I don't understand Gillian Tett's article in the Financial Times

She writes:

Reality of America’s fiscal mess starting to bite

By Gillian Tett

Published: June 17 2010 16:15 | Last updated: June 17 2010 16:58

If you pop into a toilet on the Seattle waterfront this summer, you might see over-flowing bins. The reason? A polite notice explains that “because of 2010 budget reductions”, the Seattle government can no longer afford to “service this comfort station” each day. Hence the dirt.

Investors would do well to take note. In recent months, America’s fiscal mess has assumed a rather surreal air. On paper, the country’s federal-level deficit and debt numbers certainly look very scary. But in practical terms, the impact of those ever-swelling zeroes still seems distinctly abstract.

After all, so far the federal government has not been slashing spending; on the contrary, there was a stimulus bill last year. And, as my colleague John Plender pointed out this week, Treasury bond yields have been falling as investors flee the eurozone woes. As a result, those scary numbers still seem to be a problem primarily concocted in the world of cyber finance.

But there is one place where reality is already starting to bite in America and that is in terms of state finances. Just look at the statistics. A report from the US Center on Budget and Policy Priorities issued last month estimates that in fiscal 2010 the US states collectively posted a $200bn-odd budget shortfall, equivalent to 30 per cent of all state budgets.

Last year, that pain was partly eased by Barack Obama’s stimulus package(s). But that spending splurge is now fading away. And in fiscal 2011 and 2012, the states are expected to face another combined budget deficit of $260bn, with the 2011 shortfall in places such as New Jersey, Illinois, Nevada and Arizona projected to be more than 35 per cent of last year’s budget.

So far, the municipal bond market has been dangerously complacent about all this, with yields on 10-year municipal bonds hovering just above 3 per cent. But even if markets seem relatively relaxed, the key point is that the state statistics are already having a very real world impact – in contrast to the federal debt.

Never mind the trivial matter of Seattle’s comfort stations; as it happens, Washington State’s finances are better than most. In New Jersey schools, classes are being cut. In California, public sector employees are not getting paid. In New York, a subway extension has just been cancelled. And in places such as Illinois and San Diego, pension benefits are being renegotiated altogether, breaking numerous taboos.

This, in turn, begs a bigger question: what will be the wider economic and psychologal impact? One obvious, immediate consequence of these cuts is that they appear to be undermining consumer confidence, over and above the damage already being inflicted by the stubbornly high unemployment rate. The pattern may also be fuelling some subtle shifts in terms of how investors view the future.

In Seattle, for example, local insurance companies have recently changed the message they are giving to customers. For though financial planners used to steer households into tax-deferred products (such as 401K), since they assumed that employees would pay lower taxes when they retired, the new mantra is “tax diversification”. That is based around the idea that households should not defer tax payments, since taxes wll inevitably rise in the future, as the fiscal squeeze takes hold. And that, in turn, raises another question: namely what all of this real-world squeeze in Seattle (and eslewhere) might - or might not - do to the bigger debate about the federal debt.

It is a fair bet that eventually the debate about state spending cuts will encourage investors and voters to start paying more attention to the seemingly abstract federal fiscal numbers.

That might spark more market upheaval. it might also create more political upheaval. Just look at the rise of the Tea Party for signs of that.

But if you want to be optimistic, it is also possible to put a more upbeat spin on this. For all the gloomy statistics about state deficits and spending cuts, what has not received as much attention is that some states are now trying proactively to tackle their woes. Illinois, for example, is facing a big crunch due to credit downgrades; but it is also doing some imaginative things, such as raising the retirement age for local state employees.

That may not please voters. Nor will it necessarily save Illinois from further downgrades to its debt. But this is the type of step that needs to embraced at the federal level, too. So if places such as Illinois can actually break these taboos, it could be a reason for cheer; conversely, if it sparks too much social unrest, it will be a powerful warning sign. Either way, holders of US Treasury bonds had better keep a close watch on what happens to state budgets this year; even in the all-too-tangible world of the Seattle waterfront.

She seems to be saying that large deficits and debt are a problem at the state level and this signals that trouble may be brewing over federal debt as well. She takes some comfort in the fact that states like Illinois are making some tough budget cuts, and hopes that the federal government can do this too. She is warning us, I think, that although standard indicators like interest rates on Treasury bonds do not suggest that bond markets think there's a problem with the federal debt right now, trouble is right around the corner.

But her article actually provides strong anecdotal evidence that it is not large deficits and soaring debt that are a problem, but efforts to cut those deficits and debt during a recession. It is the spending cuts that are having an impact on consumer confidence, not the deficits. This is an excellent argument for another round of federal government support for state budgets; why doesn't she come right out and say that?

Live versus internet instruction

Dave Figlio, Mark Rush, and Lu Yin report in an NBER working paper that students randomly assigned to live lectures generally do as well or better than students who get their lectures over the internet. Male students, Hispanic students, and underachieving students seem to do better getting their lectures live.

I'd like to know if a live-internet hybrid would suit our students better. Specifically, I think there are dozens, perhaps hundreds of instructors out there who can deliver a canned Econ 101 lecture better than I can ("better" defined in terms of smooth delivery, clever one-liners, pretty charts, and so on). The comparative advantage of the real live instructor, I believe, is in answering questions, recognizing a quizzical look on a student's face and probing him to see what is puzzling him, connecting one student's comments to another's, connecting the lecture material to today's news or something happening on campus or in students' lives. Wouldn't students be better off if they watched canned lectures on Youtube and I organized classes more like the tutorial sections I taught in grad school?

Next: the virtues of outsourcing the grading of exams and papers.

The politics of financial reform

I'm having a hard time figuring out Congress' motivations regarding financial reform. While Congress worked on health reform my political science colleague and I discussed the infuriating behavior of "moderate" Democrats in light of two competing theories of Congressional behavior. One theory holds that our representatives in Congress are intensely concerned with appealing to the median voter in their districts. They will not act on principle if doing so leaves them even minutely vulnerable to defeat in a primary or general election. Thus Ben Nelson, Blanche Lincoln and the like dug in their heals against the public option and other key parts of the reform package because their constituents opposed these provisions. An alternative theory is that our Congressional representatives seek to retain their seats in a less direct manner. Their goal is to maximize campaign donations, ordinarily from special interests of one kind or another, in order to build up a campaign war chest that will ensure victory and/or discourage viable opponents from running. Thus Max Baucus' goal in negotiating with the Republicans on the Senate Finance committee in the summer of 2009 was not to reach bipartisan agreement on a bill, but to string negotiations along as long as possible in order to squeeze campaign contributions out of the health care lobbies. Ben Nelson was responding to the interests of Mutual of Omaha, not the median Nebraska voter.

Now comes financial reform. At the end of 2009 the House of Representatives, typically, passed a fairly aggressive reform package. The Senate's job, it seems, is to water consequential bills down to the point of being completely toothless. In this case, however, the Senate passed a bill that in some respects (the Volcker rule, treatment of derivatives) was harsher than the bill that passed the House. The conference committee, remarkably, seems to be forgoing opportunities to weaken the bill. And here is the puzzle. Bank lobbies are pouring billions of dollars into this process. According to theory number two, members of the conference committee ought to be weakening provisions right and left. Perhaps they don't because they are concerned about the likely reaction to a weakening of financial reform by the median voter in their districts - that's theory number one. But look at the issues they are debating: how much authority should the Federal Reserve have to regulate interchange rates on debit cards? Should banks be required to spin off their swaps units or can these be operated as separately capitalized subsidiaries within the same bank holding company? Can banks continue to count trust-preferred securities as Tier I capital? It's safe to say that the median voter in any Congressional district has absolutely no understanding of any of these issues, which in theory gives the conference committee members leeway to make concessions to the banking industry while claiming to their constituents that they are putting the screws to them. This seems to be happening to some extent, but by and large the provisions that are most costly to the banking industry continue to be part of the legislation. The article linked to above quotes a banking industry analyst as saying:

“Even if Congress moderates some of these provisions, they are going to be onerous,” said Jaret Seiberg, an analyst with Washington Research Group, a division of Concept Capital. “We continue to believe on issues like interchange and derivatives that the movement will be toward the banks, even though it will be hard to describe any of this as a real victory. It just won’t be as brutal a defeat.”

So what explains Congressional behavior in this case? It's quite a mystery. It can't be that our Congressmen are acting according to principle, can it?

Mini-TARP

It would have been quite satisfying if in 2008-09, instead of recapitalizing weak and irresponsible banks under TARP, the government had taken the same money and recapitalized strong and responsible banks instead. Let Citigroup die, said I at the time; take the $25 billion you wanted to give them, and instead find some small banks out there in the hinterlands that didn't load up on subprime mortgage backed CDOs and let them use the money to take Citigroup's business away from them. Well, that plan was never going to be practical on the scale and at the pace that was required at the time, but now it seems that the Obama Administration is pushing a small-scale version of this plan. Edmund Andrews reports:

Having bailed out big banks and big car companies, Congress and President Obama now want to throw some big money at small business.

On Tuesday, the House will take up legislation that would provide $30 billion in taxpayer money to subsidize bank loans for small companies. The bill also includes billions of dollars in new tax breaks and an increase in the Small Business Administration’s loan-guarantee programs....

The biggest proposal is for a Small Business Lending Fund, a $30 billion fund that Obama first proposed in his State of the Union Address in January. The new fund would in some ways be a mini-version of the $700 billion TARP program that propped up big banks, insurers and car companies.

Like the TARP (short for Troubled Asset Relief Program), the small business lending fund is intended to spur lending by injecting capital into banks. Supporters of the new fund say it would underwrite as much as $300 billion in new small business lending, because the banks would be able to lend as much as $10 for every $1 invested by the Treasury.

Of course the idea was to do this instead of the big bank bailout, but we'll take what we can get.

Grand unified theory of everything

A quick thought on Brad DeLong's post on fiscal austerity and link to post on EPA regulations on carbon emissions. The Obama Administration would solve a number of problems in a couple of fell swoops if it (1) had the EPA draw up a state-level cap-and-trade system for carbon emissions to be phased in beginning in say 2012; (2) introduced legislation imposing a carbon tax phased in beginning in say 2012, with the proviso that proceeds would be used first for reducing the budget deficit, and offset by a payroll tax reduction only if the deficit was under control; (3) sell a bunch of gold to the world's insatiable gold bugs and use the proceeds to pass a "clean jobs bill" focused on teachers, cops, firefighters, and oil spill cleanup. We'll get BP to reimburse us for the cleanup later, if they've got any money left.

Ironic bumpersticker

From FAIL Blog.

How to pay for fiscal stimulus

Congress is dithering over a second fiscal stimulus bill that would among other things extend unemployment benefits and give money to states to avoid layoffs of teachers and other employees. A small number of misguided Senators and Congressmen are holding up progress on the bill because of concerns over its effect on the budget deficit. Here's a suggestion: the Treasury owns 261 million ounces of gold that it holds at the Federal Reserve and that appears on the asset side of the Fed's balance sheet (it is quaintly valued at $42 per ounce, the par value when the US officially abandoned the gold standard in 1973). Gold sells for $1250 per ounce today, meaning the US holdings are worth about $327 billion. I think you can see where I'm going with this...

The idea of selling off US gold reserves has been raised before, but dismissed for reasons I have a hard time understanding. This article, for example, gives a number of nonsensical reasons we haven't done it yet:

"If we started selling gold from our official reserves, it would be recognized as a sign of weakness for the dollar," said Jeffrey Nichols, managing director of American Precious Metals Advisors and senior economic advisor to Rosland Capital. "America's relatively large gold holdings provide some psychological benefit to our currency."

That's an awfully high price to pay for an imagined "psychological benefit." There is no reason that a sale of gold to fund spending on teachers would call the dollar's stability into question.

"Geithner doesn't want to be the Treasury secretary that sells gold at $1,100 an ounce and next year it's at $2,000," said Shelton.

So is there a magic number at which the Treasury will sell? I'm guessing not. I'd rather have $1100 an ounce (now $1250) than $0.

Furthermore, a sale of all the country's gold wouldn't make much of an impact. With the nation's annual deficit at $1.7 trillion, a $787 billion stimulus package and a $700 billion bank bailout, $300 billion is kind of puny in comparison.

"The Fed has plenty of tools to pump money into the economy; it doesn't need to sell gold to do it," said Lyle Gramley, a former Fed governor. "The government has its gold by historic accident, but there's no reason why they'd sell it -- there's no motivation."

But now there is a motivation. Apparently your kid won't have a teacher next fall unless Congress can be persuaded that her salary won't increase the budget deficit.

But most of all, a sale of the government's gold would be especially poorly timed now, since foreign central banks are lining up to add gold to their reserves. As a result, experts say a mass-sale of gold would mostly end up in other nation's coffers.

That could spell disaster for the U.S. government, which is trying to finance its economic rescue packages by selling record amounts of debt to foreign countries in the form of Treasury securities. As gold holdings take up a larger percentage of foreign reserves, Treasury holdings could be reduced.

Crazy. Private investors and central banks crave a safe, liquid asset. They are willing to pay a premium for such assets. The Federal Reserve is sitting on hundreds of billions of them. There is no reason not to provide the market what it wants. Especially if doing so helps fund the jobs programs that we need to recover from the recession.

Superfreakonomics - the animated version

Should we panic about jobs?

Analysts and stock markets around the world are clearly panicked about the disappointing May jobs numbers. Paul Krugman is warning once again about a "lost decade" scenario as a result of the G-20's apparent determination to begin a fiscal retrenchment before the recovery has found its legs. Commentators on CNBC Friday took the jobs report as evidence of a jobless recovery.

One element of the report that has not received as much attention as it should, however, is the increase in hours worked. The BLS's measure of aggregate hours worked increased by 0.3 (in May, below the increase of 0.4 in March and April but still not bad. For the first five months of 2010 hours worked has increased at an annual rate of 3.4 percent. This is hardly a blistering pace, but it is significantly better than what the US experienced after the 1990-91 and 2001 recessions. Following the 2001 recession, for example, the US did not achieve a sustained pace of hours increases at this level until early 2006. We are certainly not experiencing the kind of rebound we did in 1983-84 when hours worked in some quarters rose at 8 or 9 percent, but 3.4 percent is still consistent with a sustained recovery. Add a guess of 1.5% for productivity growth, and we're looking at GDP growth of 5 percent - in the same range as what the ISM numbers indicate as noted in an earlier post.

One thing that appears to be happening is that the increase in hours worked is affecting the average work week more than employment; as the work week hits normal this summer we should see a pickup in job creation. The big decline in workers working part time as reported in the household survey suggests a shift from temporary work to full-time work. This is obviously good news for the economy, but it does not show up in the headline employment numbers.

That said, however, there are real concerns as to whether the recovery is sustainable at this point given what's happening in Europe. And the economy is in such a deep hole that we really shouldn't be satisfied with GDP growth in the 4-5 percent range, if that's what we're looking at now.

Responses to the Great Recession: What Worked, What Didn't

Download now or preview on posterous

Alumni College Lecture 6-10.pdf (1175 KB)

Posted via email from Maynard

Time to get out of the forecasting business

The BLS jobs report was much bleaker than I had thought it would be. One can't overreact to every squiggle in the data, but the May employment numbers provide no evidence for the robust recovery scenario. Highlights:

Payroll employment: +431,000, of which 411,000 are temporary Census workers; I had thought it would be closer to +700,000

Private nonfarm payroll employment: +41,000 - close to the much-maligned ADP figure

Unemployment rate: down to 9.7%, but largely due to unemployed workers (net) dropping out of labor force

Employment from household survey: -35,000

Unemployment from household survey: -287,000

Labor force: -322

The one bright spot in the report: aggregate weekly hours rose by 0.3 percent following 0.4 percent increases in March and April. The economy continues to use more labor, but is finding it by increasing average weekly hours worked rather than new employees.

Bottom line: I can continue to be a contrarian for at least one more month.

The ADP numbers are missing the increase in BLS employment

ADP reported today that private non-farm employment increased by 55,000 in May. ADP is widely thought of as a good predictor of the BLS figure which comes out tomorrow. But lately the ADP numbers have been way off, as the graph below shows. Last month, for example, ADP showed an increase of 32,000 - two days later the BLS came out with an increase of 231,000. Since January ADP has understated the BLS numbers by about half a million jobs. The difference between ADP and BLS numbers appears to be larger and more persistent now than it was in 2009; I wonder why. At any rate, the fact that ADP is predicting sluggish jobs growth is not convincing evidence that the BLS number will not be large.

Blog posts I never finished reading

From Atlas Shrugs:

John McCormack at the Weekly Standard has obtained an advance copy of Governor Palin's imminent Facebook Post:...........

GDP growth and ISM figures

The Institute for Supply Management reports that its purchasing managers index for manufacturing was 59.7% in May. Its non-manufacturing business activity index was 61.1%. Numbers above 50 indicate expansion in that sector. I ran a regression of quarterly GDP growth on quarterly average manufacturing PMI and non-manufacturing BAI and I get:

GDP growth = 0.58+0.09*(PMI-50)+0.28*(BAI-50)

Plugging in a guess of 60 in each index for 2010Q2 (which is now two-thirds over), I get 2010Q2 GDP growth = 4.2%. Let's guess productivity growth = 1.5% at an annual rate; that gives us 2.7% growth in employment (annualized) or 300,000 net new jobs per month (we had +290,000 in April). Sounds right to me.

Adventures in pivoting

President Obama apparently is trying to take advantage of the BP oil spill to push for "clean energy" legislation. As a card-carrying environmentalist and policy wonk egghead, I wholeheartedly approve. But right now more Americans are worried about jobs than clean energy, and the president could do himself more good by pivoting toward the jobs bill that is currently languishing in the Senate than the energy bills that are currently languishing in the Senate (the Senate: where good policy initiatives go to languish).

So President Obama, go out on the hustings today and propose a "clean jobs bill": strip out the "doc fix" and research tax credit extension and other garbage from the Senate bill and replace it with funding to hire - pick a number, say 100,000 - people to spend the summer cleaning up the coastal areas in Louisiana, Mississippi, Alabama, and (coming soon) Florida. Challenge Congress to pass the jobs bill - jobs for teachers, firefighters, cops, and oil cleanup crews - right now. Dare Republicans to stand in the way over concerns for the deficit.

Simple extrapolation again

Calculated Risk previews Friday's jobs report. The consensus forecast is for an increase in employment of around 540,000, about 400,000 of which are temporary Census jobs (the Census will start cutting employment in June, so from then on Census hiring will reduce the employment numbers. Since government employment has been roughly stagnant for the past year, the experts are essentially forecasting an increase in private sector employment of 130,000 to 150,000.

The 130-150,000 forecast is an argument that the current recovery will look something like the recovery that began in 2003. The experts could be right. But simple extrapolation of the trend begun last spring would suggest that private sector employment will rise by 60,000 more than it rose last month, or roughly 290,000. That would give us a headline number of close to 700,000, plus or minus whatever happens with non-Census government employment. Is there any good reason to believe that private sector employment grew more slowly in May than in April? I don't see any, so I'll go with +290,000 private sector, +700,000 overall.

Gaza

Running an illegal blockade to bring food and medicine to starving civilians is a noble act. But my idea of "peace activists" is people who engage in nonviolent resistance to show the world the inhumanity of their opponents. Beating soldiers with metal pipes as they try to detain you tells me that whoever they are, the people on the flotilla trying to bring aid to Gaza are not "peace activists."