Month: December 2008

Forecasting the Official Forecasts

The IMF is signalling that it will further revise down its global growth forecast.  This is after cutting the forecast sharply in October and again in November.  Their latest published view is growth in 2009 will be 2.2% year-on-year, and 2.4% fourth quarter on fourth quarter.  This view is dated November 6, 2008, so you should think of it as reflecting what the IMF knew at the end of October.

I obviously can’t predict exactly what the next forecast will look like, as there is a lot of economic ground to cover between now and mid-January.  But here are some considerations to keep in mind. Continue reading “Forecasting the Official Forecasts” →

Causes: Free Market Ideology

Other posts in this occasional series.

Joseph Stiglitz, the 2001 Nobel Prize winner and the most cited economist in the world (according to Wikipedia) has an article aggressively titled “Capitalist Fools” in Vanity Fair that purports to identify five key decisions that produced the current economic crisis, but really lays out one more or less unified argument for what went wrong: free market ideology or, in his words, “a belief that markets are self-adjusting and that the role of government should be minimal.”

The five “decisions,” with Stiglitz’s commentary, are:

  1. Replacing Paul Volcker with Alan Greenspan, a free-market devotee of Ayn Rand, as Fed Chairman. (Incidentally, when I was in high school, I won $5,000 from an organization of Ayn Rand followers by writing an essay on The Fountainhead for a contest.) Stiglitz criticizes Greenspan for not using his powers to pop the high-tech and housing bubbles of the last ten years, and for helping to block regulation of new financial products.
  2. Deregulation, including the repeal of Glass-Steagall, the increase in leverage allowed to investment banks, and the failure to regulate derivatives (which Stiglitz accurately ascribes not only to Greenspan, but to Rubin and Summers as well).
  3. The Bush tax cuts. Stiglitz argues that the tax cuts, combined with the cost of the Iraq War and the increased cost of oil, forced the Fed to flood the market with cheap money in order to keep the economy growing.
  4. “Faking the numbers.” Here Stiglitz throws together the growth in the use of stock options – and the failure of regulators to do anything about it – and the distorted incentives of bond rating agencies – and the failure of regulators to do anything about it.
  5. The bailout itself. Stiglitz criticizes the government for a haphazard response to the crisis, a failure to stop the bleeding in the housing market, and failing to address “the underlying problems—the flawed incentive structures and the inadequate regulatory system.” (There’s regulation again.)

Continue reading “Causes: Free Market Ideology” →

Remember Sovereign Wealth Funds?

An interview with Representative Jim Moran in the National Journal reminds me that we haven’t heard much about sovereign wealth funds recently.  These are the large pools of money (in foreign currency) that were created as a result of large cumulative current account surpluses in some parts of the world (e.g., oil exporters, China, Singapore).  They were quite controversial back in mid-2007, with concerns being raised – by Congress and others – regarding various aspects of their operation.

There are still some issues around the lack of transparency of these funds, although a great deal of progress on this dimension has been made (including in and around the IMF) and we learned to worry more about black boxes in other parts of the financial system.  But these funds might be coming back as a discussion item; for example: can they, should they, would you want them to, invest in US banks to help speed a turnaround?

Personally, I think the underlying current account surpluses are going to fall – this is one likely implication of the decline in world trade for next year that the World Bank is forecasting and the counterpart of what must be an increase in US savings (and thus a fall in our current account deficit).  The accumulated stocks, in the form of sovereign wealth funds, will remain but they are no longer on explosive growth paths and this should take most of the edge off the conversation.  But how open the US remains to various kinds of capital flows – and on what exact terms – will be a prominent issue on the Congressional agenda as we move into 2009.  We do, after all, want people to buy the debt we will issue to fund the fiscal stimulus.

Auto Bailout Update

I admit – I have auto bailout fatigue. But given the amount of virtual ink that has been spilled on this topic here, I think I owe you a place where you can express your thoughts on the current plan.

The Times says we are close to a vote, although Senate Republicans may block it. Here is the draft bill. The news article says it would take the form of $15 billion in short-term emergency loans. Reading the bill itself, though, I can’t find the number “$15 billion” anywhere. This is what I read:

  1. The President can appoint a person (or persons) to implement the bill, apparently colloquially known as the car czar.
  2. Once the bill passes, the car czar can make bridge loans or lines of credit right now. Those loans can be for as much as is needed under the plans submitted to Congress last week.
  3. The money is coming from “section 129 of division A of the Consolidated Security, Disaster Assistance, and Continuing Appropriations Act, 2009, relating to funding for the manufacture of advanced technology vehicles,” which I’m guessing is the pre-existing bill providing $25 billion in loans for R&D for fuel-efficient vehicles. That money will be then be replenished. It’s not clear whether this creates a $25 billion cap or not (how many times can the car czar draw on that money after it’s been replenished?).
  4. The loans are at 5%, increasing to 9% after 5 years. The government also gets a warrant to buy up to 20% of the loan amount in stock, at a price equal to the average price during the 15 days prior to December 2.
  5. The short-term loans are conditional on the government, the automakers, and all interested parties (including unions and creditors) being able to agree on a comprehensive, long-term restructuring plan by March 31, 2009. The car czar can extend this deadline by 30 days, but that’s it.
  6. The car czar has a lot of power to monitor the auto companies and make sure they are meeting the targets of their restructuring plans; if they aren’t, he can call in the loans.
  7. There are some other fun but peripheral provisions, like getting rid of corporate aircraft, dropping lawsuits against state greenhouse gas regulation, and executive compensation limitations.

The big point is #5 (in my list). In short, this isn’t a comprehensive bailout: it’s a bridge loan to buy time to come up with a comprehensive bailout. This is roughly what Simon predicted (although I can’t remember where). It enables the Bush administration to avoid having a car company fail on its watch, and enables the Democratic majority to say that they are doing something for the automakers, while deferring the hard questions. I assume that all of the controversial questions, like how big a concession the unions have to make, and whether or not it’s possible to force creditors to take equity in place of debt, will re-emerge over the next few months.

Of course, we may still have the live TV drama of not quite knowing if the Republicans will provide the needed votes, like we had with the first TARP vote. I would also be shocked to see President Bush sign a bill that requires car companies to drop their lawsuits against greenhouse gas regulation.

Let me know if I read the bill wrong.

Update: More from Felix Salmon on why it may be hard to get bondholders to agree to restructuring short of bankruptcy.

To Lend or Not To Lend, Fed Edition

This is so brilliant I’m going to just copy Mark Thoma’s entire post right here:

Tim Duy emails:

Discordant headlines in Bloomberg:

Fed’s Kohn Says Regulators Should Encourage More Bank Lending Amid Turmoil: U.S. regulators should rise to the “challenge” of encouraging an expansion in bank lending amid a weakening economy and continuing financial-market turmoil, Federal Reserve Vice Chairman Donald Kohn said.

Fed’s Kroszner Urges Banks to Increase Capital Reserves to Buffer Losses: Federal Reserve Governor Randall Kroszner urged banks to hold more reserve capital to protect themselves from future “cascading losses,” as potential market fixes are “no guarantee” against another credit crisis.

It’s nice to see the Fed getting its communication problems under control.

This is the inconsistency I pointed out in the goals of the financial sector bailout. Banks need new capital to protect themselves against falling values of their existing assets. But if they use the new capital to make new loans, you defeat the purpose of the new capital, because that new capital is no longer helping support the existing assets. These are two separate and somewhat contradictory goals. Note that, according to Bloomberg (see the second link above), financial institutions have taken $978 billion in writedowns – so far – and raised only $872 billion in new capital. So while politicians rail against banks that took TARP money but haven’t expanded lending, the banks at least have logic on their side. I’ve been surprised that no one in Washington that I’m aware of has been willing to point this out.

(And do visit Mark’s blog – it’s a great place to get a variety of perspectives, updated throughout the day.)

Global Fiscal Stimulus: Will This Save Weaker Eurozone Countries?

Finally, the global economic policy ship begins to turn.  We are now seeing fiscal stimulus package announcements every week, if not every day.  And packages that we previously knew about are re-announced for emphasis and with an expanded mandate.  In all likelihood, we are looking at a fiscal stimulus in the order of 1-2 percent of world GDP, which is exactly what the IMF has been calling for.  Is this a modern miracle of international policy coordination?

The problem is – the IMF started calling for this in January 2008 when, with the benefit of hindsight, it would really have made a difference.  Fiscal policy is slow.  Even when everyone wants to move fast, when you can get the legislation through right away, and when there are “ready to go” projects, infrastructure spending will take at least 6-9 months to have perceptible effects in most economies. 

In the US we have some additional ways to boost spending, most notably as support to local and state governments, extending food stamps and the like (see my recent testimony to the Senate Budget Committee for further illustrations), and in most other countries that kind of government activity comes by way of “automatic stabilizers,” i.e., it happens without discretionary packages of the kinds that make headlines.  Still, the general point holds – the big fiscal stimulus package you put in place today is a bet on how the economy will be doing in a year or so.  And a year ago would have been a good time to start – remember that the NBER has just determined that the US recession actually started in December 2007 (but they were able to make the call only now, demonstrating how hard it is to forecast the present, let alone the future.)

My concern today, however, is not about the appropriateness of the overall package in the US, China or other emerging markets – in a crisis, erring on the side of “too much, too late” is better than “too little, too little.”  The problem is that in Europe we need not just a general fiscal stimulus (and more interest rate cuts), but also specific targeted measures that will provide appropriate, largely unconditional support to governments with weaker balance sheets (read: Greece, Ireland, Italy, but don’t exclude others from consideration). 

Monetary policy was consolidated in Europe (i.e., there is one currency for the eurozone) but fiscal policy substantially was not.  This imbalance is going to be addressed, one way or another, and perhaps under great stress.  Much progress has been made towards sensible policies in the US and some parts of Europe over the past two months, and calamity can still be avoided.  Let us not fall at the final hurdle.

Update: I talked with Madeleine Brand of NPR about some of these issues earlier today; audio recording and transcript are here.

Causes: Maybe People Are Just Like That

This is the second in my new occasional series of reflections on some of the root causes of the global economic crisis. As is probably evident from the first one, I’m not going to try to identify the cause of the crisis, or even render particularly analytical judgments about the relative importance of various contributing factors. Instead, I’m more just presenting and thinking about some of the forces that were at work.

One of the singular features of the last decade was the U.S. housing bubble (replicated elsewhere, such as the U.K. and Spain, but nowhere on such a grand scale), which was accompanied by a broader though not quite as frothy bubble in asset prices overall, including the stock market. One of the standard explanations is that bubbles are created when greed takes over from fear: people see prices rising, and at first their fear of getting burned keeps them on the sidelines, but as the bubble continues and other people get rich their own greed increases until it wins out over fear, and they buy into the bubble as well. As a result, some say, we are bound to have bubbles periodically, especially when new investors (young people), who have never experienced a crash, come into the market.

There is psychological research that not only backs all of this up, but goes even further and says that bubbles are a virtual certainty. Virginia Postrel has an article in The Atlantic that centers on experimental economics research by people such as Vernon Smith and Charles Noussair. In one experiment, investors trade a security that pays a dividend in each of 15 periods and then vanishes; the dividend in each period will be 0, 8, 28, or 60 cents with equal probability, so the expected dividend is 24 cents, and there is no time value of money (the whole experiment takes an hour). Despite the fact that the fundamental value of the security is absolutely, completely, easily knowable, bubbles develop in these markets . . . 90% of the time. When the same people repeat the same experiment, the bubbles get gradually smaller; but simply change the spread of dividends and the scarcity of the asset, and the bubbles come back with full force (so much for experienced investors).

Continue reading “Causes: Maybe People Are Just Like That” →

Is This A Crisis Or Just A Recession?

The world seems quiet.  Sure, we have record job losses in the US, a likely decline in global trade for 2009, and what seems like to be a Great Leap Downwards for Chinese growth.  But no one is quite as worried as they were a month ago, let alone two months ago.  It feels, perhaps, like a “regular” global recession (albeit not something we have seen in 20+ years), in which growth decelerates markedly, but then we start to rebound in a timely manner.

Now, I’m happy to accept that as part of my current baseline view (and we will revise our forecast accordingly).  But there are serious downside risks to this forecast, i.e., we could move again into crisis mode.  The three places I look at on a daily basis for crisis-promoting potential are: Continue reading “Is This A Crisis Or Just A Recession?” →

Causes: Where Did All That Money Come From?

We’ve gotten some comments to the effect that, for all the discussion of the financial crisis and the various bailouts, we haven’t looked hard at the underlying causes of the financial crisis and accompanying recession. The problem, as I think I’ve hinted at various times, is that any macroeconomic event of this magnitude is overdetermined, on two dimensions. First, there are just too many factors at play to identify which are the most important: in this case, we have lax underwriting, lax bond rating, skewed incentives in the financial sector, under-saving in the U.S., over-saving in other parts of the world, insufficient regulation, and so on. How many of these did it take to create the crisis? There is no good way of knowing, because the sample size (one, maybe two if you add the Great Depression) is just not big enough. Second, there is still the conceptual problem of identfying the proximate cause(s). To simplify for a moment, we had high leverage which made a liquidity crisis possible, and then we had the downturn in subprime that made it plausible, and then we had the Lehman bankruptcy that made it a reality. Which of these is the cause? Leverage, subprime, or Lehman?

In any case, we’re not going to resolve these issues. But I want to start an occasional series of posts looking at one of the root causes at a time.

Today’s topic was inspired by this week’s meetings between U.S.-China meeting in Beijing, where, according to the FT, “the US was lectured about its economic fragilities.”

Zhou Xiaochuan, governor of the Chinese central bank, urged the US to rebalance its economy. “Over-consumption and a high reliance on credit is the cause of the US financial crisis,” he said. “As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.”

Continue reading “Causes: Where Did All That Money Come From?” →

How Can GM Avoid Bankruptcy?

With the Big 3 back in Washington, it seems like time to resuscitate the debate over the auto industry bailout. Luckily, Felix Salmon took the time to look through GM’s bankruptcy plan, which is being advertised on GM’s new, also gag-inducing GM Facts and Fiction website. Here’s one particularly gag-worthy claim from the plan:

GM has never failed to meet a Congressional mandate in the important areas of fuel efficiency and vehicle emissions, and sets the industry standard for “green” manufacturing methods.

Let’s not mention that GM has fought increased fuel efficiency standards with every dollar it could spend on lobbyists for decades.

Anyway, Salmon’s post focuses on one issue that has troubled me as well. One of GM’s biggest problems, along with plummeting demand for cars, is $62 billion in debt. In order to become a financially viable company, they have to reduce this debt, presumably by converting some of it into equity. But that debt is held by private entities, and no amount of pleading from the Big 3, the UAW, Jennifer Granholm, Congress, or Barack Obama HIMSELF can force them to restructure the debt. My worry is that in negotiations of this sort, where each side is holding a gun to the head of the other, debtholders could very well say: “Go ahead, go bankrupt, we’ll take our chances that we can get a better deal from a bankruptcy court or, worst case, we can recover more in cash than the value of the equity you’re offering today.” One of the points of a bankruptcy is to get a court that can force bondholders to accept a settlement rather than relying on their good graces.

On a related subject, a lot of people are throwing around the 80% number: supposedly, 80% of people will not buy a car from a company in bankruptcy. A GM spokesman said (to Felix Salmon) that GM’s sales were already falling because of fears about bankruptcy. Maybe. But I strongly suspect that 80% is just a poorly worded and interpreted poll question. If you ask people in the abstract if they would buy cars from a bankrupt car company, of course they will say no. But in the real world, if the car they want is made by a bankrupt company, and they get a good deal, they will buy it. Just look at the November auto sales. GM was down 41%; Toyota, Honda, and Nissan were down 34%, 32%, and 42%, respectively. And everyone buying a car in November must have been aware that bankruptcy for GM was a serious possibility. (Besides, haven’t we been talking about a GM bankruptcy on and off for years?) Sure, bankruptcy will hurt sales a little. But 80% is just not credible.

We Are All in This Together

Dani Rodrik has a short, clear post on (a) why countries are tempted to engage in protectionism during recessions and (b) why they shouldn’t. It only uses 1st-semester macroeconomics. The bottom line is that the preferred outcome is for all countries to engage in fiscal stimulus at the same time. The hitch is that most of the developing world can’t afford to. The implication is that it is in the interests of the wealthy countries to find a way to support the developing world.

How the SEC Could Have Regulated Subprime Mortgages

From a new paper (link below):

Kafka would have loved this story: According to our current understanding of U.S. law there is far better consumer protection for people who play the stock market than for people who are duped into buying a house with an exotically structured subprime mortgage, even when the mortgage instrument is immediately packaged and sold as part of a security.

The crux of the matter is that securities transactions – notably, the sale of a security to a customer by a broker – are governed by SEC regulations, which impose a fiduciary relationship on the broker, meaning, among other things, that the broker can only sell financial products that are suitable for that customer. However, no such rule governs the relationship of a homebuyer to a mortgage broker or company, meaning that behavior by the latter must be actually fraudulent before it can be sanctioned.

Jonathan Macey, Maureen O’Hara, and Gabe Rosenberg (two of whom are at my very own Yale Law School) have a new paper (abstract and download available) arguing not only that mortgage brokers should have a fiduciary responsibility to their customers, but that they already do under two reasonable interpretations of existing SEC regulations. (It has to do with whether a complex subprime mortgage is already a security or, failing that, whether it is related to a security transaction.) This means that the SEC could have been regulating these things all along.

More Danger for the Eurozone?

Back in the exciting days of October, Peter, Simon, and I wrote an op-ed in The Guardian about the potential for cracks to appear in the Eurozone, even possibly leading to one or more countries withdrawing from the euro. With so many other things to worry about, this scenario didn’t get a lot of attention. Since then, pressures have been slowly building. For example, the spread between the 10-year bonds of Greece and Germany has grown from around 30 basis points during most of the decade to over 1.5% now. (The picture below is from last week.)

Greece-Germany

According to an FT chart (sorry, can’t find the link), Greece also has to raise 20.3% of its GDP in debt next year (the equivalent figure for the U.S. is 10.3%), so the spread should only get bigger.

The Eurozone is based on the idea that a single monetary policy can serve the interests of all of the member countries. The problem is that when macroeconomic conditions vary widely between countries, they will have different interests. In a severe crisis, some countries may be tempted to (a) engage in quantitative easing (of the sort the Fed is beginning to do) or (b) implement a large fiscal stimulus (of the sort that Pelosi, Reid, and Obama are about to do). (a) is impossible for a Eurozone member, and (b) is constrained by limits on deficit spending, although I believe those limits are honored more in the breach than in practice.

In any case, the potential problems are getting big enough that Martin Feldstein has weighed in as well. Hopefully this will draw more attention to the issue. It may still be a low probability, but the economic and political consequences of undoing the greatest step toward European integration in, oh, the last thousand years would be huge.