Topic: Finance, Banking & Monetary Policy

Volcker Rule Misses the Mark

Today Paul Volcker appears before the Senate Banking Committee to argue for the separation of proprietary trading and commercial banking.  In Mr. Volcker’s own works “what we plainly need are authority and methods to minimize the occurrence of those failures that threaten the basic fabric of financial markets.”

Using his own test, the Volcker Rule fails miserably.  Had this rule been in place say five or even ten years ago, we’d most likely be in the same place we are today.  It would have not avoided the crisis, and may potentially have made it worse.

First of all the proposal ignores the fact that those institutions at the heart of the crisis, Bear, Lehman, Fannie, Freddie, AIG, were not commercial banks.  They were not using federally insured deposits to gamble in our financial markets.  Those commercial banks with proprietary trading activities that did fail, such as Wachovia, were sunk not by proprietary trading, but by bad mortgage lending.

Mr. Volcker is correct in arguing for a change in assumptions that institutions and their creditors will not be bailed out.  He errs in believing that the House passed financial “reform” bill achieves that.  One has to wonder if he’s bother to even read the bill.  The House bill explicitly allows for rescuing creditors.  The House bill does not reduce the chance of bailouts, it increases them.

While the Obama Administration may have changed the face of its reforms, sadly the substance of its proposals continue to bear little relation to the actual causes of our financial crisis.  Nowhere in the President’s proposals do we see any efforts at avoiding future housing bubbles.  Perhaps this should come as no surprise given Washington’s continued attempts to re-inflate the last housing bubble.

Financial Fiasco: ‘Best Books of 2009’

Johan Norberg’s Financial Fiasco: How America’s Infatuation with Homeownership and Easy Money Created the Economic Crisis has been named one of the best books of 2009 by the Spectator, Britain’s most important political affairs magazine. Excerpt:

Ever since the crash, I have been waiting for Johan Norberg to write about it – and finally, this year, he has obliged. I have three copies of his first book, In Defence of Globalisation, with varying degrees of annotation. I have already started to deface Financial Fiasco, his book showing how governments created this mess. The American government pumped up the housing bubble – and then there was a collective delusion that the market was rational. As Norberg says, the market is no more than a collection of humans who fall prey to hubris. And their hubris was imagining that computer models had eliminated risk: that the boom would not be followed by a bust.

It previously got an excellent review in the Financial Times. It’s enough to make you think that the elite British press are smarter than the elite American press.

Do Democratic Presidents Create More Jobs? looked into a remark from Rep. Carolyn Maloney, D-N.Y., that “Democrats have been considerably more effective at creating private-sector jobs.”

The statement was rated true, as a purely statistical matter.  Yet the poltifact researcher did a good job questioning the significance of his own figures.  He noted, correctly, that the president usually “deserves less credit for the good times – and less blame for the bad times.”  And he added that job figures can be driven by outside factors such as oil price shocks, demographic changes or soldiers coming home after World War Two.  He wryly noted “how surprised we are that Eisenhower, who presided over the ‘happy’ 1950s, managed an anemic half-percent job growth per year, while Jimmy “Malaise” Carter finished second with 3.45 percent annual job growth.”   Anyone who remembers the runaway inflation of the Carter era will realize that annual rates of job growth are not enough to describe the overall economic situation.

The author also quoted me making the point that “timing can be hugely important.”   It is so important, in fact, that we may need to add another dimension to politifact’s true-false meter to deal with political comments that are simply meaningless.

For the record, what follows is the full text of my email on this topic:

The error involved with assigning rates of job growth to Presidential terms is that six recent Presidents took office within a few months of the start of a recession: Obama (recession began December 2007), H.W. Bush (July 1990), G.W. Bush (Mar 2001), Reagan (July 1981), Nixon (Dec. 1969) and Ike (July 1953).   As it happens, four of the five were Republicans.

One might argue that recessions launched near the end of the previous administration helped get these men elected. But these recessions were clearly left over from events that began previous years.  It didn’t help that the first Pres. Bush passed a tax increase three months after the 1990 recession began, but the start of that recession is more plausibly blamed on the earlier spike in oil prices when Iraq invaded Kuwait.

Since employment is a lagging indicator (one of the last things to improve), that means average job growth among Presidents who took office near the start of recessions is bound to look bad in comparison with Presidents who took office after an expansion was well underway.  Bill Clinton took office in 1993, long after recession ended in March 1991.   The same was true of Truman, LBJ and Carter.   JFK took office a month before the 1960 recession ended.

Two-term Presidents also have more time to show good numbers, but only if they’re lucky enough to get out of office just before the next recession starts.  Clinton squeaked by (despite falling stock prices and industrial production 2000), but Nixon, Eisenhower, Carter and G.W. Bush did not.

Since Bush 2nd began and ended office in recession, averages over 8 years outweigh 4 reasonably good years.  This unprecedented bad timing is exaggerated by Paul Krugman’s comparison of “decades” [and President Obama’s recent reference to “the lost decade” of 1999-2009] which relies on starting and ending each decade in boomy 1959 rather than slumping 1960, ditto 1969 rather than 1970, 1979 rather than 1980, 1989 rather than 1990, and 1999 rather than 2000.

In short, statistics about employment growth over Presidential terms are dominated by the timing of the “business cycle” (including Federal Reserve policy), and have no apparent connection to economic policies attributed to the White House (as opposed to Congress).

Can Unemployment Benefits Create Jobs?

At the Center on Budget and Policy Priorities, sociologist Michael Leachman claims “some of the most effective job-creation and job protection measures” in last year’s American Recovery and Reinvestment Act are excluded from the job figures to be released on on January 30.   He explains that, “Most of ARRA’s distributed dollars to date have gone directly to individuals (including greater jobless benefits and food stamps) and states (including greater federal support for Medicaid).  Although these dollars are likely protecting or creating hundreds of thousands of jobs, none of the aid for individuals or the Medicaid support are [sic] reflected in the January 30 jobs data release.”

In particular, Leachman claims Recovery Act funds to extend unemployment benefits from 26 to 79 weeks (and to 99 weeks since November) “produces and sustains jobs.”  For proof, he cites estimates from Mark Zandi of “that every dollar spent on extending unemployment insurance benefits produces $1.61 in economic activity.”

This analysis runs into two big problems.  The first is that it assumes that the amount of time people spend on unemployment insurance is unrelated to how long the government offers to keep paying benefits.  The second is that it assumes that the assumptions about “fiscal multipliers” built into econometric model are actually evidence rather than just assumptions.

On the first point, page 75 of the 2007 OECD Employment Outlook explains: “It is well established that generous unemployment benefits can increase the duration of unemployment spells and the overall level of unemployment… This could have a negative impact on productivity through inefficient use of resources and depreciation of human capital during long spells of unemployment. In addition, by reducing the opportunity cost of unemployment, generous unemployment benefits may lead existing employees to reduce their work effort, thereby lowering productivity (see e.g. Shapiro and Stiglitz, 1984; Albrecht and Vroman, 1996).”

As I recently noted, the overwhelming evidence that extended unemployment benefits raise the duration and rate of unemployment comes from economists in the Obama administration, Larry Summers and Treasury economist Alan Krueger, as well as many others such as Lawrence Katz of Harvard and Bruce Meyer of the University of Chicago.

Contrary to Leachman, bribing people to stay on the dole for an extra 53-73 weeks leaves them with less money to spend, not more.   It also looks bad on resumes, and may cause lasting damage to future job prospects.

Leachman’s second problem concerns fiscal multipliers, such as Zandi’s astonishing 1.6 multiplier for unemployment benefits.

In a similar effort to pretend that borrowed money is free, and therefore “creates jobs,” the Council of Economic Advisers claims to use “mainstream estimates of economic multipliers for the effects of fiscal stimulus.” Yet the cited sources are not from academic research at all, but from the mysterious innards of notoriously unreliable econometric forecasting models from, Global Insight, J.P. Morgan Chase and Goldman Sachs.

At the Federal Reserve Bank of San Francisco, by contrast, economist Sylvain Leduc surveyed contemporary research by ten distinguished scholars, including current CEA chair Christina Romer and IMF chief economist Olivier Blanchard.

“An interesting aspect of this new literature,” wrote Leduc, is that, notwithstanding their vastly different methodologies, they reach surprisingly similar conclusions. Regarding the impact of tax cuts on the level of real GDP one year after the change in taxes, the three studies predict a multiplier of roughly 1.2…  Moreover …  in contrast to theoretical predictions from the simple Keynesian framework, the analyses found that government spending had less bang for the buck than tax cuts. For instance, one year after the increase in spending, the impact on the level of real GDP is less than one-for-one, partly reflecting a decline in investment.”

In this new academic research, the estimated multiplier for deficit spending ranged from 0.4 to 0.6 — meaning a dollar of added federal debt added far less than a dollar to GDP.   Moreover, an IMF paper on “Fiscal Multipliers” adds that negative multipliers are quite possible: “fiscal expansions can be contractionary if they decrease consumers’ and investors’ confidence, especially if the fiscal expansion raises, or reinforces, fiscal sustainability concerns.”

Whether the government pays people to work or to stay on the dole, it has to get the money by taxing, borrowing or printing money — all of which reduce real income and employment opportunities in the private sector.  To imagine that borrowing from Peter to pay Paul is a way to create or save Paul’s job is to forget that Peter expects his money back with interest.

If every dollar of unemployment benefits really added $1.61 to real GDP, then putting everyone on the dole would make us all much richer

Are We Mad about SAFRA?

This morning I mused about whether yesterday’s Massachusetts miracle would curb the drive to have the feds take over K-12 education. In particular, I wondered if the president’s new proposal to extend the “Race to the Top” – and as part of that directly connect local districts to the feds –will meet an almost immediate demise as legislators dive frantically to avoid the backlash against ever-expanding federal power.

My hope is that it will, but I’m not especially sanguine. The prospects for stemming the centralization tide are probably better today than they were yesterday, but federal education initiatives tend to have a fair amount of bipartisan support, especially if they throw money at public schools – which liberals like – as well as things like charter schools, merit pay, and “standards” that conservatives support. Indeed, I wouldn’t be surprised if President Obama, facing hopeless prospects on health care, cap and trade, and other anger-igniters, were to propose reauthorizing the No Child Left Behind Act as one big Race to the Top. Incorporating both big bucks and things conservatives endorse, it would stand a pretty good chance of garnering some Republican support. And that would allow Obama to say he has learned his lesson about working with both parties while letting legislators head back home declaring that they’d done something “for the children.”

In sum, I’m not sure whether Scott Brown’s election is actually a good or bad thing at the K-12 level. I am much more optimistic about higher education, specifically the effect Brown’s victory will have on the odious Student Aid and Fiscal Responsbility Act, a piece of legislation that supporters say will save taxpayers money but that will almost certainly cost them dearly. The House passed SAFRA in September, but Senate action has been in a holding pattern while that body has been paralyzed by health care.

Why the optimism on SAFRA and not in K-12? Because Race to the Top is stealthy, involving relatively small amounts of money and ostensibly letting states and districts freely choose if they want to participate. Not so SAFRA, which if anything has been overly demonized as a federal takeover of the student-lending industry because it would cut “private” lenders out of massively subsidized federal-loan programs.

Of course, if the lenders are hugely subsidized they are hardly private, at least in any meaningful sense. Nonetheless, the loudest argument against SAFRA – which would consolidate some additional power at the federal level and spend like a drunken sailor – is that it’s a federal takeover. From a political standpoint that’s huge. With Brown having successfully run on a platform primarily opposing big and ever-growing government, many one-time congressional supporters of SAFRA will no doubt have to think long and hard if they really, really want to bear the label of “federalizer.”

My suspicion is that, given the new political environment, a great many will decide that they don’t.

FHA’s New Stringent Standards

The Federal Housing Administration will reportedly announce more stringent lending requirements and higher borrowing fees. The move comes in response to growing concerns that rising losses on mortgages it insures will require a taxpayer bailout. Although any credit tightening is welcome, the agency will not propose an increase in the minimum downpayment, currently 3.5 percent. (Borrowers with credit scores below 580 will be required to put down a minimum of 10 percent, but most FHA lenders already require a 620 minimum score.)

Yesterday, the Wall Street Journal noted that “home builders are worried” the FHA would propose raising the minimum downpayment. The CEO of a Texas builder said it would be a “game changer,” meaning that it would hinder the nascent housing recovery. However, other industry observers believe otherwise:

In markets where home values are still falling, buyers who put little money down could see their equity wiped out quickly. The FHA is “just manufacturing more upside-down homeowners by the truckload in Arizona, California, and Nevada,” says Brett Barry, a Phoenix real-estate agent who specializes in selling foreclosed homes.

FHA commissioner David Stevens counters that inhibiting lending by increasing downpayment requirements would “perpetuate” price declines. But falling prices are a painful, but necessary, correction needed to bring the housing market back into equilibrium. Government interventions in the wake of the housing bubble’s burst have created an artificial cushion. Thus, any alleged housing recovery could prove illusory when the cushion is removed. In addition, the longer the government tries to prop up the housing market, the greater the economic distortions and risk to taxpayers.

The article cites the example of a 42-year-old air-conditioning repairman who just bought a house with the FHA minimum 3.5 percent downpayment. To meet the requirement he had to borrow part of the money from his father-in-law, which he then repaid with the $8,000 first time homebuyer tax credit. He now has a $1,466 monthly mortgage payment on a $50,000 salary. Factoring in utilities and other homeownership costs, it’s not inconceivable that half of his pre-tax salary will be devoted to just his home. Is it any wonder the FHA is experiencing large default rates?

In Case This Needs Saying: It’s a Tax

Last week, President Obama unveiled a plan for something he called a ”Financial Crisis Responsibility Fee,” to be fleshed out in his forthcoming budget proposal. He will seek to have some set of financial services providers pay money to the government as comeuppance for the recent financial crisis and government involvement in trying to remedy it.

The naming of the “Financial Crisis Responsibility Fee” is a fairly conspicuous attempt to avoid calling it a tax. (My colleague David Boaz points out the sheer number of taxes the Obama administration and its allies are considering.) But it’s fairly clear that this thing is, indeed, a tax.

The galaxy of government revenues has a number of different planets—taxes, fees, penalties, and a few others. If they’re well constructed, fees are generally favored because the recipients of services or benefits pay their costs. Fees avoid redistribution of wealth (either toward or away from payers). But this doesn’t mean that you can name any payment to the government a ”fee” and produce fair and appropriate results.

When I worked on Capitol Hill, I was tasked with writing a bill to deny federal agencies the power to raise taxes, requiring them to be approved by Congress. (You’d think that only Congress should set or raise taxes, right? Sorry to disappoint.) The goal was not to draw fee-setting into the ambit of the bill.

After extensive reasearch into the dividing line between fees and taxes, which is not as simple as one might imagine, I produced the following definition, as found in the Taxpayer’s Defense Act (introduced in the House during the 105th Congress, and the House and Senate in the 106th Congress):

[T]he term “tax” means a non-penal, mandatory payment of money or its equivalent to the extent such payment does not compensate the Federal Government or other payee for a specific benefit conferred directly on the payer.

Parsing it briefly: A penalty is not a tax. A voluntary payment is not a tax. Both payments of money and tranfers of value not denominated in dollars can be taxes. A payment that compensates a benefit conferred is not a tax, but the part of a payment going above the benefit conferred is. Non-tax payments are for a specific benefit conferred directly on the payer, not benefits conferred on regulated entities generally or on the country as a whole. (Though this isn’t specified in the definition, being regulated isn’t a benefit.)

With even the New York Times referring to President Obama’s “Financial Crisis Responsibility Fee” as a “tax,” there doesn’t seem to be much chance of that the administration will get the “fee” label to stick. But, just in case, here’s confirmation: It’s a tax.