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July 13, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View

Dynasty Trusts

Posted: 13 Jul 2010 12:42 AM PDT

An American aristocracy?:

America Builds an Aristocracy, by Ray Madoff, Commentary, NY Times: Americans have always assumed that wealth comes and goes. A poor person can work hard, become rich and pass his money on to his children and grandchildren. But then, if those descendants do not manage it wisely, they may lose it. "Shirtsleeves to shirtsleeves in three generations," the saying goes, and it conforms to our preference for meritocracy over aristocracy.
This assumption is now being undermined, however, through the increasing use of so-called dynasty trusts. These estate-planning instruments enable affluent people to provide their heirs with money and property largely free from taxes and immune to the claims of creditors ... for generations in perpetuity — truly creating an American aristocracy. ...
This type of trust is new because until very recently most states had a "rule against perpetuities," which limited the term of any family trust to about 90 years... In the mid-1990s, however, many states repealed the perpetuities rule...
What caused state legislatures to abandon a rule that had existed since the late 1600s? ...Congress ... set the stage nearly 25 years ago. In 1986, Congress instituted the generation-skipping transfer tax. This closed a loophole in the estate tax... However, in enacting this tax, Congress gave each taxpayer a $1 million exemption, which was raised over the years to $3.5 million.
Naturally, estate planners began to create trusts that could ... avoid taxes for the term of the trust. The term, however, was limited by the rule against perpetuities.
Bankers then realized that if they could persuade their state legislatures to repeal that rule (as well as state income taxes on trusts), they could attract business. And in more than a dozen states the banking lobbyists were successful..., and dynasty trusts ... were born. This did generate business. ...
Dynasty trusts can grow much larger than the $3.5 million exemption amount would suggest. A couple can, for example, put $7 million (their two $3.5 million exemptions) into a life insurance policy owned by the trust. The... trust is forever free from taxes — even when, after the death of the second spouse, the life insurance policy pays off at $100 million. Alternatively, a trust can use the $7 million as seed money for a profitable business that the trust then owns. ...
But tax breaks are not the only special advantages that dynasty trusts provide. Even more troubling, they commonly include a "spendthrift clause," which provides that trust assets cannot be reached by a beneficiary's creditors. If a beneficiary causes a car accident, for example, the victim cannot be compensated with assets from the trust, even if they are the driver's only resources. So beneficiaries are free to behave as recklessly as they like, knowing that their money is forever protected for themselves and their heirs. ...
Congress could fix the problem... Then America would not have to face the uncontrollable growth of a new aristocracy.

Congress could fix it, but will it actually do so? To me, this says a lot about where our political system has devoted its effort in recent decades. It takes valuable legislative time, staff effort, etc. to implement new legislation such as this, time that could have been spent on other pressing issues. Yet these are the kinds of things -- enabling the creation of a permanent wealthy class -- that legislators carved out time to do. There were still other issues on the legislative agenda, of course, but this is an example of how legislative effort has shifted in recent decades to satisfy particular political interests.

"Sagging Global Growth Requires Us to Act"

Posted: 13 Jul 2010 12:33 AM PDT

Nouriel Roubini and Ian Bremmer are worried about the prospects for world economic growth:

Sagging global growth requires us to act, by Nouriel Roubini and Ian Bremmer, Commentary, Financial Times: It looks as if the global economy is heading for a serious slowdown this year. ... The most realistic scenario for global growth is painful, even if we avoid a double dip. ...

Politically, this second global slowdown could not have come at a more difficult time. In the US, Democrats and Republicans will soon retreat to their corners to prepare for November's mid-term elections. Meanwhile, President Barack Obama must again persuade America's taxpayers that a new surge in government spending is needed to protect a fragile recovery – and at a moment when voters are telling pollsters that America's debt is as great a threat as terrorism.

So the president must also tell voters that the longer-term solution to America's economic insecurity involves both austerity and sacrifice. But abroad he faces an even larger problem. Mr Obama has limited leverage ... to persuade European governments to shrug off fiscal worries. These countries seem unlikely to shift from their view that events of the past year in Greece, Spain and elsewhere – and fears of further crises to come – demand that the continent must learn to live within its means. Nor should we expect much from the next G20 meeting in Seoul in November. ...

Yet ... words matter. Plans to boost government spending in the near term, and to embrace austerity in the longer term, will only become more difficult if the president fails to explain the need for them. For their part, America's Republicans need to accept that the path to a global recovery begins at home, with extended unemployment insurance and help for state and local governments.
Countries that save too much must also do their part for global demand. In particular, the Chinese leadership should recognize that failure to allow a more substantive revaluation of its currency will have serious consequences at home. ...
The eurozone needs fiscal austerity, but it also needs a level of growth best provided by an easing of monetary policy from the European Central Bank. Early debt-restructuring of insolvent members should also be on the agenda. Germany should postpone its fiscal consolidation for a couple of years to boost disposable income and consumption. Outside Europe, Japan must accelerate economic reforms.
These steps will take time. Even if all are undertaken properly, global growth will recover only slowly. But if they are not undertaken at all, the risk of a global double dip, and a new financial crisis, will grow sharply. Policymakers cannot keep kicking the can down the road for much longer.

links for 2010-07-12

Posted: 12 Jul 2010 11:01 PM PDT

Fed Watch: A Deepening Divide?

Posted: 12 Jul 2010 03:06 PM PDT

One more from Tim Duy:

A Deepening Divide?, by Tim Duy: Last week the Washington Post raised expectations that the Fed was seriously considering additional policy action:

Federal Reserve officials, increasingly concerned over signs the economic recovery is faltering, are considering new steps to bolster growth.

Today nonvoter Richmond Fed President Jeffrey Lacker pushed back hard on those expectations:

Federal Reserve Bank of Richmond President Jeffrey Lacker said any consideration of further monetary easing by U.S. central bankers "is very far away."

"It would take a very substantial, unanticipated adverse shock" for further steps at stimulus to be appropriate, Lacker told reporters today in Richmond. "Consideration of further easing steps is very far away."

And note this morning I concluded with:

My concern is that policymakers will view a retrenchment in growth as a natural "pause," simply a delay on the path the strong rebounds that have traditionally followed deep recessions.

This is not dissimilar to Lacker's interpretation of the data:

"I'm comfortable with rates where they are now," Lacker, who doesn't vote on rate decisions this year, said today at the opening of an exhibit at the Richmond Fed on the history of the central bank. "You have some surges, some slower periods. It's just going to be a choppy recovery."

Interestingly, he appeared to be joined by Governor Elizabeth Duke:

Separately, Fed Governor Elizabeth Duke said in an interview with CNBC that the central bank is "in the right place" on its monetary policy and that she sees a "moderate recovery" taking place.

It sounds as if a battle is brewing within the Fed, with the Washington Post's unnamed sources trying to keep monetary policy options open while another contingent is happy shutting down those options. Separately, Felix Salmon opines that the debate has already been decided:

Bernanke is a consensus builder, as Krugman knows, having been part of the Princeton economics department during Bernanke's tenure as its head. And it may or may not make sense for the Fed to ease much more aggressively. But so long as that remains outside the general consensus, Bernanke's not going to do it.

Salmon believes that Federal Reserve Chairman Ben Bernanke - a Republican - will not break from that party's consensus that too much has been done already. Some of Bernanke's defenders may find that paints a too narrow view of his motivations. But Salmon also notes that even Democrats are not eager for additional policy action. If the White House is not willing to push for more, why should Bernanke do so, especially when it will apparently require him to expend political capital internally?

If Salmon's thesis is correct, it is a particularly sad outcome given Bernanke's own words from 2002:

In short, Japan's deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has. Thus, I do not view the Japanese experience as evidence against the general conclusion that U.S. policymakers have the tools they need to prevent, and, if necessary, to cure a deflationary recession in the United States.

Politics could be every bit a problem in the United States as it has been in Japan. More to the point, it already is.

"Michael Perelman, International Economist Manqué"

Posted: 12 Jul 2010 02:34 PM PDT

This is from Michael Perelman, who once got very annoyed with me when I was an undergraduate over a poster I designed to advertise a seminar for a speaker he had invited to campus. At the instruction of the Department Head, I included a hammer and sickle on the poster, and that didn't go over so well:

Michael Perelman, International Economist Manqué: I see that PBS is going to broadcast a review of the world of George Shultz. I fear that they will leave out the time that Schulz was interested in promoting my career. While Secretary of State under Ronald Reagan, Schultz's son, Alex, took a class from me. At first I knew him only as a very good and personable student. Later, I discovered his family ties.

Knowing that the sins of the father should not fall on the son, I always had fun feelings for Alex. One day after returning from vacation, Alex told me that he had a number of arguments with his father based on ideas he picked up in my class. He told me that at one point his father responded, "that man should not be teaching in this country." Knowing Shultz's position as Secretary of State, I awaited a call. Was I going to be made ambassador to France? Or perhaps advising the world on a rational method of organizing society.

After a few seconds, I began to realize that no such offer was on the horizon. I would do more good remaining in Chico with the opportunity to other enlighten children of the power elite.

I never heard from Alex after he left Chico. I wish them the best and hope that did not get entangled in the dark networks of Hoover, Bechtel, or the other nefarious organizations with which his father associated.

Now that I think about it, Al Davis's son was in several of my classes (owner of the Raiders). I specifically remember him being in a very radical version of a history of economic thought class that I also took. Don't know if Michael got to him as well.

Update: Michael Perelman in comments:

I spent a lot of time with Mark Davis, who even wanted his dad to hire me to represent the Raider in their case against Oakland. I declined because I thought that the Raiders were wrong in trying to screw Oakland.

Rodrik: The Market Confidence Bugaboo

Posted: 12 Jul 2010 10:17 AM PDT

What does market confidence represent?:

The Market Confidence Bugaboo, by Dani Rodrik, Commentary, Project Syndicate: A specter is haunting Europe – the specter of "market confidence." ... Governments all over are being forced into premature fiscal retrenchment, even though unemployment remains very high and private demand shows few signs of life. Many are driven to undertake structural reforms that they don't really believe in – just because it would look bad to markets to do otherwise. ...
If you want to keep borrowing money, you need to convince your lender that you can repay. ... But in times of crisis, market confidence takes on a life of its own. It becomes an ethereal concept devoid of much real economic content. It turns into what philosophers call a "social construction" – something that is real only because we believe it to be. ...
A government's capacity and willingness to service its debt depend on an almost infinite number of present and future contingencies. They depend not just on its tax and spending plans but also on the state of the economy, the external conjuncture, and the political context. All of these are highly uncertain, and require many assumptions to reach some form of judgment about creditworthiness.
Today, markets seem to think that large fiscal deficits are the greatest threat to government solvency. Tomorrow they may think the real problem is low growth, and rue the tight fiscal policies that helped produce it.
Today, they worry about spineless governments unable to take the tough actions needed to deal with the crisis. Perhaps tomorrow they will lose sleep over the mass demonstrations and social conflicts that tough economic policies have spawned.
Few can predict which way market sentiment will move, least of all market participants themselves. Even with hindsight, it is sometimes not clear why markets go one way and not the other. Similar policies will produce different market reactions depending on the prevailing story, or fad of the moment. That is why steering the economy by the dictates of market confidence is a fool's errand.
The silver lining in all this is that, unlike economists and politicians, markets have no ideology. ... They simply want whatever "works"—whatever will produce a stable, healthy economic environment conducive to debt repayment. ...
This opens up some room for ... political leaders to take charge of their own future.  It allows them to shape the narrative that underpins market confidence, rather than play catch-up.
But to make good use of this maneuvering room, policymakers need to articulate a coherent, consistent, and credible account of what they are doing, based on both good economics and good politics. ... Their storyline needs to convince their electorates as well as the markets. If they succeed, they can pursue their own priorities and maintain market confidence at the same time.
This is where European governments (along with their economist advisors) have kept missing the boat. Rather than face up to the challenge, leaders ... ended by fetishizing the pronouncements of market analysts. In doing so, they have denied themselves economically desirable policies that have greater chance of garnering popular support.

If the present crisis gets worse, it will be political leaders that bear primary responsibility – not because they ignored markets, but because they took them too seriously.

Dani Rodrik talks about market confidence, and as he notes it is undoubtedly skittish. But I think it's also worth pointing out that in many cases, reactions to this thing called "market sentiment" are based upon what some influential group believes markets ought to be saying rather than what they are actually telling us, or on worries about how sentiment might change in the future. So it isn't always or even mostly what markets are actually saying that is driving the austerity narrative, it is based on someone's belief about what the market would be saying (or will say) if it was as smart as they are. There are some countries with real problems, and the markets are telling us that. But more generally, e.g. in the US, the narrative has been driven by people saying that markets have it wrong, or that they know for sure what markets will say in the future. It's not clear to me why these voices have prevailed over those basing their outlook on actual economic data, an examination of which groups in society have Washington's ear might be telling on this score, but I agree that "steering the economy by the dictates of market confidence" has been and continues to be a "fool's errand."

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