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If the Fed had Bailed Out Lehman, Who Would Have Stopped Them? Print
Tuesday, 30 September 2014 04:57

We continue to be treated to stories of how everything about the housing bubble and the economic crisis caused by its collapse was simply unpreventable. None of the people responsible for this immense policy failure has been held accountable in any way. With few exceptions, all are now incredibly rich.

One of the items on the failure list that deserves immense ridicule is that the Fed did not rescue Lehman because it lacked the legal authority. (There is another question as to whether it should have allowed the whole cabal of Wall Street banks to crash in their own greed. No, it would not have condemned us to a second Great Depression -- save that fairy tale for the kids shows.) The NYT has a piece with the Fed Chair Ben Bernanke and Treasury Secretary Henry Paulson reasserting their position that the Fed lacked legal authority to bail out Lehman. 

The question that is never asked in this piece is, who would have stopped them? If Bernanke and Paulson had taken steps to rescue Lehman, did they think someone would file a suit in court to undo the rescue? If so, who would it be and what would the legal case look like?

That question makes the claim that they didn't save Lehman because of lack of legal authority look absurd on its face. Many of the actions taken by the Fed and Treasury during the bailout had questionably legal authority, yet no court case ever interfered with their actions in any important way. No one would have had standing to prevent a rescue of Lehman.

If Bernanke and Paulson had wanted to go the route of rescuing Lehman they undoubtedly could have done so. They chose not to rescue the bank and were obviously unprepared for the consequences. The story about lacking legal authority was clearly made up after the fact in the great Washington tradition of CYA. And in the great Washington media tradition of protecting the powerful, this story has been treated as credible for the last six years. 



Dax makes a very good point in his comment. We do know what a legal action against a Fed bailout of Lehman would like look, it would look like the suit now coming to trial over the bailout of AIG. In other words, Bernanke, Paulson, and Geithner want us to believe that they didn't rescue Lehman, even though they knew it was essential to the stability of the financial system, because they were worried they might face long shot legal suit six years later. That might sell at NYT and WaPo, but not among actually serious people.

Consumers Do Not Start Delaying Purchases If Inflation Crosses Zero: #65,786 Print
Tuesday, 30 September 2014 04:18

I guess this is one of those unsupported assertions that reporters think they just have to repeat to show someone they know economics. In fact they show the opposite. When inflation is near zero, many prices are already falling. Crossing zero, just means more prices are falling. So what?

Again, inflation is too low in the euro zone now. If it crosses zero, then it will be too low by a larger amount: end of story.

The Vicissitudes of the Market Would Be a Big Improvement Print
Monday, 29 September 2014 03:58

Bob Kuttner has a good column in the Huffington Post comparing the progress made in improving the living standards of ordinary people in the forty years following the New Deal with the deterioration of the last three decades. However the piece doesn't go far enough in contrasting the former period with the latter period.

After noting the lack of progress in recent years he comments:

"You wonder why people are turning away from the Democrats' proposition that affirmative government can buffer people from the vicissitudes of the marketplace? You wonder why millennials are attracted to the libertarian proposition that we're all on our own anyway?"

Of course the problem of the last three decades is not the "vicissitudes of the marketplace," but rather deliberate actions by the government to redistribute income from the rest of us to the one percent. This pattern of government action shows up in all areas of government policy.

For example an explicit goal of our trade policy is to put our manufacturing workers in direct competition with low paid workers in the developing world. This has the predicted actual result of driving down the wages of manufacturing workers and less-educated workers more generally. At the same time we deliberately depress their wages we largely protect the most highly paid professionals (e.g. doctors, lawyers, and dentists) from the same sort of international competition.

The government has strengthened and lengthened patent and copyright monopolies. This allows for absurdities like a treatment with the hepatitis C drug Sovaldi costing $84,000 when the drug would sell on the free market for less than $1,000. There would be no hand-wringing moral dilemmas about treating people with hepatitis C at less than $1,000 per person. If we just had a free market the government would not be putting people behind bars for 16 months for allowing people to download recorded material. 

The vicissitudes of the market would also not have bailed out the Wall Street banks, ensuring that many of the top 0.1 percent or 0.01 percent did not lose their fortunes due to their own greed and ineptitude. It also wouldn't exempt the financial sector from the same sort of taxes imposed on all other industries. And the vicissitudes of the market would not have a Federal Reserve Board that is prepared to raise interest rates in order to keep people from getting jobs and keep workers from having enough bargaining power to get wage increases.

In these and other areas the government is actively working to redistribute income from the rest of us to those on top. Under such circumstances, a libertarian view that reduces the power of the government likely looks pretty good to many people. Certainly in these areas, less government would be a very big victory for most of the population.


Steven Pearlstein Isn't Into Shorts Print
Sunday, 28 September 2014 08:18

Don't worry folks, this is a family-friendly blog. The issue is that Steven Pearlstein takes great offense at the possibility that people are manipulating the stock price of a biotech company by shorting its stock on a massive basis. Pearlstein is right to be angered about stock manipulation, he is wrong to imagine it bears any direct connection to shorting stock.

The issue here is that short sellers of Northwest Biotherapeutics (people betting against the company's stock) are supposedly spreading rumors to push down its price. This could be true, and if so, the perps should be nailed and jailed. But people often spread false stories to push up the price of stocks as well. This is every bit as pernicious. It means that suckers could pay high prices for stock that may have little or no value. This could deprive people of large portions of their savings. It also diverts capital from companies that may actually have worthwhile products to companies that don't.

It is much easier to manipulate the stock price of a small company than a large company, but this is true on both the short and long side. Shorts can serve a valuable function. Imagine that the investment banks had been shorted in a massive way in 2004 just as the housing bubble was really going crazy. It might have stopped the bubble in its tracks. There is nothing inherently pernicious about shorts. It is wrong to make an automatic connection between shorts and stock manipulation. There is none.

Unmentioned Myth About Billionaires: They Know Anything About Public Policy Print
Sunday, 28 September 2014 07:59

The Washington Post treated us to "five myths about billionaires" this morning. Incredibly, they missed the most obvious one: that billionaires know anything special about what is good for the country and the world.

Most billionaires (at least those who didn't inherit the money) are probably smart and hard-working, but so are millions of other people. What most distinguishes someone like Bill Gates from the hundreds of thousands of other software entrepreneurs is luck and sharp elbows. Suppose IBM had refused to allow Gates to keep control of the Dos operating system? Gates might still be very rich, but certainly not the richest man in the world. Alternatively, if the government still enforced anti-trust laws Microsoft might have faced serious penalties for engaging in textbook anti-competitive practices to get and keep a near monopoly in operating systems, Gates also would not have the fortune he has today.

Anyhow, there is no reason to think that Gates' luck and ruthlessness make him particularly competent to pass judgment on world poverty, education, or any of the other issues for which he is now viewed as an authority. The same applies to the other billionaire policy types cited in the piece. While these people obviously have the money to ensure that their views carry force in the world, there is no more reason to think that these billionaires' judgments on public policy carry particular value than the judgments of people who win the lottery.


The Washington Post Is a Mess: Social Security Edition Print
Sunday, 28 September 2014 07:28

The Washington Post brought its campaign against Social Security into the name-calling phase with a full page article headlined, "Social Security Is a Mess. How to Fix It." (That is the print edition headline, the web version is slightly different.) The piece includes a standard list of revenue and spending items that could close the shortfall that is first projected to arise in 19 years.

There are a few points worth making about this piece. The first is the obvious. Name-calling doesn't belong in a serious newspaper. The Social Security system faces problems, but so does the Justice Department and the Defense Department, or for that matter Amazon, the company controlled by Washington Post owner Jeff Bezos. It is unlikely we will ever see an article headlined "Amazon is a Mess." The Post should try at least a little bit to separate the views of the editors/publisher from the way it presents the news. That is what serious newspapers do.

The second point is that in the scheme of things Social Security is an incredibly effective program. It has kept tens of millions of people out of poverty. It is the main source of retirement income for current retirees and will grow as a share of most workers' retirement income in the years ahead. It has very little fraud and abuse. In fact, fraud is so rare that the Washington Post thought it was worth a front-page story to report that 0.006 percent of Social Security benefits over the prior three years had been paid out to dead people. And its administrative costs are less than one-tenth as large as those of private sector firms providing retirement accounts. If Social Security is a "mess," then the adjectives appropriate for other large institutions could not be printed in a family paper.

The piece also wrongly asserts that the shortfall would be easier to solve if it were done sooner. That might be true if we envision that the gap would be closed entirely or in part on the benefit side. However if the gap is closed on the revenue side it doesn't follow that there is an special advantage to having a fix implemented sooner. For example, if we raise the cap on taxable wages and raise the payroll tax beginning in 2025, it is not clear that there is any big advantage to writing that into law in 2014 as opposed to 2024. (There may be some small advantage that people can adjust their behavior, but this is a very minor issue.)

It would also have been useful to put the projected shortfall in some context. Much of the shortfall stems from the upward redistribution of income over the last three decades. This is in turn is attributable to policies like special too big to fail insurance for Wall Street banks, trade policy that was designed to put downward pressure on the wages of ordinary workers, and Federal Reserve Board policy that has deliberately kept unemployment high in order to undermine workers' bargaining power.

This upward redistribution is important to Social Security for two reasons. First, it has shifted a large amount of wage income to workers earning above the cap. The share of wage income that has escaped taxation in this way rose from 10 percent in 1983 to 18 percent in recent years. Similarly, the shift from wage income to profits in the last 14 years has also deprived the system of revenue.

The other reason this shift is important is that it has kept wages from growing in step with productivity. If the typical worker's wages had risen in step with productivity since 1980 they would be more than 30 percent higher today. In this context, a 2-3 percentage point rise in the payroll tax (like we saw in both the decade of the 1970s and the 1980s) would probably not seem like that big a deal. Workers care first and foremost about their after-tax wage, not the tax rate. While politicians and newspapers might focus on the latter, workers would be far better off with 30 percent more going into their paychecks, even if 2-3 percent more was coming out in taxes.


Don't Buy Gross Domestic Income Print
Saturday, 27 September 2014 07:57

Justin Wolfers is trying to sell gross domestic income (GDI) as a more accurate measure of growth than GDP. He notes that gross domestic income grew at a 2.2 percent annual rate in the first half of 2014 and says that this "more accurate" measure of the economy should be taken over the 1.2 percent annual rate shown by the more widely used GDP measure.

In principle GDI and GDP should show the same growth. GDI measures the economy by measuring the incomes generated in production (e.g. wages, profits, interest, and rents). GDP measures the economy by counting the goods and services sold (consumption, investment, government, net exports, and inventories). In principle they should show the exact same number, but due to errors in measurement they always differ and sometimes by a large amount. (The gap is defined as the statistical discrepancy, which is GDP minus GDI.)

While Wolfers tells readers that the GDI measure is more accurate the good folks at the Bureau of Economic Analysis generally say that the GDP numbers provide a better measure. The data (Table 1.17.6) show that GDI is far more erratic than GDP. For example, if we believe the GDI measure then the economy grew at a 7.2 percent annual rate in the 2nd quarter of 2012 and then slowed to a 0.6 percent rate in the third quarter. The GDI data also show the recovery barely budged in the second half of 2009 even as the stimulus kicked in, growing at just a 1.1 percent annual rate. Growth then surged to a 5.7 percent annual rate in the first quarter of 2010 before falling back to a 0.5 percent rate in the second quarter.

If that doesn't sound like the economy you remember there is an alternative explanation for the erratic movements in GDI. David Rosnick and I did a paper regressing the changes in the statistical discrepancy against lagged measures of capital gains. We found a strong relationship with the GDI becoming a larger negative number (GDI rises relative to GDP) following periods of strong capital gains.

For this to be plausible we would need a story whereby some amount of capital gains income shows up as ordinary income. (Capital gains income is not supposed to be counting in GDI.) Since one of the sources for GDI is tax returns, this seems plausible. While long-term capital gains are taxed at a lower rate than ordinary income, short-term gains (assets held less than one year) are taxed at the same rate. This means that people filing tax returns have no particular reason to distinguish between capital gains income and ordinary income.

If we hypothesize that some amount of capital gains income always shows up as ordinary income, then we would expect that the amount of capital gains income showing up as ordinary income would be higher when people have lots of capital gains income. This means that when there is a big run-up in asset prices, we would expect the statistical discrepancy to become a larger negative number, as the data show. See, economics is simple and fun.

Including Capital Gains Exaggerate Income of the Rich Print
Saturday, 27 September 2014 07:36

Neil Irwin has a useful piece reporting on a journal article by Pavlina Tcherneva documenting the increased share of income growth going to the top 10 percent and especially the top 1 percent. While there can be little doubt about the basic patterns, it is worth noting that the data include capital gains income. This is important because by this measure the change in income shown in any given year will be hugely influenced by the movement in stock prices in the recent past.

For example, if stock prices stay more or less at their current level for the next two years and then we compared the income growth of the top 1 percent in 2016 with the growth in 2012 (after three years of sharp price increases) our numbers would show a sharp fall in the income of the top 1 percent even if nothing else in the economy had changed. While it is worth noting changes in wealth and capital gains, it is useful to examine income with gains (or losses) excluded. If the stock market stabilizes at its current level and the pattern of income distribution has otherwise not changed, the country will not have become more equal.

Rising Dollar Costs Jobs Print
Friday, 26 September 2014 07:18

The NYT ran an article celebrating the recent run-up in the dollar. The headline is "buoyant dollar recovers its luster, underlines rebound in U.S. economy." The headline could have with at least as much accuracy substituted "undermines" for "underlines." While the piece attributes the rise in the dollar to all sorts of good things about the U.S. economy, there actually is a much simpler explanation. Interest rates are higher in the United States than elsewhere.

Relative interest rates determine where investors choose to park their money. They are not assigning gold stars to economies for good behavior. There is some relationship between interest rates and growth, but it is the former that matters for investors, not the latter.

The piece gets many other points wrong. For example, after the dollar has risen, investment in developing countries becomes more attractive, not less attractive. But the big point left out of this story is that the over-valued dollar is the main cause of what has become known as "secular stagnation."

Fans of national income accounting everywhere (i.e. anyone who knows economics) know that a trade deficit creates a gap in demand that must be filled through some other source. Currently the trade deficit is running at more than a $500 billion annual pace or around 3.0 percent of GDP. For the economy to be at its potential, this gap in demand must be fill by higher consumption, investment, housing, or government spending.

The reason the economy is still more than $600 billion below its potential level of output is that it doesn't have a source of demand to fill this gap. It is not easy to make any of the other components of GDP rise, with the exception of government spending, but that is ruled out for political reasons. We could do it with a stock or housing bubble, but those stories don't have happy endings.

So the rise in the dollar translates into slower growth and fewer jobs. Goldman Sachs estimates that the 3.0 percent rise in the dollar we have seen to date will shave 0.1 to 0.15 percentage points off GDP growth in each of the next two years (sorry, no link). That is a pretty good size hit in an economy that is only growing at a 2.0 percent annual rate.

It also translates into lost jobs. If the economy is 0.25 percent smaller in 2016 due to the higher dollar that would imply a loss of roughly 350,000 jobs. So, does the NYT have any more good news for us today? 


That Two Percent Inflation Target and Silly Things Economists Say Print
Friday, 26 September 2014 04:34

I see Paul Krugman has picked up on my friend Jared Bernstein's post asking where the Fed's 2.0 percent inflation target came from. He argues that it is a pretty much arbitrary compromise between the idea that the target should be zero (the dollar keeps its value constant forever) and the idea that we need some inflation to keep the economy operating smoothly and avoid the zero lower bound for interest rates. This is far too generous.

I recall reading the literature justifying the 2.0 percent inflation target last year when I was researching my book with Jared, Getting Back to Full Employment. I was shocked to see how weak the argument was. Not only is there not much justification for 2.0 percent, there is not much justification for any target. After all, most central banks have not had any explicit inflation target for most of their existence. These countries didn't get hyperinflation and their economies did fine. There isn't much evidence that an inflation target will prevent bad things from happening.

While as a rule stable prices are better than unstable prices, economists have been largely untroubled by unstable prices in other areas. Look at the real value of the dollar over the last three decades. Rises and falls of 20 percent over a two or three year period are not uncommon. This means that the price of large chunks of our economy fluctuate in large and unpredictable ways, apparently without negative effect, or at least not enough of a negative effect to concern the bulk of the economics profession. So if these big changes in relative prices of imports and exports  don't have much consequence, what's the big deal if inflation is 2.5 percent rather than the 2.0 percent we all are supposed to treasure? (If the dollar falls by 20 percent, as a first approximation, exporters are getting 20 percent more for their products, measured in dollars. They get the same amount of foreign currency, but it buys 20 percent more dollars.)

The other part of the 2.0 percent story that I really loved is that some economists argued for it by saying that it could be reconciled with the dream of zero inflation because of errors in measurement. Krugman briefly refers to this view, but doesn't explain the meaning of this claim. The argument here is that our price indices overstate the true rate of inflation and that the overstatement is on the order of 2.0 percentage points annually.

If you just read that and your hair didn't stand on end, read it again. Many of us have been writing on the stagnation of wages and income over the last three decades. (For example, Thomas Edsall had a good piece in the NYT earlier this week, although he gets the dates wrong.) If we have been overstating the true rate of inflation by 2.0 percentage points annually then wages and income have actually been rising very rapidly. Instead of near zero growth since 1980, real wages have risen by more than 96 percent. (Take 1.02 to the 34th power.)



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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.