Topic: Finance, Banking & Monetary Policy

David Brooks — An Update

After carefully transcribing and then posting the nearly indecipherable argument forwarded yesterday on NPR’s All Things Considered by David Brooks, I thought, well, even the smartest people in the world can make a verbal hash of things when put on the spot with a live radio or television interview.  I had a nagging feeling that there must have been a well-thought-ought perspective knocking around in those words somewhere.  Was I being unfair to the man?  

And this morning — what do you know! — I open up Friday’s New York Times (I didn’t get to it yesterday) and see an op-ed length treatment of the very argument Brooks tried to make on NPR.  Alas, even when Brooks had a couple of days to think about each and every word, he still managed to be only a smidge less opaque than on NPR.

David Brooks: Thumbs Up for the Housing Bailout

On Friday’s All Things ConsideredNew York Times columnist David Brooks was dismissive of Rick Santelli’s now-celebrated rant against President Obama’s housing bailout.  Brookes conceded that there was a “fundamental unjustice [sic]” associated with the bailout, but…

We’re not just individuals; we have a system, a system we all share.  And the system right now is so unsteady that we have no individual responsibility in our own system because the economy is so unsteady.  If you deserve a job sometimes you get laid off, if you don’t deserve, sometimes you don’t get laid off.  And the government’s fundamental responsibility right now is to make sure the system is stable. And that may reward people who took unnecessary risks but we just have to live with that. The primary responsibility here is not to worry about the moral hazard; it’s to keep the stability of the system as a whole intact.  And I think that the housing plan is a pretty moderate and respectable way to go about that.

If you can figure out what the heck Brooks is saying here, my hat’s off to you.  As best as I can tell, Brooks is arguing that the economy is in free fall and the only way to arrest the collapse is to stop the foreclosures.  If that means bailing out the irresponsible, then bail them out we must.  At least, I think that’s what he’s saying.

But do foreclosures equal macroeconomic collapse?  It’s not obvious that they do.  Foreclosures should only bother the unforeclosed if they reduce the value of their homes.  Do they?  Empirical investigation suggests that the impact of foreclosures on unforeclosed housing values is quite small.  It’s vacant homes that (sometimes) drive down the value of neighboring inhabited homes.  But if foreclosures are quickly followed by sales to new owners, that problem does not arise.  And even if it takes a while for the empty houses to sell, the impact on neighborhood housing value is temporary.  That is, as long as you’re not trying to sell when all the for-sale signs are littering the neighborhood, you’ll be OK.  Hence, the problem here is excess housing stock — empty houses that can’t find buyers — not foreclosures per se.

Will Obama’s plan reduce the excess housing stock?  It’s hard to see how.  Foreclosures have been most heavily concentrated in places where housing supply is elastic and prices remain well above construction costs.  As long as that is the case, new construction will go on — and has gone on — even in the teeth of the ongoing house price collapse.

But maybe Brooks isn’t really worried about foreclosures.  Maybe he’s worried about the decline in housing prices and the related collapse of securities built on existing mortgages.  Maybe he’s arguing that propping-up — or at the very least, stabilizing — housing prices is the only way to rescue the trillions of dollars worth of assets tied to the housing market and, thus, to rescue the economy as a whole.  If so, then good luck. Harvard economist Edward Glaeser makes a very strong argument that nothing the feds can do will keep housing prices at the inflated levels reached over the last decade.  And even were such a thing possible, Glaeser argues it would be economically counterproductive:  

Artificially boosting prices will distort construction decisions and redistribute wealth from buyers to sellers. Moreover, most schemes seem unlikely to significantly raise prices, especially in the elastic areas that have seen the largest reductions in prices. Against these uncertain benefits, the costs of many of the schemes seem quite large.  Using hundreds of billions of dollars to buy or refinance mortgages represents a large transfer from taxpayers to current homeowners… Moreover, a large-scale intervention that makes the government a vast lender is likely to create permanent institutions that impose large future costs on taxpayers. Recent events at Fannie Mae and Freddie Mac certainly suggest the difficulties that result when government-sponsored enterprises play mortgage lender to the nation. 

Nor is Glaeser sympathetic with the political rush to save those threatened with foreclosure:

As foreclosure becomes more difficult, the value of mortgages declines, which reduces the value of banks assets. Direct aid to distressed homeowners may be less problematic, but it isn’t clear that the government can or should be trying to keep people in homes they can’t afford at any reasonable interest rate.  In most cases, a small amount of aid to help in moving would be a more sensible, and cost effective, response to foreclosures.  We do need action to fix our banking system, but those actions should be targeted towards the banking system itself, not towards the housing market.

While public intellectuals like Brooks are — for the moment anyway — inclined to lecture the Rick Santellis of this world about the necessity of housing bailouts for the greater good, there is far less substance to that lecture than one might think.

Inflation and the Fed

In a National Review post on the recent Producer Price Index numbers, I argued that inflation worries are overwrought — for now. If inflation does become a problem, though, the Fed could have trouble controlling it. Here’s why.

According to a recent AP story, “Federal Reserve Chairman Ben Bernanke told an audience at the National Press Club on Wednesday that … once the economy begins to rebound and financial markets stabilize, the Fed will be able to quickly reverse the actions it has taken before inflation becomes a problem.”

That’s the trillion dollar question.

Federal Reserve bank credit rose from $890.4 billion on September 10 to $1.83 trillion by February 11, mainly because the Fed purchased a lot of semi-toxic securities (e.g., from Bear Stearns) and made huge loans against other dodgy assets. That allowed a similar doubling of the monetary base (bank reserves and currency). Even before that happened, the Fed was selling off Treasuries to make room for lesser investments. The Fed’s holding of government securities has fallen from $790.5 billion in September 2007 to $470.7 billion on February 11 (not counting some second-rate IOUs from Fannie Mae and Freddie Mac).

To assume, as Bernanke does, that inflation cannot possibly accelerate until “the economy begins to rebound and financial markets stabilize” is to assume stagflation is impossible, though 1973-75 and 1979-82 proved otherwise. If inflation catches the Fed by surprise, are they really “able to quickly reverse the actions,” as Bernanke says? How could they do that?

The Fed could certainly raise the interest rates on bank reserves — the fed funds and discount rate — which is how it makes money and credit tighter in normal times. But that rationing device would not prove so effective in times like these, because banks are already sitting on a mountain of untapped reserves. Besides, once expected inflation has begun to rise, the Fed has usually moved rates up in tiny 25-basis point steps — increases so small that perceived real interest rates can continue to fall even as nominal rates rise.

To literally reverse the actions that doubled its assets since last September, the Fed would have to sell nearly a trillion dollars worth of IOUs. Unfortunately, they don’t have nearly that many Treasury securities to sell. And even if the Fed were willing sell off all of its Treasury bills and bonds, the remaining backing for Federal Reserve notes would be little better than junk bonds. Meanwhile, private and agency securities acquired since last September must be very hard to sell — or else the Fed would not have felt obliged to buy them.

The Fed’s System Open Market Account at the Federal Reserve Bank of New York holds $39.4 billion in inflation-protected Treasury bonds — more than twice its $18.4 billion stash of short-term Treasury bills. Are they trying to tell us something?

Masters of the Universe - On the Dole

In one of the most “you’ve got to be kidding me!” stories that I’ve come across in a while, The New York Times reports that New York City wants to spend $45 million to retrain laid-off Wall Street financiers.  This is so incredibly offensive that I don’t know where to begin.  But I’ll give it a try nonetheless. 

First, just because they are laid-off does not mean that they are poor.  Won’t a lot of this taxmoney be going to, well, rich people who don’t really need it?  Second, even if they now find themselves with nothing, why should the taxpayers come to the rescue?  If they didn’t manage to sock away anything for a rainy day, then tough.  Third, exactly what is New York going to retrain these masters of the universe to do?  This ought to be well worth watching.  Fourth, if they’re smart enough and savvy enough to be the master of the universe, they are smart enough and savvy enough to get back on their own two feet without the hard earned cash pinched from some cabbie somewhere. 

It’s as if The New York Times has become The Onion.

The Biggest Check Ever Signed

The Obama Administration has banked a lot of political capital on the economic “stimulus” package signed into law today, and is hailing the measure as a sound-minded reaction to a dreary economic climate.  In truth, many of the programs in the bill are not only wasteful and inefficient, but have the potential to do some real long-term harm to U.S. policy.

Among them:

The economic stimulus bill is merely a nearsighted return to government spending policies which have been discredited over and over again [PDF].

For more on the package, check out Cato’s Fiscal Reality page.

The Blogosphere Has Corrected the Record

Will Paul Krugman?

At a Heritage event, Arnold Kling said:

Back in September when they were talking about taking $700 billion dollars to unclog the financial system I wanted to yank Henry Paulson out of the TV screen and say to him: “Keep your hands off my daughter’s future.” But he got away with it. For me it felt like sitting there watching my home being ransacked by a gang of thugs. And now we’ve got a new gang of thugs and they are doing the same thing.

Careless blogging and hyper-ideology twisted that into a knock on President Obama and imputed racism to Kling. Krugman incorporated it all into a column decrying the “ugliness of the political debate” over Obama’s stimulus.

Well, Paulson’s TARP and Obama’s stimulus are ugly, and so evidently is the cacophony in the echo chamber where Krugman gets his information. But not Kling.

The Last Word on Fiscal Stimulus?

From “the best-selling Principles of Economics textbook [which] has been teaching students in a clear, unbiased way for 40 years.” Campbell R. McConnell, Economics: Principles, Problems, and Policies.  McGraw-Hill, 7th edition, 1978.

The Last Word: The Impotence of Fiscal Policy
Some economists feel that fiscal policy is an impotent and unpredictable stabilization tool.

Well, as I wrote in a 1977 Tax Review article (reprinted 1w permission of the Tax Foundation, Inc.):

The real question is whether or not conventional fiscal policy works as advertised. If fiscal policy works, and its impact is properly measured by the size of the full employment deficit, then it should be possible to find some correlation between either the level or direction of the full employment budget and some measure of current or subsequent economic activity. George Terborgh tried to find some such link back in 1968, in The New Economics, but found only a weak correlation that turned out to be perverse. That is, larger full employment surpluses were associated with faster economic growth. More rigorous tests by economists at the St. Louis Fed, and again at Citibank, had no more luck in uncovering the magical properties of the full employment budget. A sharp shift toward larger full employment deficits did not prevent the recession of’ 1953-54, for example, nor the mini-recession of 1967. In 1946, a $60 billion reduction of Federal spending (equivalent to $400 billion today) was followed by a vigorous boom, and a combination of tax cuts and higher spending in 1948 (the equivalent of S75 billion today) was followed by a sharp recession.

The theory of fiscal policy is almost as messy as the evidence. If deficit spending is financed by borrowing from the private sector, there is no obvious stimulus-even to that undifferentiated thing called “demand.” Whoever buys the government securities surrenders exactly as much purchasing power as is received by the beneficiaries of Federal largess. There would be a net fiscal stimulus only if there were no private demand for the funds needed to cover the added Treasury borrowing. Otherwise, lendable funds are just diverted from market-determined uses to politically determined uses.

There may be a stimulus in some circumstances if the deficit is financed by a more rapid increase in the money supply, but this is really a monetary stimulus, not a purely fiscal effect.

In the long run, resources allocated through the government must displace those allocated through markets, and growth of government spending must be at the expense of the private sector. The government has only three sources of revenue – taxes, borrowing, and printing money – and increasing any one of those must reduce the private sector’s command over real resources. Although deficit spending may at times be a short-run stimulus to nominal demand, it is also a long-run drag on real supply-siphoning resources from uses that would otherwise augment the economy’s productive capacity, and instead diverting those resources into hand-to-mouth consumption through government salaries, subsidies, and transfer payments.

So, the theory and evidence suggests that fiscal policy is essentially impotent, or at least unpredictable, except as a device to promote inflationary monetary policy and/or to reduce investment and growth.