Thursday, September 8, 2011

Today's links

1--U.N. study savages U.S., European economic policy, Reuters

Excerpt: The pursuit of austerity measures and deficit cuts is pushing the world economy toward disaster in a misguided attempt to please global financial markets, the annual report of the United Nations economic thinktank UNCTAD said on Tuesday.

The report, entitled "Post-crisis policy challenges in the world economy," savaged U.S. and European economic policies and called for wage increases, stricter regulation of financial markets, including a return to a system of managed exchange rates, and a conscious break with market-led thinking.
"The message here is very pragmatic: we need to reverse our course quickly," said UNCTAD Secretary General Supachai Panitchpakdi.

Supachai, a former head of the World Trade Organization, said the policy response to the crisis, with an emphasis on fiscal tightening, was misconceived and inept.

The report's lead author Heiner Flassbeck said the global economic situation was extremely dangerous and, without more stimulus, a decade of stagnation was the best-case scenario.

The current policies were a disaster, said Flassbeck, head of the globalization and development strategies division at the U.N. Conference on Trade and Development, and a former deputy finance minister in Germany.

"If interests rates everywhere are zero, and if governments stick to the policy of not only keeping fiscal deficits where they are but retrenching, cutting public expenditure, then we will end up in permanent recession," he said.

"Unemployment depends very much on demand. And if you have no demand then you need government to step in with a huge program for stimulating the economy. This was the U.S. scenario in the past. Now it's worse because wages are rising less than in the past so you're going to need a bigger stimulus program."

The recovery from the financial crisis was not only jobless, which was to be expected, but it was also "wageless," he said, with Americans, Japanese and Europeans -- 70 percent of the world economy -- expecting their incomes to stagnate.

In its last report a year ago, UNCTAD said a premature removal of stimulus policies might cause a deflationary spiral with attendant slumps in growth and employment around the world.

"Let's not fool ourselves. This is a realistic scenario for the whole developed world, if we do not understand the lessons now, and really quickly, because we do not have other instruments any more," Flassbeck told a news conference to launch this year's report.

"To revive the economy with a wageless recovery with diminished expectations by the private economy, by private households, what are the instruments at hand? There is nothing."

He said that even if things go well, global economic growth would slow to about 1.5 percent in 2012, less than half the U.N. forecast of 3.1 percent growth for this year.


The report put much of the blame for the crisis on deregulation of financial markets, which it said invited destabilizing "herd behavior" by speculators, and allowed an over-concentration of banking activities.

"What we've seen in the past and we never learn is that countries seem to have excessive belief in the financial markets. And we've seen time and again that financial markets are not very sound in their judgment," said Supachai.

"But still people keep thinking that they are doing these austerity measures because they want to please the markets so that the markets give them better ratings, including the rating agencies which do not always produce the best assessment."

Flassbeck said the herd mentality was evident whenever equity markets and commodity markets all lurch in tandem on the same day, an effect that could not conceivably be caused by real swings in demand. But the world was ignoring it, he said.

3--Finance and Macroeconomics: The Role of Household Leverage, Atif R. Mian and Amir Sufi, NBER Reporter 2011 Number 3: Research Summary

Excerpt: The increase in household leverage prior to the most recent recession was stunning by any historical comparison. From 2001 to 2007, household debt doubled, from $7 trillion to $14 trillion. The household debt-to-income ratio increased by more during these six years than it had in the prior 45 years. In fact, the household debt-to-income ratio in 2007 was higher than at any point since 1929. Our research agenda explores the causes and consequences of this tremendous rise in household debt. Why did U.S. households borrow so much and in such a short span of time? What factors triggered the slowdown and collapse of the real economy? Did household leverage amplify macroeconomic shocks and make a quick recovery less likely? How do politics constrain policy responses to an economic crisis?

While the focus of our research is on the recent U.S. economic downturn, we believe the implications of our work are wider. For example, both the Great Depression and Japan's Great Recession were preceded by sharp increases in leverage.1 We believe that understanding the impact of household debt on the economy is crucial to developing a better understanding of the linkages between finance and macroeconomics.

The Rise in Household Debt

Our explanation for the increase in household debt begins with the dramatic expansion in mortgage originations to low credit-quality households from 2002 to 2007. 2 Mortgage-related debt is a natural starting point, given that it makes up 70 to 75 percent of household debt and was primarily responsible for the overall increase in household debt. Further, the expansion of new mortgage originations was much larger in zip codes with a large fraction of low credit-quality households.

We argue that the primary explanation behind the dramatic increase in mortgage debt was a securitization-driven shift in the supply of mortgage credit. The fraction of home purchase mortgages that were securitized by non-GSE (government sponsored enterprise) institutions rose from 3 percent to almost 20 percent from 2002 to 2005, before collapsing completely by 2008. We show that non-GSE securitization primarily targeted zip codes that had a large share of subprime borrowers. In these zip codes, mortgage denial rates dropped dramatically and debt-to-income ratios skyrocketed. Our evidence contradicts the hypothesis that the expansion in mortgage credit reflected productivity or permanent income improvements for marginal borrowers. For example, mortgage credit growth and income growth become negatively correlated at the zip code level from 2002 to 2005, despite being positively correlated in every other time period back to 1990.

Part of our research explores the relationship between house prices and mortgage credit growth, which is difficult to disentangle because mortgage credit is likely to both respond to and to drive house price growth. We address this issue by focusing on areas of the country with extremely elastic housing supply, where both expected and realized house price growth is very low. The logic of this test is straightforward: house price expectations cannot drive credit supply decisions in cities where house price growth expectations must be constrained to be close to the rate of inflation. Even in cities with very elastic housing supply which did not experience house- price growth, there was a sharp increase in mortgage originations in low credit-quality zip codes corresponding to falling incomes and a sharp rise in securitization. However, these effects are larger in cities with an inelastic housing supply. Therefore we conclude that the expansion in mortgage credit was more likely to be a driver of house price growth than a response to it. In cities with inelastic housing supply, though, the initial increase in house price growth likely had important feedback effects on mortgage credit during the housing boom.
We focus on the feedback effect from house prices to household borrowing by analyzing individual-level borrowing data on U.S. households that already owned their homes in 1997, before mortgage credit expanded.3 Using an instrumental variables approach and isolating the direct impact of house price increase on home equity-based borrowing, we find that existing homeowners borrowed 25 to 30 cents against the rising value of their home equity from 2002 to 2006. Further, this effect is concentrated among borrowers with a weak credit history.

Our findings are in line with models that propose a "feedback" or "accelerator" effect of asset prices on the real economy through collateral constraints. For example, we find that the home equity-based borrowing channel is largest for low credit-quality and high credit-card-utilization individuals. Moreover, the borrowings were not used to purchase new properties or to pay down expensive credit card balances, implying that they were likely used for real outlays, such as home improvement and consumption. Overall, we estimate that the home-equity based borrowing channel can explain 50 percent of the overall increase in debt among homeowners from 2002 to 2006.

Household Debt, the Recession, and the Weak Recovery

An expansion in the supply of credit, coupled with the feedback effect of borrowing against rising house values by existing homeowners, led to an unprecedented growth in U.S. household leverage between 2002 and 2006. One strand of our research has shown that during the Recession of 2007-9 and beyond, the cross-sectional variation in leverage growth across U.S. counties as of 2006 is an early and powerful predictor of the severity of the recession. The predictive effect of household leverage on macroeconomic outcomes is large enough to explain the entire rise in mortgage defaults, the fall in house prices, and the fall in durable consumption measured by auto sales.

4--Obama ratings sink to new lows as hope fades, Washigton Post

Excerpt: Public pessimism about the direction of the country has jumped to its highest level in nearly three years, erasing the sense of hope that followed President Obama’s inauguration and pushing his approval ratings to a record low, according to a new Washington Post-ABC News poll.

More than 60 percent of those surveyed say they disapprove of the way the president is handling the economy and, what has become issue No. 1, the stagnant jobs situation. Just 43 percent now approve of the job he is doing overall, a new career low; 53 percent disapprove, a new high....

Nonetheless, current trends are highly unfavorable for the president. By 2 to 1, more Americans now say the administration’s economic policies are making the economy worse rather than better. The number who say those policies have helped has been chopped in half since the start of the year.

The percentage of Americans disapproving of how Obama is doing when it comes to creating jobs spiked 10 percentage points higher since July.
Of the more than six in 10 who now disapprove of Obama’s work on jobs and the economy, nearly half of all Americans “strongly” disapprove.

5--Obama Said to Seek $300 Billion Jobs Package, Bloomberg

Excerpt: President Barack Obama plans to propose sparking job growth by injecting more than $300 billion into the economy next year, mostly through tax cuts, infrastructure spending and direct aid to state and local governments.

Obama will call on Congress to offset the cost of the short-term jobs measures by raising tax revenue in later years. This would be part of a long-term deficit reduction package, including spending and entitlement cuts as well as revenue increases, that he will present next week to the congressional panel charged with finding ways to reduce the nation’s debt.

Almost half the stimulus would come from tax cuts, which include an extension of a two-percentage-point reduction in the payroll tax paid by workers due to expire Dec. 31 and a new decrease in the portion of the tax paid by employers.

Obama is set to lay out his plans in an address to Congress tomorrow as unemployment remains at 9.1 percent more than two years after the official end of the worst recession since the Great Depression. Payroll growth stalled last month.

6--The White House’s two priorities, Ezra Klein, Washington Post

Excerpt: The bulk of what will be in President Obama’s jobs speech Thursday will not be new stimulus. The big-ticket items will be a slightly expanded version of the payroll tax cut and an extension of unemployment insurance. Together, these two pieces cost about $200 billion a year, which accounts for most of the $300-$400 billion in jobs spending that the White House is set to announce. But since they are already in effect, extending them will not, from an economic point of view, add much new demand into the economy. It will simply prevent demand from being sucked out. The rest of the proposal is likely to be an infrastructure plan — I would expect the price tag here to be in the $50-$100 billion range for 2012 — and more state and local aid. There will also be a call for Fannie and Freddie to extend refinancing help to more underwater homeowners.

Getting less attention in the media is the follow-up speech the White House is planning, which will lay out a specific deficit-reduction agenda that not only meets the $1.5 trillion goal of the “supercommittee,” but exceeds it and pays for the new jobs spending. These proposals will look quite similar to the grand bargain the White House offered Speaker John Boehner, and liberal groups are grimly preparing for the administration to call for raising the Medicare eligibility age.

7--Many in U.S. slip from middle class, study finds, Washington Post

Excerpt: Nearly one in three Americans who grew up middle-class has slipped down the income ladder as an adult, according to a new report by the Pew Charitable Trusts.

Downward mobility is most common among middle-class people who are divorced or separated from their spouses, did not attend college, scored poorly on standardized tests, or used hard drugs, the report says.
“A middle-class upbringing does not guarantee the same status over the course of a lifetime,” the report says.

The study focused on people who were middle-class teenagers in 1979 and who were between 39 and 44 years old in 2004 and 2006. It defines people as middle-class if they fall between the 30th and 70th percentiles in income distribution, which for a family of four is between $32,900 and $64,000 a year in 2010 dollars.

People were deemed downwardly mobile if they fell below the 30th percentile in income, if their income rank was 20 or more percentiles below their parents’ rank, or if they earn at least 20 percent less than their parents. The findings do not cover the difficult times that the nation has endured since 2007.

8--WSJ: Fed Prepares to Act, CalculatedRisk

Excerpt: Federal Reserve officials are considering three unconventional steps to revive the economic recovery and seem increasingly inclined to take at least one as they prepare to meet this month.
One step getting considerable attention inside and outside the Fed would shift the central bank's portfolio of government bonds so that it holds more long-term securities and fewer short-term securities.
A second step under consideration at the Fed, one getting mixed reviews internally, would reduce or eliminate a 0.25% interest rate the Fed currently is paying banks that keep cash on reserve with the central bank.
A third step Fed officials are debating would involve using their words to make their economic objectives and plans for interest rates more clear.

9--Weekly Initial Unemployment Claims increase to 414,000, CalculatedRisk
The DOL reports:

Excerpt: In the week ending September 3, the advance figure for seasonally adjusted initial claims was 414,000, an increase of 2,000 from the previous week's revised figure of 412,000. The 4-week moving average was 414,750, an increase of 3,750 from the previous week's revised average of 411,000....

Weekly claims increased slightly, and the 4-week average is still elevated - and remains above the 400,000 level.

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