Before its collapse, Lehamn Brothers played a series of games with its balance sheets to hide its true level of indebtedness. Apparently, the games continue. The WSJ has a nice piece showing that three major banks, Bank of America, Citigroup, and Deutsche Bank AG have all been sharply reducing their borrowings just before the end of the quarter so that their quarterly reports would not reflect the true extent of their leverage.

Just a quick note to prevent some mistaken reporting. The Census Department reported a 14.8 percent jump in new home sales in April from March and a 47.8 percent increase from April of 2009. However, this increase in sales was accompanied by a 9.7 plunge in the median house price.

These numbers should not be seen as contradictory. The new home sales series measures contracts. The first-time home buyers tax credit expired at the end of April, which meant that people had to have a signed contract by the end of the month. This gave them incentive to rush out and buy homes. First-time buyers are likely to be concentrated in the low end of the market. This means that a surge in home sales coupled with a skewing to lower priced homes is exactly what we should have expected.

The Washington Post wrongly implied that a provision in the Senate bill that prohibits banks from brokering derivatives will prevent them from offering trades in derivatives to clients. The Post article contrasted this restriction with "one-stop-shopping" offered by European banks.

Actually, this provision would only prevent the bank itself from brokering derivatives which would mean that this trade would not be provided with the protection of the FDIC and the Fed that are intended to apply only to insured deposits. Under this provision, there is nothing that would prevent bank holding companies from establishing derivative trading divisions, which would have to be independently capitalized, or from contracting with independent brokers to offer services to their clients.

In both cases, the banks would be able to offer the same one-stop-shopping provided by their European counterparts. Therefore, one-stop-shopping is clearly not an issue in the debate over this provision.

The NYT reports on how the euro crisis may end up impeding the U.S. recovery. By lowering growth in Europe and reducing the value of the euro, it will reduce U.S. exports which were expected to be an important engine of growth for the U.S. economy. The article included a quote from Joseph Stiglitz making this point. However, it later presents a comment from James Bullard, the President of  the Federal Reserve Bank of St. Louis that directly contradicts Stiglitiz and appears to defy basic national income accounting, claiming that the United States:

"must 'directly address' its fiscal problems if it is to retain credibility with credit markets. After all, along with the countries of the euro zone, Britain and the United States are running outsize deficits, compounded by their spending to stimulate the economy."

As a matter of accounting identity, net national saving is equal to the trade surplus. Since the United States is running a large trade deficit, because of the over-valued dollar, it must have negative net national saving. This means either very large budget deficits and/or very low private saving. If the government were to reduce its deficit, then either private saving would have to fall, which would mean even further declines in consumer saving from already low levels, or we would see a fall in output and a rise in the unemployment rate.

It is not clear whether Mr. Bullard advocates more consumer indebtedness or higher unemployment, but it would have been useful to point out the logical implications of the policy that he was advocating.

Back when I learned economics, companies were supposed to make profits and economies were supposed to grow. That doesn't seem to be the case anymore. We have "saavy" businessmen like Goldman Sachs CEO Lloyd Blankfein who took his company to the edge of bankruptcy only to be rescued by bailouts from the Fed and Treasury. Most of the crew of Wall Street multi-millionaires would be on the unemployment line today without the big helping hand from the Nanny State.

In the same vein, the NYT is now citing research from Deutsche Bank reporting : "that euro-area countries 'can learn some valuable lessons from the Baltics’ experience over recent quarters.' Those countries survived drastic budget consolidation without devaluing their currencies."

The article then continues to quote the Deutsche Bank experts: "Restoration of competitiveness and weighty fiscal consolidation in the absence of currency adjustment is difficult but doable ... as long as politicians and the general public are willing to accept some up-front pain in return to longer term gains.”

Just to give a clearer idea of what the Deutsche Bank crew is talking about, the IMF projects that GDP in each of the Baltic countries will drop by close to 20 percent from its 2007 levels. In the United States this would be equivalent to losing $3 trillion in annual output. By 2014, the last year for the projections, GDP is expected to be 7.1 percent lower than its 2007 level in Lithuania, 9.1 percent lower in Estonia, and 14.5 percent lower in Latvia. Unemployment in these countries is more than 15 percent in Estonia and Lithuania and more than 20 percent.

It is nice to see that German bankers applaud this pain. Needless to say, it is unlikely that many bankers will ever have the pleasure of making similar sacrifices for the long-term good of their own countries. Of course, it is not clear how long the Baltic countries will have to endure this pain before GDP is back on a healthy growth path and the unemployment rate is at a more normal level. The IMF tends to be overly optimistic in evaluating the prospects of the countries adopting policies it favors.

It would have been worth explicitly discussing the alternative strategy that some countries may wish to pursue -- devaluation and debt restructuring. Argentina pursued this path at the end of the 2001. While the IMF and virtually all economic authorities insisted that this path would lead to disaster, the economy only contracted for six more months. It then turned around and grew robustly for the next six years until it followed the world economy into recession. At its pre-recession peak in 2008 Argentina's economy was more than one-third larger than it had been in 1998 when its crisis first sent GDP downward.

While the bankers may be more inspired by the tales of sacrifice by the Baltic peoples, many non-bankers may find the Argentine experience more interesting. Responsible reporting should note both options.

At its peak in 2006, the median house price in the United Kingdom was 10 percent higher than the median price in the United States, even though its per capita income is more than 10 percent lower. This bubble was driving the economy in the UK in the same way that it was driving the economy in the U.S.. The collapse of this bubble led to the recession in the UK and its financial crisis in the fall of 2008.

The bubble was completely absent from the NYT's discussion of the UK's current economic problems. Instead, it attributed fiscal profligacy for the UK's problems. In particular, it focused on the UK's public health care system, which it tells readers: "soared to 9 percent of G.D.P. from 3 percent."It also described the public health care system as " elephantine."

It was many decades ago when health care costs in the UK were just 3.0 percent of GDP. Health care costs in the UK have increased in GDP like as in all other wealthy countries. When the Labor government took office in the mid-90s, health care costs in the UK were close to 6.0 percent of GDP.

With the increase in spending, the UK is still spending only a bit more than half as much as the United States, which spends 17 percent of GDP on health care. When adjusted for the difference in per capita income, the US still spends more than twice as much per person on health care as the UK. It therefore seems somwhat bizarre to describe the UK system as elephantine, especially when life expetancy is longer in the UK than the US.

It is also worth noting that the build up of a large debt burden during the housing crash recesssion is the result of the policy decision by the Bank of England not to simply buy and hold the debt issued to finance the deficits currently needed to support the economy. If the Bank of England followed this strategy, then the debt burden would not increase as a result of the downturn.

The Bank of England created this crisis by failing to take steps to rein in the UK's housing bubble. It now appears to be compounding the crisis by failing to use appropriate monetary policy.

 

I'm back -- thanks for all the nice wishes.From my occasional glimpses at the newspapers the last week and a half I see that I have a lot of work to do.

I'll start with a cheap shot. The NYT just noticed that the pay or play provision in the health care bill makes no sense. The issue here is the extent to which larger employers will be obligated to pick up a portion of their workers' health care costs. The final bill included a provision that subjected employers of more than 50 workers to penalties if employees' health care costs exceeded a certain percent of family income.

The problem with this sort of penalty structure is that employers do not have control over workers family income and in general should not even know it. This sets up an absurd penalty structure where employers do not have the knowledge they need to act to avoid the penalty -- it's sort of like enforcing speed limits that randomly change and are never posted.

The problem with the NYT coverage is its description of this problem as: "a little-noticed provision of the law." Yes, it is true the provision got relatively little attention, but the NYT played a big role in this. Had the NYT opted to pick up on a problem that some people were trying to call attention to, notably Robert Reichsauer, the President of the Urban Insititute and also the former director of CBO (also CEPR), then maybe this ill-conceived penalty never would have made it into the final law.

 

 

 

I'm on vacation until Tuesday, May 25th. Remember, don't believe anything you read in the paper until then and while I'm gone, take a look at the CEPR Blog for some good reads on economics and policy analysis.

Thanks to Senator Al Franken it appears the Senate took the obvious step to end the conflict of interest associated with issuers paying the credit rating agencies for rating their new issues. The Franken amendment to the financial reform bill requires the Securities and Exchange Commission (SEC) to assign the raters. This would mean that the rating agency has no reason to bend its rating to curry the favor of the issuer, since the issuer does not control whether they get hired in the future.

The Post reported on this amendment and then gave the rating agencies complaint, that this will remove the rating agencies incentive to improve their ratings. This is not true. As my friend Peter Eckstein has pointed out, it would be very easy for the SEC to keep a record of the accuracy of ratings (scoring upgrades and downgrades) and then assign business in proportion to the agencies' relative track record. This will ensure that the agencies have incentive to improve their rating systems.

My colleagues at CEPR, Mark Weisbrot and David Rosnick gave me grief for saying that Argentina's economy shrank in the year following its default. Actually, Argentina's economy shrank in the first quarter of 2002, the quarter immediately following the December default, and then began growing robustly. It continued to have robust growth for 5 more years until it got caught up in the world recession. If we were having an honest debate over Greece, then everyone would be talking about Argentina's remarkable turnaround. Instead, we have experts telling us that the economy shrank 20 percent following the default.

 

 

 

New York Times columnist David Leonhardt told readers today that the problem of the debt is “we, the people.” Is that so?

Was it we the people who were too dumb to see an $8 trillion housing bubble and recognize that its collapse would wreck the economy? No, that was the job of the great Maestro Alan Greenspan and his sidekick Ben Bernanke, the brilliant scholar of the Great Depression. It was also the job of all the economists who do research and opine to the public on the macroeconomy. Virtually all of these highly educated highly intelligent economists either did not see the bubble or insisted it was not worth their time.

Our deficit today is due to the collapse of this bubble. There is no dispute about this. If there had been no bubble and the economy was still chugging along with 4.5 percent unemployment, the budget would either be balanced or close enough that no serious person would be expressing alarm (check out the pre-crisis CBO projections).

Is our huge deficit a problem today? Not if you think people should have jobs. Private sector demand has plunged because of the collapse of the bubble. If the public sector does not fill the demand gap with deficit spending, then we have less demand and fewer jobs. That’s worth saying a few hundred thousand times since the deficit hawks have filled the airwaves and cyberspace with so much nonsense.

People who want smaller deficits want fewer jobs – that is the way the economy works right now. There is no plausible story through which cutting demand from the public sector will generate more jobs in the private sector.

How about those scary long-term deficit stories? It’s all health care; it’s all health care. Those who know arithmetic know this.

The deficit hawks tell us we can’t fix our health care system. What they actually mean is that they don’t want to confront the powerful interest groups that cause the United States to pay two or three times as much per person – with no obvious benefit – as people in other wealthy countries. It is easy to devise mechanisms that will get our costs more in line with other countries (e.g. this or this).

Because such measures threaten the incomes of powerful interest groups the politicians won’t push them. And, because they have not been endorsed by enough elite economists (you know, the folks that couldn’t $8 trillion housing bubble) elite journalists will not talk about them either. Instead, they will blame ordinary workers for thinking that they should be able to get a decent retirement and have the same sort of health care coverage as people in every other wealthy country.

That could have been the title of this CNNMoney.com piece that touted the idea of "fixing" Social Security. The peice begins by quoting Robert Bixby, the director of the Concord Coalition, an organization that was founded by Peter Peterson and is still partially funded by him. Mr. Bixby described fixing Social Security as "low-hanging fruit" when it comes to deficit reduction.

The piece then went on to Mr. Peterson himself:

"While a Social Security fix would cure only a small part of the country's long-term fiscal shortfall, it could pay big dividends in terms of the U.S. standing internationally, deficit hawks say. 'It would be a confidence builder with our foreign lenders,' said Pete Peterson at a recent fiscal summit organized by his foundation, the Peter G. Peterson Foundation.

That could lessen the risk of a big rise in interest rates and buy the country more time to handle other debt-related issues, such as tax and budget reform and further changes in Medicare."

Mr. Peterson's ability to assess what builds confidence with foreign investors or anyone else is somewhat questionable. He managed to somehow completely overlook an $8 trillion housing bubble, the collapse of which gave us the worst downturn in 70 years.

Mr. Peterson's logic is also somewhat confused. If foreign investors lose confidence in the United States then the value of the dollar would fall relative to other currencies. This will make U.S. exports cheaper to foreigners and make foreign imports more expensive to people in the United States. The result would be that we would export more and import less. This improvement in the trade balance would increase employment and reduce the deficit. If the reporter has spoken to someone other than Mr. Peterson and his employees, she may have caught Mr. Peterson's mistaken logic and pointed it out to readers.

The rest of the piece is devoted to misrepresenting Social Security's financial situation. It notes that the program is projected to pay out more in benefits than it takes in as SS taxes this year. It then tells readers:

"When the system takes in less than it has promised to pay out, the government will need to make up the difference by paying back the surplus revenue that has been paid into Social Security over the years, but which Uncle Sam spent on other things."

This is true in the same way that if Mr. Peterson spends the interest from government bonds that he owns or cashs in bonds that hit their expiration date -- rather than reinvesting the money in government bonds --  the government will need to make up the difference by paying back the money that Mr. Peterson has lent over the years, but which Uncle Sam spent on other things.

In other words, the article is implying that there is something sinister about a normal business practice. The Social Security trust fund bought government bonds with its surplus, just like private pension funds do, as well as wealthy individuals. Under the law, this money will be paid back to Social Security  -- that is what governments do with their debts -- they pay them back -- unless they default.

 

That's right, the Post wants the Germans to let out their belts. Its editorial board probably doesn't realize this (they think that Mexico' GDP quadrupled since NAFTA was passed -- the actual growth was about 80 percent), but the statement: "the European Union's more successful economies, especially Germany, must retool to depend less on exports for growth," means that these countries should consume more.

As an accounting identity the trade surplus is equal to the the excess of national savings over national investment. As a practical matter, it is very difficult to change rates of investment. This means that the Post's complaint about Germany's trade surplus is a complaint about excessive savings and insufficient consumption. So, this sounds like the Post wants Germany to make its generous welfare state even more generous. It would be good if the Post's editors could learn a little economics so that they could at least figure out what they are sternly lecturing people to do.

The Washington Post (a.k.a. Fox on 15th Street) is getting ever more aggressive in pushing its anti-welfare state agenda. A front page news article on the Greek financial crisis told readers that: "And though economists and other analysts generally agreed that the program was necessary to prevent a full-blown financial crisis, they also agreed that it won't work unless European governments follow through on promises to bring down their large deficits and restructure their economies to become more competitive."

It then added: "'We can't finance our social model anymore -- with 1 percent structural growth we can't play a role in the world,' European Council President Herman Van Rompuy said Monday in remarks at the World Economic Forum in Brussels, just hours after European Union finance ministers approved the new program."

In fact, there is nothing resembling the consensus about the failure of Europe's social model that this editorial implies. Unlike the United States, Europe as a whole has generally run balance of trade surpluses, suggesting that the European economies are more competitive than the U.S. economy. It is also worth noting that the welfare states in the countries facing crises right now (Greece, Portugal, Spain, and Ireland) rank among the weaker ones in Europe. The relatively healthy economies of France, Germany, the Netherlands, and the Scandanavian countries all have much stronger welfare states.

It's also worth noting how Europe and the world got into this crisis. The problems originated in letting housing bubbles grow unchecked and creating enormous economic imbalances. Apparently, news of the housing bubble still has not reached the Post.

The NYT had a question and answer session to inform readers about the issues surrounding the Greek crisis. Unfortunately, the experts didn't get things quite right. Carmen Reinhart, an economic historian at the University of Maryland, told readers that: "Argentina’s economy contracted 20 percent in 2001 after its default, as it was shut out of international markets for a time."

Actually, Argentina defaulted at the end of 2001. According to the IMF, it's economy then contracted 10.9 percent in 2002. It then turned around and grew at an average rate of almost 9.0 percent in the next five years. No one has such an optimistic set of projections for the Greek economy right now.

 

That is the only thing that readers of his column on the "death spiral" of the welfare state can conclude. After all, he notes the size of the budget deficits facing various European countries, but discusses them entirely in the context of their wlefare states. He apparently does not know that these countries all face severe downturns as a result of the collapse of housing bubbles in the United States and elsewhere. During recessions budget deficits always expand as tax collections fall and spending on items like unemployment insurance and other benefits rise.

Contrary to what Samuelson claims in this column. Most European countries have been willing to pay the taxes needed to support their welfare states. And this has not prevented them from maintaining rates of productivity growth (the long-term determinant of living standards) comparable to the United States.

The economic crisis caused by the collapse of the housing bubble does make sustaining the welfare state more difficult, just as it makes every other aspect of economic life more difficult. This points to the need to have more competent people setting monetary policy (unfortunately, none of the incompetent central bankers have been fired), but it does not provide insights into the viability of the welfare state, which is most needed in times of economic hardship.

Paul Krugman rightly notes the enormous regulatory failure that allowed BP to drill in the Gulf without an emergency plan to deal with a spill. However, he misses part of the story when describing the problem as one of anti-government sentiment.

The government actually played a big role in this spill. Congress passed a law following the Exxon-Valdez spill in 1991 that restricted the liability of oil companies in these incidents to $75 million. There are estimates that the damage from this spill to the fishing and tourism industry in the region could exceed $100 billion. Would BP be as anxious to drill recklessly if it knew that it could be picking up this tab?

The problem is not just a failure of the government to regulate. The problem was a government policy that effectively expropriated property rights from the people in the region and gave BP and other would be polluters the right to do damage without providing compensation. We need government to do the right things, but as a first step, let's not have it actively intervene on the wrong side.

Ross Douthat gave us a quick morality discussion about the growing numbers of children born out of wedlock. It might have helped to add some of the economic dimension to this story, both positive and negative. The positive is that economic opportunities for women have increased enormously over the last four decades. This means that many women who might have felt trapped in a bad or abusive marriage years ago now feel that they can survive on their own.

The negative side is that wages for most workers have stagnated for the last three decades as the bulk of the gains from productivity growth have gone to the most highly educated workers. Lower and insecure income places more stress on families and undoubtedly has been a factor in family breakups in many cases.

Okay, now we can go back to Douthat's morality story.

The NYT tells us that there is "heightened public concern over spending." How does the NYT know this? What does it mean? Has the public checked the amount that we are spending in Afghanistan? Has it noted the cost of government payments to first-time homebuyers?

Does the public know that -- according to the methodology used by President Obama's administration -- each billion reduction in spending will lead to the loss of roughly 10,000 jobs? Therefore, according to the Obama administration's assessment, when Democrats in Congress claim that they are cutting spending (as claimed by Representative Chris Van Hollen in this blog post) they are making plans to throw people out of work.

It would be helpful if the NYT devoted more space to the meaning of policies rather than gossip about who says what.

The folks who couldn't see an $8 trillion housing bubble are spouting off like crazy about what the Greek debt crisis means. The NYT told us that: "While the immediate causes for worry are Greece’s ballooning budget deficit and the risk that other fragile countries like Spain and Portugal might default, the turmoil also exposed deeper fears that government borrowing in bigger nations like Britain, Germany and even the United States is unsustainable."

Fears that government borrowing in the United States is unsustainable should manifest themselves in higher interest rates on long-term government bonds. Unfortunately for this story, the interest rate on long-term government bonds fell last week. So, the NYT wants us to believe that investors are more fearful about the status of U.S. debt, but they were willing to hold it at lower interest rates?

Umm, no, this is a "night is day" line. The NYT is telling us something that it 180 degrees at odds with what we see in the world. There are large numbers of wealthy and politically powerful people who want to scare the public about the U.S. debt in order to advance their agenda of cutting Social Security and Medicare, but the events of last week point in the opposite direction. Investors still have great confidence in the ability of the U.S. government to pay its bills.

The theme of deficit hawks was further reinforced in the next paragraph which told readers:

"'Greece may just be an early warning signal,' said Byron Wien, a prominent Wall Street strategist who is vice chairman of Blackstone Advisory Partners. 'The U.S. is a long way from being where Greece is, but the developed world has been living beyond its means and is now being called to account.'"

The savings for the developed world as a whole is determined by its trade deficit or surplus with the developing world. The latter is determined primarily by currency values of the level of output in various countries. As a result of conscious policy by the United States and the IMF, the dollar rose sharply in value against the currencies of most developing countries in the late 90s (following the East Asian financial crisis). This laid the basis for the huge imbalances associated with the stock bubble and the housing bubble.

The complaint about inadequate savings belongs at the door of the U.S. Treasury and IMF. It was the explicit and intended result of their policies. The moral haranguing about people not saving enough is utter nonsense that belongs in gossip pages, not in a serious newspaper.


You get paid a really big premium for ignorance at the NYT, just ask Thomas Friedman who undoubtedly gets paid more than 99 percent of his generation. Thomas Friedman likes to tout the fact that there are still good paying jobs for people without skills in every column he writes.

He's in top form today, getting just almost everything wrong about the current economic situation as he tells readers: "My generation, 'The Baby Boomers,' turned out to be what the writer Kurt Andersen called 'The Grasshopper Generation.' We’ve eaten through all that abundance like hungry locusts."

Of course those who know anything about the economy know that the vast majority of baby boomers have not fared especially well. In the years before the baby boomers entered the workforce wages for most workers rose consistently between 1-2 percent a year, after adjusting for inflation. However wages began to stagnate in the mid-70s, when the oldest baby boomers were in their mid-twenties and the youngest were not yet teenagers. Baby boomers entered this labor market and most saw very little gain in living standards relative to what their parents had. Many had to go heavily into debt to buy and hold a home, to send their kids through college or to cover the cost of a serious illness.

There were gains in living standards during the last three decades, but they overwhelmingly went to the people at the top. This included the Wall Street crew, corporate executives, highly educated professionals, like doctors and lawyers, and elite columnists like Mr. Friedman. This was not an accident. These people designed economic policies that were intended to redistribute income upward. The government became openly hostile to unions. It pushed trade policies that made our factory workers compete with low-paid workers in Mexico and China while leaving our doctors and lawyers largely protected from the same sort of competition. The government also deregulated sectors like airlines, telecommunications, and trucking that offered good paying jobs for millions of workers without college degrees. The result of these and other deliberate policies was to ensure that most of the gains from productive growth went to those at the top rather than the vast majority of baby boomers.

Now the baby boom cohort is retiring. The vast majority have next to nothing to support themselves other than their Social Security. The vast majority of baby boomers do not have the defined benefit pensions that their parents did. They never had much money in 401(k) accounts and they lost much of what they did have in the stock crashes of 2000-2002 and 2008. More importantly, they lost most of their home equity, the major source of wealth for most families, with the collapse of the housing bubble.

We can blame the average auto worker, shoe salesperson and school teacher for not being smarter about the macroeconomy than Robert Rubin, Alan Greenspan, and other managers of economic policy, but the fact is that they made the mistake of listening to these people. They thought that stock prices and house prices would just keep rising forever. Sure, this was stupid, but Rubin, Greenspan and the rest were supposed to be really smart people, and it was their job to know the economy. Too bad Thomas Friedman was never smart enough to notice either the stock bubble or the housing bubble and to warn his readers.

Instead, Thomas Friedman wants to lecture us all about how we have been living too lavishly. We have to give up our Social Security and Medicare and accept lower living standards. This would be laughable except for the immense political power and the hundreds of billions of dollars that stand behind Friedman's agenda.

At the moment, the concern about deficits is painfully absurd. If only Friedman could learn the most elementary economics he would know that the economy's problem right now is too little spending, not too much. He probably hasn't noticed, but the unemployment rate is almost 10.0 percent. If we got frugal now, then the unemployment rate would go still higher -- of course that probably would not matter where Mr. Friedman lives.

Over the long-term we do face a problem with our broken health care system. This is the cause of our projected long-term budget problems. Of course fixing our health care system would hurt the health insurance industry, the pharmaceutical companies and highly paid medical specialists, so that is not on Mr. Friedman's agenda. Instead, he wants to tell school teachers and auto workers (both current and retired) that they have to tighten their belts. And, he gets paid big bucks for this.

 



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