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Gretchen Morgenson Warns on Pensions and Private Equity (Guest Post) Print
Sunday, 19 October 2014 20:16

by Eileen Appelbaum

Gretchen Morgenson had a great column in Sunday’s New York Times that pulls back the veil of secrecy surrounding pension fund investments in private equity. PE firm Carlyle recently agreed to pay $115 million to settle charges that it had engaged in illegal activities. Shockingly, neither Carlyle nor the firm’s executives and shareholders will pay a penny of this amount. Instead, it’s the pension funds and other limited partners in this PE fund that are on the hook for paying the fine. As Morgenson points out:

Instead, investors in Carlyle Partners IV, a $7.8 billion buyout fund started in 2004, will bear the settlement costs that are not covered by insurance. Those investors include retired state and city employees in California, Illinois, Louisiana, Ohio, Texas and 10 other states. Five New York City and state pensions are among them.

The retirees — and people who are currently working but have accrued benefits in those pension funds — probably don’t know that they are responsible for these costs. It would be very hard for them to find out: Their legal obligations are detailed in private equity documents that are confidential and off limits to pensioners and others interested in seeing them.

Indeed, Morgenson only knows about this because in a rare coup, the New York Times was able to obtain a copy of an agreement that limited partners in a Carlyle fund signed. In general, the secrecy surrounding the agreements that pension funds and other limited partners sign has made it impossible to tally up the total fees and expenses PE firms charge pension funds and their other PE fund partners. Despite the fact that public employee pension funds provide almost a quarter of the capital committed to private equity, while private pension funds commit another 10 percent, the terms of these partnership agreements are kept secret from the workers and retirees whose money is at stake. This is especially egregious in light of the sunshine laws that in most states require transparency and accountability on the part of government agencies, including public pension funds. Yet, as Morgenson documents, the version of the Limited Partner Agreement with Carlyle that the New York Times obtained through a Freedom of Information request was heavily redacted – 108 of its 141 pages were either entirely or mostly blacked out.

In an otherwise excellent article that should be read by every worker and retiree whose retirement savings are in a pension fund, Morgenson makes two misstatements that need to be corrected. First, she uncritically repeats the PE industry’s false characterization of its own activities.

"Private equity firms now manage $3.5 trillion in assets. The firms overseeing these funds borrow money or raise it from investors to buy troubled or inefficient companies. Then they try to turn the companies around and sell at a profit."



The Post Tells Us the Economy is SO Complicated Print
Sunday, 19 October 2014 10:47

The Post is really angry that people are talking about the rich getting everything at the expense of everyone else. It demands in the headline of an article, "stop with the fiction of a binary economy." 

Actually, nothing in the article really gives us much reason to question the reality of the binary economy that many economists have written about. For example, it tells readers:

"The jobless rate in the center of the United States from North Dakota to Texas is less than 5 percent and has been well below the national rate for five years."

Yes, and this means what? Wages are rising in North Dakota, with a labor force of 470,000 (just over 0.3 percent of the national labor force), but not much in Texas. Furthermore, the country had a 4.0 percent unemployment rate as a year-round average in 2000. This meant that many states were around 3.0 percent.

Then we get this bizarre discussion:

"But the top two income quintiles saw annual gains of a percent to a percent and a half until 2008.

"That isn’t what it was in the 20th century, but we tend to forget that the 20th century also saw much higher inflation. And we forgot that just as income growth has slowed, the costs of many basic goods and services also dropped. In 1950, food represented 32 percent of a family’s budget, according to federal statistics; today, it accounts for less than 15 percent. Energy use has seen similar declines, along with clothing and basic necessities. Health care costs more, but that in part is because we are living longer. Education eats up more costs, but many more people are going to college."



In Context of Accusations of CIA Drug Smuggling, WaPo Calls $10 Million a Week "Relatively Small" Print
Sunday, 19 October 2014 08:07

The movie Kill the Messenger has brought to new attention to charges that the CIA was involved in drug smuggling in the 1980s. The central allegation is that the CIA at least looked the other way, as its allies in arming the Contras trying to overthrow the Nicaraguan government smuggled large amounts of cocaine into the United States. Jeff Leen, the Post's assistant managing editor for investigations, took up the issue in the Post's Outlook section today.

Leen is essentially dismissive of the charges, at one point telling readers:

"The first thing I looked for was the amount of cocaine that the story said 'the CIA’s army' had brought into the country and funneled into the crack trade. It turned out to be relatively small: a ton in 1981, 100 kilos a week by the mid-1980s, nowhere near enough to flood the country with crack."

For those not familiar with the price of cocaine in the mid-1980s, the Office of National Drug Control Policy reported (Figure 1) that the price for major wholesalers was around $100 a gram, while the price for users was between $200-$300 gram. (Prices did fall sharply toward the end of the decade.) This means that the flow of 100 kilos a week would have had a wholesale value of around $10 million and a retail value between $20-$30 million. That amounts to over $500 million a year at the wholesale level and between $1.0-$1.5 billion at the retail level.



I will give some additional context for the "relatively small" drug trade. relative to today's economy, the cocaine would be worth between $4.0-$6 billion a year at the retail level. It is also enough to supply 100,000 users with a gram of cocaine a week. 


The text has been corrected -- thanks ltr.

The Unmentionable Trade Deficit Doesn't Appear Again Print
Sunday, 19 October 2014 07:24

It is really bizarre how folks find it so difficult to mention the trade deficit as the obvious source of weak demand in the economy. This is not a debatable point. We have a trade deficit of around $500 billion a year or roughly 3.0 percent of GDP. This is money that is creating demand elsewhere, not in the United States.

If we are going to maintain something like full employment then we need to make up this $500 billion in lost demand with higher than normal expenditures from another sector, which means either government spending, investment, residential construction, or consumption. This is all simple GDP accounting, the stuff everyone learns in intro economics. This is about an accounting identity, it is not a theory that can be debated. It is by definition true.

In the last decade we made up the shortfall in demand with consumption driven by ephemeral housing equity created by the housing bubble and by a boom in housing construction. In the late 1990s, when the deficit first exploded, the gap was filled by demand generated by the stock bubble. 

Now, with no bubbles in the economy, we are facing a $500 billion shortfall in demand due to the trade deficit. But no one seems able to talk about it.

Today's culprit is Matt O'Brien. In a mostly good piece about the death of inflation (we'll have to talk about the claims of overstated inflation later) O'Brien explains the cause:

"Well, it's the crisis, stupid. Households can't or won't borrow, even though interest rates are zero, because they're still trying to pay down their old debts. That means growth is weak, and price pressure is too."

This one doesn't work because households are in fact borrowing. Consumption is actually quite high as a share of disposable income or GDP (pick your denominator). It's not quite as high as it was at the peak of the housing or stock bubbles, when it was being spurred by trillions of dollars of ephemeral wealth, but it is far higher than at any point in the post war period until the end of the 1990s.

In other words, it makes zero sense to blame the ongoing weakness of the economy on weak consumption. It just ain't so. While investment is not booming, it is actually above its 2005 level as a share of GDP, which means it is not especially weak either. We can say we need larger government budget deficits (fine by me), but the deficit is also not especially low by post-war standards. 

The obvious culprit in the story is the unmentionable trade deficit. In the standard textbook story, rich countries like the United States (and Europe and Japan) are supposed to be running trade surpluses with fast growing developing countries like China and India. The idea is that capital should be flowing to the countries that can use it better. 

That story did reasonably well describe the world in the 1990s until the East Asian financial crisis. The botched bailout (brought to you by the I.M.F. and the U.S Treasury Department) reversed these flows in a big way, setting the stage for the global imbalances were see today.  

It should be possible for reporters to talk about the trade and deficit and its causes. What's the problem here, will the NSA throw people in jail for jeopardizing national security?

NYT Tells Readers Maine Governor Boasts About Creating Jobs at 75 Percent of the Rate of the Rest of the Country Print
Sunday, 19 October 2014 07:04

That is what the NYT told readers, but because of the way it told them, most readers probably did not realize it. The paper had an article on Maine's gubernatorial race in which it reported that Paul LePage, the incumbent Republican governor, boasts of creating 22,000 private sector jobs during his term of office.

It is not possible to know whether this is a good or bad performance without knowing the size of Maine's labor force. While most readers would probably not know this statistic offhand, NYT reporters should have the time to look it up. The Bureau of Labor Statistics reports that in January of 2011 there were 490,000 private sector jobs in Maine. This means that the number of private sector jobs has increased by 4.5 percent during Mr. LePage's term in office.

By comparison, the number of jobs in the country as a whole increased by just under 6.0 percent over this period. This means that Maine has seriously lagged the rest of the country in private sector job creation.

While there may be factors that would slow Maine's job growth that are beyond the control of the governor, on its face, his job creation record is something he should be apologizing for, not boasting about. Unfortunately, most NYT readers would not recognize this fact.

Lesson for Steven Pearlstein: Economies Ordinarily Grow Print
Saturday, 18 October 2014 08:21

Steven Pearlstein is usually pretty astute in his comments on the economy, but not today. In his complaint about Yellen's lose monetary policy he tells readers:

"With stock and bond prices back around record levels, however, and the recession long since ended, output, employment and business lending are above where they were at the height of the bubble. That is why the Fed has been winding down the extraordinary measures it took during the recession of buying up vast quantities of Treasury and home-mortgage bonds."

Umm, no, this is just about 100 percent wrong. The Fed is not targeting the stock market, it's not even particularly targeting the bond market, although lower interest rates (interest rates and bond prices are inversely related) do help the economy. And the fact that employment and business lending are above pre-recession levels has almost nothing to do with the time of day.

The recession began almost 7 years ago. Economies typically grow. This means that we would expect that in 2014 we would expect that employment and lending would be much higher than they were in the fall of 2007. The Fed is not looking to get back to pre-recession levels, it is looking to get back to the economy's potential level of output.

And, we have large amounts of data showing that we are still very far from the potential level of output. The share of the prime age population (ages 25-54) that is employed is still down by more than 3.0 percentage points from pre-recession level. The share of the workforce that would like full-time jobs but can only get part-time employment is more than 40 percent above pre-recession levels. And the weakness of the labor market is still preventing most workers from seeing real wage growth which would allow them to share in the benefits of economic growth. Also, there is zero evidence of any inflationary pressure in the economy.

For these reasons, which Yellen and other people at the Fed talk about all the time, the Fed is keeping its foot on the accelerator rather the brake. This has nothing to do with Pearlstein's fantasies about a "Yellen put" supporting the stock market.


Low Down Payment Mortgages Have Much Higher Default Rates Print
Saturday, 18 October 2014 08:14

That is a fact that would have been worth mentioning in a Washington Post article on plans by Fannie Mae and Freddie Mac to lower the down payment requirements on the mortgages they purchase. The delinquency rate, which closely follows the default rate, is several times higher for people who put 5 percent or less down on a house than for people who put 20 percent or more down.

Contrary to what some folks seem to believe, getting moderate income people into a home that they subsequently lose to foreclosure or a distressed sale is not an effective way for them to build wealth, even if it does help build the wealth of the banks.

What Percent of Retail Workers are Full-Time? Print
Saturday, 18 October 2014 07:48

News reporting should not be a he said, she said affair when it comes to factual matters. In principle, reporters have the time to determine the truth, readers do not.

For this reason, it was disappointing to read in an otherwise good NYT article on the push for higher wages at Walmart:

"Retail workers ages 25 to 54 who work full time for at least three consecutive months make an average of $38,376 a year, slightly more than full-time workers in nonretail jobs, the group [the National Retail Federation] said."

This was the effort by the retailers to claim that they actually pay good wages. The problem with letting this claim appear with no context is that readers have no idea what percent of the industry's workers are classified as "full-time" and work for more than three months at the same store. The classification of full-time is central here.

The report does shed some additional light on this issue. It tells readers that 23.3 percent of the workers in the industry are between the ages of 16-24. It estimates that 30.5 percent are part-time and 32.2 percent are classified as unstable, meaning that they aren't employed for three consecutive months. While there is substantial overlap in these three categories, it is also important to realize that employees over age 55 are not included in the industry group's $38,376 average annual wage either. In other words, this average is among workers who comprise a minority, and likely a relatively small minority, of industry employees. It would have been helpful if the NYT article had pointed this fact out to readers.

Arthur Brooks Argues We Should be Soft on Rich Criminals in Sharing Economy Print
Saturday, 18 October 2014 06:57

We all know how hard is to get rich these days, so it's understandable that Arthur Brooks wants to give the young men and women making fortunes in the "sharing economy" a hand. (He even dubs it the "helping industry," which apparently is to distinguish it from sectors like health care and education.) Anyhow, the gist of his piece is that companies like Airbnb are actually about helping people -- allowing people with unused rooms to make a bit of extra money, while people from out of town get to find a room at a lower cost than a traditional hotel. He is upset that governments around the country are trying to apply the same regulations to his friends in the helping industry as they do their competition in the hotel industry, taxi industry, or other sectors where the helpers compete.

First, we all understand that the Airbnb billionaires just want to help people (Brooks assures us that getting rich was beside the point), but sometimes the government does get in the way. Let's take a simple example that even conservative types might understand. The Hepatitis C drug Sovaldi is being sold in the United States for $84,000 for a 3-month course of treatment. This high price is due to a government granted patent monopoly. Indian producers can profitably sell generic Sovaldi for $1,000 a treatment.

Suppose I set up a helping industry company that bought up generic Sovaldi in large quantities in India and sold it to patients in the United States for $10,000 a treatment. Brooks would undoubtedly defend Baker's Cheap Drugs Inc., since we are just allowing people to get needed health care at an affordable price. And, we are creating jobs in India for people working in the drug industry. Why would big bad government interfere?

Okay, we all know the story about needing patents to provide an incentive for research (which happens not to be true). But the key point is that there are all sorts of situations in which the government doesn't just let "helpers" go about their business because third parties get hurt in important ways.



The Deflationary Trap: Europe Has Already Fallen Print
Friday, 17 October 2014 06:55

The NYT had an interesting piece about growing opposition to Germany's creationist economics. The piece reports that France and Italy are leading the opposition to German's insistence that austerity is the key to economic growth, in the face of massive amounts of evidence showing that the euro zone needs stimulus to boost growth. 

At one point the piece points to worries over "the prospect of falling into a deflationary trap." It is difficult to see what anyone would be worried about. The euro zone already has an inflation rate that is far too low. The latest data show inflation to be 0.4 percent over the last year, well below its 2.0 percent target, which is itself almost certainly too low to allow for effective monetary policy given the severity of the downturn.

Lower inflation will make matters worse, but nothing happens when the number turns negative. In other words, whatever concerns people have about a future of negative inflation they should already have now about a current inflation rate that is far too low.


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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.