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Tuesday, January 26, 2010

Transcript: 350 Joseph Stiglitz and Nell Minow on Financial Industry compensation distorts the economy

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Today we have Marc Faber and Steven Roach courtesy of Geoff Cutmore and CNBC's Squawk Box, but also testimony from Joseph Stiglitz and Nell Minow on compensation in the financial industry courtesy of Chairman Barney Frank and the House Financial Services Committee.  We also take a couple of exceptions to Steve Keen and Hyman Minsky.

First a note on some of the newest housing data.

The Atlanta Fed says the agency MBS purchase program nears its goal of $1.25 trillion.  Thirteen months after its inception, the Fed has purchased over $1.1 trillion in mortgage backed securities.  The wind-down of these purchases causes concern in the housing market that it will put upward pressure on interest rates and stall out whatever housing recovery was in prospect.

Most importantly for the economy, we think at Demand Side, some homeowners were able to refinance and lower monthly payments.  The housing collapse is still in progress, and the effort by the Fed was a fool's errand in that regard.  Now it looks forward to $1.25 trillion in securities in a market where it was the only buyer.  What is the exit strategy for the nation's central bank?

Existing home sales collapsed by nearly 17 percent in December.  The false alarm on the expiration of the first-time homebuyers tax credit encouraged a boom in existing sales in November and put more debt into the economy.  The extension of the credit did not extend the boom.

And the New York Times and Wall Street Journal report that Tishman Speyer Properties and BlackRock Realty have turned the immense Stuyvesant Town and Peter Cooper Village over to their creditors.  A strategic default, if you will, of a property encompassing 56 buildings and 11,000 units which was acquired for $5.4 billioin in 2006.  Some accounts put the current value at $1.6 billion.  Equity investors like the California Public Employees' Retirement System, a Florida pension fund and the Church of England, as well as many debtholders, including the government of Singapore Investment Corporation and Hartford Financial Services Group are seeing their investments wiped out.

Now directly to the House Financial Services Committee and its hearing on financial sector compensation practices with the opening statements of witnesses Joseph Stiglitz, the eminent economist, here with Nell Minow, founder and editor of the Corporate Library.


Joseph Stiglitz and Nell Minow

And to end, from Squawk Box, an exchange between Marc Faber, Geoff Cutmore and Steven Roach, head of Morgan Stanley Asia.


Steven Roach with the notorious investor Marc Faber.

Now, reluctantly supplying some of our own content.

Over the past several months we've exposed our listeners to Hyman Minsky and one of his most able students Steve Keen.  Now we would like to expose what we believe to be two aspects not fully appreciated by these two.

The models of both Minsky and Keen and others have not yet incorporated the dynamic contribution of public goods.  Nor have they addressed sufficiently the role of energy prices, particularly oil.

Government is seen by almost every economist as a consumer, employer, regulator and source of uncertainty, but rarely except anecdotally as a contributor to growth.  Yet education, infrastruture, pbulic safety, legal structures and more are the products of govenrment without which private business, workers and consumers cannot function efficiently, or in some cases at all.  These are the public goods, financed ultimately by taxation.  Taxes are the way we purchase public goods.  it is not from an absence of value that these are ignored, but the fact that they have no market value.  By their nature, being not excludable and not depletable -- to a greater or lesser degree -- public goods are not effectively produced by private businesses nor effectively valued by economists.

It is precisely because the U.S. has skimped on public goods that it finds its economy in stagnation and decline.  Rather than buy the productive assets of roads and education, a "taxes are theft" mentality shifted investment to nonproductive residential housing, speculative activity in financial markets and military adventures.  This at the expense of true public goods.

Take the example of a road.  A public good.  Except in relatively few toll roads, it is not excludable.  Anyone can use it.  Freight is delivered, workers transported, all manner of activities happen with a road that do not happen without it and freely.  It is not depletable.  My using a road -- and realizing there are limits to everything -- does not preclude your using it.

Immense private financial benefit accompanies the construction of a road or bridge.  To perperty owners in newly accessible areas to transport activities that broaden markets or convenience to individuals.  These are real private gains that could be computed.

The same is true of education, where individuals, communities, employers and society at large all benefit from the successful education of citizens.

Taxes are viewed as theft.  In fact they simply finance the progress of the society.  If this were not true Somalia would be Sweden.  But in a very real measure, the higher the tax level, the more prosperous the citizenry.  This is not an observation that is refuted by anti-tax voices.  It is simply ignored.

Incorporating the value of public goods into one's way of thinking, whether that way is mathematical or narrative, is required to fill out one's understanding.  This has yet to be done.

Also not well acknowledged is the role of energy and anergy prices.

From the new and wonderful book by Joe Stiglitz, Freefall, we read,

"The burden on monetary policy was increased when oil prices started to soar after the invasion of Iraq in 2003.  The United States spent hundreds of billions of dollars importing oil -- money that otherwise would have gone to support the U.S. economy.  Oil prices rose from $32 a barrel in March 2003 when th Iraq war began to $137 per barrel in July 2008.   This meant that Americans were spending $1.4 billion per day to import oil (up from $292 million per day before the war started), instead of spending hte money at home.  Greenspan felt he could keep interest rates low because there was little inflationary pressure, and without hte housing bubble that the low interest rates csustained and the consumption boom that the housing bubble supported, the American economy wold have been weak."

Stiglitz main point is valid.  Though we correct the highest price from $137 to $147, and cite a oil and commodities bubble that began in the fall of 2007.  Stiglitz cites the Iraq war, but it was speculation turning from stocks and housing to commodities, assets believed to be inflation proof.  Ironically the oil and commodities bubble produced the inflation of the first part of 2008.

But the purchase of energy is correctly seen as a subtraction of support from the real U.S. economy.

Andrew Oswald of Warwick University observed that everything is composed of labor and energy.  When energy prices go up, the wage rate goes down.  Inflation has not been driven by wages for decades, but by the exogenous price of energy, particularly oil.  This is a commodity with an inelastic demand curve.  The Clinton years benefited as much from low oil prices as from policy choices.  Again oil induced inflation reduces real incomes and subtracts from demand.

It is no accident that the oil price shock of the first part of 2008 was followed by the severe economic contraction of the second part.   We do not dispute the primacy of the financial sector's incompetence, but we insist that oil prices have led all recessions in the past half century and absent inclusion of this phenomenon, ones view is incomplete.

Enough for today.

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