Tuesday, September 13, 2011

Today's links

1--The Oddness of the President’s Upcoming Deficit-Reduction Plan, Robert Reich's blog

Excerpt: On Monday the President will offer ways to pay for his $467 billion American Jobs Act mostly by increasing taxes on the wealthy.

I’m all in favor, but it’s an odd strategy. If any Republican was prepared to vote for the jobs bill, this will send him or her scurrying.

So if the President was never really serious about getting Republican votes in the first place — if his jobs bill and the tax increase on the wealthy were always going to be part of his 2012 election year pitch — why didn’t he make his jobs bill big enough to do the job?

Here’s another odd thing.

The deficit-reduction plan the President will present Monday to Congress’s special supercommittee on the debt (now struggling to come up with $1.5 trillion in deficit reduction) will also propose some $2 to $3 trillion in additional deficit reduction over the next ten years — including changes in Medicare.

According to the President’s plan, those tax increases and spending cuts would go into effect in 2013.

But there’s a strong likelihood the American economy will still be anemic in 2013, if not on life support. Even if we avoid a double dip the jobs picture we’ll almost certainly be terrible. Even if by some miracle job growth soared to the average monthly growth over the past decade, the unemployment rate wouldn’t get back down to 6 percent until 2024.

When unemployment is still in the stratosphere, it would be insane to start cutting the deficit by $3 trillion to $4 trillion. That would push unemployment into outer space.

And in proposing such a huge deficit reduction package, the President continues to reenforce the Republican lie that the budget deficit is our biggest challenge — indeed, that we’re in the fix we’re in because government has become too big.

If the President wants to show his creds on deficit reduction, at least put in a trigger that begins to lower the deficit only when unemployment falls to 6 percent.

2--White House Would Cut Deductions to Pay for Its Jobs Plan, New York Times

Excerpt: The White House said on Monday that it would cover most of the cost of his payroll tax cut and other job initiatives by limiting the deductions that can be claimed on the tax returns of wealthier taxpayers.

President Obama, repeating what is clearly going to be the mantra for his stump speeches this fall, called on lawmakers Monday to “pass this bill” — his $447 billion jobs package.

At the White House, his budget director described how the administration would propose to pay for the plan, as the president has promised to do.

Jack Lew, the director of the White House Office of Management and Budget, said the bulk of the plan –- $400 billion over 10 years — would be raised by limiting the itemized deductions, such as those for charitable contributions and other expenditures, that may be taken by individuals making more than $200,000 a year and families making over $250,000 a year. The rest would come from provisions affecting oil and gas companies, hedge funds, and the owners of corporate jets.

3--The European debt crisis in charts, News N Economics

Excerpt: I present some basic statistics to highlight the problem in Europe. In short, there exists a deleterious positive feedback loop between overly leveraged banks and their sovereigns in key markets.

Exhibit 1: European Banks are overly levered. Spanning 2006 through the latest data point, key European banking systems - France, Germany, and Italy - increased leverage. (Charts)

....bond markets are in crisis mode, and there's a stark segmentation in yields across the region.

Cross border exposure dictates that some of these highly levered banking systems are exposed to the same government securities currently trading at distressed levels.

4--What do low government bond yields signify?, Econbrowser

Excerpt: Brad DeLong and Tyler Cowen point to an interesting exchange in the Financial Times.

Martin Wolf argues that in the U.S., U.K., and Germany, the household, business, and foreign sectors want to spend much less than they earn, pushing interest rates to exceptionally low levels, and signaling that the public sector in these countries needs to borrow more and spend more to pick up the slack.

Stephen King maintains instead that Treasury yields are low for the same reason that gold prices are high-- naked fear: "Investors are trying to find pockets of safety in a world where the financial system appears to be slowly crumbling." King notes that in September 2005, the interest rate on 10-year government bonds from countries like Greece and Italy was only 3.3%, but denies that the willingness of creditors to lend at those low historical rates should have been interpreted by the governments at the time as encouragement for even bigger deficits.

Fear seems to be one of those things that can quickly change focus.

5--The Context: The Stimulus Package of 2009 (Then and now), Econbrowser

Excerpt: To begin with it’s useful to review a little history, given the heated rhetoric that has been used in the past few years. From Chapter 5 of Lost Decades (forthcoming 9/19, W.W. Norton), written by me and Jeffry Frieden:

The standard macroeconomic view is that in recessionary conditions, incremental government spending and tax cuts can stimulate the economy. If the government spends an additional million dollars to build a bridge, that spending directly adds to GDP. But that is only the beginning: the spending on materials and labor is income to suppliers, contractors, and workers, and some of this income will be spent on consumer goods and services, which then further increases GDP. This in turn becomes income for other workers, who similarly increase their spending, again adding to GDP. This process suggests a “fiscal multiplier,” typically associated with Keynesian macroeconomics, such that every one-dollar increase in government spending results in a greater-than-one-dollar increase in GDP. Especially when the economy is stuck at ZIRP, so that private borrowing and spending are particularly weak, the multiplier can be large...

Even before the new administration took office, its economic team had been considering a fiscal stimulus. Romer’s evaluation indicated that a $1.2 trillion package was needed. However, President-elect Obama’s political advisers insisted that this was not feasible, and the numbers were shaved. Once in office, President Obama proposed a $675–$775 billion package to stimulate the economy.32

....Using the CBO's measure of potential, the lost output has been $2.8 trillion (Ch.2005$) through 2011Q2. Using the WSJ mean forecast, another $1.4 trillion will be lost by 2012Q4. The CBO-implied output gap as of 2011Q2 is 7.1% (log terms). Using a cubic in time trendline, the gap is still 3.4% (and then one has to believe that output was above potential 3.3% in 2007Q3).

Extended unemployment insurance, extension of the payroll tax holiday [CBPP], and infrastructure spending are all means by which aggregate demand can be sustained...

Update, 9/9, 7:30AM Pacific:

Estimates suggest a more substantial boost than early assessments (including mine). From Macroeconomic Advisers:

American Jobs Act: A Significant Boost to GDP and Employment

We estimate that the American Jobs Act (AJA), if enacted, would give a significant boost to GDP and employment over the near-term.

•The various tax cuts aimed at raising workers’ after-tax income and encouraging hiring and investing, combined with the spending increases aimed at maintaining state & local employment and funding infrastructure modernization, would:

◦Boost the level of GDP by 1.3% by the end of 2012, and by 0.2% by the end of 2013.

◦Raise nonfarm establishment employment by 1.3 million by the end of 2012 and 0.8 million by the end of 2013, relative to the baseline.

•The program works directly to raise employment through tax incentives and support to state & local governments for increasing hiring; it works indirectly through the positive boost to aggregate demand (and hence hiring) stimulated by the direct spending and the increase in household income resulting from lower employee payroll taxes and increased employment.

Because the package is some $100-$150 billion larger than the proposal widely reported in the press and that we wrote about two weeks ago, these effects are expected to be significantly larger than previously expected.

6--Lehman Brothers: three years of denialLehmans crashed for a simple reason: an ignored $8tn housing bubble. But don't expect the Greenspan sycophants to admit it, The Guardian

Excerpt: As we prepare to celebrate the third anniversary of the Lehman Brothers bankruptcy and the ensuing financial crisis, it's a good time to assess the situation and ask what has changed. The answer is not encouraging.

Very little has changed about either the realities on the ground or the intellectual debate on economic issues in the last three years. The "too-big-to-fail" banks are bigger than ever as a result of crisis induced mergers. Financial industry profits now exceed their pre-crisis share of corporate profits, and executive pay and bonuses are again at their bubble peaks.

None of the executives who pushed and packaged fraudulent mortgages has gone to jail. Even those who have faced civil actions, like Countrywide's Angelo Mozilo, have almost certainly still come out ahead after making large payments to settle suits.

And all the top policy people who guided us to this economic disaster are still doing just fine. When former Fed Chairman Alan Greenspan isn't collecting his seven-figure salary from Pimco, the country's largest bond fund, he is sharing his wisdom with the world on the Sunday morning talk shows....

It took nothing more than third-grade arithmetic to recognise a housing bubble that had grown hugely out of line with the fundamentals of the housing market. There was no explanation that passed the laugh test for the fact that house prices had diverged sharply from their long-term trend, and from rents – creating a housing bubble that peaked at more than $8tn. This was recognisable at least as early as 2002.

And, it was easy to see that this bubble was driving the economy, both by pushing construction to record levels as a share of GDP and leading to a consumption boom that depressed the saving rate to zero. There was nothing in the Fed's bag of tricks that could replace the 8% of GDP (that was, $1.2tn) of bubble-driven demand that the economy stood to lose when the housing bubble burst.

7--Massive default is best way to fix the economy, Marketwatch

Commentary: Clearing away the debt is the only way forward

Excerpt: You want to fix this economic crisis? You want to put people back to work? You want to light a fire under the economy?

There’s a way to do it. Fast. And relatively simple.

But you’re not going to like it. You’re not going to like it at all.

Default. A national Chapter 11 bankruptcy.

The fastest way to fix this mess is to see tens of millions of homeowners default on their mortgages and other debts, and millions more file for bankruptcy....

mass Chapter 11 is, by far, the least obnoxious solution to our problems.

That’s because the real cause of our economic slump isn’t too much government or too little government. It isn’t red tape, high taxes, low taxes, the growing divide between the rich and the poor, too much government debt, too little government debt, corporations, poor people, “greed,” “socialism,” China, Greece, or the legalization of gay marriage. It isn’t, in short, any of the things all the various nitwits say it is.

It’s the debt, stupid.

We’re hocked up to the eyeballs, and then some. We’re at the bottom of a lake of debt, lashed to an anchor. American households today owe $13.3 trillion. That has quadrupled in a generation. It has doubled just in the last 11 years. We owe more than any other nation, ever. And for all the yakking about how people are “repairing their balance sheets,” they’re not. From the peak, four years ago, they’ve cut their debts by a grand total of 4%.

And a lot of that was in write-offs.

The key thing to understand is that most of that money has gone to what a fund manager friend of mine calls “money heaven.” Most of these debts will never, ever be repaid in real money. Not gonna happen.

Think how corporations handle this kind of situation.

It happens all the time. Banks and bondholders find they have lent, say, $1 billion to a company whose assets and earning capacity will only repay, say, $300 million. What happens? Does the company soldier on with $1 billion in debt it can never repay? Do the stockholders send back their dividend checks? Do they sell their homes to pay off the bonds?

Not a chance. The company goes through Chapter 11. The creditors ‘fess up to their blunder, they face up to their losses, and they fix it. They write down the loans and take the equity instead. The balance sheet is cleaned up, and the company starts again.

Why not homeowners?...

Some will say the financial impact would be terrible. But the banks would just be facing up to reality. And a lot of these mortgages are already trading at distressed levels.

Some will say, “why should people get away with borrowing imprudently?” The response: Why should the banks get away with lending imprudently?
...

Some will say, “it’s immoral” for borrowers to default. Alas, most of these people are being inconsistent. They are usually the first ones to defend a company when it closes down a factory and ships the jobs to China, or pays the CEO $50 million for doing a bad job, on the grounds that “this ain’t morality, pal, this is business!”

But when Main Street wants to do the same thing, they start screaming “Morality! Morality!”

We don’t live in an economy based on morals and fairness....

We have tens of millions who cannot repay their debts. But they are all trying to. That sucks huge amounts of money out of the economy. And that means these people cannot function properly as consumers or workers. That’s the reason people aren’t coming into your restaurant. It’s the reason people aren’t taking your yoga class. It’s the reason they haven’t hired you to redo the kitchen.

And so tens or hundreds of millions of perfectly responsible business owners and employees are also suffering from this slump. That’s the reason we have a shortage of demand. That’s the reason no one is hiring.

Even worse: People who are underwater on their mortgage, but who do not want to default, cannot move to where the jobs are either. They are stuck with their home.

You want to break this logjam? Try Chapter 11 for the nation. Massive defaults. Clear the decks, clean the books.

What are the alternatives?

Government cutbacks, higher taxes, and a balanced budget? In a normal economy, fine. But in this situation, when the private sector is also slashing its spending, that could lead to absolute catastrophe. That’s what happened in the Great Depression. And our debt levels are worse than in the Great Depression.

Government borrowing? That’s the Keynesian solution. “The consumer can no longer borrow like a crazy person,” says the Keynesian, “so Uncle Sam has to do so instead.” It’s just transferring private madness to public madness.

Inflation? That’s probably the least bad alternative. But it’s just default by another name. And instead of taking money from the imprudent banks that caused the problem, it robs grandma’s savings.

Twice before, advanced economies have gone through what we are going through now — namely a massive hangover after a massive debt binge.

The first was the U.S. in the 1930s, the second was Japan in the 1990s.

The U.S. didn’t get out of it until the 1940s unleashed inflation and reduced the debt’s value in real terms.

Japan still hasn’t gotten out of it. They have deflation, while government debt has skyrocketed.

The correct moral hazard is to punish the banks who lent imprudently by making them eat their own losses.

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