Thursday, October 6, 2011

Today's links

PLEDGE DRIVE: Please, help if you can. Mike

1--Trapped, John Mauldin, Pragmatic Capitalism

Excerpt: There are clear-cut things that you do if you’re in a liquidity trap. A liquidity trap is simply defined as when the private sector is in a deleveraging mode, or a de-risking mode, or an increasing savings mode — all of which you can also call deleveraging phenomena — because of enduring negative animal spirits caused by legacy issues associated with bubbles. In that scenario, the animal spirits of the private sector are not going to be revived by a reduction in interest rates because there is no demand. It’s not the price of credit driving the deleveraging. It’s “I took on too much debt during the bubble. I have negative equity in my home. I don’t care what the price of credit is, I already have too much outstanding. I am paying down credit!” That can be entirely rational for an individual household. It can be rational for an individual firm. It can be rational for an individual country. However, in the aggregate, it begets the paradox of thrift. What is rational at the microlevel is irrational for the community, or at the macro level, and I’m amazed that this is not assumed as a given description of what we’ve got going on right now. The paradox of thrift and the liquidity trap are fellow travelers that are functionally intertwined....

If the private sector is delevering and derisking and you’re caught in the paradox of thrift, the public sector is supposed to go in the exact opposite direction. The exact opposite direction.

You mean that cutting federal spending in a liquidity trap, like we’re in, is absolutely counterproductive?

Yes, it’s ludicrous and I don’t use that word too often. There’s a large range of opinions about most issues, and rightfully so. But if you are in a liquidity trap and you are advocating frontloaded austerity—
The Tea Party is really talking about killing the economy —

Again, it’s absolutely ludicrous. And if we need an example, we can just look across the pond and see what’s going on in Euroland. Putting somebody who is suffering from anorexia on a diet doesn’t make a lot of sense to me. But essentially that’s what the austerity folks are preaching and that’s what we’ve been grappling with here in the United States....
And it only took World War II to lift us out of that extension of the Depression.

Yes. What I mean is that the war in effect forced the application of the government’s balance sheet to a deficiency of aggregate demand — and it worked. Some might call that Keynesianism, and I would. But you could describe it more simply by saying that the government’s balance sheet — including the central bank’s balance sheet (because the Fed was subordinate to the fiscal authority during WWII) — was used to stimulate aggregate demand. And it absolutely worked, although I don’t think anyone would applaud going to war to accomplish that. However, it is interesting that after World War II the biggest concern in economic policy circles was that we would fall back into a depression because we were taking away all of the government demand, for the war machine. But what we found out was that this didn’t necessarily have to be the case. Partly, the postwar recovery came about because of the infrastructure and the technologies, etc., that had been developed during the war. But another important ingredient after the war was the GI Bill.

The GI Bill and the Marshall Plan basically saved the West.
And they both used the government’s balance sheet, I’ll point out. My dad went to college on the GI Bill. He was one of the youngest WWII veterans — he’s 85 now but he went into the service in ’44.
Same as mine.

So he went to college on the GI Bill, bought his first house on the GI Bill — and he didn’t consider either one of those to be welfare....

the house became the magic genie that made up for the fact that we’ve had stagnant real wages in our country for a long time — and then the genie died....

the easiest way to have super-low interest rates is to have a depression. Interest rates are low, but they’re low in many respects for unhealthy reasons. There’s absolutely no private-sector demand for credit and so there is no crowding out. I mean, that’s the old textbook notion —you aren’t supposed to want to add government debt because that supposedly would crowd private sector investment out of the market. But, excuse me, exactly what are we crowding out right now? Where is the evidence that the marketplace for credit is tight and that government borrowing is displacing private sector borrowing? There’s zero evidence for it. Yet this “crowding out” dogma keeps being invoked when people claim that we can’t have government deficits because they’re going to crowd out private sector investment. God, I wish it were so, because that would mean that private sector investment was doing fine, just fine. And that we were going to overheat the labor market. As I said, that would be a very high-quality problem....

On China..Right, with their mercantilist economic model! If you’re building a mercantilist economic model, by definition, you are piggy backing on somebody else’s demand. Why would you even contemplate having freedom in your currency until you have sufficient homegrown demand to eat the fruits of your own production? You wouldn’t
On housing---So tell me, is there a way to address the housing problem within this liquidity trap?

I think there is. It’s been pretty clear cut for a long time that we need to reset the mortgages that are massively under water. This is sometimes known as “principal forgiveness” and the words are usually uttered with a pejorative lisp.

But wouldn’t that be terribly unfair to everyone who has faithfully made their mortgage payments?

Yes, exactly. I can’t argue with the proposition that it would be unfair. But the only way that I can respond is that life is not necessarily always fair.

Indeed, sometimes foolishness is rewarded.

It is — and as long as we hold to the existing pretense that a large chunk of our housing stock is worth the debt on it, we’re going to be stuck in this liquidity trap. So the reason we’re going to be stuck here is this issue of moral hazard. There’s a reluctance to do anything because, you know, restriking mortgage terms would be letting people off the hook.

There’s a moral overtone that we can’t deal with, so therefore we will just live with it. Actually, in that camp, you also have those who are genuine liquidationists. But society is not going to stand for the wholesale liquidation of 25 million families in America, so they’re not going to follow the Mellon prescription. In other words, if you’re not going to recast the mortgages to get rid of the negative equity, and you’re not going to force people out of their homes and liquidate them, then the market gets stuck in suspended animation. And that’s where we are. I’d like to think that for mortgages held by Fannie and Freddie, this should be pretty easy to deal with because we, the taxpayers, are already taking the credit risk on all of those mortgages. So to recast those, conceptually, is simply to recast the credit risk that we’ve already assumed. I mean, if I’m the taxpayer and we’ve lent you $100,000 to buy a house that’s now worth $75,000, I’m nonetheless on the hook for the $100,000. Since your house is worth $75,000, this is an existing loss, whether I crystallize it or not. Conceptually, this should not be that big of a deal — but it is a huge deal...

And I’m not a socialist by any stretch of the imagination. Therefore, I don’t think that the notion of equal incomes is a valid idea at all. But I do believe that our country was founded and has prospered on the notion of equal opportunity.

Hear, hear!

And to say we have equal opportunity right now is to be speaking with forked tongue. That discourages me as a citizen. Let me be plain: My own circumstances are fine; my son’s circumstances are fine. So I’m not talking in the particular. I’m talking as a citizen and it makes me discouraged going forward about the vibrancy of our economy and our society and I think the valuation of assets, including the damn stock market, is going to reflect that. The P/E level of the stock market is tied to a lot of things. But fundamentally it’s tied to — and it’s interesting that I used the word fundamentally there, because many people would think I am making a statement about behavioral economics here. But I do think that behavioral economics has a lot of fundamental truth to it.

And I do think the stock market’s multiple is tied to the notion of whether or not we have optimism about the future. If we do have optimism about the future, it can be a self-fulfilling optimism — if we believe we can, we can. That’s what I’m not seeing out there on the horizon anymore.

Let’s go back to the equity market, where this is working in reverse. Defeatism is also self-feeding — and fiscal austerity in a liquidity trap, my favorite hobbyhorse these days, is defeatism on broad display, naked. It’s really unfortunate. I’d be ecstatic to be able — a year from now — to look back and say that I underestimated the ability of our political system to transform itself. I would be ecstatic to reach that conclusion....

Anyway, the topic I’m taking on is, Does Central Bank Independence Interfere With Pursuing An Optimal Monetary/Fiscal Policy Mix In A Liquidity Trap?

It’s completely ineffective in a liquidity trap. I start with the presumption that if you religiously maintain central bank independence when you’re in a liquidity trap you will get a sub-optimal monetary/fiscal policy mix. That’s because if you want to increase aggregate demand and output in a liquidity trap, you have to do it with fiscal policy. You can’t do it with monetary policy alone, so fiscal and monetary policymakers have to work together. I’ve been preaching this for quite some time. Actually, when I go back and read Ben Bernanke’s work of a decade ago about Japan, it’s clear that he has the same questions as I do about the sanctity of central bank independence in the context of a liquidity trap. But he’s obviously in a different situation now because he actually is the head of an independent central bank.

2--"611", The number of days the average borrower in foreclosure hasn't made a mortgage payment, Mark Whitehouse, Bloomberg

Excerpt: The market isn’t doing a very good job of cleaning up after the housing bust, more evidence that this is a place where government intervention could help.

Banks are taking ever longer to get houses through the foreclosure process, onto the market and into the hands of new owners. As of August, the average mortgage borrower in foreclosure hadn’t made a payment in 611 days, according to data provider LPS Applied Analytics. That's up from 599 in July and more than double the level of three years ago.

The banks' slowness has various explanations. For one, problems with documentation have prompted them to hold off on foreclosure actions and even pull some loans back out of foreclosure. Beyond that, selling the homes would require them to fully recognize losses on the attached loans -- something many banks are reluctant to do.

The longer the banks delay, the greater their losses are likely to be. As of August, some 38 percent of loans in the foreclosure process -- representing hundreds of thousands of houses -- hadn't been paid in more than two years. All those homes are stuck in a sort of twilight zone, either sitting empty or being exploited by nominal owners who have little incentive to invest in their upkeep. Many may already be worthless.

Bloomberg View has advocated principal reductions on mortgage loans as a way to realign owners' and lenders' incentives, curb losses and clear the market. It would have been better to start before things got as bad as they have, but it's still not too late to make a difference.

3--CBO: Deficit Would Be One-Third Lower if Economy at Full Potential, Wall Street Journal

Excerpt: The U.S. federal deficit in fiscal year 2012 would be about one-third lower if the economy were operating at its full potential, the Congressional Budget Office said in a letter to a member of the bipartisan deficit-reduction committee, released Tuesday.

The official budget score-keeper said the deficit would only be about 4% of gross domestic product, instead of CBO’s 6.2% projection for 2012, if the economy was not under-utilizing capital and labor resources, according to the letter answering a Sept. 27 request from Rep. Chris Van Hollen (D., Md.).

If the economy were stronger, incomes would be higher, sending more tax revenue to the government and unemployment would be lower, reducing the cost of some government benefits, CBO said in its letter. These “cyclical factors” contributed about $340 billion to the roughly $973 billion deficit projected for 2012, the nonpartisan agency said.

Van Hollen, the top Democrat on the House Budget Committee, is also one of 12 lawmakers on the Joint Select Committee on Deficit Reduction, which must find a way to curb the federal deficit by at least $1.2 trillion over 10 years or automatic spending cuts will be triggered.

It’s not clear yet what yardstick the so-called supercommittee will use to measure their savings. House Speaker John Boehner (R., Ohio) insisted even before the group’s members were named that it should use the CBO’s current law baseline from March, which assumes tax cuts for the wealthy will expire, among other provisions. White House officials said at the time that the group can use any yardstick it chooses.

At the supercommittee’s last public hearing, Republican lawmakers–who have argued that lowering tax rates would boost economic growth–pushed to change how the nonpartisan Joint Committee on Taxation officially analyzes tax provisions to show how much revenue is generated if tax policies motivate people or businesses to change their behavior.

The Tuesday CBO letter was also sent to Rep. Paul Ryan (R., Wis.), chairman of the House Budget Committee.

4--Nearly Half of U.S. Lives in Household Receiving Government Benefit, Wall Street Journal

Excerpt: Families were more dependent on government programs than ever last year.

Nearly half, 48.5%, of the population lived in a household that received some type of government benefit in the first quarter of 2010, according to Census data. Those numbers have risen since the middle of the recession when 44.4% lived households receiving benefits in the third quarter of 2008.

The share of people relying on government benefits has reached a historic high, in large part from the deep recession and meager recovery, but also because of the expansion of government programs over the years. (See a timeline on the history of government benefits programs here.)

Means-tested programs, designed to help the needy, accounted for the largest share of recipients last year. Some 34.2% of Americans lived in a household that received benefits such as food stamps, subsidized housing, cash welfare or Medicaid (the federal-state health care program for the poor).

Another 14.5% lived in homes where someone was on Medicare (the health care program for the elderly). Nearly 16% lived in households receiving Social Security.

High unemployment and increased reliance on government programs has also shrunk the nation’s share of taxpayers. Some 46.4% of households will pay no federal income tax this year, according to the nonpartisan Tax Policy Center. That’s up from 39.9% in 2007, the year the recession began.

Benefits programs have come under closer scrutiny as policymakers attempt to tame the federal government’s budget deficit. President Barack Obama and members of Congress considered changes to Social Security and Medicare as part of a grand bargain (that ultimately fell apart) to raise the debt ceiling earlier this year. Cuts to such programs could emerge again from the so-called “super committee,” tasked with releasing a plan to rein in the deficit.

Republican presidential hopefuls, meanwhile, have latched onto the fact that nearly half of households pay no federal income tax, saying too many Americans aren’t paying their fair share.

5--The eurozone officially contracts for the first time in two years, Reuters

Excerpt: The euro zone's private sector contracted for the first time in two years last month, shrinking faster than first reported as new business dried up while the debt crisis cut expectations for the future to two-year lows, surveys showed on Wednesday.

A downturn that began in smaller members of the 17-nation bloc has gone mainstream. Survey compiler Markit said the latest figures suggest the economy will contract in the fourth quarter unless business and consumer confidence rallies.

"The malaise is spreading to the core, where surging rates of expansion earlier in the year have turned rapidly into contraction in Germany and only very modest growth in France," said Chris Williamson, chief economist at Markit.

Markit's Eurozone Services Purchasing Managers' Index (PMI) fell to 48.8 last month from 51.5 in August, its lowest reading since July 2009 and below an earlier flash reading of 49.1.

It is the first month the index has been below the 50 mark that divides growth from contraction since August 2009.

The composite PMI, which combines the services and manufacturing data published earlier this week and is seen as a guide to growth, fell to 49.1 from 50.7 in August, its lowest level since July 2009 and down from a flash estimate of 49.2.

6--ROBERT REICH: Behind Europe's Debt Crisis Lurks Another Giant Bailout of Wall Street, Business Insider

Excerpt: A Greek (or Irish or Spanish or Italian or Portuguese) default would have roughly the same effect on our financial system as the implosion of Lehman Brothers in 2008.

Financial chaos.

Investors are already getting the scent. Stocks slumped to 13-month low on Monday as investors dumped Wall Street bank shares.
The Street has lent only about $7 billion to Greece, as of the end of last year, according to the Bank for International Settlements. That’s no big deal.

But a default by Greece or any other of Europe’s debt-burdened nations could easily pummel German and French banks, which have lent Greece (and the other wobbly European countries) far more.

That’s where Wall Street comes in. Big Wall Street banks have lent German and French banks a bundle.

The Street’s total exposure to the euro zone totals about $2.7 trillion. Its exposure to to France and Germany accounts for nearly half the total.

And it’s not just Wall Street’s loans to German and French banks that are worrisome. Wall Street has also insured or bet on all sorts of derivatives emanating from Europe – on energy, currency, interest rates, and foreign exchange swaps. If a German or French bank goes down, the ripple effects are incalculable.

Get it? Follow the money: If Greece goes down, investors start fleeing Ireland, Spain, Italy, and Portugal as well. All of this sends big French and German banks reeling. If one of these banks collapses, or show signs of major strain, Wall Street is in big trouble. Possibly even bigger trouble than it was in after Lehman Brothers went down.

That’s why shares of the biggest U.S. banks have been falling for the past month. Morgan Stanley closed Monday at its lowest since December 2008 – and the cost of insuring Morgan’s debt has jumped to levels not seen since November 2008.

It’s rumored that Morgan could lose as much as $30 billion if some French and German banks fail. (That’s from Federal Financial Institutions Examination Council, which tracks all cross-border exposure of major banks.)

$30 billion is roughly $2 billion more than the assets Morgan owns (in terms of current market capitalization.)

7--How a Good Idea Became a Tragedy, Der Speigel

Excerpt: The Greek crisis has revealed why the euro is the world's most dangerous currency. The euro was built on a foundation of debt and trickery, where economic principles were sacrificed to romantic political visions. The history of the common currency is the story of a good idea that turned into a tragedy of epic proportions.

The Maastricht Treaty, which marked the establishment of the European Union when it was signed in 1992, made it all possible. It placed Europe on "three columns," the first of which was an economic column, complete with an "Economic and Monetary Union." The treaty provided the necessary legal framework, so that a common financial policy would have been conceivable, as would a coordinated fiscal and interest-rate policy. But the political will to fill out the Maastricht framework was missing.
The "United States of Europe" remained little more than a soundbite. And yet the introduction of the euro created a fait accompli that could no longer be rolled back. This European Big Bang, if you will, was to be followed by a process of evolution, during the course of which all the details were to be resolved....

Greece was already well over its head in debt at the time. The country's liabilities exceeded its real economic strength, with the national debt amounting to 114 percent of the gross domestic product. Athens was battling more than 14 percent inflation and the economy was shrinking.
Any economist could have recognized that the Greek economy was not competitive, and that the country, without outside impulses, seemed incapable of fundamentally changing its situation. The euro and its regime were to forcibly bring about necessary reforms, particularly making it easier to obtain credit. Gaining accession to the euro zone became Finance Minister Papantoniou's mission....

Across the Atlantic, American economists were busy examining Europe's plans, which they felt were half-baked and "oversized," in the words of financial economist Kenneth Rogoff, a Harvard professor and adviser to US presidents and governments around the world....

When the euro became a real currency, Rogoff ....agreed with his fellow US economists' view that the euro was conceived "on too grand a scale."

Rogoff observed that a trans-Atlantic rift was developing between two groups of economists. The Americans and the Western Europeans.... The Europeans accused their overseas colleagues of failing to recognize the historic processes, the grand vision and Europe's great leap forward. The Americans, dry and pragmatic, accused their European counterparts of downplaying the risks. Once again, they felt that Old Europe was being overly romantic and blind to reality.

8--ECRI Explains Its Recession Call, Wall Street Journal

Excerpt: The U.S. recovery wasn’t much to begin with, and now it’s dead.
That is the news from the widely respected Economic Cycle Research Institute that said the U.S. has already or is about to tip into recession. The announcement, made public Friday, was met with skepticism by other economists who are more hopeful the U.S. and the world will skirt recession.

Lakshman Achuthan, co-founder of ECRI, however says the hope is misplaced. He says the call is based not just on the weekly leading index that is disseminated to the public, but also on dozens of other ECRI leading indexes that are available mainly to ECRI’s clients.

Growth in the weekly leading index, released on Fridays, began to decelerate in April and turned negative in mid-August.

Economists downplay the WLI because of its high correlation with movements in the stock markets that have been volatile lately. Joseph LaVorgna, chief U.S. economist at Deutsche Bank, calculates a correlation coefficient of 90% between the WLI and the S&P 500 stock price index.
“Essentially, so goes the S&P 500, so goes the ECRI,” he says.

The WLI, however, is not the only hammer in ECRI’s toolbox, says Achuthan.

9--The 4 Trillion-Euro Fantasy, New York Times

Excerpt: Some officials and former officials are taking the view that a large fund of financial support for troubled euro-zone nations could be decisive in stabilizing the situation. The headline numbers discussed are 2 trillion to 4 trillion euros — a large amount of money, given that the gross domestic product of Germany is 2.5 trillion euros and that of the entire euro zone around 9 trillion euros.

This approach has some practical difficulties. The European Financial Stability Facility as currently devised has only around 240 billion euros available (and this will fall should more countries lose their AAA credit ratings). The International Monetary Fund, the only ready money at the global level, would be more than stretched to go “all in” at 300 billion euros.

Never mind, say the optimists — we’ll get some “equity” from the stability fund and then leverage up by borrowing from the European Central Bank.

Such an approach, if it could get political approval, would buy time, in the sense that it would hold down interest rates on Italian government debt relative to their current trajectory....

In Europe, the first thing peripheral governments need to do is stop accumulating debt, and quickly. Italian fiscal plans to balance the budget in 2012 look implausible, as they assume unrealistic growth. The planned Greek debt restructuring and increased taxes will not turn that economy around, nor prevent Greece from accumulating further debt. Despite all the reported austerity, the Irish government is still running a budget deficit near 12 percent of gross national product in 2011, while nominal G.N.P. actually declined in the first half of 2011.

Europe’s periphery also needs to recognize that it signed up to a currency union, and that requires a new approach to adjustment. Instead of having huge devaluations like those suffered in Mexico under Mr. Zedillo, in Indonesia under Mr. Suharto or in Poland under Mr. Walesa, Europe’s troubled nations need to raise competitiveness by reducing local costs.

That must primarily come through wage reductions and more competitive tax systems. In Ireland a pact with the major unions is preventing further wage reductions, while in Greece the government is strangling corporations with taxes in order to avoid deeper wage and spending cuts. The proposed Portuguese “fiscal devaluation” — meaning lower payroll taxes to reduce labor costs and an increase in the value-added tax to replace the revenue — looks like a weak attempt to avoid talking about the need to cut public spending and wages much more sharply in real, purchasing-power terms.

Putting in place a huge financial package is not enough. Policies have to adjust across the troubled euro-zone countries so that nations stop accumulating debt, and the periphery moves rapidly from being among the least competitive nations in the euro area to the most competitive — and this includes lower real wages, even if debts are restructured appropriately.

The European leadership is a long way from even recognizing this reality, let alone talking about it in public.

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