OK. Pass 'em. Pass ''em fast. Maybe if it's done fast enough no one will see what it's in 'em. Stimulus Bills - full stimu-steam ahead...
Faster than a speeding bullet.
More powerful than a presidential veto...
Look up in the sky!
It's a BIRD!
It's a PLANE!
No!!!
Its a FLYING PIG!
Yes the stimulus plan is here when pigs fly!
It's a porkadelllic wonder!
That of course should cause us all to wonder what is in these bills. Republicans shunned the bills. Are they being obstreperous or do they have a point?
Cushion, Agenda and Stimulus
These are the holy trinity of the Obama plan: spending on his agenda, spending to cushion the blow of recession and spending to stimulate the economy, plus tax cuts. All spending comes under the name of stimulus but just because you call your cat "Fido' doesn't mean it will be happy eating dog food.
The Senate Plan - It is hard to categorize the spending. But I have looked at the Senate plan in more detail and my rough estimate is that its $365bln of spending is roughly 24% stimulus, 36% cushion and 40% agenda. Admittedly, constructing these categories is quite subjective but let's understand the idea first. 'Stimulus' is something intended to propel the economy ahead. 'Cushion' is something that will not propel the economy but will soften the blow of recession on parties injured by the recession in various ways. 'Agenda' is the pursuit of polices endorsed by the administration that are not clearly linked with helping the displaced or with cushioning the blow, although admittedly most dollars spent will have some positive role of cushioning the impact on somebody.
The House Plan - The CBO has scored the HOUSE plan and has found that of the House plan's $819 bln of spending and tax cuts only 21% will have impact in 2009 and by the end of 2010 only 64% of the plan will have had its impact on the deficit. Almost by definition then, we can say that 36% of the House plan is 'Agenda' since it is going to have its impact beyond the year 2010 and can't be categorized in any reasonable way as a recession buster.
Cush-Da-Lus
A reading of these plans which are for 'special spending' leads me to think they will not be as stimulative as the CBO expects since a lot of what Congress seeks to do in its bills is stuff that, in in the bill's absence, would have been pursued in the context of a normal budget by a new administration with an AGENDA. So if the normal budget is smaller because 'stuff' has been crammed into a stimulus bill (a bill with the the ingredients of cushioning, agenda and stimulus we could also call a Cush-Da-Lus bill) maybe the actual stimulus we get from that bill is even less than the CBO calculates. CBO, of course, calculates the stimulus as though it is in addition to the normal budget, but since we don't know what that is yet I'd argue that the risk is that passage of this as-it-is Cush-Da-Lus bill will leave the primary Obama deficit smaller than it otherwise would have been.
How to tell one type of spending from another
There are all sorts of clear Democrat agenda items in the spending portion of this bill. Much of it is on social welfare type plans. But the monies being spent in pursuit of Green also look much more agenda-like that stimulus-like. I say that because the markets, left alone, don't do Green. They don't because Green is not economic. So spending in which you spur that which is not economic surely is 'agenda' driven.
Agenda?
I am not taking agenda as a category that is bad. It is simply 'agenda' and not 'cushion' and not 'stimulus'. We have a new president and clearly he was elected to pursue a new agenda. My point is that a lot that is really agenda is getting mixed into the stimulus bill and it won't help to stimulate very much. It may even cut back on the amount of agenda spending that gets into the ordinary budget this year.
Angry Republicans have a point...but they did lose the election
It is no wonder Republicans are angry about how this is being done. You can disagree with my numbers but clearly there is a lot of Democrat policy that is whizzing past us in the sheep's clothing of stimulus.
Deja Vu baby...Deja Vu
This is the sort of thing that happens with stimulus bills as we saw last year. It is EXACTLY the SAME THING that the BUSH administration did with the IRAQ WAR VOTE, too a vote that Democrats hated so much. Well, what goes around comes around. Maybe it's a bit clearer why I have no love lost for either of these parties. Both like to kick the other when its down. Congress just can't help itself. Every emergency is an opportunity for someone to get a pet project or two - or maybe their favorite war - crammed in. Only the Senate and House know how the system works that determines who gets to attach the barnacle to the ship. Yeah, the ship will still sail, but not as efficiently.
I guess it's the American way. But when I use that term this is not what I have in mind...
Saturday, January 31, 2009
Wednesday, January 28, 2009
Mini max mini max mini max mini max
Mini-Max?
When it is hard to decide what to do, studies find that businesses often pursue what is called a mini-max strategy. While economics looks at transactors as maximizing agents that maximize things (income, output, utility, etc), min-max refers to a totally different way of acting. It refers to businesses making decisions under uncertainty so that if they make the wrong decision they minimize the damage that would come from that. Hence the term mini-max.
With that as background we can look at the Fed statement with what I believe is a fresh eye. The Fed does not simply do things based on forecasts. The Fed has to weigh and balance risks and scenarios as well. It is further aware that what it does today will affect events down the road since monetary policy works with a lag. It is also aware that what it does as well as what it says it does and how it says it will do it all have some impact on the markets. Welcome to the land of sophistication, if not sophistry.
The Fed undoubtedly uses the mini-max strategy too, since it may have a forecast but it can't be sure it is right. The Fed statement had several examples of that sort of complexity. The Fed noted that there were significant risks. It said that inflation may be too low for the needs of long term price stability and growth (..." the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term"... ). Yet it also said it expected growth to begin before the end of the year. So the Fed's statement seemed to emphasize certain aspects of its worry but in the end the Fed is forecasting growth.
Its policy statement had references to a lot of remedies. The Fed may be 'forecasting growth' before the end of the year but it is not going to sit back and wait. It is going to implement asset-backed lending. It is going to continue to buy mortgage-backed paper in the markets. And it sounds a bit more serious about buying treasury securities to try to lower long term rates (although I seriously doubt if that would have much impact).
So what we see is the Fed trying to guide our expectations to see growth while doing what it can to help ignite activity. Yet the Fed is still issuing warnings about deflation. I do not fear deflation that much. A lot of fiscal stimulus is on the way and the Fed has cut rates savagely. Its special lending can be augmented whenever it chooses. It seems to have mechanisms in place to spur growth in various ways. Existing home sales did re-start by themselves out West after house prices fell by enough. We have some reason to think that the economy still will work if given the right motivations.
Beyond the Fed
One loose end is the bad bank - and it's a big loose end. There have already been a lot of capital infusions into organizations that took the money and did things the authorities did not like, such as paying retention bonuses, paying ordinary bonuses, spending on CEO office redecoration, and buying new and fancy corporate jets. One problem with the bad bank is that once the government removes the bad assets it losses its ability to influence any decision at that institution. As things stand, if the bank has to continue to work out its problems it is always in the lap of the regulators. And that is one thing banks are trying to avoid. Yet they have not shown much restraint when they have gotten even a modicum of financial freedom.
The bad bank is a final solution of sorts for the assets that the bad bank consumes. But at what price? How many of them does it take? And what subsequent leverage do the authorities have over the bank it has liberated from such an affliction? I think that also needs to be a question that is addressed since this will not be a normal market transaction with both parties mutually satisfied and agreed on a price. This is still a bailout of sorts. We just must make sure that the bad bank does not become the foundation of bad policy.
When it is hard to decide what to do, studies find that businesses often pursue what is called a mini-max strategy. While economics looks at transactors as maximizing agents that maximize things (income, output, utility, etc), min-max refers to a totally different way of acting. It refers to businesses making decisions under uncertainty so that if they make the wrong decision they minimize the damage that would come from that. Hence the term mini-max.
With that as background we can look at the Fed statement with what I believe is a fresh eye. The Fed does not simply do things based on forecasts. The Fed has to weigh and balance risks and scenarios as well. It is further aware that what it does today will affect events down the road since monetary policy works with a lag. It is also aware that what it does as well as what it says it does and how it says it will do it all have some impact on the markets. Welcome to the land of sophistication, if not sophistry.
The Fed undoubtedly uses the mini-max strategy too, since it may have a forecast but it can't be sure it is right. The Fed statement had several examples of that sort of complexity. The Fed noted that there were significant risks. It said that inflation may be too low for the needs of long term price stability and growth (..." the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term"... ). Yet it also said it expected growth to begin before the end of the year. So the Fed's statement seemed to emphasize certain aspects of its worry but in the end the Fed is forecasting growth.
Its policy statement had references to a lot of remedies. The Fed may be 'forecasting growth' before the end of the year but it is not going to sit back and wait. It is going to implement asset-backed lending. It is going to continue to buy mortgage-backed paper in the markets. And it sounds a bit more serious about buying treasury securities to try to lower long term rates (although I seriously doubt if that would have much impact).
So what we see is the Fed trying to guide our expectations to see growth while doing what it can to help ignite activity. Yet the Fed is still issuing warnings about deflation. I do not fear deflation that much. A lot of fiscal stimulus is on the way and the Fed has cut rates savagely. Its special lending can be augmented whenever it chooses. It seems to have mechanisms in place to spur growth in various ways. Existing home sales did re-start by themselves out West after house prices fell by enough. We have some reason to think that the economy still will work if given the right motivations.
Beyond the Fed
One loose end is the bad bank - and it's a big loose end. There have already been a lot of capital infusions into organizations that took the money and did things the authorities did not like, such as paying retention bonuses, paying ordinary bonuses, spending on CEO office redecoration, and buying new and fancy corporate jets. One problem with the bad bank is that once the government removes the bad assets it losses its ability to influence any decision at that institution. As things stand, if the bank has to continue to work out its problems it is always in the lap of the regulators. And that is one thing banks are trying to avoid. Yet they have not shown much restraint when they have gotten even a modicum of financial freedom.
The bad bank is a final solution of sorts for the assets that the bad bank consumes. But at what price? How many of them does it take? And what subsequent leverage do the authorities have over the bank it has liberated from such an affliction? I think that also needs to be a question that is addressed since this will not be a normal market transaction with both parties mutually satisfied and agreed on a price. This is still a bailout of sorts. We just must make sure that the bad bank does not become the foundation of bad policy.
Monday, January 26, 2009
Housing: good news or more crap?
Existing home sales did rise in December (hooray!) but prices continued to fall fast. (Rats!).
The worst of the news is the way that sales in California (Collie-fornia, for natives) and the West have surged as prices there have plunged. In the West prices are down by over 30% Yr/Yr and over the past year, sales of existing homes are up by about thirty percent. That's about an elasticity of unity if you are an economist. But it does not work anywhere else in the country apparently since dropping prices by 20% has only left sales elsewhere still in a state of decline.
Now there have been some programs to aid sales and to forestall bankruptcy. The Fed has cut rates a lot and it has started its special purchase of mortgage-backed securities to try and drive mortgage rates even lower. Meanwhile home affordability has surged higher. But in the end it is only the WEST that is doing well. What does THAT tell us?
Unfortunately what THAT says is that people who could afford homes and who could get financing do not think that the downside in housing is over to a significant degree except in the WEST.
That's a real bummer.
Low mortgages rates do help with home affordability, but if you can afford it but you think the price will fall you probably shun it like a leper- even if it is a beautiful leper...
So that is the bad news. Home prices in the WEST have dropped by some 40% from their peak compared to a peak-to-now drop of 20% elsewhere in the country- That is a big difference. It makes a big difference, too, in how people view value in the housing market. The West has gone from being the priciest region to the second priciest as it has been overtaken by the Northeast. But since prices in the NE probably need to fall by a lot we will keep track and see how long that lasts.
Sorry for the bad news.
Back to saving for that down payment... Look at the bright side: you might have it by the time house prices stabilize.
The worst of the news is the way that sales in California (Collie-fornia, for natives) and the West have surged as prices there have plunged. In the West prices are down by over 30% Yr/Yr and over the past year, sales of existing homes are up by about thirty percent. That's about an elasticity of unity if you are an economist. But it does not work anywhere else in the country apparently since dropping prices by 20% has only left sales elsewhere still in a state of decline.
Now there have been some programs to aid sales and to forestall bankruptcy. The Fed has cut rates a lot and it has started its special purchase of mortgage-backed securities to try and drive mortgage rates even lower. Meanwhile home affordability has surged higher. But in the end it is only the WEST that is doing well. What does THAT tell us?
Unfortunately what THAT says is that people who could afford homes and who could get financing do not think that the downside in housing is over to a significant degree except in the WEST.
That's a real bummer.
Low mortgages rates do help with home affordability, but if you can afford it but you think the price will fall you probably shun it like a leper- even if it is a beautiful leper...
So that is the bad news. Home prices in the WEST have dropped by some 40% from their peak compared to a peak-to-now drop of 20% elsewhere in the country- That is a big difference. It makes a big difference, too, in how people view value in the housing market. The West has gone from being the priciest region to the second priciest as it has been overtaken by the Northeast. But since prices in the NE probably need to fall by a lot we will keep track and see how long that lasts.
Sorry for the bad news.
Back to saving for that down payment... Look at the bright side: you might have it by the time house prices stabilize.
Friday, January 23, 2009
Robert Barro's WSJ Op-ED on Fiscal Spending
There he goes again...
Robert Barro is nothing if not an accomplished economist with a penchant for skewing stats in his favor. His recent WSJ article, he once again plays fast and loose with some data and purported facts on the way to trashing the use of fiscal policy...
Barro-nomics
Let's remember that one of Barro's most memorable opuses on this WSJ Op-Ed page came in 1993 when he trashed Clinton's pick to head the CEA (Council of Economic Advisors), Laura Tyson. Tyson was selected and Barro was incensed that one his more favored (male) Ivy League counterparts was not selected -Paul Krugman had been widely mooted as one of the front runners for the job). Barro proceeded, in the best spirit of the fable of the sour grapes, to show 'statistical evidence' that the CEA position was so unimportant that it did NOT matter who was there. He produced statistical results that demonstrated that the economy did best when the office of the CEA was VACANT.
Well, gee there' a real boost for economics, Robert- thank Yoouuu for that.
Barro's CEA fantasies
There are several points here. One is that no one thinks the CEA head runs or sets economic policy to begin with. It is mostly a platform to make ideological points. Few CEA heads seem to have influenced policy all that much. You work for the President after all - not the other way around. The Administration's economic implementation team is at Treasury or in the White House (recently) as the NEC (National Economic Council). Treasury Secretaries are powerful. The CEA position is a bit above ceremonial but is not the economic juggernaut Barro seems to contend with his statistical analysis. Still Barro was angry enough that 'his guy' or someone similarly credentialed did not get it that he lampooned Tyson then produced the study that the WSJ ran in its Op-Ed page.
Figures lie and liars figure
With econometrics, a little time, and playing with lag structures there is no end to what you can find...maybe even a a cure for cancer, but one that wouldn't work ex-post.
Barro's sin du jour...
In the January 22 Op-Ed section of the Wall Street Journal Barro opines on fiscal spending and the size of the multiplier for government spending. He makes one particularly egregious and obnoxious statement after noting how difficult it is to make these estimates correctly. He goes back to the US WWII (1943-44) expenditures on the war and finds that the multiplier was less than unity, at 0.8. That means government spending caused other spending to fall so that the net result was that GDP increased by only 80% of the government's outlays. While the military spending did raise GDP dollar for dollar, as any accountant knows, the economic impact was to reduce spending elsewhere in the economy. The net impact was a MINUS not a plus!
Don't prove or justify but ASSERT!
Before making this point Barro goes on to take this amazing assertion, saying that he thinks that large expenditures on military goods by the government make a particularly good example of fiscal stimulus. He then says (I suppose with a straight face) " I think that most macroeconomists would regard this case as a fair one for seeing whether a large multiplier ever exists.' And that is the brilliance of assertion. Assert your study to credibility.
Wow! I For my part, doubt any good macroeconomist would agree with that!
How statistics works or fails...
For one thing there is the matter of statistical association. In the war period, consumption dropped and rationing was in effect. People were dishoarding, donating scarce metals for the war effort and planting victory gardens. People were consuming less of everything as goods were pulled out of the private sector to serve the war effort. Women could not get silk stockings, since silk was used for parachutes. All sorts of things were rationed but Barro runs his regressions, not mindful of these facts...numbers, t-statistics, R-squared results...got to run regressions....
Losing track of causation
I have not seen his model or statistical results other than what he presents in his OP-Ed. But forget the data and think. If private sector consumption was falling and you start increasing something else (whatever- call it government spending) you are going to get a negative correlation (and probably a causation link) between this thing that is expanding and the other thing that is falling. I don't even begin to believe that war spending had a negative impact as we might construe it in a modern fashion. It may have contracted private investment and consumption by monopolizing ('mobilizing' would have been the term used in its day...) all the available resources for the war effort. But that is stimulus with scarcity (not with plenty of idle resources) - it's not the same thing Robert baby. Sure unemployment was high but there were product constraints BECAUSE OF THE WAR. Consumption fell BECAUSE OF THE WAR not BECAUSE OF GOVERNMENT SPENDING - post hoc ergo proper hoc, Mr Barro.
THIKN! err think?
Thought experiments serve us better here. Even if there was some negative impact from government spending due to imposed rationing or the military soaking up most of the natural resources the objective of the day had been to WAGE WAR not to stimulate the economy. All those war time jobs did help to put people back to work. Unfortunately many of them were 'working' in Europe and in the Asian Theater and their 'efforts' were not doing much to stimulate those economies either. Are we to believe that all the military spending in the US had no positive impact? How would you ever measure that and control for war? War. Ugh! What is it good for?
Face value? About face!
In short Barro, in carting out this result, has showed us how unreliable and capricious empirical economics can be when it is mis-applied to a set of data to which it is not suited. His results should stand as warning as to why you never EVER take this stuff at face value.
Application to current events--coming full circle
Barro's warning about runaway fiscal stimulus still seems to be on the right track. Barro is often on the right track but then let's his ideology sidetrack him. I am skeptical of so much fiscal stimulus. But you still have to look at the facts on the ground. You have to look at what is wrong and what the government (and Fed) actions are trying to fight off. History will not necessarily have a kind view...but that does not mean it was a wrong thing to do, but it may not prove to be the best thing to do.
A prospective retrospective
The government is now borrowing when the private sector won't. If you, in 20 years, were to go back and run regressions you'd find there had been 'a crowding out' in the credit markets. You'd find that public borrowing 'pushed out' private borrowing. But, in reality, nothing could be further from the truth. The Fed's lending survey tells us the real story. Banks are cutting back and tightening standards. Statistics could find causation running from more government activity to less private sector activity in the credit markets. But we know that would muddle the true cause and effect here. We know which is the cart and which is the horse.
Think critically!
So regardless of some one's high confidence estimates on some economic estimates do not forget to subject it to the old fashioned scratch and sniff and cranial crunch tests. If it seems an odd ball conclusion it probably is. It helps to know the bias of the economist doing the empirical work, too. You can be sure that there are few conservative economists coming up with work saying more regulation is good and fiscal stimulus works. And few (If any) liberal economists will find the opposite. Why is that? Just the luck of draw on empirical work or bias?
Bias is as bias does
Just a thought: there are many different kinds of bias. Just because you can't find any of the statistical sort does mean there is not any of the other sort present: personal bias.
What it all means for us now
Obama's plan remains as the political football it has been from the start. Let me also warn of all the 'democrat' economists whose studies are showing how much stimulus is needed. Those saying (like Christine Romer- head of the CEA!) that the crises will not have passed even in four years time are looking for more excuses to spend even more now. Beware of this too.
Robert Barro is nothing if not an accomplished economist with a penchant for skewing stats in his favor. His recent WSJ article, he once again plays fast and loose with some data and purported facts on the way to trashing the use of fiscal policy...
Barro-nomics
Let's remember that one of Barro's most memorable opuses on this WSJ Op-Ed page came in 1993 when he trashed Clinton's pick to head the CEA (Council of Economic Advisors), Laura Tyson. Tyson was selected and Barro was incensed that one his more favored (male) Ivy League counterparts was not selected -Paul Krugman had been widely mooted as one of the front runners for the job). Barro proceeded, in the best spirit of the fable of the sour grapes, to show 'statistical evidence' that the CEA position was so unimportant that it did NOT matter who was there. He produced statistical results that demonstrated that the economy did best when the office of the CEA was VACANT.
Well, gee there' a real boost for economics, Robert- thank Yoouuu for that.
Barro's CEA fantasies
There are several points here. One is that no one thinks the CEA head runs or sets economic policy to begin with. It is mostly a platform to make ideological points. Few CEA heads seem to have influenced policy all that much. You work for the President after all - not the other way around. The Administration's economic implementation team is at Treasury or in the White House (recently) as the NEC (National Economic Council). Treasury Secretaries are powerful. The CEA position is a bit above ceremonial but is not the economic juggernaut Barro seems to contend with his statistical analysis. Still Barro was angry enough that 'his guy' or someone similarly credentialed did not get it that he lampooned Tyson then produced the study that the WSJ ran in its Op-Ed page.
Figures lie and liars figure
With econometrics, a little time, and playing with lag structures there is no end to what you can find...maybe even a a cure for cancer, but one that wouldn't work ex-post.
Barro's sin du jour...
In the January 22 Op-Ed section of the Wall Street Journal Barro opines on fiscal spending and the size of the multiplier for government spending. He makes one particularly egregious and obnoxious statement after noting how difficult it is to make these estimates correctly. He goes back to the US WWII (1943-44) expenditures on the war and finds that the multiplier was less than unity, at 0.8. That means government spending caused other spending to fall so that the net result was that GDP increased by only 80% of the government's outlays. While the military spending did raise GDP dollar for dollar, as any accountant knows, the economic impact was to reduce spending elsewhere in the economy. The net impact was a MINUS not a plus!
Don't prove or justify but ASSERT!
Before making this point Barro goes on to take this amazing assertion, saying that he thinks that large expenditures on military goods by the government make a particularly good example of fiscal stimulus. He then says (I suppose with a straight face) " I think that most macroeconomists would regard this case as a fair one for seeing whether a large multiplier ever exists.' And that is the brilliance of assertion. Assert your study to credibility.
Wow! I For my part, doubt any good macroeconomist would agree with that!
How statistics works or fails...
For one thing there is the matter of statistical association. In the war period, consumption dropped and rationing was in effect. People were dishoarding, donating scarce metals for the war effort and planting victory gardens. People were consuming less of everything as goods were pulled out of the private sector to serve the war effort. Women could not get silk stockings, since silk was used for parachutes. All sorts of things were rationed but Barro runs his regressions, not mindful of these facts...numbers, t-statistics, R-squared results...got to run regressions....
Losing track of causation
I have not seen his model or statistical results other than what he presents in his OP-Ed. But forget the data and think. If private sector consumption was falling and you start increasing something else (whatever- call it government spending) you are going to get a negative correlation (and probably a causation link) between this thing that is expanding and the other thing that is falling. I don't even begin to believe that war spending had a negative impact as we might construe it in a modern fashion. It may have contracted private investment and consumption by monopolizing ('mobilizing' would have been the term used in its day...) all the available resources for the war effort. But that is stimulus with scarcity (not with plenty of idle resources) - it's not the same thing Robert baby. Sure unemployment was high but there were product constraints BECAUSE OF THE WAR. Consumption fell BECAUSE OF THE WAR not BECAUSE OF GOVERNMENT SPENDING - post hoc ergo proper hoc, Mr Barro.
THIKN! err think?
Thought experiments serve us better here. Even if there was some negative impact from government spending due to imposed rationing or the military soaking up most of the natural resources the objective of the day had been to WAGE WAR not to stimulate the economy. All those war time jobs did help to put people back to work. Unfortunately many of them were 'working' in Europe and in the Asian Theater and their 'efforts' were not doing much to stimulate those economies either. Are we to believe that all the military spending in the US had no positive impact? How would you ever measure that and control for war? War. Ugh! What is it good for?
Face value? About face!
In short Barro, in carting out this result, has showed us how unreliable and capricious empirical economics can be when it is mis-applied to a set of data to which it is not suited. His results should stand as warning as to why you never EVER take this stuff at face value.
Application to current events--coming full circle
Barro's warning about runaway fiscal stimulus still seems to be on the right track. Barro is often on the right track but then let's his ideology sidetrack him. I am skeptical of so much fiscal stimulus. But you still have to look at the facts on the ground. You have to look at what is wrong and what the government (and Fed) actions are trying to fight off. History will not necessarily have a kind view...but that does not mean it was a wrong thing to do, but it may not prove to be the best thing to do.
A prospective retrospective
The government is now borrowing when the private sector won't. If you, in 20 years, were to go back and run regressions you'd find there had been 'a crowding out' in the credit markets. You'd find that public borrowing 'pushed out' private borrowing. But, in reality, nothing could be further from the truth. The Fed's lending survey tells us the real story. Banks are cutting back and tightening standards. Statistics could find causation running from more government activity to less private sector activity in the credit markets. But we know that would muddle the true cause and effect here. We know which is the cart and which is the horse.
Think critically!
So regardless of some one's high confidence estimates on some economic estimates do not forget to subject it to the old fashioned scratch and sniff and cranial crunch tests. If it seems an odd ball conclusion it probably is. It helps to know the bias of the economist doing the empirical work, too. You can be sure that there are few conservative economists coming up with work saying more regulation is good and fiscal stimulus works. And few (If any) liberal economists will find the opposite. Why is that? Just the luck of draw on empirical work or bias?
Bias is as bias does
Just a thought: there are many different kinds of bias. Just because you can't find any of the statistical sort does mean there is not any of the other sort present: personal bias.
What it all means for us now
Obama's plan remains as the political football it has been from the start. Let me also warn of all the 'democrat' economists whose studies are showing how much stimulus is needed. Those saying (like Christine Romer- head of the CEA!) that the crises will not have passed even in four years time are looking for more excuses to spend even more now. Beware of this too.
Thursday, January 22, 2009
Housing: Gimme Shelter!
Housing starts are off sharply and so are permits. The growth rates for housing show that the decline is actually still accelerating after all this time. The charts above show that three-month growth rates are usually the weakest followed by six-month rates and then by twelve-month rates. That pattern says things are getting worse and at even faster pace.
The pace of starts has dropped back to 0.55mln units compared to new household formations; formations are running at about 1.5 mln per year. Thus the excess stock of homes is being whittled away by the light building calendar. But the excess in housing has to do with new and existing homes. Some areas of the country have a great excess supply; others are in better balance. The final arbiter on housing still will be pricies, house prices- and they are still falling rather rapidly.
Fed rate cuts to the extent they reduce mortgage rates could help to firm house prices. The drop in the cost of financing already has sent housing affordability up sharply. Unfortunately that flies in the face of banks that are tightening standards. Houses at one point were easier to buy because banks would approve funding so readily. Now with tighter lending conditions that include income tests and downpayments and at higher credit scores housing is hard to start even with lower rates. The rise in affordablity is not helping all that much, it is more theoretical than practical.
Still the Fed's rate drop is helpful as it facilitates those that do qualify for a mortgage to purchase a more expensive home. In some sense the drop in mortgage costs works like a cut in housing prices. The Fed is on its way to providing help and is expected to do more to drop home financing rates in the future. For banks whose mortgage portfolios are still spinning out losses that is welcome news as well as it is welcome news to consumers and potential home buyers - as well as to those trying to refi.
The pace of starts has dropped back to 0.55mln units compared to new household formations; formations are running at about 1.5 mln per year. Thus the excess stock of homes is being whittled away by the light building calendar. But the excess in housing has to do with new and existing homes. Some areas of the country have a great excess supply; others are in better balance. The final arbiter on housing still will be pricies, house prices- and they are still falling rather rapidly.
Fed rate cuts to the extent they reduce mortgage rates could help to firm house prices. The drop in the cost of financing already has sent housing affordability up sharply. Unfortunately that flies in the face of banks that are tightening standards. Houses at one point were easier to buy because banks would approve funding so readily. Now with tighter lending conditions that include income tests and downpayments and at higher credit scores housing is hard to start even with lower rates. The rise in affordablity is not helping all that much, it is more theoretical than practical.
Still the Fed's rate drop is helpful as it facilitates those that do qualify for a mortgage to purchase a more expensive home. In some sense the drop in mortgage costs works like a cut in housing prices. The Fed is on its way to providing help and is expected to do more to drop home financing rates in the future. For banks whose mortgage portfolios are still spinning out losses that is welcome news as well as it is welcome news to consumers and potential home buyers - as well as to those trying to refi.
Monday, January 19, 2009
The Aggregator...
One bank
two bank
black and
blue bank
'The aggregator' is not a new Sci-Fi movie starring the current Governor of Collie-fornia. It is a proposal to form a bank with bad assets
Bad banks
talking about the sad banks
sad banks
talking about the bad banks, yeah
See them out on the street all right, makin'
loans to all kinds of strangers
if the credit score is right you may win
if you're pocket's not full
but you want a good time
don't ask them for the time day.
They only lend to those who can pay...
bad banks...
Yes the bad banks have learned a lesson; they are now more discriminating- too discriminating for the universe of credit scores most borrowers have. So there is a plan being considered to form a truly bad bank - a sort of Bank in Black (one that is really in the red) that will combine the worst, of the worst, of the worst. Do not look for Will Smith or Tommy Lee Jones to star in this one. And let's hope it does NOT have a sequel.
As usual the PROBLEM with a Bad-ASSet Bank is deciding how to acquire the assets for it- how to price them really. Recall the TARP was set up to do this at first. It had proposed a novel reverse auction process to to put a price on bad assets. In the end the novelty of that scheme was its undoing and it was judged to be an approach that would have been too slow. So now we come full circle. Had the reverse auctions been done, there might not now be a second round of Kool-Aid being distributed (just shut up and drink it -it will work).
The problem with capital injections is that they do not remove the troubled asset. So if it continues to deteriorate, it still can throw off more loss. If you remove it in a BAD ASSet purchase program it cannot go bad and hurt that bank again. But now its on the taxpayers' clock. Since it seems that the taxpayer is on the hook eventually, maybe this solution is a bit more palatable now (you can pay me now, or pay me later). But the acquisition cost is still key since it defines where the risk-line is drawn.
While some suggest that the government could buy these assets at their fair market accounting prices (or current price) given that things continue to go so bad one should be skeptical that all securities are properly marked. Look at Merrill Lynch... Thain had asserted that they had written things down strongly and realistically. Yes, the mortgage market is still deteriorating but WHAT view of reality has this paper been written to? What time line holds its value? Does it reflect real estate prices NOW? Does 'NOW' mean it reflects when someone last looked at it? Does it mean 'in the last accounting quarter (Q4)?' Or does 'Now' mean this quarter, Q1?
If we could mark the BAD ASSets right the idea would be more of a final solution for banks. The government's loss sharing and loss indemnifications programs for Citi and BofA and previously for JP Morgan-Chase on the Bear Stearns purchases are examples of how the government has assumed risk and liability in the past. So let's not pretend that a BAD BANK asset purchase program is any worse than previous actions. It's advantage is that it does stop the bleeding. Still, it is important where the vlaue line for acquisition is drawn. And there is nothing in it that would promote lending and that is still a missing piece of the puzzle, although a new FDIC plan has that as an objective.
two bank
black and
blue bank
'The aggregator' is not a new Sci-Fi movie starring the current Governor of Collie-fornia. It is a proposal to form a bank with bad assets
Bad banks
talking about the sad banks
sad banks
talking about the bad banks, yeah
See them out on the street all right, makin'
loans to all kinds of strangers
if the credit score is right you may win
if you're pocket's not full
but you want a good time
don't ask them for the time day.
They only lend to those who can pay...
bad banks...
Yes the bad banks have learned a lesson; they are now more discriminating- too discriminating for the universe of credit scores most borrowers have. So there is a plan being considered to form a truly bad bank - a sort of Bank in Black (one that is really in the red) that will combine the worst, of the worst, of the worst. Do not look for Will Smith or Tommy Lee Jones to star in this one. And let's hope it does NOT have a sequel.
As usual the PROBLEM with a Bad-ASSet Bank is deciding how to acquire the assets for it- how to price them really. Recall the TARP was set up to do this at first. It had proposed a novel reverse auction process to to put a price on bad assets. In the end the novelty of that scheme was its undoing and it was judged to be an approach that would have been too slow. So now we come full circle. Had the reverse auctions been done, there might not now be a second round of Kool-Aid being distributed (just shut up and drink it -it will work).
The problem with capital injections is that they do not remove the troubled asset. So if it continues to deteriorate, it still can throw off more loss. If you remove it in a BAD ASSet purchase program it cannot go bad and hurt that bank again. But now its on the taxpayers' clock. Since it seems that the taxpayer is on the hook eventually, maybe this solution is a bit more palatable now (you can pay me now, or pay me later). But the acquisition cost is still key since it defines where the risk-line is drawn.
While some suggest that the government could buy these assets at their fair market accounting prices (or current price) given that things continue to go so bad one should be skeptical that all securities are properly marked. Look at Merrill Lynch... Thain had asserted that they had written things down strongly and realistically. Yes, the mortgage market is still deteriorating but WHAT view of reality has this paper been written to? What time line holds its value? Does it reflect real estate prices NOW? Does 'NOW' mean it reflects when someone last looked at it? Does it mean 'in the last accounting quarter (Q4)?' Or does 'Now' mean this quarter, Q1?
If we could mark the BAD ASSets right the idea would be more of a final solution for banks. The government's loss sharing and loss indemnifications programs for Citi and BofA and previously for JP Morgan-Chase on the Bear Stearns purchases are examples of how the government has assumed risk and liability in the past. So let's not pretend that a BAD BANK asset purchase program is any worse than previous actions. It's advantage is that it does stop the bleeding. Still, it is important where the vlaue line for acquisition is drawn. And there is nothing in it that would promote lending and that is still a missing piece of the puzzle, although a new FDIC plan has that as an objective.
Sunday, January 18, 2009
Oh what tangled loss we spread, when we cheat to get ahead
It ain't me babe...
I am struck by how Wall Street has gotten away with magician's misdirection in bellying up to the bar to take its share of the 'credit' for the ongoing financial disaster. IF you are a banker it is the unexpected performance of the cash flows in mortgage securities. IF you are a securitizer it is the credit enhancements that did not work. If you are a credit assessor it's that these assessments were misunderstood from the beginning. You know that AAA does not equal AAA. In credit rating not only does transitivity not hold but neither does reflexive identity. To hear firms speak of it, they were just doing their jobs. No one was untoward. There was no mischief. It was unexpected. And so on... It was an act of God- although whose god we may never find out...
Moral Hazard Meets Hippocratic Oath
It has been pointed out to me that if you go to a Doctor and ask for heroin or he/she will not prescribe it. Sure they could make a lot of money writing such prescriptions for addicts. Or they could invent some reason why an applicant 'needs' it. But in the 'famous' word s of Richard Nixon...'it would be wrong.' Some stop there some go on to do it anyway. . But doctors are a special breed; they have taken an oath to do no harm.
Maybe bankers need an oath other than a hypocritical one?
Don't Fence me in...
In the past bankers were the gate-keepers for prudence. Knowing they were at risk on a loan they set clear and restrictive standards for lending. This in turn corralled the prices of the assets they lent against (houses, for example).
Wipe Out...notwithstanding
It will long remain a point of contention as to why banks were willing to step out from behind their shields of proof of income, their ratio of income to payments, their down payment rules and so on to take nothing but the house as collateral- something they always had anyway. Perhaps the years of a rising equity market and a market that so quickly recovered from its demise (in 1987 anyway) gave a false sense of risk and exposure. One analyst/journalist (James K Glassman) had before the Tech Bubble came opined that the Dow could soar to over 36,000 as he applied the 'P/E' ratio for bonds to stocks as he argued market stability had reached a new plateau and all old metrics for valuation would ratchet upward as a result. This sort of thinking has been there for some time and was not eradicated by the Tech wipe out.
Getting beyond this one question remains and that is WHAT NOW?
WHERE TO NOW ST PETER?
I keep folding back time to go over 'old ground' to re-explore what happened because until we know the cause we cannot propose a good solution. Markets and market players are in denial in no small part because they fear liability claims against them.
Whatever the reason denial is not helpful. I offer these observations:
1.Do-gooding is dangerous. Once rules were broken to let economically disadvantaged to 'borrow more than 100% of their home's value' in a single mortgage, the flood gate was opened. If the disadvantaged could do it or have down payments waved and income tests set aside then aren't we all 'disadvantaged' with respect to wanting to buy a home we can't afford? That was one slippery slope.
2. Policy makers must do their jobs. The SEC embarked on something called self regulation. We can call it the fox guards the hen house. Oh, but these were reformed foxes. They were vegetarian foxes. They were ethically strong. They promised to use new sophisticated technology to...yeah right. Foxes don't guard the hen house period. And as a corollary regulators must regulate.
3. Regulators too must use judgment and prudence. It goes without saying that at the Fed Greenspan's constant testimonials to de-regulate every, and any, industry contributed to all this. His own very flawed analysis that in the US nationwide house prices had not fallen was historically correct but economically flawed. I wrote several research pieces showing that real prices had fallen. While nominal prices did not fall in the severe recessions of 1973-75 and 1981-82 (or more broadly 1980-82) that was because inflation was so high in those episodes. One we reduced inflation to a 2% range the risk to nominal house prices increased sharply but the Chairman did not see it that way - or did not WANT TO SEE IT that way. Was this simply bad economics on his part or a 'damn the torpedoes full speed ahead' tact toward what he believed - misusing the 'facts' to achieve his desired objective? We will never know and Greenspan will never admit failure. So check his speeches and think for yourself on that one.
4. Assessment of technology must be thorough. In an advanced economy such as ours consider this a broad warning about which technologies seem appropriate. Technology- new investment methods, rocket science in economics, call it what you will - it failed badly: Markets 'Ten' quants 'Zero' and this is AFTER LTCM, some lesson we learned from that one, eh? One thing we NOW HAVE learned is that statistical stress tests do not replicate real life situations very well. But didn't we know that already? Don't economic (econometric) models fail to track most of what happens in recession unless you go back and refit it with hindsight? As a very oversimplified example, I refer you to the ADP survey that was such a stellar performer until recession struck. Even in the mild portion of the recession ADP failed to work. In the severe phase its results were laughably bad. Then ADP/Macroeconomic Advisors went back to work to 'fix' it. The first estimate out of the revamped framework overshot the true job losses by a mile instead of undershooting. This is typical of modeling 'X' in recession. It is not really a failing of ADP/MA as it is simply an economist's reality. So why think stress tests on market valuation will work? I love technology and am not being a Luddite here, but do be careful how you employ technology and how soon you come to depend on a new approach that has not been tested in even one real world cycle.
5. Creeping dysfunction is a nefarious risk. Standing the test of time does not apply until you have a business cycle or two under your belt... Credit rating agencies have been there for some time. Markets eventually came to lean on them too hard and failed to understand that raters worked for issuers not buyers, just as real estate agents worked for sellers, not buyers. Rating agencies said their ratings were no substitute for investor due diligence but in fact that substitution became practice and ratings were used that way-and the agencies knew it. The market wanted a way to homogenize disparate paper to facilitate trading. What is worse is that agencies began to rate very different financial structures using the same nomenclature as for corporate ratings. Asset backed paper rated AAA was in fact in no way comparable to a corporate bond rated AAA but that 'fact' slipped by the market. The credit agencies were happy to post their disclaimers and to continue to collect their fees. They even rated and collected fees on munis (Municipal bonds) where defaults were rare. It was fine until things began to unravel. But then you could have guessed that. Who goes bust in good times? In retrospect we can say issuers got what they paid for: advertising that promoted their issues very successfully. At least on TV we are TOLD the difference between a commercial and an INFOMERCIAL. Not so in securities markets. The lesson again? Buyer beware. Distrust PAID third parties, unless YOU are paying them.
6. Leverage: Beauty and the beast. There is no need for a full discussion of leverage here. I'm simply making these points with some examples to flesh out the point. But when it comes to leverage what was the flaw? Was it excessive because rocket science failed to grasp how correlated risks were? Was the misjudgment in ratings or in credit enhancements a failure of institutions? Part of it was just that there was too much leverage. Why firms thought they could have so much more leverage with impunity still is not perfectly clear. This is where you see the perfect storm coming together.
7. Greed IS good but it failed in its mission-Why? In the Movie 'Wall Street' (that was nearly shot partly in my corner office) Gordon Gecko claimed that greed is good. Adam Smith had argued the same centuries earlier. Smith however showed that good things come when people are driven by self-interest or greed. Alan Greenspan does admit to being flummoxed on this point. He says he could not imagine firms would make such a mistake about their own self interests. Whatever you think about Greed and its role in this episode remember that these financial firms drank their own Kool Aid. They held this flawed paper on their own books. It has come back to haunt them. So it was not simply them gouging YOU to make money for THEMSELVES; it was something else... Greed failed more than greed itself was a problem - or is that not true? Why did firms so fail to get the risk and payoff right? Again we have to look above to the patterns and interlocking nature of mistakes that were made. Maybe managers and professionals were truly blinded by greed? Or simply motivated by it. Was there so much money to be made for EMPLOYEES that they were too willing to sell down the river of risk SHAREHOLDERS and BONDHOLDERS and GENERAL CREDITORS and their firms? Maybe some CLAW BACK provisions pertaining to employee compensation (bonuses in particular), as in the case of fraud, could stop such behavior?
8. Be careful what you wish for - People are drawn to Wall Street to make BIG MONEY. And that they do. But is The Street's payoff scheme an attractive nuisance? It does seem that Wall Street's asymmetrical payout scheme is at least partly to blame: I make Big Money I get a piece; I make a big loss and Oops it hits the firm's capital. As evidence of compensation dysfunction. Merrill's John Thain wanted a $10Million bonus for running his firm so badly he had to jump into the arms of BofA. John Mack of Morgan Stanley said it would look bad for Wall Street execs to get a bonus this year (2008) so they should not ask for one. But he misses the point too. It would be bad because they did not earn it. Moreover they should offer back to their respective firms the monies they were paid over the past two years for creating the mess than came home to roost this past year. But NO CEO is offering that, are they? Now that's leadership.
Has Policy Now Run Amok?
Firms may have been emboldened - or employees - to take more risk, thinking that FAILURE was NOT AN OPTION. By this I do not mean Hubris but the notion that they worked for firms that were too-big to fail. If that sort of belief is a root CAUSE of the problem then all these combinations that are making firms even bigger are a dysfunctional response to a pressing problem. At the very least firms must be able to fail so firms and employees will see risk and act as if risk is present. Claw back provisions on bonuses would make firms (employees and CEOs) more careful to see that their deals made money the right way instead of on a statute of limitation of one year subject only to board oversight instead of to legal redress. To facilitate the ability of all firms to fail, all derivative deals probably need to be washed though an exchange. Banks may have to have their options to do business limited. Structures like SIVS make no regulatory sense. If you can't do it on the balance sheet you can't do it all. Regulators need a framework and a mission. they also need some backbone and leadership that does not undermine the mission.
The failure of management theory-
For a long time, as an economist, I have been disdainful of the all the business school gurus and their various theories of management (okay, maybe a bit jealous of the limelight, too). That so many theories exist is a testament to how little we know about management or what a demand there is to obscure what management is and what it does. The objective for firms is to oversee and control managers so that they have the best interests of the corporation at heart. But who can oversee the one who oversees? Few corporate boards really control their CEO, usually it is the other way around. Plus it is complicated. You hire a CEO to lead so when should you stop them? Some firms try to get at fairness and independence by having a compensation committee to decide CEO pay. That committee may be different from the board but to whom does it report and who staffs it? Right! Management theories eventually come around to one thing: getting compensation right. Stock options were once thought to be the key but the CEO has a much different time horizon than the firm. Managing in up and down cycles is different and stock options may not fairly reflect effort or results in uncertain times. So where do we go?
A New Future Course of Action
I think the only effective oversight on a CEO will have to come from judicial oversight and clawback provisions for excessive bonuses. Such second guessing would kick in when it becomes clear a bonus was given for an activity that was not valuable to the firm. On this notion bonuses on Wall Street paid over the past several years could be 'clawed back' by shareholders who realized that the deals firms made were destructive and money-losing. Before you ponder what a hammer blow that would be to employees in this recession, ponder how different the outcome of the past several years might have been had this 'law' been in effect and had Wall Street been aware of such a provision. The idea is not to clamp a penalty on past activity but to impose a rule to affect behavior in the future. Clearly firms cannot police themselves. Boards simply are not independent except in extreme times - and not always then. Shareholders are powerless, scattered and without information. The only option for redress it to take the oversight out of the firm. It is not my intent to have THE COURTS oversee each CEO bonus but for each bonus to be subject to oversight and to the potential for rescission if it is paid by a too-pliant board for conduct that was actually detrimental to the firm. I think this could be a very promising avenue for oversight, especially since firms and their boards have failed so completely and management theories have given us nothing that is useful. It might also be a way to endogenize the asymmetry of risk on Wall Street by making traders know that their statute of limitations on a trade is not just this calendar year and to make employees know that risk matters, it does not simply revert to 'the firm' and get borne by its shareholders.
I am struck by how Wall Street has gotten away with magician's misdirection in bellying up to the bar to take its share of the 'credit' for the ongoing financial disaster. IF you are a banker it is the unexpected performance of the cash flows in mortgage securities. IF you are a securitizer it is the credit enhancements that did not work. If you are a credit assessor it's that these assessments were misunderstood from the beginning. You know that AAA does not equal AAA. In credit rating not only does transitivity not hold but neither does reflexive identity. To hear firms speak of it, they were just doing their jobs. No one was untoward. There was no mischief. It was unexpected. And so on... It was an act of God- although whose god we may never find out...
Moral Hazard Meets Hippocratic Oath
It has been pointed out to me that if you go to a Doctor and ask for heroin or he/she will not prescribe it. Sure they could make a lot of money writing such prescriptions for addicts. Or they could invent some reason why an applicant 'needs' it. But in the 'famous' word s of Richard Nixon...'it would be wrong.' Some stop there some go on to do it anyway. . But doctors are a special breed; they have taken an oath to do no harm.
Maybe bankers need an oath other than a hypocritical one?
Don't Fence me in...
In the past bankers were the gate-keepers for prudence. Knowing they were at risk on a loan they set clear and restrictive standards for lending. This in turn corralled the prices of the assets they lent against (houses, for example).
Wipe Out...notwithstanding
It will long remain a point of contention as to why banks were willing to step out from behind their shields of proof of income, their ratio of income to payments, their down payment rules and so on to take nothing but the house as collateral- something they always had anyway. Perhaps the years of a rising equity market and a market that so quickly recovered from its demise (in 1987 anyway) gave a false sense of risk and exposure. One analyst/journalist (James K Glassman) had before the Tech Bubble came opined that the Dow could soar to over 36,000 as he applied the 'P/E' ratio for bonds to stocks as he argued market stability had reached a new plateau and all old metrics for valuation would ratchet upward as a result. This sort of thinking has been there for some time and was not eradicated by the Tech wipe out.
Getting beyond this one question remains and that is WHAT NOW?
WHERE TO NOW ST PETER?
I keep folding back time to go over 'old ground' to re-explore what happened because until we know the cause we cannot propose a good solution. Markets and market players are in denial in no small part because they fear liability claims against them.
Whatever the reason denial is not helpful. I offer these observations:
1.Do-gooding is dangerous. Once rules were broken to let economically disadvantaged to 'borrow more than 100% of their home's value' in a single mortgage, the flood gate was opened. If the disadvantaged could do it or have down payments waved and income tests set aside then aren't we all 'disadvantaged' with respect to wanting to buy a home we can't afford? That was one slippery slope.
2. Policy makers must do their jobs. The SEC embarked on something called self regulation. We can call it the fox guards the hen house. Oh, but these were reformed foxes. They were vegetarian foxes. They were ethically strong. They promised to use new sophisticated technology to...yeah right. Foxes don't guard the hen house period. And as a corollary regulators must regulate.
3. Regulators too must use judgment and prudence. It goes without saying that at the Fed Greenspan's constant testimonials to de-regulate every, and any, industry contributed to all this. His own very flawed analysis that in the US nationwide house prices had not fallen was historically correct but economically flawed. I wrote several research pieces showing that real prices had fallen. While nominal prices did not fall in the severe recessions of 1973-75 and 1981-82 (or more broadly 1980-82) that was because inflation was so high in those episodes. One we reduced inflation to a 2% range the risk to nominal house prices increased sharply but the Chairman did not see it that way - or did not WANT TO SEE IT that way. Was this simply bad economics on his part or a 'damn the torpedoes full speed ahead' tact toward what he believed - misusing the 'facts' to achieve his desired objective? We will never know and Greenspan will never admit failure. So check his speeches and think for yourself on that one.
4. Assessment of technology must be thorough. In an advanced economy such as ours consider this a broad warning about which technologies seem appropriate. Technology- new investment methods, rocket science in economics, call it what you will - it failed badly: Markets 'Ten' quants 'Zero' and this is AFTER LTCM, some lesson we learned from that one, eh? One thing we NOW HAVE learned is that statistical stress tests do not replicate real life situations very well. But didn't we know that already? Don't economic (econometric) models fail to track most of what happens in recession unless you go back and refit it with hindsight? As a very oversimplified example, I refer you to the ADP survey that was such a stellar performer until recession struck. Even in the mild portion of the recession ADP failed to work. In the severe phase its results were laughably bad. Then ADP/Macroeconomic Advisors went back to work to 'fix' it. The first estimate out of the revamped framework overshot the true job losses by a mile instead of undershooting. This is typical of modeling 'X' in recession. It is not really a failing of ADP/MA as it is simply an economist's reality. So why think stress tests on market valuation will work? I love technology and am not being a Luddite here, but do be careful how you employ technology and how soon you come to depend on a new approach that has not been tested in even one real world cycle.
5. Creeping dysfunction is a nefarious risk. Standing the test of time does not apply until you have a business cycle or two under your belt... Credit rating agencies have been there for some time. Markets eventually came to lean on them too hard and failed to understand that raters worked for issuers not buyers, just as real estate agents worked for sellers, not buyers. Rating agencies said their ratings were no substitute for investor due diligence but in fact that substitution became practice and ratings were used that way-and the agencies knew it. The market wanted a way to homogenize disparate paper to facilitate trading. What is worse is that agencies began to rate very different financial structures using the same nomenclature as for corporate ratings. Asset backed paper rated AAA was in fact in no way comparable to a corporate bond rated AAA but that 'fact' slipped by the market. The credit agencies were happy to post their disclaimers and to continue to collect their fees. They even rated and collected fees on munis (Municipal bonds) where defaults were rare. It was fine until things began to unravel. But then you could have guessed that. Who goes bust in good times? In retrospect we can say issuers got what they paid for: advertising that promoted their issues very successfully. At least on TV we are TOLD the difference between a commercial and an INFOMERCIAL. Not so in securities markets. The lesson again? Buyer beware. Distrust PAID third parties, unless YOU are paying them.
6. Leverage: Beauty and the beast. There is no need for a full discussion of leverage here. I'm simply making these points with some examples to flesh out the point. But when it comes to leverage what was the flaw? Was it excessive because rocket science failed to grasp how correlated risks were? Was the misjudgment in ratings or in credit enhancements a failure of institutions? Part of it was just that there was too much leverage. Why firms thought they could have so much more leverage with impunity still is not perfectly clear. This is where you see the perfect storm coming together.
7. Greed IS good but it failed in its mission-Why? In the Movie 'Wall Street' (that was nearly shot partly in my corner office) Gordon Gecko claimed that greed is good. Adam Smith had argued the same centuries earlier. Smith however showed that good things come when people are driven by self-interest or greed. Alan Greenspan does admit to being flummoxed on this point. He says he could not imagine firms would make such a mistake about their own self interests. Whatever you think about Greed and its role in this episode remember that these financial firms drank their own Kool Aid. They held this flawed paper on their own books. It has come back to haunt them. So it was not simply them gouging YOU to make money for THEMSELVES; it was something else... Greed failed more than greed itself was a problem - or is that not true? Why did firms so fail to get the risk and payoff right? Again we have to look above to the patterns and interlocking nature of mistakes that were made. Maybe managers and professionals were truly blinded by greed? Or simply motivated by it. Was there so much money to be made for EMPLOYEES that they were too willing to sell down the river of risk SHAREHOLDERS and BONDHOLDERS and GENERAL CREDITORS and their firms? Maybe some CLAW BACK provisions pertaining to employee compensation (bonuses in particular), as in the case of fraud, could stop such behavior?
8. Be careful what you wish for - People are drawn to Wall Street to make BIG MONEY. And that they do. But is The Street's payoff scheme an attractive nuisance? It does seem that Wall Street's asymmetrical payout scheme is at least partly to blame: I make Big Money I get a piece; I make a big loss and Oops it hits the firm's capital. As evidence of compensation dysfunction. Merrill's John Thain wanted a $10Million bonus for running his firm so badly he had to jump into the arms of BofA. John Mack of Morgan Stanley said it would look bad for Wall Street execs to get a bonus this year (2008) so they should not ask for one. But he misses the point too. It would be bad because they did not earn it. Moreover they should offer back to their respective firms the monies they were paid over the past two years for creating the mess than came home to roost this past year. But NO CEO is offering that, are they? Now that's leadership.
Has Policy Now Run Amok?
Firms may have been emboldened - or employees - to take more risk, thinking that FAILURE was NOT AN OPTION. By this I do not mean Hubris but the notion that they worked for firms that were too-big to fail. If that sort of belief is a root CAUSE of the problem then all these combinations that are making firms even bigger are a dysfunctional response to a pressing problem. At the very least firms must be able to fail so firms and employees will see risk and act as if risk is present. Claw back provisions on bonuses would make firms (employees and CEOs) more careful to see that their deals made money the right way instead of on a statute of limitation of one year subject only to board oversight instead of to legal redress. To facilitate the ability of all firms to fail, all derivative deals probably need to be washed though an exchange. Banks may have to have their options to do business limited. Structures like SIVS make no regulatory sense. If you can't do it on the balance sheet you can't do it all. Regulators need a framework and a mission. they also need some backbone and leadership that does not undermine the mission.
The failure of management theory-
For a long time, as an economist, I have been disdainful of the all the business school gurus and their various theories of management (okay, maybe a bit jealous of the limelight, too). That so many theories exist is a testament to how little we know about management or what a demand there is to obscure what management is and what it does. The objective for firms is to oversee and control managers so that they have the best interests of the corporation at heart. But who can oversee the one who oversees? Few corporate boards really control their CEO, usually it is the other way around. Plus it is complicated. You hire a CEO to lead so when should you stop them? Some firms try to get at fairness and independence by having a compensation committee to decide CEO pay. That committee may be different from the board but to whom does it report and who staffs it? Right! Management theories eventually come around to one thing: getting compensation right. Stock options were once thought to be the key but the CEO has a much different time horizon than the firm. Managing in up and down cycles is different and stock options may not fairly reflect effort or results in uncertain times. So where do we go?
A New Future Course of Action
I think the only effective oversight on a CEO will have to come from judicial oversight and clawback provisions for excessive bonuses. Such second guessing would kick in when it becomes clear a bonus was given for an activity that was not valuable to the firm. On this notion bonuses on Wall Street paid over the past several years could be 'clawed back' by shareholders who realized that the deals firms made were destructive and money-losing. Before you ponder what a hammer blow that would be to employees in this recession, ponder how different the outcome of the past several years might have been had this 'law' been in effect and had Wall Street been aware of such a provision. The idea is not to clamp a penalty on past activity but to impose a rule to affect behavior in the future. Clearly firms cannot police themselves. Boards simply are not independent except in extreme times - and not always then. Shareholders are powerless, scattered and without information. The only option for redress it to take the oversight out of the firm. It is not my intent to have THE COURTS oversee each CEO bonus but for each bonus to be subject to oversight and to the potential for rescission if it is paid by a too-pliant board for conduct that was actually detrimental to the firm. I think this could be a very promising avenue for oversight, especially since firms and their boards have failed so completely and management theories have given us nothing that is useful. It might also be a way to endogenize the asymmetry of risk on Wall Street by making traders know that their statute of limitations on a trade is not just this calendar year and to make employees know that risk matters, it does not simply revert to 'the firm' and get borne by its shareholders.
Friday, January 16, 2009
Hero to zero in record time
Remember all those articles about Kenneth Lewis and what a great CEO he was and how well Bof A was doing and how well-run it was and.... never mind.
Another Citigroupie
With the new government bailout plan for B of A and with a new capital infusion of $20 billion and $118bln of assets under a loss-sharing government guarantee, Bof A now looks a lot more like Citigroup than like some bank run by a near rock-star CEO.
Merrill Lynch is Bullish on Bank of America?
BofA simply bit off more than it could chew. Left unsaid is how much of this loss is from its earlier Countrywide acquisition. Stories only want to talk about losses and the more newly acquired Merrill Lynch. Who knows what Merrill had and how it was marked but we KNOW about Countrywide. Hey Pssst: don't ask, don't tell. If Merrill's losses were so huge how could Merrill/BofA and Flowers (Bof A's vetting firm for the Merrill investment) not have known that before the acquisition? If they were known problems, then - hey - time to roll back the clock and give Thain that $10mln bonus! It now appears he richly deserved it. This is not because he ran Merrill into the ground, but because he sold BofA a pig in a poke at a very respectable price.
A Cynics View of Wall Street
And, of course, that's what Wall Street pays people for. They don't 'give you crap.' Anyone can do that. They SELL IT TO YOU. And that takes a real master.
So who is the villain and who is the hero? Or is Heroes just a TV show - definitely not a reality show?
Or has everyone tied a different 'Nell' to the train tracks?
AAh So...Sushi with those banking problems, sir?
We are becoming Japan. I have always said we are different but we are becoming Japan. We not longer have any strong banks left- only strong-smelling banks. We merged and combined and 'saved' so many ailing institutions that we have spread this disease and banks have readily exposed themselves to it because, well, in banking there is no other way to say this: size matters. Every bank wants to be bigger. Now every bank's losses are bigger. Good Job! No wonder those CEOs get the BIG BUCKS! They are paid for balls not for brains that is now very clear. Maybe they should recruit from the ranks of the WWF?
Oh what tangled losses we spread when we cheat to get ahead...
Imagine what things would be like had Citibank gotten Wachovia? Oh, they we also were going to get for $45bln or so in government assistance or in portfolio guarantees, weren't they? Never mind. I guess the Wells-Fargo bid blew the doors off that 'stealth' bail out. Now Citi is exposed and Bof A is right beside it.
...and on and on this saga goes.
Bank is just a four-letter word
But whatever - WHATEVER - you do, DO not help the floundering homeowners. No THAT would surely bring moral hazard into play. Authorities rightly understand you can't have moral hazard where there are not morals - so bailing out our bankers is a safe bet.
Who's next? Who's left?
Obama-rama meets loss cram-a-rama ding dong
I guess Obama should appoint a head of nationalized banking because that is clearly where we are headed. And we may be headed for a new guy at Treasury too. Things change and fast. Welcome to Washington, Mr-O.
Another Citigroupie
With the new government bailout plan for B of A and with a new capital infusion of $20 billion and $118bln of assets under a loss-sharing government guarantee, Bof A now looks a lot more like Citigroup than like some bank run by a near rock-star CEO.
Merrill Lynch is Bullish on Bank of America?
BofA simply bit off more than it could chew. Left unsaid is how much of this loss is from its earlier Countrywide acquisition. Stories only want to talk about losses and the more newly acquired Merrill Lynch. Who knows what Merrill had and how it was marked but we KNOW about Countrywide. Hey Pssst: don't ask, don't tell. If Merrill's losses were so huge how could Merrill/BofA and Flowers (Bof A's vetting firm for the Merrill investment) not have known that before the acquisition? If they were known problems, then - hey - time to roll back the clock and give Thain that $10mln bonus! It now appears he richly deserved it. This is not because he ran Merrill into the ground, but because he sold BofA a pig in a poke at a very respectable price.
A Cynics View of Wall Street
And, of course, that's what Wall Street pays people for. They don't 'give you crap.' Anyone can do that. They SELL IT TO YOU. And that takes a real master.
So who is the villain and who is the hero? Or is Heroes just a TV show - definitely not a reality show?
Or has everyone tied a different 'Nell' to the train tracks?
AAh So...Sushi with those banking problems, sir?
We are becoming Japan. I have always said we are different but we are becoming Japan. We not longer have any strong banks left- only strong-smelling banks. We merged and combined and 'saved' so many ailing institutions that we have spread this disease and banks have readily exposed themselves to it because, well, in banking there is no other way to say this: size matters. Every bank wants to be bigger. Now every bank's losses are bigger. Good Job! No wonder those CEOs get the BIG BUCKS! They are paid for balls not for brains that is now very clear. Maybe they should recruit from the ranks of the WWF?
Oh what tangled losses we spread when we cheat to get ahead...
Imagine what things would be like had Citibank gotten Wachovia? Oh, they we also were going to get for $45bln or so in government assistance or in portfolio guarantees, weren't they? Never mind. I guess the Wells-Fargo bid blew the doors off that 'stealth' bail out. Now Citi is exposed and Bof A is right beside it.
...and on and on this saga goes.
Bank is just a four-letter word
But whatever - WHATEVER - you do, DO not help the floundering homeowners. No THAT would surely bring moral hazard into play. Authorities rightly understand you can't have moral hazard where there are not morals - so bailing out our bankers is a safe bet.
Who's next? Who's left?
Obama-rama meets loss cram-a-rama ding dong
I guess Obama should appoint a head of nationalized banking because that is clearly where we are headed. And we may be headed for a new guy at Treasury too. Things change and fast. Welcome to Washington, Mr-O.
Wednesday, January 14, 2009
The Daze News...
Every picture tells a story
It was a bad day for economic numbers and a bad day for stock markets. Retail sales plunged, Inventories are falling rapidly and export and import prices are falling.
Paint by numbers
Retail sales fell by 2.7% in December and are falling at a 25% annual rate in the quarter. Excluding the volatile food and energy portions of retail sales leaves us with the rest of retail sales in decline at a pace of 16% (saar) and that is close to what it will be in real terms. The consumers spending is about 70% of GDP and retail is about half of consumer spending. So having about 35% of the economy dropping at a pace of 16% or so is not good news. This is especially true when of the other GDP components only the government sector and perhaps commercial construction can be counted on to be positives. As I said, it was a bad day.
Beige bok is aptly named
The Fed had little to add to the panoply of data in its Beige Book release. There were no revelations. For the most part the Beige Book echos the ongoing tales of weakness we had been seeing.
Markets worry
As much as markets are reacting to weakness in the data du jour, markets might be reacting to the policy confusion. Yesterday featured a sharp differnce of opinion as Ben Bernanke stumped for more help for banks and as Bill Poole warned of the inevitability of inflation from the Fed's outsized balance sheet expansion. As for markets, the Tips spreads are pointing to deflation or low inflation as far as the eye can see (and far as the TIP can be tipped -that's about 30 Years). So at this point there is no market concern about inflation If there is any market concern its that markets are more preoccupied with the prospects of deflation. Right or wrong that's how markets see it.
It was a bad day for economic numbers and a bad day for stock markets. Retail sales plunged, Inventories are falling rapidly and export and import prices are falling.
Paint by numbers
Retail sales fell by 2.7% in December and are falling at a 25% annual rate in the quarter. Excluding the volatile food and energy portions of retail sales leaves us with the rest of retail sales in decline at a pace of 16% (saar) and that is close to what it will be in real terms. The consumers spending is about 70% of GDP and retail is about half of consumer spending. So having about 35% of the economy dropping at a pace of 16% or so is not good news. This is especially true when of the other GDP components only the government sector and perhaps commercial construction can be counted on to be positives. As I said, it was a bad day.
Beige bok is aptly named
The Fed had little to add to the panoply of data in its Beige Book release. There were no revelations. For the most part the Beige Book echos the ongoing tales of weakness we had been seeing.
Markets worry
As much as markets are reacting to weakness in the data du jour, markets might be reacting to the policy confusion. Yesterday featured a sharp differnce of opinion as Ben Bernanke stumped for more help for banks and as Bill Poole warned of the inevitability of inflation from the Fed's outsized balance sheet expansion. As for markets, the Tips spreads are pointing to deflation or low inflation as far as the eye can see (and far as the TIP can be tipped -that's about 30 Years). So at this point there is no market concern about inflation If there is any market concern its that markets are more preoccupied with the prospects of deflation. Right or wrong that's how markets see it.
Monday, January 12, 2009
Trichet: Forever In the shadow of the Bundesbank
Trichet- A moment of weakness or of insight? Last week in a moment of weakness - or was it insight? - amid a torrent of weak economic reports ECB president Jean-Claude Trichet admitted that the economy was getting much weaker in Europe. Has he really changed his mind? Is the ECB on the brink of a real policy switch?
ECB- a single mandate: Unlike the Fed, the ECB has one policy objective and that is to contain inflation. To pursue that objective the ECB has imposed a ceiling on the rate of inflation, its HICP headline measure. Since that rate has fallen sharply and is now well below its ceiling, many think that the ECB is on its way to aggressive rate cuts. Indeed, even
Two Views from ECB members...
In a December speech Jurgen Stark, member of the ECB Executive Board, said " After previous substantial rate cuts the remaining room for maneuver is very limited, potentially allowing for small steps only. Having only one instrument at hand the limits of what can be achieved and what cannot be achieved with a single instrument should be recognized. The key ECB interest rate is currently 2.5%. The President of the ECB has made it very clear that the decrease of 175 basis points within two months is exactly what is appropriate taking into account all available information. New relevant information for the euro area which allows for a serious re-assessment of the outlook for price stability will very likely not be available before February or March 2009."
Stark does not sound like he is on board for a much more aggressive policy. But there is more than one voice on policy...
ECB Board member and Vice President Lucas Papademos said in early January, "We will do what is necessary, in terms of the timing and in terms of the size (of interest rate policy action) to ensure that price stability is preserved." Papademos was speaking to reporters on the sidelines of the annual meeting of the American Economics Association in early January 2009. He continued, "Inflation will not be allowed to fall significantly below 2 percent for a protracted period of time, over the medium term, which we do not expect on the basis of our present analysis."
Motivations...
Trichet is like any central banker is caught in a cross current of views. But his task is to provide leadership. At the same we must look at Mr Trichet's own motivations.
Trichet's path: Trichet was supposed to be the first head of the European Central bank but he was under scrutiny for wrong-doing at the time the ECB was formed and so the first ECB head was instead Wim Duisenberg, a Dutchman. After Duisenberg left, Trichet, cleared of any wrong-doing, took the helm at the ECB. Trichet had previously headed the Bank of France.
The German legacy: The Germans pressured from the start to locate the ECB in
The Bundesbank view: With the first two chief economists at the ECB being German, Trichet, and all of the bank, cannot help but feel the imprint of the Bundesbank’s tight-fisted approach from the policy advice being given by the bank's staff. As president he will not want to look like he is less keen on fighting inflation than his German counterparts. Although the economy is weak and inflation is falling fast, Stark already has said the current policy looks ahead and anticipates furthers drops in inflation. His message is not to double count news that was already expected. Looking at the trail of inflation it is clear that the inflation rate in EMU has dropped sharply... but it is also clear that relative to its pre-oil-price spurt trend, improved performance still is not cemented. That longer term climb in inflation's (yr/yr) trend has not been so clearly broken. And it is the focus on the long run has made some of the German commentators reluctant to respond to economic weakness. That may yet stay the hand of Trichet.
The shadow knows: In the wake of rise and fall of Alan Greenspan certainly every central banker will be making policy with an eye to how the future will judge him. If Trichet is taking stock of himself we can expect he will be more affected by the still reluctant view of many Germans. This raises the question of whether
Thursday, January 8, 2009
Claims offer a breath of fresh air...Is it tainted?
Despite a substantial weakness in the economy amid soaring announced corporate layoffs, jobless claims have plunged over the past two weeks from a recession high of 589K to their current 467K.
This drop is pretty much unprecedented based on recessions since the late 1960s. Claims have fallen by 122K from their peak in the span of three weeks. The only comparable sort of drop came late in the 1981 recession when claims slid 78K from 614K to 536 before rising to a new cycle peak at 695K.
This drop is pretty much unprecedented based on recessions since the late 1960s. Claims have fallen by 122K from their peak in the span of three weeks. The only comparable sort of drop came late in the 1981 recession when claims slid 78K from 614K to 536 before rising to a new cycle peak at 695K.
Note that claims always have hit their peak in the 12 week before the end of recession or less. In the two previous long post-war recessions (1973-75 and 1981-82) claims peaked 10 weeks from those recession’s respective ends.
It is too soon to say that claims have peaked despite this since we know a lot of layoffs are still in the pipeline. And claims in the December-January period are fickle due to weather and holidays as well as the peculiarities of seasonal adjustment (i.e. if stores did not hire as much Christmas help because they braced for a poor Christmas, then they won’t be laying off as many after Christmas and this could mean lower jobless claims, especially because seasonal factors are looking for bulked up filings).
However, the non MFG ISM did bounce in December. It is still weak but looking less like a freefall. Claims have fallen sharply. There is some room for optimism on the economy, though it may be fleeting.
At this point the hint of fresh air is not enough to put a new stimulus package on hold. Remember the rule of Mini-Max. In bad times under conditions of uncertainty (aka reality) many pursue the strategy of Mini-Max. That means trying to minimize the damage that will occur if they make a bad decision. For policy right now the worst mistake to make is not to give stimulus if it isn’t needed but to withhold stimulus if it is needed. The stimulus plan should go through. In the mean time we should watch the incoming numbers closely. Thinks are getting interesting.
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Wednesday, January 7, 2009
Return of the good old days...
What won't happen...
The stock market will not jet back to normal. No one will wave the magic wand of repair. The recovery will be halting and erratic. Those who expect a quick recovery will have to endure something more painful and episodes of false hope.
What will...
But there will be recovery.
Why...Obamathon!
The Fed has flooded the markets with liquidity and the treasury has injected capital into the major financial institutions. Actions to stimulate the economy are afoot, including a new fiscal program from the new president that will include the kitchen sink. I call it an Obamathon.
Skeptics!
Some are wary of the future because they can see no drivers for growth. I make the opposite argument: what are the drivers of weakness?
A known, but treacherous, path
We know that corporate layoffs are in train and more job losses lie ahead. But that is true in all recessions. We have now entered into the 'plain vanilla' part of the recession after passing through the gates of Hell. By that I do not mean it is not painful or that the recession will be average. This recession will be severe. But we know what happens and we know weakness will run its course. Manufacturing is already at the sort of lows we see at the worst of recessions. Auto sales at 10mln units or so are scraping the bottom. Want recession? You got it. But conditions do not deteriorate forever. Recessions do end.
Argument for optimism
We expect services demand to remain as a drumbeat of growth and for the goods sector weakness to moderate as auto sales recover in part due to GMAC financing. Housing starts are so low there is little weakness left there. New household formations are about 1.5mln/Yr so housing demand is already making a dent in the overhang of new home supply that is running at 0.4mln units per year.
The main residual risk
Inventories are up relative to sales because sales have fallen, more than because inventories have grown. Government spending will advance. The main downside risk is from the business sector where construction has so far held up. Equipment and software spending could still fall sharply too. The main risk of setback is in the corporate sector. Unfortunately all the extended tax credits will not encourage much new spending there, if the economy is still contracting. So this remains a risk to further weakness. But if the consumer re-starts, that will mitigate the risk of corporate sector implosion.
Tug of war between forces of good and evil
The already extreme weakness in consumption will undergo the two way tug, lower from job losses, and upward, from the coming stimulus plan. On balance, it appears that much of the downward economic momentum is being spent in 2008-Q4 and in 2009-Q1. With stimulus coming on line quickly, perhaps late in Q1 and in Q2, the fundamental negative forces on the economy will have played out. Auto and home sales can hardly get much weaker. As long as the Fed/Treasury keep the financial sector intact the prospect for a return to growth in the second half is quite good. This a positive outlook but also a reasonable one. There is nothing 'natural' about continuing economic contraction.
Just how far can consumption fall in the face of countervailing stimulus?
Growth is natural
Economies have natural forces that propell growth like population expansion. And although unemployment is set to rise even at 8% most people have jobs. Pull backs in the economy stop when the domino effect runs out. The Fed/Treasury have stoppered the financial sector and blunted the risk for those dominos to continue to drop. The stimulus program will put a floor on consumer spending drops- that sector already has key sectors in what should be regarded as 'worst case scenarios' (autos and homebuilding).
Housing...
With some sort of plan in place to help the mortgage market the scenario for recovery is complete. Already the Fed's low interest rates and mortgage purchase plan are reducing mortgage rates and that helps to support home prices. Prices already have taken a big hit. Each 50bp drop in mortgage rates allows a buyer to purchase a home that is 6% to7% more expensive so the Fed has already cut rates obviating the need for home prices to fall by a further 6% to 7%. With 20% declines already a reality, housing must be close to the price levels needed to sustain it. I am an optimist on housing. The problem for housing will be credit scores...
The good becomes the bad, the bad becomes the ugly...how about in reverse?
There is a danger in thinking that the bad can't get worse. Still, I think a recovery is by and large the most reasonable path after the end of 2009-Q1. The deficit will expand sharply and the economy will get back on its growth path. What I do not understand is the logic for continued declines- what is the engine for that? Much of the weakness now is reverberating through sectors hit by the excesses in the commodity markets, in housing, and in retailing. Banks have already seen the worst of it. So What I find less plausible is that the slippage under these circumstances would continue to snowball. With a large fiscal plan underway the turning point seems to be cemented.
Markets
For markets the situation is different. There are many investors with funds trapped that want to release them and this potential selling stands in the way of a rapid fire market recovery. A rising market will get hit by waves of hedge fund selling. This will help to restrain the rebound in markets. Ultimately that will make the rebound more enduring. As always, having funds set to sell will not stop the market's rise if the rise is based on a positive shift in fundamentals.
Recovery phase two
After recovery is in gear there will still be a lot of work left to do. The financial sector will have to be weaned off of its support. The Fed will have to withdraw its excess liquidity and do it fast. So rates might rise quickly in the early recovery phase. There are many risks and inflation is one of them. But I throw my lot in on the side of betting on recovery to start and to endure.
The stock market will not jet back to normal. No one will wave the magic wand of repair. The recovery will be halting and erratic. Those who expect a quick recovery will have to endure something more painful and episodes of false hope.
What will...
But there will be recovery.
Why...Obamathon!
The Fed has flooded the markets with liquidity and the treasury has injected capital into the major financial institutions. Actions to stimulate the economy are afoot, including a new fiscal program from the new president that will include the kitchen sink. I call it an Obamathon.
Skeptics!
Some are wary of the future because they can see no drivers for growth. I make the opposite argument: what are the drivers of weakness?
A known, but treacherous, path
We know that corporate layoffs are in train and more job losses lie ahead. But that is true in all recessions. We have now entered into the 'plain vanilla' part of the recession after passing through the gates of Hell. By that I do not mean it is not painful or that the recession will be average. This recession will be severe. But we know what happens and we know weakness will run its course. Manufacturing is already at the sort of lows we see at the worst of recessions. Auto sales at 10mln units or so are scraping the bottom. Want recession? You got it. But conditions do not deteriorate forever. Recessions do end.
Argument for optimism
We expect services demand to remain as a drumbeat of growth and for the goods sector weakness to moderate as auto sales recover in part due to GMAC financing. Housing starts are so low there is little weakness left there. New household formations are about 1.5mln/Yr so housing demand is already making a dent in the overhang of new home supply that is running at 0.4mln units per year.
The main residual risk
Inventories are up relative to sales because sales have fallen, more than because inventories have grown. Government spending will advance. The main downside risk is from the business sector where construction has so far held up. Equipment and software spending could still fall sharply too. The main risk of setback is in the corporate sector. Unfortunately all the extended tax credits will not encourage much new spending there, if the economy is still contracting. So this remains a risk to further weakness. But if the consumer re-starts, that will mitigate the risk of corporate sector implosion.
Tug of war between forces of good and evil
The already extreme weakness in consumption will undergo the two way tug, lower from job losses, and upward, from the coming stimulus plan. On balance, it appears that much of the downward economic momentum is being spent in 2008-Q4 and in 2009-Q1. With stimulus coming on line quickly, perhaps late in Q1 and in Q2, the fundamental negative forces on the economy will have played out. Auto and home sales can hardly get much weaker. As long as the Fed/Treasury keep the financial sector intact the prospect for a return to growth in the second half is quite good. This a positive outlook but also a reasonable one. There is nothing 'natural' about continuing economic contraction.
Just how far can consumption fall in the face of countervailing stimulus?
Growth is natural
Economies have natural forces that propell growth like population expansion. And although unemployment is set to rise even at 8% most people have jobs. Pull backs in the economy stop when the domino effect runs out. The Fed/Treasury have stoppered the financial sector and blunted the risk for those dominos to continue to drop. The stimulus program will put a floor on consumer spending drops- that sector already has key sectors in what should be regarded as 'worst case scenarios' (autos and homebuilding).
Housing...
With some sort of plan in place to help the mortgage market the scenario for recovery is complete. Already the Fed's low interest rates and mortgage purchase plan are reducing mortgage rates and that helps to support home prices. Prices already have taken a big hit. Each 50bp drop in mortgage rates allows a buyer to purchase a home that is 6% to7% more expensive so the Fed has already cut rates obviating the need for home prices to fall by a further 6% to 7%. With 20% declines already a reality, housing must be close to the price levels needed to sustain it. I am an optimist on housing. The problem for housing will be credit scores...
The good becomes the bad, the bad becomes the ugly...how about in reverse?
There is a danger in thinking that the bad can't get worse. Still, I think a recovery is by and large the most reasonable path after the end of 2009-Q1. The deficit will expand sharply and the economy will get back on its growth path. What I do not understand is the logic for continued declines- what is the engine for that? Much of the weakness now is reverberating through sectors hit by the excesses in the commodity markets, in housing, and in retailing. Banks have already seen the worst of it. So What I find less plausible is that the slippage under these circumstances would continue to snowball. With a large fiscal plan underway the turning point seems to be cemented.
Markets
For markets the situation is different. There are many investors with funds trapped that want to release them and this potential selling stands in the way of a rapid fire market recovery. A rising market will get hit by waves of hedge fund selling. This will help to restrain the rebound in markets. Ultimately that will make the rebound more enduring. As always, having funds set to sell will not stop the market's rise if the rise is based on a positive shift in fundamentals.
Recovery phase two
After recovery is in gear there will still be a lot of work left to do. The financial sector will have to be weaned off of its support. The Fed will have to withdraw its excess liquidity and do it fast. So rates might rise quickly in the early recovery phase. There are many risks and inflation is one of them. But I throw my lot in on the side of betting on recovery to start and to endure.
Tuesday, January 6, 2009
Do you believe in magic?
No belief in magic?
How about Santa Claus? ...or the tooth fairy?
How about stimulus programs?
Ah, stimulus programs...
Open wide, say AHHH.. Oh yes some stimulus programs are hard to swallow then some are just second helpings of your favorite dish.
Tax credits extended help...whom?
The tax credit portion of the Obama plan is such an example. This will allow firms to write off losses over five years so those with past (boom era) profits will be able to write off some bust-era (current) losses to generate cash. The cost is not free it's federal and it means a larges fiscal deficit. The good news is that this will help to funnel money into the firms that are being hurt the most and that are in the greatest need of help. In that sense it seems targeted. The bad news is that these are the very same firms that made the biggest mistakes. It's like a reward for failure. Banks and homebuilders are expected to be among the biggest beneficiaries of this largesse. I guess that the old saying is true. On Wall Street we always used to say if you don't want to be fired, be sure to lose a lot of money if you are going to have a loss.
Fiddle Dee dee please help ME!
Such a credit will help them. But that won't make homebuilders build more homes or make banks lend more money. Fiddle dee dee.
Still out in the cold
By the way all this and still nothing concrete for homeowners... except maybe some concrete. You got a problem wit dat? Housing is still widely said to be at the bottom of all the troubles. Unfortunately lip service is not mortgage servicing.
There are plans...
There are plans to help displaced workers. Plans to help them to make their Cobra payments. There are public works plans. There are tax rebate plans and even outright payments to families with children at income levels below past thresholds that used to determine who would receive 'rebate' monies. There are a lot of plans and a lot of moving parts. And all of these actions will help the people that get these monies. But none of this will reverse recession.
How to save a life...an economic one
Recession is a process. It has to run its course or be diverted by an authentic new trend. Government monies are temporary infusions. They can help to prop income but apart from the funds given to the truly desperate, not all of them will be spent. And there is no promise of follow-up spending for retailers who will be glad to sell their existing stocks of goods and then NOT REORDER... Tax credits for investment will not be used until the economy turns higher. So before these stimulus plans really kick in, the economy itself needs to be in a better state. That, seemingly, is a paradox, but even in medicine we know that patients have to be healthy enough before we can operate on them. Why should the economy be any different?
Splenda is not Sugar... artificial stimulus is not real growth
The economy does well when business is profitable and expanding, paying wages that in turn are supporting consumption. The idea of a stimulus plan is to artificially create some of these same circumstances. But a cost incentive to invest is not the same as a profit motive that looks ahead. A one time boost to income is not the same as a real job and the sense of security it imparts to a family. Make-work public works programs can be more potent when the projects are long lived, but then the monies get into the economy slowly. Just as artificial strawberry flavoring may bear a resemblance to the real thing, it still is not that. In the economy some may find the artificial help of some use, others may remain the skeptical consumers or businesses that they were before getting the extra help.
Recovery is a process not a destination
It is hard to mimic with artificial means the health of a real and vital economy. This economy has some bad investments that are lingering, and lines of business that are in the process of being shut down. Unfortunately they are impacting other sectors. Housing is a still vital sector but one that underwent too much expansion and price appreciation. That is a travesty since excess housing stock is worked off so much more slowly that an excess of shirts or dresses. What miracle of stimulus can put that right? Answer: Nothing. Recovery is a process; it takes time.
Tax credits and help: which ones work?
But working our way out of these excesses is the path to a better economy. Some artificial stimulus can help, but think it through. Do you really want to help the homebuilders who overbuilt homes with such high prices tags? Do this and you encourage their homes - currently for sale -- to stay on the market at barely reduced prices. Bankrupt them and others buy their assets and resell the stock of unsold new homes for pennies on the dollar, since that is what they purchase them for. Housing prices must adjust to what the population can afford, not to the cost that builders have in them. Does bankruptcy suit home builders? Does it suit and help the economy? These should be the central questions for policymakers.
Stimulus and models
It is hard to create a stimulus program and while econometric models may show some benefit (indeed current growth will respond to such hefty sums of spending) in truth the impact is a guessing game. It is the way funds are channeled as much as it is how many funds are channeled and in ways models often don't account for that is really critical. The impact of income on an individual is the money it means he or she can spend today and in the future. Simple money given today lacks many of the characteristics of income rightly earned and projectable into the future. The recipient of such funds knows that best of all and his/her propensity to spend such funds reflects this knowledge.
At heart a stimu-skeptic
Recessions are processes that must wring certain accumulated excesses out of the system. In this one the Treasury acted to make sure banks were not a casualty that could drag everything down with them. Good choice. But that is damage control not stimulus. Damage control is much easier to do. The last stimulus package in 2008 did not give us much more than the spending in the quarter in which it was executed. There was no spillover. The economy continued down its slippery slope after a one-quarter bounce. Was that really worth it? As we look as what could be $775bln in stimulus in 2009 and 2010, we have to ask if it is the sort of thing that will help boost the economy or is it wasted? Is it damage control? Even if it cushions those that recession might take advantage of, that alone could be reason enough to do it. But that is a different objective and rationale than 'stimulus' per se. Into 2010, with nothing much done, the economy should be recovering. After all we already are one year into it so we are talking about a 2-3 year period when, in fact, the longest Post-War recession was 16-months. I do believe in these packages as damage control and as band aids for the injured but I remain skeptical of stimulus. Keep spending long enough and you'll get a recovery. That does not mean your spending created the recovery. But we know who will take credit for it...
How about Santa Claus? ...or the tooth fairy?
How about stimulus programs?
Ah, stimulus programs...
Open wide, say AHHH.. Oh yes some stimulus programs are hard to swallow then some are just second helpings of your favorite dish.
Tax credits extended help...whom?
The tax credit portion of the Obama plan is such an example. This will allow firms to write off losses over five years so those with past (boom era) profits will be able to write off some bust-era (current) losses to generate cash. The cost is not free it's federal and it means a larges fiscal deficit. The good news is that this will help to funnel money into the firms that are being hurt the most and that are in the greatest need of help. In that sense it seems targeted. The bad news is that these are the very same firms that made the biggest mistakes. It's like a reward for failure. Banks and homebuilders are expected to be among the biggest beneficiaries of this largesse. I guess that the old saying is true. On Wall Street we always used to say if you don't want to be fired, be sure to lose a lot of money if you are going to have a loss.
Fiddle Dee dee please help ME!
Such a credit will help them. But that won't make homebuilders build more homes or make banks lend more money. Fiddle dee dee.
Still out in the cold
By the way all this and still nothing concrete for homeowners... except maybe some concrete. You got a problem wit dat? Housing is still widely said to be at the bottom of all the troubles. Unfortunately lip service is not mortgage servicing.
There are plans...
There are plans to help displaced workers. Plans to help them to make their Cobra payments. There are public works plans. There are tax rebate plans and even outright payments to families with children at income levels below past thresholds that used to determine who would receive 'rebate' monies. There are a lot of plans and a lot of moving parts. And all of these actions will help the people that get these monies. But none of this will reverse recession.
How to save a life...an economic one
Recession is a process. It has to run its course or be diverted by an authentic new trend. Government monies are temporary infusions. They can help to prop income but apart from the funds given to the truly desperate, not all of them will be spent. And there is no promise of follow-up spending for retailers who will be glad to sell their existing stocks of goods and then NOT REORDER... Tax credits for investment will not be used until the economy turns higher. So before these stimulus plans really kick in, the economy itself needs to be in a better state. That, seemingly, is a paradox, but even in medicine we know that patients have to be healthy enough before we can operate on them. Why should the economy be any different?
Splenda is not Sugar... artificial stimulus is not real growth
The economy does well when business is profitable and expanding, paying wages that in turn are supporting consumption. The idea of a stimulus plan is to artificially create some of these same circumstances. But a cost incentive to invest is not the same as a profit motive that looks ahead. A one time boost to income is not the same as a real job and the sense of security it imparts to a family. Make-work public works programs can be more potent when the projects are long lived, but then the monies get into the economy slowly. Just as artificial strawberry flavoring may bear a resemblance to the real thing, it still is not that. In the economy some may find the artificial help of some use, others may remain the skeptical consumers or businesses that they were before getting the extra help.
Recovery is a process not a destination
It is hard to mimic with artificial means the health of a real and vital economy. This economy has some bad investments that are lingering, and lines of business that are in the process of being shut down. Unfortunately they are impacting other sectors. Housing is a still vital sector but one that underwent too much expansion and price appreciation. That is a travesty since excess housing stock is worked off so much more slowly that an excess of shirts or dresses. What miracle of stimulus can put that right? Answer: Nothing. Recovery is a process; it takes time.
Tax credits and help: which ones work?
But working our way out of these excesses is the path to a better economy. Some artificial stimulus can help, but think it through. Do you really want to help the homebuilders who overbuilt homes with such high prices tags? Do this and you encourage their homes - currently for sale -- to stay on the market at barely reduced prices. Bankrupt them and others buy their assets and resell the stock of unsold new homes for pennies on the dollar, since that is what they purchase them for. Housing prices must adjust to what the population can afford, not to the cost that builders have in them. Does bankruptcy suit home builders? Does it suit and help the economy? These should be the central questions for policymakers.
Stimulus and models
It is hard to create a stimulus program and while econometric models may show some benefit (indeed current growth will respond to such hefty sums of spending) in truth the impact is a guessing game. It is the way funds are channeled as much as it is how many funds are channeled and in ways models often don't account for that is really critical. The impact of income on an individual is the money it means he or she can spend today and in the future. Simple money given today lacks many of the characteristics of income rightly earned and projectable into the future. The recipient of such funds knows that best of all and his/her propensity to spend such funds reflects this knowledge.
At heart a stimu-skeptic
Recessions are processes that must wring certain accumulated excesses out of the system. In this one the Treasury acted to make sure banks were not a casualty that could drag everything down with them. Good choice. But that is damage control not stimulus. Damage control is much easier to do. The last stimulus package in 2008 did not give us much more than the spending in the quarter in which it was executed. There was no spillover. The economy continued down its slippery slope after a one-quarter bounce. Was that really worth it? As we look as what could be $775bln in stimulus in 2009 and 2010, we have to ask if it is the sort of thing that will help boost the economy or is it wasted? Is it damage control? Even if it cushions those that recession might take advantage of, that alone could be reason enough to do it. But that is a different objective and rationale than 'stimulus' per se. Into 2010, with nothing much done, the economy should be recovering. After all we already are one year into it so we are talking about a 2-3 year period when, in fact, the longest Post-War recession was 16-months. I do believe in these packages as damage control and as band aids for the injured but I remain skeptical of stimulus. Keep spending long enough and you'll get a recovery. That does not mean your spending created the recovery. But we know who will take credit for it...
Monday, January 5, 2009
What is now our guidepost?
Markets have failed us.
Economics has failed us.
Our regulatory system has failed us.
Those that staffed that system have failed us.
No other economy held up better so there is no real model to choose from to replace ours... So what do we believe in? What will guide our way?
Creative destruction meets destructive destruction?
Joseph Schumpeter spoke of capitalism as full of waves of 'creative destruction'. And as surely and the computer and software became king the typewriter's future was set along with that for 'White-out" and correction tape. No one would suggets government should go in an bail them out. Or the makers of buggy whips...
Yet we see the goverment is bailing out banks and the Fed is lending more broadly. What is going on?
Daydream believers...
The system we believed in is in shambles. In trying to save it, we have violated just about every rule it purports to stand for. Yet, we are still capitalists and the Fed/Treasury was looking for a way that markets could find the solution (reverse auctions) even as markets pitched us into a deep morass of trouble.
Markets lose the functionality
Markets are suppsoed to get prices right. But oil rose to $70/bbl, surged to nearly $150/bbl then fell back sharply. So what service did this market provide to help investors sort out alternative energy issues? None. Markets have failed as the gatekeepers for getting pricing right and helping to direct investor traffic. Markets have sent many an investor scurrying in the wrong direction. Some volatily is to be expected. But look at house prices. They are not supposed to be so volatile but look at what they have done. Look at how badly they have led the consumer. Look at the eveil they have brought for banks. How are we to look at that?
Like the rest of you I expect us to put these failings behind us and to look ahead. But there is a good lesson here for using judgement and for regulators to show some gumption in doing their job.
What market failure means
No matter how much economists want to revere markets there is no denying that markets have failed in such an extreme way it will be hard to argue that there is not a a substantial role for regulators to interfere- to show judgement.
Dealing with a stacked deck
It is also hard to know when markets are by themselves going back to do the job they for a while did so well. There will be no public announcement. No email will be sent to your in-box. But markets have failed us us in so many ways that it is hard to know when to start trusting them again. So between now and then what will guide policy? How much stock will investors and the Fed place in the behavior of markets? That remains an intersting question. Unilt then we will be guided by the judgements of our main institutions, substantially the policies of our central bank.
Economics has failed us.
Our regulatory system has failed us.
Those that staffed that system have failed us.
No other economy held up better so there is no real model to choose from to replace ours... So what do we believe in? What will guide our way?
Creative destruction meets destructive destruction?
Joseph Schumpeter spoke of capitalism as full of waves of 'creative destruction'. And as surely and the computer and software became king the typewriter's future was set along with that for 'White-out" and correction tape. No one would suggets government should go in an bail them out. Or the makers of buggy whips...
Yet we see the goverment is bailing out banks and the Fed is lending more broadly. What is going on?
Daydream believers...
The system we believed in is in shambles. In trying to save it, we have violated just about every rule it purports to stand for. Yet, we are still capitalists and the Fed/Treasury was looking for a way that markets could find the solution (reverse auctions) even as markets pitched us into a deep morass of trouble.
Markets lose the functionality
Markets are suppsoed to get prices right. But oil rose to $70/bbl, surged to nearly $150/bbl then fell back sharply. So what service did this market provide to help investors sort out alternative energy issues? None. Markets have failed as the gatekeepers for getting pricing right and helping to direct investor traffic. Markets have sent many an investor scurrying in the wrong direction. Some volatily is to be expected. But look at house prices. They are not supposed to be so volatile but look at what they have done. Look at how badly they have led the consumer. Look at the eveil they have brought for banks. How are we to look at that?
Like the rest of you I expect us to put these failings behind us and to look ahead. But there is a good lesson here for using judgement and for regulators to show some gumption in doing their job.
What market failure means
No matter how much economists want to revere markets there is no denying that markets have failed in such an extreme way it will be hard to argue that there is not a a substantial role for regulators to interfere- to show judgement.
Dealing with a stacked deck
It is also hard to know when markets are by themselves going back to do the job they for a while did so well. There will be no public announcement. No email will be sent to your in-box. But markets have failed us us in so many ways that it is hard to know when to start trusting them again. So between now and then what will guide policy? How much stock will investors and the Fed place in the behavior of markets? That remains an intersting question. Unilt then we will be guided by the judgements of our main institutions, substantially the policies of our central bank.
Friday, January 2, 2009
Happy New Year...happy but cautious
Happy New Year.
Today's ISM is posting some of the weakest readings it ever has offered in its history that extends back to the late 1940s.
Also today the stock market 'jumped' crossing the 9,000 barrier (DJIA, of course) for the first time since 1998.
Another lost decade for investors.
The ISM is a reminder that the economic downturn is no flash in the pan. But the stock market's rise is a notice that investors, while bloodied, still have their wits and hopes about them.
The economy has been deeply damaged as has been the finances of all investors. But there is still economic activty and like people after a big snow storm, they are starting to dig their way back out and test the climate.
I am not so surprised by the ISM whose new order reading is the weakest in its entire history. The descent of the ISM in this cycle is stunning even bythe standards of recession. In its ninth month of this recession the ISM was the second strongests in recession hisotry since 1960 at that mark. But by the 13th month the index is at its weakest point for that month and at one of the weakest readings ever.
We are inthe grip an intense down phase of a manufacturing downturn. We still have to expect the next several months to be bad. The question is how soon will we recover? Stocks started 2008 on a good note a hopeful note as investors were not dismayed by the still-weak ISM. But a lot lies ahead of us. The Fed, the treaury the new Administration still have a lot to do. There is grounds for optimism ...and for caution.
Today's ISM is posting some of the weakest readings it ever has offered in its history that extends back to the late 1940s.
Also today the stock market 'jumped' crossing the 9,000 barrier (DJIA, of course) for the first time since 1998.
Another lost decade for investors.
The ISM is a reminder that the economic downturn is no flash in the pan. But the stock market's rise is a notice that investors, while bloodied, still have their wits and hopes about them.
The economy has been deeply damaged as has been the finances of all investors. But there is still economic activty and like people after a big snow storm, they are starting to dig their way back out and test the climate.
I am not so surprised by the ISM whose new order reading is the weakest in its entire history. The descent of the ISM in this cycle is stunning even bythe standards of recession. In its ninth month of this recession the ISM was the second strongests in recession hisotry since 1960 at that mark. But by the 13th month the index is at its weakest point for that month and at one of the weakest readings ever.
We are inthe grip an intense down phase of a manufacturing downturn. We still have to expect the next several months to be bad. The question is how soon will we recover? Stocks started 2008 on a good note a hopeful note as investors were not dismayed by the still-weak ISM. But a lot lies ahead of us. The Fed, the treaury the new Administration still have a lot to do. There is grounds for optimism ...and for caution.
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