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The Invisible European Central Bank: A Missing Part of the Euro Zone Crisis Print
Monday, 16 January 2012 08:35

The NYT had a mostly good piece discussing the gap in competitiveness between the northern and southern European countries that lays at the heart of the debt crisis in the euro zone. One item that would have been worth adding is the fact that European Central Bank is making any potential adjustment process far more difficult by not having more expansionary policies and by refusing to act as a lender of last resort.

Forcing heavily indebted countries to meet tough deficit targets, at the same time that their interest burdens are soaring, is creating an impossible situation. This is leading to a downward spiral in which austerity measures slow growth and raise deficits, which undermines confidence in the debt. This pushes up interest rates, which makes the deficits even larger.

The Average 12-Year-Old is Taller Than the Average 6-Year-Old: The Post Gets Desperate in Making the Case Against an Inequality Problem Print
Monday, 16 January 2012 07:49

The Washington Post has consistently used both its news and opinion pages to try to convince readers that the main threat to their well-being and that of their children came from older people getting fat Social Security checks and generous Medicare benefits. This position has become harder to maintain, both because the economic collapse has made these benefits more important than ever to middle and lower income families and also because the fact that rich are making off with the bulk of the benefits of economic growth is becoming increasingly apparent. Still, the Post labors on.

Today, the paper featured a column by political consultant Bill Knapp arguing that we should all be happy because the economy has created jobs over the last 40 years and also because people at most points along the income distribution have seen some gains in income.

This is known as "the 12-year-olds are taller than 6-year-olds" argument in reference to the claim that poor nutrition might be stunting growth. The Bill Knapps of the world would get out their yardstick and measure a representative sample of 12-year-olds and do the same for 6-year-olds. After careful analysis of the data they would find that the 12-year-olds are taller. They would then write up their findings and get a column in the Washington Post telling readers that bad nutrition is not affecting growth.

Let's skip the idiocy. Economies grow, they add jobs, and people get on average richer. This happens everywhere barring war, natural catastrophe, or incredible economic mismanagement. The issue is the rate at which they grow and that people see improvements in their living standards. And for most people in the United States, the improvements in living standards over the last three decades have been very modest. The reason is that most of the gains have gone to the richest one percent.

Remarkably, Knapp can't even get his numbers right on how rich the one percent are. He tells us that:

" When you adjust for family size, the top 1 percent made, on average, $335,779 a year."

Actually, that is a cutoff for entering the 1 percent, not the average for the group. (Math is hard.) The average income for families in the top 1 percent is over $1.3 million.

After flunking the arithmetic portion of the column, Knapp then turns to the Nigerian cell phone user argument. Knapp thinks that the average Nigerian in 2012 enjoys a higher standard of living than did the average American in 1990, because Nigerians in 2012 have a higher rate of cell phone usage.

Okay, he didn't make this argument directly about Nigeria and the United States, but he did make this sort of argument about the "telling facts about our economic growth and future," which amounted to a rundown on the numbers for the use of cell phones, computers, and broadband. Knapp didn't even try to put these numbers in comparative terms, for example seeing how we measure up against Europe and Japan (not especially well).

So there you have it. Don't worry about how much money Robert Rubin and Angelo Mozilo made off the housing bubble and the difficulty that you are having finding a job, paying for your health care or your kids' education. Just be thankful that you have an iPhone.

Is Thomas Edsall the High Priest of Loser Liberalism? Print
Sunday, 15 January 2012 22:13

Thomas Edsall does the classic caricature of the debate between liberals and conservatives telling readers:

"Looked at another way, the two sides are fighting over what the role of government in redistributing resources from the affluent to the needy should and shouldn’t be."

This is absolutely not true. The government decides how to structure the market. Its decisions in this area swamp the impact of the redistributive policies that liberals and conservatives often fight over.

For example, patent protection for prescription drugs redistributes more than five times as much money to the holders of patent monopolies as the Bush tax cuts did for the richest two percent of the population. Similarly, the protectionist barriers that limit the competition that doctors, lawyers and other highly paid professionals face from foreign competition are comparable to giving them a welfare check that averages in the neighborhood of $100,000 a year.

There are many other ways in which government policy on structuring the market have enormous impact on the distribution of income. It is understandable that conservatives would like to divert the public's attention from the ways in which the government structures the market to redistribute income upward. It is hard to understand why liberals would ever accept this "loser liberalism" framework which reduces the policy debate to the extent to which government should redistribute money from the winners in the market to the losers.

The Washington Post's Tortured Logic On the Fed's Housing Proposals Print
Sunday, 15 January 2012 09:18

The lead Washington Post editorial noted (and excused) the Fed's complete failure to understand the dangers posed by the housing bubble (the economy is soooo complicated) and then somehow used this failure as an argument against its housing proposals. The Fed's main housing proposals were that Fannie and Freddie should make it easier for underwater homeowners to refinance and also that they should look to convert some of their foreclosed properties to rental units. The Fed also suggested that it might be advantageous to allow foreclosed homeowners to stay in their home as renters. (Yes, that one is my right to rent plan.)

The Post doesn't like the plans because the government could lose money on the deals. They also say that they may not fix the housing market.

Let's take these in turn. In answer to the first, the question is how much money does the government stand to lose by allowing homeowners who are already underwater to refinance at lower rates. Remember, we are already on the hook for the loans. The deal is simply that homeowners will now be paying lower interest to holders of mortgage backed securities, or in cases where Fannie and Freddie held the loans directly, to the government. The downside risk to the government seems pretty small and, as the Fed noted, if it reduces the default rate, then it could be a net gainer. Of all the ways in which we can conceivably help homeowners, this one should top the list as no-brainer.

The question about fixing the housing market depends on what we mean by "fixing?" There was a housing bubble. It burst. Does the Post think that we will get house prices back to their bubble-inflated levels? That is probably not possible and certainly not desirable. If the point is to get homes occupied and to allow people who are no longer homeowners to find good rental housing, then again the Fed's proposals seem like no-brainers.

The Fed deserves tons of ridicule; letting the housing bubble grow to such dangerous levels was an act of ungodly stupidity. But its latest proposals on housing are definitely a step in the right direction. 

Does the Post Have to Call Trade Deals "Free Trade" Deals? Print
Sunday, 15 January 2012 08:54

Reporters always complain about space constraints. Therefore it is difficult to understand why they feel the need to add the word "free" when reporting on trade deals, as the Post did in a piece talking about the possible implications for trade of President Obama's plans for restructuring the Commerce Department.

Of course the deals in question (recent pacts with South Korea, Colombia, and Panama) were not free trade agreements, since they increased barriers in some areas, most obviously intellectual property rights. They were just called "free trade: agreements by proponents, presumably because they think this will make them politically salable.

It would have been helpful to include the views of a critic of U.S. trade policy in this piece. If the restructuring makes the government less effective in promoting a trade agenda that they consider harmful, a restructuring may be viewed positively.

Why Rich People Prefer Cuts to Their Social Security Over Tax Increases Print
Sunday, 15 January 2012 08:32

In an article on the richest one percent of families in the country, the NYT told readers that:

"they may prefer facing cuts to their own benefits like Social Security than paying more taxes."

The average income among the richest one percent is roughly $1.5 million. The maximum Social Security benefit for a retired couple is around $45,000. If we assume that the everyone in the one percent gets the maximum benefit (which would certainly be an overstatement of their benefits), then completely eliminating their Social Security would be equivalent to a 3 percentage point increase in their tax.

For families with higher incomes in the one percent, the potential loss due to a reduction in Social Security benefits would be an even smaller share of their income. For this reason, it is understandable that they would prefer to go the route of reduction in benefits to tax increases.  

The NYT Lectures France on How to Restore Its Aaa Rating Print
Saturday, 14 January 2012 08:35

Arguably the main reason that France and the rest of the euro zone countries are facing recession and debt downgrades is the failure of the European Central Bank (ECB) to act as a lender of last resort and promise to back up the debt of its member states. This failure, coupled with its obsession to curb inflation even at the expense of growth, would seem to be the main source of the euro zone's economic problems at the moment.

However the NYT sees it otherwise. In an article on Standard & Poor's downgrade of French debt it told readers:

"France will have to work to restore its financial luster, especially if it is subsequently downgraded by other ratings agencies. French officials say their priority now is to demonstrate that the euro area is solid, while also showing that France is working to improve its own finances.

Mr. Sarkozy’s austerity programs, including higher taxes on items like some food and beverages that kicked in across France recently, are aimed at whittling the country’s budget deficit to 3 percent of G.D.P. by 2015."

Austerity is of course one route, although if it leads to further weakness in the French economy, it is not clear that it will be a successful route. Another possible route would be for France to pressure the ECB to adopt sounder policies.

The NYT seems to have ruled this path out for France, but the French people might see changing ECB policy as preferable to tax increase and spending cutbacks that will have an uncertain impact on the deficit and France's financial standing.

The Washington Post Has Not Heard About the Health Care Crisis Print
Friday, 13 January 2012 06:41
In an article explaining why older people are increasingly deciding to work the Washington Post neglected to mention the cost of health care. If a person over 55 is not getting health care insurance through their employer, the cost of insurance would typically be more than $10,000 per year per person and several times this amount for people with a pre-existing condition. The rising cost of care and the sharp decline in the percentage of workers with retiree health benefits is undoubtedly a major factor behind the decision of more older workers to remain in the workforce.
NPR Does Fluff Piece for Private Equity Print
Friday, 13 January 2012 05:19

A Morning Edition segment today told listeners (sorry, no link yet) that "there's no doubt that private equity firms create value," which it then justified by referring to the high returns earned by those who invest in private equity (PE) companies. This is WRONG!!!!!!!!!!!!

First, it is not at all clear that those who invest in PE funds (not the PE partners themselves) do beat the stock market when a full accounting is done. Recent research shows that net of fees, private equity investors (pension funds and university endowments) would have been better off buying the S&P 500.

Furthermore, even if the PE investors did come out ahead, this does not mean it created value. Investors in Bernie Madoff's fund, who got out, made money too, but Bernie Madoff did not create value.

Much of what private equity does is financial engineering. For example, it is standard to load up the companies they purchase with debt. The resulting interest payments are tax deductible. This increases profitability but creates no value for the economy. It simply transfers money from taxpayers to the private equity company. 

To take a simple example, suppose a public company (let's call it Gingrich Inc.), has $1 billion a year in profits. If Gingrich Inc. paid taxes at the full 35 percent rate (fat chance), it would have $650 million [thanks Robert] a year to either keep as retained earnings or to pay out as dividends to its shareholders.

Now suppose that a PE company (we'll call it Romney Capital) steps in. The current price to earnings ratio in the stock market is around 14, so Gingrich Inc. would have a pre-takeover market value of approximately $9.2 billion (14*$650 million). Romney Capital then arranges for Gingrich Inc. to borrow $6 billion which it pays out as a dividend to itself. This means that the Romney Capital has just gotten back almost two-thirds of its investment.

Suppose that Gingrich Inc. pays 5 percent interest on its debt (closer to the 5.20 Baa rate than the 3.80 Aaa rate). This means that before tax profit falls by $300 million. This leaves Gingrich Inc. with $700 million in before tax profit. Deducting the 35 percent tax, Gingrich Inc. now has $455 million a year to distribute to Romney Capital, 70 percent as much as before ($455 million/$700 million) even though Romney Capital has already recovered two-thirds of what it paid for Gingrich Inc.. In this case, the benefit to the Romney Capital came at the expense of taxpayers, not through the creation of value.

Now suppose that the Romney Capital arranges to sell off some of Gingrich Inc.'s assets, such as real estate or a highly profitable subsidiary, and then uses the proceeds to make a payment to the Romney Capital rather than leaving the money under the control of Gingrich Inc. Such sales may allow Romney Capital to recoup the rest of its investment and possibly more. Gingrich Inc. is then left as a highly indebted company with few assets.

In this story, Romney Capital may have earned a substantial profit on a limited investment (it recouped most of its money almost immediately when it loaded Gingrich Inc. with debt), without doing anything to improve the operation of Gingrich Inc. If Gingrich Inc. manages to stay in business and generate profits, then this will increase the return. Romney Capital may be able to resell the company and treat the whole sale price as profit.

On the other hand, if Gingrich Inc. goes bankrupt, this will primarily be a problem for creditors, since Romney Capital has already gotten its investment back. In effect, Romney Capital might have secured large gains entirely by financial engineering, while creating no value whatsoever.

The sort of asset stripping described here, which harms creditors by taking away potential collateral for their loans, violates the law. However it is extremely difficult to prevent, especially with private equity companies that have to make few public disclosures. If Gingrich Inc. were to fall into bankruptcy, this is the sort of thing that would likely be contested in the bankruptcy proceedings. Of course the resources used in fighting out this sort of legal battle are a pure waste from an economic perspective.

Anyhow, these are the sorts of issues that are raised with private equity. It is flat out untrue to say, as NPR does:

"Here's what private equity firms like Bain Capital do: First, they go out and find a few large investors — usually pension funds, university endowments and possibly wealthy individuals. Then, says Ohio State professor Steven Davidoff, they take that money, borrow a lot more, and buy companies — usually companies that are in trouble or undervalued.

'They buy them in hopes that they can increase the value of the companies and sell them at a fantastic profit,' Davidoff says."

Private equity companies absolutely do not have to increase the value of a company to make a profit. They can end up making a profit on their investment even if they take the company into bankruptcy and leave it much worse off than it was before the takeover.

How Is It Possible The Fed's Image Can Be Tarnished Further? Print
Thursday, 12 January 2012 19:37

At this point it should be universally known that the Federal Reserve Board has been guilty of disastrous incompetence. It allowed an $8 trillion housing bubble to grow unchecked. The inevitable collapse of this bubble has produced the worst downturn since the Great Depression and ruined the lives of tens of millions of people across the country.

This is why it was striking to read a Washington Post headline for an article on newly released Fed transcripts that showed that Greenspan and the rest of the Fed were completely oblivious to the bubble and the risks it posed to the economy as late as 2006:

"Fed's image tarnished by newly released transcripts."

At this point, the Fed should not have an image that could possibly be tarnished further. If its record had been reported accurately, everyone would be well aware of its incredible incompetence as a manager of the economy. 

btw, as noted in the article, many of the people at these Fed meetings are still in top policy making positions. This shows that the U.S. economy still produces good-paying jobs for people without skills.

Addendum: This is what people who were not Greenspan sycophants were saying at the time. And, here's another blast from the past.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.