Krugman on Posen on TARP

Paul Krugman has an interesting quote from Adam Posen's testimony tomorrow before the Joint Economic Committee (Princeton must have a time machine):

The guarantees that the US government has already extended to the banks in the last year, and the insufficient (though large) capital injections without government control or adequate conditionality also already given under TARP, closely mimic those given by the Japanese government in the mid-1990s to keep their major banks open without having to recognize specific failures and losses. The result then, and the emerging result now, is that the banks’ top management simply burns through that cash, socializing the losses for the taxpayer, grabbing any rare gains for management payouts or shareholder dividends, and ending up still undercapitalized. Pretending that distressed assets are worth more than they actually are today for regulatory purposes persuades no one besides the regulators, and just gives the banks more taxpayer money to spend down, and more time to impose a credit crunch.

These kind of half-measures to keep banks open rather than disciplined are precisely what the Japanese Ministry of Finance engaged in from their bubble’s burst in 1992 through to 1998 …

The U.S. is very good at lecturing other countries on how to stabilize their economies during a crisis, not so good at following our own advice. There seems to be an irresistable political dynamic at work here that is common across countries and political institutions. Every single opportunity for self-denial must first be exhausted before serious restructuring is attempted.

Another political dynamic seems to be at work regarding fiscal policy. FDR embarked on a (modest) fiscal expansion in 1933 to fight the Great Depression. After four years of small budget deficits and an economy in recovery, he tightened fiscal policy in 1937. Result (a monetary contraction contributed too): another recession and a delay in the road to full employment until 1942.

In 1992 Japan's stock and real estate markets collapsed. The Japanese government embarked on an ambitious fiscal expansion. The economy began to improve. In 1996 the government stopped the fiscal expansion and in 1997 raised consumption taxes. The result: a decline in consumption spending and another recession.

In 2009 the U.S. adopted an ambitious program of fiscal stimulus. By 2010 (I've borrowed Krugman's time machine here) the economy had begun to recover. Under pressure to rein in budget deficits and in an attempt to fulfill his pledge to cut the budget deficit in half by the end of his first term, in 2012 President Obama cut spending and raised taxes. The result...

We are the world

People, Harvard University's Department of Economics is in trouble! Greg Mankiw pleads for more resources:

I am confident we in the economics department would be happy to hire more faculty if only the university would allocate us more faculty slots. In a world of finite resources, the question becomes, where would those faculty slots come from? I would be eager to hear from the students which departments they think should shrink...

There is one final possibility: Some angel with deep pockets could give the university a wad of cash with the stipulation that it be spent on the economics department. If any would-be angels are out there reading this blog post, we in the economics department would be happy to hear from you.

Fear not Greg, the students and faculty at Gettysburg College (endowment: $200 million) are happy to come to your assistance. I have placed a cardboard receptacle outside the department office. If you have any cash or canned goods that you can contribute the the Harvard Economics Department in its time of need, please place them there. I thank you.

A Tale of Two Countries

France bails out its automakers:

French President Nicolas Sarkozy's office unveiled an auto industry plan late Monday afternoon that would include credit lines of 3.0 billion euros ($3.9 billion) each for Renault and Peugeot Citroen...

The loans will last five years and include conditions such as a halt to layoffs, the exclusion of major restructuring plans and a suspension of factory closures in France during the period of the credit. The state will make the lines of credit available at an interest rate of 6.0%. The French government will reportedly not be a stakeholder in the companies.

Peugeot has said it will not close any plants or cut any jobs in France...

The United States bails out its automakers:

G.M. will file what is expected to be the largest restructuring plan of its 100-year history on Tuesday, a step it must take to justify its use of a $13.4 billion loan package from the federal government.

The plan will outline in considerable detail, over as many as 900 pages, how G.M. will further cut its work force, shutter more factories in North America and reduce its lineup of brands to just four, from eight, according to executives knowledgeable about its contents...

In its overall plan, G.M. needs to show President Obama’s new cabinet-level task force that it can substantially reduce costs and make a convincing case about its long-term viability by a March 31 deadline.

The company has already extended buyout offers to its entire United States unionized work force to reduce their ranks by another 20,000 jobs. It has also announced a 14 percent reduction in salaried workers around the world, leaving many of its white-collar workers in Detroit with limited prospects.

I really don't understand what Harvard does with all its money

Greg Mankiw reports:

Another Casualty of the Crisis
Small classes at Harvard econ are disappearing:
Junior seminars in economics—the only small undergraduate courses taught by the department’s faculty—may become yet another victim of the University-wide strain borne of the financial crisis. With faculty departing and Harvard’s hiring slowdown hindering their replacement, the already stretched department does not have enough faculty members to teach the seminars, according to some department members.

Harvard's endowment was about $37 billion in June and is now probably at around $25 billion. That is, if my math is correct, still approximately 125 times Gettysburg College's endowment. With a 5% draw, Harvard can spend $1.25 billion per year just from its endowment. The income from Harvard's endowment is over six times Gettysburg's entire endowment. With some frequency Harvard receives gifts totaling half the size of Gettysburg's endowment. Compared to Harvard, Gettysburg is very very poor. Yet Gettysburg is filling positions, even expanding in some departments. How can Harvard possibly be suffering more than Gettysburg?

From now on, 5 follows 3.

I hereby retire the number 4.

Ray Fair on the stimulus package

Ray Fair used his micro-founded, somewhat Keynesian model to estimate the effects of a stimulus package to estimate the effects of a stimulus package the size of the House bill. Here's what happens to real GDP in his simulations (my graph based on his data). The green line is real GDP without stimulus (baseline), red is with stimulus (STIMUL1), and blue is the difference. The red and green lines are measured on the left scale, blue line on the right scale.

For the four year simulation period (2009-2012), real GDP is a total of $569 billion higher under the plan, which he assumes has a cost of $775 billion over that period. That's a multiplier of about 0.73. At the end of 2012 the national debt is $608 billion larger.

I'm not sure why he has output end up lower with stimulus than under the baseline scenario. It may be the dynamics of the model, and they converge in the years that follow; or he's assuming some fairly large cost of a higher government debt. If it's the latter, then the fix would be a tax increase once the economy recovers.

Below is a similar graph for the unemployment rate:

In the baseline scenario unemployment peaks at 8.8% in 2009Q4, then starts falling. With stimulus, the peak is 8.2% in 2009Q2 and it's below 8% by the fourth quarter. Fair's simulations could explain why Republicans hate this plan so much: in 2010Q3, just before the midterm elections, unemployment is 8.2 percent in the baseline scenario but only 6.6 percent with stimulus. Or am I too cynical?

A useful comparison

Menzie Chinn asks, what do these three bars represent? A very useful comparison.

Wait, here's a sensible alternative to the Democratic stimulus plan!

Greg Mankiw says, cut payroll taxes, offset with a carbon tax implemented gradually but that keeps the present value of taxes unchanged, let governors divert payroll taxes to states rather than individuals.

Where was this guy when the last administration was doing all those boneheaded things with economic policy? Oh.

Conservatives on stimulus

Democrats have proposed a large stimulus plan focused on spending increases and tax cuts mostly targeted to low income households. Conservatives in general, and Republicans in particular, do not like this plan. What do they propose in its place?

First, let's look at the cuts proposed by the Senate "centrists." Here's a list: Most of the cuts listed are for odd-sounding spending programs that cost a few tens of millions here, a few tens of millions there. It's hard to oppose removing the $100,000,000 for "subsidy for aquaculture producers for high feed input losses." But the big bucks come from cutting aid to state governments. They want to cut $40 billion from the state stabilization fund. This is absolutely insane. Every state government is talking about laying off or furloughing workers. Soon we'll be hearing about university tuition hikes, school construction delays, maybe delaying the opening of schools next year. Aid to states is one of the most effective ways to stimulate the economy; it's also consistent with the conservative belief in federalism. Why do the centrists want to cut this? Meanwhile, in their hunt for wasteful spending they've completely overlooked the money added to the stimulus bill to patch the AMT. Upshot: less money for police and schools, more money for the richest 10% of the population.

Now, how about some ideas found on the cutting room floor? Here's the DeMint amendment, that won overwhelming support from Senate Republicans but did not pass.

o Permanently repeal the alternative minimum tax once and for all;
o Permanently keep the capital gains and dividends taxes at 15 percent;
o Permanently kill the Death Tax for estates under $5 million, and cut the tax rate to 15 percent for those above;
o Permanently extend the $1,000-per-child tax credit;
o Permanently repeal the marriage tax penalty;
o Permanently simplify itemized deductions to include only home mortgage interest and charitable contributions.
o Lower top marginal income rates from 35 percent to 25 percent.
o Simplify the tax code to include only two other brackets, 15 and 10 percent.
o Lower corporate tax rate as well, from 35 percent to 25 percent.

This, of course, is not stimulus - it is an attempt to complete the "reform" of the tax code begun under George W. Bush. Tried it. Didn't work too well. No reason to think it'll do any good now.

Further to the right, there's Jeffrey Miron's proposal from the libertarian perspective. Highlights:

1. Repeal the Corporate Income Tax
2. Increase Carbon Taxes While Lowering Marginal Tax
3. Moderate the Growth of Entitlements
4. Eliminate Wasteful Spending
5. Withdraw from Iraq and Afghanistan
6. Limit Union Power
7. Renew the U.S. Commitment to Free Trade
8. Expand Legal Immigration
9. Stop Bailing out Businesses that Took on Too Much Risk

Seriously, this is what this Harvard economics professor thinks will pull the economy through these troubled times. Number 2 is a fine idea, and one that should be implemented soon. It will not stimulate the economy. I'm all over #5 and #8 as well, but again - they are not stimulus. #3, 4, and 9 are likely to push the economy deeper into recession.

As John Cole says, via Brad DeLong,

I really don’t understand how bipartisanship is ever going to work when one of the parties is insane. Imagine trying to negotiate an agreement on dinner plans with your date, and you suggest Italian and she states her preference would be a meal of tire rims and anthrax. If you can figure out a way to split the difference there and find a meal you will both enjoy, you can probably figure out how bipartisanship is going to work the next few years.

Employment revisions

Bob Barbera comments on the revisions in the employment report:

Remember my assertion that revisions are in the direction of theinflection? Look at first six months of recession for payrolls, asoriginally reported and as now calibrated after benchmark revisions:

"I still think we will avoid recession, after all the jobs losses are much smaller than in any previous recession pattern." That was the lame consensus call through July. It was a product of comparing benchmark revised--and therefore fully tallied and seasonally recalibrated--data to preliminary estimates. It is a blind spot that keeps the consensus missing the recession every time!

Bob

Stimulate me!

The BLS reports that in January total employment fell by 598,000 and the unemployment rate rose to 7.6 percent. The pace of economic collapse is quickening. Paul Krugman is worried about deflation, and he is right to do so. Congress needs to pass a stimulus package right away.

I hope that the "centrists" in the Senate who are trying to "trim" $100 billion from the package are sincere in their efforts to make the bill better rather than destroy it. The fact that they're aiming at aid to states rather than tax cuts to businesses is a big red flag. And if they do come up with a compromise, I expect a healthy fraction of the Republicans in the Senate to vote for the package. Otherwise I will accuse them of attempting to sabotage the American economy to advance their political interests.

By the way, wasn't it those same "moderates" who insisted on bloating the Senate bill up with another temporary fix for the alternative minimum tax? News reports keep talking about this as if it's a benefit to the middle class, but the Tax Policy Center reports that "More than 80 percent of the benefits of this provision [the AMT "patch"] would go to the highest-income 20 percent of households, and more than half would go to the top 10 percent." The TPC also says "Although potentially justifiable on other grounds, the provision would provide virtually no economic stimulus." If the "moderates" want to keep the price tag of the stimulus package down they will eliminate the AMT patch (saving about $70 billion). Then they can introduce separate legislation to patch the AMT and replace the lost revenue with a more efficient tax.

One fewer Job Opportunity for Economists

From the JOE:


JOE ID: 20081002101
Employer: Bank of America
Position Title: Sr. Risk Loss Modeler - Home Equity Risk
Status Update: Suspended

Ferret-legging

I don't know why my lunch companions are unfamiliar with this sport. Don Katz wrote about it in Harper's Magazine, November 1992. Here are some videos.

More work to be done

The American Banker says Obama's new rules on executive compensation at banks getting TARP money are toothless:

WASHINGTON — The executive compensation guidelines President Obama released Wednesday allow the new administration to claim it is cracking down on financial firms receiving government help, but the changes are unlikely to have much impact.

The guidelines will not apply to any institution that has already received help — including Citigroup Inc., Bank of America Corp., and American International Group Inc. — and will apply going forward only to companies that get "exceptional assistance."

"It's much ado about nothing," said Brian Gardner, a political analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc.

But some observers said keeping the scope narrow was smart because overly restrictive compensation limits could have started a chain reaction that hurt the economy.

"It shows that the White House is being realistic," said Chris Low, the chief economist at First Horizon National Corp.'s FTN Financial Capital Markets. "They've weighed the options and decided that" tighter restrictions "would do more harm than good to the financial system and U.S. competitiveness in that system."

The guidelines cap pay at $500,000 for senior executives at institutions receiving extraordinary assistance, which the Treasury Department did not define but said would include the type of help given to Citi and B of A. Any compensation above that level must be paid in the form of restricted stock that vests only after the company has repaid the government.

Perhaps the weakest provisions apply to companies that get Troubled Asset Relief Program, or Tarp, funds in the future. They would face the same $500,000 executive compensation limitation but could get around it merely by publicly disclosing the higher pay and putting it to a shareholder vote. The vote, however, would not be binding. So a company could pay its executives more than $500,000 even if the shareholders rejected it — as long as it disclosed the amounts.

All companies that get government aid in the future — whether "exceptional" or not — would have to adopt procedures for reclaiming payments to the top 25 executives if they are found to have knowingly provided false information. Current clawback provisions only apply to the top five executives.

Golden parachute payments could not exceed one year's compensation for the top five executives, and boards would be required to adopt policies related to luxury expenditures.

President Obama touted the guidelines during a press conference Wednesday, saying bankers have engaged in "shameful" behavior.

"For top executives to award themselves these kinds of compensation packages in the midst of this economic crisis is not only in bad taste — it's a bad strategy, and I will not tolerate it as president," he said.
Sources viewed the move Wednesday as spade work for next week when the Treasury Department is scheduled to unveil the next phase of the financial sector's rescue. "They're trying to sell this whole thing," said Oliver Ireland, a partner at Morrison & Foerster LLP. "They're trying to make sure that the program that the Treasury is putting together to bail these banks out is politically palatable."

Many faulted the Treasury for not defining the term "senior executive" and apparently leaving out a large pool of influential employees, such as traders.

"It doesn't cover all of the right people," said Mark Flannery, banking chairman at the University of Florida. "There seems to be a very serious problem with the people who are making deals, in how they are compensated … . There are a lot of decisions made at the trader level not covered by these regulations."
FTN's Mr. Low agreed.

"The way these rules are written, most of the Street gets a free pass," he said. "I believe that's because they realized restrictions any more onerous than this are going to cause a lot more problems. But they sort of established the public mood, and now they risk sort of falling victim to it."

For the industry, however, the guidelines came as something of a relief. Some industry representatives had worried that restrictions would be applied retroactively.

Diane Casey-Landry, the chief operating officer and senior executive vice president of the American Bankers Association, said harsh restrictions could have scared away top talent.

"Obviously there has been a lot of concern, but one of the things, in order to get in the path to recovery, you need to have the right people and right compensation," she said. "There's a balancing act here. When you start talking with compensation of a star performer, a goal of management is always to retain your top employees."
Gil Schwartz, a partner in Schwartz & Ballen LLP, agreed.

"Anything that puts artificial constraints on the ability of institutions to get the right people into the right jobs is going to be problematic," he said. "It always has some type of unintended consequences on the long-term performance of the institutions."

Keefe Bruyette's Mr. Gardner said the guidelines are a victory for bankers.

"A lot of people were fearful that it was going to really drive a lot of talent away from the management ranks and that it was going to be overly burdensome and that it was going to be retroactively imposed," he said. "Well it's not retroactive, it doesn't impose burdensome restrictions on management, and it won't prevent banks from attracting talent."

Tough restrictions could have discouraged bankers from participating in Tarp at all — or encouraged them to pay back their existing Tarp money.

"When you step back from all of it, what it suggests is that the banks will have an incentive to pay the money back as soon as possible once they take it and become subject to it," said Tim McTaggart, a partner in Pepper Hamilton LLP.

Some companies are already rushing to pay money back. David Viniar, the chief financial officer at Goldman Sachs Group Inc., said Wednesday at an investor conference that the company wants to repay the $10 billion it received from the Treasury to escape any limitations that might be imposed.

It also remains possible that lawmakers could push for tougher restrictions.

House Financial Services Committee Chairman Barney Frank included a provision in a bill that passed the House last month imposing tough executive compensation rules that apply retroactively to Tarp recipients.
Sen. Claire McCaskill, D-Mo., and other lawmakers are pushing an amendment to the stimulus bill that would limit executive pay to $400,000 a year.

"I'm not sure Barney Frank and Claire McCaskill are going to be happy with the [Obama] proposal," Mr. Low said. "I don't know that it goes far enough to satisfy what they want. It certainly doesn't come close to what they asked for. I don't think this conversation is over."

Senate Banking Committee Chairman Chris Dodd said Wednesday he would also introduce an amendment to the economic stimulus package that would require the Treasury secretary to review any bonus paid to executives of Tarp recipients to determine if the payments were appropriate.

Two suggestions: (1) Capital infusions under TARP should come in part in the form of common stock. If the government owns a controlling share of these companies it can dictate the terms of compensation, striking the appropriate balance between preventing executives from running off with taxpayer dollars and retaining talented personnel. (2) If that doesn't work, set the top marginal tax rate to 100% for all income over, say, $5 million.

Barney Frank on bankers

Quoted in the American Banker:

"Here's the problem: People really hate you, and they are starting to hate us just for hanging out with you. And you have to help us deal with it. You have to avoid being stupid."

Efficiency in the public and private sectors

Greg Mankiw has been raising questions about the efficacy of Obama's stimulus package for awhile now. His latest post on the topic is this snippet on infrastructure investment in my home town:

The Problem of Hasty Public Investment
The Mikwaukee (sic) Journal Sentinal reports:
Milwaukee Public Schools would reap $88.6 million over two years for new construction under the economic stimulus package just passed by the U.S. House of Representatives - even though the district has 15 vacant school buildings, a large surplus of property and no plans for new construction....The amounts for MPS are particularly eye-catching, and not only because they are the largest in the state. Enrollment is declining every year, and the last major wave of construction in MPS - the $102 million Neighborhood School Initiative launched in 2000 - resulted in projects that are underused, have not met enrollment projections or have closed.

I will stipulate that in the rush to spend hundreds of billions of dollars in as short a time as possible much of the money is unlikely to be spent in an optimal manner. Would that a previous administration had laid some of the groundwork for this (say, by having a Treasury task force look into possible infrastructure projects). In the future it would be helpful to have a government agency maintain a catalogue of needed infrastructure projects to be funded in a semi-automatic manner during economic downturns. But for now we'll have to go to war with the army we have, not the army we want to have, and the result will be a certain amount of inefficiency.

But the problem with this particular component of the stimulus plan is not as bad as it seems from the passage in Mankiw's post. Reading on in the article, we find:

Perhaps the biggest question will be what falls under the title "construction" when rules for spending the money are finalized.

Rachel Racusen, spokeswoman for the Democratic majority on the House Education and Labor Committee, said "school modernization" might be a better label than "construction." That could include renovation of existing facilities, she said. Improving energy efficiency, dealing with environmental hazards such as asbestos and repairing roofs might all be included.

"There's probably ways the funds could be used to build 21st century classrooms," Racusen said.

It seems to be Congress' intent to give local authorities leeway in determining how this money is spent. I'm sure the MPS district can come up with useful modernization projects on which to spend the money. If the result is that some school ends up with a greenhouse for its biology classes, solar panels on its roof, a new football field, or a state-of-the-art computer lab, I'm not going to be asking for my money back.

The more fundamental issue here, however, is the different criteria by which Mankiw and other critics of the spending proposals ask us to evaluate government spending versus private spending. A project funded by government needs to demonstrate usefulness. Do we really need those solar panels on the schoolhouse roof? Isn't that a bit extravagant? Whereas the attitude seems to be that private spending is by assumption efficient - give businesses or households money and they will spend it in a way that maximizes their utility, QED.

Surely the proposition that the private sector spends money efficiently ("you know how to spend your money better than the government") has taken a beating lately. Did the recipients of the Bush tax cuts who invested their money with Bernie Madoff demonstrate the wisdom that the free marketeers ascribe to them? Was Dennis Koslowski's $2 million birthday party (complete with a vodka-pissing ice sculpture of Michaelangelo's David) a wise use of society's resources? More importantly, what can we say about the vast overinvestment in housing in the 2000s, fiber optic cable in the 1990s, and the financial system since the 1980s?

Here's a test. Suppose I proposed that as part of the stimulus package, the government pays for celebrity appearances at schools and community organizations. You want Michael Phelps to speak to your high school swim team? He's yours for an hour, and the government will pay him $175,000 per engagement. A wise use of resources? Justifiable on efficiency grounds? Probably not. But it turns out that corporate America in its wisdom is paying Michael Phelps that amount of money for personal appearances at various events, as well as paying to put his picture on cereal boxes and so on. And of course this is routine - I would guess corporations lavish hundreds of millions, maybe billions of dollars on celebrity spokesmen. Because corporations do this, is it suddenly an efficient use of resources? What is the economic theory that justifies this type of expenditures? I submit there is none. I'll be happy if someone instructs me otherwise.

Refuted economic doctrines

John Quiggin has identified five economic doctrines that "have been refuted or rendered obsolete by the financial crisis." Brad DeLong provides the links:

#1: The efficient markets hypothesis
#2: The case for privatisation
#3: The Great Moderation
#4: individual retirement accounts
#5: Trickle down

I would add: the sufficiency of monetary policy as a stabilization tool.

Damn you, Punxsutawney Phil!

The WSJ writes:

Groundhog Day 2009: How Many More Weeks of Recession?

...On Groundhog Day 2007, the economy was in tough shape, but there were hopes for a turnaround. There was a stimulus package in the works, the Federal Reserve had taken several unprecedented steps to get credit flowing again and just a quarter of economists in the monthly Journal forecasting survey said the worst of the credit crisis was still to come.

Phil came out of his hole last year, and forecast six more weeks of winter. Who could blame him for heading back to bed? By the time he was ready to come out, economists were forecasting the worst of an economic slowdown was likely to pass and things would be starting to turn up.

But it wasn’t to be. Six weeks to the day after the groundhog made his announcement, Bear Stearns collapsed, signaling a new phase to the credit crisis and much more pain ahead. Coincidence? Surely.

But it does serve as a reminder of how much can change in six weeks. There is a lot of hope that the stimulus package and a restructured bank bailout could help pull the U.S. out of the current recession, but a turnaround still is far from certain. Let’s hope that this year when Punxsutawney Phil crawls out of his hole, there isn’t another Bear Stearns waiting for him. –Phil Izzo

And here's the official proclamation:

Hear Ye Hear Ye
On Gobbler's Knob this glorious Groundhog Day, February 2nd, 2009
Punxsutawney Phil, Seer of Seers, Prognosticator of all Prognosticators
Awoke to the call of President Bill Cooper
And greeted his handlers, Ben Hughes and John Griffiths
After casting a joyful eye towards thousands of his faithful followers,
Phil proclaimed that his beloved Pittsburgh Steelers were World Champions one more time
And a bright sky above me
Showed my shadow beside me.
So 6 more weeks of winter it will be.

Damn you, Punxsutawney Phil!

Not a good reason to oppose the stimulus bill

Some commentators have obsessed about the length of the House stimulus bill:

"Heaven knows what else is in the 680-page bill." (Alabama Press Register)
"There is much to grumble about in the 680-page stimulus package the House passed last week." (Harrisburg Patriot-News)
"It is 680 pages long. According to my calculations, not one member of Congress read the entire bill before this vote." (Ben Stein, The American Spectator)
"However outraged you might be at the executives' $18 billion in bonuses, that pales in comparison to Congress' pork-filled, 680-page, $825-billion stimulus bill." (Investors Business Daily)

1. It takes a lot of ink to explain how you're going to spend $825 billion. 680 pages does not seem excessive - it's over a billion dollars a page! If I asked you for a billion dollars, wouldn't you want me to write at least a page explaining what I was going to do with it?

2. I have textbooks on my bookshelf that are over 680 pages long. I am undaunted by 680 pages.