The Topic of Depression Economics in a Nutshell - Grasping Reality with Both Hands

The Topic of Depression Economics in a Nutshell - Grasping Reality with Both Hands:

...how you should think about the topic of “depression economics. ...Why should there be such crashes in the level of employment? How can it be that there is not enough spending, not enough demand in the system to put everyone who wants to work to work productively? Back in 1803 Jean-Baptiste Say observed that nobody makes except to use or to sell. and nobody sells except to buy. Thus, he argued there can be particular shortages of demand in some commodities balanced by excesses of demand for others. But “overall excess demand” is self-contradictory because everybody’s spending is someone else’s income and everyone’s income is then spent sooner or later on something. How is it that the economy can wedge itself into a position like it is in today? That is an important question.

Read more at medianism.org:

Ratings Agencies and Predatory Lending vs. Irresponsible Borrowing

PBS NewsHour | Nov. 18, 2010 | PBS:

PAUL SOLMAN: You frame this book as a look back at the whole financial crisis, so I thought I would frame this interview as a: Who is the biggest culprit?

JOE NOCERA: I certainly would put the rating agencies right at the top of my list of bad guys, or my list of devils.

A place like Moody's took a culture that had a reputation for some integrity, and completely corrupted it in a drive for market share and profits.

PAUL SOLMAN: So, biggest culprit, ratings agencies; you agree?

BETHANY MCLEAN: I do agree. If they hadn't taken subprime mortgages and rated enormous quantities of them AAA, meaning they gave those bonds the same credit rating as the U.S. government debt has, this -- this whole thing couldn't have happened, because debt that is rated AAA is precisely the debt that is snapped up by the largest quantity of buyers all around the world, buyers who are not capable of doing the detailed work to analyze these bonds by themselves....

BETHANY MCLEAN: ...But one of the really interesting things, if you go back to the 1990s to the birth of subprime lending, it was never about homeownership.

PAUL SOLMAN: What do you mean it wasn't about homeownership?

BETHANY MCLEAN: It was never about homeownership, because subprime lending grew out of cash-out refinancings, meaning the ability of somebody to go to a bank, refinance their mortgage, and take cash out of their house in order to live on that cash.

And that enabled consumer spending through the 1990s and through the early part of -- of this decade. Most of the business of the major subprime lenders, from Countrywide, to Ameriquest, to New Century, was cash-out refinancing. It wasn't the first-time purchase of homes by homebuyers. And this was celebrated by Republicans, as well as Democrats.

JOE NOCERA: Homeownership was a giant fig leaf, particularly for the rise of subprime.

I was stunned, in the reporting of this book, how much subprime was about predatory lending. And it was way more than I thought. And then, when you find that a company like New Century, which really, you know, 85 percent of its business is refinancing, 15 percent of its business is homeownership, that's astounding.

PAUL SOLMAN: What does predatory lending mean in this situation?

JOE NOCERA: Taking advantage of unsophisticated people to put them into loans that -- knowing, absolutely knowing, that they can never pay them back, often lying about what the interest rate hike is going to be, prodding them to lie themselves about their income, about their true financial condition.

BETHANY MCLEAN: I -- I started this book with a bias toward personal responsibility, and, if consumers got in over their head on their mortgage, that was their fault.

And one of the big discoveries to me in the course of reporting the book is the extent to which these loans were sold; they weren't bought. And one of the most telling moments were these internal documents from Washington Mutual, one of the big subprime lenders, around 2003 talking about how to get consumers who really wanted safe 30-year fixed-rate mortgages to take out these dangerous option ARMs instead.

PAUL SOLMAN: ARMs meaning adjustable rate.

BETHANY MCLEAN: Adjustable rate mortgages -- how to sell those to people, and how to confront a consumer who said, but it doesn't feel right to me.I want to pay back my mortgage every month. This is what my parents did.

How do you get these people to take out a risky mortgage instead? You told them that home prices could only go up. And the reason Washington Mutual wanted to sell these option ARMs, instead of the 30-year fixed rate mortgages, is that Washington Mutual could turn around and sell these to Wall Street for a lot more money than it could sell the old 30-year fixed-rate loans.

Yglesias » The Importance of Models

Yglesias » The Importance of Models:

Try to draw up a model—a simple one, but one where you do try to make sure that your numbers all add up—in which everyone has high savings rather than high debt. Households have high savings. Firms have high savings. The government has high savings. And the governments of your trading partners have high savings. But so do their citizens. And their firms, too. It’s the old wisdom of common sense! You’ll find that it doesn’t add up. Japanese people save by lending money to the Japanese government, which borrows. I borrow to buy a condo, and the money I’m borrowing is the money other people have saved in the bank. You put your money in the bank rather than leaving it under the mattress because the bank pays you interest. But they pay you interest because they can charge interest to other people—people who are in debt.

The old wisdom isn’t nutty or anything. Borrowing a ton of money so you can buy a fancy new car is probably a worse idea than buying a cheap used car and saving your money. But if you’re poor live in a city with bad mass transit and you borrow money to buy a cheap used car so you can make sure you’re on time for work every day, you’re making a prudent investment in your own future. Likewise, if you’ve got a successful store and you take out a loan to open a second location, you’re building the future of the American economy. Thriftiness is a good character trait because it tends to make people averse to accumulating debts for frivolous reasons. But if you try to build a systemic model, you’ll see that universal thrift doesn’t work at all.

Indeed, though thrifty people play an important role in making the economy function, they do so in part because their thrift creates resources that others can use to be venturesome and fuel innovation, entrepreneurship, and prosperity. Capitalist success stories are built on the ability and willingness of people to fail. For every hugely successful startup, you’ve got a dozen or more failures and behind those failures you’ve got bad loans. The willingness to issue those loans makes the world go ’round, and we need the savers because without them there’s no money to lend.

- Sent using Google Toolbar"

What Should Macroeconomics Do? - Grasping Reality with Both Hands

What Should Macroeconomics Do? - Grasping Reality with Both Hands:

What is wrong with American macroeconomics? In a nutshell, when 2007-9 came along every single macro textbook (including mine) and every single macro course (save possibly Perry Mehrling's) was of little or no use in helping people who had read or taken them to read publications like the FT as they chronicled the downturn or understand the policy debates hosted by the FT.

At the very minimum, a macro course should teach people enough about the macroeconomy that they can then read the reporting of the FT. And it should teach people enough about the theoretical approaches that underpin policy advocacy that they can then understand and evaluate the policies proposed in contributions to the FT.

What would such a macroeconomics course look like?

It would, I think, teach the five still-live theories of the causes of economic downturns that underpin people's analyses:

• The theory that high unemployment is produced by real wages stuck at too high a level for a full-employment economy to sustain. It must be suffered.

• The theory that high unemployment today is the unavoidable consequence of past overinvestment. It must be suffered.

• The monetarist theory that a downturn is the result of a shortage of liquid cash money which induces people desperate to build up their cash balances to try to switch their spending away from currently-produced goods and services. It is fixed by expanding the money supply or increasing velocity and so reducing money demand.

• The Keynesian--or is it Wicksellian?--or is it a Hicksian?--theory that a downturn is the result of a shortage of bonds, of vehicles that savings can use to transfer purchasing power into the future which induces people desperate to build up their assets to try to switch their spending away from currently-produced goods and services. It is fixed by expanding the supply of bonds or reducing savings.

• The Minskyite theory that a downturn is the result of an overspeculation-caused panic that generates a shortage of safe high-quality assets, of vehicles that people to park their wealth and be sure it will not melt away while their backs are turned, which induces people desperate to build up their safe asset holdings to try to switch their spending away from currently-produced goods and services. It is fixed by expanding the supply of safe assets or restoring confidence and so diminishing the demand for safety.

• 
  

Accounting Identities - NYTimes.com

Accounting Identities - NYTimes.com:

Peter Dorman has a good post on the meaning of deficit misses in Europe, This Is What Accounting Identities Look Like. It meshes with the way I’ve been trying to explain our mess lately; so let me go back to Sam and Janet — that is, to how to think about the role of debt in our problems.

The background to the world economic crisis is that we went through an extended period of rising debt. Now, one person’s liability is another person’s asset, so rising debt made the world as a whole neither richer nor poorer. It did, however, leave the borrowers increasingly leveraged. And then came the Minsky moment; suddenly, investors were no longer willing to roll over, let alone increase, the debts of highly leveraged players. So these players are being forced to pay down debt.

The process of paying down debt, however, must obey two rules:

1. Those who pay down debt must do so by spending less than their income.
2. For the world as a whole, spending equals income.

It follows that

3. Those who are not being forced to pay down debt must spend more than their income.

But here’s the problem: there’s no good mechanism in place to induce those who can spend more to do so. Low interest rates do encourage spending; but given the size of the debt shock, even zero rates are nowhere near low enough.

So since the world economy can’t raise the bridge, it is lowering the water: without sufficient spending from those who can, the only way to make the accounting identities hold is for incomes to decline — specifically, the incomes of those not constrained by debt must decline so as to create a sufficiently large gap between their (unchanged) spending and their incomes to offset the forced saving of debtors. Of course, the mechanism here is an overall global slump, so the debtors are squeezed as well, forced into even more painful cuts.

To avoid all this, we’d need policies to encourage more spending. Fiscal stimulus on the part of financially strong governments would do it; quantitative easing can help, but only to the extent that it encourages spending by the financially sound, and it’s a little unclear what the process there is supposed to be.

Oh, and widespread debt forgiveness (or inflating away some of the debt) would solve the problem.

But what we actually have is a climate in which it’s considered sensible to demand fiscal austerity from everyone; to reject unconventional monetary policy as unsound; and of course to denounce any help for debtors as morally reprehensible. So we’re in a world in which Very Serious People demand that debtors spend less than their income, but that nobody else spend more than their income.

And the slump goes on.

Why Quantitative Easing Needs to Involve Securities Other than Government Securities - Grasping Reality with Both Hands

Why Quantitative Easing Needs to Involve Securities Other than Government Securities - Grasping Reality with Both Hands:

The point--from one point of view, the neo-Wicksellian point of view--behind quantitative easing is to reduce the interest rate that matters for private business investment: the long-term, default-risky, systemic-risky, beta-risky, real interest rates at which private businesses finance their capital expenditures. You can reduce this flow-of-funds equilibrium interest rate and raise the level of economic activity in any neo-Wicksellian framework in two ways:

1. Reduce the 'safe' real interest rate on short-term, safe government bonds.
2. Reduce the various premia--duration, default, systemic risk, and beta risk--between the rates the Treasury pays to borrow in T-bills and the rates businesses pay to borrow.

Conventional open-market operations that lower the nominal interest rate on T-bills accomplish the first. Once the nominal interest rate on T-bills has been pushed to zero, quantitative easing policies that create expectations of higher future inflation continue to lower the real interest rate on T-bills and thus help the situation.

Suppose, however, that the nominal interest rate on T-bills is zero and that you cannot alter inflation expectations--cannot commit to keeping your quantitative easing permanent, cannot commit to an exchange rate path, whatever, you cannot do it and inflation expectations are immovable. Then what?

Then, as Paul Krugman says, quantitative easing is working be altering the spread between the short-term safe T-bill rate and the long-term, systemic-risky, beta-risky, default-risky rate. How does it do that? Lloyd Metzler and James Tobin would say that it does so by altering relative asset supplies--by taking duration risk, systemic risk, beta risk, and default premia off of private savers' books and placing them on the government's books (and thus on the taxpayers, who are a very different group of people than are private savers). To the extent that quantitative easing thus involves assets whose risk characteristics are very similar--federal funds and two-year T-notes, say--we would not expect even a lot of quantitative easing to have much of an effect on anything.

Thus a quantitative easing program that is going to have bite should involve Federal Reserve purchases of long-term risky private assets rather than merely long-term U.S. Treasuries. Hiring PIMCO as an agent to manage a long bond index portfolio naturally comes to mind--if one could avoid its front-running.

And, of course, the most effective quantitative easing program of all would involve the Federal Reserve issuing reserve deposits and using that purchasing power to buy the assets that are the furthest away in their risk characteristics from short-term government bonds: bridges, dams, the human capital of American citizens, police protection, research and development. The best quantitative easing program of all is a money-financed fiscal stimulus, as Jacob Viner said back in 1933

The Young, the Old, the Unemployed » New Deal 2.0

The Young, the Old, the Unemployed » New Deal 2.0:

College educated 20-24 year olds have the highest percentage increase in unemployment. This should go against a structural unemployment story, as college educated people have the ‘freshest’ skills and incredibly high mobility. It’s worth pointing them out in particular because if their careers hit a rough spot, hysteresis sets in and they’ll have serious wage losses years down the road (see this classic White House blog post on the subject by Peter Orszag). Their situation is also important because the crisis is often seen as a small deal for college educated workers.

The other thing that jumps out at me is that the unemployment rate for everyone 55-64 has more than doubled. One thing we aren’t talking about enough is that someone who is 60 and has been unemployed for a year isn’t going to find a decent job again. Other ways of looking at the labor search outcomes of 55-64 year olds are even more worrying.