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May 7, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View

Paul Krugman: A Money Too Far

Posted: 07 May 2010 01:08 AM PDT

Will Greece leave the euro? At present, that appears to be the only plausible alternative it has:

A Money Too Far, by Paul Krugman, Commentary, NY Times: So, is Greece the next Lehman? No. It isn't either big enough or interconnected enough to cause global financial markets to freeze up the way they did in 2008. Whatever caused that brief 1,000-point swoon in the Dow, it wasn't justified by actual events in Europe.

Nor should you take seriously analysts claiming that we're seeing the start of a run on all government debt. U.S. borrowing costs actually plunged on Thursday to their lowest level in months. ...

That's the good news. The bad news is that Greece's problems are deeper than Europe's leaders are willing to acknowledge,... and they're shared, to a lesser degree, by other European countries. Many observers now expect the Greek tragedy to end in default; I'm increasingly convinced that they're too optimistic, that default will be accompanied or followed by departure from the euro.

In some ways, this is a chronicle of a crisis foretold. I remember quipping, back when the Maastricht Treaty setting Europe on the path to the euro was signed, that they chose the wrong Dutch city for the ceremony. It should have taken place in Arnhem, the site of World War II's infamous "bridge too far," where an overly ambitious Allied battle plan ended in disaster. The problem ... is that Europe lacks some of the key attributes of a successful currency area. Above all, it lacks a central government.

Greece ...[is] in deep fiscal trouble,... despite the demonstrations, Greece's Parliament has ... approved harsh austerity measures. ... Greece's budget cuts ... will have a strong depressing effect on an already depressed economy.

So is a debt restructuring — a polite term for partial default — the answer? It wouldn't help nearly as much as many people imagine, because interest payments only account for part of Greece's budget deficit. Even if it completely stopped servicing its debt, the Greek government wouldn't free up enough money to avoid savage budget cuts.

The only thing that could seriously reduce Greek pain would be an economic recovery... If Greece had its own currency, it could try to engineer such a recovery by devaluing that currency, increasing its export competitiveness. But Greece is on the euro.

So how does this end? Logically, I see three ways Greece could stay on the euro.

First, Greek workers could redeem themselves through suffering, accepting large wage cuts that make Greece competitive enough to add jobs again. Second, the European Central Bank could engage in much more expansionary policy, among other things buying lots of government debt, and accepting — indeed welcoming — the resulting inflation; this would make adjustment in Greece and other troubled euro-zone nations much easier. Or third,... fiscally stronger European governments could offer their weaker neighbors enough aid to make the crisis bearable.

The trouble, of course, is that none of these alternatives seem politically plausible.

What remains seems unthinkable: Greece leaving the euro. But when you've ruled out everything else, that's what's left.

If it happens, it will play something like Argentina in 2001, which had a supposedly permanent, unbreakable peg to the dollar. Ending that peg was considered unthinkable for the same reasons leaving the euro seems impossible: even suggesting the possibility would risk crippling bank runs. But the bank runs happened anyway... This left the door open for devaluation, and Argentina eventually walked through that door.

If something like that happens in Greece, it will send shock waves through Europe, possibly triggering crises in other countries. But unless European leaders are able and willing to act far more boldly than anything we've seen so far, that's where this is heading.

"Deficit Hawkery's Harsh Impact on Education"

Posted: 07 May 2010 12:42 AM PDT

Why are we letting this happen?:

Deficit hawkery's harsh impact on education, by Harold Meyerson, Commentary, Washington Post: ...The worst recession since the 1930s is clobbering the nation's schools. ... A recent American Association of School Administrators survey ... shows how bad things are. One-third of the districts are looking at eliminating summer school... Fourteen percent are considering going to four-day weeks (last year, just 2 percent did). Fully 62 percent anticipate increasing class size next year, up from 26 percent in the current school year. ... Nationwide, estimates of teacher layoffs range from 100,000 to 300,000, with some experts pegging the most likely number nearer the high end. ...
One of the signal accomplishments of the Obama stimulus package ... was to spare school districts from more draconian cuts. Of the $787 billion legislation, $100 billion was directed to schools; while districts still had to lay off teachers and reduce course offerings, hundreds of thousands of layoffs and other cuts were averted. ...
But the $100 billion ... is largely spent, and no omnibus second stimulus looms. One problem with the current wave of deficit hawkery is that while it purports to be concerned with the nation's long-term debt,... it endangers our short-term recovery and our long-term economic prospects. Not to mention the development of America's children.
"You can't just push the pause button on kids' education and say, 'Wait a while,' " says Iowa Democrat Tom Harkin... Yet there is little willingness in Congress to craft another broad stimulus package even though education provisions plainly enhance the nation's ability to create a globally competitive workforce. There is also little support for finding offsetting cuts or tax hikes to pay for such a bill. ...
It is a mantra of the deficit hawks that they are working to ensure their children and grandchildren will one day have the same opportunities that they have had. But right now, in real time, those same children and grandchildren are having those opportunities taken away. ...

A "Foreclosure Society"

Posted: 07 May 2010 12:33 AM PDT

It's hard to defend the home mortgage interest deduction, but if you're so inclined, feel free to try:

A tax break that is breaking us, by Edward L. Glaeser, Commentary, Boston Globe: The latest Case-Shiller housing data suggest that housing markets have now stabilized. ... This stability makes it possible to move beyond stop-gap measures and to envision fundamental reforms that will make the next housing crisis less damaging. Lowering the $1 million cap on the home mortgage interest deduction is a good place to start. ...
I'm not claiming that government policies, like the mortgage interest deduction, caused the bubble. The deduction is an old policy that has remained a constant in good times and bad. Moreover, the bubble can't be explained by low interest rates or easy mortgage approvals or high loan-to-value ratios. The historical relationship between these variables and housing prices is just not large enough to explain either the boom or bust. America's great housing convulsion is best seen as an enormous, almost inexplicable whirlwind that was created by ebullient, but incorrect, beliefs about never-ending home price appreciation.
But while government policies cannot be blamed for the bubble, they did exacerbate its damage. For decades, the home mortgage interest deduction and government-subsidized institutions like Fannie Mae and Freddie Mac have made mortgages artificially inexpensive. This subsidy encouraged homebuyers to borrow like mad and tie their fortunes to the housing market.
During the boom, these policies were thought to lead Americans to accumulate housing wealth and create an "ownership society.'' We now know that encouraging people to borrow to buy homes can just as easily lead towards a "foreclosure society"...
The home mortgage interest deduction also subsidizes Americans to buy bigger homes... In an age of global warming, why should we subsidize the greater energy use inherent in larger homes? There is a powerful connection between structure type and ownership, which means that encouraging homeownership implicitly encourages sprawl..., which is bad for cities, bad for traffic congestion and bad for carbon emissions.
The mortgage interest deduction is also extremely regressive. ... Now that prices have stabilized, we can imagine slowly leading this political sacred cow towards a good stockyard. The interest deduction currently has an upper limit of $1 million. That limit could be reduced by $100,000 per year over the next seven years, which would lead to a less regressive $300,000 cap. After that point, we could consider replacing the interest deduction altogether with a flat homeowner's tax credit that would encourage homeownership without encouraging borrowing or big houses. ...

links for 2010-05-06

Posted: 06 May 2010 11:02 PM PDT

Should Hank Paulson be Congrtulated for a Job Well-Done?

Posted: 06 May 2010 07:38 PM PDT

I see Hank Paulson is defending is policies during the financial crisis once again, e.g. see "Paulson defends actions in financial crisis."

Here's what I wrote about Hank Paulson in November 2008 when he "pats himself on he back" for a job well done:

I see it a bit different. The financial bailout was necessary, but the initial rollout was botched badly and it created a huge backlash against the bailout program by the public. That didn't have to happen, and it has made it much more difficult to do what is needed.

But that is another problem, getting the Treasury to understand what is needed, and then do it. I think the toxic asset removal program might have worked - a year ago - but they waited too long to do anything and it won't work now. Buying the assets months ago when they were at a higher value would have, essentially, recapitalized the banks and helped them to avoid insolvency. (But it also means that the government would have probably taken losses on these assets. I think the losses would have been less than they will be now when you include the deterioration in the overall economy, but taking the losses would have likely created a public backlash. Demanding a share of future profits in return for removing the toxic assets might have helped on this front.)

For the most part - in every case I can think of - Paulson generally waited until he was forced to act. After dealing with a series of problems with individual financial intermediaries that were on the brink of failure, then making a big mistake by letting Lehman fail, things got so bad he was convinced we were close to, or at the meltdown point. Given that, he had no choice but to ask for a massive bailout.

Paulson now claims the problem is too large to do anything about now, or even on October 3 when the plan was passed, though the toxic asset removal plan would of worked a couple of weeks earlier in mid September. However, as he admits, the plans weren't ready then, it took them until now to have the asset removal plans ready to go, so how could he have put the plan in place by October 3 even if congress had approved it the day he asked for it?

Instead of having plans ready, plans that that had been thought through enough so they could explain how they were supposed to work, they fiddled around with various ideas while bank balance sheets deteriorated. That left banks with a insolvency problem that needed to be addressed, but again Treasury was slow to do anything about it. They only acted when they were forced into this step and led by the nose by the British (and Paulson is now taking credit for doing this).

This financial crisis has been going on a long, long time, and they should have been planning long ago about how to deal with various contingencies. Plans should have been on the shelf and ready to go. Even now, they don't have an agreed upon plan to address the foreclosure problem, something Paulson says he has believed all along is the key to stopping the deterioration. Then why don't we have a plan? It has been in the planning stages for who knows how long, and the plans are now being abandoned since the clock has run out. It's hard not to wonder if the delaying tactics are ideologically based and intentional. Hem and haw long enough so that nothing gets done.

A committed and competent Treasury could have done a lot to help the situation, but unfortunately, that is not what we got. Let's hope the next administration makes better choices.

"Gambling with Other People's Money"

Posted: 06 May 2010 10:08 AM PDT

This paper on the cause of the financial crisis is from Russell Roberts of the Mercatus Center at George Mason University. As you might expect, it puts government front and center when it comes to assigning blame. [This summary of the paper is from an email]:

Gambling with Other People's Money, by Russell Roberts: The argument in the paper is:
1. It isn't "too big to fail" that's the problem, it's the relentless government rescue of creditors over the last three decades. That policy encouraged imprudent lending and allowed large financial institutions to become highly leveraged.
2. Shareholder losses do not reduce the moral hazard problem even when the executives making the decisions are shareholders
3. These incentives allowed execs to justify and fund enormous bonuses until they blew up their firms. Whether they planned on that or not doesn't matter. The incentives remain as long as creditors get bailed out 100 cents on the dollar.
4. Changes in regulations encouraged risk-taking by artificially encouraging the attractiveness of AAA-rated securities.
5. Changes in US housing policy helped inflate the housing bubble, particularly the expansion of Fannie and Freddie into low down payment loans.
6. The increased demand for housing resulting from Fannie and Freddie's expansion pushed up the price of housing and helped make subprime attractive to banks. But the ultimate driver of destruction was leverage. Either lenders were irrationally exuberant or were lulled into that exuberance by the persistent rescues of the previous three decades.
7. Unless we stop bailing out creditors, we will have a very fragile financial system that allocates capital unwisely and transfers money from taxpayers to very wealthy people.

I'm on the road again (to this conference), so I don't have time to say much about this -- hopefully you will -- but I disagree with the part on Fannie and Freddie's role in the crisis, e.g. see these links for several posts on this topic.

Initial Claims for Unemployment insurance Fall Slightly

Posted: 06 May 2010 09:00 AM PDT

A MoneyWatch, I give two views of recent labor market data, a pessimistic view and an optimistic view:

Initial Claims for Unemployment Insurance Fall Slightly

I also ask which of the two views you think policymakers will adopt.

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