Moving to Capital Gains and Games

After several years of blogging on my own at Vox Baby, I am joining Stan Collender and Pete Davis over at the newly redesigned Capital Gains and Games blog. Stan and Pete are two of the sharpest people writing about fiscal policy and financial matters, and so you should expect triple the fun at half the price.


The new feed is http://www.capitalgainsandgames.com/rss.xml, so set your bookmarks and feed readers accordingly.


Vox Baby will remain intact, so there's no need to change any links.


See you over at Capital Gains and Games.

Pass the Spittoon, Mortgage Meltdown Edition

I confess: I get annoyed beyond measure when I read articles like this one from Alan Zibel and J.W. Elphinstone of the Associated Press, which ran in my local paper this week. It manufactures drama where none is warranted. Here's the hook:

Just when consumers and the U.S. economy need banks to lend more freely, the mortgage industry is making it harder to borrow — even for those with good credit.

Mortgage insurers, whose backing is required for borrowers who can't afford the traditional 20 percent down payment on a home, have already flagged nearly a quarter of the nation's ZIP codes where they refuse to insure some home loans.

I'm already annoyed in three ways, and it's just two sentences in:

1. Consumers and the U.S. economy do NOT need banks to lend more freely. Banks lending too freely is what got us into the current mess.
2. The traditional 20 percent down payment for a home exists in part because mortgages are nonrecourse loans--the property is the only security the lender has in the transaction. While some reductions of that number may be appropriate, it was the abandonment of sensible lending standards that got us into the current mess.
3. The word "some" in the last sentence smuggles in quite a lot. If the meaning of "some" were made plain early in the article, we would stop reading and disregard the article as not worth our time.

We do find out what "some" means later on in the article:

In recent weeks, mortgage insurers have flagged more than 9,600 ZIP codes in at least 34 states where they won't insure certain types of home loans — those for investment properties or second homes, those with riskier adjustable-rate or interest-only mortgages, or for buyers making down payments of less than 3 percent.

"Some" home loans are now revealed to be loans that are extremely risky--loans whose pervasive use are what got us into the current mess--in areas where house prices are declining the most. So a shorter version of the article is that mortgage insurers are now not willing to insure loans that they shouldn't have been insuring earlier. That this is a good thing has completely escaped the notice of the two authors.

If This Meltdown Were a Movie

Ben Bernanke would be played by Harvey Keitel, reprising his role as Winston Wolf if we're lucky or Victor the Cleaner if we're not.

The responsibility for this financial meltdown does not rest with him. It was his predecessor, Alan Greenspan, whose stewardship of monetary policy set the stage for the debt-laced consumption rampage of the American consumer and the leverage-soaked financial carnival of mortgage lenders and investment bankers. (If you're keeping score at home, Greenspan still doesn't get it.) Based on his performance so far, I'm nominating Ben Bernanke to the All-Madden team of central bankers.

Bernanke has two broad categories of options:

1) Damned if He Doesn't

Bear Stearns just collapsed--it cannot pay its creditors. What was a liability to Bear Stearns was an asset to some other investor. That asset now has no value. If the other investor was also a financial institution, then it has fewer assets relative to its liabilities and is now less solvent. It may not be able to pay all of its creditors. And so on, all through the leveraged financial sector.

The Fed can act to prevent or mitigate this cascade. Looking at the prospect of contagion, the Fed has acted on two fronts. It has lowered short-term interest rates to prop of asset values across the economy. As discounting for risk has increased, discounting for time has decreased. The Fed has also intervened in specific episodes, directly backstopping private actors like JP Morgan who have stepped in to assume the liabilities of the likes of Bear Stearns.

Bernanke can't sit idly while large financial institutions crumble. There is a perception, if not the reality, of too much collateral damage in the process.

2) Damned if He Does

The Fed is supposed to be the economy's lender of last resort. If a solvent but illiquid bank needs short-term cash and cannot find it on the private market, the Fed should make credit available. Without this backstop, financial institutions would be less willing to take leveraged positions in support of beneficial economic activity.

But sometimes financial institutions take these leveraged positions in support of exceedingly risky activities. This is particularly true when they hold a put option to sell the activity to someone else if its value falls. Any intervention by the Fed extends that put option to would-be speculators, if not today, then certainly in the future.

You can call this Samwick's Law if you like:

If an institution is deemed too big to fail, then it is only a matter of time before it finds a way to get big and fail.

When you provide insurance against outcomes that a financial institution cannot control, you distort incentives on the activities it can control. Specifically, they take on more risk. To address the immediate problem, Bernanke invites the next one. Snotty bloggers two or five or ten years from now may be hanging the next crisis--runaway inflation, a persistent liquidity trap, even more spectacular bubbles in financial markets--around Ben's neck.

The task of finding the least worst way to do the wrong thing is a thankless one, but Bernanke is persevering admirably. Let's see what he does at 2:15 today.

Life is unfair, and so is the bailout

My commentary on the Bear Stearns bailout aired on NPR's Marketplace this evening. Here's the teaser:

The collapse of Bear Stearns prompted the Fed to once again cut interest rates. Commentator and economist Andrew Samwick says whether you call it a bailout or a rescue, all Americans have a stake in the outcome.

And here's an excerpt:

Two questions immediately come to mind: Is this fair, and should we care? The question of fairness is easier to answer -- of course it isn't fair. Bear Stearns' fall from grace was its own fault. It was the high-wire act in a leverage-soaked financial carnival.

And yet those in the corridors of power have intervened on the perpetrators' behalf. Some people call this "socialism for the rich." Even that's too generous -- under socialism, the rich would be paying higher taxes during the boom times. No, "fairness" is not a word that describes this bailout.

So life is unfair... Does that mean we should care?

Enjoy!

Samwick Media Watch

I'll be on NPR's Marketplace this evening, putting in my 1% of a share of Bear Stearns stock on the goings-on in financial markets. The theme--is this fair and why should you care?

Find your local station here.

Gaps and Redundancies

There is some irony to be found in the title of Tamar Levin's excellent article in Friday's edition of The New York Times, "Report Urges Changes in Teaching Math." To do anything other than what the report recommends would hardly qualify as teaching math. Here's the crux of the matter:

Closely tracking an influential 2006 report by the National Council of Teachers of Mathematics, the panel recommended that math curriculum should include fewer topics, spending enough time to make sure each is learned in enough depth that it need not be revisited in later grades. That is the approach used in most top-performing nations, and since the 2006 report, many states have been revising their standards to cover fewer topics in greater depth.

It was the frequent revisiting of earlier topics in later grades, with little increase in the sophistication of the approach, that drove me crazy in primary and secondary school. And it wasn't just math--it was virtually every subject. And despite this revisiting in later grades, students' achievements lag those in other countries. So much redundancy in instruction, and yet so many gaps in knowledge. That's strong evidence of the possibility of making gains in outcomes without additional resources.

There is more of interest in the article, particularly in this passage:

After hearing testimony and comments from hundreds of organizations and individuals, and sifting through a broad array of 16,000 research publications, the panelists shaped their report around recent research on how children learn.

For example, the report found it is important for students to master their basic math facts well enough that their recall becomes automatic, stored in their long-term memory, leaving room in their working memory to take in new math processes.

“For all content areas, practice allows students to achieve automaticity of basic skills — the fast, accurate and effortless processing of content information — which frees up working memory for more complex aspects of problem solving,” the report said.

Dr. Faulkner, a former president of the University of Texas at Austin, said the panel “buys the notion from cognitive science that kids have to know the facts.”

We needed cognitive science to figure that out? There was some competing notion, masquerading as an educational philosophy, that suggested that kids did not have to know the facts? The recommended approach all sounds very familiar, if not widely utilized.

Read the whole thing.

Bair 1, Abernathy 0

We'll give FDIC Chairman Sheila Bair credit for this bit of lonely prudence in a financial sector gone mad:

"There are significant uncertainties regarding our projections, and given the challenges facing the banking industry and the likelihood of more bank failures, I believe preparedness should be our overriding concern," said Sheila C. Bair, FDIC Chairman. "Because we are anticipating more difficult times, it would be prudent to continue to build the deposit insurance fund at the pace allowed by the current rates and the remaining credits. As we build up the insurance fund, banks and thrifts should be taking steps to bolster their capital and reserves.

This was her very sensible justification of the FDIC's board's decision to keep the assessment rates charged to insured banks and savings associations unchanged for 2008. And into the fray jumps Wayne Abernathy, now the executive vice president at the American Bankers Association, who is quoted as follows:

The decision today could mean that as much as $20 billion or more of bank services will now not be available to invest in new jobs and new businesses this year, precisely when new jobs and new business investments are most needed.

So, according to this logic, it makes sense to blame the FDIC for its prudence rather than the worst offenders represented by the ABA for their recklessness for the absence of $20 billion dollars from the banking system in the near term.

It is amazing what a change of employer and address can do.

Are We in a Recession?

The honest answer is that we cannot provide an answer in real time.

The rule of thumb is that a recession is two or more consecutive quarters of negative growth in real GDP. The latest estimate of 4th quarter GDP was 0.6%. Not negative, but certainly not great. So to say that we are in a recession, according to this rule of thumb, is to say that we have knowledge that the current quarter's growth rate is negative and either or both of the following:

1. 4th quarter GDP growth from 2007 will be revised below zero when the next estimate is released on March 27.
2. 2nd quarter GDP growth from 2008 will be negative.

I don't see how anyone could be sure of this. The starting point for 2nd quarter GDP itself is not known and will not be officially estimated in advance form until late April. There is already considerable monetary and fiscal stimulus in the pipeline that will begin to have an impact over the second quarter.

Then NBER has a broader defintion of a recession than the rule of thumb:

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion.

So to assert that we are in a recession is a claim that a peak has occurred, that the subsequent decline is significant, that the decline will last more than a few months, and that the decline will be evident in many if not all of the indicators listed in the definition. What do the indicators say?

• The Real GDP growth has been positive thus far according to official estimates (as noted above).
• Real personal income less current transfers, with data available through January, peaked in September 2007 (see Table 1 for income and transfers and Table 9 for the price deflator) but has fallen only 0.3% since then. We get February data on March 28.
• Employment peaked in December 2007 and has fallen by less than 0.1% over the subsequent two months.
• Industrial production fell from September to October 2007 and then rebounded to achieve the same index value in January as it had in September. We'll learn about the February value on Monday.
• Wholesale-retail sales. Wholesale trade fell slightly between November and December but more than made up the decline in January. (February data are released on April 9.) Retail sales fell between January and February.

Each of these indicators seems to be some version of flat. It is premature to be making pronouncements like this these, from Congressman Frank and Senator Dodd:

“We are in a recession now that has an unusual cause. It is not your usual cyclical problem… This is a structurally caused recession,” Mr. Frank told reporters at a press conference. Mr. Dodd, also appearing at the press conference, had an even gloomier take.

“This is the worst housing crisis in our lifetime. We are in a recession. People want to talk about ‘Are we?’ — we’re in one. The question is: how deep is this going to go? How long lasting will it be? The underlying economic conditions in our country are not good for resolving this. Almost every other recession we can talk about lasted eight months. When you’ve got deficits running as high as they are — The value of the dollar… inflation going up, unemployment going up, these are not great underlying economic circumstances to respond to the situation.”

They are right that the present period is different from past recessions--first, because we cannot assert that it is a recession, and second, because we have already stretched our policy responses just about as far as they will go.

Governor Spitzer, We Hardly Knew You

My first reaction to the news of Eliot Spitzer's demise was that I felt bad for his three daughters, for reasons discussed here. My second reaction was that I felt bad for his wife for having to stand there and face the public glare as well. I presume that she did that for her daughters if not for her husband. It is the adultery embedded in the transaction, particularly by a father of teenage daughters in the public eye, that most disturbs me.

But that's a personal judgment and a matter that may be relevant in a divorce proceeding. It doesn't necessarily have to guide public policy. What of the transaction itself, if it did not involve adultery? For a public official, the big danger is that Spitzer's desire to keep the activity secret would subject him to blackmail by those in on the secret. With the secret out in the open, there's no longer any danger in that happening, even if he hadn't resigned. Perhaps we need a disclosure policy for elected officials?

What of the transaction itself, if it did not involve adultery or a public official? Now we get to find out whether I'm a libertarian or not, I suppose. Here is a libertarian's case in defense of legalized prostitution. Here's another defense of legalized prostitution based on strengthening the legal status of women who currently engage in illegal prostitution.

What does the economist in me say? Despite the rather high price paid by Governor Spitzer ($4300 per hour), prostitution--particularly if legalized--lowers the cost to the man of obtaining more and more varied sexual activity from women. Who is made better off by this change in price?

• Men who partake of prostitutes (buyers).
• Women who engage voluntarily in prostitution but not other types of sex (sellers).
• Men who do not partake of prostitutes but who face less competition in finding sexual partners from the men who are now content with prostitutes (buyers of substitutes).

Who is made worse off?

• Women who do not engage in prostitution (sellers of substitutes)

The last one is a pecuniary externality. Though not a threat to economic efficiency, I'm not enough of a libertarian to ignore it.

Gridlock on Electric Highways

When I suggested the need for a capital budget, these were the sort of problems I wanted to avoid (this one in my own backyard):

CONCORD, N.H.—Northern New England is turning to the sun, wind and waste wood for clean, renewable power, but there's a serious problem: the threat of gridlock on electricity "highways."

A prime example is New Hampshire's northern Coos County, where there are proposals to build renewable energy plants with roughly 460 megawatts of capacity -- two-thirds of the proposed renewable projects in the state -- to run over a transmission line that can only handle 100 megawatts.

The bottleneck is in Whitefield, the end of a transmission loop that runs through Berlin and Lost Nation.

Projects are approved on a first-come, first-served basis, and the first in line, Noble Environmental Power, stands ready to claim the entire 100 megawatts in 2009 for a wind park. That will leave the other proposals to wither and die if investors, electricity consumers or the government don't spend $200 million to upgrade 100 miles of line.

Even if the money were available now, the upgrade could take six years to complete, presenting investors with another hurdle -- time.

Last month, backers of a proposed 70-megawatt biomass plant in Groveton announced they had had enough, at least for now. Joshua Levine, project developer for Tamarack Energy, a partner in North Country Renewable Energy's plant, said the project is on hold despite the $1 million already spent on it.

The plant would burn wood chips, low-grade wood from logging operations and other clean wood readily available in the economically stressed region.

If we intend to bring new sources on line, we need to upgrade capacity. It's crazy to have $150 billion for economic stimulus on things we don't need and yet be cash starved on projects for which we've articulated a need.