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December 11, 2007

Economist's View - 5 new articles

It's *Not* Social Security

This is important. It's from Peter Orszag, Director of the CBO:

The Biggest Budget Buster, by Peter Orszag, Commentary, WSJ: The nation's economic outlook may look troubling in the short run, but these difficulties pale beside the economic consequences that will follow if we don't address the nation's long-term fiscal gap...

The fiscal gap does not arise, as many believe, primarily from the coming retirement of the baby boomers. Rather, the rate at which health-care costs grow will be the primary determinant of the nation's long-term budget picture. ...

The bottom line is that while we need to address the effects of the coming retirement of the baby boomers and the projected imbalance in Social Security, we have to pay even more attention to the health-care costs that exert the dominant influence on our fiscal future. ...

Over long periods, the cost growth per beneficiary in the Medicare and Medicaid programs has tracked cost trends in private-sector health-care markets. As a result, many analysts believe that significantly constraining the growth of costs for the public programs while maintaining broad access to hospitals and doctors under them will be possible only in conjunction with slowing cost growth in the health sector as a whole. ...

But it's too soon to conclude that the fiscal picture is hopelessly dismal. There remains the promising possibility of restraining health-care costs without incurring adverse health consequences. It may even be possible in some cases to reduce cost growth and improve health at the same time. Costs per beneficiary in Medicare, for example, vary substantially across the U.S. for reasons that cannot be explained fully by the characteristics of the patients or price levels in different areas.

High-spending regions do not generate better health outcomes, on average, than the lower-spending ones. ... Some academic research suggests that national costs for health care can be reduced by perhaps 30% without harming quality. ...

Here's a graph and accompanying report.

"Productivity vs. Employment Growth: A Zero-Sum Game?"

New Economist discusses a new paper by Ian Dew-Becker and Robert J. Gordon on a potential tradeoff between employment growth and productivity growth, and what it could mean for growth policy:

Productivity vs employment growth: a zero-sum game?, by New Economist: All economists know productivity matters. But they also know it isn't easy to measure, nor to explain the often large and persistent productivity gaps between nations. A new paper by Harvard's Ian Dew-Becker and Northwestern University's Robert J. Gordon makes a provocative contribution to the productivity debate. Presented at a meeting of the NBER Program on Technological Progress and Productivity Measurement in Boston last week, the authors argue there is a "strong negative tradeoff between productivity and employment growth". The ... paper [is] The Role of Labour‐Market Changes In the Slowdown of European Productivity Growth...

The policy implications of their research are stark:

The strong evidence that we find for a productivity‐employment growth tradeoff changes the questions that European policymakers should be asking. They should no longer ask how they should boost productivity growth or raise employment growth. Most policies will push productivity and employment in opposite directions, and we have shown that these offsetting effects make the effects of policies on growth in output per capita ambiguous. Our new policy framework suggests that policy changes be assessed as much on their effects on government budgets as on productivity or employment, since the productivity-employment tradeoff causes some policy changes to have a negligible effect on growth in output per capita.

I'm not sure I'd necessarily agree with the authors 'zero sum' conclusions. There are for example some economies which perform better on both productivity and employment growth than others; so it's not always such a direct trade-off. One implication - that higher employment rates or higher productivity in large part reflect different national preferences - has certainly been argued before. But if their general 'zero-sum' argument proves to be more the rule than the exception, it has profound implications for policy makers throughout the OECD - especially in Europe.

Update: In comments, Ian Dew-Becker says:

I guess I should probably make it clear that we never in the paper say that anything is "zero-sum" or that raising employment by 1% lowers productivity by an equal amount. Nor do we say that there are never times when both productivity and employment rise. What we simply do is ask what happens if there is an *exogenous* change in employment. In that case, theory tells us that we should expect productivity to fall by about 1/3 of one percent for every 1% rise in employment. Our point estimates are closer to 2/3, but they have large standard errors. We directly address the criticism that there can be times when technological improvements raise employment and productivity simultaneously. A good chunk of the paper is spent on statistical methods to deal with that problem.

The FOMC Cuts the Federal Funds Rate to 4.25%

No real surprise - the Fed lowered the federal funds rate by a quarter point - but the details are more interesting.

  • The Fed believes that growth is slowing and that strains on financial markets have increased recently.
  • There is still some inflation risk, but it is not emphasized as much as in previous statements.
  • There was one dissent, with Boston president Eric Rosengren preferring a more aggressive half point cut (the vote was 9-1, there are two open positions on the Committee).
  • The Fed dropped its balanced risk statement and now says it will act as necessary.
  • Only seven banks requested a quarter point decrease in the discount rate. Assuming that Boston requested a half point cut, that leaves four banks (Dallas, Kansas City, Minneapolis, and San Francisco) who either requested no cut, or a half point cut (or perhaps some other action, though that's unlikely). My guess is three requested no cut (Dallas, Kansas City, and Minneapolis), and one a half point cut (San Francisco), but there's no way to know for sure until the minutes are released. [Update: The WSJ's Economics blog sees it the same way.]

Here's the Press Release:

Press Release Release Date: December 11, 2007 For immediate release

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/4 percent.

Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time.

Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; and Kevin M. Warsh. Voting against was Eric S. Rosengren, who preferred to lower the target for the federal funds rate by 50 basis points at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 4-3/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, and St. Louis.

"The Real Story is Fraud"

Angry Bear's rdan points to this commentary on the motivation for the Paulson subprime mortgage plan. I don't know if there's anything to these accusations or not, but if they're correct, there are reasons for concern:

Interest rate 'freeze' - the real story is fraud, by Sean Olender, Commentary, SFGate: New proposals to ease our great mortgage meltdown keep rolling in. ... Now, just unveiled Thursday, comes the "freeze"... But unfortunately, the "freeze" is just another fraud - and like the other bailout proposals, it has nothing to do with U.S. house prices, with "working families," keeping people in their homes or any of that nonsense.

The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth.

The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.

And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it. I can hear the hum of shredders working overtime...

Despite Thursday's ballyhooed new deal with mortgage lenders, does anyone really think that it can ultimately stop fraud lawsuits by mortgage bond investors, many of them spread out across the globe?

The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC. ...

As home prices fall, defaults will rise sharply - period. And so will the patience of mortgage bondholders. Different classes of mortgage bonds from various risk pools are owned by different central banks, funds, pensions and investors all over the world. Even your pension or 401(k) might have some of these bonds in it.

Perhaps some U.S. government department can make veiled threats to foreign countries to suggest they will suffer unpleasant consequences if their largest holders (central banks and investment funds) don't go along with the plan, but how could it be possible to strong-arm everyone?

What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back. The time to look into this is before the shredders have worked their magic - not five years from now. ...

The goal of the freeze may be to delay bond investors from suing by putting off the big foreclosure wave for several years. But it may also be to stop bond investors from suing. If the investors agreed to loan modifications ..., mortgage originators and bundlers would have an excuse once the foreclosure occurred. They could say, "Fraud? What fraud?! You knew the borrower's real income and asset information later when he refinanced!"

The key is to refinance borrowers whose current loans involved fraud in the origination process. And I assure you it was a minority of borrowers whose loans didn't involve fraud.

The government is trying to accomplish wide-scale refinancing by tricking bond investors, or by tricking U.S. taxpayers. Guess who will foot the bill now that the FHA is entering the fray?

Ultimately, the people in these secret Paulson meetings were probably less worried about saving the mortgage market than with saving themselves. Some might be looking at prison time. ...

It is truly amazing that right now everyone in the country is deferring to Paulson and the heads of Countrywide, JPMorgan, Bank of America and others as the best group to work out a solution to this problem. No one is talking about the fact that these people created the problem and profited to the tune of hundreds of billions of dollars from it.

I suspect that such a group first sat down and tried to figure out how to protect their financial interests and avoid criminal liability. And then when they agreed on the plan, they decided to sell it as "helping working families stay in their homes." That's why these meetings were secret, and reporters and the public weren't invited. ...

We are on the cusp of a mammoth financial crisis, and the Federal Reserve and the U.S. Treasury are trying to limit the liability of their banking friends under the guise of trying to help borrowers. At stake is nothing short of the continued existence of the U.S. banking system.

Update: Felix Salmon reacts strongly - and negatively - to the editorial.

links for 2007-12-11

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