Friday, February 22, 2008

PP: Quick fix is beyond government's power

Edward Lotterman: Quick fix is beyond government's power

St. Paul Pioneer Press
Wednesday January 23, 2008 Pg 1A

Don't put too much hope in the Fed's latest cut in its target interest rate or in any eventual fiscal stimulus package on which President Bush and Congress may agree. The ability of government to offset swings in employment, output and prices is much more limited than many people think, especially when dealing with a $14 trillion economy that is highly enmeshed with the rest of the world. At least that is my humble opinion.

The economic news this week has been dramatic. Several Asian stock markets fell more than 10 percent in two days. In an unscheduled meeting, the Federal Reserve's policymakers cut its target for the federal funds interest rate an unprecedented three-fourths of a percentage point, from 4.25 to 3.5 percent. Meanwhile, the president, Congress and sundry presidential candidates are falling over each other with proposals for "fiscal stimulus."

The situation raises many questions: Just what can government do to solve growing economic problems? Should the Fed cut interest rates even further? Is the danger of inflation real? Will rebates, further tax cuts or greater government spending forestall a recession?

Unfortunately, economists have different views on these issues, depending on the degree to which they are convinced by competing economic theories. John Maynard Keynes (1883-1946) argued government can manipulate four variables - taxes, government spending, the money supply and interest rates - to ward off recessions or curb inflation. Monetarists, led by the University of Chicago's articulate and energetic Milton Friedman (1912-2006), saw government tromping on fiscal and monetary gas and brake pedals as not only doomed to failure but also inherently harmful. So did a later group called "rational expectationists."

Virtually all economists agree on one thing: A central bank can control inflation if it does not let the money supply grow too fast. Prime Minister Margaret Thatcher of Great Britain and U.S. Fed Chairman Paul Volcker proved that.

What economists don't agree on is how well government policies can ward off a recession and on the relative usefulness of monetary policy (money supply and interest rates) compared to fiscal policy (government taxing and spending).

The historical record is mixed. Many argue that military spending wasa the primary factor in ending the Great Depression. Others point to the tax cuts enacted after John F. Kennedy's assassination as a success story of fiscal stimulus that worked. Some view the 2001 Bush tax cuts as having increased consumer spending, even though their stated purpose was to encourage long-term investment.

But there are many counter-arguments or examples. Rising spending on the Vietnam War was probably a bigger stimulus than the Kennedy-Johnson tax cuts. And in 2001, the Fed increased the money supply, pushing short-term interest rates to historic lows at the same time the Bush tax cuts took effect.

Moreover, after most industrialized countries overtly adopted Keynesian policies in the 1950s, many experienced increases in inflation even during recessions with high unemployment. Such "stagflation" dominated the 1970s and baffled both political parties.

Richard Nixon expolicitly proposed fiscal stimulus in 1971 and 1972 even as he cynically kept the lid on inflation with wage and price controls. Both inflation and unemployment soared a year later. Neither Gerald Ford nor Jimmy Carter could settle on a coherent response for either inflation or unemployment, and the nation suffered.

The 1980s demonstrated that the Fed could tame inflation if politicians were able to tolerate a harsh recession in the short term. Moreover, a stable price environment fostered investment by households and businesses.

But human nature leads central bankers into temptation. As memories of the 1970s inflation faded in the go-go years of the 1990s, arguments for faster money growth and lower interest rates overwhelmed calls for prudence. The Fed needed to lower interest rates to help out banks wracked by bad loans on commercial property. It needed to stop contagion from Asian financial crises or from Russia or Brazil.

Then, when the U.S. economy slowed in 2000, monetary expansion seemed necessary. People agreed it was even more true after Sept. 11.

Overall, we nearly doubled the money supply since the mid-1990s, while the real economy grew by about 50 percent. Such easy money clearly created many of the problems we face today.

Some say that calls for even lower interest rates mimic Will Rogers' sarcastic query "If stupidity got us into this mess, then why can't it get us out?" Moreover, as the Fed increases the money supply to lower interest rates, the value of the dollar tends to slide compared to other currencies.

Fiscal stimulus packages are even more fraught with difficulty.

Politicians love to step on the gas pedal, increasing spending and cutting taxes. They are especially quick to call for fiscal largesse in election years. The unemployment rate is never low enough or growth fast enough for a congressman facing reelection.

Politicans never want to step on the brake pedal, even when inflation gets out of control as it did in the 1970s. Moreover, the time lags in getting tax and spending bills through Congress are such that the economic effects often arrive too late. In many cases, they make business cycle fluctuations more extreme instead of dampening them.

At this juncture, the impulse to try anything with some plausible chance of success is powerful. Easier money and an even looser federal budget may ameliorate a bad, and worsening, situation. But the monetary, budgetary and trade imbalances that have accumulated over the years are large and difficult to resolve. Americans should not delude themselves with the idea that there are quick and easy fixes.

LTTE: Sound as a Dollar?

Wall Street Journal
Tuesday January 22, 2008 Pg A17

Regarding David Malpass's op-ed ("Markets and the Dollar," Jan. 14), I cannot tell you how refreshing it is to see an economist take issue with the Fed lowering interest rates in these times of high inflation as well as the relentless printing of U.S. dollars, and its subsequent devaluation. While we're at it, could we please make a token effort at balancing our fiscal budget? Perhaps then we'll be real "conservative Republicans" instead of the "radical Republicans" who have been "governing" these last seven years. Doesn't anyone on the Bush economic team care what kind of currency and country their kids and grandkids will inherit? If not, please tell me where they are planning to relocate when the bottom drops out.

Mike Fitzsimmons
Crossville, Tenn.

WSJ: Feel-Good Economics

By Bruce Bartlett

Wall Street Journal
Jan. 19-20, 2008 Weekend Edition Pg A12

With remarkable speed, Congress, the White House, Republicans, Democrats and even the Federal Reserve have come to a consensus on the need for economic stimulus to moderate and perhaps forestall a recession. It seems certain that the final stimulus package will contain a tax rebate.

The underlying theory for the rebate idea traces back to the British economist John Maynard Keynes. He believed that spending was the driving force in the economy. It didn't matter whether the spending was done by businesses on capital equipment, by governments on public works, or by consumers - spending is spending in the Keynesian modeal, and all of it is stimulative.

In Keynes' defense, his theory was developed during a severe, world-wide deflation. Spending of all kinds was paralyzed by a lack of liquidity, and the Federal Reserve had difficulty injecting money into the economy because so many banks had closed. Under these circumstances, deficit spending by governments made sense as a means of getting money into circulation and overcoming deflation. The problem is that, once World War II seemed to validate Keynes's theory, the idea of stimulating the economy by increasing government spending became the all-purpose cure for every economic slowdown, regardless of its underlying cause.

In the 1960s and 1970s, this usually took the form of public works spending. But in 1974, the White House was keen on the idea of cutting taxes to stimulate private spending. Since it was feared that a permanent tax cut might be inflationary, President Gerald Ford and the Democratic Congress agreeed on a one-shot tax rebate. It was thought that cash-strapped consumers would take their government checks and immediately run out and spend them on food, clothing and other necessities. This would give the economy a Keynesian boost.

One dissenter was economist Milton Friedman. His research had led him to conclude that consumer spending was less a function of liquidity than something he called "permanent income." Friedman observed that when workers lost their jobs, they didn't immediately cut back on spending. They borrowed or drew down savings to maintain spending, in the expectation of finding a new job shortly. Conversely, consumers didn't immediately spend windfalls. They kept spending on an even keel until they achieved a promotion at work, or other increase in their long-term income expectations.

Thus Friedman predicted that the $100 to $200 checks disbursed by the Treasury Department in the spring of 1975 would have a minimal impact on spending, because they did not alter peoples' permanent income. Most likely, people would save the money or pay down debt, which is the same thing. Very little of the rebate would cause consumers to buy things they wouldn't otherwise have bought in the near term.

Subsequent studies by MIT economists Franco Modigliani and Charles Steindel, and Alan Blinder of Princeton, showed that Freidman's prediction was correct. The 1975 rebate had very little impact on spending and much less than a permanent tax cut - which would change peoples' concept of their permanent income - of similiar magnitude.

In 2001 - despite the thoroughness and general acceptance of these studies - Congress and the White House once again chose a one-shot tax rebate to deal with an economic slowdown in 2001.

To his credit, Treasury Secretary Paul O'Neill cautioned against the rebate. "I was here when we tried that in 1975, and it just didn't work," he said. "If we want to change consumption patterns, we need to make permanent changes in peoples' tax burdens." But President George W. Bush overruled his Treasury secretary and approved the rebate idea. Checks of $300 to $600 per taxpayer were sent out in the late summer. Contemporaneous polls by Gallup, Bloomberg and the University of Michigan all found that the vast bulk of consumers expected to save the money or use it to pay bills. Subsequent studies confirmed these forecasts.

In short, there is virtually no empirical evidence that tax rebates are an effective response to economic slowdowns. The increased personal saving doesn't help the economy because the federal budget deficit, which can be thought of as negative saving, offsets all of it in the aggregate. The main benefit of a tax rebate would seem to be political - giving politicans a way of appearing to be doing something about the nation's economic problems that is superficially plausible.

A new rebate probably won't do much harm. But anyone who thinks it will prevent a recession - if one is actually in the pipeline, which is not at all certain - is dreaming. It's an insult to Keynes even to call a tax rebate Keynesian economics. It should be called "feel good economics" because its only real effect is to make politicans feel tood about themselves and buy reelection with the public purse.

Mr. Bartlett was deputy assistant secretary of the Treasury for econoimc policy during the administration of President George H.W. Bush

Wednesday, February 20, 2008

WSJ: In Times of Turmoil, Cautionary TIPS Tale

In Times of Turmoil, Cautionary TIPS Tale
Investors Flock to Bonds With Inflation Protection, Sending Prices Soaring

Wall Street Journal
Wednesday January 9, 2008 Pg C13

In times of market turmoil, many investors seek a haven for their money. And right now many are buying up inflation-protected U.s. government bonds in the belief that they are the safest investment around.

The markets are volatile amid worries about a recession, even as signs of inflation pressure emerge.

The best TIPS funds, meanwhile, offer low fees and a straightforward exposure to TIPS. Among the most popular, are Vanguard's Inflation Protected-Securities Index fund, and an exchange-traded fund, Lehman TIPS iShare.

All Crowd In?

The only problem is that everyone has the same idea. Huge demand has sent the price of these bonds, known as Treasury Inflation-Protected Securities, or TIPS, soaring to lofty levels. And while investors may not realize it, at current valuations thaey offer much more meager returns than normal.

TIPS are a relatively new class of government bond, launched in the 1990s. They offer an appealing double benefit for investors - especially those, such as retirees, seeking safety and conservation of capital.

First, like ordinary U.S. government bonds, they offer guaranteed income and return of capital. They are issued by the federal government and the risk of any default is miniscule.

Second, unlike most government bonds, they contain insurance against a rise in inflation as well. Through a complex formula involving both coupons and bond prices, TIPS guarantee that their annual interest rate will keep up with fluctuations in the consumer-price index over the price of the bond. They offer a guaranteed "real" yield on top of the CPI.

Careful on the Seesaw

Bonds work like a seesaw: When the price rises, the yield you get falls.

The accompanying chart shows that this is doing to TIP yields. The "real" or after-inflation yield on a benchmark 10-Year TIP has plunged by nearly half, from over 2.8% in August to just 1.57% today.

History is pretty clear. That tends to prove a poor deal for investors.

Only twice in recent history have these real yields fallen to similar levels: In early 2004, and again in 2005. On both occasions, those who invested quickly lost money as the bonds fell back again and the yields rose.

The best time to buy TIPS is when they are out of fashion and the real yield being offered is over 2%. The market seems to consider that a good long-term value.

TIPS do offer guaranteed income and protection against inflation. But always on Wall Street, price matters too. And there is no safety in numbers.

If TIPS appear to offer meager pickings right now, the same could also be said for regular government bonds - the ones with no inflation protection. The current yield on the 10-year Treasury is a dismal 3.85%, and 4.36% on the 30 year. Both have collapsed since last summer. It is worth adding that these yields are all subject to federal income tax as well, unless the bonds are held in a tax-sheltered account like an IRA.

For savers seeking better interest, it may be sensible to wait in cash for better opportunities. E*Trade Financial Corp.'s E*Trade Bank, for example, offers a savings account paying 4.93%. And deposits are federally guaranteed up to $100,000.

WSJ: Consumer Borrowing Rises At Fastest Rate in 3 Months

Wall Street Journal
Wednesday January 9, 2008 Pg A2

U.S. consumer borrowing rose at an annual rate of 7.4% in November, the fastest pace in three months, the Federal Reserve said.

The 0.6% monthly increase in consumer credit outstanding, to $2.505 trillion, is a positive sign for consumer spending, which accounts for more than two-thirds of the nation's economic activity. Consumer credit increased at an annual rate of just 1% in October, or 0.08% for the month.

The Fed said revolving credit - largely credit-card financing - grew at an 11.3% rate to $937.5 billion, the fastest pace in six months.

Households' nonrevolving credit, such as car and boat loans, rose at an annualized 5.1% pace to $1.568 trillion, rebounding from October's drop in that category, the Fed said.

Separately, the National Association of Realtors said its forward-looking indicator of existing-home sales fell in November after rising for two months. The industry group's pending-home-sales index, based on signed contracts for homes, declined at a seasonally adjusted annual rate of 2.6% to 87.6.

Monday, February 18, 2008

Delinquency rate up on consumer loans

Delinquency rate up on consumer loans

St. Paul Pioneer Press
Friday January 4, 2008 Pg 2C

Late payments on a cluster of consumer loans, including those for autos, home improvement and certain home-equity loans, climbed in the summer to their highest point since the country's last recession in 2001. The American Bankers Association said Thursday the delinquency rate on a composite of consumer loans increased to 2.44 percent in the July-to-September quarter. That was up sharply from 2.27 percent in the previous quarter and was the highest late-payment rate since the second quarter of 2001. Payments are considered delinquent if they are 30 or more days past due. The survey is based on information supplied by more than 300 banks nationwide. Late payments on credit cards, meanwhile, dipped during summer. The delinquency rate on credit cards dropped to 4.18 percent in the third quarter, down from 4.39 percent in the second quarter.

Bankruptcy filings back on the rise

Bankruptcy filings back on the rise

St. Paul Pioneer Press
Friday January 4, 2008 Pg 1C

U.S. personal bankruptcy filings jumped 40 percent in 2007 because of rising mortgage payments, job losses and other financial pressures. The increase followed a sharp decline from a year earlier, when a new law made it more difficult for consumers to seek bankruptcy-court protection from creditors.

More than 800,000 personal bankruptcy filings were made in 2007, compared with more than 573,000 in 2006 - the lowest level since 1998, according to data collected by the National Bankruptcy Research Center and published by the American Bankruptcy Institute, a research group in Alexandria, Va.

Personal bankruptcy filings soared to more than 2 million in 2005 for the nation, with more than 600,000 filings made in October, when the law took effect.

Minnesota bankruptcies through November totaled 10,834, compared with 7,729 filings for all of 2006. The 11-month 2007 total is well below 2005's 25,420 for the same period. From 1999 through 2004, Minnesota saw between 14,510 and 19,416 filings during hte first 11 months.

Financial Times: Recession Risks

This article appeared in the Wed. Jan. 2, 2008 issue of the Financial Times:

Whatever the inflationary risks lurking in the US economy, recession is the fear that is keeping policymakers up at night. Rightly so. The long-resilient US faces a series of blows that will cut into growth. The residential housing market is dealing with an almost unprecedented nationwide fall in prices. Meanwhile, unstable credit markets, roiled by the subprime crisis, could have a significant impact on the availability, and price, of credit.

How big will the impact be? US growth will certainly slow. But a house price correction in itself should be manageable, unless it turns into a freefall. After all, the pain so far has been concentrated among poorer, subprime borrowers, whose spending is very small in the context of the overall economy.

The trouble is, we are heading into largely uncharted territory on housing when it comes to guessing whether consumers, already heavily burdened with debt, will lose confidence. That is a significant risk. And it could feed back into credit market problems.

Banks are already building up their own liquidity and are worried about lending to each other because of the credit market crisis. Now they also have to factor in the risk of a recession. If they are bearish, they are likely to ratchet up credit standards and reduce lending somewhat to prepare for loan losses. There is the risk of a downward spiral, where such a credit contraction in itself increases recession risk.

As the property and credit markets undergo a slow and ugly repricing, it would be little surprise if the US slipped at least briefly into recession. Stronger export growth, on the back of a weak dollar and healthy demand from the rest of the world, will struggle to offset the domestic forces at work.

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