IMF: Political Lobbying ~ Financial Risk

A new IMF analysis tests the common sense assertion that some mortgage lenders engaged in heavy political lobbying in the years prior to the financial crisis, and that the political results helped to precipitate the financial crisis (emphasis added):

On December 31, 2007, the Wall Street Journal reported that Ameriquest Mortgage and Countrywide Financial, two of the largest mortgage lenders in the nation, spent respectively $20.5 million and $8.7 million in political donations, campaign contributions, and lobbying activities from 2002 through 2006. The sought outcome, according to the article, was the defeat of anti-predatory lending legislation. In other words, timely regulatory response that could have mitigated reckless lending practices and the consequent rise in delinquencies and foreclosures was shut down by some mortgage lenders. Such anecdotal evidence suggests that the political influence of the financial industry contributed to the 2007 mortgage crisis, which, in the fall of 2008, generalized in the worst bout of financial instability since the Great Depression.

The researchers’ findings lend strong empirical support to the common sense:

Using detailed information on lobbying and mortgage lending activities, we find that lenders lobbying more on issues related to mortgage lending (i) had higher loan-to-income ratios, (ii) securitized more intensively, and (iii) had faster growing portfolios. Ex-post, delinquency rates are higher in areas where lobbyist’ lending grew faster and they experienced negative abnormal stock returns during key crisis events…These results show that lobbying lenders engage[d] in riskier lending.

URLs:

http://www.imf.org/external/pubs/ft/wp/2009/wp09287.pdf

More confusion on federal deficits

BNET’s Steve Tobak, in a series of retrospectives, penned a critique of federal spending in 2009. While he’s spot on regarding the role of leverage in creating systemic fragility, and about the importance of agency risks, potential and realized, he displays the same kind of confusion about federal deficits and debt levels that threatens to end a still short-in-the-tooth recovery:

I would hope we learned from the subprime mortgage crisis that got us into this mess that too much leverage is a bad thing. That’s sort of a no-brainer, isn’t it? I mean, giving people mortgages they can’t afford with no money down is bad, right? Banks betting the farm on mortgage-backed securities and credit-default swaps … also bad.

And yet, our national response to this crisis has essentially been to leverage the entire country by ratcheting up the national debt to record levels. What message does that send to each and every American business and family with a budget to manage?

When federal deficits and central bank balance sheet expand in response to a financial crisis and deep economic recession, this does not necessarily increase the overall debt in the domestic economy.  Rather, it means that the public sector, because it has the greatest capacity to bear risk, takes on some of the burden of existing private sector debt. To do otherwise would mean a sharper and deeper recession, i.e., a depression. While “liquidation” has its benefits, one of the tradeoffs is a greater level of defaults and even higher unemployment (i.e., even lower national income), at least over the short to intermediate term. And like it or not, our political system, which does a pretty good job of discounting the desires of the entire electorate, decided long ago that unbridled liquidation was not the optimal path for economic policy. Had the federal government and the federal reserve kept the purse strings tight, given the global nature of the recession and – as Tobak pointed out – the high systemic leverage and fragility that preceded it, the outcome would almost surely have been much, much worse.

Tobak also makes the mistake of comparing private sector budgets to the federal budget. There are some critically important distinctions between them, the primary one being that the federal government creates the money needed to pay its obligations out of thin air – which is a critical part of its risk bearing capacity.

Macro errors aside, in another article Tobak offers a great strategic approach for dealing with personal nemeses in the workplace, which we highly recommend.

URLs:

http://blogs.bnet.com/ceo/?p=3499&tag=nl.e713

http://www.j-bradford-delong.net/pdf_files/Liquidation_Cycles.pdf

http://blogs.bnet.com/ceo/?p=3493&tag=nl.e713

MSNBC: Economists against additional stimulus

MSNBC.com is reporting that a majority of economists it surveyed (9 out of 11) are opposed to additional economic stimulus. We think there are a couple of errors in the panel’s prevailing outlook. First is that 2010 GDP and hiring will be sluggish — we expect that both will surprise to the upside in 2010, especially GDP. However, this will be a function of rising volatility more than a return to robust trend growth; we also see a chance that 2011 or 2012 GDP could surprise to the downside.

The prevailing view seems to be that a mild but fragile recovery is underway, and that the public sector should allow the private sector to do the heavy lifting from here. But this view might be relying on a significant ommission of evidence, if public sector (federal government) stimulus and demand have been the primary drivers of recovery thus far. As we’ve noted in recent months, there appear to be important long term factors at work (e.g., demographic ratios, increased private sector saving, slack credit demand) that will cause orthodox economic theories and policy prescriptions to present a serious and growing risk of premature fiscal tightening – again, as in the U.S. in the late 1930s and Japan in the 1990s and 2000s. The views reported by MSNBC lend additional support to our assessment.

URLs:

http://www.msnbc.msn.com/id/34452363/ns/business-personal_finance/

http://symmetrycapital.net/index.php/blog/2009/11/19046mauldin-on-japan/ 

http://symmetrycapital.net/index.php/blog/2009/11/recent-articles-on-federal-debt-and-budget-deficits/

http://symmetrycapital.net/index.php/blog/2009/12/1937-public-debt-and-job-creation/

The “Obamacare” Debate

Some key pieces in the debate over the healthcare reform bills passed by the House and Senate are linked below (TOH to Brad DeLong for the first three). We put “Obamacare” in quotes in the title of this piece because, while Obama’s election certainly paved the way for health care legislation to proceed, ownership of health care reform extends far beyond - and before - the current administration.

A WSJ editorial from mid-December argued against cost containment arguments made in support of the legislation:

The White House hawked a permanent entitlement expansion on flimsy and speculative theories that its own partisans now admit—albeit when it is nearly too late—aren’t more substantive than the triumph of hope over experience, while simultaneously writing off the one policy that has been effective in the real world. The cost control mantra of ObamaCare was always a political bill of goods, and its result will be the opposite of its claims: poorer quality care at higher costs.

The editorial incited a spirited defense from Peter Orszag, head of the Administration’s Office of Management and Budget (OMB):

We are not setting out a plan with every detail laid out for what the health care system of the future should look like.  Thinking that we could lay out in full detail a perfect system today would show a foolish disregard for the dynamism of the health care sector – and of the American economy in general.  Instead, we are putting in place processes by which what works and what doesn’t can be rigorously tested, and then scaled up over time as they are reflected in the decisions of thousands upon thousands of hospitals, physicians, and other providers.  Does the Journal have a better suggestion about how to approach policymaking in a dynamic world?

…Can more work be done on health reform? Sure. And that is what is occurring through the legislative process as I write. Moreover, even after passage, we will need a continuous assessment of what works and what doesn’t and rapid adjustments to a changing market – all of which can be done with the mechanisms laid out in this bill.

The bottom line is that continuing on the road we are on will overwhelm our economy and our federal budget. The health care plan being considered in the Senate now is built on the best available knowledge and most promising ideas from across the political spectrum. Critics may fear this change, but what we should fear more is doing nothing.

Along those lines, David Frum, a bit of a black sheep in the GOP of late, offered a pithy but interesting critique of his party’s strategic response to health care reform and other legislation: “Republicans could have been architects of improvement, instead we made ourselves impotent spectators as things get radically worse. Plus – the bad new Democratic proposal will likely be less unpopular with voters than their more promising earlier proposal. Nice work everybody.”

Frum’s position on healthcare is fairly orthodox among conservatives, but for those who subscribe to Barron’s, we highly recommend the columns that Thomas Donlan has posted on the issue over the past year. While Donlan normally has clear conservative/libertarian leanings on issues he writes about, he has seemed far more open and self-critical on health care. In his most recent column on the subject, he reviewed T.R. Reid’s The Healing of America: A Global Quest for Better, Cheaper, and Fairer Health Care, and pointed to at least three critically important factors that will be stubborn barriers to cost control:

American docs can make four times as much as those in Japan, France, Britain and other countries. The foreign docs, however, mostly go through med school on government-paid tuition, and graduate free of debt. They pay what Americans would consider extremely low malpractice-insurance premiums. And those in private practice do not need to hire their own administrative staffers to deal with a myriad of insurance administrators and claims adjusters.

Donlan recaps Reid’s overview of the French health care system, illuminating some of the contrasts (and critical differences) between our system and one designed to provide universal access at a relatively low cost. Anticipating concerns about the potential for waste, fraud, and abuse in a system like France’s, he asks “what accounts for the fact that the country spends $3,165 per citizen for a system that covers everybody, while the U.S. spends almost twice as much per citizen and covers only 85% of them?” Donlan concludes:

Americans…should come to grips with [T.J.] Reid’s frank advocacy of some kind of universal health care for the U.S. on the grounds that everyone has a human right to “adequate” health care — although not without limits, whatever they may be.

Every other country that can afford it has decided to provide a minimum level of health care to everyone, regardless of income and wealth, at a minimum cost out-of-pocket. The U.S. Medicaid program also provides a minimum level of nearly free health care, but not to everyone. It aids 59 million people, the poorest 20% of Americans, by Medicaid but the coverage and eligibility vary widely.

Too many Americans say health care is a right and don’t want to have any responsibility in paying for it. Too many want market-driven health care without winners and losers. A close reading of Reid’s book may help them think more clearly.

Donlan’s conclusion lends support to our prior assessments of health care reform — that it is complicated stuff, both philosophically and operationally.

URLs:

http://delong.typepad.com/sdj/2009/12/ten-economic-paragraphs-worth-reading-december-21-2009.html

http://online.wsj.com/article/SB10001424052748703558004574583962940536556.html

http://www.whitehouse.gov/omb/blog/09/12/14/No-Illusions/

http://www.frumforum.com/the-cost-of-no-deal

http://online.barrons.com/article/SB125935468698266957.html

http://www.amazon.com/gp/product/1594202346?ie=UTF8&tag=symmetrycapit-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=1594202346

http://symmetrycapital.net/index.php/blog/2009/07/ryan-what-does-it-look-like-in-september/

http://symmetrycapital.net/index.php/blog/2009/07/should-health-care-be-a-right/

DISCLOSURES: Symmetry Capital Management, LLC is an Amazon associate and earns a referral fee for any sales resulting from a “click through” purchase on Amazon.com.

CFO.com: NACM’s Credit Managers Index

Interesting story on CFO.com about the latest Credit Managers Index reading from NACM:

As of December 1, the index, based on a survey of about 1,000 trade-credit managers during the last 10 days of the month, had risen to an annual high of 52.3. (A score of 50 means creditors think they’ve entered a growth mode. The index is based on credit managers’ perceptions of growth, decline, or status quo conditions in various aspects of trade credit.)

…the index hit 39.7 during December 2008, the all-time bottom in the index’s seven-year history. Since then, it’s risen steadily to its current annual high. That surge has been cause for an enthusiasm among creditors that’s “not really champagne-cork-opening excitement, it’s wine-box-opening excitement. We’re getting there,” says the NACM’s economist, Chris Kuehl.

That’s a mildly bullish sign, although as the article points out, “a true strengthening…depends on an upsurge in consumer demand.”

[Kuehl's analogy resonates in my house -- it's been a box wine recession for us. In fact, we've been bottle free for so long that we now have a nook carved out among the cookbooks in which a five liter box of cabernet (Almaden or Carlo Rossi, whoever's cheaper) fits like a glove. We're still trying to come up with a clever idea for all those plastic bags though -- suggestions are welcomed!]

URLs:

http://www.cfo.com/article.cfm/14462467

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2003/12/04/WIGV13EPSU1.DTL

1937, Public Debt, and Job Creation

CEA chair Christina Romer penned an interesting guest article for The Economist (subscription required) on parallels between the 1937 recession and today (emphasis added):

The recovery from the Depression is often described as slow because America did not return to full employment until after the outbreak of the second world war. But the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid. Annual real GDP growth averaged over 9%. Unemployment fell from 25% to 14%. The second world war aside, the United States has never experienced such sustained, rapid growth.

However, that growth was halted by a second severe downturn in 1937-38, when unemployment surged again to 19%… The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy.

Romer’s assertion generally comports with a recent paper from the Chicago Federal Reserve, in which Francois Velde found that “monetary and fiscal factors account fairly well for the pattern of [decline in] in industrial production and, in particular, for the depth of the recession.”

These are timely analyses, as debt and deficit phobia appear to be gaining ground inside the Beltway. A notable development is recent bipartisan legislation introduced by Sens. Conrad (D-ND) and Gregg (R-NH) that would establish a ‘fiscal task force’. While this isn’t necessarily a bad idea, it appears to be based on an incomplete understanding of financial principles, and it risks putting fiscal priorities in an order that could cause economic harm in 2011 or 2012.

First, Sen. Gregg’s frequent argument that we should not “saddle” our children or grandchildren with additional debt takes an overly simplistic view of financial principles. Debt levels by themselves don’t typically mean a whole heck of a lot. There are clearly upper limits to how much debt any entity can carry, and the 400% debt-to-GDP figure that Gregg and Conrad are fond of citing might well be it.

But before reaching that point, what matters is the activities that debts are used to finance. For example, at the level of an individual, it makes a big difference whether a person goes into debt to finance things like (1) an expensive new car, flat screen TV and A/V system, and nights out on the town or (2) an education that will enhance their future income. In the first case, the ability of one’s “future self” to service the debt incurred does not improve as a result of the things purchased (though as acquisitive beings we’re very good at justifying them). However, in the second case, the debtor’s ability to service their debt is expected to improve enough to make it not just tolerable but worthwhile. 

This difference reveals a fundamental tenet of finance; when financing anything, be it an education or a new piece of equipment, the borrower must ask themselves if the expected return on the purchase exceeds the expected cost of the financing. Thus, in financing decisions, whether undertaken in the public or the private sector, the question should not just be “how much debt”, but rather, “how will the debt be used, and is the expected return positive?” Any idea that would leave our children, grandchildren, and great grandchildren better off — the analogues of our “future selves” — should be on the table. And that means that we cannot reflexively dismiss all public measures that would increase federal deficits in the short to intermediate term. Otherwise, we could do as great an injustice to future generations as incurring a massive and wasteful public debt would do.

It seems clear to us, based on current and historical evidence, that we are in a period where the public sector (specifically, the federal government, given its relative scale and, most importantly, its monopoly over money issuance) is the debtor and economic actor at the margin (an assertion that issues like infrastructure disrepair might lend additional support to). But currently, as in 1936, the banking sector and market prices are signaling that there is a relative shortage of public sector credit! Granted, the desire for government paper could be due in part to the pro-cyclical nature of credit markets, and/or international currency interventions. But it might also be an indication that, at the margin, public initiatives present the most attractive financing opportunities right now (an idea that demographic trends seem to lend support to). Of course, that statement will cause our more conservative and libertarian friends to shudder, but we would simply point out that Christina Romer’s claim about the strength of the economic recovery in the 1930s is strongly supported by the data, rather than being informed by a purely ideological slant. Thus, beyond ensuring that sufficient counter cyclical stabilizers remain funded, the primary question that policymakers should be asking is, “How can we best put the proceeds from additional debt issuance to work in improving the country’s future productivity?” If the federal debt begins pushing the limits, it will be reflected in market prices. And to this point, nothing like that has happened.

If our assessment is on target, it raises some important considerations for President Obama’s current ‘job push’, and especially the use of excess TARP funds and the possibility of tax cuts and credits. The President, embodying the tension between fiscal and economic priorities, recently opined that surplus TARP funds (sometimes it’s good to be the ‘investor of last resort’) could be used to provide loans to allow small businesses to hire employees, or to reduce the deficit. More recently, the Administration floated the idea of various tax breaks for small businesses:

To encourage investment by small businesses and improve their access to capital, the administration is…calling for a one-year elimination of the tax on capital gains from new investments in small business stock…for the extension through 2010 of the Recovery Act provision that allows small businesses to immediately expense up to $250,000 of qualified investment…[and] for extending the Recovery Act provision that accelerates the rate at which business can deduct the cost of capital expenditures.

This is good stuff, though it’s fairly low hanging fruit. More important to long run investment and productivity is to make our national tax code less distorting and more competitive.

Obama also wants to make additional investments in roads, bridges, highways, transit, rail, aviation and other infrastructure to encourage job growth. More infrastructure investment projects would be selected on the basis of merit, through a combination of grants and loans.

The president called on Congress to consider a new program to provide rebates for consumers who retrofit their homes for greater energy efficiency. He also wants to expand several oversubscribed Recovery Act programs that have leveraged private investment in energy efficiency to create clean energy manufacturing jobs. Those include industrial energy efficiency investments and tax incentives for investing in renewable manufacturing facilities in the U.S.

Beyond any positive environmental impacts, these measures will improve long run productivity and efficiency. However, Obama has exhibited some conservative tendencies, at least in his words, regarding federal spending. Note the heavy reliance on loans as opposed to grants in the measures above, as well as this statement:

“There is only so much government can do,” said Obama. “Job creation will ultimately depend on the real job creators: businesses across America. But government can help lay the groundwork on which the private sector can better generate jobs, growth and innovation.”

We certainly agree that this is a valid statement most of the time, but we’re not convinced that it’s the case now. Even if GDP and employment do surprise to the upside as we expect in 2010, there will still be plenty of slack in domestic resource utilization. We should be careful not to underestimate the positive impact that the public sector is having on current and planned hiring and investment (of course, we’re also mindful of the uncertainty that policymaking has created in the past days, months, and couple of years). And as we noted recently, if the federal government’s support is given generously enough, it would allow the Federal Reserve a lot more wiggle room to raise rates and stem the increasingly speculative USD carry trade.

URLs:

http://www.economist.com/businessfinance/PrinterFriendly.cfm?story_id=13856176

http://www.chicagofed.org/publications/economicperspectives/ep_4qtr2009_part2_velde.pdf

http://www.ft.com/cms/s/0/893f01ec-e524-11de-9a25-00144feab49a.html

http://www.webcpa.com/news/Obama-Proposes-Tax-Cuts-Spur-Hiring-52689-1.html

http://www.newsweek.com/id/214096

http://symmetrycapital.net/index.php/blog/2009/11/right-on-cue/