Category: Commentary

The Mystery of Rating Agencies

Calculated Risk has a routine post about S&P increasing its loss projections for subprime and Alt-A loans and for the mortgage-backed securities built out of those loans. These announcements have been so common over the last several months that I usually don’t even think about them. But today I had a thought about them: these are forecasts, which means that they should not get worse just because the economy is getting worse. Forecasts should only change when there is new news that affects expectations about the future. So if you take these rating agency reports at face value, they imply not only that the economy is getting worse (by traditional measures such as the unemployment rate), but that there is new bad news about the future of the economy, despite all this talk you hear about green shoots and a recovery. If there is only old news, then that should have been “priced in” to S&P’s forecasts already.

So what gives? Do the rating agencies see some new perils in the economy that are being overlooked? Or are they just stretching out a writedown in their forecasts over several quarters? Under the latter theory, they should have known what would happen to subprime and Alt-A loans the same time people like Calculated Risk did – that is, several months ago – but it would be too embarrassing to do a massive writedown all at once, so they are spreading it out over time for respectability.

By James Kwak

Little Hoovers, Part-Time Employment, and Me

Paul Krugman is generally credited with coining the term “fifty little Hoovers” to refer to our state governments and the current economic crisis. The macroeconomics textbook says that when a recession hits, the government should implement expansionary policy, whether monetary – making cheap money available – or fiscal – borrowing money and spending it to compensate for falling private-sector demand. However, states have no monetary policy, since they don’t control the money supply, and they generally can’t engage in expansionary fiscal policy, because most have made it prohibitively difficult to borrow money and go into deficit. So in a recession, states tend to cut spending and raise taxes, which only compound the effect of a recession. Since most states’ fiscal years end on June 30, some of the effects of this belt-tightening should be hitting right about now.

One thing that states spend money on, but that people generally don’t think about, is legal services for poor people. I think about this because I am spending the summer working (for free) for a legal services provider in Massachusetts. In Massachusetts, like in many states, funding for legal services for the poor comes mainly from two sources: (a) interest on lawyers’ trust accounts (IOLTA) – that is, the short-term interest paid on money that your lawyer is holding for you for some reason; and (b) direct appropriations in the state budget.

Continue reading “Little Hoovers, Part-Time Employment, and Me” →

The Jones Doctrine: Economic Development For Afghanistan

The administration is signaling a new strategy for Afghanistan: “economic development and governance”.  On the front page of the Washington Post last week, President Obama’s national security adviser, James L. Jones, told Bob Woodward:

“The piece of the strategy that has to work in the next year is economic development. If that is not done right, there are not enough troops in the world to succeed.”

This is an appealing statement.  But does it make any sense?

Continue reading “The Jones Doctrine: Economic Development For Afghanistan” →

Catching Up with the Bandwagon

Sorry about the recent silence; I’ve been trying to kill off a rewrite of a paper, and sometimes I find that to get things done you just have to be singleminded about your priorities.

In case you haven’t seen them yet, I wanted to point out a couple of things that have been making the rounds of the Internet:

  • Most of the people writing about health care reform on economics blogs – present company included – are not health care economics specialists. Uwe Reinhardt is. So when he writes about “rationing health care,” I recommend reading (hat tip Mark Thoma).
  • Brad Setser is branching out from foreign reserves, holdings of U.S. government and agency bonds, and China – on which he is probably the leading figure on the Internet – to, well, everything. Visit the Council on Foreign Relations’ “Crisis Guide: The Global Economy” and click on Motion Charts. There are four charts in the sidebar to the right. For each one, you can watch Setser on video, or you can click the “Interact with Motion Chart” link and play with it yourself.

Happy reading.

By James Kwak

How To Buy Friends And Alienate People

The banking industry is exceeding all expectations.  The biggest players are raking in profits and planning much higher compensation so far this year, on the back of increased market share (wouldn’t you like two of your major competitors to go out of business?).  And banks in general are managing to project widely a completely negative attitude towards all attempts to protect consumers.

This is a dangerous combination for the industry, yet it is not being handled well.  Just look at the current strategy of the American Bankers’ Association. Continue reading “How To Buy Friends And Alienate People” →

This Is Their Reform Strategy For Big Banks?

Anil Kashyap is one of our leading researchers on banks.  His book with Takeo Hoshi on the evolution of the Japanese corporate finance is a must read on the twists and turns that built a great economy and then laid it low.  And he has many other papers and relevant recent commentary.

Professor Kashyap has a sharp perspective the administration’s financial sector reform thinking, in part because he has long worked alongside key people now at the National Economic Council (the NEC, by the way, has disappointingly little transparency; even Treasury is more open).

So we should take him seriously, writing Tuesday in the Financial Times, on the importance of the proposed new “funeral plans” for banks. Continue reading “This Is Their Reform Strategy For Big Banks?” →

The Two Sides of the Balance Sheet

Noam Scheiber at The New Republic has the inside scoop (hat tip Ezra Klein) on why Treasury is letting the Public-Private Investment Program die a quiet death (although at this point the legacy securities component may still go ahead). In short, the argument is that the point of PPIP was to help banks raise capital by cleaning up their balance sheets; since they have been able to raise capital themselves, there is no need for PPIP. According to one person Scheiber spoke to: “If you had asked–I don’t want to speak for the secretary–what’s problem number one? I think he’d say capital. Problem two? Capital. Problem three? Capital.”

This represents the latest swing of the pendulum between the two sides of the balance sheet. As anyone still reading about the financial crisis is probably aware, a balance sheet has two sides. On the left there are assets; on the right there are liabilities and equity; equity = assets minus liabilities. (There are different definitions of capital, depending on what subset of equity you use.)

Continue reading “The Two Sides of the Balance Sheet” →

Benefits of Size?

Felix Salmon points out that Bank of America can now charge customers overdraft fees ten times a day (up from five). (Read the original Washington Post article if you want to be aggravated.) Well, I can do one better.

I recently had to track down some past bank records. Local banks? No problem, no fee. At Bank of America, however, they insisted on charging me $5 per page – even though they were breaking a state law forbidding them from charging a fee. (All I’ll say is that they weren’t allowed to charge a fee because of the characteristics of the person I was getting the records for and the purpose for which he needed the records.) I pointed out to the drone at the bank that she was breaking the law, but she insisted she couldn’t do anything about it and we would have to sue them to get the money back. And I believe her; the problem is almost certainly that requests go from the local branch to some central processing center, and there is no way for the local branch to tell the central processing center not to deduct the fee from your account.

Now perhaps this central processing center setup reduces costs for Bank of America. But do they charge lower mortgage rates? No. Do they offer higher savings rates? No. Are they too big to fail? Absolutely. Do things have to be this way?

Update: Some people have pointed out that you don’t actually have to sue B of A to get your money back. That is correct. In my state you can send them a demand letter and they should pay you. However, the problem is that because you are dealing with your bank, they can just deduct the money from your account and force you to fight them to get it back. And most people don’t want to deal with that.

By James Kwak

The Cost of Life

Mark Thoma links to a medical paper that brings up the issue that few people want to talk about: at what point is the cost of medical care to extend life not justified? Like Thoma, I don’t have a great answer, except to point out that in a world of scarce resources, the answer cannot be that any effort to extend life by any small amount is always a good idea. (And as David Leonhardt explained, our health care system is certainly constrained by scarce resources, whether we like it or not.)

I just have one observation and one recommendation.

The observation is that our political and legal systems already put price tags on life routinely. If you die on the job, the workers’ compensation system calculates how much your life was worth; if you are killed as a result of someone else’s negligence, the tort system does the same. In either case, the calculation is primarily based on your expected earnings for the rest of the life; in other words, young high-earners are worth more than old poor people. And for virtually everyone, the number you end up with is much less than the value implied by the cancer treatment discussed in the paper Thoma cites.

I’m no fan of that system. I’m just surprised that as a society we can be so brutal and inegalitarian in one sphere and so touchy in another (health care, where the thought that any life-extending treatment might be too expensive is probably considered morally abhorrent by most people).

The recommendation is that if you are interested in this issue, you should listen to Dr. Robert Martensen on Fresh Air. Martensen is not only a doctor and a bioethicist, but at the time of the interview I believe (my memory might be failing me) he was dealing with the imminent death of one of his parents, and the medical choices involved.

By James Kwak

No Way Out: Treasury And The Price Of TARP Warrants

Buried in the late wire news on Friday – and therefore barely registering in the newspapers over the weekend – Treasury announced the rules for pricing its option to buy shares in banks that participated in TARP.

The Treasury Department said the banks will make the first offer for the warrants. Treasury will then decide to sell at that price or make a counteroffer. If the government and a bank cannot agree on a fair price for the warrants, the two sides will have the right to use private appraisers.

This is a mistake.  Continue reading “No Way Out: Treasury And The Price Of TARP Warrants” →

Debating the Public Plan

Greg Mankiw weighs in directly (as opposed to beating around the bush) on the public plan. Here’s the summary:

Recall a basic lesson of economics: A market participant with a dominant position can influence prices in a way that a small, competitive player cannot. . . .

If the government has a dominant role in buying the services of doctors and other health care providers, it can force prices down. Once the government is virtually the only game in town, health care providers will have little choice but to take whatever they can get. . . .

To be sure, squeezing suppliers would have unpleasant side effects. Over time, society would end up with fewer doctors and other health care workers. The reduced quantity of services would somehow need to be rationed among competing demands. Such rationing is unlikely to work well. . . .

A competitive system of private insurers, lightly regulated to ensure that the market works well, would offer Americans the best health care at the best prices.

Whenever someone uses the phrase “basic lesson of economics” when discussing the U.S. health care system, you should be suspicious. As Paul Krugman says, “the standard competitive market model just doesn’t work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough.”

Continue reading “Debating the Public Plan” →

The Paradox of Strategic Defaults

Real Time Economics and Calculated Risk both discuss new research by Paola Sapienza, Luigi Zingales, and Luigi Guiso on homeowners defaulting on mortgages even though they have the money to pay them. According to their research, 17% of households would default when their negative equity reaches 50% of the house’s value. The argument is that public policy has not sufficiently addressed this problem, focusing instead on homeowners who cannot afford their mortgages.

Let’s make this a little more concrete. Let’s say you bought a house with zero money down for $300,000 in early 2006. A few years later, the house is now worth $200,000, so your negative equity is 50% of the market value. Yet only 17% of people in your situation would walk away from the house. The other 83% would continue to pay the mortgage,  essentially throwing money away. Apparently people value the transaction costs of moving and the damage to their credit ratings at $100,000 (I think my numbers are approximately on the right scale – if anything they are probably low) – even after the fact that you can live in a house for free for several months before being evicted.

Or people are not as rational as economists would assume.

By James Kwak

The Danger of Discretion

Justin Fox says that financial regulation should be simpler and should give less discretion to regulators.

The argument goes like this: the biggest flaw in current financial regulation is not that there is too little of it or too much, but that it relies on regulators knowing best. We regulate because financial systems are fragile, prone to booms and busts that can have harmful effects on the real economy. But regulators aren’t immune to the boom-bust cycle. They have an understandable habit of easing up when times are good and cracking down when they’re not.

As I’ve said before, the Obama Administration’s plan is likely to give us more sophisticated regulation, but if it doesn’t give us more powerful regulators with more incentive to stand up to the industry, all the sophistication in the world won’t matter. Regulators didn’t use the tools they had – the Fed could have policed risky mortgages (and raised interest rates), the bank regulators could have insisted on higher capital requirements, etc. – because they lacked the motivation to use them in the face of overwhelming opposition from the banking industry and, probably, the power to resist Congress and the administration, whichever party controlled them.

As Ezra Klein puts it: “When evaluating a particular financial regulation proposal, ask yourself this question: Would these regulations have worked if Alan Greenspan hadn’t wanted to implement them?” That’s a good question, although it’s a bit unfair: if you posit a regulator who doesn’t believe in regulation, then virtually any regulatory scheme is bound to fail. This is why Fox and Klein argue for ironclad rules that don’t leave room for discretion. In addition, though, I think we also need to think about how to make sure we get regulators who are not cheerleaders for or captives of the financial services industry.

By James Kwak

Questions about Doctors

Greg Mankiw posts data showing that doctors in the U.S. make much more than doctors elsewhere. From a 1999 paper by Uwe Reinhardt, among others:

As a dollar amount, U.S. per capita spending for physician services was the highest in the OECD in 1999: $988, compared with an OECD median of $342. . . .

In 1996, the most recent year for which data are available for multiple countries, the average U.S. physician income was $199,000. The comparable OECD median physician income was $70,324.* The ratio of the average income of U.S. physicians to average employee compensation for the United States as a whole was about 5.5. Germany’s was the next highest, at only 3.4; Canada, 3.2; Australia, 2.2; Switzerland, 2.1; France, 1.9; Sweden, 1.5; and the United Kingdom, 1.4.

Continue reading “Questions about Doctors” →

Hedge Funds Make A Political Mistake

The political flavor of the month is to push back against even the Obama adminstration’s mildly reformist inclinations on finance (e.g., Peter Weinberg in today’s FT is a nice example).  And, of course, once you hire a lobbyist, he or she tells you that “winning” means stirring up Congress in favor of the status quo.  Measured in these terms, the hedge fund industry has had a string of notable recent victories effectively preventing tighter regulation.

Advocates have a point, of course, when they argue that big banks rather than hedge funds were primarily responsible for crisis.  But this misses where we are in the long-cycle of regulation/deregulation.  Look at this picture (source: WSJ; more on Ariell Reshef’s webpage). Continue reading “Hedge Funds Make A Political Mistake” →