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September 10, 2010

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Paul Krugman: Things Could Be Worse

Posted: 10 Sep 2010 02:16 AM PDT

Too little too late is better than nothing at all:

Things Could Be Worse, by Paul Krugman, Commentary, NY Times: ...In the 1990s, Japan conducted a dress rehearsal for the crisis that struck much of the world in 2008. Runaway banks fueled a bubble in land prices; when the bubble burst, these banks were severely weakened, as were the balance sheets of everyone who had borrowed in the belief that land prices would stay high. The result was protracted economic weakness.
And the policy response was too little, too late. The Bank of Japan ... was always behind the curve and persistent deflation took hold. The government propped up employment with public works programs, but its efforts were never focused enough to start a self-sustaining recovery. Banks were kept afloat, but were slow to face up to bad debts and resume lending. The result of inadequate policy was an economy that remains depressed to this day.
Yet the picture is grayish rather than pitch black. Japan's economy may be depressed, but it's not in a depression. The employment picture has been troubled... But thanks to those government job-creation plans, the country isn't suffering mass unemployment. Debt has risen, but despite constant warnings of imminent crisis — and even downgrades from rating agencies back in 2002 — the government is still able to borrow, long term, at an interest rate of only 1.1 percent.
In short, Japan's performance has been disappointing but not disastrous. And given the policy agenda of America's right, that's a performance we may wish we'd managed to match.
Like their Japanese counterparts, American policy makers initially responded to a burst bubble and a financial crisis with half-measures. ... The question is: What happens now?
Republican obstruction means that the best we can hope for in the near future are palliative measures — modest additional spending like the infrastructure program President Obama proposed this week, aid to state and local governments to help them avoid severe further cutbacks, aid to the unemployed to reduce hardship and maintain spending power.
Even with such measures, we'll be lucky to do as well as Japan did at limiting the human and economic cost of the economy's financial woes. But it's by no means certain that we'll do even that much. If the Republicans go beyond obstruction to actually setting policy — which they might if they win big in November — we'll be on our way to economic performance that makes Japan look like the promised land.
It's hard to overstate how destructive the economic ideas offered earlier this week by John Boehner, the House minority leader, would be... Basically, he proposes two things: large tax cuts for the wealthy that would increase the budget deficit while doing little to support the economy, and sharp spending cuts that would depress the economy while doing little to improve budget prospects. Fewer jobs and bigger deficits — the perfect combination.
More broadly, if Republicans regain power, they will surely do what they did during the Bush years: they won't seriously try to address the economy's troubles; they'll just use those troubles as an excuse to push the usual agenda, including Social Security privatization. They'll also surely try to repeal health reform, which would be another twofer, reducing economic security even as it increases long-term deficits.
So I find myself almost envying the Japanese. Yes, their performance has been disappointing. But things could have been worse. And the case Democrats now need to make — the case the president finally began to make in Cleveland this week — is that if Republicans regain power, things will indeed be worse. Americans, understandably, are disappointed over, frustrated with and angry about the state of the economy; but disappointment is better than disaster.

They Call Him "The Leader"

Posted: 10 Sep 2010 01:34 AM PDT

John Keefe:

Food Stamps Slated For Cuts, by John Keefe: While the numbers of people receiving food assistance through the USDA SNAP program (formerly know as food stamps) are growing, funding is set to be cut, if a bill passed by the House makes its way into law. It comes down to budget priorities, and is a preview of the "austerity" we will be seeing from federal and state governments as they try to mitigate the costs of the financial crisis and the weak economy we are all grappling with.

Yesterday I wrote about how the SNAP has grown in the past few years (see that post here). ... Mark Thoma followed up on the topic, wondering how food stamps would fare in the proposed rollbacks of federal spending declared by House Minority Leader John Boehner (Republican, Ohio). (See Mark's post here.)

Mark closes by posing:

Given all the worries Boehner and others have expressed about the bad incentives that social insurance creates, worries that are not supported by the empirical evidence on this question, is this one of the programs that would be on the chopping block? I wish a reporter would ask him that question.

Well, Mark, I'm a reporter, after reading your note I did ask, or at least tried to. I called Rep. Boehner's press people, and they switched me over to his staff. (They call him "The Leader.") I left a message, and it's been several hours but there has been no call back, and I don't expect one. In my experience politicians don't like to answer questions, they prefer to make statements, such as this one where The Leader derides recent efforts to restore jobs ...

Anyway, I wasn't able to reach Rep. Boehner's people, but here's what has already happened in the House, two weeks ago, as the Democrats who still are in the majority try to spur the economy with the shrinking funds available, and deal with the political will of Republicans:

This afternoon, the House, reconvened for a special emergency vote, passed a $26.1 billion bill providing aid to cash-strapped state governments. The bill provides $16.1 billion in Medicaid funding and $10 billion to help states keep teachers on the payroll. …

To pay for the bill - Republicans refused to cross the aisle unless the bill was entirely deficit-neutral - the Senate resorted to some controversial cuts… [M]ost controversially, it took $12 billion from future Supplemental Nutrition Assistance Program, or food stamps, funding. Senate aides stress that the cut does not cut the benefits authorized in the most recent Farm Bill. It takes from expanded benefits created in the $787 billion American Recovery and Reinvestment Act, the Feb. 2009 stimulus. ...

Rep. Rosa DeLauro (D-Conn.) has spoken out against the cut to SNAP. "This is a bitter pill to swallow," DeLauro told The Hill. "I fought very hard for the food assistance money in the Recovery Act and the fact is that participation in the food stamps program has jumped dramatically with the economic crisis, from 31.1 million persons to 38.2 million just in one year." DeLauro said she will attempt to restore the SNAP funds, though she has not specified how.

Is This Your Grandfather’s Mortgage Crisis?

Posted: 10 Sep 2010 12:26 AM PDT

Via Vox EU:

Is this your grandfather's mortgage crisis?, by Kenneth A. Snowden, Vox EU: The current mortgage crisis in the US is more severe than any since the 1930s. So it makes good sense to examine the origins, impacts, and consequences of that last great mortgage crisis great mortgage crisis – indeed many commentators have made a direct comparison between the two (see for example Eichengreen and O'Rourke 2010). The case for examining the last great crisis is especially pronounced given that the US Secretary of the Treasury has just asked Americans to "consider the challenge of how to build a more stable housing finance system" (Geithner 2010).

Yet we should be humble in taking up this challenge. We are after all reforming a mortgage system that was built on a framework that Depression-era policymakers forged in response to their own crisis. One of those policymakers was Henry Hoagland, who described the situation he faced in 1935 as a member of the Federal Home Loan Bank Board thus:

[A] tremendous surge of residential building in the [last] decade…was matched by an ever-increasing supply of homes sold on easy terms. The easy terms plan has a catch…[o]nly a small decline in prices was necessary to wipe out this equity. Unfortunately, deflationary processes are never satisfied with small declines in values. In the field of real-estate finance… we have depended so much upon credit that our whole value structure can be thrown out of balance by relatively slight shocks. When such a delicate structure is once disorganized, it is a tremendous task to get it into a position where it can again function normally. (Hoagland 1935)

This column looks back over the terrain that Hoagland described by examining how the residential mortgage market worked before 1930 and how it was changed by crisis and policy in the 1930s. It turns out that this history lesson provides some fresh perspective on today's mortgage crisis (see my accompanying paper, Snowden 2010, for more details).

A century-long view of the 1930s mortgage crisis

To place events in the 1920s and 1930s into perspective, Figure 1 presents a long-run view of developments in the housing and residential mortgage sector using annual series of non-farm residential building starts and growth rates of inflation-adjusted residential mortgage debt.

  • Between 1921 and 1929 the nominal volume of non-farm residential mortgage debt tripled, and inflation-adjusted debt grew faster than in any decade before or since.
  • The rapid expansion financed a home-building boom and an increase in the rate of home ownership from 41% to 46%.
  • Nominal mortgage debt started to contract abruptly in 1930, but remained constant in inflation-adjusted terms over the next decade as the visible manifestations of a mortgage crisis unfolded – record levels of foreclosure, widespread distress among mortgage lenders, a collapse and weak recovery in home building, large decreases in home values, and the reversal of the gains in home ownership made in the 1920s (Wheelock 2008).

Figure 1. Building starts and decadal change in CPI-deflated mortgage debt, 1910-2008

Notes: see Snowden (2010).

Figure 2 provides a companion view showing how the structure of the residential mortgage market has changed over the past century. During the 1920s, for example, the share held by institutional lenders – commercial banks, life insurance companies and, savings institutions – remained virtually constant. The big change during that decade was the rapid growth in two new forms of private real estate securities that by 1929 funded nearly 10% of the outstanding residential mortgage debt. Goetzmann and Newman (2010) examine one of these innovations: single-property real estate bonds that were used to finance commercial property, including multifamily residential projects, in large urban areas. The second form of securitisation was introduced by New York mortgage guarantee companies that issued participation certificates, similar to modern pass-through securities, on groups of mortgages that they insured and placed into trusts.

Figure 2. Shares of non-farm residential mortgage debt, 1910-2007


Notes: The Savings Institutions category includes Building & Loan Associations, mutual savings banks, Savings & Loan associations and other savings institutions. See Snowden (2010).

Against this backdrop, two striking changes in market structure occurred during the 1930s.

  • First, the share of private real estate securities gradually fell to zero.

Behind this decline, however, were decade-long liquidations of both single-property real estate bonds and guarantee mortgage companies after both innovations failed in the early 1930s. Unwinding these structures proved to be so difficult, involved, and costly that privately-sponsored mortgage insurance and securitization disappeared from the US mortgage market for decades (Snowden 1995).

  • Second was the the large impact of the Home Owners' Loan Corporation (HOLC) during the mortgage crisis (Figure 2).

This agency was created in 1933 to serve as both a bad mortgage bank – by buying distressed mortgages from private lenders – and as a loan modification program – by refinancing the mortgages it purchased with long-term, high-leverage, amortized loans. Within three short years the HOLC held mortgages on one-tenth of the nation's owner-occupied homes and only now are beginning to understand just how it worked and how well it worked (Courtemanche and Snowden 2010, Fishback et al. 2010 and Rose 2010).

A few other institutional developments during the 1930s deserve comment. One set involved Building & Loan Associations (B&Ls) which were the most important source of home mortgage debt during the 1920s, but hit hard by the onset of the crisis. Three new programs were created for B&Ls between 1932 and 1934: the mortgage loan discounting facility of the Federal Home Loan Bank System, a new system of Federal Savings & Loan charters, and an insurance program (FSLIC) for members' share accounts. Most B&Ls did not participate in these new programs and by 1941 a total of 6,000 B&Ls had failed – half of the number that had been operating in 1929. Some 4,000 of the remaining associations embraced the new system and became the core of the modern S&L industry.

A second development of note was the creation of a federal mortgage loan insurance program in 1934 through the auspices of the Federal Housing Administration (FHA). The FHA loan program was heavily used by intermediaries that were not served by the Federal Home Loan Bank System – mortgage companies, commercial banks, and life insurance companies. To provide a dedicated secondary market facility for the new insurance program, the National Housing Act of 1934 authorized federal charters to be issued to privately-financed, mortgage associations that were permitted to use FHA loans as collateral for covered mortgage bonds. Not a single private mortgage association had been chartered by 1938 and the responsibility for creating the secondary market for FHA loans was then given to the federally-funded Federal National Mortgage Association (FNMA).

How did we get here?

Figures 1 and 2 also show how the crisis of the 1930s altered the long-run development of the residential mortgage market. After WWII the portfolio lenders that were so well-supported by the new federal programs of the 1930s became dominant as Savings & Loans, commercial banks, insurance companies, and mutual savings banks held an unprecedented 80% of the nation's residential mortgage debt. Competition was limited and innovation de-emphasized within the postwar system, but all major lenders had plenty of "skin in the game" as they held mortgages that they, or close affiliates, originated and serviced. Supported by the secondary market operations of the Federal National Mortgage Association and the Federal Home Loan Bank System, this framework financed a rapid expansion in home building, mortgage debt and home ownership in the 1950s without, as shown in Figure 1, crisis or substantial instability.

The postwar mortgage system began to unravel in the late 1960s because portfolio lenders could not profitably underwrite the risks of funding long-term mortgages with fixed rates and generous prepayment privileges after the rate of inflation, and nominal interest rates, became high and variable.
While bad policy and lax regulation eventually turned the failure of this business model into the thrift debacle, the key development during the 1970s was the return of securitization. The innovation did not return as the federally-sponsored, covered mortgage bond system that had been envisioned in 1934. Instead, securitization reappeared through the operations of one federal agency (Ginnie Mae) and the two Government Sponsored Enterprises (Fannie Mae and Freddie Mac) that were carved out of secondary market facilities – the Federal National Mortgage Association and the Federal Home Loan Bank System – that had been designed in the 1930s to support portfolio lenders.

We can see in Figure 1 that the distress and change in the nation's residential mortgage market between 1970 and 1990 was accompanied by increased instability in home building and in the growth of inflation-adjusted mortgage debt. This volatility, however, was moderate by historical standards.
Figure 2 shows that agency securitization made modest inroads at first, but captured virtually all of the mortgage business lost by insurance companies and savings institutions during the 1980s. Private agencies played an important role in the process by repackaging the virtually default-free cash-flows generated by government-sponsored enterprise pass-through securities into collateralized mortgage obligations that offered investors different exposure to the prepayment and interest rate risks that were generated by the underlying pools of mortgages.

The boundaries in mortgage securitization became blurred during the 1990s in two ways.

  • First, government-sponsored enterprises began to hold large numbers of the mortgages and securities that they underwrote in their own portfolios because they could profitably fund them with debt that enjoyed an implicit federal guarantee.
  • Second, private agencies began to securitize on their own by underwriting the credit risk on pools of mortgages that the government-sponsored enterprises, at least at first, would not securitize.

After 1995 the two forces converged to generate the third great expansion of residential mortgage debt in the past century, a re-emergence of private-label securitization on a scale not seen since the 1920s, and a surge in homebuilding and homeownership. The second great mortgage crisis was just around the corner.


Courtemanche, Charles and Kenneth Snowden (2010), "Repairing a Mortgage Crisis: HOLC Lending and Its Impact on Local Housing Markets", NBER Working Paper 16245, July.

Eichengreen, Barry and Kevin H O'Rourke (2010), "A tale of two depressions: What do the new data tell us?",, 8 March.

Fishback, Price, Shawn Kantor, Alfonso Flores-Lagunes, William Horrace, and Jaret Treber (forthcoming), "The Influence of the Home Owners' Loan Corporation on Housing Markets During the 1930s", Review of Financial Studies.

Geithner, Timothy (2010), "Opening Remarks at the Conference on the Future of Housing Finance: August 18, 2010", Downloaded 8/18/10.

Goetzmann, William N and Frank Newman (2010), "Securitization in the 1920's", NBER Working Paper 15650, January.

Hoagland, Henry (1935), "The Relation of the Work of the Federal Home Loan Bank Board to Home Security and Betterment", Proceedings of the Academy of Political Science, 16(2),45-52.

Rose, Jonathan (2010), "The Incredible HOLC? Mortgage Relief during the Great Depression", Unpublished Working Paper, April.

Snowden, Kenneth (1995), "Mortgage Securitization in the U. S.: 20th Century Developments in Historical Perspective", in M Bordo and R Sylla (eds.), Anglo-American Financial Systems, New York: Irwin, 261-98.

Snowden, Kenneth (2010), "The Anatomy Of A Residential Mortgage Crisis: A Look Back To the 1930s," in L. Mitchell and A. E. Wilmarth (ed.), The Panic of 2008: Causes, Consequences and Proposals for Reform. Northampton, MA, Edward Elgar Publishing.

Wheelock, David C (2008), "The Federal Response to Home Mortgage Distress: Lessons from the Great Depression", Federal Reserve Bank of St. Louis Review, May/June, 90(3):133-48.

links for 2010-09-09

Posted: 09 Sep 2010 11:02 PM PDT

"Illegal immigration: What's the real cost to taxpayers?"

Posted: 09 Sep 2010 06:18 PM PDT

Here's a follow-up to the post on immigration and Social Security:

Illegal immigration: What's the real cost to taxpayers?, by Edward Schumacher-Matos, Commentary, Washington Post: In 1909, at the height of the last great immigration wave, when immigrants reached a peak of almost 15 percent of the U.S. population, they made up about half of all public welfare recipients. ... In the country's 30 largest cities, meanwhile, more than half of all public school students were the children of immigrants. ...
This history is forgotten in the angry debate over the cost to taxpayers of unauthorized immigrants and their children today. My recent column reporting that unauthorized immigrants were making unexpectedly large contributions to Social Security, for example, led to denunciations that I was being misleading by not looking at the total fiscal picture.
The truth is that unauthorized immigrants are probably a net burden on taxpayers in the short term, but only if you consider education as a cost and not as an investment in the nation's future, as it was seen a century ago. ...
Any fiscal look ... has to be placed in the context of overall economic contribution. Economists overwhelmingly agree that the unauthorized contribute to the nation's economic growth..., though wages for unskilled workers suffer. None of this is to say that we should allow illegal immigration. As Milton Friedman once noted, you can't have open borders and hope to maintain generous government benefits for your citizens. ...
But you ask: What is the fiscal balance, anyway? No one knows..., no definitive study has been done. ... The most insightful study remains one done by the National Research Council in 1997. ... The study found that an immigrant high school dropout -- which characterizes nearly half of today's unauthorized people -- received $89,000 more in services than he paid in taxes in his life. But an immigrant with at least some college -- a quarter of today's unauthorized -- gave $105,000 more than he got. For the high school graduates left, those who arrived during their teens or earlier were slightly profitable for the government, while the children of those who arrived later paid off the small deficit of their parents. ...
A tough federal law passed in 1996 has since cut almost all benefits to unauthorized immigrants. Even the Center for Immigration Studies, which advocates forcing out immigrants here illegally, acknowledged that the average undocumented household in 2002 received fully 46 percent less in federal benefits than an American one. But this likely would go up with legalization.
So, the main question may be: Are they deserving? Look around you at the people whose European-born ancestors were on the dole and overcrowding schools a century ago. You decide.

Rodrik: Is Chinese Mercantilism Good or Bad for Poor Countries?

Posted: 09 Sep 2010 11:07 AM PDT

Dani Rodrik argues that China's currency policy has hurt other developing countries, but "we should not hold China responsible for taking care of its own economic interests":

Is Chinese Mercantilism Good or Bad for Poor Countries?, by Dani Rodrik, Commentary, Project Syndicate: ...Discussion of China's currency ... is viewed largely as a US-China issue, and the interests of poor countries get scarcely a hearing... Yet a noticeable rise in the renminbi's value may have significant implications for developing countries. Whether they stand to gain or lose from a renminbi revaluation, however, is hotly contested. ...
 Strip away the technicalities, and the debate boils down to one fundamental question: what is the best, most sustainable growth model for low-income countries? Historically, poor regions of the world have often relied on ... exporting to other parts of the world primary products and natural resources such as agricultural produce or minerals. ...
But this model suffers from two fatal weaknesses. First, it depends heavily on rapid growth in foreign demand. When such demand falters, developing countries find themselves with ...  a protracted domestic crisis. Second, it does not stimulate economic diversification. Economies hooked on this model find themselves excessively specialized in primary products that promise little productivity growth.
Indeed, the central challenge of economic development is not foreign demand, but domestic structural change. The problem for poor countries is that they are not producing the right kinds of goods. ... The real exchange rate is of paramount importance here, as it determines the competitiveness and profitability of modern tradable activities. When developing nations are forced into overvalued currencies, entrepreneurship and investment in those activities are depressed.
From this perspective, China's currency policies not only undercut the competitiveness of African and other poor regions' industries; they also undermine those regions' fundamental growth engines. What poor nations get out of Chinese mercantilism is, at best, temporary growth of the wrong kind.
Lest we blame China too much, though, we should remember that there is little that prevents developing countries from replicating the essentials of the Chinese model. They, too, could have used their exchange rates more actively in order to stimulate industrialization and growth. True, all countries in the world cannot simultaneously undervalue their currencies. But poor nations could have shifted the "burden" onto rich countries, where, economic logic suggests, it ought to be placed.
Instead, too many developing countries have allowed their currencies to become overvalued... And they have made little systematic use of explicit industrial policies that could act as a substitute for undervaluation.

Given this, perhaps we should not hold China responsible for taking care of its own economic interests, even if it has aggravated in the process the costs of other countries' misguided currency policies.

I don't think I have anything to say about this that hasn't already been said, many times, and I'm running behind at the moment, so I am am going to leave comments to you. One question might be whether or not rich nations are, in fact, obligated to pay part of the "burden" for the development of poorer countries. If so, why, and if not, why not?

About that Ever Expanding Government Sector...

Posted: 09 Sep 2010 09:35 AM PDT

Here's a follow-up to Menzie Cinn's post showing changes in government employment since 2000: Government Employment since 1976, by Calculated Risk

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