A big part of the story of the housing bubble is that the bond rating agencies were willing to give issuers of mortgage-backed securities collaterized debt obligations investment grade ratings even when they were clearly junk. The explanation was that the rating agencies were being paid by the issuers, therefore they had an enormous incentive to bend their ratings. If they rated these issues honestly, they would lose their business.
The conflict of interest in this “issuer pays” system has been widely noted. Unfortunately it has prompted mostly strange genuflecting rather than serious thinking. The obvious way to fix the conflict is to take away the hiring decision from the issuer. The issuer would still pay the rating agency but a neutral party — the SEC, the stock exchange on which the company is listed, the local baseball team — would make the decision as to which agency gets hired.
Some of us have been pushing this one for a while (e.g. here and also Plunder and Blunder), but Congress has preferred much more complex regulations that would have no impact on the basic conflict of interest. However, Paul Krugman comes to the rescue in his column today. Maybe now someone in Congress will be able to think clearly on this issue.
A big part of the story of the housing bubble is that the bond rating agencies were willing to give issuers of mortgage-backed securities collaterized debt obligations investment grade ratings even when they were clearly junk. The explanation was that the rating agencies were being paid by the issuers, therefore they had an enormous incentive to bend their ratings. If they rated these issues honestly, they would lose their business.
The conflict of interest in this “issuer pays” system has been widely noted. Unfortunately it has prompted mostly strange genuflecting rather than serious thinking. The obvious way to fix the conflict is to take away the hiring decision from the issuer. The issuer would still pay the rating agency but a neutral party — the SEC, the stock exchange on which the company is listed, the local baseball team — would make the decision as to which agency gets hired.
Some of us have been pushing this one for a while (e.g. here and also Plunder and Blunder), but Congress has preferred much more complex regulations that would have no impact on the basic conflict of interest. However, Paul Krugman comes to the rescue in his column today. Maybe now someone in Congress will be able to think clearly on this issue.
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The Washington Post’s most widely cited source on the housing market during the run-up of the housing bubble was David Lereah, the chief economist of the National Association of Realtors, and the author of Why the Housing Boom Will Not Bust and How You Can Profit From It. In many articles, Lereah was the only expert cited. This was ungodly bad reporting.
Today’s paper has a front page story, the main point of which appears to be that Goldman Sachs made bets against the housing market and stood to profit from the collapse of the bubble. (The story actually leaves this conclusion in question.) It’s not clear what in this story would be newsworthy and especially what would make it front page news.
If Goldman did bet against the housing bubble, then its actions were helping to bring the bubble to an end before it caused even further damage to the U.S. economy. Goldman’s actions would have the effect of making homes more affordable for new buyers. It would also help to increase the national saving rate (a top Washington post priority), by eliminating bubble generated wealth that was spurring consumption. In short, while Goldman’s actions were undoubtedly taken for profit, they would be beneficial to the economy as a whole.
Goldman has been accused by the Securities and Exchange Commission of misrepresenting its issues of collaterized debt obligations in order to get investors to take the long-end of the housing market. This is a serious accusation and presents the possibility of substantial civil, if not criminal penalties. However, there is nothing at all improper about placing a bet against a bubble in the market. It is not clear what the Post thought to be the news in this story.
The Washington Post’s most widely cited source on the housing market during the run-up of the housing bubble was David Lereah, the chief economist of the National Association of Realtors, and the author of Why the Housing Boom Will Not Bust and How You Can Profit From It. In many articles, Lereah was the only expert cited. This was ungodly bad reporting.
Today’s paper has a front page story, the main point of which appears to be that Goldman Sachs made bets against the housing market and stood to profit from the collapse of the bubble. (The story actually leaves this conclusion in question.) It’s not clear what in this story would be newsworthy and especially what would make it front page news.
If Goldman did bet against the housing bubble, then its actions were helping to bring the bubble to an end before it caused even further damage to the U.S. economy. Goldman’s actions would have the effect of making homes more affordable for new buyers. It would also help to increase the national saving rate (a top Washington post priority), by eliminating bubble generated wealth that was spurring consumption. In short, while Goldman’s actions were undoubtedly taken for profit, they would be beneficial to the economy as a whole.
Goldman has been accused by the Securities and Exchange Commission of misrepresenting its issues of collaterized debt obligations in order to get investors to take the long-end of the housing market. This is a serious accusation and presents the possibility of substantial civil, if not criminal penalties. However, there is nothing at all improper about placing a bet against a bubble in the market. It is not clear what the Post thought to be the news in this story.
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This piece includes the information that the national debt “totaled $8,370,635,856,604.98 as of a few days ago.” Boys and girls are you impressed by that big number? Are you scared yet? This is Fox on 15th here — they’ll keep trying.
This sentence continues by telling readers that this number is not “even counting the trillions owed by the government to Social Security and other pilfered trust funds.” How did the author determine that the trust funds were “pilfered.” The government didn’t do what he wanted it to with the money? Wow, that gives a reporter the right to say the money was “pilfered.” Apparently it does at the Post.
The article does not include the views of any experts who do not view the debt as a serious problem. It presents an inaccurate assertion (in the context presented) from Brookings economist Bill Gale that the debt: “This [running up the debt] is all an exercise in current generations shifting burdens on future generations.”Actually, the debt being run up at present is helping future generations by keeping their parents employed, improving the infrastructure and providing them with a better education. There is little or no real burden associated with this debt since much of the debt being issued is held by the Fed. The interest on these bonds is therefore paid to the Fed, which in turn refunds the money to the government.
Last week, the NYT reported that the Fed paid more than $47 billion in interest to the government. So, where is the burden on our children? If we do get the economy back to normal levels of output the deficit will be at a manageable level. Over the long-term, if we don’t fix the health care system, we will face serious budget problems, but this is an argument about the need to fix our health care system, not about the deficit.
This piece includes the information that the national debt “totaled $8,370,635,856,604.98 as of a few days ago.” Boys and girls are you impressed by that big number? Are you scared yet? This is Fox on 15th here — they’ll keep trying.
This sentence continues by telling readers that this number is not “even counting the trillions owed by the government to Social Security and other pilfered trust funds.” How did the author determine that the trust funds were “pilfered.” The government didn’t do what he wanted it to with the money? Wow, that gives a reporter the right to say the money was “pilfered.” Apparently it does at the Post.
The article does not include the views of any experts who do not view the debt as a serious problem. It presents an inaccurate assertion (in the context presented) from Brookings economist Bill Gale that the debt: “This [running up the debt] is all an exercise in current generations shifting burdens on future generations.”Actually, the debt being run up at present is helping future generations by keeping their parents employed, improving the infrastructure and providing them with a better education. There is little or no real burden associated with this debt since much of the debt being issued is held by the Fed. The interest on these bonds is therefore paid to the Fed, which in turn refunds the money to the government.
Last week, the NYT reported that the Fed paid more than $47 billion in interest to the government. So, where is the burden on our children? If we do get the economy back to normal levels of output the deficit will be at a manageable level. Over the long-term, if we don’t fix the health care system, we will face serious budget problems, but this is an argument about the need to fix our health care system, not about the deficit.
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Actually, that is not what the Post said about the implications of Greece defaulting on its debt. A front page story told readers:
“A default in Greece could also ripple across the Atlantic, hitting banks and pension funds holding Greek bonds and heightening investor worries about the national debt of the United States”
Yes, it “could” have this effect, just like it could lead to a run on calamari and lamb as people read about Greece in the newspapers and get the urge to eat calamri and lamb. But, that is not likely to happen. To date, as has been reported in the Post and elsewhere, the prospect of a default by Greece has been associated with the opposite reaction: a flight to the dollar as a safe haven, which has meant lower interest rates.
It is of course the Post’s editorial to promote concerns about the U.S. debt and deficit. Most newspapers try to keep a separation between their news pages and their editorial pages.
Actually, that is not what the Post said about the implications of Greece defaulting on its debt. A front page story told readers:
“A default in Greece could also ripple across the Atlantic, hitting banks and pension funds holding Greek bonds and heightening investor worries about the national debt of the United States”
Yes, it “could” have this effect, just like it could lead to a run on calamari and lamb as people read about Greece in the newspapers and get the urge to eat calamri and lamb. But, that is not likely to happen. To date, as has been reported in the Post and elsewhere, the prospect of a default by Greece has been associated with the opposite reaction: a flight to the dollar as a safe haven, which has meant lower interest rates.
It is of course the Post’s editorial to promote concerns about the U.S. debt and deficit. Most newspapers try to keep a separation between their news pages and their editorial pages.
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That’s what the Washington Post told readers this morning. This claim would news to hundreds of millions of people around the developing world. Back in the 90s the IMF came to be known as the “Typhoid Mary” of emerging markets as its policy prescriptions led to sharp economic downturns in one country after another. It tried to impose a harsh austerity plan on Argentina in 2001 and did everything it could to sabotage its economy when the country refused to go along. Its sabotage effort included economic growth projections that were likely politically motivated, since they consistently under-projected growth. This would have the effect of scaring away potential efforts. By contrast, the IMF consistently over-projected Argentina’s growth in the years when it was following policies recommended by the IMF.
The theme of the article is that people in wealthy countries will have to accept lower living standards, as indicated by its headline: “for nations living good life, the party is over, IMF says.” Of course, nations don’t live the good life, individuals within nations do. In the United States, and to a lesser extent, most other wealthy countries, the last three decades have been marked by an upward redistribution of income. This has led to a situation in which most of the gains from growth have gone to those at the top end of the income distribution. This would suggest policies that focused on cutting back on their good life, for example a financial transaction tax or the financial activities tax (FAT) that was proposed by the IMF last week. This would cutback on the high incomes of Wall Street’s “top performers” while leaving most of the rest of the country largely unaffected.
The distributional issue is also important in the context of one of the other policies highlighted by the IMF: reducing the value of the dollar against the yuan and other currencies. This will raise the price of imports and in that way lower living standards in aggregate. However, by making U.S. manufacturing more competitive, it will increase the demand for manufacturing workers, allowing many workers without college degrees to get relatively high-paying jobs. This is likely to lead to an improvement in living standards even if these workers have to pay somewhat more for imported goods. (Imagine a worker can get paid $20 in auto factory instead of $10 working in a convenience store. They will be much better off even if they have topay 20 percent more for their clothes, shoes, and toys.)
Finally, this article includes an assertion that the United States might need: “roughly $1.4 trillion annually, to be cut from government programs or raised through new taxes.” There is no remotely plausible story that would give a number even half this large. This is the size of the government’s current budget deficit. More than half of this shortfall is attributable to the fact that the economy is operating well below full employment. If the country were at normal levels of output, the current deficit would be less than 5 percent of GDP.
And, there is no reason that the country must balance its budget. Deficits equal to 2-3 percent of GDP are consistent with a stable or declining debt to GDP ratio. This means that the adjustment needed to get the budget on a stable fiscal footing are likely less than one-quarter of what is implied by this Post article. Furthermore, much of this gap can be made up simply by allowing freer trade in medical services.
That’s what the Washington Post told readers this morning. This claim would news to hundreds of millions of people around the developing world. Back in the 90s the IMF came to be known as the “Typhoid Mary” of emerging markets as its policy prescriptions led to sharp economic downturns in one country after another. It tried to impose a harsh austerity plan on Argentina in 2001 and did everything it could to sabotage its economy when the country refused to go along. Its sabotage effort included economic growth projections that were likely politically motivated, since they consistently under-projected growth. This would have the effect of scaring away potential efforts. By contrast, the IMF consistently over-projected Argentina’s growth in the years when it was following policies recommended by the IMF.
The theme of the article is that people in wealthy countries will have to accept lower living standards, as indicated by its headline: “for nations living good life, the party is over, IMF says.” Of course, nations don’t live the good life, individuals within nations do. In the United States, and to a lesser extent, most other wealthy countries, the last three decades have been marked by an upward redistribution of income. This has led to a situation in which most of the gains from growth have gone to those at the top end of the income distribution. This would suggest policies that focused on cutting back on their good life, for example a financial transaction tax or the financial activities tax (FAT) that was proposed by the IMF last week. This would cutback on the high incomes of Wall Street’s “top performers” while leaving most of the rest of the country largely unaffected.
The distributional issue is also important in the context of one of the other policies highlighted by the IMF: reducing the value of the dollar against the yuan and other currencies. This will raise the price of imports and in that way lower living standards in aggregate. However, by making U.S. manufacturing more competitive, it will increase the demand for manufacturing workers, allowing many workers without college degrees to get relatively high-paying jobs. This is likely to lead to an improvement in living standards even if these workers have to pay somewhat more for imported goods. (Imagine a worker can get paid $20 in auto factory instead of $10 working in a convenience store. They will be much better off even if they have topay 20 percent more for their clothes, shoes, and toys.)
Finally, this article includes an assertion that the United States might need: “roughly $1.4 trillion annually, to be cut from government programs or raised through new taxes.” There is no remotely plausible story that would give a number even half this large. This is the size of the government’s current budget deficit. More than half of this shortfall is attributable to the fact that the economy is operating well below full employment. If the country were at normal levels of output, the current deficit would be less than 5 percent of GDP.
And, there is no reason that the country must balance its budget. Deficits equal to 2-3 percent of GDP are consistent with a stable or declining debt to GDP ratio. This means that the adjustment needed to get the budget on a stable fiscal footing are likely less than one-quarter of what is implied by this Post article. Furthermore, much of this gap can be made up simply by allowing freer trade in medical services.
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The NYT reported on how the Senate’s Permanent Subcommittee on Investigations was struggling to find ways to remove the inherent conflict of interest that arises when a bond rating agency is paid by the company for whom it is doing the rating. Actually, there is no need for much struggle here. If the selection of the rating agency was assigned to a neutral party, like the Securities and Exchange Commission or the stock exchange on which the company is listed, then the agency would have no incentive to tilt its report in favor of the company. It would have been appropriate to point out that there is a simple and obvious solution to this problem, but that that the Senate for some reason is not interested in pursuing it.
The NYT reported on how the Senate’s Permanent Subcommittee on Investigations was struggling to find ways to remove the inherent conflict of interest that arises when a bond rating agency is paid by the company for whom it is doing the rating. Actually, there is no need for much struggle here. If the selection of the rating agency was assigned to a neutral party, like the Securities and Exchange Commission or the stock exchange on which the company is listed, then the agency would have no incentive to tilt its report in favor of the company. It would have been appropriate to point out that there is a simple and obvious solution to this problem, but that that the Senate for some reason is not interested in pursuing it.
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That’s what readers of a Washington Post article on the possibility of a default by Greece might be wondering. The Post told readers that:
“Other large nations, including the United States, that carry increasing levels of debt have worried that the Greek crisis could be a small-scale sketch of their own future. Sovereign debt is coming under increasing scrutiny by global markets, and many analysts fear that U.S. government bonds are not as attractive as they once were?
Of course “nations” cannot worry, only individuals within nations can worry, but the Post doesn’t identify any who do. Nor does it identify the “analysts” who are finding U.S. government bonds less attractive. These analsysts are apparently offset by analysts who continue to view U.S. government debt as a very attractive asset since the yields on U.S. government bonds remain extremely low.
If there was an interest in making comparisons to Greece it would have been useful to remind readers that the United States government, unlike the Greek government, can print as much money as it wants to finance its debt during a period of economic weakness like the present. It also has a large diversified economy which is still largely self-sufficient, unlike Greece.
These differences make the comparisons to Greece highly inappropriate. While there may be people who make these comparisons as the Post claims, these unnamed individuals probably have little knowledge of economics.
That’s what readers of a Washington Post article on the possibility of a default by Greece might be wondering. The Post told readers that:
“Other large nations, including the United States, that carry increasing levels of debt have worried that the Greek crisis could be a small-scale sketch of their own future. Sovereign debt is coming under increasing scrutiny by global markets, and many analysts fear that U.S. government bonds are not as attractive as they once were?
Of course “nations” cannot worry, only individuals within nations can worry, but the Post doesn’t identify any who do. Nor does it identify the “analysts” who are finding U.S. government bonds less attractive. These analsysts are apparently offset by analysts who continue to view U.S. government debt as a very attractive asset since the yields on U.S. government bonds remain extremely low.
If there was an interest in making comparisons to Greece it would have been useful to remind readers that the United States government, unlike the Greek government, can print as much money as it wants to finance its debt during a period of economic weakness like the present. It also has a large diversified economy which is still largely self-sufficient, unlike Greece.
These differences make the comparisons to Greece highly inappropriate. While there may be people who make these comparisons as the Post claims, these unnamed individuals probably have little knowledge of economics.
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It would have been reasonable to include some discussion of the economic impact of Senator Kent Conrad’s plans to cut the budget deficit below the levels targeted by President Obama. The Post reports on the political implications of the budget committee’s vote on a package that reduces the defiicit below the levels in President Obama’s budget with additional cuts beginning in October, at point at which the unemployment rate is still likely to be close to 10.0 percent.
It would have been reasonable to include some discussion of the economic impact of Senator Kent Conrad’s plans to cut the budget deficit below the levels targeted by President Obama. The Post reports on the political implications of the budget committee’s vote on a package that reduces the defiicit below the levels in President Obama’s budget with additional cuts beginning in October, at point at which the unemployment rate is still likely to be close to 10.0 percent.
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It seems that they don’t. The Labor Department reported that there were 456,000 new claims for unemployment insurance benefits last week. The 4-week moving average was 460,250. Generally the economy will not be generating jobs if claims exceed 400,000. In the first 8 months of 2008, when the recession had already begun but before the financial crisis, claims averaged around 370,000 a week.
It seems that they don’t. The Labor Department reported that there were 456,000 new claims for unemployment insurance benefits last week. The 4-week moving average was 460,250. Generally the economy will not be generating jobs if claims exceed 400,000. In the first 8 months of 2008, when the recession had already begun but before the financial crisis, claims averaged around 370,000 a week.
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ProPublica has a good piece on the dealings of Magnetar, one of the hedge funds that shorted the housing market, while at the same time taking a long position that it used to finance its short position. While the piece involves solid investigative reporting, it is more than a little oversold. The piece begins:
“In late 2005, the booming U.S. housing market seemed to be slowing. The Federal Reserve had begun raising interest rates. Subprime mortgage company shares were falling. Investors began to balk at buying complex mortgage securities. The housing bubble, which had propelled a historic growth in home prices, seemed poised to deflate. And if it had, the great financial crisis of 2008, which produced the Great Recession of 2008-09, might have come sooner and been less severe.”
According to the article, Magnetar raised a total of $40 billion. This is equal to roughly 0.2 percent of the $20 trillion value of the housing market at the time. Did Magnetar’s long investments help to prop up the market? Probably a bit, but it’s hard to see it going too far. Furthermore, by last 2005 the bubble was already pretty close to its peak (that came in the summer of 2006), so it’s unlikely that they could have pushed prices much higher than they would have otherwise gone, although it may have slowed the process of the air leaving the bubble. (Actually, a full assessment of its impact would have to factor in its short positions, which would have gone the other way.)
As a purely practical matter, business reporters like to focus on the financial crisis and blame it for the severity of the current downturn, but this really makes little sense. The financial crisis clearly sped things along, but is there any reason to believe that house prices would be higher today in the absence of the crisis. (I’m betting they will fall another 15-20 percent in real terms.) If house prices would be at current levels, is there any reason to believe that consumers would be spending more absent the crisis, that businesses would be investing more, that builders would be putting up more homes or malls? I see zero evidence on any of these fronts, hence I don’t attribute the severity of the downturn to the financial crisis. But, I’m open to persuasion.
ProPublica has a good piece on the dealings of Magnetar, one of the hedge funds that shorted the housing market, while at the same time taking a long position that it used to finance its short position. While the piece involves solid investigative reporting, it is more than a little oversold. The piece begins:
“In late 2005, the booming U.S. housing market seemed to be slowing. The Federal Reserve had begun raising interest rates. Subprime mortgage company shares were falling. Investors began to balk at buying complex mortgage securities. The housing bubble, which had propelled a historic growth in home prices, seemed poised to deflate. And if it had, the great financial crisis of 2008, which produced the Great Recession of 2008-09, might have come sooner and been less severe.”
According to the article, Magnetar raised a total of $40 billion. This is equal to roughly 0.2 percent of the $20 trillion value of the housing market at the time. Did Magnetar’s long investments help to prop up the market? Probably a bit, but it’s hard to see it going too far. Furthermore, by last 2005 the bubble was already pretty close to its peak (that came in the summer of 2006), so it’s unlikely that they could have pushed prices much higher than they would have otherwise gone, although it may have slowed the process of the air leaving the bubble. (Actually, a full assessment of its impact would have to factor in its short positions, which would have gone the other way.)
As a purely practical matter, business reporters like to focus on the financial crisis and blame it for the severity of the current downturn, but this really makes little sense. The financial crisis clearly sped things along, but is there any reason to believe that house prices would be higher today in the absence of the crisis. (I’m betting they will fall another 15-20 percent in real terms.) If house prices would be at current levels, is there any reason to believe that consumers would be spending more absent the crisis, that businesses would be investing more, that builders would be putting up more homes or malls? I see zero evidence on any of these fronts, hence I don’t attribute the severity of the downturn to the financial crisis. But, I’m open to persuasion.
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