Barry Eichengreen and Ugo Panizza write,
For the debts of European countries to be sustainable, their governments will have to run large primary budget surpluses. But there are both political and economic reasons to question whether this is possible. The evidence presented in this column is not optimistic about Europe’s crisis countries. Whereas large primary surpluses for extended periods of time did occur in the past, they were always associated with exceptional circumstances.
Pointer from Mark Thoma. Read the whole thing. Shorter version: Have a nice day.
Jed Graham writes,
The $2.8 trillion Social Security Trust Fund is on track to be totally spent by 2030, the Congressional Budget Office said Tuesday. That’s one year earlier than projected in 2013 and a decade earlier than the CBO estimated as recently as 2011.
Graham points out that lower estimates for employment are contributing to the more adverse outlook for Social Security. I would say that this links two of the three main goals for SNEP, one of which is to increase employment and another of which is to work toward a sustainable Federal budget.
In fact, the third goal, to get the FCC and the FDA out of the way of progress, also links to the other two.
1. From Edward Conard:
The key to accelerating the recovery is not to generate unsustainable consumption, as Mian and Sufi propose. Rather, we must find sustainable uses for risk-averse savings
Mian and Sufi make a big deal over the fact that consumer spending fell in places where housing prices fell. Conard suggests that this is because consumers in those areas were spending at an unsustainable rate, based on capital gains in housing that disappeared.
2. From Alex Ellefson:
Laplante said he expects all 50 states to require software engineering licenses within the next decade, and possibly much sooner.
Not surprisingly, most software engineers endorse this. [UPDATE: from the article "The licensing effort was supported by nearly two-thirds of software engineers surveyed in a 2008 poll." Commenters on this blog dispute that most software engineers endorse licensing. They may be correct.] But it is really, really, not a good idea. Bad software may be created by coders. But its cause is bad management. The typical problems are needlessly complex requirements, poor communication in the project team between business and technical people, and inadequate testing.
I would favor licensing for journalists if I thought that it would keep incompetent stories like this one from appearing. But I don’t think that would work at all.
The pointers to both of these are from Tyler Cowen.
Tyler Cowen writes,
Were not these exit strategies supposed to be easy and painless? Maybe they are, except having no exit strategy is all the more easy and painless.
The title of his post is Will the major central banks evolve into mega-hedge funds? But perhaps the title should be, will the major central banks ever give up their mega-hedge fund activities?
In the wake of the financial crisis, the Fed has decided that credit allocation is too delicate and important to be left alone. The financial crisis did to the Fed what the 9-11 attacks did to national security agencies. I think that the chances that central banks will decide that they no longer need to behave like hedge funds are about as high as the chances that our national security apparatus will decide that they no longer need to treat terrorism as a major threat.
They argue that, rather than failing banks, the key culprits in the financial crisis were overly indebted households. Resurrecting arguments that go back at least to Irving Fisher and that were emphasised by Richard Koo in considering Japan’s stagnation, Mian and Sufi highlight how harsh leverage and debt can be – for example, when the price of a house purchased with a 10 per cent downpayment goes down by 10 per cent, all of the owner’s equity is lost. They demonstrate powerfully that spending fell much more in parts of the country where house prices fell fastest and where the most mortgage debt was attached to homes. So their story of the crisis blames excessive mortgage lending, which first inflated bubbles in the housing market and then left households with unmanageable debt burdens. These burdens in turn led to spending reductions and created an adverse economic and financial spiral that ultimately led financial institutions to the brink.
Pointer from Tyler Cowen.
Summers points out that Mian and Sufi’s suggestion that we should have bailed out homeowners is probably not correct. I feel even more strongly than Summers does about this.
Suppose that we accept the balance-sheet recession story. Some comments and questions.
1. Vernon Smith is also a proponent.
2. What was the difference between the damage to consumer wealth caused by the dotcom crash of 2000 and by the housing crash of 2007-2008? Was it solely the fact that the latter had been financed more by borrowing?
3. Suppose that there had been no debt-fueled consumer boom in 2005-2006. What would there have been instead? A sluggish economy? A more sustainable boom?
4. Suppose that we take a PSST perspective. Then the period from the late 1990s to the present is one long, painful, still-unfinished adjustment to the Internet and factor-price equalization. We happened to have a sharp boom-bust cycle in home construction in the middle of it, but even during the boom we did not have four consecutive months of gains in employment over 200,000. Then, in 2008 we had a panic about large financial institutions, leading to a big increase in government intervention, which mostly consisted of transfers of resources to less-productive businesses, such as GM, Citigroup, and Solyndra.
Hester Peirce writes,
AIG’s securities lending program is just as critical to the story of its downfall. Through the securities lending program, AIG and its life insurance subsidiaries had massive exposure to residential mortgage-backed securities. At the height of the 2008 crisis, the program experienced a run, and AIG could not meet the massive repayment demands. The losses in the securities lending program were severe enough to imperil a number of AIG’s regulated life insurance subsidiaries. Before the bailout, AIG itself may have been insolvent.
The standard story is that all of the problems at AIG were caused by its credit default swaps. As those out-of-the-money options came closer to being in the money, their counterparties exercised rights to collateral calls, creating a liquidity crisis for AIG.
I have always accepted the standard story, and my view is that the way to handle it would have been to block the collateral calls. Make Goldman Sachs and DeutscheBank and everyone else wait to see how things play out.
Peirce says that in addition to the collateral calls on credit default swaps, AIG had exposure to mortgage securities through its regular insurance subsidiaries’ portfolios. Those securities lost market value during the crisis. For AIG, the problem became acute because of its securities-lending business. I don’t think I understand completely how this securities lending worked, but I think that the effect was to create a very significant maturity mismatch for AIG, so that it had a lot of short-term liabilities backed by long-term assets. When counterparties for a variety of reasons stopped providing short-term funding to AIG, it was faced with a need to sell long-term assets, and a lot of those assets were mortgage securities whose prices were depressed.
I came away from this analysis believing that the securities-lending program was important. However, I am less convinced that AIG was insolvent or that some of its subsidiaries were insolvent.
Something that is very clear, is that “de-regulation” is a term empty of explanatory power. All successful six have liberalised financial markets–Australia and New Zealand, for example, were leaders in financial “de-regulation”. If someone starts trying to blame the Global Financial Crisis (GFC) on “de-regulation”, you can stop reading, they have nothing useful to say.
Pointer from Scott Sumner.
The deregulation story amounts to saying that we know that regulation can prevent a crisis, but a crisis occurred, therefore there must have been deregulation. In fact, the risk-based capital rules that I have suggested helped cause the crisis were at the time they were enacted viewed as regulatory tightening, to correct flaws in the regime that existed at the time of the S&L crisis. The deregulation that did take place was intended to reduce bank profits by making the industry more competitive, not to increase profits or risk-taking.
Lorenzo’s post mostly beats a drum that I have been beating, which is that government tends to get worse as scale increases. He writes,
It is generally just harder to stick it to folks (either by what you do or what you don’t do) in a way that doesn’t get noticed in smaller jurisdictions. (Unless jurisdictions are so small they fly under the media radar but are big enough to be semi-anonymous–urban local government in Oz has a bit of a problem there.)
Ryan Avent writes,
What is needed, they argue, is to make debt contracts more flexible, and where possible, replace them with equity. Courts should be able to write down the principal of mortgages as an alternative to foreclosure. They recommend “shared-responsibility mortgages” whose principal would decline along with local house prices. To compensate for the risk of loss, lenders, they reckon, would have to charge a fee equal to 1.4% of the mortgage, or receive 5% of any increase in the value of the property.
Pointer from Mark Thoma. “They” are Mian and Sufi, in House of Debt. Avent argues similarly that student loans should have an equity component.
What these forms of bad debt have in common, in my view, is that they reflect clumsy social engineering. Public policy was based on the idea that getting as many people into home “ownership” with as little money down as possible was a great idea. It was based on the idea of getting as many people into college with student loans as possible.
The problem, therefore, is not that debt contracts are too rigid. The problem is that the social engineers are trying to make too many people into home “owners” and to send too many people to college. Home ownership is meaningful only when people put equity into the homes that they purchase. College is meaningful only if students graduate and do so having learned something (or a least enjoyed the party, but not with taxpayers footing the bill).
As long as we still have these sorts of public policies, monkeying around with the nature of the loan contract is simply doubling down on clumsy social engineering.
Andrew Biggs writes,
Included in Sen. Rubio’s ideas are:
–Social Security solvency: Rubio would gradually increase the retirement age in line with life expectancies and reduce the growth of benefits for higher-earning individuals. In addition, Rubio favors strengthening the safety net for lower-income retirees.
–Delayed retirement: Rubio would eliminate the 12.4% payroll tax for retirement-age individuals to encourage them to stay in the work force. I really like this idea and wrote on it for the Wall Street Journal.
–Open the TSP: Rubio would allow workers who are not offered retirement plans by their employers to participate in the federal government’s Thrift Savings Plan, the DC pension for government employees. In a way, this builds upon the President’s myRA proposal, but allows for greater choice in investments.
I am a big fan of indexing the age of eligibility for retirement benefits to average life expectancy at age 60. I would like to see that done for Medicare as well. People can still retire when they are younger and healthier, but not on someone else’s nickel.
One of my former students asked me about the Gorton-Metrick theory of the financial crisis. I have a lot to say about it. Basically, although I agree that what they call the run on repo is an element of the crisis, I think they are wrong in some important respects. Continue reading