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May 31, 2005

Can Bush Salvage Political Gains Even if Social Security Reform Fails?

The Baltimore Sun makes a good point. Even if Bush loses the battle over Social Security reform, he may be able to salvage some political gain:
Bush could draw voters through Social Security debate - GOP hopes to attract young, minorities even if plan flops, By Julie Hirschfeld Davis, Baltimore Sun: President Bush's drive to overhaul Social Security is foundering on Capitol Hill and sinking in public opinion polls. But … Bush is positioning himself to win - even if he loses. Bush is increasingly targeting his Social Security push to minorities and younger people - groups that disproportionately vote Democratic - in efforts to reap electoral benefits for Republicans even if he ultimately fails to enact his proposal. … Demographic data give Bush reason to hope that his Social Security push could have a substantial upside for his party in future elections. Hispanics and blacks are more heavily reliant on Social Security income in their retirement, tend to hold lower-paying jobs without employer-sponsored pensions, and own fewer assets than their white counterparts, researchers say. Like young people … minority voters are disproportionately supportive of the concept of expanding ownership. …
But, from the same article:
Some analysts who study minority voters say Bush's arguments are not resonating with them … "This whole campaign of his has been an utter flop. ... with African-Americans ..." said David A. Bositis, senior researcher at the Joint Center for Political and Economic Studies, who specializes in black voters and their attitudes. Early in his Social Security roadshow, Bush argued that creating private accounts that could be inherited would especially benefit African-Americans because of the shorter life expectancy for black men. Research shows, however, that the disparity in life span comes mostly from higher infant mortality and homicide rates of young black men, and that there is little difference between the life expectancy of black and white retirees. Many blacks found Bush's argument "insulting," said Rep. Kendrick B. Meek, a Florida Democrat who is leading his party's efforts to turn young people against the Bush plan. "In the past when [Republicans have] reached out to groups of color and young people, it's always been for political reasons, and this time it seems like it's no different," Meek said.
I've discussed whether the Bush-Pozen proposal is a better deal for younger workers here, so perhaps this demographic will see through the smoke and mirrors as well. UPDATE: Here is part of Bush's press conference today. There appears to be an attempt to gain precisely the type of political advantage discussed in the article:
Q Thank you very much, Mr. President. Sir, most Democrats continue to refuse to negotiate with you on Social Security until you take payroll tax-funded personal accounts off the table. Would you insist on these accounts if it means no deal on Social Security? THE PRESIDENT: … except you got a President who's willing to talk about the issue -- and a President who, by the way, is going to keep talking about the issue until we get people to the table. I repeat to you, Keith, the Social Security issue is a really important issue for an upcoming generation. I mean, imagine realizing that we got a problem and then not doing anything about it, and watching a young generation get taxed, perhaps by as much as a payroll tax of 18 percent. How would that make somebody feel? That we shirked our duty, that we weren't responsible citizens…the President has got to push. He's got to keep leading. … One thing is for certain: The party that I represent is leading. … And so I think as people make their calculations, that I think the American people are going to end up saying to those who have been willing to lead on the issue and talk about the issue and be constructive on the issue, thanks for what you're doing and we'll send you back up there with our vote, because that's the kind of spirit we like...

Former Social Security Commissioner Says Bush Plan Will "ruin the whole system"

The Washington Post has an editorial supporting progressive indexing. But, as we shall see, Bob Ball has other ideas. Who is Bob Ball?
A Retiree Trying to Save His Life's Work, By Joel Havemann, LA Times: … Ball's goal isn't preservation of his monthly benefit check. Instead, he is defending the program that is his life's work. Before the first monthly Social Security check was delivered in 1940, he was already working as a 25-year-old clerk in the Newark, N.J., Social Security office for $1,620 a year. He shot up through the bureaucracy to become commissioner of Social Security for three presidents. On his watch, Social Security became the biggest and most popular benefits program. And in 1983, when he had been collecting retirement benefits for four years, he was a key negotiator of the law that rescued Social Security from the brink of insolvency. With the possible exception of J. Edgar Hoover and the FBI, perhaps no one has been associated with a federal institution as intimately and for as long as Robert M. Ball. He is one of the last of a nearly extinct species: career civil servants who became top policymakers…
First, here’s what the Washington Post says:
Mr. Bush's Proposal, Washington Post: Is President Bush advocating cruel cuts in Social Security? … Tying initial benefits to wage growth lets retirees share in the improved standards of living to which they contributed. But because wages generally increase faster than the cost of living, wage-indexing is also enormously costly … Simply switching from wage- to price-indexing would more than take care of Social Security's solvency problem. … Such a formula wouldn't entirely eliminate the Social Security deficit, but -- under a plan produced by investment executive Robert Pozen and endorsed by Mr. Bush -- it would address about 60 percent of the problem. The major critique of the Pozen plan is that promised benefits for the middle tier would be cut too sharply. ... Mr. Pozen is the first to say his plan could be recalibrated to be more generous to the middle class. … there's not enough money in the system to pay scheduled benefits, and tax increases can't be expected to cover all of the shortfall, … It's why progressive indexing ought to be considered as part of the solution.
What does Bob Ball think of this? Not much. Continuing with the LA Times story:
Like many other retirees, Bob Ball is concerned about what's going to happen to Social Security. From his cluttered office … he has proposed his own formula for shoring up Social Security's financial future. His relatively modest tax increases and benefit cuts, combined with some government investment in the stock market, offer a contrast to President Bush's call for individual investment accounts, which Ball abhors, and steeper curbs on traditional benefits for many future retirees. … [T]he proposals of … George W. Bush, have prompted the 91-year-old Ball to ... fight proposals that, in his view ... "would ruin the whole system," ... "It's a fundamental, philosophical policy shift." President Franklin D. Roosevelt, Ball said, wanted a government-provided benefit that would replace a fixed percentage of a workers' pre-retirement income. The vision was of a benefit based not on need — which would carry the stigma of a welfare program — but on past earnings. … Bush's suggestion that benefits be reduced from now-promised levels for future middle-income and wealthier retirees ... would eventually leave all with about the same benefit now promised to the poor… The result, he said, would be a loss of political support for Social Security. Ball has his own proposal, which includes dedicating the proceeds of the estate tax to Social Security and using a more precise — and stingier — measure of price inflation to determine annual cost-of-living adjustments. His most controversial proposal: let the government invest some of the Social Security trust fund's surplus in stock index funds. ... He hopes some Democratic lawmakers, who are refusing to deal with Bush as long as he is pushing individual accounts, will turn to his alternative when the time comes. … This is not the first time that Ball has come out of retirement to advance ideas for bolstering Social Security — and the last time, he carried the day. In 1983 … Ball was a central figure behind a bipartisan package to keep Social Security from running out of money — a prospect then only months away. … Legend has it that when a bipartisan commission deadlocked, President Reagan, a Republican, and House Speaker Thomas P. "Tip" O'Neill (D-Mass.), decided that Social Security's future was more important than partisan advantage. So the two Irishmen met alone and agreed to a rescue package. Fiction, says Ball. "Reagan and O'Neill couldn't stay in the same room together," he said. The deal was negotiated largely by Ball …Commission members quickly agreed that the final package had to include tax increases … and benefit cuts … When that didn't add up to enough cost savings, Ball hit upon an innovative step that could be interpreted by Democrats as a tax increase or by Republicans as a benefit cut: subject some Social Security benefits to the income tax. Reagan and O'Neill signed off on the deal, and Congress passed the accord handily. … Ball … was appointed commissioner of Social Security ... in 1962, a job that he held ... through … the first term of Republican Richard M. Nixon. In 1972, when he was running for reelection, Nixon supported a 5% benefit increase along with a long-time goal of Ball's — automatically adjusting benefits in future years to keep pace with inflation. Congress kept the inflation protection … Chuck Colson got the idea of including in the envelope with the first beefed-up Social Security check an insert crediting Nixon with the increase. Ball threatened to quit and, by implication, go public with the reason, if the White House took this unprecedented step. The White House backed down. Nixon replaced Ball the next year. … That was three decades ago. Ball has outlived many of the presidents for whom he worked. … And, if anyone cares to listen, he has a long view and a few more ideas about Social Security to share.
Bob Ball has gained a lot of wisdom in his many years.

Nicholas Kristof Gets a Bad Draw From His Inbox

Nicholas Kristof writes:
Day 141 of Bush's Silence, By Nicholas D. Kristof, NY Times: A reader from Eugene, Ore., wrote in with a complaint about my harping on the third world:

"Why should the U.S. care for the rest of the world?" he asked. "The U.S. should take care of its own. ... It's way past time for liberal twits to stop pushing the U.S. into nonsense or try to make every wrong in the world our responsibility."

And while that reader wasn't George W. Bush, it could have been. Today marks Day 141 of Mr. Bush's silence on the genocide, for he hasn't let the word Darfur slip past his lips publicly since Jan. 10...

I live in Eugene, Oregon, one of the few places in the country where Democrats made gains in last November’s election. Eugene, Oregon, the place where flower children come when Berkeley has offered it's full plate of liberal fare and it's not enough. This (scroll down) is more typical of the Eugene I know:

Eugene Oregon, a liberal blogger, and Feddie, a conservative blogger, started a group blog called Coalition for Darfur. If you haven't seen it, or haven't been keeping up with Eugene Oregon's (of the blog Demagogue) coverage of the crisis in Sudan, then you are missing out on much of the story.
Didn't want anyone getting the wrong impression.

May 30, 2005

James Hoffa Takes the Bait

Teamsters President James Hoffa makes a political calculation and decides to switch sides:
Reform prod by Hoffa, By Donald Lambro, Washington Times: Breaking with the Democrats and AFL-CIO on Social Security, Teamsters President James Hoffa Jr. sent a message to the White House … that he wants to help them find a bipartisan solution to the programs long-term insolvency. Mr. Hoffa not only generously praised George W. Bush … he faulted Democrats for refusing to come to the table until the president drops his personal retirement accounts plan. … Republicans will be in charge … for the next four years, and Mr. Hoffa now thinks he can work with the GOP …
Bad move.

Russia Has as Flat Tax, So We Should Too

Is this a sign of the beginning of a push for a flat tax? I find it interesting that Stephen Moore of the Free Enterprise Fund and the Cato Institute holds up Estonia, Albania, and Russia as examples of the economic miracles available with a flat tax:
Freedom to choose flat tax, By Stephen Moore, Washington Times: All over the world, from Estonia, to Albania, to Russia to Hong Kong, flat taxes are in vogue. The flat tax is being instituted to enhance economic growth, increase tax revenues and make tax codes fairer. … isn't the world topsy-turvy when Moscow, the onetime center of socialism, has a 13 percent top income tax rate compared to 35 percent in America, the land of the free? … I …suggest … adoption of a Freedom to Choose Flat Tax. …
Yes, let’s strive to emulate the economies of Estonia, Albania, and Russia – as the administration’s current economic policy seems to be doing…

Does It Matter How Aggregate Activity Is Measured?

When the latest data on unemployment, GDP, industrial production, and so on are released lots of attention is generated in the press, the blogosphere, and elsewhere. With the release of each new piece of information we hear the economy is headed towards recession or moving towards full employment depending upon who is doing the reporting and what piece of information is being reported. When measures of aggregate activity disagree, which measure should be given more weight? Does it matter which measure of aggregate activity is used to measure the state of the economy? Let’s start by looking at graphs of commonly used measures of aggregate activity. Here are three measures of aggregate economic activity, the deviation of unemployment from its natural rate, the deviation of GDP from its natural rate, and the deviation of industrial production for its natural rate. Thus, there are three gaps, an unemployment gap, an output gap, and an industrial production gap. All are measured in real terms. The first two are created using the estimates of the natural rate of unemployment and output from the Congressional Budget Office, and the last is derived from a measure of the natural rate of industrial production I created using the natural rate of GDP from the CBO (I was curious to see how well it would correspond to the other two more commonly used measures). The measures are rescaled to make it easy to graph them on the same vertical scale. The first graph shows the unemployment and output gaps, and the second shows the unemployment and industrial production gaps:
What do we learn? Here are some broad conclusions: 1. Over the long-run, there is very little difference in the underlying trend movements in the three measures. This shows that general trends in aggregate activity are evidenced fairly well by examining general trends in all these series, i.e. by examining the average movement across a variety of measures of activity over many quarters. 2. But what if recent data for the last quarter or two differ? For example, suppose the output gap is falling but the unemployment gap is not. In this case, the output gap movement might command more attention than the stagnant unemployment gap, though not too much should be made of a single observation in any case. A close examination of the first graph (and something more sophisticated empirical investigation verifies) shows that turning points in the output gap tend to lead turning points in the unemployment gap. Thus, data indicating a turning point in output without a corresponding turning point in employment are worth more attention than the opposite situation, a change in the unemployment gap not evidenced in the output gap measures. There also appears to be a similar lead-lag relationship between the industrial production and unemployment gaps, but it is not as evident as with the output gap. In addition, it is interesting to note that the lag in the unemployment gap relative to the output gap seems more pronounced since 1990. 3. While the three series move closely in the long-run, there is considerable variation across the three measures in the short-run. Thus, the current situation we are seeing in the data – monthly or quarterly data that appear confusing – is normal. Averaging the information content of the three measures both in the current time period and over time (and, of course, taking account of lags in relationships as well as other available data) will improve the picture when recent measures disagree as to the direction the econoomy is headed.

May 29, 2005

MSN Money Expert Says Economic Crises Caused by 80-180 Year "price waves"

I started reading The Fed is all wrong about inflation, by Jim Jubak in MSN Money thinking it would be an informative article about the Fed, inflation, and monetary policy. I’m not sure why I bothered to finish reading it after encountering statements such as:
... “An increase in the money supply kicks in to drive inflation higher after the initial demand-based inflation has set prices in motion. Governments typically attempt to combat rising prices by increasing the amount of money in circulation. …”
It gets worse. Economic crises are caused by 80-180 year "price waves." Even simple concepts such as real and nominal prices are confused by their "expert." Don’t waste your time on this one…I've listed much better reading in the post below the next one.

Why Has the Dividend Payout Ratio Increased?

Why has the dividend payout ratio increased in recent years? According to the article below, there are several possible reasons: (1) Concerns about future returns. When investors expect the market rate of return to exceed the internal rate of return for the firm, they would prefer to have dividends paid out instead of reinvested internally. Thus, as investors anticipate lower rates of return in the future, they will shift towards firms offering dividends and away from firms that use profits for internal reinvestment. (2) The tax act of May 2003 made dividends relatively more attractive from a tax perspective. (3) A change in corporate compensation law has led to a restructuring towards compensation packages that rely more heavily on dividends. (4) There has been a recent shift by investors towards assets with less risk, and historically firms with both solid growth and yield characteristics have less risky overall returns. Besides the changes in tax law, there are two notable changes causing the shift towards dividends. The first is the fall in expected growth opportunities which causes the fall in expected rates of return. To the extent that the shift has been driven by investor’s perception of slower growth in the future, that is not a postiive sign for the economy. The second is the shift towards less risky assets. This may also signal uncertainty regarding future economic conditions. As noted below, historically firms with a history of solid growth and dividend payments have returns, as you would expect from their general health, that perform well in volatile markets. Thus, these types of firms provide a degree of insurance against uncertain future returns. Here's the story from the AP:
Dividend-Paying Stocks May Lead a Trend, By Meg Richards, AP: The emerging leadership of dividend-paying stocks has … renewed interest in what was once considered an old-fashioned investment. Dividends … The dividend revolution is most clear in the technology sector, where they've grown at a rate of 44 percent over the past two years. ... Historically, dividends have played a much more important role than they currently do, accounting for about 4 percentage points of the roughly 10 percent average annual return stocks have delivered since 1926. But their popularity waned during the bull market, and … struck an all-time low of 1.1 percent in 2000. ... Now that number has climbed to …1.9 percent. The rate of payout has been on the rise, as well … … some of this [is due] to the tax act of May 2003, which lowered the rate for long-term capital gains and qualified dividends to 15 percent … Prior to that, dividends were taxed … at rates as high as 35 percent. … Why now, two years after the tax act was passed, are dividends taking the lead? … One of the reasons for the recent pullback in stocks was investors' concerns about earnings growth. … Another factor is the rush to restructure compensation packages before the end of the year, when corporations will be required to start expensing stock options at fair value. … On top of that, research suggests high-quality companies with both growth and yield characteristics are poised to produce market returns with meaningfully less risk. They're a safe place to seek shelter when volatility strikes… They've also performed well historically, …

Some Reading for the Weekend

China Asset Valuation and Bubbles Relatively Inelastic Demand
Information and Demand Relatively Inelastic Supply
Innovation Labor Markets I didn’t read the next one, but the teaser poses a question: How are people who show up three times less productive than those who are absent? Tax Incidence Health Care Op-Ed Mythical Beings Subscription only:

May 28, 2005

Social Security Reform, Gridlock, and the Gang of Fourteen

There are signs that the Democrats are following Former Treasury Secretary Robert Rubin’s advice (Rubin urges Democrats not to reveal their hand, see Brad Delong here):
Pelosi Moves From 'No' to 'No Dice' on Social Security Reform, Susan Jones, Morning Editor, ( … House Minority Leader Nancy Pelosi and other Democrats have said no all along, but now they're saying "no dice" to President Bush's call for change. Pelosi repeated the "no dice" phrase multiple times at a news conference on Thursday. She also condemned the "poison pill of privatization" and announced that Democrat lawmakers would testify against personal accounts for younger workers before a House subcommittee on Social Security … Pelosi accused President Bush of creating a crisis and manufacturing an issue. … 'Remove the poison pill of privatization, and Democrats will come to the table with our ideas ' … Stupak addresses Social Security concerns, By Pete Mackin, Mining Journal: … Rep. Bart Stupak, D-Menominee … said that he supports getting people to save more, but reiterated he will not support privatizing Social Security. "If this is his (Bush's) goal, a thrift savings plan - if the idea is to get people saving, I'd say that's a great idea," Stupak said. "But I cannot support a plan that slashes benefits, saddles the next generation with trillions of dollars in debt, and introduces risk into the only guaranteed income on which our retirees can depend upon."
With Democrats unwilling to negotiate until the insistence on carve out private accounts is dropped, and Republicans unwilling to take private accounts off the table, the result, for now, appears to be gridlock:
Lawmakers argue over Social Security changes, By Larry Lipman, Palm Beach Post Washington Bureau: A parade of lawmakers Thursday touted their views of how Social Security should be restructured, with Republicans offering a variety of private account proposals and Democrats warning they would oppose any plan that undercut the current system. … Rep. E. Clay Shaw Jr., R-Fort Lauderdale… said … "To tell the president that he has to drop his plan before the Democrats will talk to him, that's ludicrous," … "You're not going to be with us on the landing if you're not with us on the takeoff," … But Rep. Benjamin Cardin, D-Md., shot back: "I'm not so sure I want to be there on the takeoff if you're going to have a crash landing."… Partisan clash stalls progress on Social Security, by Carolyn Lochhead, San Francisco Chronicle Washington Bureau: A key Senate Republican conceded Wednesday that he has made little progress crafting a Social Security overhaul. Asked how close he is to coming up with a legislative package, Finance Committee Chairman Charles Grassley replied, "Not very close, I'm sorry to say. We have not made a lot of progress in the three meetings we've had with our members." … Sen. Max Baucus of Montana, the Finance Committee's top Democrat, said he will not negotiate until Bush abandons his support for private accounts. Grassley burst out in frustration after Wednesday's hearing. "The most obvious thing you heard today is that on the Democratic side of the aisle, it doesn't matter what you put out, what you talk about, there's no plan on the other side, and there's constant criticism," Grassley said. … Baucus slammed Bush's proposed benefit changes as "drastic." … After the hearing, Baucus said, "The linchpin here is private accounts. Once they're off the table, I think there would be a huge, or a significant, groundswell for trying to find a solution." [National Economic Council director Al] Hubbard refused to say whether Bush will accept a proposal without individual accounts funded by Social Security payroll taxes. "We see no reason why people shouldn't be given that option," Hubbard said. But he also said the administration is receptive to the "add-on" individual accounts Democrats favor. … It appeared more than ever after Wednesday's Senate hearing that Bush's hopes on Social Security rest with House Ways and Means Committee Chairman Rep. Bill Thomas, R-Bakersfield, who is crafting a much more sweeping plan aimed at "retirement security." Thomas is looking at a wide range of tax, health care and other changes in addition to Social Security in the hope of luring Democrats.
Some also believe Bush's hopes on Social Security rest with the gang of fourteen. Will the gang reassemble to try and overcome Social Security reform gridlock?:
Social Security is next for Gang of Fourteen, By Jackie Kucinich and Jeffrey Young, The Hill: Some of the senators who banded together to forestall the “nuclear option” are eyeing a new goal: reforming Social Security. … Sen. Lindsey Graham (R-S.C.) wasted little time in touting the group’s clout. ... “Watch this group of 14 to come out with some deal for Social Security.” “Really?” said Matthews. Graham responded, “Keep watching.” … Sen. Olympia Snowe (R-Maine) … and Sen. Joe Lieberman (D-Conn.) have been working together on developing a Social Security plan under the auspices of the Centrist Coalition, … Sen. Lincoln Chafee (R-R.I.) strongly believes that Senate centrists would be the architects of Social Security reform, according to an aide. “My boss has been saying that from the beginning,” the aide said. Chafee has been cooperating with the efforts of Snowe and Lieberman, he added. …
Until the administration puts a reasonable proposal on the table, and so far that hasn’t happened, gridlock is a reasonable response. A better outcome would create voluntary add-on accounts that simultaneously increase retirement security and increase national saving. But that won’t happen until the administration is ready drop its insistence on carve out personal accounts as an element of any reform proposal, something it has not yet indicated it is ready to do. It's possible that a centrist coalition could produce this outcome, but I worry that Democrats in such a coalition might ignore Rubin's advice and compromise on carve-out private accounts in an effort to show progress to constituents as a means of furthering political and other aspirations.

JFK Gives Advice to Washington

... I served with Jack Kennedy, I knew Jack Kennedy, Jack Kennedy was a friend of mine. ... you are no Jack Kennedy ... [1988 Vice Presidential Debate]
Theodore C. Sorensen, former special counsel to President Kennedy, offers wise advice to our leaders using words from the past:
What JFK might tell our leaders, by Theodore C. Sorensen, Boston Globe: Tomorrow would have been John F. Kennedy's 88th birthday. Were he still alive, I have no doubt that, with his customary idealism and commitment to country, he would still be offering advice to our current leaders in Washington. Based upon his words of more than 40 years ago, he might well offer the following: To President George W. Bush on Iraq, Iran, and North Korea: ''The United States, as the world knows, will never start a war. This generation of Americans has had enough -- more than enough -- of war." (American University commencement, 1963) To President Bush on stem cell research: ''For those of us who are not expert ... we must turn, in the last resort, to objective, disinterested scientists who bring a strong sense of public responsibility and public obligation." (National Academy of Sciences, 1961) To Vice President Dick Cheney on international organizations, alliances, and consultations: ''The United States is neither omnipotent nor omniscient. We are only 6 percent of the world's population . . . we cannot impose our will upon the other 94 percent of mankind." (University of Washington, 1961) To Secretary of State Condoleezza Rice on terrorism: ''If a free society cannot help the many who are poor, it cannot save the few who are rich." (Inaugural address, 1961) To United Nations ambassador-designate John Bolton on diplomacy: ''Civility is not a sign of weakness. The United Nations [is] our last best hope in an age where the instruments of war have far outpaced the instruments of peace." (Inaugural address, 1961) To Defense Secretary Donald Rumsfeld on space: ''We have vowed that we shall not see space filled with weapons of mass destruction, but with instruments of knowledge and understanding. This new ocean must be a sea of peace, [not] a new terrifying theater of war." (Rice University, 1962) To House Majority Leader Tom Delay on fund-raising: We need ''men of integrity whom neither financial gain nor political ambition could ever divert from the fulfillment of our sacred trust." (Massachusetts farewell, 1961) To Senate Majority Leader Bill Frist on judges: ''To maintain the constitutional principle, we should support Supreme Court decisions, even when we may not agree with them." (News conference, 1962) To White House Press Secretary Scott McClellan on negative news media: ''It is never pleasant to be reading things that are not agreeable news, but it is an invaluable arm to the presidency as a check on what is going on . . . [e]ven though we never like it . . . and wish they didn't write it . . . we could not do the job at all in a free society without a very, very active press." (Television interview, 1962) To pastor-in-chief Pat Robertson on church-state separation: ''I believe in an America where no [clergyman] would tell his parishioners for whom to vote, where no religious body seeks to impose its will directly or indirectly upon the public acts of our officials, where no church or church school is granted any public funds or political preference. The presidency must not be the instrument of any one religious group." (Houston ministers, 1960) To Undersecretary of State for Public Diplomacy Karen Hughes on propaganda: ''The United States is a peaceful nation where our strength and determination are clear, our words need merely to convey conviction not belligerence." (undelivered Dallas speech, 1963) How I miss his friendship. How our nation misses his wisdom.

May 27, 2005

Who Will Replace Greenspan If and When He Retires?

BusinessWeek Online’s Michael Wallace speculates on Greenspan’s successor. One possibility discussed is that Greenspan will stay on for as long as two and a half more years as the administration ostensibly searches for a replacement. As tempting as this might be from a financial stability point of view, I believe that the Federal Reserve is too important of an institution to have its rules set aside through a political maneuver to allow Greenspan to exceed the intended fourteen year term. Rules intended to be used in extraordinary circumstances are not the appropriate means to extend the normal term of a Federal Reserve Board member. Here is BusinessWeek’s discussion of Greenspan’s likely successor:
BusinessWeek Online: Who Will Fill Greenspan's Shoes?, by Michael Wallace: … Federal Reserve Chairman Alan Greenspan is due to retire on Jan. 31, 2006. … Who will be his successor? Technically, the chairman could still get a request to stay on for a spell by the Bush Administration, which is searching not only for his replacement -- potentially extending his tenure another 2.5 years -- if no replacement is put forward. FELDSTEIN IN FRONT. … Most discussions about Greenspan's succession begin with … Martin Feldstein, ... But the seeming rush to get former Fed Governor Ben Bernanke installed as head of the President's Council of Economic Advisers (CEA) … has sparked rumors of his possible candidacy for chairman. Glenn Hubbard, … probably ranks as the third-leading candidate for the Fed post … "OUTSPOKEN DOVISHNESS." … As an academic economist and monetarist, [Bernanke] shaped the policy debate on deflation risks that helped spur the decision to slash benchmark interest rates to 1% ... His outspoken dovishness on inflation during this period would qualify as a feather in his cap insofar as his backers are concerned. Yet his stated preference for inflation targeting … as do the Bank of England and European Central Bank -- risks asserting hard numbers over rationality, rendering him a risky choice for the Administration. His relatively vocal prior policy positions could potentially limit his flexibility in steering the Fed's more progressive risk-management approach, as was seen under Greenspan, and might reduce his internal bargaining power over policy choices. RISKY REMEDY. Bernanke came to the Fed Board via Princeton University, …Independence is his greatest strength, and perhaps his greatest liability. This is best illustrated by his appointment of Paul Krugman to the faculty at Princeton … Feldstein and Hubbard have liabilities that may overshadow their considerable qualifications as well. …Feldstein, as CEA chairman under President Reagan … committed the politically treacherous act of proposing a dual remedy of raising taxes and cutting spending. Feldstein has since fallen back to the position that the present deficit is a much smaller percentage of GDP than was the case in the Reagan years. Still, his previous outspokenness … may mark him as a risky candidate. Hubbard appears to have acted as a staunch defender of Bush tax cuts and downplayed fiscal risks, which will not endear him to Democrats. HONORABLE MENTIONS. Fed Governor Donald Kohn has also received honorable mention … but his status as a longtime Fed insider and right-hand assistant of the chairman perhaps makes him too much his own man at the Fed. …Other honorable mentions go to former Fed Governor Larry Lindsey and John Taylor of the Treasury, … likely the darkest horses in this race. Then again, some observers saw Greenspan himself as something of a long shot before his first appointment to the top Fed post. …

Three Discussions of the Low Long Rate Conundrum

BusinessWeek’s Kathleen Madigan, Fed Governor Susan Bies, and Bloomberg’s Caroline Baum discuss the low long-term interest rate conundrum. Here are summaries of their remarks beginning with BusinessWeek’s Kathleen Madigan:
The Long Wait for a Housing Slump, By Kathleen Madigan, BusinessWeek Online: Alan Greenspan's "conundrum" has been the housing sector's savior. … With no cooling in sight … why hasn't the big chill happened yet? It all comes down to mortgage rates, which have not risen as expected. … The drop in bond yields is unusual given the economic circumstances. Even Fed Chairman Greenspan has admitted the bond market's behavior is a riddle. … Policymakers have already noticed that ... higher energy costs ... has pushed up core inflation ... Normally, the Fed's tightening and inflation fears would be pushing up bond yields. Instead, traders seem to hold ... that ... the economy might be done growing, and so the Fed likely is just about finished raising rates this go-round. Moreover... the drop in bond yields may not be saying anything much about the U.S. economic outlook. A glut of global savings is chasing yields, and right now even a paltry 4% payout on U.S. Treasuries beats the 3.5% or less to be gotten from euro bonds. In addition, the central banks of China and other Asian nations are buying dollar-denominated assets to prevent their currencies from appreciating … Despite low bond yields, Fannie Mae's chief economist, David Berson, offers some reasons a slowdown in housing is still a good bet. First, rising prices make affordability an issue for many buyers. Second, the rates of 2003 and 2004 -- the lowest in a generation -- induced some households to buy. That pulled forward sales which otherwise would have taken place in 2005. … regulators are trying to crack down on too-easy standards for home-equity loans. At the end of the day ... a housing slowdown will depend on an attitude change in the bond market. And while market sentiment can turn on a dime, there are no signs right now that traders will pushing rates up soon.
Here are Fed Governor Bies' remarks on the conundrum along with a summary of other remarks by Federal Reserve officials from a Reuter’s report:
Fed officials leave hikes in little doubt, By Ros Krasny, Reuters: Federal Reserve officials left little doubt on Thursday that the bank has more rate increases in mind .. the Fed's program of "measured" increases in short-term rates, Chicago Fed President Michael Moskow said the bank's policy remains accommodative. Separately, Atlanta Fed President Jack Guynn said the Fed has "not yet reached a neutral policy stance." Fed Gov. Edward Gramlich, speaking in Paris, said the measured rate increases could continue. … Moskow stayed close to the Fed's central message. "We can continue to remove monetary policy accommodation at a measured pace," he said. … Federal Reserve Governor Susan Bies took on the "conundrum" of low long-term U.S. interest rates in comments to reporters after speaking at a Women in Housing and Finance event in Washington …."I honestly don't know what it's going to take. It just appears that long-term rates cannot stay at this low level," Bies said. The long rates puzzle dovetails into another worry for policy-makers, a hot housing market that has recently attracted the kind of speculative cash associated with stock market bubbles of yore. Officials repeated concerns about real estate speculation but once again stopped short of tagging the current situation a "bubble." … "At some point we do believe that the 10-year Treasury (note yield) will rise above 4 percent and take mortgage rates with it," Bies said.
Finally, Bloomberg’s Caroline Baum weighs in:
Yield Curve, More Than Shapely Body, Has a Brain, Caroline Baum, Bloomberg: … The yield curve, or the pictorial representation of the yields on Treasury securities across the maturity spectrum, has … narrowed, to the point that it's creating a source of consternation … With every indication that the Fed plans to proceed with its agenda of rate increases and every sign that long rates aren't going to budge in response (at least not higher), it's possible the curve could invert before too long. An inverted yield curve, with short rates higher than long rates, is typically a harbinger of recession. ... Not this time. … Fed officials aren't contemplating implementing a contractionary monetary policy. So what are we to make of the dramatic flattening of the yield curve? … The yield curve is a simple construct that's widely misunderstood. … I've craft[ed] a primer on the yield curve. For the purposes of this discussion, the yield curve will connote the spread between the overnight federal funds rate and 10-year Treasury note yield. 1. What's so special about two yields among thousands? … What's special is the information provided by the interaction between the two rates: one set by the central bank, the other by the market. While long rates are influenced by short rates … they're also affected by real activity and inflation expectations, not to mention a myriad of political and psychological considerations. The long rate is a window into the stance of policy. 2. My windows need washing. What do you mean by the interaction between them? … Most [central banks] use an overnight or other short-term rate as a policy tool. The monetary authority provides whatever reserves the banking system demands to achieve its target rate. If the central bank is holding the short rate steady, and market rates are rising, it's a pretty good indication that the overnight rate is too low. … Because … the demand for credit is rising faster than the Fed can supply it. 3. Who figured this stuff out? The theory behind the yield curve's role in anticipating economic growth and inflation can be traced back to the late Swedish economist Knut Wicksell (1851-1926). Wicksell argued that when the rate at which banks lend is below … the natural rate of interest, prices would rise. When the bank rate exceeds the natural rate, prices would fall. 4. How do I know what the natural rate of interest is? You don't. It's unobservable. Which is why the interaction between the two rates provides … information ... Think of the long rate as a check on the central bank. If policy is too easy or too tight, it will send up a flare. 5. Now I'm really confused. How can falling long rates be a negative? Isn't there more incentive to borrow at 5 percent than 6 percent? Yes. And that's one part of the story. If you only looked at the level of long-term rates, the Great Depression should have been the Great Boom, and Japan's lost decade should have been Paradise Regained. In both cases, low long-term rates were a symptom of weak economic growth, not a cause of stronger growth in the future. … 6. Low mortgage rates have created a boom in housing. How can you say a flatter yield curve is less stimulative? … … Ceteris paribus, declining mortgage rates make home ownership more affordable. In the micro world of housing, credit demand is strong. ... Whether it's Asian central banks or private investors wanting a risk-free investment, more people are choosing to save in dollars, which is pushing down long-term rates….
[Update: One more story on the conundrum from CNN]

May 26, 2005

CSPAN Video: Hearing on Nomination of Ben Bernanke for Council of Economic Advisers

Here is a video of the hearing on the nomination of Ben S. Bernanke, of New Jersey, to be a member of the Council of Economic Advisors and the nomination of Brian D. Montgomery, of Texas, to be Assistant Secretary of Housing and Urban Development:
CSPAN Video: Hearing on Nomination of Ben Bernanke for Council of Economic Advisers and Nomination of Brian D. Montgomery to be Assistant Secretary of Housing and Urban Development (05/25/2005): Approximate starting times of segments:
Bernanke Opening Statement: 8:50 min. Montgomery Opening Statement: 10:10 min. Q&A: 16:45 min. Total Time: 1:41:17
Written opening statements and an alternative video link are here.

The New York Post Tries Fed Watch

Here’s a sophisticated analysis of Fed policy from The New York Post telling us that it's bad when bad things happen to a bad economy:
Fed Rate Hikes Could End Badly, By Roddy Boyd, NY Post: If Ed Hyman is right, things are likely to get pretty ugly on Wall Street in the not-too-distant future. The top economist has started telling clients that the Federal Reserve's tightening cycle is almost certain to end badly. Assigning a 70 percent probability to the likelihood of a calamity this year, he argued that every Fed interest rate increase cycle since 1970 has involved at least one high-profile financial calamity. Without pointing a finger at likely targets, Hyman said the end of the Fed's tightening is an indication of the slowing growth of the economy, which alone often exposes economic weaknesses. These weaknesses, combined with some type of spectacular scandal could ignite a downturn.
Setting aside the question of how he calculated a 70% probability for a “calamity” (one of the nice things about pulling numbers out of a hat is that you don’t have to define terms such as calamity or spectacular scandal – note that he wouldn’t identify any potential events falling into this category), we are told that the Fed will ease monetary policy when growth slows, that slow growth indicates the economy is weak, and if some undefined spectacular scandal or calamity hits a weak economy that could be a problem. Wonder how much the “top economist” charged his clients for that advice. [Update: The feedback on this post suggests I should have focused on the reporter and not the analyst ... I've had my remarks filtered and misrepresented by copyeditors and reporters so I'm sympathetic to that view ...]

Is The American Dream Fading?

This article discusses the decline in income mobility in recent decades and asks if the US “… is becoming less of a meritocracy, where skill and intelligence determine success, and ... more of a class-bound society…”:
The American Dream gains a harder edge, By David R. Francis, The American dream, at least on the economic side, is fading. … Today … nearly 1 in 5 American households has zero net worth or actually owes more than it owns. And the odds of a son or daughter rising above their parents in such a financial predicament have shrunk. "Income mobility has declined in the last 20 years," says Bhashkar Mazumder, an economist at the Federal Reserve Bank of Chicago. What that means is that the US is becoming less of a meritocracy, where skill and intelligence determine success, and becoming more of a class-bound society, where economic background, including the better education money can provide, matters more. … Most Americans don't believe that to be true, surveys show. But academic studies suggest that income mobility in the US is no better than that in France or Britain. It's actually lower than in Canada and is approaching the rigidity of Brazil. That marks a change from the past… From 1950 to 1980, Americans were more and more likely to see their offspring move up - or down - the income ladder. … Today, it could take five or six generations to close the gap between poverty and middle-class status, calculates Mr. Mazumder. …
[Income Mobility Papers by Bhashkar Mazumder.]

Bloomberg Discusses Bernanke and the Opportunities and Pitfalls Ahead of Him as CEA Chair discusses Bernanke’s Senate confirmation hearing, the opportunities and pitfalls that come with appointment as Chair of the White House Council of Economic Advisers, and how Bernanke’s past outspokenness might be problematic:
Bernanke's Outspokenness at Fed Faces Test in White House Job, Bloomberg: Federal Reserve Governor Ben Bernanke is likely to win Senate approval to take over the White House Council of Economic Advisers, a job that has been a stepping- stone to the Fed chairmanship and a political minefield. … Bernanke … will be taking on a role that once was filled by Fed Chairman Alan Greenspan. Others, including Harvard economics professor Greg Mankiw, … ended their tenure with political scars and diminished chances for higher government posts. It's a job … where strong ideas frankly expressed don't guarantee success. … In a career in academia and as a Fed governor, Bernanke, 51, has rarely displayed uncertainty about economics. At the Fed, … Bernanke publicly disagreed with Greenspan on numerical goals for inflation. … Bernanke is willing to buck fellow economists, as well. … [Link to article]

CBS Poll: Disapproval of Bush’s Handling of Social Security and the Economy

There is very little good news for president Bush in a new CBS poll. More than half the respondents disapprove of the job he is doing as president, the numbers are even worse on his handling of economy, and he is increasingly viewed as out of touch. In addition, only 26 percent approve of his handling of Social Security, there is continued doubt about his plan to partially privatize Social Security, and “Most of those who have heard a lot about the President’s plan say allowing individual investments of Social Security taxes is a bad idea.” [Link to CBS article and poll results]

May 25, 2005

Bush: "Those who obstruct reform … will pay a political price..."

Following up on PGLs post at Angry Bear, here are more quotes from George "I'm a uniter, not a divider" Bush who has a message for anyone so daring as to question the assumptions used by the administration to create a solvency crisis and hence the need for reform, or anyone who might stand in the way of his philosophical vision for Social Security:
"There are some good ideas that I put on the table" that Congress has been reluctant to engage. ... Bush warned lawmakers that increasing numbers of Americans are getting the idea that the nation's retirement system is on an unsustainable fiscal course and said politicians must step up to solve the problem. "Those who obstruct reform, no matter what party they're in, will pay a political price ...
Here's my worry in the days ahead. The success of moderates in averting congressional meltdown over filibusters may tempt them to ride their wave of momentum into the Social Security arena. In doing so, they may be overly eager to show they can get things done to further their political aspirations. This may yield far too many concessions, in particular carve-out private accounts, in an attempt to gain cooperation. [Note: The linked quote "I'm a uniter, not a divider" is from an interesting 1999 interview at Salon prior to Bush's nomination for president.]

The Dropout Boom and the Growing Education Gap

This article describes the rising college drop-out rate, particularly among lower income students, and the widening education gap this is bringing about. The article also looks at potential causes of the rising dropout rate and policies attempting to reverse the trend:
The College Dropout Boom, By DAVID LEONHARDT, NY Times: …One of the biggest decisions Andy Blevins has ever made, and one of the few he now regrets, never seemed like much of a decision… He had been getting C's and D's, and college never felt like home, anyway. ... So he quit college … and … … joined one of the largest and fastest-growing groups of young adults in America. He became a college dropout … Only 41 percent of low-income students entering a four-year college managed to graduate within five years … but 66 percent of high-income students did. That gap had grown over recent years. … [continue reading…]

May 24, 2005

Mankiw Interview in Fortune Magazine

Thanks to Marginal Revolution for a link to a recent interview by Greg Mankiw in Fortune Magazine. He discusses Social Security, Inflation Targeting, the deficit, Paul Krugman, Karl Rove's role in policy, and other issues. The link has excerpts from those sections of the interview. As Marginal Revolution notes "Fascinating all around."

FOMC Minutes: Downside Risks to Growth, Upside Risks to Inflation, But Continued Measured Changes Expected

The Fed meeting minutes are out and for me this paragraph summarizes their stance fairly well. If there is any news, it is that the committee expressed a bit more concern over rising inflation and inflationary expectations than I anticipated, though that won't be surprising to everyone. There was also discussion of removing the "measured pace" language, but since the statement is clearly conditional upon future inflation, economic growth, and other economic conditions the committee decided to retain the language. The message is that any apparent change in the underlying trend for inflation or growth (more than a few monthly reports indicating weakness or strength in particular areas) could cause the Fed to deviate from the "measured pace." Here is the summary paragraph:
Minutes of the Federal Open Market Committee, May 3, 2005: … In the Committee's discussion of monetary policy for the intermeeting period, all members favored raising the target federal funds rate 25 basis points to 3 percent at this meeting. Although downside risks to sustainable growth had become more evident, most members regarded the recent slower growth of economic activity as likely to be transitory. In this regard, the ability of the U.S. economy to withstand significant shocks over recent years buttressed the view that policymakers should not overreact to a comparatively small number of disappointing indicators, especially when economic fundamentals appeared to remain quite supportive of continued solid expansion. To be sure, the Committee had raised its federal funds rate target appreciably over the past year, and, in the view of a few members, a larger-than-expected moderation of aggregate demand in response to this cumulative policy action could not be ruled out. However, all members regarded the stance of policy as accommodative and judged that the current level of short-term rates remained too low to be consistent with sustainable growth and stable prices in the long run. Against the backdrop of the recent uptick in core inflation and in some measures of inflation expectations, members agreed that they should continue along the course of removing policy accommodation at a measured pace conditional on the outlook for inflation and economic growth…

Pete du Pont Campaigns for Personal Accounts

There are those who won’t to give up on personal accounts even if everyone else believes it’s time to do so. Pete du Pont is one of them. Du Pont highlighted Social Security reform in his 1988 bid for the Republican nomination for president, so it’s understandable why he might hold on to the privatization idea longer than most. His commentary today in The Washington Times tries to rescue private accounts from the administration’s sinking ship. In his remarks, he acknowledges that personal accounts do not help with the solvency issue the adminstration claims exists. For that, he suggests the Pozen-Bush plan to cut benefits. But he says there’s still a positive aspect to privatization. If the government says "we are only going to pay 80% of what we promised, you are on your own for the other 20%," then it will be easier for the government to meet its obligations. By that logic, the government should privatize 100% because then government provided benefits would be zero and it couldn’t possibly have trouble meeting its obligation. What he doesn’t address is the shift in risk to individuals that comes with the shift in obligation to the private sector. When he says “PRAs offer the only chance for younger workers to gain anything from reform” he ignores the shift in risk to individuals. Opinion poll after opinion poll has made it clear that the public is not willing to accept the increased economic risk brought about by PRAs when they do nothing to enhance benefits. Here are du Pont's remarks:
Essential element of reform, By Pete du Pont, The Washington Times: Those who decide what is conventional wisdom inside-the-Beltway are pushing the idea President Bush is losing support for his plan to reform Social Security with personal retirement accounts and it is time for him to cut his losses. The argument goes something like this: "Since PRAs don't solve the solvency issue, they're not worth the hassle." … some are beginning to question whether PRAs are a good idea. … If personal accounts don't solve the problem, why are we talking about them? The quick answer is PRAs were never meant to be a silver bullet, but they are essential to any viable reform package. … Under most reform proposals, PRAs do not shore up the solvency problems on their own. … However, saying they "do nothing" is entirely inaccurate. … Over time, as workers with personal accounts retire, Social Security's obligations are reduced. Thus, Bush-style personal accounts alone will reduce Social Security's costs by about 10 to 15 percent over the next 75 years, and more than 20 percent beyond the 75-year horizon. Of course, Mr. Bush's approach includes more than just adoption of PRAs. He has also noted the need for other measures, like curbing the growth of future government-provided benefits. ... Adopting both aspects, reducing government's burden and including PRAs will provide benefits comparable to what the system now promises and more than it actually can afford. … PRAs offer the only chance for younger workers to gain anything from reform.
The word chance in his final sentence is important. PRAs also offer younger workers a chance to lose something from reform. Think of the person in the example in the article who receives $1,200 per month from the government and hopes to get $300 from personal accounts. The rate of return assumed to yield that amount in the calculations, 3%, is misleading. The 3% does not subtract off the clawback of 3% so the net return is zero. It would take a return of 6%, not 3% as cited, to achieve a net 3% return. The 4.6% return cited as the average return on a 50-50 bond and stock portfolio is similarly misleading. Subtract the clawback and the net return is only 1.6%. And this is an average return, some will do better, others worse. The article misleads even further when du Pont states "PRAs will provide benefits comparable to what the system now promises" while at the same time endorsing the Pozen-Bush proposal to reduce benefits:
Mr. Bush recently endorsed a proposal by a Democratic member of his 2001 commission, Robert Pozen, to make this shift from wage to price indexing on a progressive basis, maintaining wage indexing for the lowest-paid workers.
Even Bush doesn't claim that the Pozen-Bush privatization and benefit cut proposal will maintain benefits at their current promised levels. Most of the controversty surrounding this proposal involves the steep cut in benefits and du Pont is certainly aware of this. Holding on to an idea too long is understandable. Writing a misleading commentary trying to sell it is not.

Hot Jobs

Here are some of the best job opportunities as identified by the The Christian Science Monitor. Do they have it right? Or would you recommend other choices?
Now hiring: the hot jobs of the moment, by Ron Scherer, The Christian Science Monitor: … Accounting, electrical engineering, oil and gas specialists: These are just some of this year's hot jobs. Although experts are quick to agree that the job market is not quite up to the late 1990s … there are nevertheless numerous professions that are hiring as fast as the resumés come in. Many positions require math or science skills … "The hot jobs are in the forefront of technology and medicine, or they are in the sweet spot of where the economy is growing like energy, healthcare services, financial controls, and international," says John Challenger of the Chicago outplacement firm Challenger, Gray & Christmas. "Of the hot jobs, the most sustainable will be those where you can't be outsourced." The Bureau of Labor Statistics (BLS), in its employment projections, forecasts the top five industries with the fastest wage and salary employment growth between 2002 and 2012 are: software publishing; management, scientific. and technical consulting services; care for the elderly; computer systems design; and employment services. … the job market is still pretty strong for some job categories. Here are some of the strongest areas:
• Anything to do with energy, such as petroleum engineering or work on oil rigs. "It's difficult finding skilled labor, professional geologists, engineers," says Mark Baxter, director of the Maguire Energy Institute at Southern Methodist University in Dallas… • Accounting, which continues to grow. With the requirement that companies comply with the Sarbanes-Oxley legislation, which compels CEOs to certify their company's financial results, demand for accounting services has soared… • Building trades, especially as America's love affair with real estate continues... • Computer security... • Healthcare...

May 23, 2005

Fed Watch: The Fed and the Housing Bubble

Tim Duy's latest Fed Watch examines the Fed's response to the potential housing bubble: Last week saw a flurry of reports about the Fed and housing.

David Wessel reported in the Wall Street Journal that the Fed is becoming concerned about a potential housing bubble. Those concerns were reiterated by Greenspan in the Q&A after Friday’s energy speech (see Calculated Risk here and here for some enlightening quotes). I don’t blame Fed officials for raising the alarm. I’m concerned, too. But the important question is what are they prepared to do about it? I continue to believe that the Fed is not likely to change the path of monetary policy to pop a housing bubble.

Bubbles pose significant challenges for policymakers. They are economic distortions that lead to inefficient resource allocation, and tend to have nasty unexpected consequences when they pop. But to what extent, if any, should they be a focus of central bank policy? I think conventional wisdom at the Fed is that you should keep your eye on the ball, and the ball is price stability. To deviate from this objective pulls you into the uncertain world of bubble analysis. It is possible that you may not be able to conclusively identify whether a bubble exists until it is far too late to do anything about it. Moreover, the Fed is not charged with maintaining stability within any one sector of the economy, just as they cannot set monetary policy with a focus on California. The Fed will instead focus on cleaning up after the bubble pops (some will argue that this entails creating a new bubble somewhere else in the economy).

Assuming that a more aggressive monetary policy is off the table for the time being, what else could the Fed do to address the housing bubble? Often, those of us following the Fed forget that it is also charged, along with a number of other agencies, with regulatory responsibilities over the financial industry. According to Wessel:

The Fed and other bank regulators, however, this week warned banks to take more care with home-equity loans, noting that such loans are "subject to increased risk if interest rates rise and home values decline."
And, from the Wall Street Journal, on the same day of Wessel’s piece:
New Mortgage Guidelines Planned: Federal banking regulators, concerned about growing risks in the mortgage market, are planning to issue new guidelines for mortgage lenders.

The new guidelines, which could be completed as soon as early next year, come at a time of growing concern that the proliferation of new mortgage products could mean higher risks to borrowers and lenders. Regulators are turning their attention to mortgages after issuing their first-ever guidelines for credit-risk management for home-equity lending this week, warning financial institutions to re-examine their loan criteria.
Note the key phrase in this piece, "early next year." The regulatory process can move at a glacial pace, so it is apparently premature to conclude that banking regulators are about to put the kibosh on the housing market. Moreover, regulators appear to be well behind the curve. See the following piece, from the same day’s WSJ!
The Letter of Credit Returns. Buy beachfront property! Almost no money down!

More investors prowling some of the hottest real-estate in the country have discovered an old-fashioned financing tool -- the letter of credit -- and are using it in a way that may be adding fuel to an already overheated housing market.

…Some say letters of credit make it too easy for speculators. Economists estimate about 20% of residential property sales involve investors, not families or individuals who plan to live in the home. Such purchasing could be artificially lifting prices and demand and could destabilize a market should speculators start dumping homes, these economists fear.

Looks like the financial industry is working overtime to keep a fire under the housing market. Does anyone out there believe that the regulators can match their pace? And, lest we forget, interest rates have returned to their "conundrum" levels (see William J. Polley). With the financial industry pushing real estate, and low interest rates ensuring cheap financing, it is tough to see that regulators have much of a chance to get a handle on this bubble without cutting it off at the knees. So, given the lack of attractive policy options, or the ineffectiveness of these options, why the very public shift in concern at the Fed? I propose a very simple answer: The Fed is trying to protect its reputation. In the past, Greenspan has clearly downplayed the existence and impact of a housing bubble, even going so far as praising ARMs. It is getting harder to make those arguments, and consequently I suspect that Greenspan does not want to be blamed for being the cheerleader behind another bubble (see Roach’s withering criticism of Fed policy here). Unfortunately, it is probably too late for that – most of us in the blogosphere have long memories. Simply put, the Fed’s recent housing market concern is interesting and important, but not by itself likely to trigger more aggressive monetary policy. Instead, it appears to be more of a CYA maneuver – use the regulatory process to strengthen (hopefully) the financial industry, tell homebuyers they are taking a risk, and hope for the best.

Stiglitz: Bush Capitalism Undermines Fiscal Solvency and Social Security

Joseph Stiglitz, a professor at Columbia University and Nobel Prize winner in economics in 2001 is not happy with the Bush administration:
No Old-Age Security in the Private Sector Either, By Joseph E. Stiglitz, LA Times: President Bush's plan to reform Social Security requires that we trust the private sector, which isn't all that easy to do given its inability to honor its obligations in pensions or to provide adequate health plans. The recent court decision allowing United Airlines to turn over its pension system to the federal Pension Benefit Guaranty Corp. is likely to raise anxieties still further among Americans already worried about their old-age security. There is a certain irony to what's going on: As the president tries to turn over responsibility for retirement to the private sector, the private sector is simultaneously turning to the government for help. … This apparently is part of the new form of Bush capitalism, involving the nationalization of private liabilities. The bonds of GM and Ford, once bastions of American capitalism, have been downgraded to junk status … Is it only a matter of time before they too turn to the government? … The problems in the private sector are, in many cases, a combination of bad accounting, greed and lax government regulation that allowed corporations not only to put insufficient pension funds aside in the first place but to raid corporate pension funds they claimed were over-funded. The parallel to what has occurred on the public side is uncanny. A combination of bad accounting and political greed allowed the administration to claim that huge surpluses justified a huge tax cut. The accounting was a mirage; the surpluses soon disappeared, and fiscal solvency of the United States was undermined. If but a fraction of the money spent on the tax cuts had been devoted to Social Security, the fiscal solvency of the program would have been ensured for 75 years, even using conservative projections. America is the richest country in the world. We should have the ingenuity and means to design retirement programs that insures Americans against stock market volatility and inflation. Social Security is the only program that does this for most Americans. United's experience shows that private pension programs cannot be counted on. Private accounts would be subject to the vagaries of the market. And no private program would insulate against inflation. We should be focusing our attention on making our private system work better. Certainly we should do that before we begin Bush's risky path of beginning to dismantle our public one.

May 22, 2005

Social Security Legislation to Include 401(k) Opt-Out Accounts

News that House Ways and Means Chairman Bill Thomas will support opt-out 401(k) accounts as a part of Social Security reform legislation:
Automatic Signup In 401(k)s Backed - Provision Eyed for Social Security Bill, By Jonathan Weisman, Washington Post: House Ways and Means Chairman Bill Thomas (R-Calif.) will include a provision in his Social Security legislation to help employers make enrollment in 401(k) plans automatic unless workers choose to opt out, according to congressional staff and knowledgeable lobbyists. The provision could have substantial impact on the nation's savings rate … Recent academic research has shown that employee participation rates soar among companies with automatic enrollment in retirement plans. … lobbyists who have met with Thomas say he has given his word on the matter. … According to two lobbyists familiar with the discussions, Thomas has suggested to life insurance interests that he would back incentives for employers to convert 401(k) balances to private annuities that would pay out slowly over a worker's retirement. In exchange, the life insurance industry would not work against a dramatic expansion of Individual Retirement Accounts, 401(k)s and tax incentives designed to expand personal retirement savings. … Economists of all political stripes like it because it appears to work. … Mandating automatic enrollment would easily create $20 billion in new retirement savings a year, said Peter R. Orszag, director of the Retirement Security Project … If Congress pushed employers to slowly increase contribution rates over time, savings would increase well in excess of $50 billion a year. …
I’ve been wondering whether to support such a proposal. The first question I had, which I asked here, was what market failure justifies intervening to increase saving? If the loanable funds market works, wouldn’t the saving rate, whatever it is, be optimal? Through comments and an email, I am now convinced that taxes drive a wedge between private and social investment returns, that myopia might play a role, and that moral hazard may also be a problem resulting in saving below the golden rule level. Thus, I am now comfortable with government intervention to create incentives to increase private saving. That brings me to opt-out. I believe it increases saving relative to opt-in, but why is this so? Do some people perceive the transactions costs of changing status to be greater than the benefits irrespective of whether they are asked to opt-in or opt-out? In general, I hate opt-out programs. I don’t want to spend my time filling out forms and checking boxes telling people all the things I don’t want to buy. If I’m convinced there is market failure in the market for bicycles resulting in too few being purchased, is the proper solution to drop bicycles in people’s yards unless they remember to send in the proper paperwork? I remember being in music clubs like that when I was younger… Maybe a better answer is to work a little harder on the incentives and ease of opting-in. Last, I worry we have forgotten the Lucas critique yet again. Change the rules and change the behavior. I can imagine that if you impose opt-out now when it is uncommon participation might be high. But as it becomes more common and institutionalized people will more easily opt-out. In addition, it also seems participation rates will fall in the long-run as people hit financial stress points. If you can opt-out at will, then the first time a family faces financial distress, they will likely opt-out. Unless they are somehow brought back into the program later, participation rates will fall as time passes and revenues may not meet projected values.

May 21, 2005

The National Review Has a Dreary Spring

The National Review Online is unhappy with the progress of the Administration’s domestic agenda. Who do you think the National Review blames? While this Kudlow column takes the obligatory jab at Democrats as obstructionists and tries to tie the failure of Social Security and other domestic reform proposals to the filibustering of judges, it is evident that even the NRO is beginning to realize there is a clown show going on in Washington. And they aren’t laughing:
The Dreariest Political Spring, The hoped-for domestic-reform agenda has gone nowhere, Larry Kudlow, NRO: Conservatives were near ecstatic last November when President Bush won handily and the Republicans strengthened their hold in Congress. Hopes were high that little could stop the implementation of a true conservative agenda … But the hoped-for domestic-reform agenda has … degenerated into a hopeless morass of name-calling, scandal-mongering, political-bludgeoning, and relationship-breaking over the seemingly simple issue of giving the president’s judicial nominees an up-or-down vote. … According to a recent Wall Street Journal/NBC News poll, … Democrats receive a 47 percent approval rating while Republicans get only 40 percent. These are the worst polling data for the GOP since the eve of the Gingrich revolution of 1994. It is not, however, a perfect poll. .... The single biggest problem facing Americans today seems to be rising gasoline prices, with jobs and the economy following suit. Yet seldom does Bush even talk about energy. Another key issue of discontent is immigration. The president seems to want more of it while the public clearly wants less. … pollster Scott Rasmussen points out a real landmine for the Bush reform proposals of Social Security … it’s the age group of 50 to 64 years that is completely opposed to what they’re hearing. ... This group is the most likely segment of the voting population for the midterm elections — not a good sign for GOP strategists. … Is the White House and its congressional allies selling policy reforms that voters simply are not buying? … will tax-reform commissioners Connie Mack and John Breaux ever get their proposals to see the light of day in the current obstructionist congressional climate? … All senators have dirt on their hands these days. The Senate, if you can believe it, just delivered a budget-busting pork-laden $295 billion highway bill, featuring several thousand special-interest earmarks and a phony tax-transfer from general revenues to the trust fund. Where was the allegedly conservative Republican-controlled Senate? This bill was voted through 89 to 11 … the capital city seems to be disconnecting from the country. ... This is surely the dreariest political spring I can remember.
The reluctance to give the Administration and GOP leadership in Congress their full share of the responsibility for the public’s resistance to reform efforts is evident, and the argument that every problem they encounter is due to minority obstructionism is transparently weak, but the NRO is beginning to acknowledge that the failure of the Administration and Congress is causing the dreariness surrounding the domestic-reform agenda they are feeling this spring.

May 20, 2005

Fed Governor Kohn: How The Fed Forecasts Inflation and Sources of Policy Errors

Here are some remarks on the nuts and bolts of how the Fed forecasts inflation by Governor Donald L. Kohn. Points to note are (1) The Fed uses a variety of models to forecast inflation including models with naïve adaptive expectations to models with rational expectations and wage and price frictions. The forecasts from these models are examined in their totality and then “judgmentally adjusted” to arrive at a forecast for inflation. Surveys of economists and the public are also used to gain information about inflationary expectations. (2) The evidence suggests the forecasts used by the FOMC have been biased upward by .2% and have a variance that results in a .5% positive or negative error about one third of the time. (3) The reason for the bias may be due to an undetected fall in the natural rate of unemployment which in turn caused an upward bias in the inflation forecasts. (4) The remarks highlight the difficulty in estimating the natural rate of unemployment contemporaneously and how that difficulty has led to policy errors in the past. (5) A conclusion is that monetary policy could be improved through two advances, better means of estimating inflationary expectations and better means of estimating the natural rate of unemployment. Given the policy errors made in the past due to misperceptions concerning the natural rate of unemployment, I see it this as an area of particular concern. That concern is heightened by the large demographic changes likely to affect labor markets and the economy in the years ahead. Here’s a link to the remarks with graphs showing inflation forecast errors by the Fed from 1984-2000:
Remarks by Governor Donald L. Kohn To the International Research Forum on Monetary Policy Conference, Frankfurt am Main, Germany, May 20, 2005, Modeling Inflation: A Policymaker’s Perspective

Is There Market Failure in the Loanable Funds Market?

Here's something I've been wondering about and I hope someone can help me. I hear repeatedly that the national saving rate it too low. I am not arguing against that idea, one that has been around since the mid 1990's, but why is this? The right is a strong proponent of using Social Security reform to increase the saving rate. What market failure justifies such intervention into the private sector? Why doesn't this market produce the proper amount of saving? What market failure are those on the right, and others (many on the left embrace this as well), trying to correct in their call to increase saving through Social Security reform such as add-on accounts? Is it due to a distortion arising from the federal budget deficit, low interest rates from Fed policy, or some other government policy? If so, why not fix the distortion rather than try and further manipulate the market to increase saving? Before intervening, shouldn't we at least identify the market failure? And if there is no market failure, if markets always work as many believe, should we call for intervention?

Recent Changes in the Unemployment Gap

Here is a graph of the deviation of the unemployment rate from its natural rate, i.e. (UN-UN*), where UN* is the CBO’s estimate of the natural rate of unemployment (the NAIRU, or non-accelerating inflation rate of unemployment):
Remember that negative numbers represent low unemployment and positive numbers high unemployment. Notice how steadily the gap has been declining over the time period since the end of 2003. At the end of the first quarter of 2005 the natural rate of unemployment was 5.2% and the unemployment rate 5.3% for a gap of .1%. If you are the Fed and your job is to assess the overall health of the labor market and you see this diagram, what do you conclude? There are two views of the economy right now, one that says the underlying economy is strong though there are some noisy signals. This diagram would support that view. But suppose you disagree. Why would you argue this mis-measures the true state of the labor market? There are two possibilities. The first is that the natural rate is mis-measured. The CBO has not changed its natural rate estimate of 5.2% since March of 1996. Prior to that it was changed frequently. Has the natural rate changed? One reason it would vary is changes in the age distribution of the population, but significant changes in the age distribution do not appear until after 2010 as shown here so that is an unlikely explanation. The other possibility is that phenomena such as discouraged workers and underemployed workers (people working part-time wishing they could work full-time or working in an area different from their primary skill) cause the measured unemployment rate to be lower than its true value making the labor market appear stronger than it really is. If I wanted to argue that the data do not represent the true state of the labor market, I would focus here rather than the natural rate (or make the point that the average misses the high level of unemployment among some demographic groups). But from a policy perspective this misses the point. The Fed understands that the “thermometer” it uses to take the temperature of the labor market may not give the true temperature. It may read 85 degrees when it’s really 91. But it still tells the Fed whether the labor market is getting hotter or colder which is what it needs to know to determine the appropriate course for monetary policy. It doesn’t matter if the thermometer is off by a few degrees, you can still tell whether the temperature is rising or falling. As the Fed looks at the data in the diagram, it sees a labor market that is getting hotter irrespective of whether the actual measure should be higher or lower.

It’s the Economy Stupid (and Iraq Too)

There is very little good news in this survey report released today by The Pew Research Center for the People and the Press:
Economy, Iraq Weighing Down Bush Popularity - Country Losing Ground on Most National Problems: Americans are critical of President Bush's job performance in many policy areas, but negative opinions of his handling of the economy and Iraq are doing the most damage to his overall approval rating … There has been greater stability in Bush's marks on energy policy and Social Security, but he gets positive ratings of only about 30% on both issues (energy policy 31%, Social Security 29%). … Bush gets positive marks from a majority of the public on just one issue ­ his handling of terrorist threats. …
An analysis of opinions on Bush's job performance shows that views of his handling of the economy are now the biggest factor influencing his overall rating, with Iraq nearly as important. … Negative opinions of Bush's handling of Social Security outnumber positive ones by about a two-to-one margin (59%-29%), but this issue does not heavily influence Bush's overall job rating. However, Bush's association with a plan to limit the growth of Social Security benefits appears to undermine support for the concept. Most Americans say they would support limiting the growth of benefits for wealthy and middle-income retirees, while keeping the current system intact for lower-income people. But support is significantly lower when the proposal is explicitly associated with Bush. … While partisanship is a large factor, Bush also faces problems on Social Security policy among political independents. Support among independents … drops … when the proposal is attributed to the president.
Meanwhile, public support for adding private accounts to Social Security, which declined over the winter, has largely stabilized over the past three months. Since February, there has consistently been a slim plurality (currently 47%) in favor of the idea of allowing younger workers to invest a portion of their Social Security taxes in private retirement accounts, though nearly as many (40%) are opposed. Bush's endorsement of this proposal is not mentioned in this survey question.
On many key issues, from the budget deficit and Social Security to education and illegal drugs, more Americans think the country is losing ground than say it is making progress or holding its own. … Perceptions that the nation is losing ground in health care have grown sharply over the past decade or so. ... Opinions on the availability of good-paying jobs, which improved considerably from 1997-2001, have declined in recent years. … Not surprisingly, perceptions of the budget deficit have worsened considerably … Democrats are decidedly more negative than Republicans in their perceptions of how the country is doing on most of these issues, with the biggest gaps over the availability of good-paying jobs and environmental pollution. … On immigration, the partisan pattern is reversed; more Republicans than Democrats believe the country is losing ground on immigration …

May 19, 2005

Luskin is Wrong: Personal Accounts Do Not Protect Benefits

[I've moved. Please Click here to go to this post at the new site.] In his role as advocate for whatever the administration proposes, Luskin shows that he is either willing to intentionally mislead, or he does not understand basic concepts. First, he makes incorrect statements about liberal bias in the media that a simple Google search would have shown to be false. Second, he makes misleading claims about increasess in future benefits. Finally, he makes an argument that personal accounts as proposed by the administration protect future benefits. This argument is incorrect as shown below. His first complaint is that Wexler’s proposal was not reported by the press. That’s ridiculous. Here’s a link to a CNN story on May 13. And here’s a link to a NY Times story on May 14th (which is still available here as of May 19th, the day Luskin's piece appeared). Here's a Washington Post story yesterday, May 18th (Don – try Google). Yet Luskin says:
On Monday, Florida congressman Robert Wexler broke ranks with fellow Democrats by offering a plan to reform Social Security. Amazing! After months of party-line stonewalling, Wexler made a gesture of bipartisanship. And yet there hasn’t been one solitary word about it in the "paper of record," the New York Times.
Click the link above and see for yourself. Next, let’s look at his claim that:
... for the middle 20 percent of average lifetime wage earners — surely that defines the “middle class” — progressive price indexing would increase benefits payable in 2050 from $1,208 (in 2005 dollars) to $1,380. And that doesn’t even include the additional increase in benefits that would accrue from investing in personal accounts. And the benefit improvement is even greater for workers below the middle class.
Here is more perspective on these numbers. According to calculations by Jason Furman of the Center on Budget and Policy Priorities available here, a worker born in 1985 (who would be 65 in 2050) with a $50,000 income would, under the existing commitment, receive a monthly payment from Social Security of $2,355 per month ($28,260 annually). Under Bush-Pozen, it falls $1,684 per month ($20,347 annually, a cut of $7,913 or 28% relative to the current commitment). Here’s Luskin’s argument. Using my figures (I couldn’t verify his, but like his, these are inflation adjusted), a retiree today with an income of $50,000 would receive $1,654 per month and, under Bush-Pozen that increases this increases to $1,696 for somone retiring in 2050, an increase of $42 per month over today's payment (not quite as attractive as the case Luskin chose to present). However, this is not an increase relative to the current commitment to pay benefits, it represents a cut of $7,913. Luskin wants us to believe we are better off because we receive $43 more per month conveniently forgetting about the $7,913 cut (which is $659 per month). Finally, let’s look at one more claim that is used to argue against tax increases and for private accounts:
First, Social Security is already running a surplus — it takes in more in taxes each year than it will pay out in benefits (it will do so until 2017). Raising taxes today will just make that surplus larger. That’s a problem because that surplus isn’t being saved for the sake of the system’s future needs. The so-called Social Security Trust Fund uses the surplus to buy special-issue Treasury bonds — which is to say, it hands the surpluses over to the federal government to spend.
This is the standard lockbox argument for private accounts. Having had the solvency foundation crumble, this is their last resort, that the lockbox will prevent the government from spending your money. But it doesn’t, and closer inspection undermines this argument as well. Let’s take a numerical example. Suppose you currently pay $100 in taxes for promised benefits in the future of $100 (ignoring interest simplifies the exposition but does not change the basic result), but the government spends $20 so it only has the ability to pay $80 in the future (i.e. the government spends $20 more than it takes in from general fund revenues). Luskin is saying that if you raise taxes to $120 to make up the shortfall, the government will simply spend the extra $20 leaving the $20 shortfall in place. But the government can still do this even if part of the contribution is placed in a private account. Suppose we take the $20 the government is spending and put it into a private account to "lock it up" (this is like diverting 4% out of 12% to private accounts under the proposal). Thus, you now give $80 to the government and put $20 into a private account. But the government is still spending as before so now the shortfall increases to $40 since revenues have fallen by $20. A solution is simple for the government is to reduce promised benefits from $100 to $80 in the future so that the shortfall is back to $20 again (or cut benefits to $60 to achieve buget balance). There is nothing about private accounts that prevents the government from reducing its share of the promised benefits as a means of solving budget deficit problems arising from an inability to reign in general fund spending. As this shows, private accounts as proposed by the Administration do not prevent the government from spending your money and are no different than a tax increase in that regard. The argument that private accounts protect your retirement benefits is not correct because the government can always reduce its share of benefits to fund deficit spending in other parts of government.