Monday, July 20, 2009

Recommended Readings

Turning point in the crisis?

Anna Schwartz on the bailouts and Big Ben.

As someone who might go to economics graduate school, I think universities should respond to this by increasing the number of tenure track econ professors (h/t Matt Yglesias).

like CIT's bond holders are going to throw it a lifeline.

Jamie Dimon, BSD (h/t Baseline Scenario).

Cuomo goes after Chuck

The WSJ Reports:

In an official notice sent to Charles Schwab & Co. Friday, Attorney General Andrew Cuomo warned that his office plans to sue the largest online brokerage firm for civil fraud over its marketing and sales of auction-rate securities to clients. Emails and testimony cited in the letter show Schwab's brokers had little idea of what they were selling and later failed to tell clients that the market was collapsing.

Auction-rate securities -- short-term debt instruments whose prices reset in periodic auctions -- caused billions in losses for investors after the $330 billion market collapsed in early 2008.

Mr. Cuomo writes in the letter that his office would be open to a settlement with Schwab, but it must agree to buy back the securities from investors still stuck with them.

More than a dozen Wall Street firms and small brokerages agreed to pay more than $60 billion to buy back the securities from investors.... Schwab is among a handful that haven't settled.

"The Attorney General's allegations are without merit," Schwab said in a statement. "They unfairly lay blame on our company for an illiquid market and improper behavior by the large Wall Street firms that created" and then stopped supporting the market....

The attorney general's investigation of Schwab found that brokers were unaware of and misleading about the risks of the securities -- promoting them to customers as cash-like investments, according to the letter. It also found that some traders and executives knew the market was cracking as early as the autumn of 2007 and took steps to protect the company, but didn't disclose those problems to customers....

Charles Schwab executives received daily reports showing in the fall of 2007 that demand for the instruments was declining rapidly, but it didn't make that information available to clients, said the letter.

I'm not entirely sure how I stand on Cuomo's Spitzer-esq activism. On the one hand, the market collapsed and people a lot smarter than Schwab's retail brokers misread it. There was a pervasive view in the financial community that "innovations" like ARS's and sub-prime MBS's were relatively safe investments. I'm not sure how fair it is to sue Schwab for giving wrong advice. After all, they were in some pretty good company with that one.

However, there's an admittedly hazy line between simply being wrong and negligently wrong. It's one thing if they were sold as pretty safe, and should give you a good return, and a much different thing if they were sold as " cash-like investments." I suspect most of them were sold with a line similar to the first, and Cuomo cherry-picked a particularly bad statement to include in the press release.

Also, the fact that the company "took steps to protect the company, but didn't disclose those problems to customers" should surprise no one. The company made the decision to protect themselves instead of their customers, and I don't know if that warrants state and court intervention.

Was it bad business to protect the company instead of the investors? Maybe. Was it wrong to sell the ABS's to relatively unsophisticated investors? Probably. To the extent that they told them the investments were "cash-like" or near risk free the company should be held liable. Anything past that and I'm not sure why stupid advise should leave them liable in court. I'm not a lawyer, but this seems like a pretty thin case mainly designed to help Mr. Cuomo in his gubernatorial run.

Ryan Avent calls out Mankiw

Ryan Says:

Basically, Greg Mankiw is just about the least interesting economics blogger out there. I always know where he’s going to come down on an issue, and I never learn anything from his explanations of why he winds up at that position. He seems to care more about getting it Republican than getting it right, which makes for lousy econoblogging.

Pretty harsh rhetoric.

Thursday, July 16, 2009

Recommended Readings July 15, 2009

The WSJ Editorial Board complaining that Goldman's gains are due in large part to federal baking, CIT shouldn't get money, and a call for taxing leverage. Should I be worried I agree so much with a WSJ Editorial on three (somewhat) controversial financial issues?

Krugman on deficits (hint, he thinks they can/will save us)

"A Reader's Guide to Econoblogs," by the WSJ's Real Time Economics. MR and Megan McArdle are at 21 and 23 respectively, so this is purely for entertainment and should not be taken seriously.

Tipping Point or Racism: Take 2

California near a deal to avert obliteration?

Firefox 3.5 is very good, but Chrome and Safari are catching up. Internet Explorer, unsurprisingly, still lags far, far behind.

Wednesday, July 15, 2009

Menzie Chinn takes on stimulus and forecasting: Part 2

I linked favorably to a post by Menzie about the stimulus a little while ago and said:

I'm not sure if I agree with the last parenthetical sentence. If GDP is a percentage point lower than what was expected conditioning on the expected passage of the stimulus, why does that mean that "individuals who ascribe the worse-than-expected performance of the economy to the stimulus package cannot look to the ex post GDP realizations for support for their arguments"? In fact, I don't see how it supports either a pro or anti-stimulus argument. GDP could be worse than expected because the economy was worse than the consensus, the stimulus did not live up to the Obama administration's expectations, or the very, very small chance the stimulus had a negative effect (none of these are mutually exclusive). Menzie makes a good point when he states that very little of the stimulus was spent in Q1, and thus should have little effect on Q1 GDP. I can see how that means it's not right to look at Q1 numbers and conclude the stimulus was ineffective, but not the logical conclusion Menzie makes.

Menzie replied via the comment board on his blog and said this:

As of early Feb., one has an information set incorporating passage of the stimulus bill, if not with 100% certainty, then pretty high. Then you have the actual realization of GDP. You can decompose the "surprise" into a part that it "new" information regarding the state of the economy, and "new" information regarding stimulus composition and effectiveness. I set the new information regarding the latter at near zero. You could try your own decomposition; I'd welcome finding out your conclusions.

Thanks to Menzie for the reply. I understood the major point of his augment, but got a little confused with his conclusion. I said, "... he states that very little of the stimulus was spent in Q1, and thus should have little effect on Q1 GDP. I can see how that means it's not right to look at Q1 numbers and conclude the stimulus was ineffective..." From what Menzie said in his reply, I take it that's about what he meant (ie that GDP was lower that what was anticipated was due to errors in forecasting, and not an ineffective stimulus). Sorry Menzie, I guess I misunderstood what you wrote.

Income Inequality

Matt Yglesias says:

And you really don’t want to find yourself suggesting, as I think people sometimes do, that we ought to be monomaniacally focused on the income gap question. After all, consider an African-American woman working as a nurse in North Carolina in the late 1950s relative to a white male executive at North Carolina’s largest bank. There would have been a substantial gap in their incomes. But if you flash forward to today and compare an African-American woman working as a nurse in North Carolina to a top executive at Charlotte-based Bank of America you’ll find a much larger gap.

Thinking about the issue more comprehensively, though, it’s of course clear that the overall gap in social equality between two such people is smaller today than it was in the days when the African-American woman would be explicitly excluded from a wide range of social practices and opportunities open to the banker. I don’t think there’s any reason to believe that the decline of Jim Crow caused income inequality to grow thus forcing us to make an explicit tradeoff, but it’s still worth understanding which aggregate sets of social changes have and haven’t been for the better.

I credit Matt for making the point that there is a smaller difference between the two today then there would have been 60 years ago, even if there is a larger real difference in income. However, this brings up a larger point that is one of my big pet peeves in regards to income inequality. The pure difference between the richest among us and those farther down on the income spectrum is a very misleading stat. To explore why this is so, let's go through a very simple thought experiment. Suppose Town A has 100 families, half of which have an income of $100,000 a year, and the other half make $5,000. Additionally, there is little to no interaction between the two groups, including through charities. Now suppose Town B has 100 families, half make $1,000,000 and the other half mark $50,000. Town B has higher income inequality in the most literal sense of the word, but no one in the lower half of Town B would trade places with someone in the lower half of Town A, all else being equal.

This is obviously an unrealistic situation, but it shows us the absolute difference in income is a misleading way to look at inequality. The fact that the richest portion of the population saw there income grow far more than the middle class means relatively little. What matters is how much better (or worse) off the middle class and poor are today than they were back then. If there are policies that can capitalize on the increased incomes of the richest to help the poorest, then that matters. Not that there is a bigger difference.

There may be a larger difference in income between the nurse that Matt mentioned in his post and the banker, but the nurse is still far better off now than the one from the 1950s. In addition to the improved (albeit no where near acceptable) race relations, the nurse saw her income grow and can afford a lot more luxuries today. She probably lives in a far better neighborhood, has access to technological improvements like air conditioning, and while she may not be able to pay for college access for her kids fully out of pocket (assuming she has them), they still face better life prospects than they would have in the 50s. The correct question is not what is the difference between the middle class and rich today compared to the middle class and rich of yesteryear. The correct question is how much better is the life of the middle class today compared to the past, and how can we share some prosperity with people in the lowest income brackets.

Income inequality is still a big issue today, and we need better policies from various levels of government to address it. But to look merely at income differences, and not what incomes of various groups of people can buy them, misses the point and will lead us to the wrong policies.

Healthcare spending and innovation

Greg Mankiw quotes a post he wrote a couple of years ago. The normative analysis is pretty much what I wrote about in a post a couple of days ago:

The reason that we spend more [on healthcare] than our grandparents did is not waste, fraud and abuse, but advances in medical technology and growth in incomes. Science has consistently found new ways to extend and improve our lives. Wonderful as they are, they do not come cheap. Fortunately, our incomes are growing, and it makes sense to spend this growing prosperity on better health.

Ezra Klein talks about innovation and healthcare spending today, but comes down on the opposite side of Mankiw in terms of his positive analysis:

Like Kevin Drum, there's one objection to a national health-care system that I find kind of interesting. As the argument goes, the United States overspends on health-care insurance. But that overspending has a point. It supercharges innovation. The rest of the world, in fact, free rides off of the high prices we pay for new drugs and ingenious technologies. That's not a great deal for us, but it's better than the grim future that awaits us in a world where the United States is not massively overpaying, and innovation thus grinds to a global halt.

The problem with that objection is that it's all theory. I've never seen empirical evidence quantifying the benefits of domestic overpayment, nor the cost to innovation of, say, a government health-care system that cut spending by 15 percent. Similarly, you'd also want to consider whether further drug innovation was the most productive use of those dollars. Out of every $100 we spend paying more for drugs and devices than other countries, would those last $8 do more good contributing to "innovation" (along with profits, advertising, me-too drugs, etc) or funding early childhood education? Or cutting taxes?

Nor do proponents of this theory seem to take it particularly seriously. They'll use it as a cudgel against single-payer, but never as an argument to increase domestic spending. But why not? If the benefits to innovation are really so grand, why shouldn't we double our spending? Or increase it by 20 percent? It seems unlikely that fortune has delivered us to the optimal point on the curve. If the need to better fund global medical innovation were truly so persuasive, you'd imagine that it would cease being a convenient objection to universal health care and be built into an affirmative policy proposal in its own right.

I'm more with Klein on this point, but don't agree fully with what he says. Like I said a couple of days ago, some reduction in costs is necessary to make sure the federal deficit doesn't explode to ridiculous levels, as well as to ensure all people have access to the care they deserve. However, that reduction comes a price that manifests itself in may forms, most notably, reduced innovation. Some of the slack will (hopefully) be picked up by other researchers (ie universities), but innovative, if very expensive, life-saving technologies will not come to market as quickly, if at all. I don't think the ever increasing healthcare costs are the most efficient use of money (especially when an alternative use of money is covering people in the lowest income bracket), but cost inflation reduction is not a free lunch.