarrassing connections to Fannie and Freddie within the McCain campaign were revealed - nobody was saying Fannie and Freddie caused the crisis. Republicans simply worked backwards - they found connections between Democrats and Fannie and Freddie (never thinking to ask about their own connections), then tried to blame the crisis on Fannie and Freddie so as to make people think it was the Democrat's fault. And it's still going on despite the fact that the data doesn't support this story.

There is no excuse for the actions of the management of Fannie and Freddie, and I'm not trying to defend them or their choices, but the idea that Fannie and Freddie caused the general credit crisis is wrong.

Richard Green is dismissive of the whole notion:

Charles Calomiris and Peter Wallison blame Fannie Mae for the Subprime Mess:


Hmmmm. The loan performance on Fannie's book of business is substantially better than the overall mortgage market. And starting in 2002, Fannie Freddie (pink line) lost market share to ABS (light blue line). [The data underlying the graph is from the Federal Reserve, Table 1173. Mortgage Debt Outstanding by Type of Property and Holder.]

It wasn't Fannie and Freddie.

[Update: Follow-up argument: Barry Ritholtz: Fannie Mae and the Financial Crisis, What Caused the Financial Crisis?. For a recent academic paper at odds with the claim, see: It Wasn't Fannie and Freddie.]