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March 20, 2009

Economist's View - 6 new articles

"The Cyclicality of Geographic Mobility"

Chris Nekarda disagrees with Connor Dougherty's assertion that geographic mobility is procyclical, i.e. that more people move when times are good than when times are bad:

Cyclicality of Geographic Mobility, by Chris Nekarda: Connor Dougherty discusses a dramatic decline in geographic mobility during 2008 (via Economist's View):

U.S. Migration Falls Sharply, by Conor Dougherty, WSJ: Migration around the U.S. slowed to a crawl last year, especially for this decade's boom towns, as a weak housing market and job insecurity forced many Americans to stay put. ...

As asset values rose fairly steadily in the past decade, Americans young and old moved around the country in search of jobs or better weather. In many cases, people living in higher-cost housing markets such as San Francisco and New York cashed in their real-estate winnings and moved to outlying counties, or to states like Florida and Nevada, hoping to find a cheaper house and pocket the difference. Now, "people are hanging tight; they're too scared to do anything," said Mr. Frey.

Migration typically slows during recessions. But in past downturns, the slowdown has been more regional in scope, with workers fleeing weaker job markets for places where companies were still hiring. In the deep 1980s recession, for instance, laid-off auto workers fled the industrial Midwest for energy-rich states in the South with more plentiful jobs.

What's unique this time is migration has slowed almost everywhere. The sharpest year-to-year changes were among what demographers call "domestic migrants," people who moved within the U.S. That doesn't count population changes that result from births, deaths or immigration.

Although I agree with the trend behavior described above, Dougherty is incorrect about the cyclicality of geographic mobility. In fact, geographic mobility is moderately countercyclical—that is, more people move during recessions than during booms (relative to trend). This may seem counter-intuitive but makes economic sense.

Geographic mobility is a means of reallocating resources, in this case labor, to more efficient uses. In the past, 70 percent of people who move indicated having moved for economic reasons and up to 50 percent of those moves occurred because of a job separation [Lansing and Morgan (1967); Bartel (1979)]. In particular, there is a significant positive relationship between unemployment and geographic mobility [Bartel (1979); Schlottmann and Herzog Jr. (1981, 1984)]. Thus, countercyclical mobility is consistent with reallocation of idle workers across space.

I assess the cyclicality of geographic mobility in a recent working paper. I the measure the rate of geographic mobility as one minus the share of persons living at the same address one year later reported by the U.S. Census Bureau. These data come from the March supplement to the Current Population Survey, so the 2007 data do not reflect much of the distress in mortgage markets—and any concomitant effects on mobility—that began later in 2007.

Removing the low-frequency trend is important because it represents structural changes—such as demographic changes or, say, innovations in mortgage finance—that are unassociated with the business cycle. I isolate the component of the time series that moves at business cycle frequency using an unobserved components model (see paper for details). The figure below plots the cyclical component of the mobility rate together with that of the unemployment rate for comparison.


The cyclical component of mobility tends to follow the unemployment rate, indicating that more people move during recessions than during booms. This is consistent with geographic mobility as a means for reallocating idle labor to more productive uses. The contemporaneous correlation of the cyclical component of the mobility rate with the unemployment rate is 0.50, indicating moderate countercyclicality. Also note that mobility is substantially less volatile over the business cycle than unemployment.

Of course, the problems in the housing market beginning in 2007, notably the dramatic decline in prices, will undoubtedly reduce geographic mobility during this recession. This will further slow recovery because unemployed persons cannot move to areas with more favorable labor markets as easily or quickly as before.

"AIG Still Isn't Too Big to Fail"

Lucian Bebchuk says AIG is not too big to fail:

AIG Still Isn't Too Big to Fail, by Lucian Bebchuk, Commentary, WSJ: The AIG bailout -- at $170 billion and rising -- may end up as the costliest rescue of a single firm in history. There is much debate about bonuses paid to AIG's executives. But there is far too little debate on the government's willingness to back all of AIG's obligations.

The company claims any failure by the government to do so would have catastrophic consequences. This claim is exaggerated. Serious consideration should be given to forcing AIG's partners in derivative transactions -- which are mainly buyers of credit default swaps from the company -- to take a substantial haircut. ...

While AIG has thus far been able to cover derivative losses using government funds, the possibility of large additional losses must be recognized. AIG recently stated that it still has about $1.6 trillion in "notional derivatives exposure." Suppose, for example, that AIG ends up with losses equal to, say, 20% of this exposure -- that is, $320 billion. Suppose also that the value of AIG's current assets ... is $160 billion. In this scenario, the government's fully backing AIG's obligations would produce an additional loss of $160 billion for taxpayers. Should the government be prepared to do so?

The alternative would be to put AIG into Chapter 11. In this case, AIG's creditors, including its derivative counterparties, would obtain the company's assets. They would end up with a 50% recovery on their claims, bearing those $160 billion of losses themselves.

AIG recently stated that failure to meet all of the company's obligations could lead to a "run on the bank" by customers seeking to surrender insurance policies and "would have sweeping impacts across the economy." But insurance policyholders wouldn't be at risk if AIG failed to meet its obligations. The insurance subsidiaries are not responsible for the debts of their parent AIG, and insurance policy claims are backed both by the subsidiaries' required reserves and state insurance funds.

Still, what about the concern that losses to derivative counterparties -- which are now known to include major U.S. and foreign banks -- would substantially deplete the capital of some of them? That concern would be best addressed by the U.S. government (or foreign governments in the case of their banks) infusing capital directly -- in return for shares -- into the banks that need it. There is no reason to back AIG's obligations as an instrument for infusing capital (with taxpayers getting nothing in return) into, say, Goldman Sachs or Spain's Banco Santander.

It is true that the collapse of Lehman Brothers last September led to a crisis of confidence among depositors..., which had a dramatic effect on markets. Letting AIG's derivative counterparties take a significant haircut, however, should not lead to such a crisis. AIG's obligations are to derivative counterparties, not to depositors. Moreover, governments world-wide are now committed to backing fully the claims of depositors in financial institutions.

It is important to understand that the government can also employ intermediate approaches between fully backing AIG's derivative obligations and no backing. ... At a minimum, the government should conduct "stress tests," estimating potential losses in alternative scenarios, and formulate a policy on the magnitude and fraction of derivative losses it would be willing to cover. A policy that doesn't fully back AIG's obligations should be seriously considered.

Monetary policy makers often run potential policies through a wide variety of models under differing assumptions about the state of the economy, and they avoid policies that have a very bad downside even if the upside is potentially very attractive. The proposal above can be interpreted within this type of risk management approach to policy that tries to insure against really bad policy outcomes. It may very well be that financial markets can withstand the failure of AIG, but the potential downside if that assumption is wrong is very large, larger than any policymaker wants to take the blame for. Thus, in such cases, you often observe policymakers pursuing what they feel is the safest policy that moves the ball forward rather than policies that might have a better upside, but also come with the possibility of, say, market meltdown. I'm sympathetic to the argument that we should put AIG through a carefully managed failure, but saying, as above, that letting "AIG's derivative counterparties take a significant haircut ... should not lead to ... a crisis" still leaves the door open, even if only a crack, to an outcome that no policymaker wants to be responsible for.

Update: James Kwak:

Now, the government has not explicitly guaranteed AIG's liabilities. But the main reason for bailing out AIG in the first place was the fear that an uncontrolled failure would have ripple effects that would take down many other financial institutions who were dependent in some way on AIG; most commonly, they had bought insurance, in the form of credit default swaps... And a major usage of bailout money has been to make whole AIG's counterparties...

I still think it was a mistake to let Lehman fail, because of the sudden panic it created. But we are in a very different situation today. Many people now believe that the government may decide to let bank creditors lose some of their money. As Bebchuk says, instead of continually giving AIG taxpayer money that is effectively used to bail out other banks (many of which are in Europe, allowing European governments to free ride on the U.S.), the government could let AIG fail and bail out those other banks directly, thereby at least getting increased ownership stakes in return. Bebchuck also explains that AIG's insurance subsidiaries would not become insolvent if the AIG holding company went bankrupt, because they have their own reserves. ... Furthermore, he argues, failure is not an all-or-nothing proposition...

I think that the government could let AIG fail, if - and this is a big if - it can first identify which creditors and counterparties would be hurt, determine which of those cannot be allowed to fail (which should not be all of them), design a program to provide them enough capital directly, and announce everything on the same day. The net cost to the taxpayer cannot be higher than under the Too Big To Fail strategy, which implies a 100% guarantee for all counterparties and creditors...

There was clearly no time to do this between September 15 and September 16. But the government by now has had six months to study the books of AIG and its major domestic counterparties. People are no longer willing to take it on faith that the future of the free world depends on an implicit blanket guarantee for AIG. At least we want to see some evidence.

How sure are we that if we let AIG fail all of the necessary pieces - all the big and little ifs above - will fall into place, how sure are we of any evidence based upon asset valuations when there's no market price for them, and how sure are we that we've thought of all of the things that could go wrong?

"Kick Them Out"

James Kwak and Simon Johnson say the arguments made to support paying bonuses at AIG - that the bonuses are needed to retain people with specialized knowledge - do not withstand closer scrutiny. Not only can the "discredited insiders" be replaced, it's best when they are:

Off With the Bankers, by Simon Johnson and James Kwak, Commentary, NY Times: A.I.G. can hardly claim that its generous bonuses attract the best and the brightest. So instead, it defends the payments by arguing they're needed to retain employees who are crucial for winding down transactions that are "difficult to understand and manage." ... There is no reason to believe this.

Similar arguments made during the 1997 Asian financial crisis ... turned out to be a smokescreen to protect the executives who were partly responsible for the mess. Recovery from that crisis required Indonesia, South Korea and Thailand to close or consolidate banks. In all three countries, bankers protested, claiming that their connections with borrowers were critical to recovery. ...

The leaders of Thailand and South Korea did not listen to such arguments, and thank goodness. Some of the leading Thai banks were taken over by the government. After the crisis, a civil servant in charge of one such bank noted that its bad loans were much bigger than had been indicated before the takeover, largely because of an internal coverup. Only when outsiders took over did the public discover the full scope of the losses. ...

But these reforms made all the difference. Banks became healthy and resumed lending within a few years after the crisis broke. ...

Indonesia did not respond to the crisis so wisely, and the costs were severe. ... The lesson of all this is that when insiders have broken a financial institution, the most direct remedy is to kick them out. Traders are hardly in short supply, and you don't need to rely on the ones who made the toxic trades in the first place. Companies must always plan around the potential departure of even their star traders, or they are certain to fail. ...

If A.I.G. wants to argue that complex transactions, hedging positions and counterparty relationships require employees who are intimately familiar with those trades, it should at least provide evidence that the arguments for doing so are sounder than the ones made in Indonesia in 1997, when leading bank-owning conglomerates claimed that only they understood their financing arrangements... We heard variants of the same idea in Poland in 1990, Ukraine in 1994 (and in the Ukrainian crises subsequently), and Argentina in 2002.

Any grain of truth in these arguments must be weighed against the costs of allowing discredited insiders to manage institutions after they have blown them up. Even if the conclusion is that a few experts need to be retained, offering guaranteed bonuses to virtually the entire operation is hardly the way to achieve the desired results. We should not let people think that the best way to guarantee job security is to lose lots of money in a really complicated way. The argument that A.I.G.'s traders are the people that we must depend on to save the United States economy is ... weak and self-serving...

"Obama is No Socialist"

Alan Blinder is tired of hearing that Obama is "leading the country down the path of socialism":

Obama Is No Socialist, by Alan S. Blinder, Commentary, WSJ: Ever since President Barack Obama released the budget..., we have been hearing a fusillade of criticism claiming that the president ... is ... a "leftie" intent on leading the country down the path of socialism.

Let's see. Socialism means public ownership and control of businesses, right? So which industries does the president propose to nationalize?

Banking? Well, no. Secretary of the Treasury Timothy Geithner has made it clear that he opposes nationalizing banks...

What about health care? Doesn't Mr. Obama want "socialized medicine"? No. He wants to reform the current system so that it costs less and covers more people. ...

Some reformers want the U.S. to adopt a single-payer system like ... "socialist" Canada and England... But regardless of whether single-payer is a good idea, it's not Mr. Obama's. His health-insurance reform plan emphasizes choice..., greater efficiency..., and portability... Which part of that is socialist?

And ... the Obama budget recognizes, rather than hides, the need to pay the bills. Half the cost of health reform would be covered by a tax provision that has really raised a ruckus: Capping itemized deductions at the 28% bracket rate. Let's consider how socialist that idea is. ...

Suppose ... three families each pay $10,000 a year in interest on their home mortgages. The cost to the non-itemizer is the full $10,000. For the family in the 25% bracket that itemizes, the net cost ... is only $7,500. And for the upper-income family in the 35% bracket that itemizes, the net cost is a mere $6,500. Just imagine a member of Congress proposing a homeownership subsidy like that directly...: 35% to the rich, 25% to the middle class, and nothing to the poor. Would anyone support it?

Enter Mr. Obama, the alleged leftist. ... He would reduce the 35% subsidy rate to 28% -- which would still leave the costs of charitable giving, mortgage interest, and much else far lower for the rich than for the poor. That's hardly a radical proposal. Indeed, it has been under discussion since the 1980s.

It's true: The president ... proposes letting the ... the top rate ... revert to where it was during the Clinton years: 39.6%. ... Unsurprisingly, the president's proposal ... unleashed a firestorm of criticism from people who claim that such radical redistribution would prolong the recession, destroy entrepreneurship, and pretty much end capitalism as we know it -- just as it did during the Great Prosperity of the 1990s, I suppose. Some claims parody themselves.

So where does all this leave us on the road to socialism? If Mr. Obama is able to get all of these proposals through Congress, the U.S. will have a fully private banking system, propped up with temporary government support; a uniquely American health-care system that covers virtually everyone; and a somewhat more progressive income tax.

If this is socialism, then let's make the most of it.

links for 2009-03-20

"Things to Come"

Paul Krugman a little over six years ago, on 3/18/03, the eve of the Iraq war:

Things to Come, by Paul Krugman, Commentary, NY Times: Of course we'll win on the battlefield, probably with ease. I'm not a military expert, but I can do the numbers: the most recent U.S. military budget was $400 billion, while Iraq spent only $1.4 billion.

What frightens me is the aftermath — and I'm not just talking about the problems of postwar occupation. I'm worried about what will happen beyond Iraq — in the world at large, and here at home.

The members of the Bush team don't seem bothered by the enormous ill will they have generated in the rest of the world. They seem to believe that other countries will change their minds once they see cheering Iraqis welcome our troops, or that our bombs will shock and awe the whole world (not just the Iraqis), or that what the world thinks doesn't matter. They're wrong on all counts.

Victory in Iraq won't end the world's distrust of the United States, because the Bush administration has made it clear, over and over again, that it doesn't play by the rules. Remember: this administration told Europe to take a hike on global warming, told Russia to take a hike on missile defense, told developing countries to take a hike on trade in lifesaving pharmaceuticals, told Mexico to take a hike on immigration, mortally insulted the Turks and pulled out of the International Criminal Court — all in just two years.

Nor, as we've just seen, is military power a substitute for trust. Apparently the Bush administration thought it could bully the U.N. Security Council into going along with its plans; it learned otherwise. "What can the Americans do to us?" one African official asked. "Are they going to bomb us? Invade us?" ...

What scares me most, however, is the home front. Look at how this war happened. There is a case for getting tough with Iraq; bear in mind that an exasperated Clinton administration considered a bombing campaign in 1998. But it's not a case that the Bush administration ever made. Instead we got assertions about a nuclear program that turned out to be based on flawed or faked evidence; we got assertions about a link to Al Qaeda that people inside the intelligence services regard as nonsense. Yet those serial embarrassments went almost unreported by our domestic news media. So most Americans have no idea why the rest of the world doesn't trust the Bush administration's motives. And once the shooting starts, the already loud chorus that denounces any criticism as unpatriotic will become deafening.

So now the administration knows that it can make unsubstantiated claims, without paying a price when those claims prove false, and that saber-rattling gains it votes and silences opposition. Maybe it will honorably refuse to act on this dangerous knowledge. But I can't help worrying that in domestic politics, as in foreign policy, this war will turn out to have been the shape of things to come.

[See also Six Years Ago on Eve of Iraq War: Judy Miller vs. Paul Krugman which reminded me of this column.]

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