William Cohan had a column in the NYT noting that the Justice Department's settlements with the major banks over their securitization of fraudulent mortgages largely let the banks off the hook. His alternative route would have been criminal (as opposed to civil) prosecutions of the banks. While this may have led to more severe consequences for the banks and their current shareholders, it still would have allowed most of the people responsible off the hook.
In most cases, the top executives who set the course for the banks during the housing bubble years have moved on. They are either retired or employed elsewhere. Therefore they would not be affected by harsh punishments directed at their former employers. If the point is to have a sanction that will provide a serious disincentive to illegal actions then the Justice Department should have been trying to criminally prosecute the bankers themselves.
Knowingly packaging and selling fraudulent mortgages is fraud. It is a serious crime that could be punished by years in jail. The risk of jail time is likely to discourage bankers from engaging in this sort of behavior. The risk that their former employer may face serious sanctions years after they have left will not.
That's what can be inferred from his column calling for an end to tenure for public school teachers. Job security is part of the pay package for public school teachers. If they can expect less job security, it effectively amounts to a cut in pay. This would be expected to make teaching a less attractive career path compared with the alternative choices.
As a practical matter, there are few (if any) school districts that do not have provisions that allow even tenured teachers to be fired if they are not competent. This may not happen in many cases because their principals are too lazy to document the incompetence, or the higher ups in the school district don't provide them the resources they would need to ensure that classes are being well-taught. These latter problems will not be addressed by the ending of tenure.
This is the issue that Andrew Biggs implicitly raises in his Wall Street Journal column highlighting the jump in the size of the projections of the Social Security shortfall since 2008. Biggs complains that progressives have responded to the economic collapse by proposing an increase in benefits that would make the shortfall even larger rather than supporting plans for eliminating the projected shortfall. While Biggs' focus is explicitly the solvency of the program, the actions of progressives can only be understood against the larger economic context.
The calls for expansion of benefits are at least in part a response to the economic collapse.It's worth noting that this collapse was 100 percent preventable and that it was one of the worst blunders in the history of economic policy-making in the history of the world. Unfortunately the top economic advisers in both political parties whose errors were responsible did not have their standing affected by this mistake.
As a result of the collapse, many people nearing retirement saw much of their savings disappear as the stock market collapsed, house prices plummeted and they lost their jobs during their peak savings years. This meant that millions of workers had to draw down their savings to support their families at a point where they had planned to be accumulating wealth for retirement. In addition, due to the weakness of the labor market created by high unemployment, tens of millions of workers have seen stagnant wages over the last six years when they could have expected to see real wage growth in the neighborhood of 1.0 percent annually had the economy continued on the path projected in 2008.
In short, the collapse hugely increased the need for Social Security, which is the basis for the response of progressives. Biggs is correct that the cost of additional benefits will have to be covered at some point, but there is no obvious reason that it is necessary to come up with the full plan today. Part of the cost can be recovered by increasing the payroll cap as has been proposed by people across the political spectrum.
It is likely that we will need some increase in the payroll tax at some point, but there is little reason that the exact timing needs to be pinned down today. In the decade from 1980 to 1990 the payroll tax increased by over 2.0 percentage points. In spite of this hike, many conservatives tout the eighties as an economic golden age. It is difficult to see why it would be such a disaster if there were a comparable increase somewhere over the next three decades.
Workers care about their after-tax wages which are primarily determined by what they earn before taxes. Due to economic mismanagement and trade and regulatory policies that were designed to redistribute income upward, most workers have seen very little growth in before-tax wages over the last three decades. If they get an even share of the projected growth in compensation over the next three decades, then before tax compensation will be almost 60 percent higher in 2044 than it is today. It is understandable that progressives would be more focused on ensuring that workers get their fair share of economic growth than the risk 3-4 percent of these gains might be taken back in tax increases to support their retirement.
Robert Shiller had a piece in the Sunday NYT noting that the S&P 500 was unusually high relative to his measure of trailing earnings. He calculated a ratio above 25, far above the historic average of 15. Shiller said that in the past, each time this ratio crossed 25 the market took a plunge shortly thereafter. He concludes his piece by seeing it as a mystery that the market remains as high as it does.
Brad DeLong picks up on Shiller's analysis and points out that in most cases in the past where Shiller's ratio had exceeded 25, people who held onto their stock over the next decade would still have seen a positive real return. He notes the examples in the 1960s when investors would have seen a negative ten-year return, even though Shiller's ratio was below the critical 25 level. He therefore concludes there is no issue.
I would argue there is an issue, although not quite as much as Shiller suggests. To get at the problem, we have to recognize that stock returns, at least over a long period, are not just random numbers. Both Shiller and DeLong treat this as a question of guessing whether an egg will turn into a lizard or chicken based on the distribution of past hatchings that we have witnessed.
That would be a reasonable strategy if that is the only information we have. But if we saw that one of the eggs was laid by a hen, then we may want to up our probability estimate that it will hatch into a chicken.
In the case of stock returns we can generate projections based on projections of GDP growth, profit growth, and future price to earnings ratios. For example, we may note that the ratio of stock prices to after-tax corporate profits for the economy as a whole was 22.3 at the end of 2013. (This takes the value of stock from the Financial Accounts of the United States, Table L.213, lines 2 plus 4 for market valuation. After-tax corporate profits are from the National Income and Product Accounts, Table 1.10, Line 17).
This means that earnings are roughly 4.5 percent of the share price. If companies pay out 70 percent of their earnings as dividends or share buybacks (roughly the average), this translates into a 3.1 percent real return in the current year.
The Washington Post had an article reporting on the more rapid job growth in higher paying sectors of the economy in the last six years. At one point the piece tells readers:
"Even before the recession began, the economy was experiencing what academics call job polarization: growth at the high and low ends of the pay scale, but not much movement in the middle. Two major factors drove this shift: new technologies that replaced some skilled workers and increased competition from the international labor market."
Actually this is not true. Since 2000 both high and middle wage occupations were declining as a share of total employment. Only low-paying occupations saw an increase in their share of total employment.
The Washington Post had a major front page story reporting on scammers pushing unneeded motorized wheelchairs to seniors. Medicare pays roughly $5,000 for each chair, which allows for a large profit to suppliers as well as payments to intermediaries who would push the chairs to people who did not need or want a motorized wheelchair.
The piece is a useful exposure of a major scam operation, however it never puts the cost of the scam in a perspective that would be meaningful to most readers. At one point it tells readers that Medicare spent a Really Big Number ($8.2 billion) on these motorized wheelchairs since 1999. It would have been helpful to inform readers that this amounted to 0.14 percent of the $5.8 trillion that Medicare paid out over this period.
Of course not all of the payments were made for unnecessary wheel chairs. If 60-70 percent of the wheel chairs were not needed, then fraudulent sales would come to roughly 0.1 percent of Medicare spending over this period.
This is hardly a trivial sum, but by failing put the numbers in context readers may wrongly be lead to believe that the Medicare program is grossly inefficient because of such scams. In fact, because the program has much lower administrative costs than the private sector (@ 2 percent for Medicare compared to 15-20 percent for private insurers), the country is still saving an enormous amount of money because the government is providing Medicare rather than private insurers.
If administrative costs were at the level of the insurance industry, Medicare would have cost between $600 billion and $900 billion more since 1999. It is also worth noting that private insurers are also often victims of scams.
Note: The figure for administrative costs for Medicare refers to the traditional fee for service Medicare program. Parts C and D, which are administered by private insurers, have considerably higher costs.
Floyd Norris has an interesting column comparing the numbers of job openings, hirings, and quits from 2007 with the most recent three months in 2014. The most striking part of the story is that reported openings are up by 2.1 percent from 2007, while hirings are still down by 7.5 percent.
While Norris doesn't make this point, some readers may see this disparity as evidence of a skills gap, where workers simply don't have the skills for the jobs that are available. If this is really a skills gap story then it seems that it is showing up most sharply in the retail and restaurant sectors. (Data are available here.) Job openings in the retail sector are up by 14.6 percent from their 2007 level, but hires are down by 0.7 percent. Job opening in the leisure and hospitality sector are up by 17.0 percent, while hiring is down by 7.4 percent.
If the disparity between patterns in job openings and hires is really evidence that workers lack the skills for available jobs then perhaps we need to train more people to be clerks at convenience stores and to wait tables.
In one of the more remarkable shows of chutzpah in modern economic policy, Martin Feldstein and Robert Rubin penned a joint oped in the Wall Street Journal warning that the Fed needs to take seriously the risk of asset bubbles. The basis for the chutzpah is that this column is appearing in the summer of 2014 instead of the summer of 2004, when it could have saved the United States and the world from an enormous amount of suffering.
Had these men written a similar column in 2004 warning about the housing bubble (as some of us were desperately trying to do at the time) it undoubtedly would have received enormous attention in both the policy and financial community. Both men were considered the pillars of economic wisdom for their respective parties. Feldstein served as head of the Council of Economic Advisers under President Reagan and had trained most of the other leading lights of conservative economics. Rubin has served as Treasury Secretary under President Clinton and had advanced the careers of figures like Larry Summers and Timothy Geithner.
Unfortunately, instead of warning of the bubble, they were profiting from it. Rubin was a top executive at Citigroup, which was one of the biggest actors in the securitization of subprime mortgages. Feldstein was on the board of AIG, which was issuing credit default swaps on mortgage backed securities with a nominal value well into the hundreds of billions.
For what its worth, their current warnings are misplaced. The Fed has to concentrate on trying to promote growth and getting people back to work. The risk from inflated asset prices that they identify are primarily a risk that some hedge funds and other investors may take a bath when asset prices (like junk bonds) move to levels that are more consistent with the fundamentals.
Unlike the housing bubble, these inflated asset prices are not driving the economy. This means that the economic repercussions of a decline in the price of assets like junk bonds will be largely limited to the losses of the people who invested in them. That is the way a market economy works. People make bets and some lose, so what?
It is also worth noting that Federal Reserve Chair Janet Yellen is far ahead of Feldstein and Rubin on the problem of bubbles. Last month she warned of the over-valuation of some assets in her congressional testimony. Since then the price of these assets, notably junk bonds, has fallen, reducing the potential risk they pose to the financial sector. It makes far more sense to deal with out of line asset prices by trying to use targeted actions to bring them back into line than to throw millions of people out of work, and reduce the bargaining power of tens of millions more, by raising interest rates.
Matt O'Brien had a good piece in Wonkblog pointing out that the current downturn in the euro zone has been worse for these countries than the Great Depression. However it does get part of the story wrong.
At one point it outlines the troubles of the region:
"The combination of zombie banks, a rapidly aging population and, most importantly, too-tight money have pushed it into a "lowflationary" trap that makes it hard to grow, and is even harder to escape from. That's what happened to Japan in the 1990s, and now, 20 years later, its nominal GDP is actually smaller than it was then."
The aging of the population, and therefore a slow-growing or declining labor force, does not belong on the list of problems here. What matters for well-being is per capita growth. (That is not the only thing that matters, but insofar as GDP matters it is GDP per capita.) If the population is growing very slowly or even shrinking slowly, it will likely be associated with lower overall growth, but not necessarily with lower per capita GDP growth.
Germany has managed to get its unemployment rate down to 5.1 percent, compared to 7.8 percent before the downturn, in spite of having considerably lower growth than the United States over this period. Its employment rate for prime age workers (ages 25-54) has risen by 3.0 percentage points, compared to a drop of 3.5 percentage points in the United States.
As a result of its slow population growth, few in Germany would see its slow economic growth as being a problem. In fact, most view the economy as being relatively prosperous right now. This is one of the reasons that the country is reluctant to support measures that would help its neighbors, since Germany is not really sharing in their pain at the moment. Similiarly, Japan's slow population growth meant that most people in the country were not suffering in the way that its weak GDP growth may have suggested.
In its report on retail sales in July, the Washington Post told readers that consumers are being "cautious," since there was little increase from June's levels. Actually, with the saving rate hovering between 4-5 percent of disposable income, consumers are spending about as much as we can reasonably expect them to spend.
The current saving rate is well below the level of the pre-bubble years, which averaged close to 8.0 percent. The ephemeral wealth of the stock and housing bubbles drove the saving rate to lower levels. But if we pull out these unusual periods, the current saving rate is unusually low, not high as the Post article would imply.
Matt O'Brien had an interesting post in Wonkblog on the market reactions to Abenomics. O'Brien points out that the rise in Japan's stock market and the fall in the value of the yen since Abe took office are the result of market movements when Japan's markets were closed. This means that the movements in the stock market were driven by traders in Europe, the United States and elsewhere. O'Brien shows that Japan's stock market has actually declined slightly in the period when the Japanese market was open and the yen has risen in value, implying that Japanese investors don't share the views of foreign investors.
This takeaway is not quite right. It is important to remember that the outstanding amount of equity or currency vastly exceeds the amount that is bought and sold in a day or month. Japanese investors obviously noticed the dramatic rise in the stock market and the fall in the yen over the last year and a half. If they did not believe that these movements were based on solid economic foundations, presumably they would have sold their stock and bought yen in a way that offset these movements.
To see this point, imagine you had shares of stock in a company that were trading at $100 per share. Imagine you went away on vacation for two weeks, out of reach of the Internet. When you came back you discovered that the shares were selling at $150 each. If you did not believe that the higher price accurately reflected the outlook for the company's future profit potential, then presumably you would dump your shares and pocket the profit.
This is clearly not going on in Japan. While the actions of Japanese traders may very slightly be offsetting the enthusiasm of foreign investors, for the most part they obviously share this enthusiasm or they would not be willing to hold the stock of Japanese companies at current prices.
Harold Meyerson had an interesting column about how the problem of inequality is not just about low wages at the bottom, but also about people at the top ripping us off. However part of his story is not exactly right.
At one point the column tells readers:
"As a recent study in the Harvard Business Review concluded, a 'survey of chief financial officers showed that 78% would "give up economic value" and 55% would cancel a project with a positive net present value — that is, willingly harm their companies — to meet Wall Street’s targets and fulfill its desire for "smooth" earnings.'"
While Meyerson portrays this smoothing as benefiting shareholders, as he describes the process, it is actually coming at the expense of shareholders. If the company is sacrificing long-term profitability to meet earnings targets then most shareholders are likely losing in this deal. The most likely winners would be top managers whose bonuses are tied to meeting earnings targets or who have options coming due at specified times.
This distinction is important since it describes alternative political paths. The situation as Meyerson describes it clearly indicates the potential of an alliance with shareholders against top management. Since CEOs and other top management are an important part of the 0.1 percent, reducing their pay could have a substantial impact on income distribution, especially when the spillover effects are taken into account.
In this case, the nature of the problem is a corporate governance structure in which the directors, who are the immediate governing body of the corporation, act in the interest of top management instead of shareholders. Empowering shareholders would then be an effective way to rein in CEO pay.
Every now and then someone inadvertently says something that is truer than intended. Such is the case with a quote that appears in Robert Samuelson's column today.
The piece is devoted to bemoaning the reduction in entrepreneurship which Samuelson somehow thinks is tied to slower job creation. (This relationship is pretty damn weak, but no reason to waste time here.) At one point Samuelson list five possible reasons for the decline in entrepreneurship. Number one is:
"Schools — K-12 plus colleges and universities — aren’t turning out enough skilled workers. 'I have jobs,' said one Texas entrepreneur. 'I just don’t have the talent to fill them.'"
This entrepreneur is likely closer to the mark than he or she realized. The way you find skilled workers is by offering higher wages than your competitors. There are undoubtedly people in the country who have the skills that this entrepreneur needs. If he can't get them to work for him then obviously he is not offering a high enough wage, or as he said, "I just don't have the talent to fill them."
Of course it is possible that this entrepreneur could not afford to offer a high enough wage to attract the skilled workers, but then he really doesn't have the jobs. This would be like someone complaining that they couldn't get a doctor to treat them, without noting the fact that they were only willing to pay $30 an hour. The problem in that case is that the person is unwilling to pay the going wage for doctors.
This story is about as simple as economics gets. If there were a shortage of skilled workers then their wages would be rising. As it is, there is no major group of workers who are seeing rapidly rising wages, therefore it is not plausible that there are shortages of skilled workers.
The problem is likely just what Samuelson quotes the entrepreneur as saying, he lacks the talent to properly run a business.
(Btw, if Samuelson is really looking for causes for the decline of entrepreneurship, the collapse of anti-trust enforcement should probably be on his list.)
NPR harshly criticized a change in Germany's social security system which allows workers to collect benefits at age 63, rather than the previous age of 65, if they had contributed to the retirement system for 45 years. The piece repeated claims that this expansion of the retirement system was hypocritical, since Germany is demanding austerity from other members of the euro zone. It also implied that it would be a large expense, telling listeners that 50,000 workers are taking advantage of the reduction in the retirement age.
It would have been worth noting that increased spending by Germany helps it neighbors. Since the euro zone is suffering from inadequate demand, when Germany spends more money it helps Italy and Spain since it will create more demand for their goods and services.
These countries may resent that Germany has the money to spend, just as poor people may resent that rich people have the money to spend, but in the context where the rich do have the money, the poor are better off if they spend it than if they don't. While people in the rest of the euro zone have plenty of grounds for resenting the austerity demanded by Germany, which is causing mass unemployment and costing the region trillions of dollars in lost output, if they really don't want Germany to spend more on its retirees, then they must want higher unemployment and less growth in their own countries.
It would also have been useful to put the numbers here in some context. Germany has a labor force of a bit under 43 million, or roughly 28 percent of the size of the U.S. labor force. This means that this flood of new beneficiaries would be equivalent to an addition of 200,000 retirees to the U.S. Social Security system. That would be an increase of approximately 0.6 percent.
The piece also claimed that Germany is facing a labor shortage as more workers retire. It is difficult to know what this is supposed to mean. In a market economy if there are fewer workers, people switch from less productive jobs to more productive jobs. This means that there might be fewer people working in convenience stores, or as housekeepers, and kitchen workers. What's the problem?
Note: Typos corrected.
The NYT ran an AP article on the contraction in Japan's economy in the 2nd quarter of 2014. The article noted the 6.8 percent annual rate of contraction and told readers that this posed a real problem for Abenomics.
While this rate of decline is undoubtedly a cause of concern, it would have been worth mentioning that its economy grew at a 6.7 percent annual rate in the first quarter. The big factor in this seesaw was a sharp rise in the consumption tax that went into effect in April. This tax increase led many people to pull major purchases forward. As a result, they bought cars, appliances, and other expensive items in the first quarter that they would have otherwise bought in the second quarter.
The modest net contraction over the two quarters taken together should still be cause for concern, but it is a very different world than one in which an economy is sinking at close to a 7.0 percent annual rate.
The Washington Post had an article dedicated to uncovering the reason that the housing market in Washington has been slow in recent months. While it runs through several possible explanations it leaves off the most obvious one: prices are too high.
Inflation adjusted house prices are more than 50 percent above their pre-bubble levels. Back in good old econ 101 we always taught that if supply exceeded demand then the price should fall. The fact that prices in DC are so far above their pre-bubble level would be good evidence that this is the problem.
News apparently travels slowly in the nation's capital. The New York Times reported on a speech by Stanley Fischer, the vice chair of the Fed, in which he expressed confusion over the causes of the weak recovery.
It would have been helpful to express the views of economists who could have expressed surprise over Fischer's confusion. When the housing bubble collapsed, there was a massive loss of demand. Spending on residential construction fell back by more than 4.0 percentage points of GDP. With the loss of $8 trillion in housing wealth, consumption fell back by close to 3.0 percentage points of GDP. This created a total gap of 7 percentage points of GDP, which is close to $1.2 trillion in today's economy.
Residential construction has recovered to some extent, but it is still well below its bubble peaks. Unless we see another bubble, there is no reason to expect construction to get back anywhere near its 2005-2006 share of GDP. Consumption has also recovered to some extent, but without the bubble wealth that drove it, there is no reason to expect it to reach the same share of output as in the bubble years.
Unless Fischer has some very novel theory of the economy, there would have been no reason to expect a more rapid bounce back of the economy than what we saw, especially after the federal government turned to austerity in 2011. It would have been helpful if the NYT had focused on the seeming confusion in Fischer's thinking.
Having read Fischer's speech, I think the confusion is more in the reporting than in the speech, which seems largely on the mark on the current state of the economy. The spelling of "Fischer" has also been corrected.
The NYT reported that the Postal Service lost $2.0 billion in the third quarter of its 2014 fiscal year. While the piece did note that much of this loss was attributable to a requirement imposed by Congress that the system prefund its retiree health benefits, it would have been useful to also point out that a change in the accounting of liabilities in its workers' compensation fund added $0.6 billion to its losses this quarter. By contrast, in the third quarter of last year the accounting for this fund increased profits by $0.8 billion. Without the charges for workers' compensation and the prefunding of retiree health benefits, the system would not have shown a loss for the third quarter. Excluding these charges it would have shown a profit of $1.0 billion for the first three quarters of the year.
It is also worth noting that the prefunding requirement has little or no precedence in the private sector. It targets an extraordinarily high level of prefunding (many companies pay benefits as current expenses), to be reached in a short period of time. It also uses assumptions on health care cost growth that are far above recent growth rates.
Regular readers of the Washington Post have grown fond of Robert Samuelson's repeated calls for cuts to Social Security (e.g. here, here, here, here, here, here, here, here, here , and here). At the core of Samuelson's complaints are long-term projections from the Congressional Budget Office (CBO), and other sources, that the country will have large deficits 15 years, 25 years, or further in the future.
He likes to say that these deficits are due to Social Security and Medicare, although the main driver is the fact that U.S. health care costs are vastly out of line with costs in the rest of the world. If our doctors, drug companies, and other health care providers got paid the same as their counterparts in other wealthy countries, the projections would show huge surpluses, not deficits. But Samuelson prefers to go after poor and middle class seniors rather than highly paid people in the health care sector.
But this is secondary to the big issue with today's column. Samuelson's repeated hyperventilations about Social Security and Medicare are based on budget projections made for the distant and very distant future. For this purpose Samuelson apparently is willing to accept that economics can be a very precise science even though the past track record of budget forecasters has been atrocious. (For cheap thrills check out these projections for large deficits in the year 2000, big surpluses in 2003, or modest deficits in 2010. In each case the overwhelming source of error was in the economic projection, not policy changes.)
But for today's column arguing that the Fed should be looking to raise interest rates sooner rather than later Samuelson has serious reservations about the quality of economic predictions:
"Although economists are arguing furiously over this [whether the Fed should be raising interest rates], there’s no scientific way to measure slack. Economic policymaking is often an exercise in educated guesswork, built on imperfect statistics, shaky assumptions, incomplete theories and political preferences. This is an instructive case in point."
He concludes the piece:
"The Fed is expected to begin raising rates in 2015, but the time and pace are unknown. The danger of waiting too long or going too slow is that inflation, now controlled in the market and in Americans’ thinking, will escape these convenient bounds. Once that happens — as the double-digit inflation of the 1970s and early 1980s showed — inflation takes on a life of its own and becomes self-fulfilling. It can be suppressed only through tight credit, recession and high unemployment. We don’t want to go there."
That's pretty much what David Treadwell, the spokesperson for the state's Department of Economic and Community Development told an AP reporter. The article reports on a subsidized loan from the state to a German company to finance a training center for its workers. The piece then cites the views of several economists that there is no evidence that Connecticut has a shortage of trained workers. Among other things, a shortage would generally be associated with rapidly rising wages, which the state is not seeing.
It then concludes with a quote from Mr. Treadwell:
"She's hearing from the businesses and they're saying it is a problem, ... It doesn't necessarily matter what the economists are saying."
There you have it.
The Washington Post treated us to another hand wringing piece on Sovaldi. The deal is that we could virtually eliminate a major disease in 10-20 years if only we were prepared to bite the bullet and pay Gilead Sciences $84k a head for Sovaldi.
Those are not the only options. Gilead Sciences charges $84,000 for Sovaldi but it doesn't actually cost $84,000 to produce the drug. Generic manufacturers make the drug available in Egypt for less than $1,000 per person and Indian generic manufacturers believe they could produce it for even less. If we allowed people in the United States to go these countries to get treatment, covering the cost of travel for themselves and immediate family, it would be possible to provide treatment for a small fraction of this cost.
If this were done on a large scale it would undermine the model of financing research through granting patent monopolies, however it is long past time that this 16th century mode of financing be re-examined. There is a vast literature in economics on the waste and corruption that results from policies like tariffs that raise the price of products above the cost of production.
In the case of Sovaldi, the patent monopoly has a distortionary effect that is similar to a 10,000 percent tariff. Predictably it leads to a huge amount of corruption, with companies routinely misrepresenting the safety and effectiveness of their drugs. The secrecy that companies rely upon to ensure themselves the ability to capitalize on the value of their research also slows the pace of drug development. Unfortunately the industry is so powerful (it is a major source of advertising revenue for the Post), that it can prevent alternatives to patents from even being raised in public debate.