This site has moved to
The posts below are backup copies from the new site.

August 18, 2009

Economist's View - 5 new articles

Swiftboating Health Care Reform

The liars are winning:

...Majorities in the poll believe the plans would give health insurance coverage to illegal immigrants; would lead to a government takeover of the health system; and would use taxpayer dollars to pay for women to have abortions — all claims that nonpartisan fact-checkers say are untrue about the legislation that has emerged so far from Congress.

Forty-five percent think the reform proposals would allow the government to make decisions about when to stop providing medical care for the elderly. That also is untrue...

Do we blame ineffective messaging, effective liars, or an ineffective and complicit press? All bear responsibility, but it's not clear that even the best messaging effort can penetrate the cloud of disinformation and untruths that is allowed to persist so long as it is good for ratings. Tell lies to scare people, then when the other side howls, count on the press turning it into a circus that is more of a series of gotchas than anything resembling a debate or a search for the truth. The press needs to take a long, hard look at it's role in destroying public debate. But it won't.

"Social Security: Time to Uncap FICA..."

Brad DeLong:

Social Security: Time to Uncap FICA..., by Brad DeLong: For nearly thirty years--ever since the Republican congressional barons of 1982 begged Reagan to allow them to increase taxes and then figured out that a tax increase that would "save Social Security" was one that he would accept--the rest of the federal budget has ridden on the back of Social Security and its operating surplus. Those days were coming to an end, and it looks like the magnitude of the current crisis means that that end comes... now.
The Congressional Budget Office reports that the era of Social Security Trust Fund services is over:

Congressional Budget Office - Home Page

The smart thing to do would be for congress this fall to (a) uncap FICA--apply it to all of wage-and-salary income rather than just the bottom 90%--starting in 2012 and raise the retirement age to 70 in 2030, thus hitting those born in 1960 and later (i.e., me). And then revisit the system in a decade and see what shape it is in.
Adding-on some tax-preferred properly-incentivized individual accounts as an add-on, not a carve-out would be a good idea as well.

Some day the Social Security program will have to be tweaked. It doesn't need radical restructuring, but it does need to be nudged in the right direction. When that happens, I would rather have Democrats sitting in the driver's seat than Republicans. But it has to be Democrats I can trust.

The health care reform process will tell me a lot about whether I can trust the Obama administration to negotiate Social Security changes on my behalf. Right now, the tendency to give too much away in order to make a deal along with a tendency toward centrist or even conservative policies makes me hesitant to put full faith in the administration as my bargaining agent. For example, Brad says he would favor individual accounts that are an "add-on, not a carve-out," but once private accounts are on the table, will they be willing to give on this point and allow a small carve-out just to get a deal done (though the financial crisis has made this less worrisome since it will be a much harder sell)? I wish I could say no, never, but I can't. The administration seems willing to make such deals, and once that door is open, it could lead to further erosion in the program down the road. Maybe after I see then hold the line in the health care debate, I'll feel more confident, but that hasn't happened yet.

One final thought. If we are going to consider changing the retirement age, I hope we don't limit the discussion to people who spend most of their working lives sitting in a chair, i.e. that we allow people whose bodies have been broken by years and years of hard manual labor to have a voice in the discussions. I also hope that we consider more than simply how long people live in making this choice, and that whatever we do, people from all walks of life can still reasonably expect to enjoy a few years of active retirement after working for so many years. I'm not sure a retirement age of 70 meets this goal.

"Odd WSJ Story on Vermont"

Tim Duy turns from Fed Watcher to Press Watcher. Will more regulation in mortgage markets lead to outcomes like Vermont's?:

Odd WSJ Story on Vermont, by Tim Duy: The Wall Street Journal has an odd piece on the Vermont mortgage market today. Odd in that the thesis appears to be completely unsupported by the rest of the piece. The story begins:

In plenty of other states, Andrea Todd would have been a homeowner years ago. Here, she bought just this month -- a difference that helps explain how Vermont avoided the housing bust, and shows the possible pitfalls in President Barack Obama's plan to tighten mortgage regulation…

...Vermont's strict mortgage-lending laws largely prevented the state's residents from signing the types of dubious home loans written in other markets across the country. Its 1990s legislation made mortgage lenders warn customers when their rates were relatively high, and put the brokers who arranged loans on the hook if their customers defaulted. Now, by at least one measure, the state has the lowest foreclosure rate in the U.S.

It came at a cost. The rules also kept some Vermonters like Ms. Todd from buying homes, keeping this rural corner of New England on the sidelines of the housing boom and the economic bonanza that came with it. Vermont's 10-year growth trails the national average.

The tenor of the article is that Vermont has overregulated the mortgage market preventing…wait for it…the unforgivable error of restricting loans to those who can prove an ability to repay. Worse yet, consumers receive explicit notice of high rates and brokers are held accountable:

In laws passed between 1996 and 1998, Vermont required lenders to tell consumers when their rates were substantially higher than competitors', with notices printed on "a colored sheet of paper, chartreuse or passion pink." And in what officials believe is the first state law of its kind, Vermont declared that mortgage brokers' fiduciary responsibility was to borrowers, not lenders. This left Vermont brokers partly on the hook for loans gone sour.

The insanity. The horror. Encourage personal responsibility? Hold people accountable for their behavior? Unthinkable. While of course such policies would limit defaults, the economic consequences would be disastrous:

Vermont's economy grew 60% in the 10 years ending in 2008, just behind the 63% rate nationally, according to the Commerce Department. Vermont lagged Arizona, Nevada and California over the decade but outpaced most of its New England neighbors.

That's right, Vermont's growth trails the national average by an astounding 3 percentage points over a decade. They truly missed the economic boom. Why surely Vermont would have outpaced Arizona had it not been for the stunningly tight mortgage markets. The snow didn't have anything to do with it.

Of course, homeownership rates in Vermont are dismal. A state of renters, virtual serfs in this medieval land. The author forges bravely ahead:

Vermonters didn't see the same sharp rise in home ownership that swept much of America in recent decades, which, despite the bust, buoyed economic growth. And while part of the increase in U.S. home ownership reflected excesses in lending and borrowing, some of it represented real progress in the form of more Americans achieving the cherished goal of getting -- and keeping -- a home of their own. By 2007, the percentage of owner-occupied households as a whole reached 68.1%, up from 63.9% in 1990, according to U.S. Census data. Vermont started at a higher base but saw ownership rise just 1.1 percentage points in that span, to 73.7%.

The according to the article, the "pitfalls" amount to: Informed consumers, fewer foreclosures, healthier banks, higher rates of homeownership, and virtually no impact on average growth. Those are some "pitfalls" - truly, greater consumer financial protection would spell ruin for us all.

How Should Complex Securities Be Valued?

Should firms be forced to adopt fair-value accounting?:

Disclose the fair value of complex securities, by Robert Kaplan, Robert Merton and Scott Richard, Commentary, Financial Times: Banks and other financial institutions are lobbying against fair-value accounting for their asset holdings. They claim many of their assets are not impaired, that they intend to hold them to maturity anyway and that recent transaction prices reflect distressed sales into an illiquid market, not what the assets are actually worth. Legislatures and regulators support these arguments, preferring to conceal depressed asset prices rather than deal with the consequences of insolvent banks.
This is not the way forward..., allowing financial institutions to ignore market transactions is a bad idea. ... Markets function best when companies disclose valid information about the values of their assets and future cash flows. If companies choose not to disclose their best estimates of the fair values of their assets, market participants will make their own judgments about future cash flows and subtract a risk premium for non-disclosure. Good accounting should reduce such dead-weight losses.
This already happens in another financial sector. Mutual funds in the US now use models, rather than the last traded price, to provide estimates of the fair values of their assets that trade in overseas markets. ... In this way, the funds ensure that their shareholders do not trade at biased net asset values calculated from stale prices. ... Obtaining fair-value estimates for complex pools of asset-backed securities, of course, is not trivial. But these days it is possible for a bank's analysts to use recent market transaction prices as reference points and then adjust for the unique characteristics of the assets they actually hold...
Legislators and regulators fear that marking banks' assets down to fair-value estimates will trigger automatic actions as capital ratios deteriorate. But using accounting rules to mislead regulators with inaccurate information is a poor policy. If capital calculations are based on inaccurate values of assets, the ratios are already lower than they appear. Banks should provide regulators with the best information about their assets and liabilities and, separately, allow them the flexibility and discretion to adjust capital adequacy ratios based on the economic situation. Regulators can lower capital ratios during downturns and raise them during good economic times.
No system of disclosing the fair value of complex securities is perfect. ... But reasonable and auditable methods exist today to incorporate the information in the most recent market prices. Investors, creditors, boards and regulators need not base decisions on biased values of a company's financial assets and liabilities.

When we are experiencing an asset price bubble, we would prefer that firms value their assets at the intrinsic (true) value rather than the inflated bubble values, values that will crash when the bubble pops. However, bubbles do not always have to be positive, it's also possible for prices to deviate from intrinsic values on the low side, i.e. it's possible to have a negative bubble. In such cases, if you believe firms should use true prices rather that bubble prices when prices are above their intrinsic values, then you should also believe that the same is true when prices are below their intrinsic values. So one way to look at the question of whether current market prices are the right prices to use to value the assets on bank balance sheets is to ask whether there's reason to believe that we are in a negative bubble, i.e. if there's reason to believe that prices are artificially suppressed below their true values.

I'm not convinced that they are, but that's not a position held with much certainty, and the valuations that regulators are allowing implicitly assume that current market prices are, in fact, too low. The problem is that the true prices are not known, it's not even clear they can be estimated with any precision, and this leaves open the possibility of substantially upwardly biased valuations (the fact that we never know for sure if prices are deviating from true values is a reason to make fair-values available to those who want to use the information these valuations provide).

So there are two ways that banks balance sheets can present an overly optimistic picture. First, if the current market prices are correct, but we believe falsely that they are too low and allow firms to carry higher values on their books, then the values will be too optimistic. Second, even if the belief that current market prices are below true values, i.e. that we are in a negative bubble, is correct, it's not clear what prices we should use instead since the true price is not known. There's lots of room for firms and regulators looking to present best case scenarios to endorse overly optimistic valuations.

links for 2009-08-18

No comments: