December 3, 2023

New-Home Sales and Factory Activity Rise

Showing no signs of slowing in the face of higher mortgage rates, sales of single-family homes increased 8.3 percent to a seasonally adjusted annual rate of 497,000 units, the highest level since May 2008, the Commerce Department said.

Economists, who had expected sales to advance only to a 482,000-unit rate, said buyers sitting on the fence had probably rushed into the market to lock in mortgage rates in anticipation of even higher rates.

“The recent increase in mortgage rates hasn’t slowed demand as long as home affordability remains high,” said Bob Walters, chief economist at Quicken Loans in Detroit. “We are, however, seeing an increased urgency from potential new home buyers as they move to secure today’s historically low rates.”

Though the government revised down sales from March through May by a total 38,000 units, the overall tone of the report was bullish. Compared with June 2012, sales of single-family homes were up 38.1 percent, the largest increase since January 1992.

Some worried that higher borrowing costs could crimp the housing market recovery after a report on Monday showed a surprise drop in home resales in June.

Mortgage rates have been rising in anticipation of the Federal Reserve’s starting to reduce its huge monetary stimulus this year. According to Freddie Mac, the 30-year fixed mortgage rate increased 0.53 of a percentage point in June to 4.07 percent, its highest level since October 2011.

Still, mortgage rates, which edged lower last week, remain low by historical standards, and economists, including the Fed chairman, Ben S. Bernanke, contend the fundamentals in the housing market are strong enough to withstand the increase in borrowing costs.

The strengthening housing market is lending support to manufacturing, which has been hit by deep federal spending cuts and slowing global demand.

A rebound in new orders helped to lift factory activity to a four-month high in July. Markit’s preliminary Manufacturing Purchasing Managers Index rose to 53.2 this month from 51.9 in June. A reading above 50 indicates expansion in the factory sector.

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Economix Blog: The Path to Complexity on the Health Care Act

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities in Washington and a former chief economist to Vice President Joseph R. Biden Jr.

In contemplating the one-year delay in the Affordable Care Act’s employer penalty, I was reminded that the health care law is an awfully complicated piece of work.

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I’m a supporter of the bill, and someone who was working for the administration when health legislation was designed, so let’s be clear: the fact that it’s complex doesn’t mean its implementation is anything like the train wreck that conservative Republicans (and Max Baucus) like to call it.

In fact, as I read the recent report from the Government Accountability Office on setting up the state exchanges — the most complex part of the bill’s implementation — I’d say it’s proceeding apace despite train wreckers trying to derail it. I suspect most state exchanges will be up and running on Oct. 1 (the federal government is setting up and will operate most of them), and when you consider the magnitude of this challenge amid the blowback and underfunding of the effort, if I’m even close to correct, that will be a very impressive outcome.

But when the White House announced the delay in the employer penalty, a lot of people pointed out that had the United States gone with a single-payer, Medicare-for-all style system, it wouldn’t have had to futz around with Rube Goldberg policy structures like that in the illustration below from the Congressional Research Service on the employer penalty.

Congressional Research Service

It’s a fair point, and one that took me back to my days of selling the bill out on Pebble Beach, that little strip of land next to the White House where television cameras film administration officials. A typical interview back then (2009-10) would usually involve a reporter asking me to defend the proposed reform and explain why the people should be for it. I cringe to think that I often started out by suggesting that it had the potential to “bend the cost curve” — i.e., slow the unsustainable growth of health costs.

Why cringe? Not because I was wrong — that was a major motivator and the law may already be showing some promise in that critical regard. The cringe is because very few listeners knew what to make of that assertion, and it certainly didn’t answer what they really wanted to know, which was, “How is this thing going to affect me and my family?”

That’s why being able to say the other line I recall using out there — “If you’re happy with your current coverage, this law won’t affect you at all” — was so important. And that’s also why we’re stuck with a lot more complexity than we’d like.

To understand why we are where we are with the Affordable Care Act, it’s useful to think about the concept of path dependency, meaning that where you end up is often a function of where you start out. And in the United States, we start out with an employer-based system. Though employers have been shedding coverage, about 58 percent Americans and their families are still covered through their job, down from 68 percent a decade ago (not counting older Americans). Perhaps more importantly, among those with private coverage, a group that the opposition was and is trying to scare about the impact of the law, about 90 percent are covered through their employer.

That’s the path we started on, and our judgment was that straying from that path would doom the bill. I suspect we were right. I can assure you that being able to hammer home that line about keeping what you have was very important and comforting for people to hear. Passing the law was in no small part about convincing a majority of passengers on an already rickety boat that they’d be better off if they threw a life preserver to the minority floundering in the water.

That doesn’t mean that what we ended up with is optimal. Certainly, the addition of a public, Medicarelike option within the health care exchanges would have been a good compromise, a way to stay on the path but branch off in a more progressive direction. But even without that, objective analysts score the bill as eventually covering millions of people and saving billions of dollars.

Could we have bucked path dependency? Must we continue to accommodate the employer-based system, not to mention the powerful insurance industry deeply embedded in America’s uniquely inefficient health care delivery system? Do we really need a bunch of separate health care exchanges?

Well, private insurers supported the law only when it looked as though they’d get to cover a lot more people, with many getting subsidized coverage. Though the coverage offered in the exchanges has to meet national standards, states will continue to regulate the insurers within their borders. (The state accommodations are particularly ironic, because deference to states run by arch conservatives is turning out to be a tough implementation barrier; according to G.A.O., 11 states say they lack “the authority to enforce or are not otherwise enforcing” the insurance market provisions of the Affordable Care Act. It’s starting to look like the euro zone out there.)

Perhaps my former colleagues and I lacked imagination, but in the case of health care, with large, risk-averse majorities worried about keeping what they had, powerful industries lining the existent path and a largely reactionary House of Representatives, it’s hard to imagine that we could have deviated from path dependency.

So as the implementation season proceeds and new delays and complications pop up, remember the rocky path we started on. I firmly believe that if we can fully carry out the Affordable Care Act — and I think we will — the path will become smoother. And that means the next round of reform will start from a better place.

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European Central Bank Commits to Low Rate

FRANKFURT — The European Central Bank said Thursday it would keep interest rates low “for an extended period of time,” an unprecedented commitment for an institution that had steadfastly refused to offer guidance on its future policy.

With the promise of easy money, Mario Draghi, the president of the E.C.B., offered more certainty to investors at a time when tensions in the euro zone are rising again. So-called forward guidance is considered one of the tools available to central banks, but one the E.C.B. had never used before.

The E.C.B. kept its main rate at a record low of 0.5 percent, as expected. The relative calm in the euro zone has been threatened in recent weeks by a political crisis in Portugal, a rise in the risk premium that investors demand on bonds issued by Italy and other troubled countries, and reluctance by political leaders to take bold steps to build a stronger currency union.

The commitment to keep rates low may be intended to amplify the effect of the current low rate by reassuring investors that they can count on easy money for the foreseeable future. The statement may also be intended to counteract any effect in Europe from expectations that the U.S. Federal Reserve may gradually begin to tighten its monetary policy.

Mr. Draghi has in recent weeks stressed that policy makers were ready to take action if needed, but he and other members of the governing council have few obvious options left to stimulate the slumping euro zone economy.

“The bank has nothing more it can do within its institutional framework to help return the euro land economy to prosperity,” Carl Weinberg, chief economist at High Frequency Economics in Valhalla, New York, wrote in a note to clients Wednesday.

Mr. Draghi has often stressed that E.C.B. anti-crisis measures could only buy time for political leaders to take action, for example by removing barriers to entrepreneurship in countries like Italy or cooperating more closely to fix ailing banks.

But now that fear of a euro zone breakup has ebbed, political leaders seem to have lost the will to address flaws in the currency union. An agreement by national leaders last month on a so-called banking union, designed to make the euro zone less prone to financial crises, fell short of what economists say is needed to deal with weak lenders and restore the flow of credit.

In recent days market borrowing costs for Italy and Spain have risen again, after a political crisis in Portugal raised questions about whether governments will be able to withstand public discontent about budget cutting and joblessness.

Further increases in government borrowing costs could test whether the E.C.B. can deliver on its promise last year to buy bonds of troubled countries if needed to eliminate fear of a euro zone breakup. Some analysts doubt whether the program could be deployed quickly in a crisis, since it requires countries to request help and agree to economic reforms and other conditions.

The E.C.B. appears unwilling to take more radical steps to stimulate the economy, such as massive, broad-based bond purchases similar to the quantitative easing used by the U.S. Federal Reserve or Bank of England. Already, the E.C.B. faces a legal challenge in Germany’s Constitutional Court to the bond buying program and is probably reluctant to further alarm Germans fearful that they will wind up paying for problems in Italy and Spain.

The E.C.B.’s job is further complicated by signs that the Federal Reserve could begin to gradually roll back its economic stimulus in the United States. Expectations of tighter monetary policy in America have rattled financial markets in Europe, and Mr. Draghi may try to reassure investors that the E.C.B. is a long way from going in the same direction.

“President Draghi might note that contrary to market expectations the E.C.B. has not followed the strategy pursued by the Federal Open Market Committee in recent years,” economists at Royal Bank of Scotland wrote in a note to investors earlier this week, referring to the Federal Reserve’s policy-making panel.

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Economix Blog: Simon Johnson: The Problem With Corporate Governance at JPMorgan Chase


Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

Some proponents of the current American version of corporate capitalism contend that if there is a problem with the way our largest companies are run, shareholders will take care of it – by putting pressure on directors, sometimes voting them out. Shareholders are not supposed to replace chief executives directly but apply pressure to the board to improve oversight and produce management change when appropriate.

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In contrast, critics like to point out that owners – including small shareholders, pension funds and large mutual funds – seem unable to exercise even a modicum of control over many of today’s larger corporations, particularly the largest financial institutions.

The situation at JPMorgan Chase, in the run-up to its annual meeting on May 21, is an interesting test case with regard to two specific decisions: whether Jamie Dimon should continue to serve as both chief executive and chairman, and whether three members (David Cote, Ellen Futter and James Crown) of the risk committee of the board should be voted out.

Two proxy advisory firms – Glass, Lewis Company and Institutional Shareholder Services Inc. – have called for JPMorgan Chase shareholders to vote against the recommendations of management on both issues. Leading shareholders have apparently not yet made up their minds – and are being lobbied hard by supporters of Mr. Dimon to resist change. Mr. Dimon likes being chief executive and chairman and very much wants to keep things that way.

The interests of shareholders would be better served by following the advice of Glass Lewis and Institutional Shareholder Services. (Glass Lewis is also recommending that the three members of the board’s audit committee be replaced; I support that suggestion.)

Changing board governance is not a panacea at any company. An independent chairman can be an effective constraint on a chief executive, but many chairmen lack the stature or experience to play that role. And the risk committee of a big bank will always be constrained by the knowledge and ability of board members, very few of whom understand the risks in large financial institutions today. (There is a process of certifying that board members have relevant expertise; it is meaningless.)

Still, JPMorgan Chase undoubtedly has a serious problem from a shareholder perspective that needs to be addressed through strengthening board oversight.

Exhibit A in this discussion is the recent report by the Senate Permanent Subcommittee on Investigations, headed by Carl Levin, Democrat of Michigan, the chairman, and John McCain, Republican of Arizona, its ranking minority member, into the so-called London Whale trades that lost more than $6 billion. This report finds repeated failures in risk management at the highest levels within the company.

As Senator McCain put it (see the second statement):

JPMorgan executives ignored a series of alarms that went off as the bank’s Chief Investment Office breached one risk limit after another. Rather than ratchet back the risk, JPMorgan personnel challenged and re-engineered the risk controls to silence the alarms.

The report itself is more than 300 pages and the exhibits run around 500 pages (links to both documents are on the upper left on this page). For a concise statement of the core issues, I recommend this analysis by Bart Naylor of Public Citizen focusing on Exhibit 46 and explaining how JPMorgan Chase executives were gaming regulatory constraints to drive up their stock price (and presumably bonuses).

Specifically, the bank’s senior management changed how they calculated the risk of their positions so that they could reduce the amount of equity funding they needed. This allowed them to increase their leverage (borrowing relative to assets) as well as their risk – without this risk actually showing up in a report.

Mr. Dimon says he did not know this was going on, but even his denial is a concession that his management system completely broke down.

JPMorgan Chase’s policy, as stated to shareholders in its annual report, required risk limits to be taken seriously, with senior management responsible for signing off on high-level model changes. It is not unreasonable for shareholders to expect Mr. Dimon himself would take these risk limits seriously. And where was board oversight in this entire process?

For further detail, you can read the summary opening statement by Senator Levin (the first statement on the subcommittee’s Web page). Or try this somewhat more colorful and even emotional assessment by Matt Levine, a commentator who does not usually agree with people like Senator Levin, Mr. Naylor, and me that very large banks can pose serious danger to society (caution: Mr. Levine’s language is not suitable for family members too young to have a brokerage account).

Or, if you are a JPMorgan Chase shareholder, read the full report – or at least the executive summary. And wonder about whether a handful of traders and one inexperienced risk officer (with questionable authority) can effectively oversee a complex derivatives portfolio that grew tenfold over a period of months (with a notional value eventually in the trillions of dollars). How can a member of the board’s risk committee without financial services expertise possibly spot the risks and ensure management is keeping the bank out of trouble?

Senator McCain makes the link to the important broader policy issue on Page 3 in his opening statement:

This bank appears to have entertained – indeed, embraced – the idea that it was quote “too big to fail.” In fact, with regard to how it managed the derivatives that are the subject of today’s hearing, it seems to have developed a business model based on that notion.

Whether shareholders should be bothered by a firm’s being too big to fail is an interesting question. If this status purely confers a subsidy – in the form of taxpayer support when things go badly – then we should expect shareholders to be quite excited by the prospect.

Unfortunately for shareholders, the JPMorgan Chase case demonstrates that the distortion of incentives also means it is much harder to control what goes on at a large complex financial company. From 2000 through the end of 2012, the stock was down 15 percent; midsize banks have done much better over this time period. You can call this “too big to manage,” but it is more likely that executives and traders on the inside are doing well, so it is really outsiders (e.g., shareholders, as well as taxpayers) who are doing badly.

The London Whale losses did not bring down the company, but shareholders still have cause to want change. When planes almost collide at an airport, we do not say, “there was no actual accident, so that means the system works well.” Instead, our reaction is along the lines of, “What went wrong?” and “How can we prevent this from happening again?”

But at JPMorgan Chase, it is business as usual, despite reports of further regulatory investigations into other areas of the bank, including whether it helped manipulate interest rates and commodities prices and whether it was honest with shareholders and regulators about the London Whale big bets on derivatives.

What is likely to happen on or before May 21? Large shareholders will not want to rock the boat, and the prospect of continuing too-big-to-fail subsidies is too alluring. Mr. Dimon and his board will get another chance.

That will be good news for Mr. Dimon and his directors, but bad news for the rest of us, again. And JPMorgan Chase’s shareholders will likely not do so well, once more.

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U.S. Adds 165,000 Jobs; Jobless Rate Falls to 7.5%

The latest jobs figures from the Department of Labor paint a brighter picture of the overall economy than other recent data, which had been weaker and prompted economists to warn of a spring swoon for the third year in row. Those worries had been heightened after the March jobs report, which initially showed the economy to have added just 88,000 jobs, much fewer than had been expected.

On Friday, however, the government sharply revised upward its estimates for job creation in February and March, concluding that the economy actually generated 332,000 jobs in February and 138,000 in March. The unemployment rate, which is based on a separate survey, fell by 0.1 percentage point to 7.5 percent, from 7.6 percent in March.

“It’s back to normal for this cycle,” said Steve Blitz, chief economist at ITG. “This number is back to the mainstream of what we’ve seen in this recovery.”

Still, Mr. Blitz noted, many of the new jobs were in lower-paying sectors like retail and food services. Stores hired 30,000 workers, while restaurants added 38,000 employees.

“You’re hiring people, but you’re not generating high-income jobs,” he said. “But work is work. It’s honorable.”

Another positive sign was that the size of the labor force increased, while the total number of unemployed Americans dropped by 83,000 to 11,659,000.

The stock market reacted strongly to the better-than-expected figures, with the Standard Poor’s 500 index breaking through the 1,600-point level for the first time, rising almost 1 percent at the opening bell. The Dow Jones industrial average was up over 130 points, nearly 1 percent as well.

Economists have been warning that the economy — and job creation — will slow in the second-quarter, largely as a result of fiscal tightening in Washington. Payroll taxes increased in January, and across-the-board spending cuts mandated by Congress went into effect in March, and their impact is expected to be felt more broadly in the months ahead.

And while the private sector has clearly been on the upswing this year, the government continues to represent a drag on job creation, shedding 11,000 jobs during the month. Over all, April’s rate of job creation was still well below the 209,000 jobs added per month in the fourth quarter of 2012.

“In one line: Not bad, especially in the light of beaten-down expectations,” said Ian Shepherdson, chief economist with Pantheon Macroconomic Advisors. “This could have been much worse.”

The manufacturing sector, which is closely watched as a gauge of broader economic strength, was unchanged in April. Private sector job creation totaled 176,000.

With the unemployment rate still well above 6.5 percent, the Federal Reserve has promised to keep buying billions of dollars of bonds in an effort to help bolster growth. The Fed’s stimulus efforts have helped buoy the markets, but the job picture has remained weak.

Economists also noted that the number of hours worked fell in April, another sign that the economy is having trouble generating enough additional income and jobs to help lift spending.

The government could be the wild card in the coming months. Automatic, across-the-board spending cuts officially went into effect in March, and if the mandated spending cuts continue, layoffs could increase. Apart from the job figures, the economy has been showing signs of weakness of late. Several indicators beginning in March have pointed to much slower growth, with everything from retail sales to manufacturing looking soft recently.

“What’s the biggest drag on the economy? The government,” said Diane Swonk, chief economist for Mesirow Financial in Chicago. “If the government simply did no harm, we could be at escape velocity.”

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Economix Blog: Where the Raises Are: Trucking and Academia



Dollars to doughnuts.

I spoke today with Diane Swonk, chief economist at Mesirow Financial, who mentioned that she has been keeping an eye on which industries and occupations are giving raises. Unfortunately, not many fall under that category.

As of March, the Labor Department’s index for the cost of total compensation for all civilian workers was just 0.3 percent higher than a year earlier, after adjusting for inflation. To give some context, the year-over-year change in this index — which includes wages and salaries as well as benefits — has averaged 0.7 percent since 1982, the first year these data became available.

Source: Bureau of Labor Statistics, via Haver Analytics. Numbers are adjusted for inflation by Haver. Source: Bureau of Labor Statistics, via Haver Analytics. Numbers are adjusted for inflation by Haver.

Inflation has been very low in recent years, but it has still been substantial enough to mostly wipe out the meager raises that American workers have been receiving in nominal terms. (Before adjusting for inflation, compensation rose 1.8 percent year-over-year in March, compared with a long-term average of 3.7 percent.) Workers’ raises are also slightly lower if you strip out the cost of benefits, particularly since the rise in health care costs has generally outpaced the rise in wages. That’s probably not a coincidence; growing health care costs are eating up other forms of compensation that employers might otherwise provide.

Source: Bureau of Labor Statistics, via Haver Analytics. Numbers are adjusted for inflation by Haver. Source: Bureau of Labor Statistics, via Haver Analytics. Numbers are adjusted for inflation by Haver.

The lack of major wage gains across the board seems to contradict the idea that the economy is suffering from a major bout of skills mismatch. I have no doubt that employers in some industries are having trouble finding workers with relevant skills, but if skills mismatch were the primary driver of the country’s lackluster hiring in recent years, then we would expect to see many more businesses bidding up wages in pursuit of those rare skilled workers who are available.

The two categories that have shown the biggest year-over-year increases in total compensation are (1) occupations in transportation and material moving and (2) employees at junior colleges, colleges, universities and professional schools.

So what do truckers and professors have in common? Ms. Swonk observes that their jobs are both hard to either outsource or automate, unlike a lot of other occupations.

That is becoming less true for professors, though, in the age of massive open online courses, or MOOCs. MOOCs help schools cut down on labor costs by scaling up the number of students who can be taught by a single professor — in some cases, a professor they don’t even directly employ. And professors are worrying about being displaced. As The Chronicle of Higher Education reported Thursday, faculty members in the philosophy department at San Jose State University released an open letter saying they refuse to adopt a MOOC with lectures from a Harvard professor because they don’t want to enable efforts to “replace professors, dismantle departments, and provide a diminished education for students in public universities.”

On the other hand, MOOCs could still push up the overall level of wages for people employed at colleges by changing the composition of workers on those payrolls; the superstar professors whose lectures are featured in large-scale online courses will continue to be paid a lot, while the lower-wage professor jobs at community colleges and other strapped schools could be eliminated altogether, stripping out the bottom part of the pay distribution in higher education.

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Southern Europe’s Recession Threatens to Spread North

German exporters like Daimler have been bastions of stability on a continent burdened with shaky banks, dysfunctional governments and legions of unemployed youth — not to mention the worst auto industry slump in two decades. But Daimler’s glum forecast for 2013 was the latest evidence that Germany, and other relatively healthy countries like Austria and Finland, risk falling into the recession that has long afflicted their southern neighbors.

The slowdown in Germany was foreshadowed by months of declining industrial output, said Carl B. Weinberg, chief economist of High Frequency Economics in Valhalla, N.Y. “The E.U. has made Europe a much more cohesive economy, which is good when things are going up,” he said. “But when things are going down the multiplier is very strong. An outgoing tide lowers all ships.”

The region’s overall economic weakness as well as slowing demand in China and other big markets for German exports of consumer products, cars and sophisticated machine tools, industrial robots and construction equipment are finally taking their toll.

Just one more consecutive quarter of shrinking economic output and Germany would officially enter a recession. The same is true of Belgium, France, Luxembourg, Austria, even Sweden and Finland. The Netherlands has already suffered two quarters of declining gross domestic product.

Further evidence of the spreading European recession came Thursday, first from Madrid, where the Spanish government reported that unemployment had reached a record level: 27.2 percent. Then new economic data from London indicated that Britain had barely avoided slipping back into recession for the third time since 2008.

“The reality is that Europe still faces severe vulnerabilities that — if unaddressed — could degenerate into a stagnation scenario,” David Lipton, first deputy managing director of the International Monetary Fund, said in London on Thursday.

If Germany slips into recession, much would slide down with it. Germany and the other 26 countries of the European Union together represent the world’s second-largest economy and as a bloc it is the single largest United States trading partner. The further delay in Europe’s recovery that a German recession would cause would seriously hamper growth in the United States, Asia and Latin America.

What growth remains in the region is coming mostly from countries in Eastern Europe. Poland is protected by its large domestic market and a healthy banking system. After a severe downturn that began in 2008, growth is rebounding in the Baltic nations of Estonia, Lithuania and Latvia. In that recession, wages fell, real estate prices dropped and banks worked through the painful process of improving their financial condition.

Unemployment there is by no means low, but those countries benefit by being the low-wage economies of Europe. They continue to attract investment of capital. It also helps that those economies, because they do not use the euro as their currency, can adjust their currency more easily to changing economic conditions in the rest of the world. Their economic planners have more policy tools than simply adjusting interest rates.

In Germany, there is little overt sign of crisis. Unemployment is 5.4 percent compared with an average of 10.9 percent in Europe. Nevertheless, polls show businesses are growing pessimistic. “The German market cannot decouple from this environment,” Bodo K. Uebber, the Daimler chief financial officer, told analysts Wednesday.

The problem for the rest of Europe is that any hope for recovery is pinned on a robust German economy. Companies in Spain and Italy have depended on German demand to compensate for a collapse in consumer spending in their own countries.

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Today’s Economists: Simon Johnson and John E. Parsons: The Treasury’s Mistaken View on Too Big to Fail


Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management.
John E. Parsons is a senior lecturer in the finance group at the Sloan School and co-author of the blog

At this point, no one will stick up for too-big-to-fail financial institutions. Even Tim Pawlenty, the newly appointed head of the Financial Services Roundtable, a group that represents big banks, contends that we must end the phenomenon of too big to fail. No financial institution should be so big — or so systemically important for any reason — that its failure would jeopardize the macroeconomy.

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The question of the day has therefore become whether too big to fail is already dead and buried or whether, like some resilient and unsavory zombie, it still stalks within our financial system.

In a speech on April 18, Mary Miller, Treasury under secretary for domestic finance, made the case that the Dodd-Frank reform legislation has substantially ended the problem of too-big-to-fail financial institutions. This is a well-composed speech that everyone should read — and then compare with the broadly parallel messages coming from parts of the financial sector (e.g., see the presentation of the Clearing House, an association of banks).

The original written version of Ms. Miller’s speech did not contain footnotes or precise references to the sources on which she drew, but the Treasury Department was kind enough to share this information with us and has now posted a version of the speech with links to sources; this is also most helpful. As a result, we are able to evaluate Ms. Miller’s arguments in some detail.

Ms. Miller’s argument rests on eight main points. On each there is a serious problem with her logic or her reading of the data, or both. Taken together, we find her position to be completely unpersuasive. Unfortunately, the problem of too big to fail still lurks.

First, Ms. Miller makes a great deal (at the top of Page 2) out of legal changes under Dodd-Frank that make it harder to bail out financial institutions. She is right on the formal changes but misses the essence of the issue. The question is not whether the government can swear up and down not to provide bailouts or some other form of support, but rather whether such commitments are credible. If banks are so big or so linked to the rest of the economy that their distress will bring unacceptable costs, then any government or central bank will be tempted to provide support, for example by seeking new legislation that authorizes emergency bailouts.

Ms. Miller stresses the lack of potential future “taxpayer support” — and that is an appropriate point for a Treasury official to make. But sophisticated modern central bankers have many ways to provide help to troubled financial institutions (e.g., through various kinds of asset-purchase programs), while complying with the letter of Dodd-Frank. To assert otherwise is to create the wrong impression.

Second, Ms. Miller claims that “some evidence actually suggests the opposite conclusion — that larger banks’ funding costs are higher than those of their smaller peers” (see Page 2). The Treasury’s evidence on this point is embarrassingly naïve; it compares funding costs irrespective of the source (see Page 11). A small bank funded mostly with insured deposits will have a lower funding cost than a bank that relies more on wholesale funding. But this difference does not speak to the issue of too-big-to-fail implicit subsidies.

The right comparison is what large banks are paying compared with what they would pay if they did not have implicit government backing.

Banks used to be good at measuring this kind of implicit government support, when it provided an unfair competitive advantage to Fannie Mae and Freddie Mac. Now that they (the private megabanks) are the recipients of this largess, they have become much hazier on methodology — asserting that everything anyone tries to measure is awfully complicated.

In a speech at the International Monetary Fund last week, Jeremy Stein, a Federal Reserve governor, acknowledged that too big to fail is not over: “We’re not yet at a point where we should be satisfied,” he said in the third paragraph. The Fed chairman, Ben Bernanke, has recently made the same point. It’s interesting that Treasury should want to confront the Fed on this relatively technical point. This is exactly the kind of issue on which the Fed usually has better information and analysis, and in the current iteration the Fed also seems to have a distinct edge.

Third, Ms. Miller insists that “the evidence on both sides of the argument is mixed and complicated” because of the many factors besides too big to fail that could be the cause of the funding advantage. But isn’t this why we elevate Treasury appointees to such a high position in the pantheon of our officials, because they are supposed to be able to sort out complex issues?

Where is the Office of Financial Research, a unit created within Treasury by Dodd-Frank, on this issue? In her reluctance to take sides or state a clear position, Ms. Miller appears to be ducking (Pages 3-4). This is a disappointing performance by an experienced and well-informed official.

In fact, there is a long list of studies that find various ways to take into account all of the complicating factors and isolate the too-big-to-fail subsidy. None of these are cited by Ms. Miller, but taken together, the conclusion is clear — the implicit subsidy is large and still with us.

One example is a study by Profs. Viral Acharya of New York University, Deniz Anginer of Virginia Tech and A. Joseph Warburton of Syracuse (released on Jan. 1) that measures the funding cost advantage provided by implicit government support to large financial institutions, while controlling for other factors. Credit spreads were lower (because of implicit guarantees) by approximately 28 basis points on average over the 1990-2010 period — with a peak of more than 120 basis points in 2009 (when having access to this subsidy really mattered). In 2010, the last year of the study, the implicit subsidy this provided to the largest banks was worth nearly $100 billion. The authors conclude, “Passage of Dodd-Frank did not eliminate expectations of government support.”

If Ms. Miller contests the methodology or results of this (or any other) study or regards the numbers as insufficiently current, she should request that the Office of Financial Research, the Fed or any other competent government body devise better methodology on the latest available data (or even use the real-time data available to supervisors). The United States government has many smart people, the best available data and the undoubted ability to conduct sensible econometric work (with full disclosure). Five years after the onset of the worst financial crisis since the Great Depression, we should expect nothing less from the Treasury Department.

Fourth, Ms. Miller is very taken with the fact that credit rating agencies have reduced the “uplift” they determine is due to government support for megabanks — i.e., they assign a lower probability of default (and losses for creditors) because there is some form of official backstop. And she makes a great deal of Moody’s saying that it may eliminate uplift altogether. We can debate for a long time about the value of credit-rating-agency opinions, but the striking fact about Ms. Miller’s reference to Moody’s is that it exactly contradicts her on the current situation (see Moody’s report). Moody’s still has a significant too-big-to-fail uplift for big banks.

Fifth, Ms. Miller is adamant that if too big to fail were a problem, we would see low credit-default-swap spreads across the board (for megabanks). But the figure to which she refers (see Page 10) is not persuasive. Look at the pattern of credit-default-swap spreads at the height of the crisis, when the doctrine of too big to fail was undeniably in effect; it is very similar to what we see today. Or hide the date and try to find the magic moment when Dodd-Frank supposedly changed the bailout game.

Sixth, Ms. Miller points out that credit-default-swap spreads have declined since the crisis. That is correct. But all that tells you is that we are not currently in a crisis phase. The real question is what happens the next time large financial institutions mismanage their risks and bring us to the brink of disaster.

Seventh, Ms. Miller asserts that capital requirements have increased “significantly” since the crisis (Page 4). But notice the complete absence of numbers in this part of her speech. How high are minimum capital requirements under Basel III? They are low — a bank could fund itself with 97 percent debt and 3 percent equity and still comply with the rules (see Section 4 in this handy Accenture guide to Basel III, Page 32). In this context, global megabank is a fancy name for a high-risk hedge fund, albeit one with access to the government-sponsored safety net.

Eighth, Ms. Miller points out that banks now have more capital on their balance sheets than they did four years ago (meaning they are funded with more equity relative to debt). This is correct, but it is a completely standard reaction among corporate survivors of financial crises. They are more cautious, for a while. But then they start to push up their return on equity, unadjusted for risk; this is the basis for executive and trader compensation, after all. And the best way to do this is to borrow more heavily, increasing leverage and reducing equity funding relative to their balance sheets (an equivalent way of saying that they borrow more and rely less on equity — in banking jargon, they reduce their capital levels).

It is alarming that Ms. Miller demonstrates no awareness of this well-established historical pattern — or the ingrained incentives in the financial system that make overleveraging hard to avoid.

Over all, Ms. Miller’s speech is completely unconvincing on the substance of the points that she is trying to make. Dodd-Frank alone will not end too big to fail.

It makes sense that senior Treasury officials should want to put Dodd-Frank into effect. But it is disconcerting when they are unable to confront the market and political realities of too-big-to-fail banks. Any such level of denial will not serve us well.

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Drop in Jobless Claims Counteracts March Data

Initial claims for state unemployment benefits dropped 42,000 to a seasonally adjusted 346,000, the Labor Department said on Thursday, unwinding a jump in the previous week that appeared related to difficulties adjusting the data for seasonal variations.

It was the largest weekly drop since mid-November. Economists, who had expected first-time applications for jobless aid to fall only to 365,000, said the decline suggested that the sharp slowdown in employment growth in March had been an aberration.

“We will see more job creation this month than we did in March, and today’s jobless claims numbers are consistent with that expectation,” said Robert A. Dye, chief economist at Comerica.

Employers added only 88,000 workers to payrolls in March — the smallest number in nine months — after a solid 268,000 increase in February.

Economists said the jobless claims data suggested that the slowdown in job creation reflected seasonal hiring being brought forward rather than underlying weakness in the labor market.

“All the March employment report provided a hint of is that jobs that normally would have got hired in March, some of them got hired earlier in February,” said Michael H. Strauss, chief economist at Commonfund.

Jobless claims are now back at the lower end of their range for this year, suggesting the labor market recovery remains on track.

The four-week moving average for new jobless claims, a better measure of labor market trends, increased 3,000 to 358,000. It remains close to a level economists normally associate with payroll gains of about 150,000 a month.

A second report from the Labor Department showed little sign of inflation. Import prices slipped 0.5 percent last month after rising 0.6 percent in February.

In the 12 months to March, import prices dropped 2.7 percent. Prices last month were subdued by a drop in the cost of petroleum and a strong dollar.

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Economix Blog: Simon Johnson: The Flaw in Obama’s Budget Approach


Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

From the White House, we need a clearer articulation of what the federal government does and why this makes sense. Instead, the president has allowed the debate to become dominated by excessive paranoia about deficits and by extremist demands to shrink government in a radical and inappropriate manner.

Today’s Economist

Perspectives from expert contributors.

This tension reflects the three ways to think about medium-term fiscal policy — the relationship between government spending and revenue over the next decade or two. You can figure out the budget deficit that it is possible to finance by selling government bonds, and use this as your basic constraint. Or you can stipulate the maximum acceptable level of government revenue as a percentage of gross domestic product, and work out the implications of that. Or you can define what government should do, and figure out how to finance these activities in a responsible manner.

The first way of thinking becomes paramount when countries have any form of serious fiscal crisis. For example, in some parts of Europe today — what is called the euro zone periphery — the market appetite for government debt is very limited. As a result, the governments have to think hard about the deficits that they can finance through any combination of assistance from other governments — either directly or through an indirect mechanism, such as the International Monetary Fund — and through the market.

All countries need to pay some attention to the sustainable level of government deficit (this is a flow, best thought of as the difference between government spending and revenue in a year). This is what adds up to government debt (a stock of outstanding obligations at any point in time, for example at the end of the year). But countries also differ considerably in the extent to which market pressures force them to make bringing down the budget deficit a priority.

Greece and Portugal have a fiscal crisis. They need to cut spending or raise revenue in a hurry. (Of course, if their euro zone neighbors are willing to be more generous, that will make their fiscal adjustments less painful.)

The United States does not need to take any such actions on a precipitate basis. The demand for its government debt around the world remains high. Despite the extreme assertions — or wishful thinking — from apocalyptic commentators, reports of the death of United States Treasury obligations have been greatly exaggerated.

Chinese officials like to announce that their country intends to develop its currency, the renminbi, as a reserve asset available to investors in a way that will rival the United States dollar. No doubt this is their intention, but achieving this goal is not so easy.

First China needs to reform its financial sector, then it must increase the protections afforded to overseas investors. When the going gets tough, who will get the rainy-day cash you stashed in China – you or the Chinese authorities?

The second view of budgets holds that it is of paramount importance to cap the size of the federal government budget relative to the economy. Republicans on Capitol Hill discuss a potential cap of around 17 or 18 percent of G.D.P. — and a significant number of them would like to enshrine this limit in a constitutional amendment.

A major problem with this approach is that the United States population is aging. As this demographic shift occurs, if we maintain social insurance — Social Security and Medicare, primarily — at or close to current levels, there is a natural tendency for government transfers to increase relative to the size of the economy.

This is not because of any sinister plot, but rather some simple mathematics. We insure each other, fairly modestly, against outliving our assets or our families’ ability to support us. As we expect to live longer today than did people in the past, we each expect to receive more benefits (this is a statement about probabilities; of course, we do not know which of us will live to be 95 or require what kind of medical attention when we reach 85).

This is an insurance policy, mediated by the government, the value of which has increased — and we should pay higher premiums.

If we pay more in and receive more when we retire, this will increase government revenue and increase government spending. But if you cap government revenue at 17 or 18 percent of G.D.P., that cannot happen. If that cap really binds, the value of social insurance per person must shrink over time.

The recent budget prepared by Paul Ryan, Republican of Wisconsin and chairman of the House Budget Committee, would make drastic cuts in Medicaid, Medicare and other programs in order to reduce the budget deficit to zero by 2023 without increasing taxes. This budget merges insistence on immediately eliminating the budget deficit — as if this were Greece — with a strong desire to shrink the size of government.

The third approach is to figure out what you want government to do — in terms of defense, social insurance, infrastructure investments, assistance for poor children and anything else. Once you know that, you know how much revenue you need — and you should also figure out the least distorting way to raise revenue. (Or you can increase taxes on activities that you want to discourage, like smoking, for example, because of how that affects people’s health and drives up health care costs for everyone.)

When there is a budget deficit — as in the United States today — this can be brought under control in a responsible and measured manner. Limiting government spending while ensuring a broad tax base is entirely consistent with achieving robust economic growth over the coming decades.

But who talks about the budget in those terms? The recent Senate budget proposal contained some elements of this alternative approach, but it’s hard to say that this framing of the budget issues came through loud and clear.

Unfortunately, President Obama, in his budget proposal unveiled on Wednesday, did not reinforce the need to think first and foremost about what we want government to do. Rather than laying out any kind of vision for what the government should do over the next decade or two, the president put forward what he asserts is a viable compromise with the Republicans — some tax increases and some cuts to Social Security (by changing how cost-of-living adjustments are calculated, the real value of future pensions would be reduced).

I sincerely doubt that such a compromise is possible — Congressional Republicans have dug in too deeply against higher taxes, in terms of higher rates and any package of measures that would produce a net increase in federal government revenues relative to the size of the economy.

People who don’t like social insurance — or perhaps just dislike any role for government — have been preparing for this moment for a long time. They have spent many years trying to convince people that there is an immediate fiscal crisis and that government must shrink.

Social insurance is under severe political pressure. The House Republicans want to phase it out for many people — and President Obama appears willing to acquiesce.

The White House should instead focus on explaining to people how social insurance works – and why it offers irreplaceable value. There was no affordable private health insurance for 85-year-old Americans before Medicare was created. And there will be none when Medicare is swept away.

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