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There are good paying jobs for unskilled people managing pension funds. Floyd Norris reports on how these folks, who get 6-figure salaries, expected to get 8 percent returns even when the price to trend earnings ratio in the stock market exceeded 20 and even 30.
People who know arithmetic could have explained to these managers that this would not be possible. Today many of these pensions are seriously underfunded.
There are good paying jobs for unskilled people managing pension funds. Floyd Norris reports on how these folks, who get 6-figure salaries, expected to get 8 percent returns even when the price to trend earnings ratio in the stock market exceeded 20 and even 30.
People who know arithmetic could have explained to these managers that this would not be possible. Today many of these pensions are seriously underfunded.
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A Washington Post piece on German attitudes towards the crisis in the euro zone at one point refers to the high borrowing costs in Spain and Italy. It then tells readers:
“But in Germany’s view, yields on Spanish bonds — just above 7 percent as of Friday — are indeed with precedent, since Spain borrowed at rates well above 8 percent for most of the 1990s, touching 14 percent at one point. Italy had even higher borrowing costs than Spain in the 1990s.”
While the piece later notes that “many economists” say the comparison is misleading because Spain and Italy had higher inflation (much higher) and growth in the 1990s, this is in fact the view of all economists who know arithmetic. Economists focus on the real interest rate, the difference between the nominal interest rate and the inflation rate. Currently inflation in Spain and Italy is running near zero, which means that the nominal interest rates of above 7 percent translate into real interest rates above 7 percent.
By contrast, inflation in both countries averaged more than 5 percent for the first half of the 1990s. This means that a nominal interest rate of 8 percent would have translated into a real interest rate of around 3 percent.
If Germany has people in positions of responsibility who do not understand the concept of the real interest rate it would be very scary. That would be worthy of a major front page story.
A Washington Post piece on German attitudes towards the crisis in the euro zone at one point refers to the high borrowing costs in Spain and Italy. It then tells readers:
“But in Germany’s view, yields on Spanish bonds — just above 7 percent as of Friday — are indeed with precedent, since Spain borrowed at rates well above 8 percent for most of the 1990s, touching 14 percent at one point. Italy had even higher borrowing costs than Spain in the 1990s.”
While the piece later notes that “many economists” say the comparison is misleading because Spain and Italy had higher inflation (much higher) and growth in the 1990s, this is in fact the view of all economists who know arithmetic. Economists focus on the real interest rate, the difference between the nominal interest rate and the inflation rate. Currently inflation in Spain and Italy is running near zero, which means that the nominal interest rates of above 7 percent translate into real interest rates above 7 percent.
By contrast, inflation in both countries averaged more than 5 percent for the first half of the 1990s. This means that a nominal interest rate of 8 percent would have translated into a real interest rate of around 3 percent.
If Germany has people in positions of responsibility who do not understand the concept of the real interest rate it would be very scary. That would be worthy of a major front page story.
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The Post did readers a great service in providing another example of how the government makes rich people rich. The article is about how a set of drugs intended to anemia, turned out to be both ineffective and potentially harmful.
The two companies that had government-granted patent monopolies on these drugs, Amgen and Johnson & Johnson, gained tens of billions of revenue from these drugs over the last two decades. The article points out that they attempted to conceal evidence that their drugs could be harmful and used their political connections to get politicians to lobby the Food and Drug Administration on their behalf. They also designed a payments system that effectively paid off doctors to use large amounts of their drugs.
This is exactly the sort of corruption that economic theory predicts will result when the government puts an artificial barrier in the market (i.e. a patent monopoly) that allows companies to sell a product at hundreds or even thousands of times their cost of production. It might have been useful if the Post had included the views of an economist who could explain this point to readers.
The Post did readers a great service in providing another example of how the government makes rich people rich. The article is about how a set of drugs intended to anemia, turned out to be both ineffective and potentially harmful.
The two companies that had government-granted patent monopolies on these drugs, Amgen and Johnson & Johnson, gained tens of billions of revenue from these drugs over the last two decades. The article points out that they attempted to conceal evidence that their drugs could be harmful and used their political connections to get politicians to lobby the Food and Drug Administration on their behalf. They also designed a payments system that effectively paid off doctors to use large amounts of their drugs.
This is exactly the sort of corruption that economic theory predicts will result when the government puts an artificial barrier in the market (i.e. a patent monopoly) that allows companies to sell a product at hundreds or even thousands of times their cost of production. It might have been useful if the Post had included the views of an economist who could explain this point to readers.
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Morning Edition had a segment on a change in public pension fund accounting that will show many funds have a much larger shortfall. The piece included comments from a Stanford business school professor, Joshua Rauh, that complained that the discount rate assumed by pension funds assumed that future pension fund returns will be like past returns.
Rauh’s statement to this effect is inaccurate, or at least incomplete. The main question mark in pension fund returns is the return on stock, which typically accounts for 60-70 percent of pension fund assets. While stock returns can fluctuate hugely year to year, over the long-term (like the 30-year time horizon of most pension funds) they are a relatively predictable function of current price to earnings ratios and the rate of growth of the economy.
Given current price to earnings ratios in the market, it would require an unprecedented economic collapse for the market to yield substantially lower returns than what pension funds are now assuming. Ruling out a complete economic collapse might be assuming that the future will be like the past, but this sort of extrapolation is pretty much impossible to avoid.
The piece also wrongly implied that the Governmental Accounting Standards Board (GASB) agreed with Rauh’s assessment in its proposed changes to accounting standards. This is not true. A pension fund that is fully funded using the 8.0 percent discount rate that Rauh criticized would not see any change in its funding status under the new GASB rules. Only pensions that are underfunded by the old accounting standard that would see a change in their calculated level of funding.
Morning Edition had a segment on a change in public pension fund accounting that will show many funds have a much larger shortfall. The piece included comments from a Stanford business school professor, Joshua Rauh, that complained that the discount rate assumed by pension funds assumed that future pension fund returns will be like past returns.
Rauh’s statement to this effect is inaccurate, or at least incomplete. The main question mark in pension fund returns is the return on stock, which typically accounts for 60-70 percent of pension fund assets. While stock returns can fluctuate hugely year to year, over the long-term (like the 30-year time horizon of most pension funds) they are a relatively predictable function of current price to earnings ratios and the rate of growth of the economy.
Given current price to earnings ratios in the market, it would require an unprecedented economic collapse for the market to yield substantially lower returns than what pension funds are now assuming. Ruling out a complete economic collapse might be assuming that the future will be like the past, but this sort of extrapolation is pretty much impossible to avoid.
The piece also wrongly implied that the Governmental Accounting Standards Board (GASB) agreed with Rauh’s assessment in its proposed changes to accounting standards. This is not true. A pension fund that is fully funded using the 8.0 percent discount rate that Rauh criticized would not see any change in its funding status under the new GASB rules. Only pensions that are underfunded by the old accounting standard that would see a change in their calculated level of funding.
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If one of the major party presidential candidates started to claim that the sun orbits the earth, reporters would suddenly treat the issue as a matter of debate. We would be told that candidate X claims that the sun goes around the earth, however candidate Y maintains that the earth actually circles the sun.
That is the conclusion that one would get from an ABC news piece that discussed Governor Romney’s proposal to replace the existing Medicare system with a voucher system. This would in fact raise the costs of providing Medicare equivalent policies. This is a conclusion that the Congressional Budget Office reached based on years of studying both the operation of private plans within Medicare, under the Medicare Plus Choice system and the Medicare Advantage system, and the operation of the huge private insurance market outside of Medicare.
In this context, President Obama’s assertion that Romney’s plan would leave seniors unable to afford traditional Medicare is not just an empty claim. It is a fact.
Responsible reporting would inform audiences of the evidence on this issue, and not leave it as a he said/she said. Reporters have the time to investigate the truth of the candidates competing claims. Their audiences do not.
[Thanks to Robert Salzberg for the lead.]
If one of the major party presidential candidates started to claim that the sun orbits the earth, reporters would suddenly treat the issue as a matter of debate. We would be told that candidate X claims that the sun goes around the earth, however candidate Y maintains that the earth actually circles the sun.
That is the conclusion that one would get from an ABC news piece that discussed Governor Romney’s proposal to replace the existing Medicare system with a voucher system. This would in fact raise the costs of providing Medicare equivalent policies. This is a conclusion that the Congressional Budget Office reached based on years of studying both the operation of private plans within Medicare, under the Medicare Plus Choice system and the Medicare Advantage system, and the operation of the huge private insurance market outside of Medicare.
In this context, President Obama’s assertion that Romney’s plan would leave seniors unable to afford traditional Medicare is not just an empty claim. It is a fact.
Responsible reporting would inform audiences of the evidence on this issue, and not leave it as a he said/she said. Reporters have the time to investigate the truth of the candidates competing claims. Their audiences do not.
[Thanks to Robert Salzberg for the lead.]
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Actually, he just gives the right-wing caricature of the left, telling readers:
“The argument between left and right is about what you do beyond infrastructure. It’s about transfer payments and redistributionist taxation, about geometrically expanding entitlements, about tax breaks and subsidies to induce actions pleasing to central planners.”
The real difference is not over government intervvention in the market. The right actually supports massive government interventions in the economy. For example, government granted patent monopolies on prescription drugs will transfer more than $4 trillion from consumers to drug makers over the next decade compared to a free market.
The right also supports having the Federal Reserve Board deliberately raise unemployment to put downward pressure on the wages of ordinary workers and thereby keep inflation low. And, it supports having trade agreements that put manufacturing workers in direct competition with low-paid workers in the developing world, while leaving highly paid professionals like doctors and lawyers largely protected. This has the predicted and actual effect of redistributing income upward.
The real argument between left and right has little to do with government intervention in the market. The real issue is whether the goal is to steer the economy in a direction that will allow the benefits of growth to be broadly shared or whether to structure the economy in a way that directs income upward.
Actually, he just gives the right-wing caricature of the left, telling readers:
“The argument between left and right is about what you do beyond infrastructure. It’s about transfer payments and redistributionist taxation, about geometrically expanding entitlements, about tax breaks and subsidies to induce actions pleasing to central planners.”
The real difference is not over government intervvention in the market. The right actually supports massive government interventions in the economy. For example, government granted patent monopolies on prescription drugs will transfer more than $4 trillion from consumers to drug makers over the next decade compared to a free market.
The right also supports having the Federal Reserve Board deliberately raise unemployment to put downward pressure on the wages of ordinary workers and thereby keep inflation low. And, it supports having trade agreements that put manufacturing workers in direct competition with low-paid workers in the developing world, while leaving highly paid professionals like doctors and lawyers largely protected. This has the predicted and actual effect of redistributing income upward.
The real argument between left and right has little to do with government intervention in the market. The real issue is whether the goal is to steer the economy in a direction that will allow the benefits of growth to be broadly shared or whether to structure the economy in a way that directs income upward.
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Matt Yglesias notes the housing bubble in Canada and then asks what the Canadian government could do about the bubble. His point is that it would be enormously unpopular if the government deliberately took steps to burst the bubble.
This is of course true and it is one reason why the government should have acted years earlier to prevent the bubble from getting as large as it did. However there is another actor that doesn’t appear in Matt’s story, the Bank of Canada. The official story on central banks is that they are supposed to be independent so that they can do what is best for the economy without fear of the immediate political repercussions.
As a practical matter, central banks tend not to be independent of political influence, especially from the financial sector. However it is reasonable to ask why the central bank is not doing what it is supposed to do. Suppose the Bank of Canada announced a 1 percentage point increase in the overnight money rate and that it would continue to increase interest rates until house prices fell by 30 percent, or whatever amount it considered appropriate.
It is difficult to believe that this policy would not quickly deflate the bubble. This may not be pretty (if the bank had been awake it would have done this 5 years ago), but it would be better than letting the bubble just continue to grow. And what is the Bank doing that is more important, targeting 2.0 percent inflation?
Matt Yglesias notes the housing bubble in Canada and then asks what the Canadian government could do about the bubble. His point is that it would be enormously unpopular if the government deliberately took steps to burst the bubble.
This is of course true and it is one reason why the government should have acted years earlier to prevent the bubble from getting as large as it did. However there is another actor that doesn’t appear in Matt’s story, the Bank of Canada. The official story on central banks is that they are supposed to be independent so that they can do what is best for the economy without fear of the immediate political repercussions.
As a practical matter, central banks tend not to be independent of political influence, especially from the financial sector. However it is reasonable to ask why the central bank is not doing what it is supposed to do. Suppose the Bank of Canada announced a 1 percentage point increase in the overnight money rate and that it would continue to increase interest rates until house prices fell by 30 percent, or whatever amount it considered appropriate.
It is difficult to believe that this policy would not quickly deflate the bubble. This may not be pretty (if the bank had been awake it would have done this 5 years ago), but it would be better than letting the bubble just continue to grow. And what is the Bank doing that is more important, targeting 2.0 percent inflation?
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Simon Johnson has an interesting column discussing the Fed’s response to the rigging of the LIBOR rate. He refers to the memo that Treasury Secretary Timothy Geithner (then the head of the New York Fed) sent to the Bank of England in 2008 and notes evidence that the Fed knew of rigging as early as 2005. Johnson then cites comments from Fed Chairman Ben Bernanke that the Fed couldn’t do anything more than it did in calling the Bank of England’s attention to the problem.
This is known as the Incredible Hulk theory of public policy. Comic book fans everywhere know the story of the Incredible Hulk. He is the alter ego of mild-mannered scientist Bruce Banner. While ordinarily Dr. Banner is meek and retiring, when he gets angry he turns into the gigantic and powerful Incredible Hulk.
The United States government can be the Incredible Hulk at important moments. Certainly it was the Incredible Hulk that invaded Iraq. It is also the Incredible Hulk that engages in drone strikes around the world with little regard for the wishes of the governments of the countries in which the strikes take place.
The United States government as the Incredible Hulk also can also show up in the world of finance. After the September 11th attacks the United States demanded that European governments change their rules on bank secrecy in order to allow it to better track the financing of terrorist networks. The European governments quickly complied.
However the United States government can also be mild-mannered Bruce Banner, as was apparently the case with the LIBOR scandal. As noted, Federal Reserve Board Chairman Ben Bernanke told a congressional committee that the Fed had sent a memo to the appropriate officials at the Bank of England, and that was all it could do.
While Johnson sketches out how this was an enormous failure of the Fed in its responsibility to regulate U.S. banks and protect U.S. financial markets, it is also interesting to ask how the Incredible Hulk might have dealt with this problem. While it is unlikely that an invasion of the U.K. or drone strikes against the Bank of England would be necessary, there were some simple steps that Fed could have taken that would almost certainly have quickly brought an end to the rigging.
For example, if a month or two passed following the Geithner memo with no action, there could have been a follow up memo. This one would explain that the LIBOR is of fundamental importance to the U.S. since so many loans are tied to it. It would then demand action and explain that if no action is taken by a date certain (tough guy language), then the Fed would hold a press conference in which it would publicly disclose both its evidence of LIBOR rigging and its unsuccessful effort to get the Bank of England to clean up the cesspool.
I could be mistaken, but my guess is that such a memo would have prompted Mervyn King (the head of the Bank of England) to move very quickly to stop the rigging rather than risk public humiliation and dismissal from his position. Unfortunately, we had Bruce Banner at the Fed, so we will never know exactly what the response to stronger measures would have been.
Simon Johnson has an interesting column discussing the Fed’s response to the rigging of the LIBOR rate. He refers to the memo that Treasury Secretary Timothy Geithner (then the head of the New York Fed) sent to the Bank of England in 2008 and notes evidence that the Fed knew of rigging as early as 2005. Johnson then cites comments from Fed Chairman Ben Bernanke that the Fed couldn’t do anything more than it did in calling the Bank of England’s attention to the problem.
This is known as the Incredible Hulk theory of public policy. Comic book fans everywhere know the story of the Incredible Hulk. He is the alter ego of mild-mannered scientist Bruce Banner. While ordinarily Dr. Banner is meek and retiring, when he gets angry he turns into the gigantic and powerful Incredible Hulk.
The United States government can be the Incredible Hulk at important moments. Certainly it was the Incredible Hulk that invaded Iraq. It is also the Incredible Hulk that engages in drone strikes around the world with little regard for the wishes of the governments of the countries in which the strikes take place.
The United States government as the Incredible Hulk also can also show up in the world of finance. After the September 11th attacks the United States demanded that European governments change their rules on bank secrecy in order to allow it to better track the financing of terrorist networks. The European governments quickly complied.
However the United States government can also be mild-mannered Bruce Banner, as was apparently the case with the LIBOR scandal. As noted, Federal Reserve Board Chairman Ben Bernanke told a congressional committee that the Fed had sent a memo to the appropriate officials at the Bank of England, and that was all it could do.
While Johnson sketches out how this was an enormous failure of the Fed in its responsibility to regulate U.S. banks and protect U.S. financial markets, it is also interesting to ask how the Incredible Hulk might have dealt with this problem. While it is unlikely that an invasion of the U.K. or drone strikes against the Bank of England would be necessary, there were some simple steps that Fed could have taken that would almost certainly have quickly brought an end to the rigging.
For example, if a month or two passed following the Geithner memo with no action, there could have been a follow up memo. This one would explain that the LIBOR is of fundamental importance to the U.S. since so many loans are tied to it. It would then demand action and explain that if no action is taken by a date certain (tough guy language), then the Fed would hold a press conference in which it would publicly disclose both its evidence of LIBOR rigging and its unsuccessful effort to get the Bank of England to clean up the cesspool.
I could be mistaken, but my guess is that such a memo would have prompted Mervyn King (the head of the Bank of England) to move very quickly to stop the rigging rather than risk public humiliation and dismissal from his position. Unfortunately, we had Bruce Banner at the Fed, so we will never know exactly what the response to stronger measures would have been.
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