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Small is Beautiful? Maybe. But Big is Bad.

At least this headline holds true for banks. Steve Randy Waldman, as so often, gives us cogency--in this case on why big banks are a problem. My favorite part (and my emphasis):

Scale breeds agency problems. Earning an extra five basis points on $100B in assets amounts to $50M in extra income a year, a fraction of which can make a manager very wealthy in an eat-what-you-kill bank. Making that same five basis points on a $100M portfolio earns a small bank 50K, a fraction of which amounts to a nice bonus, but not a lifestyle change.

For both managers, the downside if something goes wrong is the same: they lose their jobs.

For the managers, big is good. For the rest of us, not so much.

Want Prosperity and Stability? It's About Wages and Salaries

What caused the Great Depression? What caused the current...whatever it is?

According to James Livingston, the roots of both lie in shares of income. When not enough people are getting not enough wages and salaries--and when a large share of income is derived from financial investments, not work--we're in bubble land, and things fall apart.

(My explanation: because income is not widely distributed, aggregate demand cannot support productive industry, hence there are not enough productive investments available, hence financial assets seek out imaginary returns. We know the result.)

Here's what that picture looks like (BEA; data here):

The story this mirror-image picture tells: In 1929, the percent of income received in wages and salaries was at a historic low (see below for 1920s data). There was a strong (and volatile) correction during the Depression and war/post-war years, followed by a long period of stable and historic highs during The Great Prosperity.

Those highs started declining in the seventies, continued down under the sway of Reaganomics, and fell even further under Bush II. By 2008, wage-and-salary share had reached profoundly historic lows.

Did we see the same type of decline pre-1929? Yes—even more so. The BEA time series doesn't extend before 1929, and I haven't found a comparable/contiguous series going father back. But we can get a picture of the 1920s from tax return data. (Large scanned PDFs here [Table 196 p. 203] and here [Table 173 p. 173]). Here's what that picture looks like:

By this measure, in just a few years the wages-and-salaries share of personal income plummeted from the 50/60% range to less than 40%. '25 to '29 represented a truly profound historic low. (Wage-and-salaries' share snapped back after the crash, of course, because financial profits constituted a proportionally much smaller share of income.)

What about this time? It took a long time for those decades of decline to achieve their ill effects. There are many plausible explanations for this. Here are a few.

• The Fed got a lot more competent at managing the economy's volatility.

• There was much wider participation in the housing/asset markets/bubbles--maintaining the illusion was a larger group effort.

• Consumer credit became ever-more widely available, temporarily counteracting the declining/stagnating income share.

• Increasing government redistribution (15% of total income in 2008, up from 3% in 1945 and 9% in 1970) buoyed aggregate demand by giving people money to spend even while wage-and-salary share declined.

But the fact remains: both crashes occurred at a time of historically low ebbs in wage/salaries' share of total income.

Caveat: It must be admitted that total employee compensation (including benefits and employers' social insurance expenditures) has not shown quite as clear a picture as have wages/salaries alone:

Total compensation in 2008 was nowhere near the lows of 1929 (when there was no Social Security and benefits were quite limited). But even with those huge benefit boosts, it had declined to a level not seen since the '40s—well below the level that prevailed during the Great Prosperity.

This is perfectly in keeping with both a common-sense and an empirical behavioral view of economic incentives. The actual dollars people receive in their paychecks (and/or their transfer payments) every week or two provide them with a far more moving (if short-term) gauge and incentive than the uncertain, rarely perused, and long-deferred benefits that are (only implicitly) promised in boxes 4 and 6 of their annual W-2s.

When people are taking home good money from their paychecks, they spend it on goods and services. That demand supports productive enterprises. That provides truly productive investment vehicles for financial assets. And so the log keeps rolling.

Businesses Constrained by Lack of Investment? Oh, Maybe Not.

A while back I pointed out that in 2007, only 9 percent of U.S. privately-held businesses cited a shortage of investment money as a constraint on their growth. In response to a rather maniacal comment on that post, I went looking to see what things are like today.

Answer: about the same. The National Federation of Independent Businesses gives us this up-to-the-minute snapshot. (Update: yes that is a mislabeling--should be February 2009. It's from the March 2009 report and the other tables in that report are properly labeled.)

Just as in the 2007 survey (from another outfit) cited in the previous post, financing and interest rates come in dead last (selected by only 3% of businesses) among small businesspeople's concerns. Their problems, which should be obvious to anyone with eyes and a mind, are on the demand side.

Drill Here Drill Now! Oh....Wait...

It's now clear that the McCain/Palin shout-outs for more domestic drilling were not, in fact, tawdry and childish pitches to get votes from jingoistic know-nothings. They were, in fact, calls for an energy policy that would lead this country into a future of responsibility, prosperity, and well-being.

The free market is speaking...

Seattle's a Happy Place! Outstate Washington, Appalachia: Not So Much

Showing that great minds think alike, my friend Steve also noticed the new national survey of well-being from Gallup. Though he only seems to have read an article about it, and based on that he wonders:

» Would Washington be the “Happiest” State if Seattle Was Elsewhere?.

Research from Gallup puts Washington State near the top of states rated for happiness.

At the same time, Seattle is ranked by Business Week as one of America’s most “miserable” cities. ... one can’t help but wonder how the state would rank if Seattle was not a factor.

Maybe if the residents chose to fund schools and cops instead of monorails, trains, and nutty eco-nanny programs to eliminate plastic bags, the people would be happier.

He could have found his answer quite easily by actually visiting the survey site (a pretty remarkable survey indeed: talking to a thousand people a day, every day, asking people about their well-being).

 

Looks like they're pretty miserable in Portland, too. Must be the mass transit, bike lanes, zoning policies, crap like that.

Especially interesting: it's people in their prime family-raising years who are made especially miserable by all those pinko policies:

Meanwhile the national map...

...can't but remind you of another that we've seen recently:

(No, the well-being survey was not done after the election--mostly before.  It started in January 2008 and the data currently presented is aggregated through December. The survey's slated to continue for 25 years. Methodology here.)

I'm sure that profound well-being in Appalachia is a result of their excellent mass-transit systems, top-notch education, and progressive environmental policies.

Steve's right: the correlations here are obvious.

Banks? Who Needs 'Em?

James Livingston once again sheds serious light on our current situation, as illuminated by the Great Depression.

Condensed:

• Economic recovery was actually going gangbusters '33-'37.
• It wasn't because banks started lending; they didn't.
• The government (Reconstruction Finance Corporation) was doing the lending.
• We should try doing the same thing now.

More detail on those four statements below. Here's the heart of his argument:

...reports of the Comptroller of the Currency tells us that the banks sat out the recovery.  The summary Table 47, "Total Assets and Liabilities of National Banks, June 1933-June 1937," Report of the Comptroller of the Currency 1937 (Washington: GPO, 1938), pp. 488-94, shows that during the recovery, [banks'] total deposits increased 52 percent, holdings of government securities increased 57 percent, and (idle) reserves held with Federal Reserve banks increased 140 percent.  Meanwhile loans and discounts--that is, the extension of credit to businesses and/or consumers--increased only 8 percent.   

So there was an economic recovery from the depths of the Great Depression with no financial fix, or rather with almost no participation by the banks, except of course that.they bought the government securities that financed net contributions to consumer expenditures out of federal deficits.  And no nationalization, either.  How is that possible?

In short: the Reconstruction Finance Corporation replaced the banking system as the lender of first resort to businesses large (the railroads) and small (most of its loans were under $100,000).  The volume of its loans and discounts during the four years of recovery was roughly five times that of the national banks.   

The way to deal with the current crisis short of nationalization may, then, be to bypass the moribund banking system with a new RFC capitalized with the remainder of the TARP and other funds authorized by Congress.

Back to those four statements:

Economic recovery was actually going gangbusters '33-'37.
The reversal and repudiation of Hooverite creative-destructionism under Roosevelt really, really worked, as evidenced by many economic indicators. The big impact was from monetary loosening after three years of churlish stupidity at the Fed and Treasury '29-'32. But the fiscal stimulus policies (though actually rather tepid in those years) also contributed, at least by making the monetary moves more effective.

Tyler Cowen has been making this argument with some cogency for some time (with some serious pushback from moi in email back-and-forths, which he has been kind enough to engage in). I'm somewhat grudgingly coming around to his view, especially since Christina Romer made the same point very strongly just the other day at Brookings (PDF), concluding:

Had the U.S. not had the terrible policy-induced setback in 1937 [both monetary and fiscal], we, like most other countries in the world, would probably have been fully recovered before the outbreak of World War II.

She's referring to both fiscal and monetary tightening in 1937--fiscal tightening (cutting spending and increasing taxes) driven by deficit fears, and monetary tightening driven by misplaced technical anxieties at the treasury and the fed.

Even the weakest indicator in this period--unemployment--had plummeted from 25% to 15% '33-'37. It surged back in '38, but then continued its downward trend into the war years.

 

Another crucial issue which has not been widely discussed: Alexander Field demonstrated in his 2003 paper, "The Most Technologically Progressive Decade of the Century" (PDF), that the 1930s saw growth in "multifactor productivity" (largely technology-driven) surpassing anything before or since. This goes a long way to explaining why employment and employees were slow to feel the benefits of the recovery. Productivity was skyrocketing, so less workers were needed for each unit of output.

It wasn't because banks started lending; they didn't.

Livingston lays out the numbers in the passage above, but even his numbers give the banks more credit than they deserve. Here are the numbers from All-Bank Statistics: United States 1896-1955, available as honking-huge scanned PDFs from the St. Louis Fed.

Outstanding Loans for All U.S. Banks. In millions.
1929 $42,944
1930  40,990
1931  35,416
1932  28,071
1933  22,337
1934  21,309
1935  20,240
1936  20,640
1937  22,435
1938  21,033
1939  21,300
1940  22,311
1941  25,273
1942  25,043
1943  22,248
1944  25,435
1945  27,996
1946  31,506
1947  38,365

After diving off a cliff between '29 and '33, the size of banks' loan books basically didn't change at all in the years 1933-1940. (Thanks for the help, guys!)

The government (Reconstruction Finance Corporation) was doing the lending.

Compared to the banks' failure to lend (despite massive government prop-ups), RFC lent approximately $5.8 billion in the years 1932-1937. This makes it look like the government accounted for all the new net lending over those years.

We should try doing the same thing now.

I don't know enough to say whether direct government lending would offset the counterparty disasters that would result from letting the banks fail. But from a moral (and moral hazard) perspective, it sure is tempting to throw all those government dollars at direct loans--and let the banks go hang.

Home-Work: 25% of GDP

I wrote recently about the fact that non-remunerated work--anything that doesn't involve a money transfer--isn't included in GDP. So painting your mother's house, fixing your car, or cooking dinner isn't reflected in that key measure of our prosperity and well-being--even though that work quite clearly contributes greatly to our prosperity and well-being.

Which got me wondering: how much of that type of work do we do? And what's it worth?

The American Time Use Survey (ATUS), conducted by the U.S. Bureau of Labor Statistics, measures the amount of time people spend doing various activities such as paid work, childcare, volunteering, commuting, and socializing. (PDF) I extracted activities that most of us would call "productive."

2007 average hours per person (over age 15) per day
Housework    0.64
Food preparation and cleanup    0.52
Lawn and garden care    0.21
Household management    0.14
Purchasing goods and services    0.78
Caring for and helping household members    0.53
Caring for and helping nonhousehold members    0.2
Volunteering (organizational and civic activities)    0.16

Total hours per day    3.18
Total hours per year    1160.7

There are approximately 200 million Americans over age 15, meaning that we put in something like 232 billion home-work hours per year.

Value at different wage rates
At $5 an hour    $1.2 trillion
At $10 an hour    $2.3 trillion
At $15 an hour    $3.5 trillion
At $20 an hour    $4.6 trillion

This last--$20 an hour--was the median hourly wage in America for 2007 (not including benefits). Half the people make more, half the people make less.

Okay, the official GDP for 2007 was $13.8 trillion. Add $4.6 trillion and you get a total GDP of $18.5 trillion.

Home-work makes up 25% of that total GDP.

Now you have to figure that Europeans--with their shorter work weeks and long vacations--have a lot more time for home-work than we do. That may go a long way to explaining why the quality of life feels so gosh-darned good over there, even while their official GDP per capita hovers at 75-80% of the U.S.

If you truly believe in family values, those are some numbers worth pondering.

An Open Letter to Robert Barro

Robert J. Barro is Paul M. Warburg Professor of Economics at Harvard University, a senior fellow of the Hoover Institution of Stanford University, and a research associate of the National Bureau of Economic Research. He is the third-ranked economist in the world, according to RePEc.

Dear Professor Barro:

I'm compelled to write after following your writings for many years, in response to your recent article (PDF) in the Wall Street Journal, your interview with Conor Clark on the Atlantic web site, and your published email interchange with Clive Crook on his Atlantic blog.

In 2000 you demonstrated that in OECD and Rich countries, government consumption levels have no significant correlation to long-term growth rates. (PDF)

In their 2003 meta-analysis (PDF), Nijkamp and Poot demonstrated (with multiple references to your works) that in aggregate, dozens of your colleagues who have actually studied this issue support those results--in spades.

In prosperous, developed countries, smaller government does not yield faster growth. As you and your colleagues have demonstrated, that belief is a myth. (The U.S. has been taxing about 28% of GDP for decades--local, state, and federal combined. Europe has been taxing 40%. But growth rates have been the same.)

But you have constantly promulgated that myth--and you continue to do so--in your scholarly and popular writings, and public pronouncements. This is especially concerning because your statements receive widespread attention and credence regarding taxation and spending policies in the U.S.--which is a decidedly rich country.

Facts on the ground:

In your 2000 paper you broke out growth rates for a panel of Rich countries, of OECD countries, and of Poor countries (PDF: table 1.1, page 35). Results:

Correlations: Government consumption versus growth in real GDP per capita
Rich-countries: -.014 (.042)
OECD-countries: .015 (.040)
Poor countries: -.167 (.030)
All countries: -.157 (.022)

For prosperous countries the results are one positive (more government consumption, faster growth), one negative, neither even vaguely significant.

Only the poor-country panel shows significance. So the negative correlation for the overall sample is completely dominated by the poor-country results. (Not surprisingly: The correlation for poor countries is relatively large, and poor countries in the sample--which are weighted equally with rich countries--greatly outnumber the rich countries.)

As far as I can determine, your 2000 findings regarding rich versus poor countries have been completely absent from your other (widely-cited) works in the field.* Your conclusions in those works have been based on your full sample of approximately 100 countries, which is dominated by poor countries.

You consistently state that greater government consumption reduces growth rates, with some iteration of the following graph.

Even in your 2000 paper, you make no mention of your own findings therein, but rather make the following blanket--and importantly misrepresentative--statement (page 12).

Table 1, column 1 indicates that the effect of the government consumption ratio, G/Y [consumption as a percent of GDP --Steve], on growth is significantly negative. The coefficient estimate implies that an increase in G/Y of 10 percentage points would reduce the growth rate on impact by 1.6% per year.

Is that  true for prosperous countries like the U.S.? And is it wise to make recommendations about U.S. policy based on findings dominated by countries like Thailand and Mozambique?

Can you explain why you have ignored your own findings--seemingly swept them under the rug--and consistently made statements contradicted both by those findings and by the aggregate findings of your colleagues who have--like you--actually studied this issue?

Thanks,

Steve

* I've gone back through much of your work, but the key works on this subject are Determinants of Economic Growth (1998), "Recent Developments in Endogenous Growth Theory" (chapter, 2000), Economic Growth in a Cross Section of Countries (2001), and Economic Growth (2003).

Republicans, In Lockstep, Oppose Largest Tax Cut in History

Yeah, that's the one: the one Obama just handed them.

The compromise stimulus plan includes $282 billion in tax cuts over two years.

According to the Wall Street Journal, Bush's first two years of tax cuts amounted to $174 billion. A second batch in 2004 and 2005 cost $231. And those were thought to be bigger than the tax cuts offered by Reagan, Kennedy or others.

Sure, go ahead and correct for inflation. But still.

Exports Ended the Great Depression: Yeah, Right

A commenter tagged arogersb replied to one of my comments on Bruce Bartlett's Forbes article (see my previous post), reiterating a familiar canard:

True, the US recovered after WWII. But the reason of that recovery was not debt, it's that the rest of the world factories were destroyed and had to import from the US.

I'll spare all of us a thousand-word response:

Reagan Supply Sider on The New Deal: "Deficits were too small, not too large."

Forget "centrism." How about "sensible-ism"?

Bruce Bartlett displays it in spades in his new Forbes article. Just as he did--to some extent--in his book Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy.

Bartlett also wrote Reaganomics: Supply-Side Economics in Action--which is decidedly admiring of that belief system--so you know where he's coming from.

His article limns an economic history of the Depression, the New Deal, WWII spending, and the ensuing Great Prosperity that's quite similar to mine. (i.e. "net fiscal stimulus '32-'39 was actually quite tepid.")

...John Maynard Keynes and other economists argued that in such circumstances, which economists call a liquidity trap, the federal government had to compensate for the falloff in private spending in the economy by increasing government spending. This was necessary to get the economy moving from a stationary position, at which point money would begin to circulate, Fed policy would again be effective, and prices would start to rise...

...there were those who nevertheless viewed any rise in prices as the first step on the road to German-style hyperinflation. Insanely, they argued that the government had no business compensating for any amount of deflation...

The critics were also totally opposed to deficit spending. As with Republicans today, they said that federal borrowing would simply draw funds out of productive uses in the private sector to be squandered on make-work government jobs, pork barrel projects of dubious value and welfare programs that would sap the dynamism of the American economy. Apparently, it didn't occur to these critics that the existence of vast unemployment, closed factories, abandoned farms and extremely low interest rates meant that much of the private sector's resources were simply idle. Borrowing them by running deficits didn't reduce private output because there were no alternative uses available.

Furthermore, an expansive fiscal policy was essential to recovery because without it monetary policy was impotent...

I've highlighted those passages because Bartlett highlights this point in responding to commenters on his article:

One of the points I have tried to emphasize, but I don't think is yet clear, is the essential connection between monetary and fiscal policy. I don't believe, as many Keynesians do, that fiscal policy is inherently stimulative. In this sense, Barro is right. But he forgets that there are times, like now, when we are in a liquidity trap, when fiscal stimulus is essential to make monetary policy effective. The monetary policy is what provides the real stimulus, but it needs fiscal policy to be operational.

Fiscal policy can make monetary policy work. This viewpoint isn't getting the discussion it deserves--at least not in those clear terms.

Even the most wild-eyed Keynesians will stipulate that monetary policy (Fed funds rate, money supply) has by far the greatest leverage--it sometimes seems magical. When Volcker eased in the early 80s, the economy started surging back within months. I heard Krugman make exactly that point in a lecture last week.

Supply-side monetarists, on the other hand (think: Tyler Cowen), make no concessions. They think fiscal stimulus--no matter how large--has no effect on anything except government debt. Bartlett is to be admired for bucking that blindered, faith-based intransigence.

Inflation in the early 80s was still high. That's why Volcker's move was so powerful, and its effects so immediate. Today, with Fed funds at zero and inflation threatening to go negative, monetary moves are like Superman on kryptonite.

Fiscal stimulus can give the Fed back its mojo. Unfortunately, fiscal policy doesn't have the leverage that monetary policy does. (Whatever reasonable multiplier you choose.) That--sad to say--is why you need lots of it.

(Paul) Romer: Start New Banks?

Paul Romer, husband and co-author to CEA head Christy Romer, has a suggestion that on the surface makes all kinds of sense.

Paul Romer Says Starting New Banks Would Keep TARP Money Away From Bad Banks - WSJ.com. Everyone agrees that the United States urgently needs a few good banks. Turning bad banks into good banks is a difficult and risky way to get them. It's simpler and safer to start entirely new banks. ... The government has $350 billion in Troubled Asset Relief Program (TARP) funds ... it could support $3.5 trillion in new lending with a modest 9-to-1 leverage.

Short story, government provides seed capital for new private banks that have clean balance sheets, and owns all the shares in those banks. Since they don't have toxic assets lurking, they don't need to hoard their cash, so they can provide the lending necessary for recovery, and give economic breathing room to let legacy banks take their hits.

Over time, private players buy the shares from the government, and the banks become completely private. It seems damned sensible.

The problems, pointed out by some of his commenters:

• You can't just flip a switch to create banks on the massive scale that Romer suggests. There are all those pesky details of thousands of employees, management and information systems, physical locations, etc.

• Cronyism, lobbying, and general corruption and malfeasance: who gets to start these new banks? Who decides?

Commenter BruceCopeland points to a much better option: government investment in solid banks with a proven track record of responsible management--mostly smaller, regional banks. The government could invest in these banks via new or existing share purchases, loans with options, or other well-established and transparent vehicles. Whatever the vehicle, it expands these banks' capital base so they can increase lending under traditional fractional-reserve policies.

As with Romer's proposal, those shares would eventually be sold to private investors, removing the government's ownership share in those banks.

Advantages:

• Less concentration and too-big-to-fail curses. Let a thousand flowers bloom.
• It’s far easier to evaluate an existing track record than to predict who will successfully launch and operate a new bank.
• The whole mechanism of investment is extant, transparent, and immediately available. (Though we should probably hire Warren Buffet to cut the deals for us.)
• Much faster effect. Existing banks can scale up internal operations, or farm out parts to the many existing shops, while retaining the crucial management control–deciding who to lend to at what rates–with more limited and judicious staff increases.
• The expanded lending from these juiced-up banks would provide the economic breathing room to let big legacy banks take their hits.
• It seems that selling government shares back to the public could/would happen more rapidly if those shares are in a company with a proven track record.

Others?

Tyler Cowen: $10 Trillion in Stimulus Would Have No Effect

I heard him on an NPR show last night, and was pulling my hair out with frustration.

I admit that was partly because of comments by Cato's Chris Edwards, who acts as if Keynesians don't believe in monetary policy, calling them "childish." When in fact it's fundamentalist monetarists (read: supply-siders) who refuse to believe in fiscal policy. At all.

But Tyler: He's still on with his claims that government deficit spending during WWII (to the tune of 70% of GDP) had nothing to do with ending the Great Depression. His main argument is that life didn't get any better during the war--people weren't buying anything. So obviously, all that deficit spending had no effect at all.

People during WWII weren't spending for obvious reasons, of course--mainly that there was nothing to buy. Everything was rationed, even clothing; huge swaths of industry stopped making consumer products for domestic consumption; 50% of output was going to the military, largely overseas. (And talk about Higgsian regime uncertainty!)

Today, spending 70% of GDP would mean $10 trillion in stimulus. Obviously that would have no effect either.

So where did all that money go in WWII? Tyler forgot to mention one little thing:

So...yeah. People didn't spend the stimulus money in the war years. But as soon as all those war distortions went away...they did.

Tyler studiously ignores the massive scale of fiscal stimulus during the war--as if it were immaterial, and the Great Prosperity would have happened without it. Will he also ignore the spectacular, unprecedented (choose your adjective) amount of personal savings, and their subsequent dissolution?

We Need to Spur Business Investment. Yeah, Right.

Comes before the court: Floyd Norris to point out that the heady dividends delivered by corporations 2004-2008 were in many cases not profits, but recycled loans.

They borrowed the money, then paid it out to shareholders. Every penny in profits ($2.4 trillion) went out in dividends ($.9 trillion) and stock buybacks ($1.7 trillion), plus another $.2 trillion--seven percent more than they earned.

What's not to like? Shareholders are happy (just borrow the money and buy 'em off!), stock prices rise, and the execs are in clover--they get those unearned dividends (funneled from oh-so-familiar "creative" loans) on their shares, plus whopping bonuses to reward artificially inflated stock prices, and their troves of dividend- and buyback-inflated shares are worth even more. (Until the loans come due. Dividends are now being slashed everywhere.)

It's like the Republicans borrowing money abroad for the last 28 years, to buy votes here. Great minds think alike.

If investment capital was so crucial to growth, would these companies have been divesting themselves of capital for all those years? If investment capital was so hard to come by, would they have found it so easy to borrow, only to give it away again?

As I pointed out in an earlier post, only 9% of U.S. privately held companies cite a shortage of long-term capital as a constraint on their growth. According to the people who run those companies, long-term capital is the last thing they need.

But here comes the likes of Hal Varian in (surprise) the WSJ (with an approving link from Greg Mankiw) singing that same old song. And the Obama people seem to be listening (or, "caving")--they're talking about giving $150 billion--a third of the tax cuts (14% of the stimulus plan)--to businesses. This is presumably to spur investment that creates jobs.

But businesses obviously don't need more investment capital. (There are oceans of it out there, frantic to find actual productive uses delivering real returns). That's a faith-based, supply-side delusion. What they need is demand--people, companies, and governments who have money and want to buy their products and services.

Absent that demand--or prospect of same--how much do you think businesses are going to invest in expansion?

It's time to put aside childish supply-side voodoo and deal with the facts on the ground.

The Massive Missing Link in GDP: Home-Work

I've spilled a lot of electronic ink over the last few years arguing about what causes GDP growth (especially in developed countries like the U.S.), tacitly accepting that GDP per capita was a reasonably good proxy for prosperity and well-being. And it is--reasonably. It has the advantage of being widely and fairly consistently measured throughout the world, and most measures of well-being do correlate quite strongly with GDP per capita: life expectancy, child mortality, "happiness," material well-being, access to education and health care, absolute poverty levels, etc. So it's not crazy to look at this measure, and try to figure out what government policies increase it.

But there's always been something nagging at me, telling me that GDP has something missing--something big.

That something is home-work. GDP doesn't count any work that that isn't somehow part of the "market."

Suppose you buy some pasta and tomato sauce and cheese, and make lasagna for your family and friends. That doesn't count as "production." If you'd bought the lasagna ready-made at the supermarket, that would count (because people were "employed" making that lasagna). But your work at home doesn't count.

Now multiply that by 100 million households, 365 days a year.

Or suppose you spend your vacation painting your house. Does it count? No. (Except for the paint and materials you buy.) But if you hire a contractor to do it for you, that counts.

There have been many attempts over recent decades to more accurately measure countries' "informal sectors" (partly correlated with the "shadow" and in part illegal economy)--individuals working for themselves and in small groups--attempting to include this notoriously difficult-to-measure but huge sector in GDP estimates. (The IMF estimates that the shadow economy accounts for 12-15% of GDP in OECD countries, and 35-44% in developing economies.)

But even those studies don't attempt to measure what is undoubtedly a massive amount of production that has nothing to do with markets.

There's a nice writeup of this conundrum on page 79 of Norman Frumkin's Tracking America's Economy.

Says Frumkin:

In the 1970s, the Bureau of Economic Analysis began to develop estimates of such items that economists could use to modify the traditional GDP measures, but the project was discontinued for lack of funding.

This all leads me to wonder: when Europe builds a system based on shorter work weeks and long vacations, how much more home-work gets done as a result? If that work were included in GDP estimates, what would it say about economic growth, prosperity, and well-being in those countries? (This not even counting the inherent "good" of leisure time.)

I'm here to say that there are few things that contribute more mightily to a society's happiness and well-being than people cooking meals with and for their friends and families. Home maintenance undoubtedly contributes massively to the general prosperity.

Reading to our children and taking care of our elderly? You decide.

Depression Lessons: How Much Fiscal Stimulus?

There's lots of talk these days on upcoming fiscal stimulus--how much it should be and how it should be delivered. The NYT Economix blog offers recommendations from several economists, assuming a $500-billion package. Here's one that Greg Mankiw likes.

When it comes to the size of the stimulus--and as Krugman argues quite cogently, in this case size is what matters--the Great Depression, and our recovery from same, gives some pretty solid clues.

So first, a brief history. How did we get into the Great Depression, and how did we get out of it?

1. Technology and corporate capitalism pre-'29 delivered a huge productivity/efficiency boom.


2. Absent sufficient redistribution, a smaller percentage of GDP went to wages, and more to profits--there was more money, but it wasn't widespread.


3. This resulted in insufficient consumer demand to support the upward spiral, and excessive speculative investment from all those profits because there weren't enough productive investments available (because there wasn't enough demand). The log stopped rolling and things fell apart.


4. The government/Fed response was initially almost nonexistent. They never even touched the most powerful lever--monetary easing--until '31/'32. (Gotta let that creative destruction happen...)


5. By that point deflation had set in, making monetary easing largely ineffective.


6. Despite widespread notions to the contrary, net fiscal stimulus '32-'39 was actually quite tepid. In '36 Roosevelt even raised taxes and cut spending out of budget concern, and the still-latent depression surged back.


7. Starting in '39, orders from Europe increased demand, offering some relief, but with little or no effect on U.S. domestic consumer demand.


8. During the war years U.S. government (deficit) spending surged spectacularly. The federal debt when from 50% to 120% of GDP. Consumer demand remained low, but for reasons unrelated to monetary or fiscal policy. (50% of output going to the military--and much going overseas--and rationing on everything, right down to clothing.)


9. Personal savings (especially E Bills) did climb rapidly, and production spiked as government spending (read: demand) put unproductive capacity (plants, financial capital, and people) to work.


10. When the war ended--with the wheels of the economy rolling full-speed and wartime distortions removed--people started spending their savings and their wages (think: demand), and we entered the great prosperity.


11. Over the next 35 years that prosperity allowed us to pay down the debt that pulled us out of the Depression, bringing it steadily down, to 35% of GDP by 1980. (Then came Reagan; we're now back to 70%.)

Short story, it was the massive fiscal stimulus of wartime deficit spending that finally broke the Depression's back.

Now we're in the same situation (with the same causes--but with a worse debt position). The Fed has pulled out every monetary stop, and it's still not enough. Fiscal spending it the only shot we have left in the locker.

If we take WWII deficit spending as a model, how much fiscal stimulus should we provide?

If we do half of what we did we World War II--increase our government debt by 35% of GDP--we're talking something like 4 trillion dollars in government deficit spending. Since most proposals include big chunks of productive investment as opposed to mere government consumption (i.e., bombs and bombers), we can probably get by with far less. (Though investment spending takes longer to work.)

If that spending also serves to raise our ongoing government/redistributive spending and (especially) taxing to a responsible level at which a high-productivity economy has the aggregate demand to thrive without meltdowns, the resulting prosperity should allow us to pay off that debt in less than 20 years. (This assumes the kind of more-responsible government we had pre-Reagan.)

I think that puts the current proposals--for stimulus of $500 to $700 billion--in appropriate historical perspective.

Medicare: Government Does It Right

I recently had occasion to go through two years of my 84-year-old mom's medical and insurance statements, to be sure that everything was kosher and that insurers were, in fact, paying all the bills they were supposed to be paying.

You've undoubtedly attempted similar, so you can imagine that it was a daunting task--trying to cross-reference all the providers' bills against the insurance statements.

All I can say is, thank god for Medicare.

The bills and statements from private providers and private insurers were nightmarish--mostly just dollar amounts (often lacking dates of service) attached to cryptic codes--often providers' internal codes unrelated to standard practice codes. If I'd been relying on these private statements alone, it would have taken me at least week to sort through all the statements--searching the web to track down those codes, and spending hours on hold with all the providers and insurers.

Happily, the Medicare statements made it easy. They are clear, well-laid out, and fully informative (in plain English)--exactly the kind of statements I insisted on when I was running a company. I was able to cross-check all the private statements against the Medicare statements to figure out what those private statements were actually referring to, then determine if private insurers had covered their share.

Thanks to the Medicare statements, I got the job done in a few hours.

Then, this fall it was time to choose a Medicare drug plan for my mom. Guess what? Medicare has the best insurance comparison engine, hands-down, anywhere on the web. You enter the prescriptions you currently take or expect to take, and it throws up an easily apprehensible list of insurers, sorted by your total costs per year and including quality ratings for the insurers. You click deeper for details on each, compare them, or jump to their sites for more info.

No private entity is offering anything even approaching this site. Market incentives?

So when somebody tells you that you can't trust governent to do anything right...well, you won't convince them because it's a faith-based belief...but you can take comfort in knowing that they're just plain wrong.

Mankiw (Mis) Channels Romer

In the grand conservative tradition of cherry-picking convenient quotations, Greg Mankiw pulls one from Christina and David Romer's paper, "The Macroeconomic Effects of Tax Changes" (PDF).

Tax changes have very large effects on output. Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent.

While ignoring an equally or actually far more important statement, given current conditions. (Also cherry-picked. But fair's fair.)

...tax increases to reduce an inherited budget deficit do not have the large output costs associated with other exogenous tax increases. This is consistent with the idea that deficit-driven tax increases may have important expansionary effects...

Why Prosperity Requires a Welfare State

I've been spending a lot of time lately pondering James Livingston's insights on how modern, high-productivity, post-industrial economies work, as expressed in two of his posts which I link to and encapsulate here.

What finally closed the loop for me was re-reading Ray Kurzweil and others on past trends, and what the future holds: exponential growth in productivity.

Note the logarithmic scale.

I think I can best encapsulate my conclusions by asking a question: What would happen if labor productivity increased a thousandfold? So creating a certain amount of stuff/goods/prosperity currently requires a thousand workers; suddenly, it only requires one.

Those 999 workers suddenly have no "legitimate" claim to any of that stuff, because they don't do anything to "earn" it. Those kind of claims are inscribed in both law and practice, so those 999 workers don't get any of that stuff/goods/prosperity/money. How could they? They're superfluous.*

Put aside for a few paragraphs the ultimately inescapable issues of fairness, equity, and "just deserts."** Can such an economy work?

No. Because those 999 people don't have any money to buy the goods that the one person produces. And there's no way that one person can purchase/consume all the goods produced. So they don't get purchased. So they don't get produced.

The economy--which is essentially a huge logrolling enterprise--stalls and stops.

This is a simplistic thought experiment. In particular, it assumes that the same amount of goods will be produced--ignoring the inevitable efforts of those 999 people to produce more goods, and get paid for them. (As productivity increases so the one guy can produce everything everyone "needs," they will be increasingly unsuccessful in doing so because their labor becomes steadily less valuable.)***

It's simplistic, but it still represents--accurately and increasingly--the state of modern economies since the industrial revolution. The spectacular efficiencies of technology and corporate capitalism make labor (especially low-skilled labor) increasingly valueless. So in the real world a few people make a lot of money and a lot of people make less money. Absent some intentional intervention, it's an inevitable result of rising labor productivity.

Left to its own devices, this system will inevitably grind (or crash) to a halt as more people fall off the log. That one person can't keep it rolling while all the others drown nearby.

So why does the log keep rolling? Because of redistribution in modern, prosperous economies. It maintains the necessary level of "aggregate demand" as productivity increases.

Free markets don't achieve that distribution or maintain that demand (as explained above, they work in the opposite direction), so government has to do it—for the good of all, including the one person standing there all alone on the stationary log.

It's no coincidence that:

1. Every thriving, prosperous, modern country has significant redistribution systems--social support services, infrastructure spending, wage laws, labor protections, and yes, welfare. There are no exceptions. (The relative merits and demerits of those systems require far lengthier discussion.)

2. The two great economic crashes of the past century occurred when social support systems were at a historically low ebb, and inequality (in wealth and income) was at an apogee.

A certain amount of government--and redistribution--is not simply desirable in a high-productivity economy; it's necessary for a modern economy to operate. The U.S.--taxing 28% of GDP compared to Europe's 40%--has been the epicenter of both of the the aforementioned crashes. The only modern economies (of any size) that tax less than the U.S. are Mexico, Japan, and (barely) Korea.

At 28%, the U.S. appears to be teetering at the bottom edge of the range in which a modern economy can prosper and thrive.

Or...it's already tipped off the edge—again.

* A semi-aside: who gets that one job? It looks decidedly like a matter of luck. Any number of the 999 could do the job just as well. Perhaps "merit" is the criterion, but merit is both widespread and difficult to gauge. Even if you use smarts and industry as the measures, let's face it: some people are just lucky enough to be born smart and industrious; others aren't. (And let's not even get started on the lucky-sperm contest for being born wealthy.) Meanwhile, most of those 999 people have no hopes of landing the one job; remember that by definition, 50% of people have an IQ below 100.

** The "fairness" argument has justifiable legs. That one person does all the work, so that person "deserves" all the returns for that labor. Counter: those 999 people are out of work (or receiving low wages while working hard) through no fault of their own; given the huge prosperity that productivity and efficiency provide, don't they "deserve"--just by merit of being alive--to live decent lives? See "luck" in the previous footnote.

*** Take this thinking further, to the world Kurzweil describes--in which computer-driven nanotechnology can take the wood in your house and reconfigure the atoms into latticed nanomaterials sufficient to build several skyscrapers. It can convert a pile of dirt into a thousand Thanksgiving dinners. Who gets "paid" for that? (If this future seems fantastical, imagine living in 1508 or 1808 and looking forward to the way we live today. And remember: that efficiency is increasing far faster today, and the pace of that increase is itself increasing.)

Investing: Government Knows Better

I know: that headline is hate speech. But the fact is that it's sometimes true.

Take education. Here's the kind of reliable payoffs we get from investing there:

And this doesn't even count the long-term aid to business that education spending provides.

Remember: few businesses are seriously constrained by a lack of investment capital (only 9% in the U.S.). Many are seriously constrained by a lack of skilled workers (35%).

Do the math. No private-market investor can expect those kind of returns. If rich people all gave a larger chunk of their (nonproductively-invested) incomes to government to invest wisely, everyone--including them--would be much better off.

Oh, hey: that's called progressive taxation! And surprise surprise, it results in more growth and prosperity. Whodathunkit.

Tyler Cowen Ignores the Elephant

Tyler Cowen's Sunday NYT discussion of The New Deal is getting all sorts of play in the econoblogosphere--pro and con.

What's not getting much discussion (except here) is the elephant that Tyler rather inexplicably fails to even mention: massive government (deficit) spending during the war. (It's not the war, stupid, it's the spending.)

The consensus opinion out there seems to agree that:

• Government response to the crash and depression was in retrospect actually quite tepid pre-war.

• Everyone--starting with Milton Friedman--agrees that monetary policy was way too tight. And once deflation began it was an ineffective tool in any case.

• Fiscal policy, net, was also not terribly proactive. Spending increased, but so did taxes. This especially in '36 and '37 when FDR tried to balance the budget, leading to the resurgence of the still-lurking depression.

It wasn't until the war that government made really big moves (necessarily, fiscal), with just-plain-mind-boggling deficit spending. U.S. government debt went from 50 to 120 percent of GDP.

(Yes, shortages continued/increased during the war, but for reasons unrelated to fiscal or monetary policy--notably the redirection of resources.)

The fiscal effect of war spending broke the Depression's back and got the economy moving, setting us up for the sustainable post-war prosperity boom.

That boom allowed us to pay down the resultant debt-to-GDP ratio over the next thirty-five years, bringing it to 32%.

Then...1980. The elephant landed with all four feet:

Do Wealthy Investors Create Growth and Prosperity? Not So Much

Here's the central tenet of supply-side/trickle-down/voodoo Reaganomics:

If rich people get (and keep) more money, they will invest it and promote economic growth, so everyone will prosper.

That would (perhaps) be true if a shortage of investment were an important constraint on businesses and on economic growth. But according to the people who run those businesses, availability of investment money is the least important constraint.

A company called Grant Thornton runs an annual survey (PDF) of privately held businesses worldwide, asking them among other things what constrains their growth.

In 2007, only 9% of privately-held U.S. businesses (21% worldwide) cited a "shortage of long-term finance" as a constraint on expansion.

Constraints on Growth Reported by Privately-Held Businesses
 

Presumably even fewer cite it as a "major constraint." Both domestically and worldwide, it ranks dead last on the list of business constraints.

(I can attest to this from personal experience. My partner and I had to make some small--low five-figure--personal loans while building a multimillion-dollar business. But we never tapped credit of any kind--though we could have, easily).

Understand: these are privately-held businesses being surveyed--not public corporations (which have far greater access to financing through debt and equity issues, and from massive global pools of private-equity and sovereign-wealth cash). These are the very hotbeds of entrepreneurship that supply-siders constantly tout as the innovative engines of economic growth.

A dearth of financing definitely isn't impeding their growth. Grant Thornton's 2007 study puts regulations and red tape at the top of the list, and it's been there for some years. But in 2008 (for which I can only find global numbers), that changed.

A shortage of skilled workers in now the #1 constraint. (35% of businesses cited it.)

This is completely in keeping with the economic view so ably explicated by James Livingston, which I summarize and link to here. The fact is that wealthy people can't find truly productive investments offering sufficient returns, so they turn instead to investments that don't have anything to do with production or productivity. (Think: MBSes, CDOs, CDSes, etc.)

Since the greatest constraint on growth is currently a shortage of skilled workers, the best path to prosperity seems to be taxing those unproductive dollars and investing them in the thing that every economist (and most people and politicians) agree is prosperity-producing: education.

Making sure that wealthy people have plenty of money is not the way to produce prosperity. That's a self-serving myth—one that needs to be soundly discredited.

"Springboard," Not Safety Net

I wrote an email to economist Alan Blinder at Princeton last week (which he was kind enough to respond to), in response to his NYT piece addressing our current...issues.

“social safety net”...America’s is in tatters...we need both repairs and a new metaphor. Lyndon B. Johnson had it right when he called upon the government to provide a “hand up, not a handout.” The Obama administration should seek to create a new “social trampoline” that not only catches people when they fall, but also propels them back into productive employment. If properly designed, such a social trampoline would both ease the short-run pain of recession and facilitate the long-run adjustment to globalization.

This man was speaking my language, though not quite in my words. I sed:

Just to second your notion in the NYT of renaming the safety net. If I could give our new president one piece of advice, it would be that.

But..."trampoline" sounds decidedly...risky, unpredictable, unsafe.

How about "platform," or "springboard"?

Professor Blinder liked the language.

This may seem like nothing but rhetorical spin, but it's important. "Safety net" gives the impression of catching failures. "Springboard" is about encouraging achievers--giving them a little extra bounce on their way up.

Rhetorical advantages aside (it's a lot easier to sell Americans on opportunity than on rescue, as the Republicans demonstrated for thirty years), it frames the whole discussion as a way to make everyone more prosperous--a non-zero-sum game--and thus engenders policies and programs that pursue that goal.

Yes, social-support programs can give some people the incentive to screw off and game the government. But they can equally give people the stable platform they need to work their way up and into the greater economic system--to succeed.

Again, progressives need to stop playing defense in the prosperity game. It's not equity versus growth; it's equity and growth. The Republicans don't have the pro-growth policies. We do.

Kristol's Conservative Economic Cluelessness

Now that he's finished his series of columns giving sage political advice to John McCain (hey John, how'd that Palin pick work out for you?), Bill Kristol thinks he has some good ideas for a Republican party that is wondering whether it has any apparent reason for  continued existence.

To begin with, Republicans should:

...develop an economic agenda moving forward that seems to incorporate lessons learned from what’s happened...

Emphasis, mine. Reality slip, Kristol's. It pretty much embodies the conservative inability to distinguish between spin and reality.

He does acknowledge reality here:

...Republican ticket lacking any coherent economic message...

Then after an obsequious nod to faux humility ("I don’t pretend to know just what has to be done"), he proceeds to tell Republicans just what has to be done:

...free-marketers need to be less doctrinaire and less simple-mindedly utility-maximizing...

This from the decades-long doctor of doctrinaire. Now he's acknowledging that conservative economics is  simple-minded. (It's nice to know that there's such a thing as progress.)

Serious-minded utility maximizing, by the way--creating prosperity for all--is an obvious goal for everyone; the question is how to achieve it. Decades of postwar empirical econometrics demonstrate that progressives know the answers to that question. Conservatives have simplistic (he got that right) faith-based theories that aren't borne out by the facts on the ground. Which leads to:

...they should depend less on abstract econometric models...

He doesn't seem to understand that econometric models are rooted in data (though the analytic methods applied to this data are, of necessity, abstract). What conservatives have offered are napkin-scribbled economic theories and nostrums. When they use data, it's almost uniformly cherry-picked, short-term statistical slices and dices creating rhetorical heat, not illumination. (This presumably because the long-term, big-picture data shows that their theories deliver less prosperity, not more.) Does Kristol think that "econometric" makes him sound knowledgeable and sophisticated? He should look words up in the dictionary before he uses them.

What else should Republicans do?

...take much more seriously the task of thinking through what are the right rules of the road for both the private and public sectors. They’ll have to figure out what institutional barriers and what monetary, fiscal and legal guardrails are needed for the accountability, transparency and responsibility that allow free markets to work.

Notice his desperate avoidance of the "R" word (regulation). That aside, his advice here is excellent: Republicans should start thinking about creating good government, instead of destroying government.

In a final, frigid dose of reality, Kristol (while meaning something different) concludes his column by explaining the Republican party's gravest problem:

...conservatives didn’t govern.

Problem is, we've already elected somebody who's dedicated to doing that.

Maybe the Republicans can help?

Want Prosperity? Tax the Rich

The right-wing blogosphere has lately been touting a table that the Norquistina Tax Foundation cherry-picked from a recent OECD study, showing that the U.S. has the most progressive income tax system in the OECD--perhaps excepting Ireland.

This may well be true. But I'm not totally sure what they're trying to say—except maybe that the U.S. tax system should be less progressive? This is the exact opposite of their typical equality arguments, though: we're less equal, and we've grown faster (we haven't actually, but they like to think we have), so we should be even more unequal. If that argument holds, shouldn't we have a more progressive tax system?

In any case, it got me wondering: do more progressive tax systems in developed economies correlate with faster or slower growth?

Answer: more progressive = faster growth. The correlation is .13 (using either of the measures in the Tax Foundation table). Not a huge correlation, but it does show that a strongly progressive tax system does not hurt growth; if anything, the contrary is true.

There are no big X-axis outliers here (which tend to pull trend lines and correlation coefficients around inordinately), but it's worth looking at a subset of countries that are largely similar, in hopes of ameliorating the effects of lurking, confounding, or otherwise pesky variables that might be polluting the analysis.

If you exclude very small, eastern European, and non-European countries. (Leaving Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Sweden, Switzerland, United Kingdom, United States), the correlation goes up to .21.

If you also exclude Australia, Canada, and the U.S., leaving only the advanced European countries, the correlation hits .36.

So we can say that at least for developed European countries, the Tax Foundation data shows (by social science standards) a strong correlation between progressive tax systems and increasing prosperity.

Is this what the Tax Foundation was trying to point out?

This is a single statistical slice/snapshot from a huge data set, and many things could paint a different picture: the taxes being analyzed in this particular table by the OECD, the Tax Foundation's calculation methods based on those figures, the periods being analyzed (by the OECD and by me here, for growth), etc. I don't know of any serious regression analyses that seek to control for these variables. I'd especially like to find any surveys or meta-analyses of such studies.

A Land of Magical Thinking: Becoming a Millionaire

I saw mention of this statistic in a blog comment last week, and went looking. Here is the central faith-based delusion regarding The American Dream:

Belief: 45% of Americans think it is somewhat or very likely that they will become wealthy in their lifetimes.*

Fact: in 2005, 5.7% of households were worth a million dollars or more. (Source PDF. See Table 3.)

Understand: A million dollars isn't even close to "wealthy." It represents, say, $40K to $60K a year in income.

So:

Chance of being wealthy: One in twenty. At best. Only 1% of households had more than $5 mil.

Perceived chance of being wealthy: One in two.

This explains Joe the Plumber. He made $40K in 2006, but in 2008 he was big-talking to Barack Obama about how we was gonna buy the business he works for--for a quarter of a million dollars.

This also explains how Joe and his co-delusionists could believe, for thirty years, that we could increase tax revenues by cutting taxes. Or that prayer would have any effect on any of this.

* NYT/CBS poll, March 3-14, 2005, question 24: Looking ahead, how likely is it that you will ever be financially wealthy? Would you say it is very likely [11%], somewhat likely [34%], not very likely [30%] or not at all likely [22%]?

The Man Who Shorted Subprime (Must Read)

The End of Wall Street's Boom - National Business News - Print - Portfolio.com.

Run don't walk to read this. It's gripping. About Steve Eisman, who started shorting every subprime play in sight back in 2005, while simultaneously proclaiming market insanity to anyone who would listen--in decidedly not-fit-to-print language.

It's long, but you won't be able to put it down.

The most amazing new insight I got from the piece: even the people who were shorting the insanity were feeding the insanity.

That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. “They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford,” Eisman says. “They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?”

‘By shorting this market we’re creating the liquidity to keep the market going.’

“It was like feeding the monster,” Eisman says of the market for subprime bonds. “We fed the monster until it blew up.”

Republicans Create Opportunity? Yeah, Right.

Republicans constantly proclaim that inequality is the price of prosperity. If things are more unequal, there's more incentive--and crucially, opportunity--for people to better themselves. Everyone benefits from that.

Except it's not true.

Let's think about Joe the Plumber, who made $40K in 2006 but would like to buy the plumbing business he works for--for a quarter of a million dollars. It hardly seems likely (absent a windfall lightning-strike of media attention). But what about his kids? Maybe they'll be able to climb the ladder and do better than their dad has.

That's the real measure of opportunity and the American dream. And the American dream is failing:

What are your chances of having the same income as your parents? (Left scale.) They're way better if you live in Britain, Italy...or the U.S. Want your kids to climb the ladder? Try Denmark, Norway, or Canada.

Norway and Canada are second and third for both median and top-decile income. So there's plenty of mid-level and top-end opportunity there for aspiring Joe the Plumbers. And bottom-decile folks are significantly better off than in the U.S.

I've pointed out before that wealth equality correlates strongly with greater prosperity, especially over the long term. Give tens of millions of Americans a place to stand, and they'll move the world.

Quarterly-report-driven Republicans will happily point out some cherry-picked, transitory short-term gains from enriching the rich. But which party is building America's future?

How dare these people call themselves conservatives?

Mankiw's Right: Money's Not the Incentive

Subtitle: Pipe Dreams

Greg Mankiw makes more than a quarter-million dollars a year. We know that, because he's expecting to pay the 2-4% payroll tax surcharge under Obama's tax plan, on any extra dollars he earns.

He's also planning to leave his children more $3.5 million dollars (the current inheritance tax exclusion) when he dies. We know that, because he's expecting them to pay the 55% inheritance tax on any extra dollars he adds to his estate.

But he's a simple guy. He doesn't have fancy tastes, and he's not concerned with leaving his children with a huge windfall.

Nice of him to prove the point: when you've got that much money, and are making that much money, more money isn't the key incentive to work more. There's far more utility in spending time with your loved ones.

If Greg's offered a speaking gig with a $10,000 honorarium, it's not the $10,000 that's gonna get him on the plane on that snowy winter night. It's the benefits to his reputation, the opportunity to rub shoulders with his colleagues, the non-financial incentives that accompany that speaking offer.

Larry Ellison isn't looking to build his business bigger because it's gonna have any perceptible impact on his lifestyle or his children's inheritance. They'll be fine.

But what about Joe the plumber? He made $40,000 in 2006. (But he'd like to buy the plumbing business he works for. The owner wants $250,000.) Do you think Joe's $500 tax savings every year under the Obama plan might give him more incentive to work hard and strive for greater things? It doesn't seem like he'll be buying that business any time soon. But maybe one of his kids will...

Give ten, twenty, forty million more Americans a place to stand, and they'll move the world.

All Cashed Up with Nowhere to Go: What Caused the Depression(s), and What to Do About It

I've been meaning to post about this great two-part article by James Livingston (H/T to Mark Thoma), on the causes of the Great Depression and the current...whatever it is.

Livingston's explanation for both cases (in my words):

• There were oceans of money with not enough productive uses available (like, investments in physical plants and wages--things that would increase productivity and production).

• To get returns, money-holders' only option was gambling (investments not tied or only loosely tied to production).

• Naturally, financial companies' share of GDP and profits skyrocketed.

• Wages became a smaller part of GDP, and profits a larger part.

• Income and wealth inequality increased--more money went to, and stayed with, the wealthiest.

• The wealthy thus had oceans of money with not enough productive uses...

• At the same time, lower wages threatened to kill the golden domestic goose: consumer spending.

• In our current case, government deficit spending and loose Fed policy were gasoline on the fire. It ameliorated--temporarily--the weak consumer spending, but simultaneously exacerbated the more fundamental trends.

Livingston's prescription:

The responsible fiscal policy for the foreseeable future is, then, to raise taxes on the wealthy and to make net contributions to consumer expenditures out of federal deficits if necessary.

His structural analysis is, in my mind, profound. Read his pieces and you'll see that he both adopts the facts of Friedman/Schwartz's Great Contraction narrative, and eviscerates the self-contradictory conclusions that Friedman and Schwartz draw from those facts.

And the first half of his prescription is also dead-on, in my opinion. More below.

But the second half of prescription is far less profound. Some might argue that if we give more money to consumers then they, in their infinite collective wisdom, will find productive uses for it. Without lengthy discussion here, I'll just say that the presumption is somewhat tarnished.

Rather than addressing the fundamentals (productive capacity), Livingston wags the dog: consumer spending. (Because consumer spending constitutes 70% of U.S. GDP--extraordinarily high, BTW, by international standards--it is the big dog. But spending is not production, which is the tail that actually does the wagging.)

If the wealthy can't find productive places to put their money,

1. There's obviously a problem with supply-side theory. Lack of capital was decidedly not a constraint on growth in the 20s, or the 00s (or, once government started pouring money in, in the 30s or 40s). With oceans of cash sloshing around, transfers to the wealthy (by whatever means) do not spur real productivity/production growth.

2. Policy should concentrate on moving money into productive uses.

There are two obvious productive places that pretty much everyone agrees are screaming for money right now: infrastructure, and education. The market provides few or no incentives for individuals to invest in these areas. (I'm not talking about individual spending on education, which obviously has high incentives. I'm talking about building schools, lowering student-teacher ratios, providing class materials, etc.)

So Livingston's right: tax the wealthy--who, pace Grover Norquist, aren't investing their money productively--and put that money into the things that we know will spur long-term productivity and production growth.

As a side-effect, this will spur consumer spending (not as quickly as cash dropped from helicopters, but still...) and create jobs (yes, sorry, a lot of them will be government jobs), which hopefully will tide us over until the payback kicks in from those long-term investments.

Does this make sense? Talk to me. And, I'd love to hear from anyone with time-series statistics on percentage of capital stock invested in productive assets. I've done some digging, but without success so far.

Europe vs. U.S.: Family Time Versus Four-by-Fours and Two-by-Fours

Finally! Someone has come back at me (well he didn't know he was talking to me) with the key, perhaps-trumping argument on my Europe vs. US longatribes. I gave this argument away in a previous post, hoping someone would pick it up, but have yet to hear it well enunciated elsewhere.

Summary of my arguments: the US and Europe have been growing at the same rate for decades, despite huge disparities in tax burdens (28% versus 40% of GDP), and profound, systematic differences in social support systems. Sort of suggests that their system is not the disaster, growth-wise, that many like to believe it is.

Ian Maitland (I'm assuming it's this Ian Maitland) comments on a Brad DeLong post:

Brad writes: "Studies of the relative aggregate efficiency levels of the economies of the US and EU come out... inconclusive--not finding that the EU is depressed by 30%."

How does that square with this (from The Economist, "Old before their time," 5-11 March 2005, p. 73)?: "In the post-war years to the 1980s, the world's richest economies were mostly converging towards similar levels of income per person. During the 1990s, however, that convergence came to a halt. Nowadays, income per person in the euro area is around 30% less than in America... And average growth rates in the euro area lagged behind
America's in the ten years to 2003."

Brad says that: "Western Europe ... has chosen politically to have a lot more leisure time than the United States."

Isn't it more accurate to say that Europe has "chosen politically" to take away people's choices, say, regarding whether or not to continue working after they are 60? In the same article we read: "The OECD has attempted to measure the implicit 'tax'on working for someone nearing retirement age.... For 55-year-olds in Germany or France, this implicit tax amounts to 50% of the average wage for people in that group. For 60-year-old Dutch people, the loss of benefits is 90% of the wage; Belgians face an effective tax rate of 80%. Faced with such arithmetic, why should older people bother to work?... If the EU does reduce the obstacles to work, many Europeans might still choose to toil less than Americans. But that would be an entirely different matter--a choice made freely, rather than in response to powerful government-supported incentives."

Okay, point by point:

Economist: "In the post-war years to the 1980s, the world's richest economies were mostly converging towards similar levels of income per person. During the 1990s, however, that convergence came to a halt."

Correct. (Though I'd say the catchup ended in 1980. They did hit almost 90% of US GDP in a couple of years in the 90s, but right now they're about even with '80.)

There was a big, easily explicable European catchup effect for three decades after the war. They've been pretty much stuck, comparatively, ever since.

Economist: "average growth rates in the euro area lagged behind America's in the ten years to 2003"

As I demonstrated, you can cherry-pick your periods as you wish. Which is what our Economist correspondent did here. While I rarely recommend ignoring The Economist, you really should so in this case.

Economist: "Nowadays, income per person in the euro area is around 30% less than in America."

The numbers I've run suggest that Europe runs more like 25% behind, but that's just noise. This is the crucial question for all us teat-sucking socialists: Why can't Europe catch up?

There are many many factors, but it's really a simple answer, and both Ian and Brad are right: each "capita" works less in Europe than in the U.S. This is both a good and a bad thing.

I like Bernard Wasow's quote:

Between 1970 and 2000, GDP per person rose by 64% in the United States and by 60% in France. In America, this came about because productivity per worker rose by 38% and hours worked per worker rose by 26%. In France, it came about because productivity rose by 83% while hours worked fell by 23%.

The Europeans prefer free time, while American's prefer big houses and big cars. Fine.

But the fact is--and both Brad and Ian stipulate to this, at least implicitly--to a great extent the society you live in imposes that choice on you. Sure, Europe has in many cases removed the option of people choosing "whether or not to continue working after they are 60." But the U.S. has effectively removed the option of working 35-hour weeks and taking six-week vacations. (Milton Friedman's obsession with coercion is well-placed, but he fails to realize--or at least acknowledge--that coercion goes beyond the physical; any economic system is coercive.)

Europeans have chosen leaders who instituted policies that provide (and to some extent require) what they care about. Ditto in the U.S.

But preferences are changing in this country, and globalization is coercing those changes--especially on those of more modest means. The quarter-acre lot with two or three cars is beyond the reach of most people these days, absent dual incomes and long hours/multiple jobs.

Given that reality, more people are liking the looks of the European system. Yeah, you have to give up the house/castle idea. But what do you get in return? The time to do things that---pretty much everybody agrees--actually provide a joyous life. If I have to be coerced, that's what I'll choose.

One last thing that really sticks in my craw: Each society is free to choose what it prefers. But when Europeans have so much time to spend with their families and friends—and when they do in fact use that time for that purpose (think: long, liesurely afternoon lunches at tables filled with loved ones, lounging in pleasant city courtyard cafes as your neighbors stroll by to chat)--how dare American get-back-to-work conservatives crow about their devotion to "family values"?

Study Sez: Rich States Are Full of Swingers

No, I'm not commenting on their sexual mores. I'm talking swing voters.

A new study (PDF) by Joe Stone and Steve Hayes suggests that most or all of the market-crash-fueled movement to Obama in these closing weeks is likely to be in rich states. If you're thinking battlegrounds/close contests, that means Colorado, Virgina, and Nevada. (Here's Wikipedia's list of states by GDP per capita.)

You can get an excerpt and some discussion of the paper from Mark Thoma's site. I've highlighted the strong/significant vote influencers on the regression table and posted it here.

But first, what I know you all really want—the prediction:

As of September 17, when they ran the numbers, they projected Obama with 50.14%--with a margin of error of 1.58%, a statistical dead heat. (They're not counting electoral votes, just the popular vote. Based on McCain's many wasted votes--taking 62% in Oklahoma doesn't help him any--a 50.14% result would almost certainly deliver a strong Obama electoral win.)

But Thoma re-runs their equations for October 22--after the stock-market dive: "if they redid them today the aggregate estimates predict a 4 percentage point win for Obama." (Which I guess means 52/48, presumably with a similar MOE. Translated into electoral votes, that's huge.)

Background: Economists have been developing and fine-tuning economics-based presidential win-prediction models for years. Here's the most basic form of the model, comparing the incumbent party's win percentage to GDP/capita growth in the first half of each election year.

There's obviously a strong correlation, but there are far too many outliers (like, most of them) to make a prediction on any individual election.

Haynes and Stone (and their many predecessors, cited in the article) have added a bunch of other variables to improve the model's predictive power:

• What party's in power?
• How long have they been in power?
• What's the Dow done since the start of the election year?
• What was the GDP growth percentage in the second and third quarters?
• How has the percent of Americans in uniform changed in the two years before the election?
• How has defense/security spending (as a percent of the budget) changed in the two years before the election?

By the authors' calculations, these factors accounted for between 55% and 75% of the incumbent party's percentage variance over 23 elections.

Far more intesting than the baseline results, though, is their application of the model to five tiers of states, divided by GDP per capita.

Short story, over the course of 23 presidential elections:

• In poor states, the only strong win predictor is GDP growth. And it's not a terribly strong correlation. But as Mark Thoma says, "Voters in the lower income states only care about real GDP growth."
• In rich states, several of the variables have a statistically significant impact on voting decsions. The  big correlations are (in increasing order of impact) the incumbent's party, the performance of the Dow, and the two-year change in security/military spending.

Only one of these variables has changed much recently--the Dow--and it's changed a lot. So you should expect a lot of market-driven movement in the twenty states with the highest per-capita incomes. Again, think Colorado, Virgina, and Nevada.

But what about Pennsylvania? Even though Obama seems to own it at this point (and his lead's increasing fast), McCain is making a big play for it cause it straddles his only plausible path to victory.

Pennsylvania is 28th on Wikipedia's rich-states list. According to Stone and Hayes' analysis, among the factors they looked at, the only ones that stand to move Pennsylvania voters much are the incumbent's party (that's not gonna change) and the two-year change in military spending (ditto). IOW, don't expect much change based on the stock market.

This is all in keeping with the work done by Larry Bartels and Andrew Gelman showing that rich people in poor states are the ones most strongly influenced by "social" issues. In rich states, those issues don't have nearly as much traction with either rich or poor.

It seems that what does have pull in rich states is--only somewhat surprisingly--the status of people's stock portfolios.

Oh and of course, I should probably include here the authors' obligatory cautionary footnote:

Every election includes idiosyncratic determinants unique to that election. For the 2008 election, these would in part include the race and gender of the candidates, Black turnout, new voter registration, and the financial crisis of fall 2008 (beyond its direct impact on the economic regressors in the model). Of course, no model, no matter how elaborate, can fully capture in advance all factors that influence voters the day of the election.

Reagan, Bush, and McCain: Selling America First

This 2003 article by Warren Buffet--explaining in his usual pithy manner how we're frittering away our future well-being by borrowing abroad and selling off our assets--got me looking once again at our country's long-term financial position in the world.

And once again, I came across one of those profound inflection points at--you guessed it--1980. The dawn of Reaganomics.

Just one paragraph from Buffet's article, but you should read the whole thing:

In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4 percent more than we produce -- that's the trade deficit -- we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.

Here's what "selling the farm" looks like (Update: added percent of private fixed assets):

Reagan took office, and almost instantly drove us off a cliff. The rest of the world has been, literally and figuratively, buying our children's inheritance—the fertile land that we should be preserving for them.
.
It would even more interesting to see net foreign ownership as a percentage of US national net worth (how much of us do they own?). But for whatever reason the BEA stopped calculating national net worth in the early 90s. (Australia and Canada, among others, continue to calculate this.)

When Cheney said, "Reagan proved that deficits don't matter," it was not an economic statement. (The man's not stupid, and I'll give you odds he wasn't talking about Ricardian Equivalence.) It was a typically craven Republican political statement.

Ever since Reagan, with their "we'll cut your taxes!" economic "policy," the Republicans have been borrowing money abroad (in your name, and in your children's and great-grandchildren's names) to buy votes here.

To get those votes, they're willing to turn our children and grandchildren into servants and sharecroppers.

How dare these people call themselves conservatives?

Yeah, absolutely: the Dems have been helping them. They're no strangers to this kind of vote-buying. Bill "The Great Enabler" Clinton knows which side his skillet-bread is buttered on. You can see in the graph that he managed to pull the nose up a bit, briefly, but still: he was right in there drinking the Kool-Aid. He only choked slightly on Reagan's seed.

It was that sticky-sweet Kool-Aid that Republicans/conservatives have been pouring down Americans' throats for thirty years (with--it's true--little objection from many/most Americans) that was the real culprit.

So here's the real question: is that Kool-Aid more like the stuff you get from Ken Kesey, or from Jim Jones?

Update 2/1/2009. Despite continuing massive trade deficits, our net investment position stayed pretty flat 2000-2007, largely due to a weakening dollar. (The foreign assets we own got more valuable, and the U.S. assets they own got less so.)

Not any more. Our net investment position plunged by $2 trillion in 2008—15% of GDP. Click on the image to read the article.

Milton Friedman Caused The Great Depression

Yes, yes, I know he was only 17 when the market crashed.

But still.

As Friedman pointed out quite accurately, inept (excessively tight) monetary policy caused the downturn to go much deeper and last much longer than it should have. Pretty much everyone will stipulate to that.

And hence--here's his logical non sequitur--government and the Fed are at fault, and should be eradicated.

Wrong. Bad monetary policy was at fault. Good monetary policy--according to Friedman--would have resulted in the recession ending by '31.

All he really demonstrates is that bad government is bad, and good government is good. Hardly a profound insight.

The real irony, though: the Fed kept money tight why? Because they clung to an almost theologically orthodox belief in the value of Friedman's beloved free markets and "creative destruction."

Friedman's belief system is what caused the government ineptitude/failure that he so bemoans.

Update 10/19: In a WSJ interview, Anna Schwartz, Friedman's co-author, says that we should hew to the very "creative destruction" philosophy that justified the inept monetary policy that she and Friedman so effectively disparaged. Because this time it's different. Really.

The dizzying depth of these nested ironies is approaching the level of clinical schizophrenia.

How to Avoid Regulation: Smart Regulation

Every economist agrees that regulation has the potential to stifle economic growth. But every economist also agrees that we need regulation to make markets efficient (and relatively stable).

Given those two givens, free-market advocates should be jumping into the fray, proposing smart, targeted, easily manageable, surgical regulation, that obviates the need for heavy-handed, clunky, hard-to-manage regulation.

My favorite example is regulation of ratings agencies--making it illegal for them to accept money from issuers of the securities they're rating, or at least requiring a cigarette-type warning on each bought-and-paid-for, collusively prepared rating.

It's relatively easy to administer and enforce, and while it blows a hole in today's ratings-agency business model (as it should), it creates a market for objective, accurate ratings that actually have some value.

The effect of accurate ratings would ripple and amplify up the food chain, making it difficult or impossible for mortgage sellers to profit by pawning off mis-rated risk.

One type of regulation that this might preclude: federal rules for mortgage factories, who are currently regulated only (and only lightly and erratically) by the states. Even those who believe in the (potential) efficacy of government regulation should blanch at the prospect of such a federal regulatory bureaucracy.

Government is not the problem. Bad government is the problem. Good government is the answer.

Pro-Growth Republicans III: Yeah, Right.

Following up on previous posts here, here, and here, yet some more debunking of this myth:

Various have shot spitballs at this chart, but add it to all the others in previous posts—showing that over the long haul, Democrats deliver prosperity and Republicans don't—and the notion that Republican policies promote growth is nothing short of lunacy. The idea is just completely contrary to "the facts on the ground."

Fareed Zakaria for President

I just came across Fareed Zakaria's The Future of Freedom: Illiberal Democracy at Home and Abroad at my mother's house, read it, and came away wildly impressed. His basic thesis is that what we want is constitutional liberalism (classic sense of liberalism, as in Milton Friedman's usage, though not necessarily via his prescriptions)—not a priori, always, greater democracy. Democracy--in the fundamental sense of majority rule--gave power to Hitler and Hamas, both inveterate enemies of constitutional liberalism. It's also, fundamentally, what allows for government-by-lobbyist.

As of this moment he's my nominee for Most Pragmatic Realist, regarding both domestic and foreign affairs.

And I'm happy to see one paragraph in his latest Newsweek column that could almost be substituted, wholesale, for the description of this blog, above.

In a world of competitive capitalism, you need not big government or no government but smart government. We are not in a race to the bottom, on wages, regulations, or anything else. But we are competing against other countries to come up with the government policies that most effectively foster growth, innovation, and productivity. It's a time to figure out what works, not what ideological mantras to keep repeating. It's the age of Michael Bloomberg, not Margaret Thatcher.

I'm Patriotic: I Pay Taxes

Don Pedro says it better than anyone else I've heard, with this woulda-coulda-said-it response for Biden:

“Governor Palin, if paying taxes is not considered patriotic in your neighborhood, who is going to pay for the body armor that will protect your son in Iraq? Who is going to pay for the bailout you endorsed? If it isn’t from tax revenues, there are only two ways to pay for those big projects — printing more money or borrowing more money. Do you think borrowing money from China is more patriotic than raising it in taxes from Americans?”

That is not putting America first. That is selling America first.

"Pro-Growth" Republicans. Debunked. Again. Some More.

A while back I posted some comparative numbers for postwar economic indicators, Dems versus Pubs. Clear results for the clear-eyed.

Brad Delong has even more.

Just one here, for your delectation:

How dare these people call themselves conservatives?

The Problem Was Not Deregulating. The Problem Was Not Regulating.

Most economists agree: deregulation is not what caused today's problem. (The repeal of Glass-Steagal, for instance—the Gramm-Leach-Bliley Act allowing commercial banks to act as investments banks, and vice-versa—wasn't the cause. It might even be one of the reasons things aren't worse than they are.)

What' they're not saying: not regulating is what caused the problem.

Everyone agrees: today's regulatory structure is not designed or sufficient for today's financial markets. A modern regulatory structure would, for instance, impose capital/leveraging limits on issuers of complex derivatives, such as credit default swaps—just as commercial bankers and insurers are required to maintain sufficient reserves to cover losses.

But that's illegal, thanks to the Commodity Futures Modernization Act, snuck through by Phil Gramm during Clinton's waning days.

That regulation specifically banned regulation of credit default swaps.

I follow all the major econoblogs via Google Reader—it's easy for me to search them all.

None of them has discussed the Commodity Futures Modernization Act (aside from passing mentions and—from Tyler Cowen—promises of future posts).

One exception: Justin Fox, who offers this brief pithy history:

Its provisions were slipped into an appropriations bill in conference committee and passed the House and Senate the very next day.

It was never debated in committee or on the floor. 

Lame-duck President Bill Clinton signed it into law six days later. And they say Paulson and Bernanke are trying to move too fast!

When we have to rely on Daily Kos and The Huffington Post to get analysis of recent economic history, it's time to take a hard look at the econoblogosphere.

Here are all the search results, going back to July 15.

Hale "Bonddad" Stewart: Who's To Blame For the Mess We're In?
...Financial Services Modernization Act repealed Glass-Steagall, a law that had separated the commercial-banking industry from Wall Street, and the two industries, plus insurance, came together again. Banks became bigger, clumsier, and hard to manage. Apparently, risk-management became all but impossible, even as banks had greater access to larger ...
The Huffington Post Full Blog Feed - Sep 28, 2008 (4 days ago)

Open Thread and Diary Rescue
...How the Commodity Futures Modernization Act Was Moved Through Congress. (ybruti) In this continuing series, LivingOxyMoron describes and defines some of the "basic" concepts underlying the sub-prime economic crisis in Understanding the Crisis, Part 2: The Borrower and Loan Originator. (vcmvo2) Eddie C relates his own traumatic experience with mo...
Daily Kos - Sep 25, 2008 9:17 pm

Robert Scheer: A Fox to Protect the Henhouse?
...and the Commodity Futures Modernization Act of 2000. By preventing mergers between the various branches of Wall Street, the former act reversed basic Depression-era legislation passed to prevent the sort of collapse we are now experiencing. The latter legitimized the "swap agreements" and other "hybrid instruments" that are at the core of the cr...
The Huffington Post Full Blog Feed - Sep 24, 2008 2:26 am

Chris Cox, American hero
...of the Commodity Futures Trading Commission--which regulates exchange-traded derivatives--campaigned for the authority to oversee the OTC kind as well, but was batted down by Congress and the Clinton Treasury Department. (I wrote about this a few days ago.) And on December 14, 2000, Phil Gramm, Jim Leach, Richard Lugar, Thomas Ewing and a few ot...
TIME: The Curious Capitalist - Sep 23, 2008 6:29 pm

Deborah Senn: Fifty Chimpanzees or One Toothless Gorilla
...is the Commodity Futures Modernization Act of 2000. The act specifically banned regulation of something called "credit default swaps." And it is precisely the creation and trading of these unregulated CDS's that led to AIG's downfall. In a nutshell, here is how a CDS works. Imagine lending money to your brother-in-law whose creditworthiness is ...
The Huffington Post Full Blog Feed - Sep 23, 2008 9:06 am

Howard Schweber: Paulson's Plan - Annotated
...2000 Commodities Futures Modernization Act. That act was added to the budget by Phil Gramm -- two days after the Court's decision in Bush v. Gore when no one was paying very much attention. "Nobody in either chamber had any knowledge of what was going on or what was in it," says a congressional aide familiar with the bill's history (quoted in ...
The Huffington Post Full Blog Feed - Sep 22, 2008 3:06 pm

The regulation of derivatives
...commodity, weather and freight derivatives."  Here is one overview of MiFID.  Implementation and enforcement is on a country-by-country basis and of course the UK is the big player.  Read pp.27-29 in the very first link above and you'll see that overall the UK has a looser regulatory approach than does the United States, though not on...
Marginal Revolution - Sep 22, 2008 6:06 am

Three Times is Enemy Action
...with the Commodity Futures Modernization Act, which was slipped into a "must pass" spending bill on the last day of the 106th Congress. This Act greatly expanded the scope of futures trading, created new vehicles for speculation, and sheltered several investments from regulation. As with both Gramm-Leach-Bliley and Garn-St. Germain, large parts...
Daily Kos - Sep 21, 2008 7:19 am

Did the Gramm-Leach-Bliley Act cause the housing bubble?
...cover the Commodity Futures Modernization Act as well.
Marginal Revolution - Sep 19, 2008 4:57 am

Arianna Huffington: How Obama Can Demonstrate Real Leadership on the Economic Crisis
...the Financial Modernization Act, which obliterated Glass-Steagall; and the Commodity Futures Modernization act, which gave us unregulated trading of derivatives and the kind of credit default swaps that threaten our economy -- both signed into law by Bill Clinton. Speaking at a large rally in Las Vegas on Wednesday, Obama declared: "we can't st...
The Huffington Post Full Blog Feed - Sep 18, 2008 4:03 pm

James Moore: A Nation of Village Idiots
...called the Commodity Futures Modernization Act into the budget bill. Nobody knew that the Texas senator was slipping America a 262 page poison pill. The Gramm Guts America Act was designed to keep regulators from controlling new financial tools described as credit "swaps." These are instruments like sub-prime mortgages bundled up and sold as ...
The Huffington Post Full Blog Feed - Sep 17, 2008 11:02 pm

McCain Adviser Phil Gramm's Role in Today's Crisis
...Commodity Futures Modernization Act], he declared, would ensure that neither the sec nor the Commodity Futures Trading Commission (cftc) got into the business of regulating newfangled financial products called swaps—and would thus "protect financial institutions from overregulation" and "position our financial services industries to be world lea...
Economists for Obama - Sep 21, 2008 8:19 pm

Robert Scheer: Earth to McCain: It's a Crisis
...were the Commodity Futures Modernization Act and the Gramm-Leach-Bliley Act. The Gramm is former Sen. Phil Gramm, who was chair of the Senate Banking Committee when he acted as chief sponsor of both pieces of legislation. The same Gramm that McCain picked to co-chair his presidential campaign. Gramm proved an embarrassment when he cavalierly in...
The Huffington Post Full Blog Feed - Sep 17, 2008 2:58 am

Yet Another Reason to Vote Against John McCain
...behind the Commodity Futures Modernization Act and the Gramm-Leach-Bliley Act. The former made legal "the mortgage swaps distancing the originator of the loan from the ultimate collector," while the latter "destroyed the Depression-era barrier to the merger of stockbrokers, banks and insurance companies.... CARLY FIORINA.... ...
Grasping Reality with Both Hands: The Semi-Daily Journal Economist Brad DeLong - Sep 16, 2008 11:44 am

Krugman: Phil Gramm would be ‘just the guy’ to lead us into a Great Depression.
...pushed the Commodity Futures Modernization Act in 2000, which made legal “the mortgage swaps distancing the originator of the loan from the ultimate collector.” The Nation writes that “those two acts effectively ended significant regulation of the financial community.”
Think Progress - Sep 16, 2008 6:56 am

Robert Scheer: She's Clueless, He's Worse
...of the Commodity Futures Modernization Act, which former Sen. Phil Gramm, R-Texas, pushed through Congress just hours before the 2000 Christmas recess. Gramm, until recently co-chair of the McCain campaign, also had co-authored the Gramm-Leach-Bliley Act, which became law in 1999 with President Bill Clinton's signature. That gem, which Gramm had...
The Huffington Post Full Blog Feed - Sep 10, 2008 12:21 am

Mitchell Bard: McCain's Claims of "Change" in His Acceptance Speech Are New Standard for Chutzpah
...as the Commodity Futures Modernization Act), which exempted energy trading from regulatory oversight. In other words, speculation was brought to the gas markets. (Keith Olbermann did an in-depth, fact-heavy, flawlessly researched report on this issue, which you can watch here.) Who was the person responsible for the Enron Loophole? Do I have to...
The Huffington Post Full Blog Feed - Sep 5, 2008 9:27 am

Oil Prices and Speculation
...when the Commodity Futures Trading Commission examined Vitol's books last month, it found that the firm was in fact more of a speculator... Even more surprising ... was the massive size of Vitol's portfolio -- at one point in July, the firm held 11 percent of all the oil contracts on the regulated New York Mercantile Exchange. The discovery...
Economist's View - Aug 21, 2008 2:40 pm

Michael B. Ellis: Fiddling As The Housing Market Burns
...of the Commodity Futures Modernization Act (helping deregulate the lending industry), and his known participation as being one of the framers of McCain's economic plan, I think it would behoove us to ask McCain, considering Gramm's past history, are we going to see a complete overhaul of his economic plan, or should we assume Gramm's "let them ...
The Huffington Post Full Blog Feed - Jul 25, 2008 3:53 pm

Robert Scheer: The Real Legacy of the 'Reagan Revolution'
...sponsored the Commodity Futures Modernization Act of 2000, which allowed Enron's scamming to happen. As Ken Lay, who was chair of Gramm's election finance committee, put it quite candidly when asked for the secret of Enron's success, "basically, we are entering or in markets that are deregulating or have recently deregulated." Part of that dere...
The Huffington Post Full Blog Feed - Jul 16, 2008 5:12 am

Max Blumenthal: Phil Gramm May Be Gone, But His Porn Lives On
...Commodity Futures Modernization Act" into a omnibus spending bill just as Congress headed off for summer vacation. His amendment instantly enabled the creation of a shadow banking system -- "weapons of financial destruction" in the words of Warren Buffet -- that directly contributed to the current mortgage foreclosure crisis. Millions of America...
The Huffington Post Full Blog Feed - Jul 15, 2008 7:11 am

Hiding the Bailout

Everyone has their two bits worth. Mine: Aside from the whole thing being incredibly vague and relying far too much on the Secretary's "discretion," this passage from the CBO's description is egregious.

...the federal budget would not record the gross cash disbursements for purchases of troubled assets (or cash receipts for their eventual sale), but instead would reflect the estimated net cost to the government of such purchases (broadly speaking, the purchase cost minus the present value, adjusted for market risk, of any estimated future earnings from holding those assets and the proceeds from the eventual sale of them).

It is license for intentional obfuscation of the very worst sort, and an invitation to government and corporate lying, cheating, stealing, and collusion.

Just give us the facts, please. You can give us a prettied-up version as well, but without the basic numbers we can draw no conclusions as to the veracity of that version.

Ahh, for European Stability...

If there's one thing people would like more of these days, it's stability. When the economy rockets up one year, then plummets or stagnates the next, it's bad for everyone—especially those farther down the income scale, who have less recourse in face of national and global events that are completely beyond their control.

This got me wondering: over the course of decades, which is more stable—the U.S., with low taxes and limited social spending, or Europe, with it's larger social support systems and higher taxes?

Here's the answer, gauged by one big-picture measure—annual growth/decline in GDP per capita:

Short answer, the U.S. economy is far more volatile. In 25 out of 30 five-year periods, the EU was more stable. Overall, '71–'06, the U.S. economic volatility has been 48% higher than Europe's.

Europe's greater stability may or may not be a result of its social policies. (Though there is good reason to think it is.) But whatever the cause, it sure would be nice to import a good-sized hamperful, if such things are exportable.

Is There a Credit Crunch?

Not on Kiva.

This site lets you make direct micro-loans to small businesspeople across the world.

The only problem, right now: there aren't enough loan requests to match all the willing lenders. You basically have to lurk, hitting refresh constantly, to make a loan before a new requested loan gets fully subscribed (like, within minutes).

More on Equality and Growth

I just came across this graph that I created a while ago, and never got around to posting.

Trickle-down theorists would have you believe that inequality is necessary for growth and prosperity, or even that inequality causes growth.

But in the decades after their theories took sway, growth declined.

It came after therefore it was caused by? You decide.

The Republican Alternative Rescue "Plan"

I think Arnold Kling's commentary pretty much says it all:

As I say in my AP stats class, "I appreciate that you raised your hand and tried to answer, but no. Anyone else?"

Now which political party is it, exactly, that's supposed to know something about finance and economics? To make sensible, judicious, reasoned judgments about the economy?

Paulson/Dodd Plan: Mankiw Stipulates to the Merits

Greg Mankiw posted the views of a surrogate (his "smart friend") to dis the Paulson/Dodd bailout compromise (buy assets, get warrants/equity as well). His friend addresses the plan on its merits. But when David Leonhardt replied , also addressing the plan's central issues, Mankiw changes tack, arguing that it will screw up the auction process:

But if each bank is required to sell the MBS plus a warrant on the bank's stock, then the items being sold are no longer comparable. A warrant on one bank does not have the same value as a warrant on another. How then can you run a competitive auction to find which bank is offering the best deal?

I suppose Treasury could hire option pricing experts to net out the value of the warrant from the price of the package to find the net price of the MBS. But doing so would certainly add noise to the process and make it harder for Treasury's auction experts to make sure the taxpayers is getting the best price for the securities it is buying.

Good point—undeniably true. But even more to the point, Mankiw is not arguing any of the points raised by his smart friend (refuted by Leonhardt). He's raising a new, somewhat mechanical, objection.

Much better use of his time and fine mind: figuring out an auction/pricing process that would work.

Bailout: Dems Have the Smart Solution (Again)

Very quickly here because I have to run out the door, you'll have to google for your own links:

Senate Banking Committee Chairman Chris Dodd has proposed an alternative to Hank Paulson's "just trust me" blank-check bailout proposal.

Simply put:

If Treasury (that means you and me) buys $1 worth of trash assets from a company, Treasury (you and I) gets those assets, plus $1 of equity (stock or senior debt) in that company.

So the companies get the bailout cash they need now, but in return they give us--at no immediate cash cost to themselves--a potential upside down the road. But believe me--because their own shares are being diluted--they're gonna be saying "ouch."

Companies don't have to take the deal, of course. They actually have to request it. If they're on the verge of bankruptcy, the choice is clear:

Take it or leave it.

This solves the fundamental problem with the Paulson plan: either he pays too much for the assets (which bails out the financial institutions), or he pays too little (which is good for the taxpayer, but doesn't solve the problem).

With the Dodd plan, even if we pay too much, we've got that equity to make up for it.

Now: which party is it that understands market discipline?

The economics bloggers--who have been uniformly ravaging the Paulson plan for obvious reasons--are starting to coalesce around the Dodd plan. Watch for more in the course of the day.

John McCain Pledges to Eradicate Government

John McCain has promised to balance the federal budget by 2013.

He's also pledged to enact a tax plan that will deliver a budget deficit of $650 billion dollars in 2013.

Just to give these numbers a little perspective:

Agency	2013 Projected Outlays
Agriculture	$120 billion
Commerce	$9 billion
Education	$86 billion
Energy	$30 billion
HUD	$66 billion
Interior	$14 billion
DOJ	$32 billion
Labor	$14 billion
Transportation	$87 billion
Treasury	$84 billion
EPA	$9 billion
TOTAL	$551 billion

"Drown it in a bathtub," indeed.

The Republican Energy "Plan"?

Here's the best description I've seen of McCain's plan for American "energy independence":

The image was produced by these guys, with data from the Energy Information Administration. 

HT to Gristmill and Mark Thoma.

Yeah, The Economy Rocks Under Dems. But It's Not Their Fault.

Greg Mankiw pooh-poohs the data using one of his favorite tactics:

Fun with Statistics

Princeton economist Alan Blinder says Democratic Presidents are better for economic equality between rich and poor.

Chicago economist Casey Mulligan says Republican Presidents are better for economic equality between men and women.

My take: These articles are completely persuasive, as long as you buy into the axiom that correlation=causation. Otherwise, not so much.

Post hoc ergo propter hoc is the eternal comeback in macroeconomics, because we can't replay the world a different way and see what "would have" happened.

It's a very effective counter when you're looking at brief periods (let's call it micromacro) with no comparative or control element.

But:

1. That comeback is much less convincing when comparing outcomes from two sets of policies

A. Over a long period
and
B. When those policies are consistently and systematically different

2. Data—especially long-term data—can quite effectively disprove a theory. (Mankiw stipulates to this in  "Growth of Nations.")

i.e.: Growth in Europe and the US have been the same over decades, while tax rates have been massively different (40% versus 28% of GDP).

i.e. 2: Since WWII, growth under Democratic presidents has been far greater.

No post-hoc argument here: These facts quite effectively disprove the theory that Republican/supply-side/trickle-down policies cause greater/faster economic growth.

On the two "equality" studies that Mankiw pooh-poohs.

Dems deliver less rich/poor inequality: Blinder's point is not that Dems deliver more equality. It's that everyone is better off under Democratic policies. (Bartels demonstrates this in spades.) The equality is a wonderful (causally connected?) bonus.

Pubs deliver less male/female inequality: women appear to have done relatively better under 'pubs because working-class men have done so poorly under same.

Update: Casey Mulligan—author of the Republicans-promote-gender-equality article—responds to Mankiw in his new blog.