Topic: Finance, Banking & Monetary Policy

A Fannie Mae for Intrastructure?

Like President Bush before him, Obama has a knack for taking the worst ideas of his opponents and making them his own.  It is truly bipartisanship in the worst of ways (think Sarbanes-Oxley, the TARP or No Child Left Behind).  The newest example is the President’s proposed “infrastructure bank.”  A bill along those lines was introduced a few years ago by then Senator Hagel, although the idea is far from new.

First, let’s get out of the way the myth that we have been “under-funding” intrastructure.  Take the largest, and usually most popular, piece:  transportation.  Over the last decade, transportation spending at all levels of government has increased over 70 percent.  One can debate if that money has been spent wisely, but there’s no doubt we’ve been spending an ever-increasing amount on infrastructure - so there goes one rationale for an infrastructure bank.

The real rationale for an infrastructure bank is to transfer the risk of default away from investors, bankers and local/state governments onto the federal taxpayer, but to do so in such a manner that the taxpayer has no idea what they are on the hook for.

If there are truly great projects out there that will pay their own way, then they should have no trouble getting private funding.

Of course, we will be told that the bank will charge an interest rate sufficient to cover losses and that the taxpayer won’t be on the hook.  Again, if it is charging an appropriate rate, then why does the bank need to be chartered (and backed) by the taxpayer?  We’ve heard this story before…with Social Security, flood insurance, FHA, Fannie/Freddie…the list goes on, that all of these programs would pay their own way and never cost the taxpayer a dime.  If there are truly outstanding infrastructure needs, then appropriate the money and pay for them.  An infrastructure bank is just another way to allow Wall Street to line its pockets while leaving the risk with the taxpayer.  If bankers aren’t willing to actually take the risks, then why exactly do we need them?

Economic Problems Won’t Be Solved by Education Stimulus, Either

Mark Calabria does a fine job dismantling Laura Tyson’s argument that we need another stimulus to spur private demand and revive the comatose economy. I would just caution against the one thing he could be construed as implicitly supporting: more federal funding for education.

I don’t dispute that there are mismatches between employers’ needs and potential employees’ skills, but the solution to the problem is not still more money going to education. As I and others have argued – especially the Pope Center’s George Leef, in a deft takedown of a recent workforce study – lobbing sacks of taxpayer dough at education will mainly enrich schools and their employees while making our resource-blowing education system even less efficient. Indeed, we already have far more bachelor’s degree holders than we have jobs for them, and the Labor Department projects that the greatest number of new jobs in the next decade will require only on-the-job training (see Table 2). And skills retraining? There are big problems there, too, with people often training for jobs that for numerous reasons they cannot get.

Putting more taxpayer money into “education” is one of those sweet sounding ideas that few people can ever resist, but which produces continually rotten outcomes. So even when it comes to education – shrill objections about “de-skilling” and being “anti-education” notwithstanding – the best thing to do for the economy is to let money stay with taxpayers and allow them to consume education as they would anything else: according to their individual priorities and abilities, which they know better than anyone else.

Tyson’s Keynesian Confusion

UC-Berkeley Professor, and former Clinton economic advisor, Laura Tyson lays out why she believes we need a second stimulus.   Her op-ed is a worthwhile read for understanding the basic assumptions behind modern Keynesian thinking.

Foremost among those assumptions is a belief we are in a recession due to “a collapse in private demand.”    In Professor Tyson’s world, if only everyone would buy more, everything would be OK (starts to sound a lot like President Bush in 2002).  But what exactly has been going on with private demand?  Judged by private personal consumption expenditures, it is actually up and higher than at any point during the boom, after reaching bottom in the Spring of 2009.

The following chart, from the St. Louis Federal Reserve, nicely illustrates the direction in private demand.

So if Tyson’s narrative that weak demand is holding back employment is false, or at least incomplete, then what is holding back unemployment?  In a word:  Investment.

Unlike consumption, which has largely rebounded, investment today is about 20% below its peak.  Of course we should keep in mind, that peak was a bubble.  The good news is that investment in such things a equipment and software, are slowly, but steadily, climbing back.  The real drag on investments is from the construction industry, particularly residential, which is still down about 50% from its peak. 

What most of this suggests to me is that unemployment is being driven mainly by a mismatch between skills of the unemployed and available job openings.  You simply cannot, overnight, turn a construction worker into a nurse or computer programmer.  Tyson seems to half-way recognize this when she argues for stimulus to be directed into education, although she only seems to be talking about future skills mismatch and ignores the mismatch facing the economy today.  For if increased aggregate demand is all we need today to reduce unemployment, then wouldn’t the same hold true for future unemployment, removing the need for educational funding?

At the end of the day, what we need to get employment increasing is to create an environment where business feel confident to invest.

Bernanke on Monetary Policy

Every August, the Federal Reserve Bank of Kansas City sponsors a conference on monetary policy. It is the most valued invitation of the year for central bankers and Fed watchers. The Fed Chairman typically presents his views on monetary policy and the economy, and his talk inevitably makes headlines. (A select few reporters are invited.)

This year, Ben Bernanke promised the Fed will do whatever it takes to aid the faltering U.S. recovery, and most of all to prevent deflation. The problem for the Fed Chairman is that the central bank is plainly running out of options, as some had the cheek to observe. He suggested the Fed could do more of the same (purchase long-term securities), or try something new and untested (tweak the interest rate it pays on bank reserves).

Bernanke also suggested a third option, plus offered some professorial speculation on another. Taken together, these suggest the Fed may be prepared to chart a dangerous course.

In its policy statement, the Federal Open Market Committee has promised to keep interest rates low “for an extended period.” Bernanke suggested (as the third option) that the FOMC might make it clear that rates will remain low for an even longer period than markets are currently expecting. Within the Committee, there have been calls for caution and to remove the “extended period” language from the statement. These have been led by Thomas Hoenig, president of the KC Fed and host of the conference. By suggesting the only option was lengthening the period of low interest rates, Bernanke delivered the back of his hand to his host and the other inflation hawks on the FOMC.

Bernanke then mused about suggestions by some economists that perhaps the Fed should set an inflation target – that is, promise to deliver higher inflation rates to stimulate the economy. Fed chairmen do not engage in abstract speculation about policy, and to raise the inflationary option gave it place above all other possibilities. Bernanke hastened to add that there was at present no support for such a policy within the FOMC, and it “is inappropriate for the United States in current circumstances.”

In other words, the Fed chairman is thinking about an inflationary policy and, if circumstances change and he can build support within the FOMC, he is willing to implement it. When central bankers speculate in public about the possibility of an inflationary monetary policy, the currency is in jeopardy and the country in peril.

What Everyone Missed in the Revised GDP Data

Quoting from the revised GDP report:  “Real gross domestic purchases – purchases by U.S. residents of goods and services wherever produced – increased 4.9 percent in the second quarter, compared with an increase of 3.9 percent in the first.”

Although 4.9 percent is clearly faster than 3.9 percent, every leading newspaper will surely report that the GDP report proves the economy is “losing momentum,” and (absurdly) that slower GDP growth in one quarter is evidence of a double-dip recession.

After accounting for slower growth of inventories, “final sales to domestic purchasers” increased 4.4 percent in the second quarter, compared with 1.3 percent in the first quarter.  Losing momentum? 

Real disposable personal income also increased 4.4 percent, compared with 1.7 percent in the first quarter. Losing momentum?

Business fixed investment increased 17.6 percent, compared with 7.8% in the first quarter.  Losing momentum?

Fiscal or (more likely) monetary “stimulus” only claims to speed up “domestic demand” (spending).  It turns out that much of that spending went to imports in the second quarter.  But that certainly does not mean, as the demand-side fetishists would have you believe, that households and firms were not spending.

Mortgage Finance around the World

As the debate on the future of Fannie Mae and Freddie Mac heats up, a useful exercise is to ask how does the U.S. system of mortgage finance compare to other countries, with the obvious caveat that there are a lot of differences to account for. 

A good place to start is a recent working paper by Michael Lea at San Diego State University.  The first observation from Dr. Lea’s paper is that several countries, with far less government involvement in the mortgage market, have comparable, if not higher, homeownership rates than the United States.  These countries include Australia, Ireland, Spain, the United Kingdom and Canada.  He also found that countries with less government support of their rental markets also have higher ownership — not surprising since higher rental subsidies would discourage ownership.

Other differences:  the United States and Denmark are the only developed countries where the predominate type of mortgage is a long-term, fixed rate.  Most countries have variable rate or fixed rate for shorter periods. For instance in Germany, many mortgages offer a fixed term for 10 years, then either adjust or roll-over. 

The United States is also almost alone in having no prepayment penalties and no recourse.  Where a mortgage is recourse, the lender is not limited to collecting just on the house but can go after a borrowers’ income or other assets.  So apparently, in the rest of the World, a borrower is expected to pay his mortgage regardless of the value of his house.

In most other countries, even those with comparable homeownership rates, most funding for mortgages is via bank deposits.  That is surprising given how often I’ve heard it claimed that you can’t rely on just deposits to fund the mortgage system. Somehow the rest of the world manages to do so.

That’s just a few of the interesting comparisons in Lea’s paper.  It is an easy read and has some great charts and tables.

Does High Unemployment Make Inflation Impossible?

Benn Steil and Paul Swartz wrote a technically brilliant yet readable Wall Street Journal tutorial explaining why “the Fed’s exit strategy is not credible, and that means a serious risk of high inflation down the road.” 

They are sure to be ignored by those of the Keynesian faith who have repeatedly assured us that inflation cannot possibly be a problem for many, many years.  Why not?  Because there is so much “slack” in the economy—a euphemism for high unemployment.
If this “slack theory” of inflation makes you too sanguine about future inflation, recall that it is the same theory that predicted stagflation would be impossible in 1973–75 and 1979–81.

Figures from The Economist, August 21, raise some doubts.  The latest unemployment rate in Argentina is 8.3%, but CPI inflation over the past year was 12.2%. Unemployment in Venezuela is 8.2%, but inflation is 13.3%. Unemployment in Egypt is 9.1%, but inflation is 10.7%.  Unemployment in India is 10.7%, but inflation is 13.7%.  Unemployment in Turkey is 11%, but inflation is 7.6%.   Wasn’t high unemployment supposed to make high inflation impossible

Perhaps Slack Theorists might take comfort from the fact that inflation is “only” 4.2% in South Africa, where unemployment is 25.3%.  But that is not exactly solid proof.

Whenever Keynesian dogma proves so completely at odds with the facts, there is a powerful inclination among true believers and their herd of media apostles to cling to the theory and diregard the facts. 

Some volatile economists who previously worried about near-term U.S. inflation have switched to assuming (as they did in 2003) that high unemployment will produce deflation.  Yet that is obviously not happening in the countries listed above.  The only country with falling prices is Japan, with an unemployment rate of 5.3% (and foolishly high tax rates and decades of wasteful ”fiscal stimulus”).

File the Steil-Swartz article away for future reference. 

And remember Reynolds’ Second Law: “Inflation is always lower before it moves higher.”