Tuesday, March 8, 2011

Today's links

1-- Degrees and Dollars, Paul Krugman, New York Times

Excerpt: It is a truth universally acknowledged that education is the key to economic success. Everyone knows that the jobs of the future will require ever higher levels of skill. ...

But what everyone knows is wrong..., the idea that modern technology eliminates only menial jobs, that well-educated workers are clear winners, may dominate popular discussion, but it’s actually decades out of date.

The fact is that since 1990 or so the U.S. job market has been characterized not by a general rise in the demand for skill, but by “hollowing out”: both high-wage and low-wage employment have grown rapidly, but medium-wage jobs — the kinds of jobs we count on to support a strong middle class — have lagged behind. And the hole in the middle has been getting wider...

Alan Blinder and Alan Krueger suggest ... that high-wage jobs performed by highly educated workers are, if anything, more “offshorable” than jobs done by low-paid, less-educated workers. If they’re right, growing international trade in services will further hollow out the U.S. job market.

So what does all this say about policy?

Yes, we need to fix American education. In particular, the inequalities Americans face at the starting line — bright children from poor families are less likely to finish college than much less able children of the affluent — aren’t just an outrage; they represent a huge waste of the nation’s human potential.

But ... the notion that putting more kids through college can restore the middle-class society we used to have is wishful thinking. It’s no longer true that having a college degree guarantees that you’ll get a good job, and it’s becoming less true with each passing decade.

So if we want a society of broadly shared prosperity, education isn’t the answer — we’ll have to go about building that society directly. We need to restore the bargaining power that labor has lost over the last 30 years, so that ordinary workers as well as superstars have the power to bargain for good wages. We need to guarantee the essentials, above all health care, to every citizen.

What we can’t do is get where we need to go just by giving workers college degrees, which may be no more than tickets to jobs that don’t exist or don’t pay middle-class wages.

2--To Fix Sour Property Deals, Lenders 'Extend and Pretend', Wall Street Journal

Excerpt: Some banks have a special technique for dealing with business borrowers who can't repay loans coming due: Give them more time, hoping things improve and they can repay later.

Banks call it a wise strategy. Skeptics call it "extend and pretend."

Banks are applying it, in particular, to commercial real-estate lending, where, during the boom, optimistic borrowers got in over their heads to the tune of tens of billions of dollars.

A big push by banks in recent months to modify such loans—by stretching out maturities or allowing below-market interest rates—has slowed a spike in defaults. It also has helped preserve banks' capital, by keeping some dicey loans classified as "performing" and thus minimizing the amount of cash banks must set aside in reserves for future losses.

Restructurings of nonresidential loans stood at $23.9 billion at the end of the first quarter, more than three times the level a year earlier and seven times the level two years earlier. While not all were for commercial real estate, the total makes clear that large numbers of commercial-property borrowers got some leeway.

But the practice is creating uncertainties about the health of both the commercial-property market and some banks. The concern is that rampant modification of souring loans masks the true scope of the commercial property market weakness, as well as the damage ultimately in store for bank balance sheets....

Regulators helped spur banks' recent approach to commercial real estate by crafting new guidelines last October. They gave banks a variety of ways to restructure loans. And they allowed banks to record loans still operating under the original terms as "performing" even if the value of the underlying property had fallen below the loan amount—which is an ominous sign for ultimate repayment. Although regulators say banks shouldn't take the guidelines as a signal to cut borrowers more slack, it appears some did.

Banks hold some $176 billion of souring commercial-real-estate loans, according to an estimate by research firm Foresight Analytics. About two-thirds of bank commercial real-estate loans maturing between now and 2014 are underwater, meaning the property is worth less than the loan on it, Foresight data show. U.S. commercial-real-estate values remain 42% below their October 2007 peak and only slightly above the low they hit in October 2009, according to Moody's Investors Service.

In the first quarter, 9.1% of commercial-property loans held by banks were delinquent, compared with 7% a year earlier and just 1.5% in the first quarter of 2007, according to Foresight.....But continuing to extend loans and otherwise modify them, rather than foreclosing, amounts to a bet that the economy will rebound enough to enable clients to find new demand for the plethora of offices, hotels, condos and other property on which they borrowed. If it doesn't work out this way, the banks will end up having to write off the loans anyway.

At that point, if they haven't been setting aside sufficient cash all along for potential losses on such loans, the banks will face a hit to their earnings....

More broadly, the failure to get the loans off banks' books tends to deter new lending to others. It's a pattern somewhat reminiscent, although on a lesser scale, of the way Japanese banks' failure to write off souring loans in the 1990s contributed to years of stagnation.

It's a Catch-22 for banks. As long as some of their capital is tied up in real-estate loans that are struggling—and as the banks see a pipeline of still-more sour real-estate debt that will mature soon—their lending is likely to remain constricted. But to wipe the slate clean by writing off many more loans would mean an even bigger hit to their capital.

"It does not take much of a write-down to wipe out capital," says Christopher Marinac, managing principal at FIG Partners LLC, a bank research and investment firm.

3--China's Wen Targets Inflation as Top Priority to Cut Risk of Social Unrest, Bloomberg

Excerpt: The world’s second-biggest economy faces heightened inflation and asset-bubble risks and banks may be saddled with more bad loans after a record expansion in credit drove China’s economic recovery.

Consumer prices rose an annual 4.9 percent in January and food prices jumped, even after the central bank increased interest rates and banks’ reserve requirements. Wen pledged a “comprehensive audit” of local-government debt, after a surge in borrowing linked to the stimulus program from late 2008.

To control inflation, the government will manage liquidity, ensure agricultural production and use price controls when needed, Wen said. Officials will curb real-estate speculation and “adjust and improve” property tax policies, he added.

“The main challenge for controlling inflation is the property-price bubble stemming from overly loose monetary conditions relative to asset prices,” economists led by Peng Wensheng at China International Capital Corp. Ltd. said in a March 2 report....

The nation’s Gini coefficient, an income-distribution gauge used by economists, has climbed to near 0.5 from less than 0.3 a quarter century ago, according to Li Shi, professor of economics, School of Economics and Business at Beijing Normal University. The measure ranges from 0 to 1, and the 0.4 mark is used as a predictor by analysts for social unrest.

Government moves to boost incomes and spending power may include raising the threshold for income tax from 2,000 yuan per month, a plan already approved by the State Council.

A stronger Chinese currency would also bolster consumption, the U.S. government says. Wen’s report said the government will improve “the exchange-rate mechanism,” while Yi Gang, the head of the State Administration of Foreign Exchange, told reporters at today’s meeting that the yuan’s rate “has never been closer to equilibrium.”

4---Oil price shock; you ain't seen nothing yet, The Telegraph

Excerpt: You don’t have to look far into the future, perhaps as little as a year to 18 months, to see that a major demand challenge is looming which even assuming no further disruption to existing production, will challenge the present supply base to breaking point.

As it is, it’s fair to assume the world is closer to full capacity than producers care to admit. Rewind to the last oil price shock in the summer of 2008, and Saudi Arabia, pumping out oil at the rate of around 9.5 million barrels a day, was having to draw on inventories to meet demand. It’s therefore reasonable to assume that 9.5 million bpd then represented maximum capacity.

Since then, the Saudis have brought a further two fields on stream with a capacity of around 2 million bpd, bringing total capacity up to some 11.5 million bpd. But there is generally reckoned to be an attrition rate of around 6pc per annum on existing fields, taking us back to square one in terms of maximum daily output. This is perilously close to what the Saudis are already producing, and makes the assumed buffer of Saudi spare capacity considerably smaller than the Saudis claim. There’s not much slack anywhere else either.

Now look at growth in demand, virtually all of which is coming from China and other emerging markets. Chinese demand at around 10 million bpd annually is already around half that of the world’s biggest oil consumer, the US. But unlike the US, where demand is in gentle decline, in China it’s rising like a rocket. Last year Chinese demand rose by close to 1 million bpd. It’ll probably be a bit lower this year, but not much. More cars are now being bought in China than the US, and they’ve got to run on something....

Do the math. Almost regardless of what happens to supply, demand will soon be outpacing the world’s capacity to meet it. The economic effect of such a mismatch is to drive up prices to a level where they eventually ration demand. Output will fall to a point which brings demand back into balance with supply. That’s called a recession.

5---The global economy is critically ill, FT Alphaville

Excerpt: You’ve had the apprentice (Dylan Grice) and now it’s time for the Dark Sith Lord (Albert Edwards).

The global economy is critically ill. The fact that it has just risen from its sick-bed to perform a frenetic Irish jig is more a function of the financial morphine and steroids that have been pumped into its emaciated body than any miracle cure. You don’t have to be Dr Doom to expect the patient to collapse back into a deep coma after the stimulus has worn off....

Over the longer term, he’s worried about the off balance sheet liabilities of the US and UK governments.

Our oft repeated refrain that it is not the on-balance sheet public sector debt of around 100% of GDP that deems governments to be insolvent, but the off-balance sheet liabilities of an additional 300%-400% of GDP that are totally impossible to fund. Governments will have to default in some shape or form and part of that process will be inflation. But you cannot inflate away some of these liabilities....

But returning to the here and now, it’s QE2 that’s on Edwards’ mind.

We await the end of QE2 in June. This will really sort the sheep from the goats. Then we will see whether this patient can keep up its frenetic Irish jig in the absence of extreme stimulants. I am in the camp (tent) that believes that QE1 and QE2 have driven equity prices which have, in turn, fuelled the economic recovery. Looking around, it is not a very crowded tent and being a city boy I’m not quite sure whether those droppings belong to sheep or goats.

6--Roubini Says Slow Growth May Mean Debt Restructuring, Wall Street Journal

Excerpt: Advanced countries with high levels of debt will have to consider debt restructuring as anemic growth won’t enable them to tackle their liabilities, U.S. economist Nouriel Roubini said in Paris Friday.

Roubini, known as “Dr. Doom” for his prescient warnings about the 2008 financial crisis, urged policy makers to include the issue of debt restructuring in global talks on the reform of the international monetary system, stressing that weak growth aside, all other options to tackle debt mountains in developed economies are closed to them.

“If growth is not going to solve this problem, if saving more and consuming less is going to lead to a double dip, if inflation is a bad idea…the only other solution is debt restructuring, debt reduction, debt conversion into equity,” Roubini told a central banking event organized by the Bank of France in Paris.

He said states, households and banks should all look at the option of debt restructuring.

7--Economists React: Last Piston of Economy Is Firing, Wall Street Journal

Excerpt: –The last piston in the economic engine has begun to fire pointing to sustaining economic growth. The job market has passed through the inflection point. Recent economic reports, both production and spending, are supportive of accelerating economic momentum… The Achilles’ heel of the economy is the state and local government. It continues to lay off people vowing to budget pressure. –Sung Won Sohn, Smith School of Business and Economics

–The gains were broad based, with manufacturing up a hefty 70,000 and most services strong except retail, -8,000. Wage dip shows no inflation threat at all. Expect gradual sustained acceleration in payrolls next few months. –Ian Shepherdson, High Frequency Economics

–The manufacturing sector, which we know is firing on all cylinders, has created 86,000 jobs in the last two months, the strongest rate of job growth since September 1998 and before that, November 1997. It was difficult to imagine the sector growing and producing as much as it has been without a commensurate gain in jobs and that appears to be happening. Further, the weather related decline in construction jobs was largely reversed in the month and while nobody believes a sustained period of robust construction hiring lay ahead, it is a welcome bit of good news in a hard hit sector. –Dan Greenhaus, Miller Tabak...

The unemployment rate ticked down to 8.9%, the third consecutive month of declines. Once again, the household-reported employment growth well exceeded the firm-reported numbers. This sort of divergence typically lasts for only one period before reversing, not for three months, as it now has. One possible explanation is structural rather than technical: the number of individuals holding two jobs is declining yet the number of individuals holding single jobs is rising, causing limited net change in payrolls numbers (which count jobs) but increases in household numbers (which count the number of people with jobs). That optimistic explanation would call for consumer spending growing at a faster pace than the current rate of payroll growth implies. –Guy LeBas, Janney Montgomery Scott

–The labor market is starting to dig out of its deep hole but job creation is not yet strong enough to draw many previously discouraged workers back. –Sophia Koropeckyj, Moody’s Economy.com

–The underlying details point to further misery for the U.S. consumer. Income growth slowed and hours worked failed to pick up, signalling that although labour demand has gathered pace we are still very far from having a tight labour market. –David Semmens, Standard Chartered Bank


8--The Madness of Jean-Claude Trichet, Paul Krugman, New York Times

Excerpt: The European Central Bank is strongly hinting that it will raise interest rates at its next meeting, in response to rising headline inflation — even though this rise is the result of rising food and oil prices, which are not the results of ECB policy.

Let me try a different take on why this is such a bad idea. Suppose that we focus on wage rates, which are often seen as the stickiest, most inertia-driven prices. The eurozone, like the United States, has seen wage growth slump in the face of high unemployment...

So what the ECB is saying, in effect, is that Europe should drive down nominal wages — which can only be done by raising the unemployment rate — in order to offset the effect of oil and food on headline inflation. (Real wages will fall in any case.)

Is this really a policy that the ECB would defend in so many words? I doubt it. But however sober and dignified talk of price stability may sound, that’s what the proposed policy amounts to.




9--Global forces driving Middle East uprisings, Nick Beams, World Socialist Web Site

Excerpt: the rapidity of these events is, in the final analysis, the outcome of deeper processes rooted in the world economy—processes that are at work in every corner of the globe.

The most obvious common feature of Tunisia, Egypt and Libya—the three principal storm centres so far—is that a far-reaching program of neo-liberal “free market” restructuring has taken place in all of them in the recent period. These policies, including large-scale privatisation, the winding back of national economic and financial regulation, the destruction of tens of thousands of jobs and cuts in state subsidies, have been overseen by the International Monetary Fund (IMF) on behalf of global finance capital.

Last October, the IMF issued a report in which it bewailed the general “lack of competitiveness in the Middle East and North Africa.” It pointed, however, to two “success stories.”

Tunisia had become the “outsourcing hub” of the region, with “simplified regulation, modern infrastructure, government incentives and commitment to a knowledge-based economy that generates well-trained, low-cost workers.” The self-immolation of a young unemployed worker last December was the trigger for the Tunisian uprising.

As for Egypt, it had attracted considerable global IT investment with recent “structural reforms” leading to “improvements in the business environment.”...

Libya has also been the subject of glowing reports. On October 28 last year, the IMF commended Libyan authorities “on efforts to enhance the role of the private sector in the economy”. It hailed “efforts to deepen the financial markets” as “commendable” and pointed out that there were no more government-owned banks and that “foreign partners” were involved in six of the country’s 16 operating banks.

The IMF report also noted that “progress” had been made in reducing civil service employment, pointing out that of the 340,000 public services employees transferred to a central labor office for retrenchment, about one quarter had found other sources of income. It called for the retrenchment program to be “accelerated.” As recently as February 9 this year, just a week before the uprising against Gaddafi began, the IMF pointed to the “ambitious program” to privatise banks and “develop the nascent financial sector,” and hailed structural reforms in other areas and “far-reaching laws” passed last year as boding well for “fostering private sector development and attracting foreign direct investment.”

The IMF directors had “commended the authorities for their ambitious reform agenda” and for the many important laws passed last year, “complemented by policies aimed at adapting the labor force to the economic transformation.”

Viewed against this background, the uprisings in the Middle East assume a broader significance. They are the first revolt against the “free market” program that has had such a devastating impact on the social position of the working class in the past 20 years. Privatisation, deepening social inequality, growing youth unemployment, the lack of opportunities for university and college graduates, falling real wages and the accumulation of vast amounts of wealth, much of it the result of what can only be described as criminal looting operations—these are not Middle Eastern, but global phenomena....

Whatever its particular form, the situation in each country is, as Leon Trotsky explained, “an original combination of the basic features of the world process.” Consequently, he insisted, the struggles of the working class in any given country, whatever their initial form, can only be taken forward on the basis of an international program and through the construction of the world party of socialist revolution. That is the perspective of the International Committee of the Fourth International today.

10--“A Healthy Financial System Cannot Be Built On The Expectation Of Bailouts”, Simon Johnson, The Baseline Scenario

Excerpt: ...Next time, when our largest banks get into trouble, they may be beyond “too big to fail”. As seen recently in Ireland, banks that are very big relative to an economy can become “too big to save” – meaning that while senior creditors may still receive full protection (so far in the Irish case), the fiscal costs overwhelm the government and push it to the brink of default.

The fiscal damage to the United States in that scenario would be immense, including through the effect of much higher long term real interest rates. It remains to be seen if the dollar could continue to be the world’s major reserve currency under such circumstances. The loss to our prestige, national security, and ability to influence the world in any positive way would presumably be commensurate.

In 2007-08, our largest banks – with the structures they had lobbied for and built – brought us to the verge of disaster. TARP and other government actions helped avert the worst possible outcome, but only by providing unlimited and unconditional implicit guarantees to the core of our financial system. This can only lead to further instability in what the Bank of England refers to as a “doom loop”....

Providing unlimited implicit guarantees does not help underpin financial stability.

At the heart of any banking crisis is a political problem – powerful people, and the firms they control, have gotten out of hand. Unless this is dealt with as part of the stabilization program, all the government has done is provide an unconditional bailout. That may be consistent with a short-term recovery, but it creates major problems for the sustainability of the recovery and for the medium-term. Serious countries do not do this.

As Larry Summers put it, in his 2000 Ely Lecture to the American Economic Association, “[I]t is certain that a healthy financial system cannot be built on the expectation of bailouts” (American Economic Review, vol. 90, no. 2, p.13)....

The Obama administration argues that regulatory reforms, including the Dodd-Frank Act and associated new rules, will rein in the financial sector and make it safer. Unfortunately, this assessment is not widely shared.

There was an opportunity to cap the size of our largest banks and limit their leverage, relative to the size of the economy. Unfortunately, the Brown-Kaufman to that effect was defeated on the floor of the Senate, 33-61, primarily because it was opposed by the US Treasury. (See http://baselinescenario.com/2010/05/26/wall-street-ceos-are-nuts/, which contains this quote from an interview in New York Magazine: “‘If enacted, Brown-Kaufman would have broken up the six biggest banks in America,’ says the senior Treasury official. ‘If we’d been for it, it probably would have happened. But we weren’t, so it didn’t.’”)

Regulation remains weak and many regulators are still captured by the ideology that big banks are good for the rest of the economy. Capital requirements will increase but are likely to remain below the level that Lehman had in the days before it failed (11.6 percent tier one capital). There will be no effective cap on the size of our biggest banks. They have an incentive to take on a great deal of leverage. This confers private benefits but great social costs – lowering economic growth, increasingly volatility, and making severe crises more likely.....


In this context, TARP played a significant role preventing the mini-depression from becoming a full-blown Great Depression, primarily by providing capital to financial institutions that were close to insolvency or otherwise under market pressure.

But part of the cost is to distort further incentives at the heart of Wall Street. Neil Barofsky, the Special Inspector General for the Troubled Assets Relief Program put it well in his latest quarterly report, which appeared in late January, emphasizing: “perhaps TARP’s most significant legacy, the moral hazard and potentially disastrous consequences associated with the continued existence of financial institutions that are ‘too big to fail.’”

Adjustments to our regulatory framework, including the Dodd-Frank financial reform legislation, have not fixed the core problems that brought us to bring of complete catastrophe in fall 2008. Powerful people at the heart of our financial system still have the incentive and ability to take on large amounts of reckless risk – through borrowing large amounts relative to their equity. When things go well, a few CEOs and a small number of others get huge upside.

When things go badly, society, ordinary citizens, and taxpayers get the downside. This is a classic recipe for financial instability.

Our six largest bank holding companies currently have assets valued at just over 63 percent of GDP (end of Q4, 2010). This is up from around 55% of GDP before the crisis (e.g., 2006) and no more than 17% of GDP in 1995.

With assets ranging from around $800 billion to nearly $2.5 trillion, these bank holding companies are perceived by the market as “too big to fail,” meaning that they are implicitly backed by the full faith and credit of the US government. They can borrow more cheaply than their competitors and hence become larger.

In public statements, top executives in these very large banks discuss their plans for further global expansion – presumably increasing their assets further while continuing to be highly leveraged.

There is nothing in the Basel III accord on capital requirements that should be considered encouraging. Independent analysts have established beyond a reasonable doubt that substantially raising capital requirements would not be costly from a social point of view (e.g., see the work of Anat Admati of Stanford University and her colleagues).

But the financial sector’s view has prevailed – they argue that raising capital requirements will slow economic growth. This argument is supported by some misleading so-called “research” provided by the Institute for International Finance (a lobby group)....

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