Reason Foundation

Picking Apart Krugman's Ridiculous Housing Op-Ed

Posted on August 3, 2012, 4:49pm | Anthony Randazzo

Most of the time when I read Paul Krugman's op-eds I disagree with him. I shake my head in frustration that he is misleading tens of thousands of people. I wrestle with the question of why economists can look at the same data and come up with different results (psychology has the answers by the way). And then I go on with life because it is just not worth it to dwell.

Today's post "Debt, Depression, DeMarco" is so ridiculous that I can't just go on. So I'm going to break down all of the manipulations and inaccuracies point by point, for my own mental relief if anything else. I will include every line of his post so nothing is taken out of context. 

"There has been plenty to criticize about President Obama’s handling of the economy. Yet the overriding story of the past few years is not Mr. Obama’s mistakes but the scorched-earth opposition of Republicans, who have done everything they can to get in his way — and who now, having blocked the president’s policies, hope to win the White House by claiming that his policies have failed."

Not that I'm a big fan of the GOP, but that is what minority parties do. They get in the way of majority parties. It is up to the leading party to, well, lead. We'll move past the sob story about the GOP beating Obama at the political game though, because that is not the point here.

"And this week’s shocking refusal to implement debt relief by the acting director of the Federal Housing Finance Agency — a Bush-era holdover the president hasn’t been able to replace — illustrates perfectly what’s going on."

Nothing was shocking about this refusal. This is not the first time that FHFA has rejected the idea of universally writing down principal on mortgages backed by Fannie Mae and Freddie Mac. All acting-director of FHFA Ed DeMarco did was maintain the agency's position. To set this up as "shocking" is to prime the reader for assuming what follows is outside normality. It is playing on psychological impulses and misframing the argument.

"Some background: many economists believe that the overhang of excess household debt, a legacy of the bubble years, is the biggest factor holding back economic recovery."

True. Count me as one who also believes that household debt is one of the largest problems holding back recovery.

"Loosely speaking, excess debt has created a situation in which everyone is trying to spend less than their income. Since this is collectively impossible — my spending is your income, and your spending is my income — the result is a persistently depressed economy. How should policy respond? One answer is government spending to support the economy while the private sector repairs its balance sheets; now is not the time for austerity, and cuts in government purchases have been a major economic drag."

You do have to give it to Krugman for never failing to push his anti-austerity argument. A challenge with this argument is that I can push back by saying, the government has supported the economy by spending hundreds of billions (both through the stimulus and the bailout) and providing dirt cheap loans through the Fed, not to mention supporting housing prices and attempting to invest in green technology. That hasn't created a recovery. Krugman will respond that we didn't spend enough. But that is an easy come back if spending doesn't succeed at its goal.

"Another answer is aggressive monetary policy, which is why the Federal Reserve’s refusal to act in the face of high unemployment and below-target inflation is a scandal."

The Federal Reserve has been acting. Krugman makes it seem like the Fed has been just standing on the sidelines for the whole faux-recovery period. Most readers of his column will know that is not true. What Krugman really means to say is that the Federal Reserves refusal to do even more is a scandal. He'll get his wish in September I think, but there is so much debate about whether QE3 could be effective in any form that calling it a scandal is absolutely ridiculous. The Fed's holding steady on course is extreme as it is, going further necessitates a substantial debate. 

"But fiscal and monetary policy could, and should, be coupled with debt relief. Reducing the burden on Americans in financial trouble would mean more jobs and improved opportunities for everyone. Unfortunately, the administration’s initial debt relief efforts were ineffectual: Officials imposed so many restrictions to avoid giving relief to “undeserving” debtors that the program went nowhere."

How terrible of the government to try and protect taxpayer money by preventing fraud and attempting to limit moral hazard. More to the point though, it is far from a widespread view that debt relief is a "should" for government policy. A debt jubilee would probably have positive effects for households free of their financial burdens, but the gains are washed out by an equal net loss to the creditors that will no longer get back the money they owed. That is a policy debate very much up in the air, not a "should."

"More recently, however, the administration has gotten a lot more serious about the issue. And the obvious place to provide debt relief is on mortgages owned by Fannie Mae and Freddie Mac, the government-sponsored lenders that were effectively nationalized in the waning days of the George W. Bush administration."

Again, I respect the rhetorical flourish of Krugman painting the GOP as always the bad guys. I don't respect him for playing politics when he should be acting like more of an professional economist though. Krugman is right that the GOP are the bad guys who nationalized the GSEs. But I would have added to that sentence, "and have continued on in government conservatorship for more than three years under the Obama administration who has failed to make a concerted effort to deal with the defunct mortgage giants." Both sides share a lot of blame for being stuck in the political mud and not wanting to take on the very powerful American housing lobby.

"The idea of using Fannie and Freddie has bipartisan support. Indeed, Columbia’s Glenn Hubbard, a top Romney adviser, has called on Fannie and Freddie to let homeowners with little or no equity refinance their mortgages, which could sharply cut their interest payments and provide a major boost to the economy. The Obama administration supports this idea and has also proposed a special program of relief for deeply troubled borrowers. But Edward DeMarco, the acting director of the agency that oversees Fannie and Freddie, refuses to move on refinancing. And, this week, he rejected the administration’s relief plan."

This is the point in Krugman's op-ed that my ears started to bleed. Bipartisan support my ass! That is like calling the stimulus bipartisan because it got a few Republican votes in the Senate. There are a few center-right economists supporting widespread principal reduction. But most of the center right is opposed. That is just plain wrong and Krugman knows it. Again, it is priming the audience to see Ed DeMarco as the evil government technocrat out of touch with the mainstream. The ironic thing is that principal reductions are something that needs to be painted as "bi-partisan" at all. This is not a political issue. It is an accounting and financial analysis issue. Sometimes reducing a borrowers principal will yield a net positive return to the lender because the borrower won't go into complete default and foreclosure. Other times not. It is a case-by-case basis. Not a left-right political debate. 

"Who is Ed DeMarco? He’s a civil servant who became acting director of the housing finance agency after the Bush-appointed director resigned in 2009. He is still there, in the fourth year of the Obama administration, because Senate Republicans have blocked attempts to install a permanent director."

At this point my eyes started to bleed with frustrated fury. It is when elements of truth are twisted to create a false reality that we should really question the legitimacy of public commenters. I am certain that I have made this error in the past and would honestly own up to it if pointed out. But Krugman could at least make an honest attempt to tell the story right here. Yes, DeMarco became acting-director after James Lockhart quit. But Obama didn't try to appoint a permanent director until November of 2010. There were legitimate concerns about whether Joseph Smith should step into the FHFA top post, and the out going GOP asked those questions. The lame duck congress in the fall of 2010 was not able to push through Smith's nomination, and it was left up to the next Congress, incoming for January 2011. But Obama decided to not renominate Smith for the 112th Congress to take a vote on one way or the other. And since then the Obama administration has not tried to reappoint anyone to the post. Krugman makes it seem that the White House has been trying hard to create replace DeMarco, but largely they've been afraid of the politics of having to honestly vet a candidate that would take the role of GSE conservator seriously vs. just being a technocratic tool of the administration. VERY different story than Krugman paints.

"And he evidently just hates the idea of providing debt relief."

Patently false. Ad hominem attack. DeMarco is on the record as saying principal reduction has the capacity to save taxpayers money. But he has argued the risks would be too high for the taxpayers. He has even written about debt forbearance a good option. He does not "evidently" hate debt relief. Either a research failure for Krugman or a misleading sentence that he should apologize for.

"Mr. DeMarco’s letter rejecting the relief plan made remarkably weak arguments. He claimed that the plan, while improving his agency’s financial position thanks to subsidies from the Treasury Department, would be a net loss to taxpayers — a conclusion not supported by his own staff’s analysis, which showed a net gain."

What DeMarco's letter actually said was that under his estimated scenario (and he is the acting-director that has been doing this for more than three years now), taxpayers might only get a savings of $500 million under a best case scenario. More optimistic estimates have suggested closer to $1.8 billion in savings to the taxpayer. DeMarco's argument was that the $500 million estimate was such a narrow margin for the calculations being discussed that it was not worth the risk. Krugman paints DeMarco as a single rouge operator in his organization. Not true at all.

"And it’s worth pointing out that many private lenders have offered the very kinds of principal reductions Mr. DeMarco rejects — even though these lenders, unlike the government, have no incentive to take into account the way debt relief would strengthen the economy."

Yes, that is worth pointing out. But it is also worth pointing out that the Red Sox have been slowly gaining ground on the Yankees in the AL East race, but will still wind up breaking my heart with failure down the stretch. Banks doing individual principal reductions on a case-by-case basis is VERY different from the GSEs just writing down principal in bulk on mortgages in a large program. The banks are not doing "the very kind" of reductions being discussed here.

"The main point, however, is that Mr. DeMarco seems to misunderstand his job. He’s supposed to run his agency and secure its finances — not make national economic policy."

No, Mr. Krugman misunderstands Mr. DeMarco's job. It is explicit in the conservatorship agreement that FHFA manage the GSEs to reduce losses to the taxpayers. If DeMarco were to bend to the push for principal reductions despite his best estimate that taxpayers might lose on the deal, then he would be setting national economic policy. There are plenty of arguments against principal reduction from a moral hazard perspective, from a rule of law perspective, from a data perspective (at least half of HAMP's modifications have re-defaulted the last I looked). But DeMarco is taking his job very seriously and considering not the housing market, but just taxpayer well-being from GSE specific losses.

"If the Treasury secretary, acting for the president, seeks to subsidize debt relief in a way that actually strengthens the finance agency, the agency’s chief has no business blocking that policy. Doing so should be a firing offense."

Again, wrong. That might be how some would like to view the FHFA director post. But that is not what the law says. If taxpayers really would be better off from a program like this, and it could be designed to avoid moral hazard and there was no violation of contracts, then I'd say go for it. Until that is the case, though, DeMarco should stand firm... and that is not a fireable offense.

"Can Mr. DeMarco be fired right away? I’ve been seeing conflicting analyses on that point, although one thing is clear: President Obama, if re-elected, can, and should, replace him through a recess appointment. In fact, he should have done that years ago. As I said, Mr. Obama has made plenty of mistakes. But the DeMarco affair nonetheless demonstrates, once again, the extent to which U.S. economic policy has been crippled by unyielding, irresponsible political opposition. If our economy is still deeply depressed, much — and I would say most — of the blame rests not with Mr. Obama but with the very people seeking to use that depressed economy for political advantage."

Nothing more need be said. A very frustrating article to read indeed. Send complaints to anthony.randazzo@reason.org

Update: An earlier version of this post mistakenly cited Obamacare as receiving a few GOP votes in the Senate, it was the American Recovery and Reinvestment Act that received three Republican votes (one of which was Arlen Specter who later switched to the Democrat party) and was therefore claimed to be "bipartisan." 

What Twists Will We See from the FOMC Tomorrow?

Posted on June 19, 2012, 1:36pm | Victor Nava and Anthony Randazzo

Rumors are flying everywhere that the Fed is going to ease policy again after its meetings today and tomorrow. The Financial Times declared yesterday that "the doves are ready to act." And a report in Forbes suggests that more Fed easing is likely to come sooner rather than later, in the form of an extension of the Feds Operation Twist program. JP Morgan Chase and Barclays are also both expecting the FOMC will extend the $400 billion dollar (to this point) bond swap program known as Operation Twist.

These rumors are not terribly unexpected. Nor would Fed action tomorrow be shocking. The economy has been deteriorating this year steadily and financial markets have been tightening up. Chairman Bernanke has reiterated time and again this year that the Fed was willing to act if it needed to, but that they wanted to wait to see if their previous QE efforts could help recovery take hold. No such luck so far though.

More than two months ago Reason's James Groth predicted that rising yields in long-dated treasury bonds would likely lead to a new bond purchasing program or an extension of Operation Twist. It is looking like this is going to put more QE very much back in the cards—if not tomorrow then in coming months, as the global economy and U.S. economy are not going to hit an upswing soon. 

To date, 30-year US Treasury Bond yields have only gone down 9 basis points since the bond swap program began in October of 2011, and at many points during the programs original run 30-year US Treasury Bond yields were actually higher than before the program started. With economic conditions slowing (Barclays forecasts Q2 GDP to grow only 1.8% and May saw only 69,000 new jobs added) it's not surprising that this Fed would seek more easing.

One possible wrinkle, mentioned in the Forbes piece, in the program were it to be extended is that the Fed could move to purchasing more mortgage-backed securities and fewer treasuries (in order to limit the impact on the treasury market). If this turns out to be the case, you can add "a slowing of housing prices declining to normal levels" to the laundry list of Operation Twists negative side-effects.

The rest of the list (as illustrated by Dallas Federal Reserve Bank President Richard Fisher), first blogged about here:

1. "Embarking on an Operation Twist would provide an even greater incentive for the average citizen with savings to further hoard those savings for fear that the FOMC would be signaling the economy is in worse shape than they thought. They might view an Operation Twist as setting the stage for a new round of monetary accommodation-a QE3, if you will. Such a program was considered redundant by business operators given their surplus of undeployed cash holdings and bankers' already plentiful excess reserves. In addition, such a program might frighten consumers by further driving down the yields they earn on their savings and/or lead to long-term inflation that would erode the value of those savings;
2. The earning power of banks, both large and small, would come under additional pressure by suppressing the spread between what they can earn by lending at longer-term tenors and what they pay on the shorter-term deposits they take in;
3. Pension funds would have to reassess their potential returns, with the consequence that public and private direct-benefit plans would have to set aside greater reserves that might otherwise have gone to investments stimulating job creation;
4. Expanding the holdings of the Fed's book of longer-term debt would likely compound the complexity of future policy decisions. Perversely, the stronger the economy, the greater the losses the Fed would incur as interest rates rise in response and the prices of those longer-term holdings depreciate. The political incentive to hold rates down might then become stronger precisely when we want to initiate tighter monetary policy. This concern, of course, would be a good news/bad news issue: The good news is that it would stem from a stronger economy; the bad is that might hurt our maneuverability and, in doing so, might undermine confidence in the Fed to conduct policy independently."

Something that had not escaped some analysts is that the above discussion didn't factor in where inflation is at. As the FT shows in a chart, a number of inflation indicators are heading downward or hovering around 2 percent. However CPI has been on steady march up and hasn't slowed down since the middle of the first quarter of 2012. Concerns about economic and financial conditions could overshadow inflation fears at the FOMC meetings this week, but most are expecting some kind of action tomorrow. 

We'll have to wait for news tomorrow, but in the mean time, please ponder why since the "twist" dance went out of style 60 years ago, why this approach to monetary policy can't go out of style as well? 

 

Alnnor Ebrahim Want His 15 Minutes Like Rajan Gupta

Posted on June 19, 2012, 12:50pm | Anthony Randazzo

With Europe falling apart but Obama v. Romney quiet at the moment, it is not clear whether the media is going to fill its air time with the story of Alnoor Ebrahim. If this story does take top headlines—or better, get featured as a punchline on The Daily Show—hopefully it can move beyond the old hat debates about insider trading as policy and focus more on the complex ways in which different people view insider trading.

Let's start with what we know of this story: Alnoor Ebrahim is a former AT&T executive and he admits that he was paid to give information about cell phone sales to particular hedge funds looking into whether or not to invest in the likes of Apple, RIM, and perhaps AT&T itself. According to BizJournal and AP: "federal authorities said Ebrahim was paid more than $180,000 to serve as a consultant for employees of Manhattan-based investment firms."

We've made it pretty clear on this blog before that we tend to stand with the "let insiders trade" side of this debate. Insider trading is about as illegal in a universal justice sense as getting called for a blocking foul (when you throw your body in front of another player's path) in basketball. It is an arbitrary law set up to try and create a greater sense of fairness. Here is a sterilized break down of what happened.

1. Potential investor in Apple seeks information about the success of Apple products
2. Potential investor reads industry reports, looks at publicly available data, analyzes news reports, pays to attend conferences where Apple executives are presenting their products, pays to fly out and visit Apple production sites, pays assistants to gather intelligence from their friends on how much they like the product.
3. Potential investor then pays an AT&T executive for data about the sales of Apple products. 
4. Potential investor uses all of this information to make a decision.

So, what was the illegal activity here? The law says that investors should have a level playing field, they should have the same opportunities. It is obvious that not every potential investor in Apple has the same resources. They can all technically attend the conferences, and spend time reading the reports, and pay some recent graduates to survey their friends (even if in reality few people have those resources), but they can't all have the same AT&T friend and pay him for special information. 

Step three is what we've declared illegal. Now, I could get into semantic arguments about how there are logistical problems with items in step 2 that, by the same logic is making insider trading illegal should make them illegal, but that is the old debate. We probably should still make those points to keep the flag in the sand established. But what new could we consider?

How about thinking on reasons why we have the divide? Often times in this debate (as nearly every other) it seems as if people have made their decision whether they think this should be illegal and then justify it some how. Many justifications for keeping insider trading illegal are flimsy and disprovable concerns—like "its not fair to trade if you have special knowledge" even though that is basically what professional investors do for a living... trade on special knowledge. Some are based in very sound reasoning that are balanced on a single point of debate from which different opinions must necessarily diverge—like "insiders are part owners in a company who have a fiduciary responsibility to their fellow owners and should not seek to gain special financial privilege by selling the group's information" where the debate rests on whether owners should have equal financial outcomes from a business and whether all insiders have fiduciary responsibilities. 

The roots of people's justifications here rest on where their values and morals have evolved to place emphasis. As Jonathan Haidt wrote about in the May 2012 issue of Reason, there are six clusters of moral concern that all political cultures and movement base their moral appeals: "care/harm, fairness/cheating, liberty/oppression, loyalty/betrayal, authority/subversion, and sanctity/degradation." We would need to do a psych study (or if one has been done, please forward me the information) on exactly how individuals with particular value sets would fall in this matrix, but my hypothesis is that individuals who place a heavy value on fairness and care are those seeking to maintain insider trading rules. The more liberty focused would come up with justifications for making it legal. 

We'll have to wait for more details on Mr. Ebrahim's case to come forward. Perhaps he is owning up to this so he can get his name in the papers like Rajan Gupta. Perhaps he has come to see his own activities as illegal. Perhaps he's just trapped with no way out. In any case, this story really should be about Ebrahim. Rather we should take this as an opportunity to understand why there are differences on insider trading, identify the root source concerns, and then many figure out if there is a way we can reform the rule which is nearly impossible to defend and restricts the rights of individuals to pursue life, liberty, and happiness.

Fannie Mae Breaks Its 14 Quarter Bailout Streak

Posted on May 11, 2012, 12:02pm | Anthony Randazzo

 

Fannie Mae performed a magic trick this past quarter: they made a net profit including their dividend payment to Treasury for the first time since the fall of 2008 when they were taken into conservatorship. This week, Fannie Mae's 1Q 2012 earnings statement was actually an earnings statement. They posted a $2.7 billion profit, and were able to make a $2.8 billion payment to Treasury, covering the balance of the payment with a few hundred million built up in positive net worth, according to The Wall Street Journal. 

Last year, Fannie Mae lost a net of $16.4 billion. With the $0 loss figure through the first quarter of 2012, that means the updated complete taxpayer bailout total (3Q2008 to 1Q2012) for Fannie Mae remains:

$116.2 billion

So while a few kudos are in order for not having to go hat in hand to taxpayers for a 14th straight quarter, Fannie Mae is far from being out of the woods. Of that $116.2 billion bailout given to Fannie Mae, $22.6 billion has been paid back, leaving a remaining balance of $93.6 billion.  

There were a few different reasons that Fannie was able to turn a profit. The WSJ reports:

Part of the profit is due to gains that resulted from an upswing in interest rates earlier in the year, according to Jim Vogel of FTN Financial. He pegs the contribution to profit at around $1 billion. With rates having retreated recently, this could reverse in the current quarter.

Another factor was an improvement in credit quality leading Fannie to set aside less money to cover souring mortgages. That the company needed $2 billion in provisions for credit losses, compared with $10.5 billion a year earlier, is positive. It shows Fannie's losses are growing at a slower rate, while profit from more recent, better-quality loans should bolster results going forward.

Fannie also said the serious delinquency rate for single-family mortgages declined to 3.67% in the first quarter from 5.47% a year earlier. A slower rate of home-price declines has helped on this front. 

The challenge for the future is that the Fed is promising continued low interest rates for the coming years, and there are million of homes that will be foreclosed on in the coming years as well. Losses will likely slow, but continue to mount in coming quarters. 

Freddie Mac also had a relatively good quarter, asking for "just" $19 million to cover losses from the first three months of the year. The combined total taxpayer bailout from 3Q2008 to 1Q2012 for Fannie and Freddie is now:

$71.365 billion (Freddie) + $116.2 billion (Fannie) = $187.565 billion

Here is an updated list of Fannie Mae's quarter bailout needs:

• 1Q 2012 — $0B
• 4Q 2011 — $4.6B
• 3Q 2011 — $7.8B
• 2Q 2011 — $5.1B
• 1Q 2011 — $8.5B
• 4Q 2010 — $2.6B
• 3Q 2010 — $2.5B
• 2Q 2010 — $1.5B
• 1Q 2010 — $8.4B
• 4Q 2009 — $15.3B
• 3Q 2009 — $15B
• 2Q 2009 — $10.7B
• 1Q 2009 — $19B
• 4Q 2008 — $15.2B
• 3Q 2008 — $0B

See last quarter's post on Fannie Mae's losses here.

See full coverage of Fannie Mae and Freddie Mac here. 

 

A Long Slog Ahead on Unemployment

Posted on May 10, 2012, 4:10pm | Anthony Randazzo

There have been a lot of stories lately about the challenges of college graduates finding a job. They aren't without merit. Here is a snapshot of the problem from The Wall Street Journal:

Graduating college students face a mixed job market at best this year, and most will leave school without an offer in hand, despite an uptick in hiring by on-campus recruiters... In a study to be released Thursday, the John J. Heldrich Center for Workforce Development at Rutgers University found that recent graduates are taking awhile to find work. Only 49% of graduates from the classes of 2009 to 2011 had found a full-time job within a year of finishing school, compared with 73% for students who graduated in the three years prior.

Daunting numbers. Here is how BLS April 2012 unemployment numbers look— 

• 20 to 24 year-olds: 13.2 percent 
• Men 20 to 24 years-old: 14.1 percent
• Women 20 to 24 years-old: 12.3 percent
• New entrants to labor force: 11 percent
• Overall unemployment: 8.1 percent

The links to those numbers will update each month so if you're reading this in June 2012 or later follow the link to see what the status is.

As bad as these numbers are, the unemployment problem is really worse than this. To start, the labor force participation numbers are artificially reducing the headline unemployment number, so there is more than 8.1 percent of the work force that is unemployed. Beyond that, there are several long-term demographic trends that are weighing on the labor force today. In a column over at Reason.com this afternoon I outline these trends and frame up a pretty negative outlook for the employment market.

(Video) Interview on Reason's New Mortgage Reform Study

Posted on May 10, 2012, 2:12pm | Anthony Randazzo

Earlier this week I appeared on Fox Business to discuss our recent Reason Foundation study "Restoring Trust in Mortgage Backed-Securities." We argue that to end the government housing monopoly and reduce the $5.8 trillion in mortgage debt liability taxpayers have as a result, that Congress should authorize MBS investors to have access to more information about the mortgages they are buying, and that the mortgage industry should create a group to create clear mortgage definitions that do not rely on federal regulations like the qualified residential mortgage.

Read the full study here

See our press release here.

Also, read our summary op-eds at RealClearMarkets and the DailyCaller.

Freddie Mac Takes $19 Million More from Taxpayers

Posted on May 8, 2012, 7:01pm | Anthony Randazzo

Freddie Mac reported last Thursday it needs $19 million from the U.S. taxpayers to remain solvent after making a dividend payment to the Treasury department following first quarter 2012 financial reporting. The government-sponsored enterprise made a net profit in the first quarter, but that was before factoring in the dividend payment they have to make to Treasury for the luxury of being bailed out of losses from previous quarters. Freddie asked for a total of $19 million from Treasury for for the first quarter of 2012. 

In total, Freddie Mac has received $71.365 billion in bailout money from the U.S. Treasury since FHFA took the GSE into conservatorship in late August 2008. Here is the most recent breakdown of taxpayer quarterly checks for Freddie Mac:

• 1Q 2012 — $0.019 billion
• 4Q 2011 — $0.146 billion
• 3Q 2011 — $6 billion
• 2Q 2011 — $1.5 billion
• 1Q 2011 — $0
• 4Q 2010 — $0.5 billion
• 3Q 2010 — $0.1 billion
• 2Q 2010 — $1.8 billion
• 1Q 2010 — $10.6 billion
• 4Q 2009 — $0
• 3Q 2009 — $0
• 2Q 2009 — $0
• 1Q 2009 — $6.1 billion
• 4Q 2008 — $30.8 billion
• 3Q 2008 — $13.8 billion

Last quarter Freddie asked for $146 million, so at least their asks have been declining since the third quarter of 2011. (See full details here.)

See our full coverage on Fannie Mae and Freddie Mac here.

Video: French and Greek Elections Were Not Proof Austerity Doesn't Work

Posted on May 8, 2012, 10:18am | Anthony Randazzo

Over the weekend France elected a new president, the Greeks shuffled their parliamentary make up, and Germany's leading party lost some local elections. The votes are viewed as a push back against the way European governments have handled the continent's sovereign debt crisis. Some analysts have been quick to argue that this proves austerity doesn't work. 

And that is the basis of the debate in the video below, a panel discussion from RT last night. However, I argue that this doesn't prove much of anything about austerity in general. Citizenry are not to be blamed for being upset with austerity measures. The whole point is that it doesn't feel good to get your fiscal house in order after a spending binge. The democratic reaction doesn't suggest the viability of the plan's capacity to achieve its goal of reducing government debt. 

While the elections don't say anything about the viability of the idea of austerity, at least the Greek election suggests that the form that austerity has taken in Greece is not the best approach. The big winners in the parliamentary elections were groups that despise outsiders and want to take back control of their country. Their win was the Greek people (at least the very low 65 percent of them that turned out to vote) saying it is unfair for Greece to take sharp budget cuts while still being saddled by the Euro so that the rest of Europe can avoid GDP losses that would occur if Greece left the European monetary union today. Eventually they will have to leave, but for now Europe gets to wall off that threat and plan for an orderly break.

In France, the election could also be seen as a nationalistic movement. All indications are that the vote was more anti-Sarkozy then pro-Hollande. There is a bit of populism that likes his tax the rich mentality. But Hollande seem to win over France with his Mr. Normal pitch vs. Sarkozy's flashy style that has worn out its welcome in France. Moreover, there could be some frustration in France that Sarkozy allowed Germany so much run of the house on the debt crisis negotiations. Germany will now have to deal with a more nationalistic government when sorting out coordinated actions to bail each other out.

(Side note on Greece: it is unlikely they will be able to form a government that lasts. The two parties receiving the most votes only form about 30 percent of the parliament, making it necessary for a big tent coalition to work out in order to avoid a new election. And even if that happens, such a coalition will be very susceptible to the need to make big decisions on budget cuts and handling negotiations with the rest of Europe. Further complicating the matter is the scatter shot approach that the Greek populace took in their choice of representatives this year. Not only did a far-right, neo-nazi group get 20 seats, but a far-left, old line communist group also got more votes then they'd seen in a long time. History does not need to be consulted that far back to suggest that the combination these two failed ideologies mixing as one is not likely to be the chemistry needed to get Greece on solid footing.) 

A Few Quick Thoughts On Mortgage Rates

Posted on April 30, 2012, 8:48am | Anthony Randazzo

The primary source of the pressure for banks and the GSE to refinance mortgages is so that those with rates around 7 percent and 8 percent can reduce their payments with the historic rates of around 4 percent that the Federal Reserve has helped artificially engineer. 

 

• Some banks don't want to refinance mortgages because the loans are underwater.
• Other banks are just backed up on the paperwork.
• Still others are just bad at the job they are supposed to perform.

 

Whatever the case, there at least two things worth considering: even a 7 percent mortgage is a good thing in relative terms, and even without a massive, national refinance program, mortgage rates on outstanding debt have been falling.

Consider the below chart developed from recently released BEA data:

The average effective rate of interest on mortgage debt never fell below 8 percent from 1977 to 1996 (that is the farthest back the data goes). After the housing finance policy changes of the 1990s began to take effect in 1995 and 1996, we see the effective mortgage rate drop below that threshold. For the first quarter of 2012 the effective rate on all outstanding mortgage debt was 5.115 percent, and it has fallen every quarter for the last 24 quarters, or since the 2Q2006. 

There does not seem to be an immediate need for a massive refi program to push past the legal boundaries of mortgage law. Banks should become better at customer service, process decision faster, but still be allowed to make prudent calls on what would be the most profitable for their shareholders—many of whom are taxpaying Americans.

Considering Causes of Recessions vs. Rates of Recessions

Posted on April 27, 2012, 3:14pm | Anthony Randazzo

High school economics wunderkind Evan Soltas put an interesting chart (see below) on his blog yesterday that The Atlantic's Matt O'Brien pointed out to me, asking for a libertarian response. I lightly and respectfully undertake an attempt below.

Evan writes that he pulled the chart together from FRED and NERB data showing that recessions have slowed down considerably since the 1850s. This is not incredibly new information—it is widely understood that since the 1930s that volatility is much more subdued than in the 19th century—though I had not seen the information presented like this before, to Evan's credit. 

(The chart was an embedded interactive file so I had to take a screengrab to show it here, but check out the original on Evan's blog here.)

By itself this chart doesn't tell you much until you start putting pieces of information on it to extrapolate as to the cause. For instance, Evan argues: 

In libertarian circles, the late 19th-century is seen as the pinnacle of growth and of laissez-faire and treated with according reverence. That story is not really true. Statistics which show unprecedented growth during the Gilded Age, I worry, are either imprecise, inaccurate, or worse, gamed according to their start- and end-points... It would be very possible that [GDP] grew quickly in between the frequent recessions, but the data do not support such a case: from 1800 to 1840, real GDP per capita grew at 0.4 percent annually; from 1840 to 1880, 1.44; from 1880 to 1920, 1.78; from 1920 to 1960, 1.68; from 1960 to 1978, 2.47.

I don't want to put words in Evan's mouth, but it appears the underlying assumption is that it was the creation of the Federal Reserve, victory of new Keynesian economic policy, Glass-Steagall, deposit insurance, and a less laissez-faire system that enabled the faster growth in the 20th century. Furthermore, I take an assumption that our present state of fewer recessions and GDP average growth of 2 percent over a multi-decade period is preferable. (I'm happy to be corrected if I am in error on these judgments.)

While I have not dug into this specific data myself for any extended period of time (and it appears there was a detailed attempt here anyway), there are a few things to consider in performing such economic analysis. To start, recessions are not ubiquitous events. They are not created equal. Their causes matter more than their numbers. For example, we might prefer five recessions that are six-to-eight months long scattered between 2002 and 2012, all caused by over investment in tech firms like we saw in the wake of the dot-com bubble's burst, to the boom from 2002 to 2007, followed by the 19 month recession, and then three-plus years of tepid economic growth. 

In the former scenario we are less likely to see recessions substantially impact household debt or long-term consumption trends. Spending would tighten up for a few months, balance sheets would be cleansed a bit, but the level of toxicity would not be so dramatic as to cause the losses we've experienced in the wake of our most recent bubble's bursting.

In the later scenario we have only 19 months of recession to deal with as opposed to as many as 40 months of recession to wrestle with. And we achieve much higher living standards for at least half of the time period. However, there is no inherent, objective measure that suggests this is better than the alternative scenario that I set up.

Nor is my alternative objectively better either. If the causes of those frequent recessions were bank runs that caused liquidity tightening and wide-spread bankruptcies as businesses failed to get access to credit to finance their payrolls, then we might not see quick bounce backs and the effects of those regular recessions could bleed into each other creating the environment Evan's data suggests for the middle part of the 19th century (which did include a devastating Civil War, by the way). 

All of this merely points out that the frequency of recessions is a relatively unimportant data point. It is the sources of such recessions. 

So to the second assumption, on the causes of the decreased volatility. This is a complex question. I pointed out the declining savings rate of the 1980s, 1990s, and 2000s earlier today on this blog and how this contributed to the economic boom years following the end of Stagflation and the Reagan recession. Perhaps if there were no technical advances to give us credit cards or if we were a less trusting society we would have had slower economic growth. Would this change have then discredited Reaganomics or influenced the way we view tax rate impact on GDP growth? Probably. 

The point here is to merely suggest that GDP growth rates as higher in the 20th century on average relative to the 19th century don't suggest much about the realities of the Gilded Age. What would the 20th century have been without the technical evolutions that gave us cars, planes, global telecommunication, and computing power? Back in 2008, this country would have given up a lot to get a 1.5 percent GDP growth rate. 

Evan concludes that his chart and argument shows "a very different picture of America, when you think about it. Frequent recessions, slow growth, little improvement in living standards, profound inequality -- all of this against what we have (had?) in the postwar era: fewer recessions, faster growth, faster improvement of living standards, less inequality."

On its face this is an efficiency argument for the central bank era vs. a supposed lassiez-faire era. The problem is that this assumes the desirability of a recession rate, speed of economic growth, and level of equality all divorced from their causes. That's not a leap of logic we should lightly undertake. 

GDP Falling Back to 2.2% is Not Surprising

Posted on April 27, 2012, 9:25am | Anthony Randazzo

 

The BEA released first quarter of 2012 GDP data this morning, with the headline figure coming in at 2.2 percent growth. This was to be expected.

GDP growth for the last quarter of 2011 was primarily built on businesses spending money to add products to their inventories. It was further manipulated by a low adjustment for inflation. Even with BEA today reaffirming its 3.0 percent growth rate for 4Q2011, there is still a measure of cognitive dissonance and gaming of the figure to look stronger than growth on Main Street really was. 

Now we get a 2.2 percent for 1Q2012 figure. 

One positive is that personal consumption accounted for 2.04 of the 2.2 growth, compared to 1.47 of 3.0 at the end of 2011. In contrast inventory building was just 0.59 percentage points of the 2.2 percent growth figure, relative to 1.81 percentage points added to 4Q2012.

The major negative shift in bringing down GDP growth, however, was a combination of reduced inventory building and decline in non-residential fixed investments, like buildings, equipment, and software.

So at the end of 2011 businesses were spending a lot, likely to take advantage of depreciation rules that allowed many fixed investments to be written off of taxes at 100 percent, and consumers were a bit tepid in the holiday season. For the first three months of 2012, consumers are spending a bit more, and saving a bit less.

The reduced savings rate, from $466.0 billion in the first quarter compared with $530.8 billion in the fourth (or 3.9 percent in the first quarter compared with 4.5 percent in the fourth), means more contribution to GDP in this measurement period, but it also means less stability for the long term. One of the problems of the economic boom from the 1980s through the 2000s was that it was build in part on a declining savings rate. 

In the chart below you can see that personal savings as a percentage of GDP fell steadily from 1982 (the end of the Reagan recession) to 2006 (the height of the housing bubble). During the recession there was a sharp bounce back in savings, but since the recession ended in mid-2009, the savings rate has begun to decline again. 

Another way to look at savings is in fixed dollars. Here, data from the BEA shows that savings maintained a relatively stable line until the 2008-09 recession (spiking a bit in relative relation to its levels during the 2001 recession, but not much change measured against the 30 years measured here). But now the savings rate is falling. That could be interpreted as a positive thing for GDP growth in the coming quarters, or as signalling a return to imprudent spending behaviors by the American public and some new, unstable bubble. 

Other, somewhat neutral news was that consumption of automobiles and parts declined 27 percent from the last quarter of 2011 until now, though it was nearly double the rate from the first quarter of 2011. 

We've now had six straight quarters of negative change in consumption of gasoline and other energy goods. And transportation services remained at a less than 2 percent change from quarter to quarter for the sixth straight month as well. 

 

The Fed As Source of Income Inequality

Posted on April 23, 2012, 2:24pm | Anthony Randazzo

We've noted before that income inequality is not inherently a bad thing—what matters is the source of the inequality. In last week's WSJ, hedge fund founder Mark Spitznagel points out one bad source creating artificial income disparagement... the Fed:

 

The Fed doesn't expand the money supply by uniformly dropping cash from helicopters over the hapless masses. Rather, it directs capital transfers to the largest banks (whether by overpaying them for their financial assets or by lending to them on the cheap), minimizes their borrowing costs, and lowers their reserve requirements. All of these actions result in immediate handouts to the financial elite first, with the hope that they will subsequently unleash this fresh capital onto the unsuspecting markets, raising demand and prices wherever they do.

The Fed, having gone on an unprecedented credit expansion spree, has benefited the recipients who were first in line at the trough: banks (imagine borrowing for free and then buying up assets that you know the Fed is aggressively buying with you) and those favored entities and individuals deemed most creditworthy. Flush with capital, these recipients have proceeded to bid up the prices of assets and resources, while everyone else has watched their purchasing power decline.

At some point, of course, the honey flow stops—but not before much malinvestment. Such malinvestment is precisely what we saw in the historic 1990s equity and subsequent real-estate bubbles (and what we're likely seeing again today in overheated credit and equity markets), culminating in painful liquidation.

The Fed is transferring immense wealth from the middle class to the most affluent, from the least privileged to the most privileged. This coercive redistribution has been a far more egregious source of disparity than the president's presumption of tax unfairness (if there is anything unfair about approximately half of a population paying zero income taxes) or deregulation.

 

See the full article here.

Durbin Swipe Fee Watch V: Gas Retailers

Posted on April 23, 2012, 12:20pm | Victor Nava and Anthony Randazzo

It is time for another edition of the Durbin Swipe Fee Watch. 

Recall that the Durbin Amendment was a last minute measure added to the Dodd-Frank Act. The provision, which directed regulators to cap bank interchange fees-the fees banks charge retailers in order for the retailers to use the banks debit card-was naturally lobbied for hard by retailers. Regulators later set the limit at 21 cents per transaction, less than half of the average 44 cents per transaction prior to the rule.

At the time, Senator Durbin hoped that the lowered fees would reduce prices and amount to savings for consumers. That hasn't been how the movie has played out though. 

The most recent evidence comes from new research showing that while the automobile gas retail industry has achieved $1 billion in annual savings from the lowered swipe fees, these are not savings being passed on to consumers. Of the 134 billion gallons of gasoline sold in 2011 approximately 48 billion gallons were purchased using debit cards, and with the average savings for gas retailers of about 3 cents/gallon on debit card purchases courtesy of the Durbin Amendment, you get the $1 billion figure. The reduced swipe fees mean less cost for the retailers, but what about the consumers?

With debit as the overwhelmingly most popular payment choice at the pump (comprising of 36 percent of all transactions), the reduced swipe fees have essentially given the gas retailers a subsidy windfall rather than any savings for consumers. 

It is well documented that gas price averages were 26 percent higher in 2011 compared to 2010. Much of this could be blamed on the Arab Spring or Federal Reserve's QE programs driving up commodities prices. The data shows that consumers should be seeing a 4-5 cent discount for an average 16 gallon pump when they pay with debit. But with prices ever climbing the ill conceived Durbin Amendment has just put that money into the pockets of the gas stations.

While it is not necessarily a bad thing that small businesses (gas retailers) have reduced costs, it is a problem that this has come at the expense of other businesses (banks), all because Washington decided to pick favorites. Disguising their rule as somehow for the betterment of consumers has simply become a joke.

We predicted this back in 2010. Since Durbin Amendment's directed regulation has started its film reel many banks have ended debit card reward programs and flirted with monthly debit card fees. Retailers such as Redbox have even had to increase prices as a direct result of the Durbin Amendment. All of this has caused measurable harm to consumers, with little evidence of an aggregate benefit for them, and all this while big box retailers stand to make millions and more. The notion that businesses would voluntarily pass along these savings to consumers and that the banks would not find other ways to make up for lost revenues is baffling, and very short-sighted by the U.S. Congress.

Now in its fifth edition, the Durbin Amendment Swipe Fee Watch has reached the level of both the Rocky and Planet of the Apes movie franchises in that, like both Rocky V and Battle for the Planet of the Apes, you are now wishing the Durbin Amendment never happened. We all fear the release of the next edition.

FHFA, DeMarco, and the Politics of Mortgage Modifications

Posted on April 16, 2012, 12:05pm | Anthony Randazzo

Mortgage principal write downs are not a Republican v. Democrat issue. At least they should not be. But just as global warming apologists and deniers split down party lines without much to connect the deep roots of conservative ideology or progressive tradition, so too have mortgage modifications become a partisan issue.

In this context, the recent comments from FHFA Acting-Director Ed DeMarco are interesting for the responses that he has gotten. He has not, despite his favorable tone given to modifications last week that has not been heard in years, changed is tune. Nor has he given blank approval to modifications. Rather, he has always relied on FHFA analysis to determine what would involve the lowest possible losses for the taxpayers and has until now come up with a "no modification" strategy. Now the analysis is providing some room for modifications.

In the wake of the FHFA report, there has been a host of comments from both sides making political hay out of DeMarco's words. Few have argued that FHFA's analysis suggests reducing taxpayer losses at the GSEs by accessing a taxpayer funded incentive program called HAMP, in effect making a gimmicky accounting transfer (that is admitted in the FHFA report as a trade-off). Rather, the comments have been black and white views on principal write down as some kind of poison or healing potion, depending on the view. 

So lets clear a few things up: How do mortgage modifications, principal write-downs or refinances, fit into the democratic platform any different from a republican platform? Does one party prefer the housing market to suffer while the other not? No. Nothing inherent about modifications makes this a partisan issue.

To hear the democrats tell it, the republicans do want the housing market to suffer more for wanting to see housing prices bottom out. Ironically, while it would be a good thing for housing prices to bottom out, most republicans (at least in Congress) have shied away from the legislative options put in front of them that would actually have the housing market bottom (lowering the conforming loan limit, unwinding the GSEs, etc). And there have been few voices on the Hill crying out about the injustice of the mortgage settlement—at least in regards to the way it treats contracts and pension funds. 

To the the republicans tell it, the democrats want to just give free handouts to deadbeat borrowers who took on more than they can pay back. Ironically, while it is true that a wide spread principal write down program divorced from case-by-case economic consideration would involve free handouts to deadbeats, the GOP stands in favor of the mortgage interest deduction which gives free handouts to successful homeowners—and the point of the critic is the handout, not the deadbeat or the actual homeowner. More over principal write downs are not always bailouts.

The reality is that writing down the principal on a mortgage, which the investor or owner of the loan chooses to do so, can be the best way of recouping lent funds. Sometimes the losses will be higher without the write down. Sometimes the best guess at maximizing return is principal forbearance, rather than a straight up write off of the debt. And sometimes foreclosing on a home, fixing it up, and selling it, will yield the highest return.

Every case is different. Mortgages are individual products that, even if offered with the same dollar amount on the same terms, have different risk profiles based on the borrower (which has a wide number of variables) and the geographical location of the mortgage.

Even trying to estimate a mortgage's risk profile based on zip code can be inaccurate because the possibility of vastly different neighborhoods and development prospects with a sometimes wide geographical zone defined by zip code. (If investors had access to address level data due diligence would be much more reliable.)

So it is ridiculous to reject principal write downs universally—as the GOP has done. And it is ridiculous to accept them blindly—as the democrats have done.

What we have written time and again is that the evidence suggests that principal write downs are often times not the best way of getting money back for lenders. That means forced principal write down programs are a bad idea—no reason to force banks to take losses. It means that the GSEs should not start writing down mortgage principal in large chunks—no reason the taxpayers hould have to cover those losses too.

But all of that is in the abstract. I don't manage the GSE mortgage portfolio or the Wells Fargo portfolio of loans. Only those running the numbers can estimate on what the best option should be. I can point to the fact that more than half of the modifications under HAMP have failed. And we have done so in trying to push back on the idea that modifications are some how the panacea needed in the housing market. 

They are not. But they might be answer to some mortgages.

Enter Ed DeMarco last Tuesday, who noted that in "some circumstances" lowering the mortgage debt level of borrowers could reduce the possibility of default. Such a conclusion is not earth shattering. While a majority of the HAMP modified mortgages have failed, some have succeeded and theoretically staved off foreclosure. What has been missed in many stories about DeMarco's speech is that he was clear to point out that principal write downs are not a "magic bullet," and the benefits are "limited." 

He is right to say these things and the GOP is wrong to suggest that there should be no modifications (though modifying the principal on a mortgage the GSEs do not own would be a problem without authorization from the investor). Democrats are equally wrong to claim some sort of victory as if the debate over whether or not to go all in on principal write downs is won. This is ultimately a debate about servicing debt and managing the deleveraging process. It is a debate about what tools to use in preventing more taxpayer losses. DeMarco framed it this way:

"This is not about some huge difference-making program that will rescue the housing market. It is a debate about which tools, at the margin, better balance two goals: maximizing assistance to several hundred thousand homeowners while minimizing further cost to all other homeowners and taxpayers."

I will offer this critique of FHFA's analysis though. FHFA suggests it can reduce losses to the taxpayers by $1.7 billion by taking advantage of incentive payments made by HAMP to those who write down mortgage principal. The challenge is that in order to do this, the taxpayers have to pay out those HAMP fees. So in this particular case, the FHFA "savings" to the taxpayers is little less than an accounting gimmick. It is possible that principal write downs would save taxpayers from higher losses, but if it is only because the losses are otherwise subsidized by the taxpayers then there is no net gain and moral hazard from the write downs wins the day.

Sheila Bair on the Prowl, a Guide

Posted on April 16, 2012, 8:40am | Anthony Randazzo

My first thought when I read the soon-to-be infamous Sheila Bair op-ed in the Washington Post this weekend was to laugh out loud and share the $10 million-loan-for-everyone suggestion with the driver of the taxi I was traveling in through downtown D.C. My second thought was "damn, I wish I'd had written the case against ZIRP like that." 

In fact we have written similar arguments as the former FDIC chairwoman articulated her humorous and cutting commentary. But not in the tone that she was able to articulate, shining a light on what has truly become a farce: the Federal Reserve's free money passed out in bulk to Wall Street to "support" the financial system. The idea Bair proposes is completely crazy, but that is the point. She is just articulating what Fed policy is for the financial system, and it is no less crazy to be handing them billions in free loans. 

Here is a guide to understanding the Bair tongue-anchored-to-cheek op-ed. First she writes:

For several years now, the Fed has been making money available to the financial sector at near-zero interest rates. Big banks and hedge funds, among others, have taken this cheap money and invested it in securities with high yields. This type of profit-making, called the “carry trade,” has been enormously profitable for them.

So why not let everyone participate? Under my plan, each American household could borrow $10 million from the Fed at zero interest. [...] Think of what we can do with all that money. We can pay off our underwater mortgages and replenish our retirement accounts without spending one day schlepping into the office. With a few quick keystrokes, we’ll be golden for the next 10 years.

Such a suggestion is usually overheard at one of D.C. well attended liquor and beer distributing establishments. Well, except for the bond trading part. The difference between professional investors and Americans suddenly power-ball-lottery-winner rich is the disciple to "order up a few trades" as she puts it later in the piece. Theoretically, if everyone just bought sovereign debt and lived off the interest we could avoid an inflation problem of all that new money chasing far too few widgets made by a rapidly declining labor force. But it is much more likely that all that money would flow into the economy, ruining creditors who are paid back to complete the deleveraging cycle, but unable to buy much with the now worthless cash that has been paid back to them (via Fed helicopter).

Bair begins to expose her point when suggesting how the "carry trade" could be accomplished for America's new denizens of wealth: 

The more conservative among us can take that money and buy 10-year Treasury bonds. At the current 2 percent annual interest rate, we can pocket a nice $200,000 a year to live on. The more adventuresome can buy 10-year Greek debt at 21 percent, for an annual income of $2.1 million. Or if Greece is a little too risky for you, go with Portugal, at about 12 percent, or $1.2 million dollars a year. (No sense in getting greedy.)

This is actually what financial institutions have been doing with all that Fed money. The bailout was supposed to shore up bank balance sheets so the failed institutions could lend. Quantitative easing was supposed to free up capital from assets and let the fresh money boost the economy. Zero interest rate policy (ZIRP) has long been declared necessary to encourage borrowing and keep housing prices propped up.

But all this has done is contribute to a limping, recoveryless recovery. As we predicted in Reason magazine two years ago, we've been going "sideways" for a while. And that is Bair's beef with the Fed.

She also has a barb to throw at Congress:

Of course, we will have to persuade Congress to pass a law authorizing all this Fed lending, but that shouldn’t be hard. Congress is really good at spending money, so long as lawmakers don’t have to come up with a way to pay for it. Just look at the way the Democrats agreed to extend the Bush tax cuts if the Republicans agreed to cut Social Security taxes and extend unemployment benefits. Who says bipartisanship is dead?

Fair point. When it comes to actually helping the economy, Congress goes AWOL. When it is time to score some political points, compromise abounds (under the cover of something substantive happening). Bair doesn't hold back from going after social issues either in the piece:

Because we will be making money in basically the same way as hedge fund managers, we should have to pay only 15 percent in taxes, just like they do. And since we will be earning money through investments, not work, we won’t have to pay Social Security taxes or Medicare premiums. That means no more money will go into these programs, but so what? No one will need them anymore, with all the cash we’ll be raking in thanks to our cheap loans from the Fed.

[...]

We can stop worrying about education, too. Who needs to understand the value of pi or the history of civilization when all you have to do to make a living is order up a few trades? Let the kids stay home with us. They can play video games while we pop bonbons and watch the soaps and talk shows. The liberals will love this plan because it reduces income inequality; the conservatives will love it because it promotes family time.

The frightening thing is that many of these attitudes are prevalent in American society even without the $10 million loans. 

The tax code is skewed. The answer is not to raise tax rates—the income tax system is a terrible way to tax a society and just slows down the economy—but that doesn't make the lower tax rates paid by wealthier segments of society any less damning. At the very least, the incentive structure of the tax code is set up to drive assets into many unsustainable things (like housing) and away from funding public liabilities (as Bair notes). 

Education is screwed up in America as well. Test scores are stagnant. High school graduation rates are sliding. Labor force mismatch issues are becoming an increasing concern. And it hasn't taken $10 million loans to end interest in math and history in many corners of America. 

So is Bair's solution viable? According to her, "This is the best American financial innovation since liar loans and pick-a-payment mortgages... Some may worry about inflation and long-term stability under my proposal. I say they lack faith in our country. So what if it cost 50 billion marks to mail a letter when the German central bank tried printing money to pay idle workers in 1923? That couldn't happen here. This is America." 

Touche. 

There will probably be more than a few out there who don't get the joke. But building on a pattern of loans without paper work to make everyone indebted to the Fed is not a serious policy proposal. Rather, her point is to channel the incredulous feelings of the readers into a criticism of the fact that the Fed does exactly this proposed idea, just with financial institutions instead of households. 

It is crazy and it has to stop. 

Discord in the Fed

Posted on April 12, 2012, 5:07pm | Anthony Randazzo

There is a bit of discord at the Fed. After Minneapolis Fed President Narayana Kocherlakota said earlier this week that the FOMC should consider raising interest rates later this year rather than maintain zero interest rate policy through 2014 (as is the current position of the Fed), vice chairwoman Janet Yellen remarked that ZIRP might actually need to be extended as far as 2015. The former San Francisco Fed President further commented in her speech at the Money Marketeers club of New York University that there has been "a significant shortfall in the overall amount of monetary policy stimulus since early 2009."

Then, at a meeting of the National Economics Club I was attending this afternoon, Philadelphia Fed President Charles Plosser note that when QE2 was launched in 2010 that unemployment was soaring and inflation was nill, and that because unemployment is falling and inflation is picking up that rather than talk about the need for QE3 we should be looking to tighten monetary policy.

After making this remark he backed off a bit and said he wasn't suggesting we should actually tighten monetary policy but rather just take it as a hypothetical response relative to the perceived need for QE3. 

Discord indeed.

At least the Federal Reserve appears to be about as conflicted as the blogosphere is on what to do and when to do it.

Barry Ritholtz On Housing Pessimism

Posted on April 10, 2012, 2:15pm | Anthony Randazzo

Last Friday, Washington Post columnist Barry Ritholtz broke down the pessimist's view on the housing market. With spring comes a traditional uptick in housing data, inspiring memory challenged journalists to wax philosophical about the bottom of the housing market finally being upon us and blue skys forever to come. But here are some reasons why that view is misinformed (regular readers will note these are not new concepts to this blog).

First, the shadow inventory:

 

"What is shadow inventory? This is important, as lowering the total inventory of houses for sale is how prices stabilize and sales volume moves higher... It includes bank-owned real estate, distressed houses not yet for sale, short sales and delinquencies that have not yet defaulted. Foreclosure properties are also in the shadow inventory. These houses will eventually become part of the total supply for sale. Although there is no official count, estimates of potential shadow inventory run as high as 10 million.

"That’s not all. There’s also a huge overhang of underwater homeowners — whose houses are worth as much as 25 percent less than what is owed. The owners don’t qualify for a mortgage modification. They may be delinquent but aren’t in default. Two-thirds of all U.S. houses have mortgages. Of those, an estimated 21 to 29 percent of the mortgages are underwater, or up to 16 million houses. When prices finally do rise, we can expect many of these no-longer-underwater owners to put their houses up for sale. If only one in three do, that is another 5 million homes in inventory."

Second, home affordability:

 

"Are houses affordable? Here’s where every discussion of affordability seems to start: the National Association of Realtors Home Affordability Index. In my view, it’s worthless. Why did I come to such a harsh conclusion? The index offers little insight into how affordable housing actually is. In the biggest run up in housing prices in American history, the index never dipped into the level of unaffordable. Imagine that.

"As ridiculous as that sounds, it’s even more absurd when we look at the NAR methodology, which ignores factors such as family savings rates, cash assets, consumer credit, indebtedness, credit servicing obligations, inflation and income gains. The affordability index looks at the wrong things and ignores the important ones. The correct question is not whether the houses are affordable in theory. Rather, it’s whether potential buyers can afford to buy them."

 

 

Third, how cheap house prices are:

 

"Are the prices cheap? Few had forecast the steep drop in median house prices. Some regions that were excessively frothy during the boom — California, Las Vegas, South Florida and Arizona — have seen much greater price drops. Other areas had laws (Texas) or financial conventions (New York City) that mandated significant down payments and other prudent requirements and avoided much of the bloodshed. The conventional wisdom seems to be that prices have stabilized and are overdue to start rising. The data, however, suggest something else. The most recent Standard & Poor’s / Case-Shiller index of national prices (January) shows prices are still falling, about 4 percent year-over-year."

Fourth, asset prices follwing a bubble:

 

"How do asset prices behave following a bubble? Regardless of the asset class — stocks, bonds, commodities, houses, etc. — assets do not merely stabilize. We have never seen a stock market run up into bubble territory and then revert to fair value. Instead, we careen wildly past that level, to deeply undersold and exceedingly cheap. That is the marvelous mechanism of markets. It is how assets are repriced, distressed holdings liquidated, capital markets stabilized, fools revealed, speculators punished — and money returned to its rightful owner, the prudent investor.

For a lasting recovery, we need to see houses cheap enough that they fall into “good hands” — long-term owners who can afford their mortgage payments. Until that happens, houses will stumble along the bottom of the price range. The nation could easily see another 10 percent to the downside — assuming nothing else goes wrong. This would actually be good news. The government interventions (first-time buyer tax credit, mortgage modifications and foreclosure abatements) have prevented prices from finding their own levels. If they did, houses would be much more affordable, and buyers would come out in droves.

That is how a true housing recovery begins.

Read the rest of the piece at Washington Post here.

 

 

A Financial Products Agency is a Bad Idea

Posted on April 3, 2012, 10:21am | Anthony Randazzo

Back in February Eric Posner and Glen Weyl, both of the University of Chicago and deservedly respected economic and legal minds, wrote a paper proposing a Financial Products Agency. The idea is relatively simple—just as the FDA must approve new food and drug products for consumption, an FPA should approve all new financial products with a test measuring for social benefit. 

This is a terrible idea for at least three reasons:

First, an FPA would not have stopped the financial crisis. Let us assume for a moment that this FPA existed in 1998. Back then, when subprime debt began to pick up its pace, there was little understanding of the risk that was building up in the system. We can't just assume that having an FPA would mean regulators have somehow gained hindsight. Regulators were aware of what was going on to the degree that they had the resources to manage and the expertise to understand and didn't do anything then. Let's assume again that the FPA existed in 2004. Around that time regulators like Greenspan and Bernanke were well aware of the housing bubble but either did not think the risks were that big or did not think it was appropriate to step in. With rising housing prices (that all the regulators never thought would go down) masking the risks of subprime debt by preventing defaults, it is very hard to believe that regulators at this FPA would have done much to stop the risky financial products Posner and Weyl blame for contributing to the financial crisis.

Second, the model of the FDA is not a great idea unless you want to stunt markets. While the public has come to depend on the FDA to keep them safe there are regular outbreaks of diseases and complications with medicine. Even approved products can be misused. Beyond this, there are numerous cases where the FDA has prevented positive health outcomes, such as slowing down cancer prevention drugs for political reasons or sheer incompetence. And given the bureaucratic nightmare that is the FDA, it is impossible to know what drugs have not been pursued simply to avoid the compliance and approval costs and headaches. What we do know is that there is a growing problem of drug shortages in the U.S. and it is in part because of the FDA.

Finally, the whole argument for an FPA is based on the premise that derivatives contracts were significant contributors to the financial crisis. But derivatives—even the most risky contracts—are innocuous vessels. Blaming them is like blaming money for the crisis or computers. Though an argument can be made that there was too much money via central banks and too much computing power pushing high frequency trades, it is not the money or the computers but how they are used in connection with the other factors that caused the crisis. Derivatives contracts became a problem because the underlying assets they were being created with were misunderstood and financial institutions did not properly hedge their risk. If AIG had set aside the necessary amount of capital relative to its risk exposure, there wouldn't be as much carping about derivatives. If lending standards had not fallen so low, the subprime debt levels that did exist would not have been there to generate such a massive amount of unhedged, misunderstood, risky derivatives for subprime debt in the first place.

Unfortunately, despite these problems, the FPA finds the approval of NY Times business columnist Gretchen Morgenson, who wrote over the weekend regarding this proposed idea:

It is a refreshing rejoinder to the mantra on Wall Street — and in some circles in Washington — that financial innovation is always good and regulation is always bad. Bankers often argue that complex financial products are among America’s great inventions. But given that exotic instruments played a central role in the credit crisis, it is worth questioning the costs and benefits of such financial innovations. 

I agree that it is always worth questioning and debating and wrestling with ideas. That is the best way to avoid getting tunnel vision on something. But in this case, the idea under consideration is not a very good one.

Ms. Morgenson makes the problematic assumption at the start of her column that regulators would somehow have behaved differently if there were an FPA before the crisis. "Imagine if there were a Wall Street version of the F.D.A.," she says, "How different our economy might look today, given the damage done by complex instruments during the financial crisis." But as we were just pointing out, there was lot of authority to limit Wall Street. Financial markets are and have been one of the most heavily regulated industries in the U.S. But the only thing that I can think of that would have actually changed regulator behavior prior to the crisis would be something that eliminated regulatory capture. An FPA, just like the SEC, would have been filled with bureaucrats more than willing to use a light hand on approval procedures to ensure they had a job with some firm after their civil minded spirit got drilled into the pavement of Manhattan with one to many luxury cars. 

Then, Ms. Morgenson begins to lay out the case for the FPA, noting that the Posner/Weyl paper argues we should be able to regulate financial markets because they are different from the real economy, where a more laissez faire approach is good. The two leading problems with this argument are that:

1. Financial markets are so interwoven with the real economy that you can't truly separate the two. Financial markets are the lifeblood of new businesses, which in turn are the lifeblood of the U.S. economy. So anything regulations that unnecessary restrict credit are actually hitting the real economy; and
2. The problem is not a lack of rules but the absence of the right rules. If we learned anything from the crisis shouldn't a key lesson be that a lot of rules without regulators smart enough or inspired enough to enforce them winds up with meaningless protections and a false sense of security. It is foolish to depend on this regulatory crutch again and again. It is literally insane.

The next piece of the Posner/Weyl argument is that derivatives that are risky bear limited social utility and can cause system risk. I counter by arguing that: 

1. Just because something has limited social utility does not mean it should be restricted. Fantasy baseball may actually reduce productivity at work places across America, for instance, and may not get past a social utility censor. But I'll join up with an Upper Peninsula anti-government militia if the government tries to stop me from competing for glory; and
2. Derivatives in a market that has too-big-to-fail banks may cause systemic risk—but the problem there is the bloated banks and the lack of handling failed institutions. If every bank had 75 percent capital requirements there would probably be very little derivative risk. Of course we'd also have a nonexistent banking system. The key here is to solve for moral hazard and improper incentives in the system, not try to limit financial activity on the other side of the equation.

Ms. Morgenson further carries the Posner/Weyl case forward by noting they also want the proposed FPA to measure financial instruments for "how they affect capital allocation, and whether they might add useful information to the marketplace." Again, a couple of points:

1. How could an FPA really understand where capital should be allocated? Every regulator under the sun thought that capital flowing to the housing industry was a good idea during the bubble era. Imagine the FPA arguing in 2002 that there was too much capital flowing to the housing industry. It never would have happened, and on the off chance that our revisionist history unearths a Mike Burry to have influence in this FPA, the counter political pressure would have been too strong to let them do anything. Everything politically during the bubble was pushing capital towards housing. The Bush "Ownership Society" mantra. The previous decade's changes at Fannie and Freddie and FHA. Basel rules favoring housing. Even a massive accounting scandal at the GSEs failed to really derail their political or financial activities, so strong were the pressures to increase home ownership rates.
2. And why should a financial product be disallowed if it doesn't provide useful information to the marketplace? If I want to structure a deal with my neighbor where we place a complicated bet on the outcomes of real estate values from the properties of people two streets over, with a few voluntary counter-parties financing the bet... why should anyone else care? Posner and Weyl may respond they would care if my personal failure on coming up short in the bet posed a risk to the financial markets. But I would again push back that the problem then would not be the derivative contract but the fact that the system was so poorly incentivized that I could become a systemic risk.

The Posner/Weyl paper says in the introduction that Dodd-Frank is an empty vessel and on this point we agree. My remarkes are not a defense of Wall Street today or the regulatory system. This FPA idea is just not the right response mechanism to that problem. 

Regulators Making Moves to Force More Banks Into Mortgage Settlement

Posted on April 2, 2012, 10:49pm | Anthony Randazzo

A few weeks ago we warned that the mortgage settlement might not be limited to just the five banks that signed on, but that regulators would find a way to force others into the agreement, like PNC and US Bancorp. Well, today the NY Times reports:

Federal regulators are poised to crack down on eight financial firms that are not part of the recent government settlement over home foreclosure practices involving sloppy, inaccurate or forged documents. Last week, a senior Federal Reserve official recommended fines for these additional firms, raising questions about how deep foreclosure problems run through the banking industry.

The firms cited include, non surprisingly, SunTrust Bank, U.S. Bancorp, PNC Financial Services, plus five more: MetLife, EverBank, OneWest, Goldman Sachs, and HSBC’s United States bank division. The Times story continues:

The recommendation is the culmination of an investigation begun nearly two years ago over accusations that bank representatives had been churning through hundreds of documents a day in foreclosure proceedings without reviewing them for accuracy, a practice known as robo-signing. Some see the Fed’s recommendation as an attempt to push these firms to agree to the terms of the broader mortgage settlement involving the state attorneys general and federal officials. 

Count me as one of those seeing a push. More of a shove really. PNC, for example, believes that it is going to be required to sign on to the new national mortgage servicing standards and modify mortgages. But where Bank of America and JP Morgan Chase have plenty of investor mortgages to write down principal on—essentially using other people's money for their own fines—PNC does not. From their perspective this is unfair punishment, since they'll actually have to pay the fine.

In one sense, they are right. It isn't fair. But there really shouldn't be any write downs. There is a $1.5 billion settlement pool set up for the roboforeclosed and anyone whose home was wrongly seized can still bring legal suit. And if PNC and others committed the same failures they should pay into the settlement pool too. But modifying the mortgages of borrowers now, borrowers unrelated to the robosigning, is bad housing policy but extortion and not justice being served. 

 

Sound Money: Tide Laundry Soap Becoming Gold Standard in the Drug Trade

Posted on April 2, 2012, 7:57am | Anthony Randazzo

It is fitting that this story would surface around the same time that Bernanke has been harping about the gold standard. From TheDaily:

 

Law enforcement officials across the country are puzzled over a crime wave targeting an unlikely item: Tide laundry detergent. Theft of Tide detergent has become so rampant that authorities from New York to Oregon are keeping tabs on the soap spree, and some cities are setting up special task forces to stop it. And retailers like CVS are taking special security precautions to lock down the liquid. [...]

Tide has become a form of currency on the streets. The retail price is steadily high — roughly $10 to $20 a bottle — and it’s a staple in households across socioeconomic classes. Tide can go for $5 to $10 a bottle on the black market, authorities say. Enterprising laundry soap peddlers even resell bottles to stores. “There’s no serial numbers and it’s impossible to track,” said Detective Larry Patterson of the Somerset, Ky., Police Department, where authorities have seen a huge spike in Tide theft. “It’s the item to steal.”

So... what is up with this? Why Tide? Joseph Salerno picks up the story on the Christian Science Monitor blog:

 

This is just another confirmation of [Carl] Menger’s insight that the market responds to the absence of sound money by monetizing highly salable commodities. It is clear that Tide has emerged as a subsidiary local currency for black-market, especially drug, transactions — but for legal transactions in low-income areas as well. Indeed police report that Tide is being exchanged for heroin and methamphetamine and that drug dealers possess inventories of the commodity that they are also willing to sell. But why is laundry detergent being employed as money, and why Tide in particular?

Menger identified the qualities that a commodity must possess in order to evolve into a medium of exchange. Tide possesses most of these qualities in ample measure. For a commodity to emerge as money out of barter, it must be widely used, readily recognizable, and durable. It must also have a relatively high value-to-weight ratio so that it can be easily transported. Tide is the most popular brand of laundry detergent and is widely used by all socioeconomic groups. Tide also is easily recognized because of its Day-Glo orange logo. Laundry detergent can also be stored for long periods without loss of potency or quality. It is true that Tide is somewhat bulky and inconvenient to transport by hand in large quantities. But enough can be carried by hand or shopping cart for smaller transactions while large quantities can easily be transported and transferred using automobiles.

Sound money can be hard to come by.

 

 

FHA's Troubles Are No Myth, Despite What HUD Tries to Spin Away

Posted on March 30, 2012, 3:42pm | Anthony Randazzo

When we have a gala later this year for the Annual Unintended Consequences Awards, the Department of Housing and Urban Development is sure to be a leading nominee in the "Overall Body of Work for a Federal Department" category. Though I will give HUD a nod for at least recognizing the rising voices of opposition to its frequent missteps as they have developed a pattern of releasing "Myth vs. Fact" documents. Their myth memo for the mortgage settlement was a real strong effort towards securing the AUC Award, and now they have followed on with a recent release for comments on the Federal Housing Administration's struggles.

Former Fannie Mae chief credit officer Ed Pinto went through their 19-point "Myths and Facts Regarding the FHA Single Family Loan Guarantee Portfolio" document and pulled out a few of the most egregious comments. Here are some of his notes. (And bear in mind his four principles for FHA reform: 1) Utilize generally accepted accounting principles, and set rigorous disclosure standards; 2) Establish and maintain loan loss and unearned premium reserves; 3) Establish and maintain a minimum capital requirement of 4 percent of amortized risk in force; 4) Fund a countercyclical premium reserve.)

HUD Lables As Myth: FHA would be declared insolvent by state regulators were it a private mortgage insurance (MI) company.

HUD’s response does not deny the truthfulness of this statement.  Instead HUD points out FHA’s counter-cyclical role.  Yet during the boom HUD used FHA and other agencies and policies to lead a self-described “revolution in affordable housing”. The central policy of this revolution was the near elimination of downpayments, a pro-cyclical policy in the extreme.   HUD seems to espouse a policy of being pro-cyclical in booms and counter-cyclical in busts.

Elsewhere HUD points out that the FHA’s access to funding from the Treasury Department makes complying with private sector standards unnecessary.  This may be comforting to HUD, but the Congress and taxpayers deserve more than HUD’s assurances that all will be well. The FHA is the third largest financial guarantee entity in the United States, surpassed only by Fannie Mae and Freddie Mac (the GSEs). Yet it continues to operate under fiscal standards that can only be described as Byzantine.

 Consider the experience with the GSEs. In July 2008 the GSEs were given a clean bill of health by its regulator, the Office of Federal Housing Enterprise Oversight (OFHEO, now FHFA).  In a statement, OFHEO Director James B. Lockhart opined: "OFHEO has been monitoring and continues to monitor closely Fannie Mae, Freddie Mac, and the mortgage and financial markets. As one would expect, we are carefully watching the Enterprises’ credit and capital positions.  As I have said before, they are adequately capitalized, holding capital well in excess of the OFHEO-directed requirement, which exceeds the statutory minimums.  They have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets."

During the month of August 2008, the Department of Treasury hired Morgan Stanley to undertake an independent review of the GSEs. 

The taxpayers know all too sadly the outcome of this review—the very next month the GSEs were placed in conservatorship by FHFA with the bailout bill now approaching $200 billion.  

The questions relating to FHA’s current safety and soundness are substantive.  A review similar to the one undertaken with respect to the GSEs in 2008 is undoubtedly needed.  Under private accounting principles FHA likely has a current net worth of -$13.5 billion and an overall capital shortfall under its mandated 2 percent standard of over $32 billion.  This is clear evidence that FHA’s current capital is woefully inadequate today.   

There is hope that this critical review will take place.  On March 27, 2012 the Financial Services Committee of the U.S. House of Representatives without objection from a single Republican or Democrat agreed to H.R. 4264: “The FHA Emergency Fiscal Solvency Act of 2012.”     

Section 15 mandates that the Comptroller General of the United States provide for an independent third-party one-time safety and soundness review of the FHA “in accordance with generally accepted accounting principles applicable to the private sector.”

HUD Lables As Myth: FHA should hold capital levels like a private MI.

HUD bases its entire response on the erroneous statement that private MIs must “isolate their older’ weaker books of business from any recent and healthier year-by-year activity.”  This is not true.  Like the FHA, each MI consolidates all its annual books of business in computing a single capital position. Further, the private MI industry has raised or received over $10 billion in new capital since September 2007, none of which was segregated by book year.

FHA should not be allowed to operate is an unsafe and unsound condition, while it unfairly competes with a private sector that has invested and continues to invest real capital. As is noted below, FHA and other government guarantee agencies should credibly begin stepping back from markets that can be served by the private sector and return to a traditional 10 percent home purchase market share.  If this were done, more not less capital would enter the market.

HUD Lables As Myth:FHA masks expected losses by using overly optimistic assumptions regarding future home prices.

HUD appears to agree with this “myth,” but uses the excuse that the projections used in the November 2011 Actuarial Study date from July 2011.  No publicly traded company would be allowed to hide behind such an excuse. Again there is hope that HUD’s disclosures will be held to a similar standard as applies to the private sector.  Section 16 of the above referenced H.R. 4264 also sets disclosure standards for HUD with respect to FHA:

1. Disclosures must provide meaningful financial information and other information that is timely, comprehensive, and accurate;
2. Disclosures must not contain any material misstatements or misrepresentations;
3. Disclosures must make available all relevant information; and
4. Disclosure must not have material omissions that make the contents misleading.

The Congress and taxpayers deserve nothing less than timely, comprehensive and accurate disclosures from a trillion dollar financial entity. While HUD is to be commended for taking steps to increase premiums, eliminate incompetent lenders, and tighten some underwriting standards, it has done little to:

- Address the urgent need to move forward with housing finance privatization; and
- Credibly undertake a return to FHA’s core mission to provide sustainable lending to low- and moderate-income and minority borrowers. Today 90 percent of all mortgages are guaranteed by the Government Mortgage Complex (GMC), consisting of Fannie, Freddie, Ginnie/FHA. Ginnie/USDA, and Ginnie/VA.  Clear and credible steps must be taken to step back from the GMC’s market domination.  Yet even as FHA takes steps to reduce its share, much of the slack is merely taken up by Ginnie/USDA and Ginnie/VA.  

Follow Ed's regular FHA missives here.

Minimum Wage Kills the $5 Footlong in Frisco

Posted on March 29, 2012, 11:37am | Anthony Randazzo

As a rule, I hate the Subway $5 Footlong commercials. I give all due deference to the ad agency that came up with the promotion. From a business perspective it is brilliant advertising. Though the "catchy" nature of the tune is why I (and I'd imagine many others) despise them. Also, I am constantly frustrated at the workers in the Subway near our Reason office in DC for being so stingy with the black olives. (Who eats just four black olive slices?)

Nevertheless, annoyingly memorable commercials aside, that is no reason to attack and get rid of the $5 Footlong—which is effectively what San Francisco has done by raising the minimum wage to $10.24 this year. Here is the story from a local Bay Area NBC affiliate:  

The sandwich-making chain stopped selling the five-dollar footlongs in San Francisco due to the "high cost of doing business," according to SF Weekly. Signs posted at Subway sandwich shops sadly inform San Francisco patrons -- we hear Willie Brown is a big fan -- that "all SUBWAY Restaurants in SF County DO NOT PARTICIPATE IN Subway National $5.00 Promotions," according to the newspaper. [...]

Apparently, the city's new minimum wage, raised to $10.24 as of Jan. 1, make $5 footlongs an impossible business model.

This is not really surprising. The economics on the unintended consequences of the minimum wage have long been established. It is almost self evident: just ask why we should not raise the minimum wage to $500 or $1,000 a hour and you get the same answer as to how $10.24 per hour can be unsustainable.

Proponents of minimum wage laws suggest that businesses should just eat the extra cost, since those rich fat cat owners of capital and industry can afford it, so that the lower class folks can earn a "livable" wage (a term highly open to interpretation). But as Subway is apparently demonstrating, at a certain point you can't run at a loss. And so the costs are getting passed on to the customers of Subway in San Francisco. 

More from Reason on the minimum wage here.

Bernanke Resolved to Favor Traders, Inflation, and Government Debt with Continued ZIRP

Posted on March 27, 2012, 1:59pm | Anthony Randazzo

Fed Chairman Bernanke told the National Association for Business Economics conference this week that the labor market was still in “deep” trouble and so we should expect ZIRP (zero interest rate policy) to continue for the next several years.

His comments stand in sharp contrast with the hyper-campaign-mode-minded Obama administration, which insists its policies since taking over are the reason why employment is improving. Ignore the data in these charts hidden behind the curtain though: White House unemployment projection and unemployment rate including labor market non-participants and dissatisfied part-time workers. 

Putting the politics aside, what Bernanke is essentially saying is that he prefers the trade off of propping up stock prices versus encouraging savings. 

He prefers low rates that enable federal borrowing to be more manageable in excess versus allowing housing prices to fall to their natural bottom and homeowner debt deleveraging to pick up steam. 

Just like his comments on the gold standard last week, he has it all backwards. The Wall Street Journal notes:

Mr. Bernanke argued, seemed likely to require "more-rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies,"

The idea is that if consumers can borrow at low rates they can consume more. But since savings rates are next to nothing, ZIRP actually is dragging the consumer’s preferred preference of develeraging. So we don’t see housing hold debt declining very far nor is consumption carrying the economy forward.

The idea is that if businesses can borrow at low rates they will invest in their operations, hiring new workers with the cheaper cost of money. But since fiscal policy is threatening substantial regulatory and tax changes, and ZIRP itself creates inflation concerns, most new business activity gets sidelined in the uncertainty.

The idea is that with ZIRP, we can get positive inflation pressures that help stave off deflation. But deflation is often a good thing. Would you rather the price of iPhones go up or down? 

Finally, even if low-interest rates were the answer to jump starting the economy, they ignore that labor market problems go much deeper than the 2008-09 recession or the financial crisis. We have structural changes in the types of labor demanded in the U.S. that our workers are not well trained to accomplish. This is something that can’t be fixed over night nor can it be addressed by a simple economic growth upswing. 

From the WSJ:

How Rising Health Costs Will Hurt the Economy

Posted on March 27, 2012, 11:48am | Anthony Randazzo

Beyond just government spending on health care increasing in the coming decades, which is a rather hot topic this week, private health care costs are set to grow at an increasingly exponential rate in the coming years. This is not necessarily something new, as we've had rising health care costs for decades now. But what is going to be a challenge for the economy is that economic prosperity trends America had in the 20^th century were able to absorb these rising costs in a way we won't see in the next few years since those trends have flatlined.

Rising health costs are not new...

America has gone from spending $147 per capita on health care in 1960 to around $8,400 per capita in 2010 on health care. And as life expectancy has increased from 69 years to 78 years during that timeframe, the costs have picked up more rapidly. And that is not to mention that technological advances while more life saving have also been more costly.

But economic trendlines are flatlining...

Prior to 1960 we had a significant period of economic prosperity. Entrepreneurship and innovation and labor force expansion and education were all on the upswing in the early to mid part of the 20^th century. As a result, we were able to absorb inflating health care costs without it too dramatically hitting economic growth. However, all of those factors have flatlined at various points in the past few decades. And the trends are catching up to us. As a result, the increased costs over the next decade are going to have much more visible effects than in the past. Here are three examples:

1—Labor Market Participation: According to the most recent BLS data, there are actually more people outside the labor force today than there were a year ago when the unemployment rate was higher. If we were to add those who have stopped looking for a job in the past month to the labor data, the headline unemployment rate would go from 8.3% to about 9.6%, according to CBO projections. Unfortunately, this weak labor market participation is a long-term trend. The labor force stopped growing substantially in 1990, and today's labor force participation rate has actually declined to levels last seen in the early 1980s.

This is important because much of America's economic growth following World War II came with a substantial surge in labor market participation, particularly by women entering into the work force, going from 32.7% of the work force in 1948 to 58.1% in 2011. The baby boomer generation also helped fuel the economic boom. Larger labor pools enabled capital to be put to work more efficiently. Even if economic output continues to grow with all these workers on the sidelines, our output is dramatically lower than where it would be if we had more people working. A two-decade flatline in labor market participation that is declining means bad news for output in the coming years.

2—Education Results: At the same time that the labor force was expanding in the 20^th century, education gains were rapidly moving forward. From 1900 to 1970, high school graduation rates climbed from 6% of children to 80% of children. But since then we have flatlined, and even declined a bit in graduation rates. The number of high school grads relative to the population has fallen to 9.6%. Even with life expectancy and the baby boomers adding age to the overall population-this is a sign of substantial stagnation. Test scores in core subjects have also flatlined since the 1970s, according to a 2011 report from the National Center for Education Statistics. This may not appear to be a problem, but given the technological advances and teaching method advances since the 1970s, we should expect test scores to increase.

These and other flatlining education trends mean less competitive American workers, slower adaptation to shifts in economic fundamentals, and exacerbated employment problems. Low-skill labor opportunities are shrinking every day due to automation, efficiency gains, and the capacity to outsource some manufacturing work. Workers of the future will have to be even better educated then the current generation to compete in a world of skilled labor.

3—Innovation and Entrepreneurship: The lifeblood of the American economic miracle has always been new businesses. But since peaking in 2006, employment in new businesses and registration of new businesses has seen substantial declines. Entrepreneurship was down nearly 25 percent in 2011 compared to 2006. And economist Tyler Cowen has laid out a strong case that innovation has been one the decline in America since the 1970s. This means that innovation and entrepreneurship have had correlated slow downs with the labor market expansion's stall out and the drop off in educational advances.

This means weak economic prospects in the near- to medium-term...

All of this suggests we should not be expecting the big GDP growth period often seen after recessions. We have had a recession, a financial crisis, a global fiscal crisis, a national debt crisis all hit at the same time that innovation, entrepreneurship, education, and labor trends have taken negative turns. And this is not to mention that America's major growth sectors are changing and it is going to take time to reorient the work force to the new growth sectors.

What kind impact will these trendline shifts cause?

To start with, having more GDP resources taken up by health care spending means less business investment, translating into fewer jobs.

• Based on current policies, the CBO has recently projected that mandatory government healthcare spending will rise from 10.4% of GDP in 2012 to 12.8% of GDP in 2020. 
• Private health care costs are also expected to rise at an increasing rate over the remaining years of the decade as the Centers for Medicare and Medicaid Services projected last summer average annual health spending to outpace growth in the overall economy and reach $4.6 trillion in national health spending by 2020, or 19.8 percent of GDP. 

The more that health care costs consume GDP, the less capital the economy will have to build on. That means lower economic growth from business expansion, and possible continued challenges for unemployment over the next decade-don't be looking for that 6% unemployment rate any time soon.

In tandem, those rising health care costs are going to limit innovation and entrepreneurship. As new business start-ups are the lifeblood of the economy, this means lower GDP growth, translating into higher federal budget deficits.

Furthermore, rising health costs also mean the household debt situation will deleverage slower, hurting housing, and by extension economic recovery.

Conclusion

The take away here is that the impact of rising health care costs will be much more acute in 2020 than in 1980-unless of course we see some unexpected innovation that is on the scale of the Internet emerge to power the economy forward. Many of the growth trends we relied on in the path are flatlining and the low-hanging fruit of innovation is disappearing, as Tyler Cowen would say.

The good news is that the nature of todays and the next decades' economic woes are transitional. Our economic sectors are shifting. Our education system is not breaking down so much as struggling to adjust to changes in economic fundamentals. And the America spirit will adapt. The question is when.

Why a Judge Should Reject the Mortgage Settlement

Posted on March 23, 2012, 1:51pm | Anthony Randazzo

We've written a lot about the mortgage settlement's flaws over the past several weeks, but the one serious chance that exists for avoiding the mess it creates is for the U.S. District Court of DC to reject the settlement. In a piece for RealClearMarkets on Thursday I laid out the case that MBS investors could make in urging a judge to order the settlement renegotiated or at least prevent the banks from using investor money to pay for the settlement. Here is the heart of the matter:

The second complaint from MBS investors will be that they are innocent of any wrongdoing in this matter. There are eight counts in the complaint filed against the banks for the mortgage settlement including: unfair and deceptive loan servicing, foreclosure processing, and loan origination practices, violations of the False Claims Act and Servicemembers Civil Relief Act, and various misconduct relating to homeowners in bankruptcy.

MBS investors have no authority over how foreclosures are processed or whether the right fees are being charged. The investors rely on the servicers to do their job as much as the homeowners. It is purely the banks at fault in this regard (even if the overall settlement fine doesn't fit the crime). Vincent Fiorillo, a portfolio manager at DoubleLine Capital and AMI's board president, says, "The banks are trying to pay [their] fines with our money."

If it is true that investors were not responsible for any of these process abuses or failures, then banks are shifting their liability on to an innocent party.

See here for the full column. If the courts don't invalidate the settlement then be on the look out for other banks being forced to join the settlement by their regulator. PNC, US Bancorp, SunTrust and others are being talked about as possible banks that would agree to the same servicing standards and pay into the fines and modifications. The thing to watch for will be whether these banks join willingly, or if their regulator strong arms them into joining. 

Finally, below is an interview I did on RT covering the MBS investor case against the settlement:

As a side note, if a judge rules that banks have to use all of their own money for principal writedowns, refinancies, and short-sales it does not change the fact that the settlement is political extortion and that the settlement has nothing to do with robosigning. For that reason it should be rejected entirely.