Monday, January 31, 2011

In 2008, half of all mortgages were high risk

See Follow the Weak Mortgages by Peter J. Wallison. He is a senior fellow at AEI and a member of the Financial Crisis Inquiry Commission.

"In my dissent, I point out that before the financial crisis began in 2008, half of all mortgages in the U.S. financial system -- 27 million loans -- were subprime or otherwise high risk. This was an unprecedented number and a far larger percentage than in any bubble in the past.

Why were so many U.S. mortgages so weak? Both the Democratic and Republican reports ignored this central question. The answer is that it was Housing and Urban Development's policy, from 1992 to 2007, to reduce mortgage underwriting standards so that more people could buy homes. Home ownership rates rose. But in 2007 it all came apart."

Sweden Has A Voucher Sytem For Education (Based on Friedman's Ideas)

See Sweden’s school voucher system is a model for America by Odd Eiken. He was State Secretary of Schools in Sweden 1991-94. From The Daily Caller, 1-23-11. Here is an excerpt:

"With 15 years of experience, we in Sweden can summarize the effects. Education’s private sector share of students has grown from 1 percent to 10 to 15 percent, depending on grades. In some areas the competition is fierce, with both public and independent schools closing as a result. The variety of independent schools is large in both ownership — from parental cooperatives to corporate chains — and in innovative pedagogy and practice, of which the much-acclaimed Kunskapsskolan is not the only interesting example.

Vouchers are not the sole fix for education — there is no such single reform. But with real competition, independent schools are still generally performing better academically than public schools, even if the differences probably will decrease as their share increases and failing schools disappear. More important perhaps, is that all schools — public and private — perform better in areas where alternatives are plentiful.

As a former Swedish State Secretary of Schools, involved in developing the reform in the 1990s, I often get comments from American friends: “You’re supposed to be the socialists, not us,” they say and ask, “How is it that Sweden, with its egalitarian tradition, has one of the most radical systems for market-driven choice in the world?”

Maybe that is the answer. With our egalitarian tradition, we can’t accept that the right to choose the best school for your child should be reserved just for those who have the means to pay for it."

The World Might Have A 250 Year Supply Of Natural Gas

See IEA: A New Superabundance of Game-Changing Shale Gas Will Provide 250 Years of Natural Gas from the "Carpe Diem" blog of Mark Perry. He has a nice chart and here is the blurb he used from the BBC:

"The world may have twice as much natural gas than previously thought, according to the rich nations' think tank the International Energy Agency (IEA). The world may have 250 years of gas usage at current levels thanks to "unconventional gas" from shale and coal beds, Anne-Sophie Corbeau, senior gas expert at the IEA told BBC News. Estimates may even be revised upwards.

Studies are underway into newly-recoverable sources, Ms. Corbeau said. "The gas story is huge. A few years ago the United States was ready to import gas. In 2009 it had become the world's biggest gas producer. This is phenomenal, unbelievable."

The U.S. achieved the change through a technological breakthrough in which firms found a way of using tiny explosions to free gas previously trapped in a common rock - shale. Miss Corbeau said other nations were now rushing to replicate the U.S. success by exploiting gas currently trapped in various types of rock where it was thought to be impossible to access."

Sunday, January 30, 2011

Federal Reserve Bank Of Richmond Lacker On The Financial Crisis

See Reflections on Economics, Policy and the Financial Crisis by Jeffrey M. Lacker. Excerpts:

"The U.S. housing GSEs and their low-income credit mandates exerted a larger influence on the subprime mortgage market than was known ex ante."

"Perhaps most importantly, the magnitude of the overinvestment in housing collectively generated by these sources of moral hazard was underestimated and emerged only gradually as the fall in residential investment unfolded."

Interview With Walter Williams

See The State Against Blacks 'The welfare state has done to black Americans what slavery couldn't do. . . . And that is to destroy the black family', from the WSJ, 1-22-11, page A13. Excerpts:

"His research also showed that Davis-Bacon, which requires high prevailing (read: union) wages on federally financed or assisted construction projects, was the product of lawmakers with explicitly racist motivations.

One of Congress's goals at the time was to stop black laborers from displacing whites by working for less money."

"Today just 17% of construction workers are unionized, but Democratic politicians, in deference to the AFL-CIO, have kept Davis-Bacon in place to protect them. Because most black construction workers aren't union members, however, the law has the effect of freezing them out of jobs. It also serves to significantly increase the costs of government projects, since there are fewer contractors to bid on them than there would be without Davis-Bacon."

""In 1794, Congress appropriated $15,000 to help some French refugees," he says. In objection, "James Madison stood on the House floor and said he could not take to lay his finger on that article in the Constitution that allows Congress to take the money of its constituents for the purposes of benevolence. Well, if you look at the federal budget today, two-thirds to three-quarters of it is for the purposes of benevolence.""

Ethanol Continues To Eat Up More Of The Grain Crop

See Amber Waves of Ethanol: Four of every 10 rows of U.S. corn now go for fuel, not food, WSJ, 1-22-11, p. A14. Excerpts:

"In 2001, only 7% of U.S. corn went for ethanol, or about 707 million bushels. By 2010, the ethanol share was 39.4%, or nearly five billion bushels out of total U.S. production of 12.45 billion bushels. Four of every 10 rows of corn now go to produce fuel for American cars or trucks, not food or feed."

"...Cornell University scientist David Pimentel calculates that if the entire U.S. corn crop were devoted to ethanol production, it would satisfy only 4% of U.S. oil consumption."

"When consumers didn't buy enough gas last year to meet previous ethanol mandates, the Obama Administration lifted the cap on how much ethanol may be mixed into gasoline to 15% from 10%. Presto! More ethanol "demand." On Friday the EPA greatly expanded the number of cars approved to use the 15% blend. Last month, Congressmen whose constituents benefit from this largesse tucked into the tax bill an extension of the $5 billion tax credit for blending ethanol into gasoline."

The Apple iPhone And Trade Statistics

See The $6.50 Trade War: What Apple's iPhone tells us about U.S. trade with China. From the WSJ, page A16, 1-11-11. Excerpts:

"In the case of the iPhone, Messrs. Xing and Detert note that the device was invented in America by an American company, Apple. The components are manufactured, either inside or out of China, by companies based in several other countries. The only part of the process that is unambiguously "Chinese" is the final assembly—a process that, in the estimation of Messrs. Xing and Detert, adds only $6.50 to the $178.96 wholesale value of an iPhone.

Yet that entire $178.96 value ends up attributed to China in official trade statistics. As a consequence, the iPhone contributed nearly $1 billion to China's bilateral trade surplus with America in 2008, and nearly $2 billion in 2009, the authors conclude. If the trade data had been based solely on the $6.50 cost of assembling each unit, the iPhone would have added only $34 million and $73 million in those years to China's surplus."

"The ADBI study doesn't break down that figure, but others have performed similar research. Economists at the Personal Computing Industry Center attempted in 2007 to estimate who profits from the iPod and how. They estimated that for an iPod retailing for $299, retailer and distributor margins account for $75 and Apple's own margin accounted for $80. In other words, more than half the retail price accrued to U.S. companies—and employees and shareholders—in some form."

Saturday, January 29, 2011

Lead Toy Law May Have Hurt Small Business

See Small Crafts vs. Big Government by Virninia Postrel, WSJ, page C12, 1-29-11.

"Frightened by news that toys made in China contained unsafe levels of lead, customers were looking for alternatives to the usual big-box offerings. Just as organic farmers gain market share whenever there's a food-safety panic, the lead scare boosted sales of artisanal children's goods."

"In response to the lead panic, Congress passed the Consumer Product Safety Improvement Act, or CPSIA, by an overwhelming majority. The law mandates third-party testing and detailed labels not only for toys but for every single product aimed at children 12 and under."

"Although big companies like Mattel could spread the extra costs over millions of toys, Mr. Marshall's small-scale suppliers couldn't. Unable to afford thousands of dollars in testing per product, some went out of business. Others moved production to China to cut costs. Many slashed their product lines, reserving the expensive new tests for only their top sellers. The European companies that used to sell Peapods such specialty items as wooden swords and shields or beeswax-finished cherry-wood rattles simply abandoned the U.S. market. The survivors jacked up prices."

""I'm a lot more cynical than I was," says Cecilia Leibovitz, who owns Craftsbury Kids, an online shop selling handmade toys and children's clothes, and also leads the CPSIA discussion group among's online sellers. Mostly individuals producing one-of-a-kind items, Etsy crafters find it especially hard to comply with, or even interpret, the law's requirements."

"By contrast, consider the recently enacted Food and Drug Administration Food Safety Modernization Act. Like the CPSIA, it establishes expensive new labeling, record-keeping, inspection and reporting requirements. But, unlike the CPSIA, it carves out an exception for small operations."

"Buying handmade toys may be nice, but eating produce from the farmer's market is a quasi-religious ritual of group identity."

John Taylor's Plan To Get The Economy Moving

See A Two-Track Plan to Restore Growth: Our economic wounds are self-inflicted. Changing fiscal and monetary policies could make a difference fast from the WSJ, 1-28-11, page A19. Taylor is a professor of economics at Stanford. Here are the excerpts:

"Why the extraordinarily high and prolonged unemployment? My research shows that discretionary government interventions—deviations from sound economic principles and policies—have been largely responsible."

"We have seen an $862 billion stimulus, an increase in federal spending to 25% from 21% of GDP, and a corresponding explosion of federal debt. We have the Fed's unconventional "quantitative easings": purchases of $1.25 trillion of mortgage backed securities and $900 billion of longer-term Treasury bonds. And we have seen hundreds of new regulations in the health and financial sectors."

"The one-time stimulus payments to people did not jump-start consumption. The stimulus grants to states did not increase infrastructure spending. Cash for clunkers merely shifted consumption a few months forward. The Fed's purchases did not have a material impact on mortgage interest rates once changes in risks are taken into account. At best these actions had a small temporary effect that dissipated quickly"

"Well-known theories of consumption predict that temporary payments to households will not increase economic growth by much."

"discretionary monetary policy, as distinct from rules-based policy, leads to boom-bust cycles with ultimately higher unemployment and higher inflation. With sounder, more stable and more predictable monetary and fiscal policies in the 1980s and '90s we had long expansions and lower unemployment.

The best way to reduce unemployment is to restore sound fiscal and monetary policies."

"Three-fourths of business economists and one-half of academic economists say that easy monetary policy exacerbated the housing boom and bust that led to the financial crisis."

"The history of the past two decades shows that lower government purchases as a share of GDP are associated with lower unemployment rates. A much better way to reduce unemployment is to encourage private investment. Over the past two decades, unemployment fell when investment increased as a share of GDP."

Unintended Consequences Of The New Credit Card Regulations

See Hope and Change--Credit Card Interest Rate Edition from Division of Labor. Here is what they said:

"Interest rates are now hovering near record highs, at an average rate of 14.72%. And if your credit is bad enough, you could even end up with a rate as high as 59.9% APR.

That's because while the CARD Act helped crack down on certain fees and requires more disclosures, it didn't cap every credit card holder's worst enemy: interest rates.

Sure, the new rules prevent banks from raising most interest rates retroactively, but there's no limit on the rates they can charge new customers.

"Rates are going up because card issuers know that once you get a card they can't raise the rates, so they're raising rates on the front end to ensure they get the revenue from that interest," said Beverly Harzog, credit card expert at"

Friday, January 28, 2011

Man Tries To Gain Weight So He Can Get Gastric Bypass Surgery

A man in England (UK) is eating alot to bring his weight from 20 stones (about 280 pounds) to 21 stones (about 293 pounds) so he weighs enough to have the government pay for his gastric bypass surgery. If you don't weigh enough (I think for your height), the government won't pay for it. So this guy wants the surgery and is eating to get it. Seems like he should be trying to lose weight. See 20st man piles on pounds to qualify for NHS gastric band. From the London Daily Mirror. (Hat tip: Freakonomics) See their The Unintended Consequences of Government-Sponsored Weight-Loss Surgery.

Thursday, January 27, 2011

Federal Agencies Spend Alot On Energy, Some Leave Lights On All Night

See Federal Agency Headquarters Leave Lights On In DC. It is from WUSA9. Excerpts:

"Night after night, year after year, this nightside reporter observed lights left on in federal government buildings. So I decided to see just how much taxpayers were spending to keep empty buildings illuminated."

"The low end is about $200,000 a month. The high end more than a million. One month's electricity bill at the Department of Labor topped a MILLION dollars. That was a bill paid in July of last year. The month before, the department paid a bill of nearly $700,000. And utility costs of that magnitude are not unusual."

"The Federal Aviation Administration's side-by-side Wright Buildings, on Independence Avenue, administered by the General Services Administration, always appear to have the majority of their lights on, including those in the cafeteria, even though a metal gate keeps anyone from entering after hours.

The Environmental Protection Agency appears to leaves its lights on. At the Department of Education, several floors always seem illuminated. Only one time, at the Department of Agriculture, did we see a cleaning person through a window."

Dissenting View On The Financial Crisis

See What Caused the Financial Crisis?: Congress's inquiry commission is offering a simplistic narrative that could lead to the wrong policy reforms by BILL THOMAS, KEITH HENNESSEY AND DOUGLAS HOLTZ-EAKIN. From the WSJ, 1-27-11, page A21.

They aim to avoid any simplistic explanation like it was all the fault of Fannie Mae and Freddie Mac or that it was all greedy bankers. Their version has 10 parts. Here are their last two paragraphs:

"We agree with our colleagues that individuals across the financial sector pursued their self-interest first, sometimes to the detriment of borrowers, investors, taxpayers and even their own firms. We also agree that the mountain of government programs supporting the housing market produced distorted investment incentives, and that the government's implicit support of Fannie Mae and Freddie Mac was a ticking time bomb.

But it is dangerous to conclude that the crisis would have been avoided if only we had regulated everything a lot more, had fewer housing subsidies, and had more responsible bankers. Simple narratives like these ignore the global nature of this crisis, and promote a simplistic explanation of a complex problem. Though tempting politically, they will ultimately lead to mistaken policies."

Wednesday, January 26, 2011

The poor are not getting poorer

That is the title of an editorial by Steven G. Horwitz.

Click here to read it

Horwitz is Chair of the Department of Economics at St. Lawrence University.

Here is an excerpt:

"If we really want to know what happened to the poor of 1979, we need to be able to track specific households through time. Fortunately, we can. According to researchers at the University of Michigan, households in the bottom fifth in 1975 earned an average of almost $28,000 more per year by 1991, adjusted for inflation. According to U.S. Treasury data, a whopping 86 percent of households in the bottom fifth in 1979 had climbed out of poverty by 1988.

The problem with the data in "The State of Working America" is that it does not account for the fact that individual households move up and out of poverty and are then "replaced" by different households. Most of the households in the bottom fifth are made up of people who have recently entered the labor market and are on the first rung of the income ladder, such as recent high school graduates and new immigrants. The vast majority of American households do move up, and over the last 30 years most Americans have gotten significantly richer in absolute terms.

Granted, even if everyone is better off, it's still possible that the rich-poor income gap has widened. But simply measuring income and wealth tells us very little about the lifestyle of typical Americans. For example, poor Americans today are more likely to own basic household goods - such as washing machines, dishwashers, televisions, refrigerators, and toasters - than average Americans were in 1973.

The gap in personal conveniences has clearly narrowed over time. Consider that both Bill Gates and more than 80 percent of poor American households own cars - though likely differing in quality. Fifty or 100 years ago, the difference would not have been in the quality of car, but in owning a car at all.

Yes, there are more Americans in poverty during a recession - some in deep poverty - as the institute's data shows. But it also shows that since about 1980, the share of the population in extreme poverty has hovered between 5 and 6 percent. In other words, there's no long-term upward trend in the percentage of households living in extreme poverty."

Tax Cuts Might Be Better For Growth Than Spending

See Why the Spending Stimulus Failed: New economic research shows why lower tax rates do far more to spur growth by Michael Boskin, from the WSJ, 12-1-10. He is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush. Key excerpts:

"In a dynamic economy, many parts are moving simultaneously and it is difficult to disentangle cause and effect. Taxes may be cut and spending increased at the same time and those may coincide with natural business cycle dynamics and monetary policy shifts.

Using powerful statistical methods to separate these effects in U.S. data, Andrew Mountford of the University of London and Harald Uhlig of the University of Chicago conclude that the small initial spending multiplier turns negative by the start of the second year. In a new cross-national time series study, Ethan Ilzetzki of the London School of Economics and Enrique Mendoza and Carlos Vegh of the University of Maryland conclude that in open economies with flexible exchange rates, "a fiscal expansion leads to no significant output gains."

My colleagues John Cogan and John Taylor, with Volker Wieland and Tobias Cwik, demonstrate that government purchases have a GDP impact far smaller in New Keynesian than Old Keynesian models and quickly crowd out the private sector. They estimate the effect of the February 2009 stimulus at a puny 0.2% of GDP by now.

By contrast, the last two major tax cuts—President Reagan's in 1981-83 and President George W. Bush's in 2003—boosted growth. They lowered marginal tax rates and were longer lasting, both keys to success. In a survey of fiscal policy changes in the OECD over the past four decades, Harvard's Albert Alesina and Silvia Ardagna conclude that tax cuts have been far more likely to increase growth than has more spending.

Former Obama adviser Christina Romer and David Romer of the University of California, Berkeley, estimate a tax-cut multiplier of 3.0, meaning $1 of lower taxes raises short-run output by $3. Messrs. Mountford and Uhlig show that substantial tax cuts had a far larger impact on output and employment than spending increases, with a multiplier up to 5.0.

Conversely, a tax increase is very damaging. Mr. Barro and Bain Capital's Charles Redlick estimate large negative effects of increased marginal tax rates on GDP. The best stimulus now is to stop the impending tax hikes. Mr. Alesina and Ms. Ardagna also conclude that spending cuts are more likely to reduce deficits and debt-to-GDP ratios, and less likely to cause recessions, than are tax increases.

These empirical studies leave many leading economists dubious about the ability of government spending to boost the economy in the short run. Worse, the large long-term costs of debt-financed spending are ignored in most studies of short-run fiscal stimulus and even more so in the political debate.

Mr. Uhlig estimates that a dollar of deficit-financed spending costs the economy a present value of $3.40. The spending would have to be remarkably productive, both in its own right and in generating jobs and income, for it to be worth even half that future cost. The University of Maryland's Carmen Reinhart, Harvard's Ken Rogoff and the International Monetary Fund all conclude that the high government debt-to-GDP ratios we are approaching damage growth severely."

Tuesday, January 25, 2011

Alesina: Tax Cuts May Be The Best Medicine In Recessions

See Tax Cuts vs. 'Stimulus': The Evidence Is In: A review of over 200 fiscal adjustments in 21 countries shows that spending discipline and tax cuts are the best ways to spur economic growth by Harvard professor Alberto Alesina. From the WSJ 9-15-10.

"My colleague Silvia Ardagna and I recently co-authored a paper examining this pattern, as have many studies over the past 20 years. Our paper looks at the 107 large fiscal adjustments—defined as a cyclically adjusted deficit reduction of at least 1.5% in one year—that took place in 21 Organization for Economic Cooperation and Development (OECD) countries between 1970 and 2007."

"According to our model, a country experienced an expansionary fiscal adjustment when its rate of GDP growth in the year of the adjustment and the next year was in the top 25% of the OECD. A recessionary period, then, was when a country's growth rate was in the bottom 75% of the OECD.

Our results were striking: Over nearly 40 years, expansionary adjustments were based mostly on spending cuts, while recessionary adjustments were based mostly on tax increases. And these results would have been even stronger had our definition of an expansionary period been more lenient (extending, for example, to the top 50% of the OECD). In addition, adjustments based on spending cuts were accompanied by longer-lasting reductions in ratios of debt to GDP.

In the same paper we also examined years of large fiscal expansions, defined as increases in the cyclically adjusted deficit by at least 1.5% of GDP. Over 91 such cases, we found that tax cuts were much more expansionary than spending increases.

How can spending cuts be expansionary? First, they signal that tax increases will not occur in the future, or that if they do they will be smaller. A credible plan to reduce government outlays significantly changes expectations of future tax liabilities. This, in turn, shifts people's behavior. Consumers and especially investors are more willing to spend if they expect that spending and taxes will remain limited over a sustained period of time.

On the other hand, fiscal adjustments based on tax increases reduce consumers' disposable income and reduce incentives for productivity."

The Democratic Process May Not Be Magical When It Is Vague And Undefined

See The Enchantment of the Democratic Process by Arnold Kling at Econlog. Here is the first part:

"Mark Thoma writes,

'the real question is why so many people have stopped believing that the state has the authority to be the arbiter of last resort in a pluralistic society. " (end Thoma quote)

Kling: Read the whole thing, which starts out as an extended excerpt from Daniel Little. Much of the riff reflects what I call an enchanted view of something called "the democratic process." This is a magical process that would allow us to live in peace with one another, if we only we would accept it.

To me, this concept of a democratic process is vague and undefined. That leaves open the possibility that two sides can disagree over what the democratic process dictates. For example, on gay marriage, does the democratic process dictate against gay marriage, because voters consistently vote against it? Or does it dictate in favor of gay marriage, because courts have ruled in favor of gay marriage, and courts are the true embodiment of the democratic process?"

Monday, January 24, 2011

Maybe Fannie Mae Did Contribute To The Crisis, Part 2

See Maybe Fannie Mae Did Contribute To The Crisis for Part 1. And click on "Credit Crisis" in the archives list on the right side for more articles.

See Moving Beyond Fannie and Freddie: The experiences of other countries show there's no need for a government role in housing finance by Peter Wallison in the WSJ, page A17, 1-3-11. Exerpts:

"In 1992, Congress saddled Fannie and Freddie with a mission to support "affordable housing." This meant supplying credit for borrowers at or below the median income—mostly through subprime loans—and required that the GSEs reduce their underwriting standards by lowering down-payment requirements and buying other risky loans. But the new mission cemented their congressional support, and so Congress, joined by the housing industry, protected the GSEs from restrictive regulation almost to the day of their final collapse and government takeover on Sept. 7, 2008.

Research by Edward Pinto, a resident fellow at the American Enterprise Institute who was chief credit officer of Fannie Mae in the 1980s, has shown that by 2008 half of all mortgages in the U.S.—27 million—were subprime and other high-risk loans, often with little or no down payments by borrowers. Because of their affordable- housing requirements, the GSEs bore the risk of default on 12 million of these mortgages. The Federal Housing Administration (FHA) and other government agencies insured or held an additional five million. And banks under the Community Reinvestment Act, and other mortgage providers under a Department of Housing and Urban Development program, made another 2.2 million.

Thus, more than 19 million subprime loans were the responsibility of taxpayers, courtesy of the federal government's housing policies. The balance, slightly less than eight million loans, were securitized by Countrywide and other private issuers.

When the housing bubble began to deflate in 2007, these loans started to default in unprecedented numbers, driving down housing prices, forcing Fannie and Freddie into insolvency, and weakening financial institutions in the U.S. and around the world. Last October the GSEs' regulator, the Federal Housing Finance Agency, estimated that the final cost for bailing them out would be between $221 billion and $363 billion."

Sunday, January 23, 2011

Maybe Fannie Mae Did Contribute To The Crisis

See The crazy housing market by Russ Roberts at Cafe Hayek.

Beginning around the year 2000, there was a dramatic increase in the dollar value of mortgage backed securities issued by Fannie Mae. The increase appears, as a chart shows, to have started before the private sector and was much bigger.

It even started sooner than the year 2000. "But between 1995 and 1998, Freddie and Fannie’s issuance of MBS more than doubled. There is also a big percentage increase in the private label MBS between 1995 and 1998, but it is dwarfed by Fannie and Freddie."

Here are some other key experts:

"...don’t get fooled when Krugman and DeLong tell you that Fannie and Freddie were “small players” after 2003 or that they withdrew from the market. As you can see, they were still massively large by any historical standard and still almost as large as the private label MBS. Between 2004 and 2006, they still issued over two TRILLION dollars worth of MBS."

"The underlying cause is whatever made it possible for Fannie and Freddie to issue increasing amounts of MBS post-1995."

"So what allowed Fannie and Freddie to expand? One answer, and it might be the only answer you need, is that starting in the mid-1990s, Fannie and Freddie were encouraged by the President and Congress to relax their previous standards for which mortgages they could buy. They were encouraged to buy loans from low-income individuals and the percentage of their business accounted for by such borrowers was required to grow steadily. See the two charts at the end of this HUD paper, written in 2001. Fannie and Freddie started buying loans with low down payments and loans with incomplete documentation."

"So if you want to know why housing prices accelerated in 1997 and then racheted upward once more in the early 2000s, I would focus on government’s bipartisan attempt to engineer an increase in home ownership that ratcheted upward in the 1990′s and extended through the 2000′s. Then add the implicit backstopping of the creditors from large financial institutions. Large financial institutions that lent money to others to buy AAA-rated MBS were very leveraged. This leveraging allowed enormous sums of money to flow into MBS."

Saturday, January 22, 2011

Systemic Risk In The Financial Sector Is Hard To Define

See The Ruling Ad-Hocracy: So much for Dodd-Frank's promise of no more bailouts from the WSJ, page A12, 1-21-11.

"...the process by which federal officials decided that Citigroup had to be saved in late 2008 "was strikingly ad hoc. While there was consensus that Citigroup was too systemically significant to be allowed to fail, that consensus appeared to be based as much on gut instinct and fear of the unknown as on objective criteria.""

"Mr. Barofsky quotes FDIC Chairman Sheila Bair: "We were told by the [Federal Reserve Bank of New York] that problems would occur in the global markets if Citi were to fail. We didn't have our own information to verify this statement, so I didn't want to dispute that with them.""

there was "..."some selective creativity exercised in the determination of what is systemic and what's not.""

Why Citigroup got an extra $20 billion in bailout funds? "...[Paulson] did not perform any analysis specific to Citigroup in arriving at the $20 billion figure."

"...according to current Treasury Secretary Tim Geithner, who told Mr. Barofsky that, "In the future we may have to do exceptional things again if we face a shock that large. You just don't know what's systemic and what's not until you know the nature of the shock."

"The new Financial Stability Oversight Council chaired by Mr. Geithner once again refused to define exactly what it means to be a systemically significant firm."

"...the Council would consider any other risk-related factors that the Council deems appropriate, either by regulation or on a case-by-case basis . . .""

Deregulation Is Hard Because Regulators Always Want More Power

See Can Deregulation Work?: It was hard under Ronald Reagan. It will be impossible under Barack Obama by Paul H. Rubin, professor of economics at Emory University. From the WSJ, page A13, 1-21-11. He says some officials in the 1980s were serious about reducing regulations but

"The permanent staffs of the agencies were always interested in more regulation, either because of self-selection or because promotions and power increase in a larger agency. It also helped that we deregulators (generally economists) were not usually interested in permanent government positions, because reducing the power of the agency is a sure way to make enemies.

Although my mandate was to cut back, I spent more time fighting new proposals than getting rid of old ones."

"The current regulatory agencies are not going to hire or promote people like me."

"The current executive order seems to impose cost-benefit analysis, but it has enough loopholes ("equity, human dignity, fairness") so that agencies will be able to do whatever they want."

Oregon's New Tax On Rich Yields Less Revenue Than Projected

See Ducking Higher Taxes: Oregon's vanishing millionaires from the WSJ, 12-21-10, page A18.

"Oregon raised its income tax on the richest 2% of its residents last year to fix its budget hole, but now the state treasury admits it collected nearly one-third less revenue than the bean counters projected."

"In 2009 the state legislature raised the tax rate to 10.8% on joint-filer income of between $250,000 and $500,000, and to 11% on income above $500,000."

"Instead of $180 million collected last year from the new tax, the state received $130 million. The Eugene Register-Guard newspaper reports that after the tax was raised "income tax and other revenue collections began plunging so steeply that any gains from the two measures seemed trivial.""

"The tax wasn't enacted into law until June 2009 but was retroactively applied to January 1, 2009. So for the first half of the year wealthy Oregon residents weren't able to take steps to avoid the tax ambush because they didn't see it coming. This suggests that a bigger revenue loss from tax mitigation strategies will show up on tax return data in 2010 and 2011."

" Instead of $3.5 billion of capital gains in 2009, there was only $2 billion to tax—43% less."

"All of this is an instant replay of what happened in Maryland in 2008 when the legislature in Annapolis instituted a millionaire tax. There roughly one-third of the state's millionaire households vanished from the tax rolls after rates went up."

Friday, January 21, 2011

Milton Friedman vs. John F. Kennedy

Yesterday was the 50th anniversary of Kennedy's famous inaugural address. You might have noticed that Google commemorated it. Many writers have commented on it this past week. Below are the first two paragraphs from the introduction to Friedman's 1962 book Capitalism and Freedom. Friedman won the Nobel Prize in Economics in 1976.

"IN A MUCH QUOTED PASSAGE in his inaugural address, President Kennedy said, "Ask not what your country can do for you - ask what you can do for your country." It is a striking sign of the temper of our times that the controversy about this passage centered on its origin and not on its content. Neither half of the statement expresses a relation between the citizen and his government that is worthy of the ideals of free men in a free society. The paternalistic "what your country can do for you" implies that government is the patron, the citizen the ward, a view that is at odds with the free man's belief in his own responsibility for his own destiny.

The organismic, "what you can do for your 'country" implies tht government is the master or the deity, the citizen, the servant or the votary. To the free man, the country is the collection of individuals who compose it, not something over and above them. He is proud of a common heritage and loyal to common traditions. But he regards government as a means, an instrumentality, neither a grantor of favors and gifts, nor a master or god to be blindly worshipped and served. He recognizes no national goal except as it is the consensus of the goals that the citizens severally serve. He recognizes no national purpose except as it is the consensus of the purposes for which the citizens severally strive.

The free man will ask neither what his country can do for him nor what he can do for his country. He will ask rather "What can I and my compatriots do through government" to help us discharge our individual responsibilities, to achieve our several goals and purposes, and above all, to protect our freedom? And he will accompany this question with another: How can we keep the government we create from becoming a Frankenstein that will destroy the very freedom we establish it to protect? Freedom is a rare and delicate plant. Our minds tell us, and history confirms, that the great threat to freedom is the concentration of power. Government is necessary to preserve our freedom, it is an instrument through which we can exercise our freedom; yet by concentrating power in political hands, it is also a threat to freedom. Even though the men who wield this power initially be of good will and even though they be not corrupted by the power they exercise, the power will both attract and form men of a different stamp."

Thursday, January 20, 2011

More Foreign Direct Investment In The U. S. Than China

This comes via Cafe Hayek. Here is a letter Donald J. Boudreaux wrote to radio station WTOP. He is an economics professor at George Mason University.

"During today’s 11am hour your anchors interviewed a “trade expert” with the AFL-CIO who asserted that “China, with its low wages, will outcompete the U.S. for investments and customers unless Congress intervenes.”

Forget that this “trade expert” seems to be unfamiliar with the principle of comparative advantage. Let’s look at some relevant empirical evidence – namely, the amount of foreign direct investment (FDI)* that China has received over the past decade compared to the amount that the U.S. has received. If the “expert’s” claim is correct, China should be receiving more FDI than is America as investors swarm into that Asian nation to take advantage of its low wages.

But in fact, over the ten-year span 2000 through 2009, the total amount of FDI received by China was $685.8 billion, while the total amount of FDI received by the U.S. was $1,799.1 billion. That is, America’s inward FDI was 162 percent higher than was China’s. On a per-capita basis, the figure is even greater: America’s per-person inward FDI during these years was ten times (!) greater than was China’s.**

So much for the case that low-wage countries suck investments away from high-wage countries.

Donald J. Boudreaux

* As defined by Richard Caves, Jeffrey Frankel, and Ronald Jones on page 285 of the 9th edition of their widely used textbook World Trade and Payments (Addison Wesley, 2002), “Foreign direct investment occurs when the residents of one country acquire control over a business enterprise in another country. The acquisition may involve buying enough stock in an existing enterprise to become a controlling shareholder…., taking over the enterprise outright, or building a new factory or enterprise from scratch….”

** FDI figures were calculated using this very helpful database from UNCTAD."

Wednesday, January 19, 2011

Tax Payer Funded High Speed Rail Does Not Seem To Work

See Subsidy Trains to Nowhere: Can we sell you a ticket to Borden? It only costs $4.15 billion. From the WSJ, 12-11/12-10, page A14.

"The problem is that high-speed rail systems almost always run over budget and end up heavily subsidized. Only two segments of two such railways in the world, in France and Japan, have broken even, and they are in high-density areas—not running across sprawling California."

"The Golden State rail authority's failure to disclose the project's significant risks are troubling. Five months before the initiative passed, the consulting firm Infrastructure Management Group told the authority that companies wouldn't operate the railway without a revenue guarantee—a subsidy—because the ridership projections were too risky. The authority failed to produce an investment-grade business plan before the initiative was put to voters, and it still hasn't produced a credible economic plan. Maybe they don't have one."

"It now projects that ridership will reach 39 million passengers a year by its 10th year, down from that projection two years ago of 94 million. The experience of other high-speed rail systems suggests they'll be lucky if they get a quarter of that, and five million riders is more likely."

"The authority estimates a project cost of $42.6 billion, but a more realistic price tag would put the cost between $62 billion and $213 billion. It also predicts that one-way tickets for the two and a half hour ride from L.A. to San Francisco would cost $105 (up from $55), but the cost-per-mile in Europe and Japan suggests a ticket price closer to $190. Many would choose to fly."

"The authority also predicted 450,000 permanent jobs; that's twice the size of the state government's active work force."

"Unless the federal government provides $19 billion in seed money, the railway will never achieve a positive cash flow."

Tuesday, January 18, 2011

The Mistaken Attack on Outsourcing

That is the title of an article by Mihir Desai, a professor of finance at Harvard Business School. It was from the WSJ, 12-29-2010, p. A11. See The Mistaken Attack on Outsourcing: When American firms grow abroad, they also grow domestically. Here is the key excerpt:

"When American firms grow abroad, they also grow domestically, as demonstrated by research I conducted with C. Fritz Foley of Harvard and James R. Hines Jr. of the University of Michigan (published in the American Economic Journal: Economic Policy, 2009).

The data do not support the crude, fixed-pie intuition that firms either invest abroad or at home. Ten percent growth in American firms' foreign investment is associated with 3% growth in their domestic investment. And when firms grow abroad, their domestic exports and R&D activities grow especially, contrary to Mr. Obama's rhetoric."
"Vilifying or penalizing American businesses for their global operations will only lead them to consider leaving the U.S.—or consider being bought by foreign companies. Such moves would hurt America by removing valuable headquarter jobs. Instead, Mr. Obama should emphasize how Americans succeed when our firms succeed world-wide. That formulation better captures reality and offers a more sensible way to engage businesses in a new spirit of cooperation."

Monday, January 17, 2011

John Taylor Shows The Importance Of Investment For Job Creation

See Higher Investment Best Way to Reduce Unemployment, Recent Experience Shows. He presents graphs that show government spending as a percentage of GDP having little relation to the unemployment rate and investment having a very strong relationship. The higher investment is as a percentage of GDP, the lower the unemployment rate. Taylor concludes with

"Encouraging the creation and expansion of businesses should be the focus on government efforts to reduce unemployment. The recent compromise agreement to prevent the increase in tax rates on small businesses and the move to lighten up on the anti-business sentiment coming out of Washington are two steps in the right direction."