Dean Baker's Blog

The Global Warming Lie Detector

2009-06-29T21:53:27Z

The House's passage of the Waxman-Markey bill raises the possibility that the United States will finally do something on global warming. This prospect has the industry hacks screaming at top volume about the horrible fate that awaits the economy. Everyone should know not to take them seriously, as I will explain in a moment.

First, we should acknowledge the obvious: The bill is awful. It gives away permits to greenhouse gas emitters that should instead be auctioned. As a result, money that could be rebated to taxpayers or used to fund the development of clean technologies instead goes to the industries that are the source of the problem.

]]> Second, the use of tradable permits rather than a tax is a rather questionable policy. Permits will almost certainly require more government enforcement bureaucracy than a system of taxes and subsidies. And, incidentally, permits will allow Goldman Sachs and our other Wall Street friends to make tens of billions of dollars on trading fees in the coming decades, a high priority for all Americans.

But a bad bill is almost certainly better than no bill. If Waxman-Markey doesn't get through, it is very difficult to see another bill getting through this Congress. And there is no reason to believe that the Congress that gets elected in 2010 will be any less indebted to the corporate lobbyists.

The Waxman-Markey bill should be viewed as a foot in the door. It is a modest first step toward reducing greenhouse gas emissions that both demonstrates a commitment and provides an opportunity to show the public that emissions can be lowered without imposing an enormous economic burden on the country.

Of course, the only reason that so many people believe that reducing greenhouse gas emissions will impose an enormous burden on the economy is that the oil and coal industry, and their friends in the media, have been pushing this tripe for more than a decade. The Congressional Budget Office (CBO) projects that the cost of the Waxman-Markey bill at $22 billion a year in 2020. That will be equal to less than 0.1 percent of projected GDP in that year, or about $70 out of the pocket of each person in the country.

The coal and oil companies are greatly anguished over this prospective burden on American families, but let's compare this burden to the burden posed by Iraq war levels of defense spending. Two years ago, the Center for Economic and Policy Research commissioned Global Insight to use its model to project the economic impact of Iraq war levels of military spending. They projected the effect on the economy of a sustained increase in defense spending equal to 1.0 percent of GDP, an amount slightly less than the increase sustained in the years following the start of the Afghanistan and Iraq wars.

Global Insight was selected because it is one of the oldest econometric forecasting firms in the country. Its model has been widely used for a wide variety of analyses and it certainly is not associated with progressive or anti-defense politics. Its model is also very much in the mainstream of the economics profession. It will not produce results that are qualitatively different than any other mainstream model.

The model projected that after 10 years of higher spending, GDP would be down by about $17 billion from baseline levels. After 20 years (2021 if defense spending stays high), GDP would be down by more than $60 billion from baseline levels, approximately three times CBO's projection of the cost of the Waxman-Markey bill.

Of course, these projections don't show the full loss to households, since they don't include the money that must be diverted from taxes or obtained by borrowing to support the higher level of defense spending. These figures are just the lost output.

Global Insight projected that after 20 years of higher defense spending, annual car sales would be down by more than 700,000. Housing starts would be almost 40,000 lower. Exports would be 1.8 percent lower and imports would be 2.7 percent higher, leading to a trade deficit that would be almost $200 billion larger. The model also projected that there would be nearly 700,000 fewer jobs as a result of the higher level of defense spending.

In short, the economic harm projected from high levels of military spending is far larger than the damage projected from the Waxman-Markey bill. Given this situation, we would have expected that all the oil and coal industry folks, who are now so concerned about the average family's well-being, would have been screaming about the economic pain that would result from sustaining the Iraq war levels of military spending.

Did anyone ever hear them raise this issue? Does anyone recall members of Congress giving speeches about how the job loss from the Iraq war levels of spending would be devastating? Does anyone recall any newspaper columns or editorials making this point? How about a news story that analyzed the economic impact of higher levels of military spending?

For some reason, job loss and economic pain associated with the military are just not worth mentioning. These items only become newsworthy when the issue is saving the environment. And the elites wonder why the public has so little confidence in the country's institutions.

Greg Mankiw Argues for a Financial Transactions Tax to Improve Health Care

2009-06-28T12:22:48Z

Okay, that's not exactly right, but there is an important link. In his column in the NYT today, the former chief economist to President Bush warns that a public health care plan could in the long-run lead to lower pay for doctors and therefore fewer doctors. Of course one of the reasons that we pay twice as much as everyone else for health care is that our doctors get paid twice as much as in places like Canada, Germany, and England, so one part of controlling costs will probably involve making doctors' pay more internationally competitive.

Greg warns that this will lead to fewer doctors in the long-run. While there is surely some truth to this (we could remove the protectionist barriers that limit the flow of qualified foreign doctors), there is the obvious question of what else these would be doctors could do. After all, physicians are the most highly paid profession.

]]> One obvious answer is that they would go to work for Goldman Sachs, Morgan Stanley and the rest and get really really rich. Surely some would be doctors who are especially driven by money will opt for this route.

One way to prevent this loss of "talent" from the medical profession would be to reduce the number of ultra high-paying Wall Street jobs. Here is where the financial transactions tax comes in. A very modest tax (e.g. 0.25 percent on a selling a share of stock, like what is charged in the United Kingdom) could substantially reduce the money going to Wall Street. Reducing the number of multi-millionaire bankers, will make the option of becoming a doctor relatively more attractive.

A financial transactions tax would also be a relatively painless way (for most of us) to raise more than $2 trillion over the next decade. Of course, as we say in Washington, the banks own this place. So Congress will instead tax the rest of us to pay for health care or let the health care industry grab the money directly.

I Tried to Warn Ed

2009-06-23T21:08:24Z

Actually I did. Ed didn't tell me that he was thinking of taking out an Alt-A loan, but I did try to warn Ed and everyone else in sight about the housing bubble. We even ran an essay contest offering $1,000 for the best essay arguing that there was no housing bubble which got written up in Ed's newspaper (twice). Needless to say, Ed didn't listen, but more importantly Alan Greenspan and the other great minds in the economics profession didn't listen.

Ed will have to deal with his loan officer, but what about all the other folks who somehow could not see an $8 trillion housing bubble expanding in front of their face? What sort of economic system do we have when you can drive your bank into the ground peddling these garbage loans and still have a job the next day?

]]> How about the economists who insisted that everything was fine? The U.S. housing market is (or was) a $20 trillion market. How can you claim to know anything about the U.S. economy when you can't recognize when a $20 trillion market is 70 percent above its trend levels. This is not rocket science. It is really really simple arithmetic.

For a 100 years house prices nationwide just tracked the overall rate of inflation. 100 years, 100 years, 100 years, just keep repeating that. 100 years is a really long trend, about as long as you can say anything meaningful in economics. Yet the boys and girls at the Fed, at the Treasury, at M.I.T., at Harvard, at Princeton etc. somehow could not see an enormous divergence from trend prices in the world's largest market.

How could anyone who claims to know anything about economics (e.g. passed an intro) have missed this one? The huge neon lights were everywhere. There were millions of people, like Ed, who obviously could not afford the mortgages they were getting. If your job was knowing the housing market, or the economy, and you didn't see this crisis coming, then it's hard to imagine what you could see.

The result of their blindness to the obvious was that millions of people, most much less educated in these matters than Ed, are losing their homes. Tens of millions are approaching retirement with almost nothing saved because they listened to the economists who told them that their housing bubble wealth was real wealth, and therefore saw no reason to save. Even worse, perhaps 10 million people will go unemployed because the folks who are paid to know the economy didn't.

To my mind, the most tragic part of this story is the lack of consequence for the folks who could and should have prevented this disaster. Many are still earning tens of millions a year on Wall Street. Some hold top positions in government. Others are still routinely cited as experts on the housing market and the economy in major media outlets.

We leave in a sharply divided country. It is not only divided between rich and poor; it is also divided between those who are held accountable for the quality of their work and those who are not held accountable.

In the former group we find people like dishwashers, custodians, and truck drivers. In the latter group we find people like bankers, Federal Reserve Board governors and economists. Under the current system, the former group of workers suffer not only for their own mistakes but also for the mistakes of their more educated brethren who are never held accountable for the quality of their work.

The worst part of this story is not just that they screwed us once. Rather, the worst part of this story is that they are going to do it again.

[This was delayed about 12 hours due to Verizon.]

NPR, the IMF, and the Global Savings Glut

2009-06-16T12:29:35Z

The Obama administration is having a tough time getting its request for $108 billion for the IMF through Congress. Bank bailouts are rapidly losing popularity. And bailouts of foreign banks are probably even less popular than bailouts of U.S. banks.

But, NPR is rushing to the rescue. It had a piece this morning telling listeners that it was important to get the IMF more money to help the poor countries of the world. The piece never mentions the fact that the bulk of the IMF lending at present is going to East European countries, not the developing world.

The basic problem is simple. The West European bankers proved to be every bit as stupid as the Robert Rubin-Citigroup crew in dishing out loans. The main outlet for their bad loans was Eastern Europe, where they made enormous loans denominated in euros.

]]> It is very difficult for the countries of Eastern Europe to maintain their exchange rates against the euro without large amounts of assistance. However, if they let their currencies fall against the euro, then the default rates on the loans from Western European banks will explode.

Of course West Europe is rich enough to bail out its own banks, but the governments in countries like France and Germany know that their people will not stand for this sort of handout. In steps the IMF, with a big assist from NPR, which managed to not even mention East Europe in the piece.

NPR made one major misrepresentation that is worth noting. It referred to a "global savings glut" which it attributes to developing countries' fears that the IMF won't have enough resources to bail them out in a crisis, and therefore their need to self-insure. WRONG!!!!!!

Developing countries only began to accumulate massive amounts of foreign exchange (i.e. savings) after the East Asian financial crisis in 1997. There was no talk at the time about the IMF not having enough money. Rather, the explicit motive of most of these countries was to accumulate enough reserves that they would never need to turn to the IMF for a bailout.

The conditions that the IMF imposed on the East Asian countries, who had previously been the superstars of the developing world, were seen as being so onerous that other countries wanted to make sure that they never were forced to turn to the IMF for help. Therefore they deliberately kept their exchange rates under-valued so that they would run huge trade surpluses, which let them rapidly build reserves.

In short, the IMF's conduct was a major cause of the global imbalances that led to the current economic crisis. NPR turns history on its head in telling listeners that more support for the IMF is the solution.

Obama and GM: The Best Outcome in an Awful Situation

2009-06-01T13:59:59Z

The Obama administration's plan for General Motors is a serious effort to try to make the best of really awful situation. In the current economic situation, sitting back and allowing GM to be liquidated was not a serious option. This would have wiped out a whole network of suppliers and ancillary businesses in Michigan, Ohio, and Indiana, devastating the economies of these three states.

The federal government would have been forced to step in with large-scale aid in this case just to prevent mass destitution.The state and local governments would have lacked the resources just to maintain basic services like schools, hospitals, and sanitation facilities. Of course the plan is not perfect and it can be argued that one or another of the parties got too much or too little.

]]> The often told story that the UAW made out like bandits is nonsense. Workers are making substantial concessions and many will be losing retiree health care benefits for which they already worked decades. The bondholders are great whiners, but none of them have said that they wanted the company liquidated. They know that they would get less if the federal government had not intervened. They whine because they know the media are always sympathetic to investors, so their whines will be presented to the public as serious arguments.This could create a political environment in which they could get more money, offering substantial returns to speculators who just bought GM debt at steep discounts.

Finally, it is remarkable how much anger has been generated over the government lending money to GM. This is an effort to save jobs and save the economy of the Midwest. In exchange, the government is getting a substantial ownership stake in GM. It could actually profit from this stake, but of course there is no guarantee.

By contrast, the government just handed $12.9 billion to Goldman Sachs through AIG. The government got nothing in return for this -- no stocks, no bonds; there is no pretense that this money will ever be paid back. And, the only jobs we saved were probably the jobs of Goldman's lobbyists who want to make sure that we don't regulate the derivatives that helped bring on this disaster. (See also Jonathan Cohn.)

To Get a Systemic Risk Regulator Fire Bernanke

2009-05-31T23:53:48Z

Everyone in Washington policy circles agrees that we need a systemic risk regulator to prevent another economic disaster like the one we are now experiencing. This quest ignores the fact that we already have a systemic risk regulator. It's called the Fed.

The Fed has often stepped outside the narrowly defined realm of monetary policy when it perceived larger risks to the economy. The two most obvious examples are its efforts to stem the stock market crash in 1987 and its intervention in the unraveling of the Long-Term Capital hedge fund in 1998. In both cases the Fed acted because it argued that there would be much greater damage to the economy if it just let the market run its course.

]]> The problem in the current situation was not that the Fed did not have the responsibility to prevent the $8 trillion housing bubble that caused this crisis. The problem was that the Fed either did not see the bubble or somehow did not think there would be serious consequences from its collapse. In short, the Fed blew it - big time.

Just to be clear, this was not a minor error. It was as bad a mistake as you could possibly make on the job. This is like the cook who leaves the stove on and causes the restaurant to burn down. It's comparable to a nurse administering the wrong medicine, not once or twice but hundreds of times, leaving a lengthy trail of illness and death in his wake. The Fed's performance is like a school bus driver who drunkenly heads into oncoming traffic, causing the death of all of his passengers. In short, this is really serious.

But, in the clubby world of high level Washington no one would ever be so rude as to suggest that Ben Bernanke should be fired for his mistakes. In fairness, his predecessor Alan Greenspan deserves more blame. But Bernanke still could have mitigated the damage even as late as January of 2006, when he took over as Fed chair.

Furthermore, Bernanke had been a member of the Fed's Board of Governors prior to becoming Fed chairman. If he ever made any effort in this important position to stem the growth of the bubble he has kept it a secret.

Firing Bernanke is not just a question of justice, although the millions of workers who have lost their jobs because of his mistake may see it that way. It is also an essential step in creating regulators who are actually held accountable for the quality of their work and therefore have a reason for taking their job responsibilities seriously.

As things work now, there is no risk for simply going with the flow. If you just repeat what everyone else is saying, and it turns out to be wrong, the Washington elite steps in for you with a supportive chorus of "who could have known?"

However, if a regulator were to step out line - imagine someone at another regulatory agency began to openly challenge Alan Greenspan and warn about the enormous danger created by an $8 trillion housing bubble - then they would be risking their future career path and their current job. It is an extremely rare public servant who will put their career path in jeopardy to promote the public good.

This is why none of the other regulators could see an $8 trillion housing bubble. They would have borne enormous career risk to make an issue out of the bubble after Alan Greenspan and Co. at the Fed had said that everything was fine.

It is not the responsibilities of the regulatory agencies that needs to be changed, but the incentives for the regulators. If the regulators face no sanction for just going along - even when they thereby get it horribly wrong - then they will always just go along.

In short, if we want regulators that actually police against systemic risk rather than ignore it, then we have to fire the regulators who failed horribly in the past. If we are serious about getting a real systemic risk regulator then Ben Bernanke must go.

Economists, Win Back the Respect of Your Children, Support the Third Stimulus!

2009-05-29T17:37:36Z

We know it's not easy being an economist these days. Everyone blames you for the fact that they are losing their jobs and their homes, and their life savings. They hold you responsible because you didn't warn the country about an $8 trillion housing bubble.

Well there's no point in mourning about the past. The point is to get it right next time. And this is next time.

The recession continues to deepen and throw more people out of work by the day. While the stimulus passed by Congress in February will be helpful, it clearly is not enough given the severity of the downturn.

So, it's time to step up to the plate and seize the opportunity. Add your name to the list of those calling for a third stimulus. It's what the economy needs and you can make your kids proud by saying it clearly.

Robert Samuelson Calls for Eliminating Social Security, the Internet and the Wheel

2009-05-24T02:54:28Z

Okay, that's not exactly right. In fact he just wants to get rid of Social Security and Medicare. Apparently he thinks the world was better back in the days when people over age 65 couldn't get health care insurance and mostly lived in poverty.

Since he considers those days so great, Samuelson no doubt thinks we would be better off without the Internet and the wheel also. After all, if we got rid of the Internet we wouldn't have any more problems of Internet porn. And think how many traffic fatalities could be avoided if we didn't have the wheel.

Samuelson is upset because out broken health care system is projected to cause Medicare to deplete its trust fund in 8 years. Serious people would look to fix the health care system. Samuelson wants to tell the elderly and disabled to die in the streets.

]]> And, the latest projections from the SS trustees show that in just 28 years its trust fund will be depleted. According to these projections, if we don't raise taxes on workers who will be earning 30 percent more than current workers, we will not be able to pay full scheduled benefits. This should get people about as scared as the fact that we will have to repave Interstate 95 some time in the next 20 years.

If Samuelson had any clue about the topics on which he wrote he would know that Medicare and SS are both great success stories. They do what they were designed to do in ensuring a decent standard of living for the elderly and the disabled. They are both more efficient than their private sector counterparts.

I suppose with the decline of the traditional media, this sort of nonsense from Samuelson is the best that Newsweek can afford.

Combating Wage Theft

2009-05-11T20:45:12Z

It is great to see Kim Bobo's book on wage theft drawing attention on TPMCafe and elsewhere. It is outrageous that millions of workers have their earnings stolen from them by their employers. Hopefully, this book will help to ensure that enforcement is stepped up so that this practice is brought to an end.

However, one aspect to this issue has intrigued me. Wage theft is often seen as an issue of regulation. The idea is that we need an effective regulator at the Labor Department to ensure that employers do not steal wages from their workers.

This is intriguing because there is no reason to view this as a question of regulation: it is a question of law enforcement. Would anyone call the prevention of shoplifting a problem of regulation? How about the prevention of bank robbery?

]]> In these cases everyone clearly recognizes the problem as one of law enforcement. We want the police to arrest people who shoplift from stores or rob banks. It's very simple. But, when it comes to employers who steal wages from their workers we want the government to "regulate" so that this does not happen.

This is yet another case where we allow an argument to be framed in a way that disadvantages progressives. The issue here is property theft just as it is in the case of shoplifting and bank robbery. We should insist on discussing it in that context (as is obviously done in the title "Wage Theft in America").

There is no reason that stealing wages from workers should be any more acceptable than robbing a bank. We are not looking for the government regulators to overturn market outcomes; we want the police to enforce the rules of the market. The police manage to enforce the rules pretty well when it comes to the property of the wealthy. We just need the same sort of enforcement when it comes to the property of low-paid workers: their wages.

Health Care and Student Loans: The Bad Guys Are on the Run

2009-05-11T14:04:26Z

Progressives should be feeling good right now. There is clear evidence that we are winning on two really big issues.

Starting with the smaller of the two, Sallie Mae, the largest private issuer of student loans, is now proposing to accept a plan in which the government is the sole issuer of government guaranteed loans. Sallie Mae's plan is that it continue to be given the opportunity to originate these loans, picking up fees in the process.

This proposal is in response to the Obama administration's plan to get the private sector out of the government guaranteed loan business. There is ample evidence that the involvement of private firms just adds costs -- approximately $90 billion over ten years according to the Congressional Budget Office. Sallie Mae's compromise proposal is a recognition of the fact that it cannot stop the Obama plan.

If this story is good, the news on health care is even better.

]]> The industry is now proposing a scheme whereby it will curtail cost growth by 1.5 percentage points a year. At these point none of the details of the proposal are public and it is unlikely that any of the commitments in the proposal will be binding in any serious way on the industry.

However, the fact that they would suggest that such cost savings are possible is an enormous concession. After 10 years, the cumulative savings from this proposal would amount to more than $400 billion a year, more than $3,000 for every family in the country.

The industry is talking this way because they are scared to death at the prospect of having a Medicare type public plan, which will both provide competition for private insurers and create an effective mechanism to constrain the fees charged by health care providers. As many have argued, the public plan is a real game changer.

These new developments in both the health care debate and the debate over student loan policy are great news. In both cases the industry groups are now prepared to make important concessions that they never would have envisioned even a year ago.

Of course, there is no reason to accept their compromises. Why should we waste any of the money that could be going to help college students so that Sallie Mae executives can draw high salaries and its shareholders can enjoy large dividends. Let them make money in the market, not by adding costs to a government program.

Similarly, the threat of a public plan has forced promises of concessions from the health care industry. If we don't actually get the public plan, there is no enforcement mechanism for these promises. If we go ahead and put the public plan in place, then we know that the industry will deliver on its promises.

Now is not the time for compromises. We must keep the pressure on. It is showing results.

Systematic Risk Regulators and the Power of Arithmetic

2009-05-07T00:52:08Z

The current craze in DC policy circles is to create a "systematic risk regulator" to make sure that the country never experiences another economic crisis like the current one. This push is part of a cover-up of what really went wrong and does absolutely nothing to address the underlying problem that led to this financial and economic collapse.

The key fact that everyone must always remember is that the story of the collapse was not complex. We did not need great minds sifting through endless reams of data and running incredibly complex computer simulations to discover the underlying problem in the economy. We just needed some people who understood the sort of arithmetic that most of us learned in 3rd grade.

]]> If the people at the Fed, the Treasury, and in other key positions had mastered arithmetic, and were prepared to act on their knowledge, they would have taken steps to stem the growth of the housing bubble. They would have prevented the bubble from growing to the point where its inevitable collapse would bring down both the U.S. economy and the world economy.

Just to repeat the basic facts: house prices began to diverge sharply from a 100-year long trend in the mid-90s as wealth created by the stock bubble began to exert upward pressure on real estate prices. After having tracked the overall inflation rate for 100 years, house prices were substantially outpacing inflation.

There was no remotely plausible explanation on either the supply or demand side for the run-up in house prices. Income growth was good, but not extraordinary in the late 90s. In the current decade, incomes actually fell slightly after adjusting for inflation. On the supply side, we built houses at near record rates in 2002-2006 indicating that there were no substantial constraints on building.

As another tell-tale sign that we were seeing a bubble, inflation-adjusted rents were not rising, indicating that there was no underlying shortage of housing driving up prices. Finally, housing vacancy rates were hitting record levels as early as 2002.

At their peak in 2006, inflation-adjusted house prices had risen by more than 70 percent, creating over $8 trillion in housing bubble wealth. There was no way that the loss of this much wealth ($110,000 for every homeowner) would not lead to a severe a recession and create the sort of financial crisis that we are now seeing.

In normal times houses are highly leveraged with down payments rarely exceeding 20 percent. In the bubble years, it was common for homebuyers to borrow the full value of their home and sometimes even a few percent more. It should have been obvious to any serious economist or financial analyst that when the bubble burst, there would be hell to pay in the financial sector.

In short, all the evidence was right there for anyone who cared to see it. We didn't need some super-genius to solve the mystery. We just needed an economist who could breath and do arithmetic. But the DC policy crowd tells us that if only we had a systematic risk regulator this disaster could have been prevented.

Okay, let's do a thought experiment. Suppose we had our systematic risk regulator in 2002. Would this person have stood up to Alan Greenspan and said that the country is facing a huge housing bubble the collapse of which will sink the economy?

Remember, before the fall Greenspan was known as "the Maestro." Politicians, reporters and economists worshipped every pearl of wisdom that came out of his mouth. In fact, when he announced his plans to retire in 2005, many of the world's leading economists and central bankers gathered at Jackson Hole, Wyoming to debate whether Alan Greenspan was the greatest central banker of all time.

Alan Greenspan said that there was no housing bubble; everything was just fine. Would our systematic risk regulator have said that Greenspan was nuts and that the whole economy was a house of cards waiting to collapse?

Anyone who believes that a risk regulator would have challenged the great Greenspan knows nothing about the way Washington works. The government is run by people who first and foremost want to advance their careers.

And, the best way to advance your career in Washington is to go along with what everyone else is saying. If that was not completely obvious before the collapse of the housing bubble, it certainly should be obvious now.

How many people in government have lost their jobs because they failed to see the bubble? How many people even missed a promotion? In fact, the top financial officials in the Obama administration, without exception, completely missed the housing bubble. One might think it was a job requirement.

This lack of accountability among economists and economic analysts is the core problem that must be tackled. Unless these people are held accountable for their failures in the same way as custodians and dishwashers, there will never be any incentive to buck the crowd and point out looming disasters like the housing bubble.

The reality is that we have a systematic risk regulator. It is called the Federal Reserve Board. They blew it completely. We will do far more to prevent the next crisis by holding our current risk regulator accountable for its failure (fire people) than by pretending that we somehow had a gap in our regulatory structure and creating another worthless bureaucracy.

And of course we should teach our economists arithmetic.

Outsourcing Top Management: The Lesson of Fiat-Chrysler

2009-05-04T17:28:14Z

The media coverage of the auto bailouts has focused on the need for union autoworkers to take big pay cuts, causing them to once again miss the real story. The Fiat-Chrysler deal shows that the pay problem is at the top, not the bottom. At the end of the day, the new Chrysler is still likely to be producing most of its cars in the United States. What the new company will be getting from abroad is technology and top management.

This big story was so easily missed because it runs against one of the main myths that our elites have cultivated about the US economy: that the country has a "comparative advantage" in highly skilled labor. In this story, the United States will continue to lose manufacturing and other "less-skilled" jobs as its economy becomes more concentrated in highly skilled sectors.

This story was convenient for our elites because it meant that the decline of manufacturing was a necessary, if sometimes painful, part of a natural economic progression.

]]> It also justified the growing inequality in US society that benefited not just Wall Street bankers and CEOs, but also millions of doctors, lawyers, economists, and other highly educated workers. These people took their six-figure salaries as a birthright, even as the pay of less educated workers stagnated or declined.

While this story of the US becoming a high skills center in the world economy may have been comforting to the elites, and was widely promoted by economists and the news media, there was never much truth to it. Highly skilled professionals did well in recent decades not because they succeeded in international competition, but rather because they were largely sheltered from it.

Trade agreements like NAFTA were explicitly designed to remove any barrier that made it difficult to export manufacturing goods to the United States, thereby placing US manufacturing workers directly in competition with their much lower paid counterparts in the developing world. Most of these restrictions had nothing to do with tariffs. Instead the key issues were rules protecting investment in the developing world along with limits on the ability of the US to exclude imports through safety or environmental regulations.

There has never been any similar effort to eliminate the barriers that prevent professionals from the developing world from coming to the United States and competing directly with their US counterparts as doctors or lawyers or in other highly paid professions.

The economists and the media somehow failed to notice that professionals were intentionally sheltered from international competition and instead just trumpeted them as the winners in the global economy. We were just treated to a beautiful example of this double standard when the media and the economists got all huffy about the "buy America" provision in the stimulus bill that might have protected a few manufacturing jobs in steel and other industries.

While this provision was roundly condemned and eventually watered down, the buy America provision in the Treasury's latest bank bailout bill went completely unnoticed. This provision requires that any investment manager taking part in the program be headquartered in the United States. Even though the argument against protectionism in financial services is identical to the argument against protectionism in steel, no one bothered to make the argument when Wall Street was the beneficiary of protectionism.

The end result of this protectionism for those at the top is a bloated overpaid sector of top managers, which is what we saw at Chrysler. If we compare wages for assembly-line workers in Europe and the United States, there would not be much difference between the pay of UAW members and their counterparts in Europe. However, there would be a very large difference between the multi-million dollar pay packages of the top executives at the US companies and their European counterparts. The pay gaps persist among the more highly paid engineers and management personnel.

Therefore, it was only logical that a bailout of Chrysler would seek to take advantage of the lower cost management and design skills available at a European car company like Fiat. In Chrysler, as in other companies, the high pay packages for these people are like an anchor dragging them down in international competition. If the US is to be competitive in the 21st century, we must either bring the pay of those at the top back down to earth or we should look to follow the lead of Chrysler and contract out for these services.

Let's Make PPIP Fun!

2009-04-30T09:38:29Z

Timothy Geithner seems intent on moving forward with his scheme to subsidize the banks by providing up to a trillion dollars of non-recourse loans to investors to buy their junk assets. As many of us have pointed out, this is a subsidy in that it creates a "heads the investors win, tails the taxpayer loses situation." If the investment turns out well, the investor makes lots of money. If the investment does poorly, then the taxpayer gets most of the loss.

As many of us have pointed out, this will allow some investors to do very well on investments they would have made otherwise, since the government is giving them a large dose of cheap loans. More importantly, it is a huge subsidy to the banks, since it will lead investors to pay considerably more than the market price for junk assets, since the government is bearing most of the downside risk. There are also ample opportunities for gaming, which the shrewd Wall Street crew can be expected to fully exploit.

While this all looks pretty bad, we can use PPIP as an opportunity to remake Wall Street.

]]> The basic point is very simple: we just put conditions on the money, like the government is doing with Chrysler and GM and has done for years with mothers receiving TANF.

There are a couple of obvious conditions that Congress can impose for PPIP loans. First, there should be full disclosure of major investment stakes. Every hedge fund, private equity fund, or other investor who gets these subsidized loans should have to fully identify any investor with more than a 1 percent interest. We should be able to go on the web and find all the individuals and corporations that are taking part in PPIP, just as we can with the stimulus money thanks to President Obama's commitment to transparency.

We can also put restrictions on compensation. Suppose we say that no one working for any investor getting PPIP money can receive total compensation of more than $2 million a year. While none of us would ever dream of restricting how much a person can earn on their own, if they are doing it on the taxpayer's dime, then we get to impose some constraints.

These are very simple conditions that investors should be happy to accept in exchange for government subsidized loans. Of course, some investors may consider these restrictions too onerous, which is just fine. They don't have to take part in PPIP. This will leave more money for investors that are prepared to live within these and other reasonable rules that Congress considers appropriate.

The basic point is simple: if we're going to give hundreds of billions of additional handouts to Wall Street, then we might as well get something in return. Even an economist or investment banker who missed the $8 trillion housing bubble should be able to understand that.

If Economists Knew Arithmetic, We Might Waste Less Money on Banks

2009-04-12T00:56:53Z

There is no doubt that the economy would be better off if most of our banks were not insolvent, but only those who are really bad at arithmetic would think that repairing the banking system will restore prosperity. The economy would still be faced with a massive shortfall in demand with the unemployment rate soaring into the double digits.

The basic problem is that the economists who missed the housing bubble (EMHB) somehow still don't understand how the bubble drove growth earlier in this decade. There were two main channels:

Residential construction expanded from its average of 4 percent of GDP to more than 6 percent of GDP at its peak in 2005; and

Consumption boomed based on ephemeral housing bubble wealth, as the adjusted saving rate turned negative over the years from 2004 to 2008, compared to a post World War II average of 8 percent.

]]> The collapse of the bubble has derailed these engines of growth. Housing construction is now less than 3 percent of GDP and the adjusted saving rate is approaching its post-war average. This is why the economy is slumping and the unemployment rate is soaring. There is no sector that can readily fill a gap in demand in the neighborhood of 8-9 percentage points of GDP.

The zombie banks don't help matters since their near death condition makes them less willing to lend money to businesses who might be able to get a loan from solvent institutions, but even if the banks were fully solvent, little about this basic picture would change.

Households are not spending more because many have just seen most of their wealth disappear with the collapse of the housing bubble and the plunge in the stock market. The rise in the savings rate is exactly what standard consumption models predict; we don't need any stories about zombie banks to explain the drop in consumption.

Similarly, the plunge in housing construction is the result of massive overbuilding. It will take years for population growth to absorb the inventories of unsold homes. Fixing the banks won't absorb excess housing supply.

There is a similar story in non-residential construction. There was a bubble in this sector that developed as housing boom began to subside. As a result, there is now enormous excess capacity in hotels, as well as office and retail space.

If consumption and construction are not likely to be affected much by the health of the banks, this leaves investment in equipment and software as a potential source of growth. But even here the impact of the financial crisis may be exaggerated.

While some businesses are undoubtedly having difficulty expanding due to lack of access to credit, this is not the case across the board. There are plenty of large healthy companies, like Microsoft, I.B.M, and Verizon that can currently borrow at very low interest rates. Investment by these firms is not being restrained by the state of the banking system.

It is also important to note that many small businesses can't get loans right now simply because we are in severe downturn. This makes all businesses much more risky bets now than in normal times.

However, there are undoubtedly businesses that would be able to get loans if the banks were healthy, but who can't raise capital now because of the financial crisis. But how much difference can this make? Here's where the knowledge of arithmetic would be so helpful to economists.

Let's assume that cleaning up the financial system would increase investment and software by 20 percent. This would be a huge increase, given that many firms would be little affected, either because they already have ample access to capital or because they are complete basket cases.

Investment in equipment and software accounts for less than 7 percent of GDP. This means that a hypothetical bank clean up would increase GDP by less than 1.4 percent. In other words, it will fill approximately one-sixth of the shortfall created by the collapse of the housing bubble.

If the EMHB knew the limited effect that a potential bank clean up could have on the economy perhaps they would not spend so much time thinking of ways to funnel taxpayer dollars to banks. Of course if the EMHB had a better grasp of arithmetic then they wouldn't have missed the housing bubble in the first place and we wouldn't be in this mess today.

How Much Do We Have to Pay Fannie and Freddie Execs to Lose Us Billions?

2009-04-04T17:47:31Z

Apparently we have to give them more than $200 million in bonuses to give them enough incentive to lose taxpayers billions of dollars. The NYT says that 213 employees are slated for bonuses of more than $100k each and the top paid ones will pocket over $1 million.

That seems like a lot of money. After all, can't we pay a high school kid the minimum wage to throw away taxpayer dollars. Just to be clear, I'm not referring to the money that was lost on their prior loans, I'm referring to the money that they are losing on the loans that Fannie and Freddie are buying every day.

]]> Fannie and Freddie continue to buy loans that were used to purchase homes at bubble inflated prices. These loans will go bad at very high rates, because the prices will plunge and the homeowner will then be underwater. Underwater mortgages are very likely to end in foreclosure or short sales.

The easy way to avoid issuing loans that are likely to lead to large losses is to base valuations on appraisals of rent. If Fannie and Freddie refused to approve any loans that could not be justified based on a multiple of 15 times the annual appraised rent (with some regional variation), then they would substantially reduce their loss risk.

Note that this policy would help, not hurt, homeowners. We do no one a favor by encouraging them to buy a home at a bubble inflated price. They end up paying more in housing costs each year that they live in the home and they likely end up with a foreclosure or short sale when they leave the home, or at the very least losing whatever equity they put up.

I argued repeatedly with the chief economists at Fannie and Freddie about the existence of a housing bubble in the years 2002 to 2007. I would think that we no longer need to have this argument. Unfortunately, Fannie and Freddie are still making loans as though they haven't noticed the bubble. It is hard to justify six and seven figure salaries for this level of incompetence.

[I almost forget to mention the boards of directors of these government owned companies. Board members at Freddie get paid $160k a year. I assume that the salaries at Fannie are comparable. That's pretty good pay for government work, especially since the directors probably only put in a few weeks a year of work. And, these are not especially astute people. Several of them slept through the original bankruptcy of Fannie and Freddie.]