In Search of a Trough

The U.S. economy still shrank in second quarter 2009 but at a much lower pace than was anticipated. That’s a pretty good indicator that the bottom or trough of The Great Recession may be near. Here’s the precise release from the Bureau of Economic Analysis (BEA).

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — decreased at an annual rate of 1.0 percent in the second quarter of 2009, (that is, from the first quarter to the second), according to the “advance” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased 6.4 percent.

While the many recent indicators show the recession is loosing some of its downward momentum, there are few economists ready to sing Happy Days are Here Again. The NYT’s coverage of the statistical release continues to bring up some of the same concerns we’ve discussed here before.

The economy’s long, churning decline leveled off significantly in the second quarter, as stock markets started to recover, corporate profits bounced back, housing markets stabilized and the rampant pace of job losses tapered off. Declines in business investment leveled off, and the economy was aided by big increases in government spending at the federal, state and local levels.

“We’re in a deep hole, and now we’ve got to dig ourselves out of it, which is a very difficult task,” Diane Swonk, chief economist at Mesirow Financial, said.

But consumer spending fell by 1.2 percent as Americans put more than 5 percent of their disposable income into savings. Economists are concerned that consumer spending, which makes up 70 percent of the economy, will not rebound as long as employers keep cutting jobs and trimming wages.

Is Something better than Nothing?

Forty-four years ago, then President Johnson handed former President Harry Truman the nation’s first medicare card. That was July 30, 1965. This measure was one of the biggest steps taken during LBJ’s Great Society programs and undoubtedly one of the biggest steps towards eliminating poverty among the elderly since the Social Security Program. Back then, its critics included George H.W. Bush and Barry Goldwater who were bandying about the ‘it’s socialism’ meme as freely as the critics of any health care reform do today. Note to Republicans, yet again. Socialism is when the government turns private assets into public assets. It’s about ownership of assets, not about providing agencies or government sponsored private monopolies the opportunity to provide third party services in failed markets. Do you consider your utility company to be an agent of socialism?

So, today, we have watered down (and that’s being generous) health reform in an era of huge democratic majorities in government. Still, we’re losing the argument for the best and most cost effective plan to hysteria around purposefully promoted misunderstanding. We stand on the verge of passing legislature that is something, which is more than nothing, but hardly much of an improvement over the very bad status quo. Is that really worth it?

The Hill reports that Waxman’s compromises have created furor among Liberals. Count me among those of us that know that the only true way to save money on health insurance, cover every one, get the benefits of risk pooling and the economies of scale that come from uniform process and paper work is with a universal health care plan. What are we getting now? Basically a foot in a closing door and that ain’t much.

That’s a problem, since the draft bill already promises to be a tough sell for liberals. It eschews two central Democratic priorities: the creation of a government-run public insurance plan option and a requirement that most employers provide health benefits.

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Leaders also agreed to allow states to create health “co-ops” that would compete with the government-run “public option” and private insurers, which deals a blow to liberals.

But why is every one afraid of expanding Medicare?

Don’t sell Tinfoil Short … yet

I was taking a break from formulating exchange rate models (yeah, I know so much excitement, so little time over the

Something smells at Citigroup

summer) at the WSJ. Nothing grabs me quite like a market manipulation story. The headline is “Traders Blamed for Oil Spike”. So, stay with me here as I quote from that article.

The Commodity Futures Trading Commission plans to issue a report next month suggesting speculators played a significant role in driving wild swings in oil prices — a reversal of an earlier CFTC position that augurs intensifying scrutiny on investors.

In a contentious report last year, the main U.S. futures-market regulator pinned oil-price swings primarily on supply and demand. But that analysis was based on “deeply flawed data,” Bart Chilton, one of four CFTC commissioners, said in an interview Monday.

The CFTC’s new review, due to be released in August, adds fuel to a growing debate over financial investors who bet on the direction of commodities prices by buying contracts tied to indexes. These speculators have invested hundreds of billions of dollars in contracts that were once dominated by producers and consumers who sought to hedge against oil-market volatility.

So, you have to remember last summer and those terrible oil price hikes that seemingly came out of no where, right? Thankfully, there’s a commission being set up to look into this and to look into what kind of regulations should be placed on speculation in markets of these kinds.

The debate over speculators underscores the shifting nature of commodities trading in recent years. Before the mid-1990s, these markets were dominated by entities that had physical dealings with the underlying commodity, and “speculators” who often took the opposite position, providing liquidity to markets.

But a new group of investors has emerged in recent years. Those who want to bet on commodities prices have increasingly put their money in indexes that track the value of futures contracts, in which investors promise to pay a certain amount in the future for oil and other commodities. As of July 2008, financial investors had about $300 billion riding on these indexes, roughly four times the level in January 2006, according to the International Energy Agency, a Paris-based watchdog.

Separately, these investors may buy derivatives, not directly traded on futures exchanges, that let them make contrary bets to offset their risks.

Crude-oil prices surged in July 2008 to a record $145 a barrel, then dropped to about $33 in December. Oil now trades at around $68 a barrel.

Hopefully, you’re still with me on this because here comes the intrigue. I may be putting on my tinfoil hat at this point but if you watched TV news yesterday you probably saw the article about absolutely, positively, in trouble Citigroup owing $100 million in Bonuses to one Andrew Hall. Now, you may remember that we fund Citigroup right now and that they are in business even though they are on double secret probation. The scuttlebutt is that this bonus is due this guy, because he earned it, but it’s going to have to be paid with a sort’ve pass through of taxpayer funds. Ring any bells yet?

Okay, so here’s my tinfoil hat part. Do you know how this guy made all this money?

The trader, Andrew J. Hall, heads Citigroup’s energy-trading unit, Phibro LLC — a secretive operation, run from the site of a former Connecticut dairy farm, that occasionally accounts for a disproportionate chunk of Citigroup income.

So get this, first we all had to pay these HIGH, HIGH gas prices last year because energy traders ran up oil prices, NOW, we as taxpayers get to pay this guy’s bonus because Citigroup’s big profit center was, wait a minute, wait for it, yup, you got it ENERGY TRADING!.

I’m going long on Tinfoil, for this one. Karl Denniger, what say you?

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The Koolaid Kult Exposed

This week’s The Economist came with the usual stuff. I almost left it on the pile of things to read later. Last night, in a fit of insomnia, I turned to Lexington’s weekly take on U.S. politics. The title surprised and beckoned. “The Obama Cult” is hopefully one of the first serious pieces in the Main Stream Media to take a look at the Elmer Gantry style political experience that was 2008.

Mr Obama has inspired more passionate devotion than any modern American politician. People scream and faint at his rallies. Some wear T-shirts proclaiming him “The One” and noting that “Jesus was a community organiser”. An editor at Newsweek described him as “above the country, above the world; he’s sort of God.” He sets foreign hearts fluttering, too. A Pew poll published this week finds that 93% of Germans expect him to do the right thing in world affairs. Only 14% thought that about Mr Bush.

Perhaps Mr Obama inwardly cringes at the personality cult that surrounds him. But he has hardly discouraged it. As a campaigner, he promised to “change the world”, to “transform this country” and even (in front of a church full of evangelicals) to “create a Kingdom right here on earth”. As president, he keeps adding details to this ambitious wish-list. He vows to create millions of jobs, to cure cancer and to seek a world without nuclear weapons. On July 20th he promised something big (a complete overhaul of the health-care system), something improbable (to make America’s college-graduation rate the highest in the world by 2020) and something no politician could plausibly accomplish (to make maths and science “cool again”).

So, what started this Brit to dissect what our country did to itself with the cult of personality during an especially challenging time in our history? You can take a look at Lexington’s blog and see that he was inspired by what he calls a prescient book by Gene Healy entitled “The Cult of the Presidency, Updated: America’s Dangerous Devotion to Executive Power.” This book was published by the Cato Institute and was written during the Bush years. Lexington’s blog summary makes me want to pick the book up and dive in despite Mr. Healy’s well known credentials as a libertarian scholar/philosopher. (Okay, so did I warn you enough that the original source is not a certified, PC, liberal meme?)

Gene Healy argues that because voters expect the president to do everything, candidates promise far more than they can possibly deliver.

When they inevitably fail to keep their promises, voters swiftly become disillusioned. Yet they never lose their romantic idea that the president should drive the economy, vanquish enemies, lead the free world, comfort tornado victims, heal the national soul and protect borrowers from hidden credit-card fees.

No president in the modern era has raised expectations like Barack Obama, so he is unusually likely to disappoint. The polls already show signs of disillusion, especially among independent voters.

I don’t buy the whole of Mr Healy’s argument, but he makes some interesting points. To win a presidential election in America, you have to say things you know to be untrue. If you make it too obvious, like John “I’ll make every school an outstanding school” Edwards, you will stumble. But the system rewards those who can peddle plausible snake oil, and excludes anyone who is scrupulous about telling the truth.

The book includes countless vignettes illustrating the oddness of those who are prepared to do what it takes to become president. One of the more surprising concerns Lyndon Johnson. When asked by a reporter in the Oval Office why America was in Vietnam, he unzipped his fly, waved the presidential member at his questioner and replied: “This is why!”

Market Rallies as K Street Wins

I never really thought that we would see a truly “progressive” agenda coming out of the Washington, D.C. this year, but with such huge democratic majorities, I did have some thought we might get something done for the people for a change. Remember, those campaign promises last year did seem pretty liberal even though most of us here on TC doubted we’d see even half of them come to fruition. Now it’s looking apparent that what’s coming out is more corporate loot fest than progress for the people. Is that why we have a market rally in what still appears to be a very poor economy?

There’s an interesting hypothesis floating around The Hill today that Wall Street may have bought into the hope and change agenda and is now rallying because it appears to now be all hype and no change. I’m not sure if I’d consider this a good hypothesis as a financial economist, but as some one more firmly planted on the behavioral finance side of things than the rational markets gang, I’m willing to give the idea an airing.

The Democratic agenda in Washington has gone off the rails just as markets are enjoying their best run of the Obama presidency, and there’s a school of thought on Wall Street that it’s no coincidence.

While a string of better-than-expected earnings reports from U.S. companies has been credited for the upswing, analysts such as Axel Merk, the portfolio manger of Merk Investments, said the stalled agenda in Congress has also helped the Dow Jones Industrial Average spike above 9,000.

So what items on the liberal Wall-Street-Hating-agenda did they fear? Well, first and foremost on the list was legislation on executive compensation. I doubt the populist outrage against the bonus class has gone any where, but now that we have a Pay Czar to oversee the problem, nothing has happened. Yesterday, I talked about the Citibank Energy Trader, Andrew Hall waiting in the wings for his $100 million bonus for driving up our energy prices last year while Citibank itself has taken $45 million in TARP funds and remains on a some kind of double secret probation with its regulators. All this while that market’s regulator is investigating issues with the traders. The Hall bonus has floated around the MSM and the news programs while CNBC, the Wall Street equivalent to the Hornet’s Honeybees here in New Orleans, continues to champion big pay for risk taking and innovation. I guess adding a little liquidity to the market was worth the worst financial crisis since The Great Depression in their eyes.

All Eyes on Ben

I’ve been Fed watching again. That’s something of both an occupational hazard and a weirdish hobby for me. Usually, Fed chairs stay off the lecture circuit until they retire and write their biographies. Ben Bernanke, however, is not your usual Fed Chair and these are not usual times. I think you may recall that part of his observations with being in charge of monetary policy when there’s no room drop interest rates (ZIRP) has to do with communicating future Fed actions to a nervous public. This continues.

Bernanke was in Kansas City over the weekend speaking to normal people and Jim Lehr of the PBS program News Hour. There were several things from this exchange worth mentioning. The first is a response to the meme circulating around the libertarian circuit that there is no accountability between the FED and any one in Washington. That is untrue for several reasons. First, because the majority of appointments (including the Fed Chair) to the FOMC are made by POTUS and approved by the Senate. Second, the Fed Chair makes biannual trips to the Hill to speak with both houses of Congress and take questions. Third, they publish their internal records as well as their research continually. It’s a matter of public record. The only thing Congress doesn’t get to see is the rationale behind monetary policy which is perfectly in keeping with the idea of independence supported overwhelmingly by evidence and theory. They have to the right to see the Fed balance sheet and items now. What they do not have is the right to ‘audit’ monetary policy. Something that would be a disaster.

“The Federal Reserve, in collaboration with the giant banks, has created the greatest financial crisis the world has ever seen,” Representative Ron Paul, Republican of Texas, said at a House hearing last week in which Mr. Bernanke testified about the state of the economy.

Republican lawmakers portray the Fed as the embodiment of heavy-handed big government, and have called for scaling back the central bank’s regulatory powers. But liberal Democrats, like Representative Dennis J. Kucinich of Ohio, have accused the Federal Reserve of caving in to demands by banks for huge bailouts, for failing to protect consumers against dangerous financial products and for being too secretive about its emergency rescue programs.

More than 250 lawmakers have signed a bill sponsored by Mr. Paul that would allow the Government Accountability Office to “audit” the Fed’s decisions on monetary policy — a move that Fed officials see as a direct threat to their political independence in carrying out their central mission of setting interest rates.

A lot of the complaints at the appearance came from the audience who basically aired Kucinich’s view that the Fed appeared all too willing to bail out the reckless big guys while letting the little guys go belly under. Bernanke did not shy away from the questions at all.

When a small-business owner asked Mr. Bernanke why the Fed helped rescue big banks while “short-changing” small companies, Mr. Bernanke answered that he had decided to “hold my nose” because he was afraid the entire financial system would collapse.

“I’m as disgusted by it as you are,” he told the audience of 190 people. “Nothing made me more angry than having to intervene, particularly in a few cases where companies took wild bets.”

He used a most interesting metaphor when explaining why he had to hold his nose and bail out the gamblers. He basically said, if an elephant falls it crushes the grass beneath it. Wow, a zen moment from a Fed Chair. Who’d have thought that was possible? He also said that the main reason he did it was because he didn’t not want to be the Fed Chair at the time of the second Great Depression. I’d say that was succinct enough.

The Realities of Market Failure

Paul Krugman jumped further in to the health care reform debate today just as the CBO announced that the Obama Plan, billed as a cost-saver, continues to be anything but cost saving. Krugman rightly points out that in a land of third party payers, you are not going to find a free market solution. This is simply true by definition so why is there so much confusion?

Krugman borrows heavily from an earlier treatise by Kenneth Arrow, one of the early pioneers of modern economics in a 1963 treatise called Uncertainty and the Welfare economics of health Care. (Note: The link on Krugman’s blog is bad so use mine.) Let me just mention here that Welfare in economics means you’re looking for allocative efficiency within an economy given that economy’s income distribution. Since so few folks in this country have the majority of income and resources, for example, the U.S. is a considered about average on allocative efficiency. Our resources are not distributed based on the aggregate welfare of society. We have a system where there are winners and losers because most of our goods are distributed by ability to pay and most of that ability to pay comes from accident of birth.

So, Krugman updates the Arrow treatise and argues that healthcare is not what you would refer to as a standard market that would thrive under free market conditions. He points to two very distinct characteristics that takes it out of contention for a completely free market solution which borrow heavily from Arrow.

There are two strongly distinctive aspects of health care. One is that you don’t know when or whether you’ll need care — but if you do, the care can be extremely expensive. The big bucks are in triple coronary bypass surgery, not routine visits to the doctor’s office; and very, very few people can afford to pay major medical costs out of pocket.

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The second thing about health care is that it’s complicated, and you can’t rely on experience or comparison shopping. (”I hear they’ve got a real deal on stents over at St. Mary’s!”) That’s why doctors are supposed to follow an ethical code, why we expect more from them than from bakers or grocery store owners.

If you’ve followed any of my blogging carefully, you will recognize two underlying themes that we’ve frequently talked about throughout Krugman’s assessment. That would be that the health care market has the two nasty frictions of moral hazard and information asymmetry. Insurance companies, theoretically, should provide cost effective remedies to both. However, there are things unique to health insurance and the underlying risk of getting catastrophic illnesses that make huge risk pools the most cost effective. This is the primary economic argument for universal healthcare. Putting every one (the healthy and the unhealthy) into one HUGE risk pool, minimizes the cost to everyone, thereby maximizing allocative efficiency and economic welfare. Insurance companies that cherry pick, and healthy folks that self opt-out of risk pools, violate these principles and make it more expensive and less efficient for every one.

What Exactly are they fighting to Preserve?

Here’s an interesting link from Foreign Policy. We’ve joined China, Russia, and wait for it, wait for it … that bastion of global civilization …Turkmenistan on the list of the World’s Worst Health Care Reforms.

I understand why Republicans are fighting progress on Health Care Reform because they don’t like progress of any sort, but what about those democrats who want to reinvigorate health insurance industry profits? What exactly are they supporting? Continuation of failure?

System: Employer-based private coverage, with an under-regulated private insurance market, and

government-subsidized public plans for the poor, elderly, and disabled

Reform: The United States has the rare distinction of being both one of the world’s richest countries and having one of its least-functional health care systems.

Americans spend around one in every six dollars on healthcare. But, in aggregate, they’re not getting much bang for their buck. People in the United States are as likely to die from diseases like lung cancer as citizens in all OECD countries – which, on average, spend less than half as much per capita. Some 47 million lack any health insurance coverage. An estimated 600,000 people file for bankruptcy every year because they cannot pay their medical expenses. Indeed, the United States is the only rich country without universal coverage.

The U.S. government has repeatedly tried to create a more coherent plan and to make sure more Americans are insured. Reformers have scored piecemeal victories — such as the 1997 creation of the State Children’s Health Insurance Plan, or Massachusetts’ recent implementation of universal coverage.

But for the most part, the history of health reform in the United States has been a history of failure. The last attempt at comprehensive reform — the 1993 bill derided as “HillaryCare,” during the administration of Bill Clinton — floundered in Congress. Since then, costs and premiums have doubled, a lower percentage of employers offer coverage, and millions more are uninsured.

Subprime Mortgage Myths

Yuliya Demyanyk, a senior research economist at the Cleveland Fed, has done a fascinating job debunking some of the bigger memes floating around main stream media outlets about the Subprime Mortgage Market. Her Economic Commentary piece here distills the more germane information found in the research published here. Her bottom line is that it was not so much the meltdown of the subprime market with its components of interest rate resets, declining underwriting standards, and declining home values that contributed to the systemic problems creating the big financial meltdown. She argues that it was the interplay between that market and the securitization process, lending and housing booms, and leveraging

One of the biggest myths surrounding the subprime market is that subprime mortgages are given solely to borrowers with impaired credit. Demyank and her fellow reseacher Van Hemmert found that many folks actually wound up in certain subprime loans not because of their credit history (which was not impaired) but the fact that certain loans were only available in the subprime market because that was the type of loan demanded by the securitization market.

But mortgages could also be labeled subprime if they were originated by a lender specializing in high-cost loans—although not all high-cost loans are subprime. Also, unusual types of mortgages generally not available in the prime market, such as “2/28 hybrids,” which switch to an adjustable interest rate after only two years of a fixed rate, would be labeled subprime even if they were given to borrowers with credit scores that were sufficiently high to qualify for prime mortgage loans.

The process of securitizing a loan could also affect its subprime designation. Many subprime mortgages were securitized and sold on the secondary market. Securitizers rank ordered pools of mortgages from the most to the least risky at the time of securitization, basing the ranking on a combination of several risk factors, such as credit score, loan-to-value and debt-to-income ratios, etc. The most risky pools would become a part of a subprime security. All the loans in that security would be labeled subprime, regardless of the borrowers’ credit score.

Mortgage originators may have directed some folks to these loans based on the characteristics of the loan, not necessarily the characteristics of the buyer.

A second myth debunked by the research is the idea that subprime mortgages were used to promote home ownership. By slicing and dicing the lending data base, the two researchers found some interesting numbers as they relate to overall homeownership statistics.

The availability of subprime mortgages in the United States did not facilitate increased homeownership. Between 2000 and 2006, approximately one million borrowers took subprime mortgages to finance the purchase of their first home. These subprime loans did contribute to an increased level of homeownership in the country—at the time of mortgage origination. Unfortunately, many homebuyers with subprime loans defaulted within a couple of years of origination. The number of such defaults outweighs the number of first-time homebuyers with subprime mortgages.

Given that there were more defaults among all (not just first-time) homebuyers with subprime loans than there were first-time homebuyers with subprime loans, it is impossible to conclude that subprime mortgages promoted homeownership.

Keyboard Cat plays off Okun’s Law

I’ve been teaching Okun’s Law in my principles level Macroeconomics courses since 1980. It’s been the policy rule of thumb since the Kennedy years on how much GDP needs to change to get a movement in the unemployment rate. Here’s the Wiki explanation which is as good as any.

In economics, Okun’s law is an empirically observed relationship relating unemployment to losses in a country’s production. The “gap version” states that for every 1% increase in the unemployment rate, a country’s GDP will be an additional roughly 2% lower than its potential GDP. The “difference version” describes the relationship between quarterly changes in unemployment and quarterly changes in real GDP. The accuracy of the law has been disputed. The name refers economist Arthur Okun who proposed the relationship in 1962 (Prachowny 1993).

I’ve mentioned recently that we’re seeing some fundamental changes in that relationship. This WSJ article talks more about how we’re breaking away from the historical pattern studied by Okun back in the 1960s. This has incredible ramifications for fiscal policy makers. Again, I think the Obama economic advisers appear to be ignoring some really important changes in the fundamentals. We’re much more oriented towards imports, service jobs, and capital than we were back in the Camelot days.