Category: Commentary

Revised Baseline Scenario: February 9, 2010

Caution: this is a long post (about 3,000 words).  The main points are in the first few hundred words and the remainder is supportive detail.  This material was the basis of testimony to the Senate Budget Committee today by Simon Johnson.

A.    Main Points

1)      In recent months, the US economy entered a recovery phase following the severe credit crisis-induced recession of 2008-09.  While slower than it should have been based on previous experience, growth has surprised on the upside in the past quarter.  This will boost headline year-on-year growth above the current consensus for 2010.  We estimate the global economy will grow over 4 percent, as measured by the IMF’s year-on-year headline number (their latest published forecast is for 3.9 percent), with US growth in the 3-4 percent range – calculated on the same basis.

2)      But thinking in terms of these headline numbers masks a much more worrying dynamic.  A major sovereign debt crisis is gathering steam in Europe, focused for now on the weaker countries in the eurozone, but with the potential to spillover also to the United Kingdom.  These further financial market disruptions will not only slow the European economies – we estimate growth in the euro area will fall to around 0.5 percent Q4 on Q4 (the IMF puts this at 1.1 percent, but the January World Economic Outlook update was prepared before the Greek crisis broke in earnest) – it will also cause the euro to weaken and lower growth around the world.

3)      There are some European efforts underway to limit debt crisis to Greece and to prevent the further spread of damage.  But these efforts are too little and too late.  The IMF also cannot be expected to play any meaningful role in the near term.  Portugal, Ireland, Italy, Greece, and Spain – a group known to the markets as PIIGS, will all come under severe pressure from speculative attacks on their credit.  These attacks are motivated by fiscal weakness and made possible by the reluctance of relatively strong European countries to help out the PIIGS.  (Section B below has more detail.) Continue reading “Revised Baseline Scenario: February 9, 2010” →

Elizabeth Warren Calls Out Wall Street

Although the Consumer Financial Protection Agency made it through the House more or less intact, the banking lobby is taking another, better shot at killing it in the Senate, and is planning to use the magic words: “big government” and “bureaucracy.” Elizabeth Warren wrote an op-ed for Tuesday’s Wall Street Journal that lays out the confrontation. For most of the past two decades, many Americans trusted the banking industry–not necessarily to be moral exemplars, but they trusted that the banks were basically doing what was right for customers and for the economy. Then in 2007-2008 that mood abruptly reversed, as it became apparent that unscrupulous mortgage lenders, the Wall Street banks that backed them, and the credit rating agencies had been ripping off mortgage borrowers on the one hand and investors on the other.

The big banks face a choice. They can agree to sensible reforms that protect consumers and rein in the excesses of the past decades. Or they can simply decide to screw customers, but do it openly this time, since they have so much market share it almost doesn’t matter what customers think. How else do you explain, say, Citigroup’s concocting a new credit card “feature” explicitly to get around a new requirement of the Credit CARD Act? Or Jamie Dimon saying that financial crises are something to be expected every five to seven years, so we should just get over it?

Continue reading “Elizabeth Warren Calls Out Wall Street” →

Whose Fault?

To believe politicians in Washington and pundits in the media, the national debt has become the most important political issue of the day. (Whether it should be–as opposed to, say, jobs–is another question.) The Republican argument is, basically: “Big deficits! Democratic president! His fault!” The Obama administration argument, by contrast, is “No way! George W. Bush’s fault!”

I generally side with Obama on this one, mainly because of the two Bush tax cuts and the unfunded Medicare prescription drug benefit. Keith Hennessey, Bush’s last director of the National Economic Council, has a counterargument. Some of his points are good. OK, well, one point–the fourth one down. Hennessey is right that what initially transformed the Clinton surplus into the Bush deficit was the 2001 recession, which was beyond Bush’s control–just like what transformed the large Bush deficits of 2007-2008 into the enormous Obama deficits of today was the 2007-2009 recession.

The other points are good debating, but I don’t buy them. This could take a while.

Continue reading “Whose Fault?” →

Fed Chair as Confidence Man

I’m not the one saying it–that would be Robert Samuelson, columnist for Newsweek and the Washington Post. The sole point of Samuelson’s recent opinion piece is that Ben Bernanke’s job is to increase confidence.

Like much but not all error, there is a grain of truth to this point. Thanks to John Maynard Keynes (whom Samuelson cites), George Akerlof, Robert Shiller, and any number of economics experiments, we know that confidence has an effect on behavior and hence on the economy. Too much overconfidence can fuel a bubble and too much pessimism can exacerbate a slowdown.

But to leap from there to the conclusion that the job of the chair of the Federal Reserve is to increase confidence–“Ben Bernanke has, or ought to have, a very simple agenda: improve confidence”–is just silly.

Continue reading “Fed Chair as Confidence Man” →

Euro Falling, US Recovery Under Threat

Intensified fears over government debt in the eurozone are pushing the euro weaker against the dollar.  The G7 achieved nothing over the weekend, the IMF is stuck on the sidelines, and the Europeans are sitting on their hands at least until a summit on Thursday.  There is a lot of trading time between now and then – and most of it is likely to be spent weakening the euro further.

The UK also faces serious pressure, and there is no telling where this goes next around the world – or how it gets there.

There may be direct effects on the US, as our banking system remains undercapitalized.  Or the effect may be through making it harder to export – one of the few bright spots for the American economy over the past 12 months has been trade.  But this is unlikely to hold up as a driver of growth if the euro depreciation continues.

Some financial market participants cling to the hope that the stronger eurozone countries, particularly Germany, will soon help out the weaker countries in a generous manner.   But this view completely misreads the situation. Continue reading “Euro Falling, US Recovery Under Threat” →

Europe Risks Another Global Depression

The entirely pointless G7 meeting this weekend only served to underline the fact that Europe is again entering a serious economic crisis.

At the end of the meeting yesterday, Treasury Secretary Tim Geithner told reporters, “I just want to underscore they made it clear to us, they the European authorities, that they will manage this [the Greek debt crisis] with great care.”

But the Europeans are not being careful – and it’s not just about Greece any more.  Worries about government debt and associated public sector liabilities (e.g., because banking systems are in deep trouble) have spread through the eurozone to Spain and Portugal.  Ireland and Italy are next up for hostile reconsideration by the markets, and the UK may not be far behind. 

What are the stronger European countries, specifically Germany and France, doing to contain the self-fulfilling fear that weaker eurozone countries may not be able to pay their debt – this panic that pushes up interest rates and makes it harder for beleaguered governments to actually pay?

The Europeans with deep-pockets are doing nothing – except insist that all countries under pressure cut their budgets quickly and in ways that are probably politically infeasible.  This kind of precipitate fiscal austerity contributed directly to the onset of the Great Depression in the 1930s. Continue reading “Europe Risks Another Global Depression” →

Is Tim Geithner Paying Attention To the Global Economy?

In an interview that will air Sunday on ABC, Treasury Secretary Tim Geithner says, “”We have much, much lower risk of [a double-dip recession] today than at any time over the last 12 months or so … We are in an economy that was growing at the rate of almost 6 percent of GDP in the fourth quarter of last year.  The most rapid rate in six years.  So we are beginning the process of healing.”

The timing of this statement is remarkable because, while the US is finally showing some signs of recovery, the global economy is bracing for another major shock – this time coming from the European Union.

The mounting debt and deficit problems in Greece might seem relatively small and faraway to the US Treasury – concerned as it is with China’s exchange rate and the ritual of G7 meetings, and likely distracted by the major snow storm now hitting Washington DC.

But the problems now spreading from Greece to Spain, Portugal, Ireland and even Italy portend serious trouble ahead for the US in the second half of this year – particularly because our banks remain in such weak shape. Continue reading “Is Tim Geithner Paying Attention To the Global Economy?” →

The Economist Backs Cantwell-Collins

Which, attentive readers know, is the climate change bill that auctions almost all emission allocations starting on day one, and refunds most of the proceeds to households. Here’s the Economist story. (Technically, it’s just the columnist “Lexington,” but the Economist has a consistency voice and position unlike any other news publication.) Here’s an excerpt:

“Of all the bills that would put a price on carbon, cap-and-dividend seems the most promising. . . . The most attractive thing about the bill is that it is honest. To discourage the use of dirty energy, it says, it has to be more expensive. To make up for that, here’s a thousand bucks.

“This challenges the conventional wisdom in Washington, DC, that the only way to pass a global-warming bill is to disguise what’s in it. Leading Democrats try to sell cap-and-trade as a way to create jobs and wean America from its addiction to foreign oil.”

Continue reading “The Economist Backs Cantwell-Collins” →

Goldman Sachs And The Republicans

I testified yesterday to the Senate Banking Committee hearing on the “Volcker Rules” (full pdf version; summary).  My view is that while the principles behind these proposed rules are exactly on target – limiting the size of our largest banks and preventing any financial institution backed by the government, implicitly or explicitly, from taking big risks – the specific rule changes would need to be much tougher if they are to have any effect.

Wall Street is strongly opposed to the Volcker Rules (link to the written testimony; webcast) and the discussion elicited some classic Goldman Sachs moments.  Gerry Corrigan, a senior executive at Goldman and former head of the New York Fed, suggested that Goldman Sachs has an impeccable approach to risk management and seemed to imply that the firm was not in trouble in fall 2008.  When pressed on why Goldman requested and was granted a banking license – and access to the Fed’s discount window – in September 2008, he fell back slightly, “There is no question whatsoever that when you look at totality of the steps that were taken by central banks and government, particularly in 2008, that Goldman Sachs was a beneficiary of this.”

The public record is clear – Goldman Sachs would have failed in September 2008, were it not for the support provided by the government. The fact that some of this support did not involve direct use of taxpayer money speaks to the ingenuity of the people involved, but it should not distract us from the substance.  Goldman Sachs was failing and it was saved.

Why is this so hard for Goldman to admit?

Continue reading “Goldman Sachs And The Republicans” →

Remember Those Stress Tests?

I’m curious to know how banks’ 2009 final results compare to the projections in the stress tests. My suspicion is that JPMorgan and Goldman did better than projected, but Citi may have done worse. Ideally you would compare both the new loan losses recognized over the year and the profits from current operations. But there are a couple of problems with doing this. One is that the stress test results were for 2009-2010 combined, without the separate years split out. The other problem is that it’s not immediately obvious how to map the line items from the stress test results to the line items on a bank’s income statement (or to changes on its balance sheet). I might be able to figure it out with a lot of study, but I might not.

Does anyone know of someone who has already done an analysis along these lines? Or does anyone know how to do the mapping correctly?

By James Kwak

Kevin Warsh: “No Firm Should Be Too Big To Fail”

The debate over Ben Bernanke’s reappointment, and his approach to the financial system, may after all have had some impact.  In a speech yesterday, Kevin Warsh – the Federal Reserve Board Governor who liaises between Ben Bernanke and financial markets – signaled a major change in Fed thinking regarding “too big to fail”.

Warsh was much blunter than we have heard from the Fed in a long while: “Moral hazard in the financial system is higher than any of us should countenance”; “eradicating the too-big-to-fail problem should be the predominant policy goal”; and “in the new regime, no firm should be too big to fail.”

At some level, Warsh and his colleagues are finally learning the main lesson of 2008-09.

“We need a system in which insolvent firms fail. Market discipline only works if governments can demonstrably and credibly commit to allow firms to fail. This system isn’t just about giving government officials better options on Sunday nights. It is about making sure that market discipline is operative in the prior months and years to avoid altogether the proverbial Sunday night judgments.”

But there is still a major problem in the Fed’s thinking. Continue reading “Kevin Warsh: “No Firm Should Be Too Big To Fail”” →

The Republican Plan, III: Comic Relief

(This is a multi-post series on the Republicans’ Roadmap for America’s Future. Part I was on how it slashes Medicare spending. Part II was on how it shifts risk from the government to individuals.)

The Roadmap brings up the issue that there is little price transparency in the health care market. This is the solution:

“The environment resembles what existed in the securities markets before the stock market crash of 1929. Abuse, fraud, and misinformation about the nature of stocks and the rules governing their purchase were rampant. In response, the Securities and Exchange Commission [SEC] was formed with the main purpose of bringing transparency to the market and restoring consumer confidence.

“With the increasingly rapid transformation of the financial markets and the growing complexity of financial transactions, the private sector began to take a more prominent role in developing accounting guidelines; and eventually the SEC began relying on the private sector to establish the basic standards by which it would be regulated. Since 1973, the SEC has recognized the nongovernment Financial Accounting Standards Board [FASB] as the authoritative standard-setting organization for financial accounting and reporting information. While the SEC has statutory authority to establish such financial standards, it has historically adopted FASB rules. The SEC allows the private sector to establish its own disclosure standards, so long as it demonstrates the ability to fulfill the responsibility in the public interest. The authority to enforce the standards, however, falls solely to the SEC.

“Applying this model to the health care industry will allow all stakeholders to come together, without heavy-handed government intervention, to establish uniform and reliable measures by which to report quality and price information.”

Enron? WorldCom? Self-regulation? FASB, the SEC, and the securities industry are their example?

By James Kwak

The Republican Plan, II: You’re On Your Own

In my previous post on the Roadmap for America’s Future, I discussed how the Republican plan is based on converting Medicare into a voucher program and then slashing the vouchers drastically relative to current Medicare spending projections, leaving seniors without the ability to buy anything close to what they get from Medicare today. In that post, I compared projected Medicare vouchers under the Roadmap to projected Medicare spending under current law. If you assume that, in the Roadmap world, the cost of Medicare-equivalent health insurance will be the same as currently projected Medicare spending, then people will die.

But, Paul Ryan would argue, the Roadmap is going to bring down the cost of health care, so the fact that we’re providing less support won’t matter. Put another way, he might say, Obama’s plan also counts on bringing down the cost of health care, so why can’t I make the same assumption? There are two problems with this argument.

Continue reading “The Republican Plan, II: You’re On Your Own” →

The Republican Plan, I: People Will Die

So the Republicans have a deficit reduction and a health care plan, all wrapped into one, the “Roadmap for America’s Future.” It’s being pushed by Paul Ryan, in part because he’s the ranking member of the House Budget Committee, in part because he’s good-looking and articulate, in part to provide the party plausible deniability if it flops (like Bobby Jindal a year ago). The CBO says that it will balance the budget and even eliminate the national debt by 2080. Ezra Klein and Matt Yglesias have commented on it. Klein says, “I wouldn’t balance the budget in anything like the way Ryan proposes. His solution works by making care less affordable for seniors. . . . But his proposal is among the few I’ve seen that’s willing to propose solutions in proportion to the problem.” Yglesias says “it’s totally unworkable.” But they’re both being much too kind.

Ryan realizes that “the deficit problem is a health-care problem,” which he agreed to in an interview with Klein. That’s good. He realizes that to solve the deficit you have to do something about Medicare. That’s good. He also puts forward a logically coherent conservative position. That’s good in itself and especially refreshing after the Bush era (and the unfunded Medicare prescription drug benefit) and all the recent posturing of the Republicans as defenders of Medicare (Mitch McConnell: “Cutting Medicare is not what Americans want.“) Ryan’s plan is basically to cut Medicare like never imagined before.

But everything else about the plan is such an unmitigated disaster I’m going to devote a whole paragraph at some point to thinking about how to label this plan. It will be a long time before we get there, though, broken into a couple of blog posts, because there are so many problems to go over.

Continue reading “The Republican Plan, I: People Will Die” →