Category: Commentary

U.S. Economy Saved (Temporarily) by Defense Spending

As you probably know by now, GDP declined at an annual rate of 0.3 percent in the 3rd quarter (July-September). Menzie Chinn has a good post at Econbrowser breaking down the components of the GDP numbers. One number jumped out at me: defense spending contributed 0.9 percentage points of GDP growth. Put another way, if defense spending had remained flat in Q3, GDP would have declined at an annual rate of 1.2 percent.

Now, there may be very valid reasons for an uptick in defense spending. For one thing, our military’s equipment is being depleted by the wars (and in some respects the equipment was insufficient to begin with). But I’m not sure we can count on it in future quarters – or that we want to count on it.

Testimony Before Joint Economic Committee, Today

Here is the written testimony I submitted to the JEC.  In my verbal presentation this morning (5 minutes only, strictly enforced) I stressed the following.

1. The global economy is slowing fast, and likely faces an unprecedented (since 1945) recesssion.  The pressures on emerging markets are intense, and inflexibility in Europe in both policy (Eurozone, I’m talking about you) and labor markets (for almost all the European Union) creates serious macroeconomic vulnerability at this stage.

2. In the US, significant (OK, also unprecedented) countercyclical policies have now been put in place.  In particular, the Fed is running through its anti-deflation playbook (which Mr Bernanke was kind enough to publish back in 2002).  We have no idea how to properly measure the scale, let alone the impact, of this increase in: liquidity, contingent liabilities, actual or potential direct lending to almost everyone in the US, and, via unlimited swap lines to some central banks and new $30 billion swap lines to four emerging markets, to many institutions around the world.

3. So deciding what to do with fiscal policy is very hard.  In other industrialized countries, you can rely on “automatic stabilizers” to a greater degree than in the U.S., meaning that their government spending (and deficit) increases in recession because unemployment benefits and the like are more generous.  In the U.S., we have to make a conscious decision.  And that decision needs to be made soon, within a month or so, because any fiscal stimulus works only with a time lag – and the more you want to do things that definitely raised GDP (like infrastructure), the longer the time lag.

So my recommendation is… (well, read the testimony; the numbers are on the first page; detailed recommendations follow on how to spend, for both immediate impact and longer-term benefits).

Comments welcome – there is still a long way to go, in terms of legislation design and implementation.

Update: If you want to see the actual session courtesy of C-SPAN, go here. (Note there were 8 speakers and the session was two hours long.)

Homeowner Bailout Around the Corner?

News sources are reporting more details on the possible mortgage restructuring plan for distressed homeowners first mentioned by Sheila Bair in her Congressional testimony last week. The basic outlines of the plan are:

  • Lenders would agree to reduce monthly payments to be affordable, perhaps based on a percentage of the homeowner’s income. The reduction could be achieved by reducing the interest rate, reducing principal, or extending the term.
  • If the amount the homeowner could pay would result in a mortgage worth less than the foreclosure value of the house, the loan would not be modified and the lender could foreclose.
  • The government would then partially guarantee the new mortgage and absorb part of the loss if the homeowner defaulted.
  • The numbers of 3 million homes and $600 billion in total mortgage value are being thrown around.

This is roughly consistent with the principles we outlined earlier: the lender gets more than it would have gotten in foreclosure, the homeowner is better off than being on the street, the community benefits because there are fewer foreclosures. There are three key issues that still need to be negotiated.

  1. How much will homeowners be expected to pay? Too much, and the lenders will not have to write down their loans very much, and the government will be on the hook for risky mortgages; too little, and the lenders will not participate.
  2. How do you solve the securitization problem, that is, the current inability of many servicers to modify loans that are owned by other parties? This may require a new law in and of itself (one suggestion here).
  3. How do you decide which homeowners are eligible? If people who are delinquent get cheaper mortgages and people who are struggling but paying on time don’t, the latter will scream. It is still in the interests and hence within the rights of the lender, the delinquent homeowner, and the government to do the deal, but that won’t reduce the indignation.

There are also a couple of enhancements to the program that could be considered. First, shouldn’t the government – by which we mean the taxpayer – get something for its guarantee (besides the satisfaction of knowing that it’s doing what’s best for the country)? The homeowner and the lender are both better off than they would be otherwise (homeowner on the street, lender forced to foreclose), and the government is worse off (because some of these new mortgages will fail). The government could get a share in the future appreciation of the house, for example.

Second, to protect against default by the homeowner on the new mortgage, the government could secure the loan against his or her future earnings, because the government already has an enforcement mechanism it can use: the IRS. This would protect the taxpayer’s interests.

Finally, one note of caution. Loan modifications should work for some proportion of delinquent homeowners, but there are probably millions of homeowners who have no chance of paying any mortgage on their houses that would be acceptable to their lenders. People with option ARMS who made minimum payments and then saw their mortgage rates reset upward by several percentage points will not be able to pay anything close to what lenders will require not to foreclose. In conjunction with any mortgage restructuring plan, there also has to be a plan to manage the flow of properties onto the market, because a flood of foreclosures will only cause prices to plummet further. It seems like there are so many things to do, but that is the price of the situation we are in.

Update: Here’s another proposed solution to the securitization problem.

IMF Creates Special Boarding Lane for 1st-Class Countries

One of the subplots of the global financial crisis has been the return of the IMF to center stage: $15.7 billion for Hungary, $16.5 billion for Ukraine, and $2.1 billion for Iceland, with talks continuing with Pakistan and other countries. The Hungary bailout, for example, looks a bit like the old IMF, which insisted on higher interest rates and fiscal austerity in exchange for loans. These conditions attached to past bailouts have made many countries reluctant to turn to the IMF; in South Korea, for example, domestic hatred of the IMF (the emerging markets crisis of 1997-98 is known as the “IMF crisis” in Korea) makes accepting money from it politically impossible.

In order to loan money quickly to countries that need it, the IMF today announced a new $100 billion Short Term Loan Facility offering three-month loans to countries that are deemed to be financially sound (public and private debt at sustainable levels) but are being buffeted by the financial crisis anyway. These loans will have essentially no conditions, and can be used to bolster foreign currency reserves to protect against currency crises, to recapitalize financial institutions, or for other purposes.

This should be a step in the right direction, but raises two issues. First, the IMF only has about $200 billion in lending capacity, and with over $30 billion allocated to Iceland, Hungary, and Ukraine, and $100 billion for “healthy” countries, it could be approaching that limit fast. G7 countries have already committed trillions of dollars to their domestic economies; $200 billion for the rest of the world could run out quickly, and raising more money from member nations would be politically difficult right now. (The US in particular is never keen to help out international organizations.)

Second, the new lending facility draws another line between the haves and the have-nots of the global economy. (The first line was drawn by the Federal Reserve in deciding who got swap lines – and, by the way, the Fed just made $30 billion each available to Brazil, Mexico, South Korea and Singapore.) Countries with the IMF’s seal of approval get loans with no conditions; other countries get the conditions that have been so unpopular in the past. This is more than a normative issue: in a financial crisis, falling on the wrong side of the line can exacerbate the problems faced by a country or a bank, because it saps confidence further and accelerates capital flight. The IMF has promised not to reveal the names of countries that are rejected for its no-condition loans in order not to destabilize them further, but speculators will speculate. And countries that do not qualify will harbor the same resentments of the IMF (and the perceived global economic order) as ever.

(IMF for Beginners, by The Big Money (from Slate).)

Things That Don’t Make Sense, Airline Edition

We now interrupt our global crisis programming to bring you news from the rest of the economy . . .

Earlier today, the Department of Justice approved the merger of Delta and Northwest, which I believe closed later this evening. In its statement, the Antitrust Division blessed the merger, saying:

the proposed merger between Delta and Northwest is likely to produce substantial and credible efficiencies that will benefit U.S. consumers and is not likely to substantially lessen competition. . . .

Consumers are also likely to benefit from improved service made possible by combining under single ownership the complementary aspects of the airlines’ networks.

Now, for literally years, every expert on the airline industry has been saying that the industry needs less competition, less capacity, and higher prices (bad for consumers), and consolidation is the way to achieve that end. Put another way, if Delta and Northwest actually believed the DOJ’s statement, they wouldn’t have bothered merging in the first place.

I’m not saying that the DOJ should have blocked the merger – not being an expert on the airline industry (although I am an expert on flying on airlines), I defer to those who say mergers are necessary for the health of the industry. But since when did the DOJ become their PR firm?

Financial Crises, Political Consequences

Hard economic times have political consequences, many of them unfortunate.

In Argentina, we’ve already seen the government nationalize the private pension system in what many believe to be a naked grab for cash with only a distant relationship to the rule of law.

In Russia, a central government with a war chest of over $500 billion in foreign currency reserves (at least when the crisis started) now has the power to determine which of the billionaire oligarchs will survive and which will be bankrupted. Yesterday the government provided $2 billion (WSJ, subscription required) to the Alfa Group, Mikhail Fridman’s conglomerate, to avoid save him from giving up his 44% stake in a cellular carrier to Deutsche Bank. On Friday, another billionaire will have to come up with $4.5 billion to avoid giving up 25% of the metals company OAO Norilsk Nickel to Western banks including Merrill Lynch and Royal Bank of Scotland, and will likely turn to the government.

Arguably the government’s power in this situation is analogous to the powers the US has granted to the Treasury Department to choose winners in the financial sector. Still, given the other things we know about Russian politics, it is not too far-fetched to see government money used to protect Vladimir Putin’s political allies, impoverish his opponents or nationalize their assets, and keep Russian assets out of Western hands. (Whether the government will have enough money for the job is another question.)

Another likely reaction of governments faced by financial and economic crisis is a return to (or, in many cases, an increase in) protectionism. Richard Baldwin describes how the current state of global trade agreements makes this not only possible but likely, further hurting the global economy.

Finally, there’s (still) Zimbabwe, forgotten by the world, where power-sharing talks are still going nowhere.

Starting to Wonder About Internal G7 Dynamics, Just A Little

The G7 did speak on major exchange rates, over the weekend, as expected. But they only spoke about the yen’s “recent excessive volatility.”  This was about the least they could say under the circumstances, and it is not clear that it will do anything – other than encourage further flows into the dollar.

Why did they not mention the dollar, the euro, and the British pound? One possibility is that they are happy with the appreciation of the dollar and the depreciation (falling value) of the euro and the pound. This would be a bit strange, given that dollar depreciation – from 2002 through the summer – was considered by the G7 to be a reasonable component of the global adjustment process that would put current accounts onto a more sustainable path (yes, notwithstanding “strong dollar” statements from the US.)  The dollar was getting close to what the G7 (and the IMF, who do a lot of the technical work in this regard) saw as a plausible “medium-term” value, at least as measured against a broad basket of currencies.  Now the dollar has taken off (i.e., rising in value against almost all currencies). How does that help with anything?

It could be the case that the Europeans like the depreciation of their currencies, as this will help cushion the recession.  The falling value of the euro makes interest rates cuts in the eurozone less likely, because the European Central Bank (ECB) will see the depreciation of the euro as helping the real economy and also increasing (their) fears about inflation.  But given the ECB’s obsession, even today, with inflation – and thus its unwillingness to cut interest rates, come what may – it might be that depreciation is the eurozone’s best short term hope (as well as its likely medium term future, as sovereign risks materialize for smaller countries).

Still, it would be odd if no one at the G7 table isn’t already raising the dangers of deflation (falling prices), particularly in the US – I’m looking at the representative of the Federal Reserve at this point.  Commodity prices are falling worldwide and now the price of imports into the US will decline sharply.  If this feeds into low prices (i.e., a lower price level, not just slower inflation) then short-term, of course, US consumers benefit.  But if lower prices lead to lower wages, then just think what that does to anyone’s ability to pay their mortgage or any other debt – these are almost always fixed nominal amounts.

When people talk about avoiding the mistakes of the Great Depression, they mean in large part not allowing prices and wages to fall.  And the faster and further that the dollar appreciates, the more likely we are to worry about deflation.

What then are the internal G7 dynamics?  Based on what we saw, and didn’t see, this weekend, I would guess that recriminations and nonconvergent policy views prevail. The spirit of cooperation we saw around bank recapitalizations, just two weeks ago, must have evaporated.  We may not want to rely on the G7 to lead the way.  Can I interest anyone in a G20 summit?

So Much Going on …

One of the challenges of the current financial crisis/credit crunch/recession/whatever you call the mess that we’re in is that there are so many things going on at once – stabilizing the financial system, housing, economic stimulus, regulation, emerging markets crisis, now incipient currency crisis, … Luckily, there are many other smart commentators out there working weekends when we all should be spending more time with our families.

On the topic of regulation and economic stimulus, Mark Thoma cites and expands on Larry Summers, who argues that we need to not just give the economy a boost in the short term, but take advantage of the opportunity to take steps – both investments and regulation – to boost productivity in the long term.

Mark Thoma (again) and Yves Smith both provide roundups and analysis of the currency crisis, which Simon raised a couple of days ago. Quick summary: it could be bad.

So if you can’t sleep, there’s plenty to read and worry about. (Or you could watch the World Series.)

Insurance Companies Line Up for Treasury Bailout

One of the big stories on Friday and Saturday was the expansion of the Treasury recapitalization program to insurance companies. The Washington Post is acting as if it’s a done deal, while the Times and the Journal said only that it was being considered.

Insurance is one of the industries I know pretty well, as my company made software exclusively for property and casualty insurers, and I must admit I didn’t expect the crisis to show up in insurance so quickly.

Continue reading “Insurance Companies Line Up for Treasury Bailout” →

The Bank Lending Debate

For those who spend too much time reading economics blogs, there was a bit of a stir in the last few days over a paper by three economists at the Minneapolis Fed, which essentially said that bank lending to the real economy had not been affected by the supposed credit crisis. There were articles on the topic by Alex Tabarrok, Free Exchange, Mark Thoma, me, Tyler Cowen, Alex Tabarrok again, Free Exchange again, and Tyler Cowen again, among others. My main issue was that the charts in the paper said nothing about new lending, and my guess was that changes in new lending practices would take time to show up in measures of aggregate lending. (Other people raised more sophisticated issues, for example that companies were racing to draw down lines of credit after September 15 out of fear they might not be around for much longer.)

I want to point out one more source of information that might shed light on this question. Every quarter the Federal Reserve conducts a Senior Loan Officer Opinion Survey which asks how bank lending practices have changed over the past three months. In the July survey, every single measure of either willingness to lend or loan spreads (price of loan, less cost of funding) was at or above the tightest values (least willingness to lend, highest prices) seen in the last twenty years. Granted, these are measures of change in lending practices, but they still show a rapid shift in sentiment at banks. The October survey should be underway now, and it’s hard to see how it won’t look even worse.

Worry Global, Talk Local

The global picture continues to worsen and Friday was a pretty bad day.  I took part in a good summary discussion hosted by Jeff Brown on the Lehrer NewsHour last night. The topics ranged from the rising dollar to falling oil prices to Treasury’s investments in insurance companies to loan modifications for homeowners.

But I don’t think anyone should throw up their hands, abandon their personal strategies, or think that any part of the sky is falling.  Here’s why. Continue reading “Worry Global, Talk Local” →

Hedge Funds, An Impression

I try to read four newspapers before the day really starts, and also look through a couple of on-line sites.  I skim the lead economic stories and randomly dig all the way through the paper to the end of some business/financial stories.

Sometimes the news jumps off the page, and sometimes it seeps through.  Now, about two hours after looking at today’s weekend papers, I realize that something is stuck in my mind, rather like a tune that you can’t get rid of. Continue reading “Hedge Funds, An Impression” →

Waiting for G7 Currency Intervention: It Won’t Be Long

Major currencies are on the move, big time, since yesterday.  The yen has risen to 91 yen per dollar (from 97) today.  The euro has fallen to nearly 1.25 dollars per euro (from 1.29).  You get the picture.

The G7 needs to slow down the disorderly run into the dollar.  This run is in danger of snowballing into a panic – as people fear further rises in the dollar (and falls in their local currency), they rush to buy more dollars (to cover debts in dollars and also to shift their portfolios), and so on.

Coordinated intervention, announced over the weekend most likely, will involve selling dollars, selling yen, buying euros and pounds.  This can calm things, by showing there are no one way bets.  (Will the Chinese be involved?)

But the global deleveraging (reduction in lending worldwide) will continue.  And this seems to involve more of a move into dollars that we previously thought.  So how long can even the most coordinated intervention hold the line?

Update: Typo fixed to clean up an inconsistency. Sorry for any confusion.

I Like the G20’s Chances, But They Need To Update Their Website

It is pretty common these days, at least in Washington, to pour scorn – or at least cold water – on the idea that a global summit could have much impact on the crisis.  I would count myself among the skeptics with regard to a mega-meeting with 100+ countries around the table, and it does seem like at least one of those meetings is scheduled for December or thereabouts.

But, in addition, President Bush has invited G20 heads of government to meet at one of his places (exact location TBA) on November 15. The G20 convenes the ministries of finance and central banks of 19 countries, and sensibly adds the European Union (represented by both the European Commission and the European Central Bank.) Continue reading “I Like the G20’s Chances, But They Need To Update Their Website” →

“Bailing Out” Homeowners Through Mortgage Restructuring

On Capitol Hill today, attention turned back to where this all started – delinquent mortgages. Sheila Bair of the FDIC is working on a program to encourage lenders and servicers to restructure mortgages by partially guaranteeing post-modification mortgages that meet certain criteria. Christopher Dodd is also considering new legislation in November to help homeowners. Here at the blog, we made intervention into the housing market one the four proposals in our first Baseline Scenario way back when in September, and we are planning to publish something more detailed in the next several days. But first, I wanted to lay out the nature of the problem.

Remember the wave of indignation that accompanied the “bailout of Wall Street” last month? Judging by some emails and comments I’ve seen, it could be even worse when it comes time to “bail out” delinquent mortgage holders. Much as people hate the idea of bailing out Wall Street “fat cats,” for some the idea of bailing out their neighbors – especially the neighbors in the new McMansion – is even worse. I think for some people it’s the idea that someone else is getting away with something that they could have done but chose not to (buying too big a house, in this case); by contrast, most people recognize they had little chance of becoming the CEO of an investment bank. OK, now that I’ve opened myself up to a flood of nasty comments, on to the substance.

Continue reading ““Bailing Out” Homeowners Through Mortgage Restructuring” →