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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.

Germany's Economy Shrank at a 1.0 Percent Rate, not 0.25 Percent Print
Thursday, 12 January 2012 09:57

One of the simplest ways in which the media could improve their reporting is by reporting numbers in ways that make sense to their readers. When the Washington Post told readers that Germany's economy shrank by 0.25 percent in the 4th quarter, I would suspect that more 99 percent of readers thought this was an annual rate of decline, which is way numbers are always reported for the United States.

In fact, this is a quarterly rate of decline, which is the standard practice in Europe and much of the rest of the world. It is not hard to convert quarterly growth numbers to an annual rate. For small numbers, multiplying by four will do the trick. (For larger numbers it is necessary to take the growth figure to the 4th power, but that still is not hard.)

Time to Panic! Unemployment Insurance Claims Jump to 399,000 Print
Thursday, 12 January 2012 08:44

It looks like unemployment is on the rise again, new claims for unemployment insurance jumped to 399,000 last week. That is 24,000 more than the consensus forecast and also 24,000 more than the prior week's number. So let's see some of those shrill talking heads getting scared -- real bad news for President Obama's re-election prospects.

Of course folks who know some economics remember that the December data showed a peculiar jump of 42,000 jobs in the courier industry in December. The same thing happened last year. Last year, all those jobs disappeared in January. And last year there was a jump in claims of 19,000 for the second week in January. Let's see if we can guess what this all means.

Are Private Equity Firms Evil Doers? Washington Post Edition Print
Wednesday, 11 January 2012 08:06

No one reads Washington Post editorials for their astute economic analysis. The paper did not surprise readers with its balanced discussion of private equity today. 

While the paper is right to point out that whether private equity firms directly increase or decrease employment is not a good measure of whether they are beneficial to the economy, it totally overlooked the main issues surrounding private equity and its impact on the economy. The question is whether the high profits earned by the partners are primarily due to increasing economic efficiency or to rents earned by dumping costs on others.

As noted here, it is standard practice for private equity to load firms with debt. This means that taxable profits are turned into tax-deductible interest payments. The difference can be a gain to Bain and other private equity firms, but it is coming at the expense of taxpayers.

In the same vein, private equity companies often in engage in complex asset shifting. This can leave a heavily indebted firm with few valuable assets. If it eventually goes bankrupt, the creditors collect little money because the private equity company has transferred the assets with value into an independent company. This can also mean big profits for Bain and other private equity companies, but this is not a gain to the economy.

Another frequent game of private equity companies is to dump pension obligations on the Pension Benefit Guarantee Corporation. The reduction in liabilities can mean big profits for Bain and other private equity companies, but does not provide any benefit to the economy.

These are the sorts of issues that appear in serious discussions of the benefits of private equity.

The Post piece also included the bizarre assertion that:

"Probably it [private equity] is one feature of U.S. capitalism that makes our system more flexible and capable of 'creative destruction' than Europe’s."

This is bizarre because the U.S. economy is not obviously more flexible and capable of "creative destruction" than Europe's economy, as people familiar with the productivity data know.



                                            Source: OECD.

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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.