A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Thursday, November 28, 2013

Relay: Jonathan Weil with Arthur Levitt

Today a relay: Jonathan Weil as interviewed by Arthur Levitt. We're short of time this week, and possibly the next few, and we worry we're repeating ourselves, so today a break for both us us with a look inside the recovery air quotes on Wall Street.

Listen to this episode

Stock prices hit new highs, and to hear the sell side, it is due to ever better economic prospects. Lean and mean corporations are producing excellent earnings. Restabilized banks -- never mind the enormous fines for what are apparently not individual frauds, but some sort of accounting problems, since nobody is going to jail -- are back in the business of making money for their stockholders. The indomitable American entrepreneur is back in the innovation business.

In fact, zero interest rates and QE injections are funding stock buybacks and dividend sweeteners. The rentier is hiding in liquid assets and the entrepreneur -- aside from the fad of the week -- is not being getting in front of the impending climate crisis. Stock prices are evidence not of strength, but of the weakness of capitalism pointed out by John Maynard Keynes so many decades ago.

Here is a short description of the euthanasia of the rentier which Keynes advocated then. This from the University of Missouri - Kansas City.
Euthanasia of the Rentier

A rentier is an individual who lives on interest income (rent) received in compensation for the loan of property held in the form of money, not to be confused with landowners who receive rent paid for the loan of property in land.

Today the term refers generically to the owner of any debt obligation, public or private, paying periodic, annual or semi-annual, usually fixed amounts of interest over a long term.

Ricardo’s early 19th century position that landlords’ interests were inimical to industrial expansion was replaced in the 20th century by criticism of the rentier as a brake on the dynamics of capital accumulation. Individuals who derived income from neither labor nor productive capital investment were viewed as parasites living off the efforts of the laborer and the entrepreneur-capitalist.

Rentiers have also been criticized for actively discouraging economic and social change in defense of their vested interests in property rights and money contracts. As well as defending the right to interest income and accumulated wealth, the rentier has to defend the purchasing power of his interest income and the capital value of his wealth. Inflation is thus the first enemy of the rentier living on fixed interest payments, for it reduces the real purchasing power of current income. As a class, rentiers will thus favor conservative government policies to balance budgets and produce deflationary conditions even at the expense of economic growth and high levels of employment.

But Keynes’s theory focused instead on the advantages that rentiers would find in holding liquid assets rather than in financing employment-creating investment in periods where they felt threatened by uncertainty over the future value of their income and capital. In such conditions, employment-generating investment would have to compete with the rentiers’ preference for liquidity, creating rates of interest far in excess of what entrepreneurs could pay from the expected earnings of productive investment. Further, rentier preferences might be so strong as to render the monetary authority powerless to reduce interest rates to stimulate activity. Keynes thus advocated a policy of direct intervention through the socialization of investment, accompanied by low, stable rates of interest which would eventually eliminate the power of rentiers to hinder policies for full employment.
The Fed's policy is to placate and protect the rentier. The historical split between the moneyed interests and the real economy is emerging again.

Lean and mean corporations mean no job growth. Restabilized banks have just added another coat of chicanery to the old fragility. The investment -- private and public -- is stymied by entrenched interests.

Jonathan Weil is a journalist, contributor to Bloomberg, and somebody with a willingness -- like Gretchen Morgensen of the New York Times -- to look into the corrupt marchinery of the financial sector.


Saturday, November 23, 2013

Transcript: Inflation and Corruption

Today on the podcast, Inflation and Corruption

Here is the conventional conversation from Boomberg:


That's William Irving of Fidelity Investments, with Bloomberg's Tom Keen and Michael McKee.

No, Inflation is not the problem. Inflation is rarely the problem. It can be the symptom of a problem, however, and this one is serious. Low inflation is a symptom of stagnation, decline and dropping incomes.
Listen to this episode

Inflation is a rise in prices -- a general rise in prices. We often hear of specific sectors having inflation, health care inflation, house price inflation. Analysts across the globe get paid good money to tease out the different components of inflation.

For example, this month's drop quickly spawned the chart at the bottom of today's transcript which shows most of the drop due to energy prices, and a simultaneous bump in transportation costs -- probably airfares.

One useful thing to come out of the idea of inflation is the idea of "real" versus "nominal." "Real" means adjusted for price rises. So it is a relative term. Incomes are down for households relative to a basket of goods, for example. Or health care is up in "real terms." Bad example. Health care is way up in price terms, that is, relative to other goods and services. In GDP  it is measured in terms of inputs rather than outputs, and outcomes have not improved, arguably the rise in health care since the early 1990s is entirely inflation. A "Real" GDP would erode by, what, seven, eight percent?

Economic science is in Bavaria with Dr. Frankenstein creating a monster out of inanimate body parts when it comes to inflation. They have created an immense and destructive and demonic force and set it loose on the population when they give inflation a life of its own. Inflation is a general rise in prices. A price rise. Nothing will be captured and eaten or infected by inflation. Perhaps it feels like an evil conspiracy. Not when it is your own income that is rising, of course, but price rises need to be looked at directly, and price declines likewise. Where do they come from? Why are consumer prices falling? And so on. If we do not do this, and do not investigate honestly the price changes, and imagine there is a dragon of inflation to be slain, we will make mistakes. Paul Volcker proved that when in trying to kill inflation in the 1970's and early 1980's, he actually killed the economy. Or damaged it considerably, at least.

So long as incomes are not the price that is falling in relative terms, we are better off.

What is a healthy inflation? There IS such a thing. A healthy inflation is whatever it needs to be to accommodate full employment and rising real incomes.

A healthy inflation typically arises with investment, which employs workers in the investment goods sectors, building plant and equipment, structures, infrastructure, schools, and other non-consumer goods. Wages are bid up and demand for consumer goods is increased. Such inflations are short-term, although one may follow another with a new round of investment. Typically there are no wide swings. Short term, since production will expand to meet the new demand. Such healthy inflation has happened here in the U.S., but not since the end of the 1960's.

A deflation indicates no investment, no growth, declining employment. A deflation is one form of very unhealthy inflation. Existing debt contracts are more burdensome. All workers get concentrated in the consumer goods sectors. Wages decline.

There can be situations where the money itself loses its value because it is debased by the government and another money is used.

If we were to get investment, public or private, and with it, low unemployment, employers must often offer better deals to attract or retain the workers they need, sometimes substantially better deals. Incomes go up. If there is substantial investment, then there is a substantial number of workers not involved in producing consumer goods but getting incomes to bid for consumer goods. Price rises attract new entries or offerings, more investment, more wage pressure. Workers buy houses, more investment, more wage pressure. That is the nightmare scenario. Wouldn't it be nice?

If we ever get around to saving the planet for human habitation, part of the experience of paying for it will be a rise in relative prices for food and transportation. That would be healthy.

Of course, in an open economy the demand for consumer goods may be filled from outside the country. In such a case, in the standard theory, the extra demand would change the exchange rates so that trade was more or less balanced. That is, prices would rise just as in a closed economy. Not in the U.S., of course, which has run immense trade deficits for decades without materially changing the exchange rate. We've been net importers big time ever since the Reagan years. If the Saudis and the Chinese are going to take green paper for real stuff, we're going to let them. Keeps inflation down. Doesn't do much for employment, but hey, I have a job.

Inflation. Does it spiral out of control? No. It does not. Not investment led wage pressure inflation. Again, things get problematic when exchange rates get into the picture. PRICE RISES NEED TO BE LOOKED AT DIRECTLY AND INDIVIDUALLY.

Productivity, as we have pointed out, rises when employment is tight, mitigating wage pressure, as workers are shifted to the most productive activities, plants are used to capacity, innovation spreads, new tools -- capital -- is substituted for labor.

But as I said, we haven't had a healthy inflation for a long, long time, since the turn of the 1970's.

What have we had?

Two oil shocks in the 1970's, one under Nixon and one under Carter -- with the Iran oil embargo. OPEC set quotas, prices rose, other forms of energy -- electricity, natural gas, coal -- followed the oil price up. This mimicked the demand side inflation pretty well, since energy is the most ubiquitous economic commodity aside from labor. Let's call this energy price rise cost-push inflation.

As prices rose from the energy price spikes, workers demanded more in wages to compensate. This became known as the wage-price spiral. Workers were excoriated for their greed. Those without bargaining power saw their real incomes drop. The heavy guns were called in.

Early on, Richard Nixon established the wage-price freeze. A success in wartime, under Nixon in peacetime it was a failure. Long lines and short tempers at gas stations were broadcast by the yet-to-be-domesticated media as images of scarcity and desperation. The wages and prices that were successfully frozen simply waited until the freeze was lifted and shot up at once. Few of his advisers saw it as a success, and fewer still were on board for the second, and even less successful freeze. Inflation became the dragon, a powerful and evil force. Not just the impact of oil and energy prices that needed to be absorbed or somehow reduced.

The high energy prices hit producers, too, along with the bite out of consumer demand. The way some found to curb labor demands was to lay off workers. Meanwhile the uncertainty made people cautious. Rather than rush to the store before their money lost its value, people saved. In the face of the inflation goblin, the savings rate throughout the 70s rarely dropped below 10 percent. See the chart online.

Of course, savings were attracted to sweet interest rates offered by banks who needed the money, as well. Long-term financing at low rates was suddenly a loser. Banks scrambled to get short-term funding to retool. The financial community was up in arms. Then Paul Volcker listened to Milton Friedman and put the clamps on the money supply. "Inflation is always and everywhere a monetary phenomenon," said Friedman. To heck with this trying to deal with specific prices. Just reduce the quantity of money. Now long-term financing at low rates was REALLY a loser because interest rates took off for another level. Cocktail parties divided into clatches to twitter where the latest best certificate of deposit could be found. 16%? 20%? Not out of reach. Unemployment moved higher, Latin America defaulted, a ragged horde of homeless finally took the field and defeated inflation.

Which is to say, Volcker's interest rates dampened demand enough that oil prices backed off. When prices fell, more production came on line to keep up revenues to oil producers. Prices fell further. Interestingly, the Fed's control of the money supply fell victim to the credit card. Also, interestingly, the wave of deregulation began during this period, when Jimmy Carter's efforts to attack inflation proceeded along the theory that increased competition would drive down prices. Alfred Kahn, his inflation czar, sold the deregulation of airlines, and essentially raised the banner that would be taken up by Ronald Reagan and subsequent anti-government champions.

This period marked an inflection point in the growth trend, which bent to half its previous slope, as well as real household incomes. Personal income stagnated. Although Volcker was let go -- not re-hired -- by Reagan for his unwillingness to get with the program, and deregulator extraordinaire Alan Greenspan taken on, the Fed was always at the ready to raise interest rates should any inflation take off.

Looking back, we can see that raising interest rates into higher oil prices is not a recipe for killing inflation, but for killing the economy. Nevertheless, Greenspan repeated the exercise in late 1999 and early 2000. The failure to understand cost-push inflation, when cost shocks need to be absorbed, from demand pull inflation is one error that continues to plague economists today, with crippling consequences. Another is to think that inflation is a monetary phenomenon, in spite of the rude experience of the Volcker Monetarist experiment and the more recent absence of reaction to Fed easy money for the past five years.

That famous stagflation was used to evict Keynesian influence from public policy, except as expressed by Congressional Democrats. Inflation had not been accompanied by economic expansion and this was outside the norm and supposedly outside Keynesian thought. Thus ended the liberal period of economics, which had lasted from the New Deal. Alfred Kahn described himself as a liberal. Most economists did. Probably not the case today.  Another interesting note. Unions at the time negotiated the COLA, cost of living adjustment, which is still around, if in a dormant state. Business assured the nation that cost of living clauses would embed high inflation into the economy, essentially institutionalize the wage-price spiral. Didn't happen. Actually, such clauses soon became widespread in many other kinds of contracts as well. Apparently distracted by other things, Inflation receded.

Another effect of stagflation and the Volcker-Reagan recession: the rise of the two-earner household. What do you do when your incomes are being held down as prices are going up. You add another income.

So that was one episode. There are others, many of them connected to oil prices. Bill Clinton enjoyed strong economic growth with low inflation partly on account of LOW oil prices, thus low energy prices. Before market manipulation on the grand scale we see today, with the Goldman Sachs traders, you saw all energy prices moving together. Now oil stays up, or actually fluctuates, as it is milked by futures market manipulators.

The point is here ...

Well, we should mention the most dramatic post-war inflation, which was just after the war. The wage and price controls that were in place during the war came off. American producers had huge markets in Europe for their products, agricultural products, in particular. A farmer could make ten percent by simply holding his produce off the market for a month. Inflation ran to 30 percent for almost a year, if I am not mistaken. The call went out to shut down the economy. Truman and his chief economist Leon Keyserling declined the invitation. At that time, the Fed and Treasury operated together, so you didn't have the Fed going off by itself as with Volcker. In any event, the speculation broke. Prices came down. Production went up. The economy was off and running. The effective rate on government and other debt was cut, as well, by this inflation.

Be aware that when you see inflation -- so-called -- from the influence of oil prices, the influence is upside down from labor tightness inflation. Not only do energy price rises take a bite out of people's discretionary incomes, when high employment increases incomes, but high oil prices actually push wages down. That is, since everything is made from energy and labor, to keep prices stable, one must go down if the other goes up. Add to this the fact that energy production is a low-employment resource extraction industry, and much investment is high employment construction, and you have the recipe for stagnation.

(I know we're all supposed to applaud the North American energy boom as a jobs producer, but that is basically bull. Many of these jobs are short term, and when they leave, the industry is among the very lowest in labor income. Fewer jobs per dollar. The clean-up, I suppose, as with the nuclear industry in Eastern Washington, will produce jobs on the public's dime. Hmmm. Maybe flammable tap water is not such a high price to pay.)

In any event, the inflation story is a jumble of meaningless words the way it is being told. You have inflation hysterics out even now shaking their fists at the Fed. Although stock and bond prices are high and higher, proceeding from the enormous debt the Fed is producing out of nothing on its balance sheet, those financial assets will not show up in consumer prices because -- most obviously -- the average American never sees a benefit from rising stock prices. But also, it will never show up because healthy inflation is not a monetary phenomenon today any more than it was under Volcker.

Healthy inflation? What a concept. Investment. Higher wages and household incomes.

One more story, about healthy inflation. Or at least more healthy inflation. Under John F. Kennedy the economy was chugging along, but steel prices were rising. The US steelmakers had a monopoly on production and we actually made things here in the US. The Steelworkers union was basically splitting the monopoly profits. Kind of like if Oil had a significant workforce, oil workers could split the profits and Oil could blame its labor for the high prices. Anyway, the price of steel was going up and getting embedded all over manufacturers. The steelmakers blamed labor. Kennedy negotiated directly with Labor and with the Big Seven steelmakers. If labor mitigated their demands, then Steel agreed it would keep the price steady. Labor agreed. Big Steel reneged and announced a price rise above the target.

It occasioned one of the earliest open mic moments when Kennedy was reported to have said, "My father always told me businessmen were SOB's. I didn't believe him till now." The federal response was furious and forceful, led by Attorney General Robert Kennedy. Every federal agency from the FBI and Justice Department to Commerce and down the line was doing investigations. All federal contracts were cancelled except with the one of the Big Seven -- Republic Steel -- which had held to the target. The water got very, very hot. Big Steel capitulated. Inflation pressures eased.

A lot to be said there. I hope I haven't said too much. Inflation is not a looming danger, a dragon. It is like body temperature. It can go up because you are exercising or working hard. Or it can go up because you are sick, or because you are being poisoned. It is a price rise, not a free-standing entity that has an always and everywhere character. It is always and everywhere better to treat the cause, not the symptom.

Now, we have to comment on Tim Geithner moving into collect. Not that Tim is alone. And that is the problem. Never having worked on Wall Street, officially, the former Treasury Secretary and New York Fed president has found the nest properly feathered at leveraged buyout firm Warburg Pincus.

Carried Interest

While buyout firms such as Warburg Pincus suffered when the financial crisis froze credit markets and the value of holdings plunged, they didn’t require bailouts like banks that had used their balance sheets to load up on mortgage securities. The industry has largely avoided tighter regulation, even as taxation of the firms’ share of investment profits, known as carried interest, came under scrutiny when Mitt Romney, the former CEO of Bain Capital LLC, sought the presidency last year.
Private-equity firms pool money from investors to buy companies within about five to six years, then sell them and return the funds with a profit after about 10 years. The firms use debt to finance the deals and amplify returns. They typically charge an annual management fee of 1.5 percent to 2 percent of committed funds and keep 20 percent of profit from investments as a carried interest. Carried interest is treated as capital gains in the U.S. and taxed at a lower rate than ordinary income.

‘Restore Fairness’

Throughout his tenure as Treasury secretary, Geithner called on Congress to “restore fairness to the tax code” by passing Obama’s proposed budgets, under which carry would be treated as ordinary income. Among the tax reform principles of the administration’s budget proposals was “eliminating the carried interest loophole that allows some to pay capital gains tax rates on what is essentially compensation for services,” Geithner told the Senate’s budget committee on Feb. 16, 2012, according to a transcript.

Arthur Levitt had this to say about that:


A priest or rabbi? A teacher? Heaven forbid. That is not the corrupt American way. With two kids at Stanford, you could hardly expect the good Secretary to do anything but collect. That is the American way. And Arthur Levitt:

Arthur Levitt is former Chairman of the Securities and Exchange Commission, a Bloomberg LP board member, a senior advisor to the Carlyle Group and a policy adviser to Goldman Sachs.

Oh. It IS the American way. The totally corrupt American way. Completely corrupt. That Geithner should be getting mega-bucks from the industry he supposedly regulated, after having run the New York Fed and shoveled money at Goldman Sachs through AIG, and the rest. I wouldn't mind if there was an 80 or 90 percent marginal tax rate on incomes over $2 million, including all that carried interest. Maybe then teaching wouldn't look so bad. But this is the payoff. The same under Obama as before. Peter Orzag. And don't forget Max Baucus and his staff on the Senate Health Committee moving on into the executive suites of the private health insurers. Completely corrupt. The system is corrupt. Everybody does it. So maybe that's why we've got what we've got.

Our question is, What About Alan Greenspan? All you private equity guys, you big banks. He has to live on his pension, I guess, and whatever few cents he can scare up writing bad books. Where is his nest? Here is the guy who fronted for you for so long. The guy who took the chainsaw to regulation when others just posed. Here's the guy who let mortgages find whatever mutation was most lucrative and as the banks' chief regulator saw nothing valuable in regulation. Bad forecasts, bad advice. Keeping his credibility by taking credit and shifting blame. My guess is he is the scapegoat. I wonder if he still gets in to the "A" list parties with Tim and Peter?

Needless to say, if Timothy had done his job at Treasury, he wouldn't be finding that fine feathered nest.

Friday, November 15, 2013

Transcript: Political Economy, Plutonomics, Health Care

At one time in the distant past, economics and political science were a combined discipline called political economy. Employment, business, money, political power and relationships were studied together. Part of the irrelevance of modern orthodox economics has to do with its being split off into a separate discipline studying an aspect of social life as if it were a free-standing natural force.
Listen to this episode
In a political economy, history is the laboratory. It is very convenient for modern economists when they say there are no experiments in economics. When all evidence is virtual evidence, then the hypothetical is king. When instead you have to explain why incomes stagnate, or climate change is ignored, observable facts, you have a problem. In the hypothetical, you can say, this is just the way things are and here are the numbers. When the milieu is human behavior, you look to policies and practice.

The practical people of Wall Street, in the main, bypass entirely the Neoclassical equilibriums and the elaborate hypothetical explanations and look for results. Let's combine history and Wall Street and look back a few years to the Plutonomy notes.

In 2005 and 2006, the highly paid strategists at Citigroup issued a series of notes, which may remind you of things we've talked about here. They held conferences with their investors to elaborate on these notes, but when they were leaked to the press and the public got wind of them, they were quickly muted. A great effort was made to take them down off the Internet where ever they may have surfaced, with legal threat and so on. But you can still see them. See the links online.

Quoting October 16, 2005.

Industry Note

Equity Strategy

Plutonomy: Buying Luxury, Explaining Global Imbalances


The World is dividing into two blocs -- the Plutonomy and the rest. The U.S., UK, and Canada are the key Plutonomies -- economies powered by the wealthy. Continental Europe (ex-Italy) and Japan are in the egalitarian bloc.

Equity risk premium embedded in "global imbalances" are unwarranted. In plutonomies the rich absorb a disproportionate chunk of the economy and have a massive impact on reported aggregate numbers like savings rates, current account deficits, consumption levels, etc. This imbalance in inequality expresses itself in the standard scary "global imbalances." We worry less.

There is no "average consumer" in a Plutonomy. Consensus analyses focusing on the "average" consumer are flawed from the start. The Plutonomy Stock Basket outperformed MSCI AC World by 6.8% per year since 1985. [It] does even better if equities beat housing. Select names: Julius Baer, Bulgari, Richemont, Kuoni and Toll Brothers.

[end summary]

Welcome to the Plutonomy Machine

In early September we wrote about the (ir)relevance of oil to equities and introduced the idea that the U.S. is a Plutonomy -- a concept that generated great interest from our clients. As global strategists, this got us thinking about how to buy stocks based on this plutonomy thesis....

[It is probably unnecessary for me to break in and explain that the strategists have no problem with Plutonomy on moral or ethical grounds, it is just a phenomenon they observe and hope to profit from.]


(1) the world is dividing into two blocs -- the plutonomies, where economic growth is powered by and largely consumed by the wealthy few, and the rest. Plutonomies have occurred before, in sixteenth century Spain, in seventeenth century Holland, the Gilded Age and the Roaring Twenties in the U.S.


Often these wealth waves involve great complexity, exploited best by the rich and educated of the time.

(2) We project that the plutonomies will likely see even more income inequality, disproportionately feeding off a further rise in the profit share in their economies, capitalist-friendly governments, more technology-driven productivity, and globalization.


(4) In a plutonomy there is no such animal as "the U.S. consumer" or "the UK consumer," or indeed the "Russian consumer." There are rich consumers, few in number, but disproportionate in the gigantic slice of income and consumption they take. There are the rest, the "non-rich," the multitudinous many, but only accounting for surprisingly small bites of the national pie. Consensus analyses that do not tease out the profound impact of the plutonomy on spending power, debt loads, savings rates (and hence current account deficits) oil price impacts, etc., that is focus on the "average" consumer are flawed from the start. It is easy to drown in a lake with an average depth of 4 feet, if one steps into its deeper extremes.


[And this is the point we've been trying to make over the past couple of months, though we've not explained it so well as the CitiGroup folks, the average is not useful to understanding an economy. Inflation, Incomes, Savings, ... When there is a real economy and a financial economy ... The real economy in which people live is bouncing along the bottom, a bottom that is sloped downward and filled with risks.]


(5) Since we think the plutonomy is here, is going to get stronger, its membership swelling from globalized enclaves in the emerging world [read sweat shop owners of China], we think a "plutonomy basket" of stocks should continue to do well. These toys for the wealthy have pricing power, and staying power. They are Giffen goods, more desirable and demanded the more expensive they are.

[And I could go on, reading under headers such as "Riding the Gravy Train -- Where are the Plutonomies?" and "The United States Plutonomy -- The Gilded Age, the Roaring Twenties, and the New Managerial Aristocracy." But before we leave this, I want to make some points. Not that these amoral folks are bad people, or the plutocrats who they serve. Yes, they may rot in hell, if there is a hell, but on the other hand, they are operating according to their own self-interest, as they have been instructed by economists, and if the larger population begins to emulate them, operating in THEIR own self-interest, the plutonomists may have a hard time here on Earth.

But there are a couple of historical points to make. One is that the plutonomy in the US began its rise in the late 1970's and took off under Reagan, and has not looked back. The second is that this phenomenon tracks the rise of the financial sector as a proportion of the economy. As the financial sector has extracted more and more of the profits of the whole, so the plutocrats have prospered. The third historical point is this was written in 2005, and its follow-up notes in 2006. The economy crashed in 2008. Yet today the richer you are the more of the pie you are getting each year.

So when the CitiGroup folks say plutonomies "will likely see even more income inequality, disproportionately feeding off a further rise in the profit share in their economies, capitalist-friendly governments, more technology-driven productivity, and globalization," they should leave out the technology-driven productivity part and emphasize control of the government and extraction through the financial sector. In fact, it is low tax rates and the monetary policy that puts banks and stocks ahead of actual investment in real stuff that has continued the well-being of the plutocrats even through the crash

And again, we want to emphasize, the decline and stagnation of the real economy, employment, investment, and the rest is masked by the plutonomy, by the averaging of the very wealthy few and the more and more insecure many.

But check out those links online and add your own commentary. There are lots of details. Tables, charts, anything you want to know about income disparity, where it has been and where it is going.

A last comment, from the third note, on September 6, 2006. "What could go wrong? beyond war, inflation, the end of the technology/productivity wave, and financial collapse, we think the most potent and short-term threat would be societies demanding a more equitable share of wealth."

Again, throw out the technology and productivity, as we've displayed elsewhere these are not the drivers. And throw out financial collapse. Not a threat. War doesn't seem to dent things. Inflation? The price of bling is always going up, otherwise, not a threat. I guess that leaves a more equitable share of wealth.

So I guess plutonomy is still a good play.

Now, on to health care. We have to comment, since everybody else is, on the roll out of the Affordable Care Act. The political and technical complexity of the Act, along with the fact that it does not control costs, but only expands subsidized coverage, make the ACA not the answer. Rather than get further into the weeds on that, look at single payer.

Single payer is not socialized medicine. That would be, as we hear from Public Citizen, the Veterans Administration, where the government pays for the doctors and hospitals. The VA is socialized medicine.

Under single payer, you get a health care card and you can go to any doctor or hospital. Call it Medicare for all. Doctors are not employees of the government. Hospitals remain in private hands.

As to costs. Currently Medicare covers the senior population, that group that is most expensive. It pays $600 for an MRI. You can get charged, as a friend's nephew did recently, $12,000 for an MRI. The mega-corporations that are the sellers have to deal with a mega-buyer. It balances the market.

Drugs would be cheaper. Research might be higher, since most of it is funded by the National Institutes of Health and through public universities, not in Big Pharma laboratories.

Single payer would mean no more bills, no more deductibles, no more co-pays. And instead of paying enormous health insurance premiums and then the first $5,000 in deductibles, you will pay a universal fee, or tax, that will be less. And the single payer will be motivated to enforce preventive medicine.

So. Obamacare is not single payer. It is not simple. It is not universal. It does not control costs. Control of costs is the key point. When the political debate says we have to cut entitlements, like Medicare, because we cannot afford them, it is really saying we have to shift medical costs into the private economy, where the market is making a mess of things. Eugene Fama, whither thy efficient market? This does not solve the problem. The problem is health care costs. Single payer is the way to get to those costs.

So, you may have noticed this week's podcast is later than usual. Very sorry. We are getting into our second book and time gets away from us. We wrote Demand Side Economics, the book, in 2011. Check it out. It has a forecast section that is still good. Find it at DemandSideBooks.com or on Amazon. The next one is "A Pundit's Guide to Economics." We've gotten tired of media talking heads just accepting the nonsense that is shoveled at them because "I am not an economist." This will be short, broad, and pungent.

More than that, we are in the process of forming the Institute for Dynamic Economic Analysis, with the very cute acronym IDEA. Idea. It is a nonprofit to expand and support the work of Australian economist Steve Keen. The current board pro-tem is composed of tech guys, economists and others here in the Northwest. We hope to have that incorporation complete later this month. It is more work than we have time for, but hopefully we'll get it up and running and funded. Steve's Minsky project, the dynamic economic modeling software, is one key mission. Another is getting him to finish his Finance and Economic Breakdown, his magnum opus. Otherwise the mission is simply the complete reformation of economics. We'll let you know when we pass a milepost. And Steve is an inveterate Twitterer. If you're into that, you should get on and follow him.

Thursday, November 7, 2013

Housing Recovery: The elephant has given birth to the mouse

Housing, like the rest of the economy: Our forecast - bouncing along the bottom with downside risks.

We have seen the Fed and others point to the housing market as the linchpin of a recovery. It is true that housing has led recoveries in the past. But blaming housing is like blaming the slow flow of water as the obstacle to irrigation downriver. It may be true, but it is not the cause. It is the collapse of the geology upstream that has dammed the river. A catastrophe is in the works if we don't address the causes.

Listen to this episode

The economic geology that has collapsed is employment and debt. When jobs recover and/or debt levels are reduced, housing is the channel by which workers invest. As we've been harping on for ... as we've said, investment is the key. It is wrong to say that only capitalists invest, particularly these days. Workers invest, government invests, businesses invest.

In 2008 we followed the lead of Robert Kuttner and others arguing for a Home Owners Loan Corporation paired with substantial, sustained public investment in roads, schools, healthcare, energy infrastructure. The first to deal with the private debt crisis and the second to deal with the jobs crisis. Didn't happen. The Obama stimulus was offset by local and state governments contracting. We did not get the revenue-sharing we needed to make the public investment -- which was about one-third of the Obama stimulus's $700 billion -- provide anything but a bump in employment and growth.  A significant bump, but not enough to avoid being caricatured as a failure.

But what does this look like inside the Fed?

From Cleveland Fed President Sandra Pianalto: Housing in the National Economy: A Look Back, a Look Forward
A major reason why the economic recovery has been so slow and has required so much policy support has been the performance of the housing market. Ordinarily, deep recessions are followed by strong economic snap-backs. But an economist at my Bank and his co-author found two exceptions to that rule: the Great Depression and the recent recession. [see: Deep Recessions, Fast Recoveries, and Financial Crises: Evidence from the American Record]. In this last episode, the evidence points to the collapse of the housing market as the key explanation for the slow recovery. Most of the time, home construction and spending on household goods can be counted on to provide a big push to the recovery. Historically, residential investment has contributed about half a percentage point to GDP growth in each quarter during the two-year period immediately following a recession. During the first two years of this recent recovery, however, the contribution from residential investment to GDP growth was basically zero. Because the recent recession was caused in part by a housing crisis, the housing market was too damaged to provide its customary lift to GDP growth.

This is analysis? Most of the time deep recessions have sharp bouncebacks? This is looking at the economy as a kind of weather pattern. Let's see what happened in the past in a storm. But private debt is like global warming. It makes the events more severe, and can lead to a self-reinforcing downward spiral, like maybe the melting of the arctic ice. In the case of the economy, it is debt deflation.

We should notice that most recessions in the postwar -- all those that came with a sharp bounce-back -- also saw inflation reducing the real burden of debt. We have the opposite today.

Sorry, back to the Fed president:
...So that is where we have been--a housing bust followed by a recession and sluggish economic recovery that was made all the more sluggish because of the weakened housing market. Looking ahead, tight conditions in mortgage credit markets will continue to hold the housing sector and broader economy from getting back to full strength more quickly.

.... In a recent Federal Reserve survey of senior loan officers, bankers reported that credit standards for all categories of home mortgage loans have remained tighter than the standards that have prevailed on average since 2005. Financing companies no longer assume that houses will provide adequate collateral for borrowers with fragile credit histories. In addition, financial market regulators are standing vigilant to ensure there is no recurrence of the housing bubble that almost brought the financial system and global economy to its knees.
Moreover, access to mortgage credit has become far more restrictive. To get a mortgage today, it helps to have a very high credit score. Lenders are more likely to extend mortgage credit to consumers they perceive as very low risk. As a result, the pool of potential mortgage borrowers has shrunk. Households with low credit scores that were able to get credit before the crisis now are the least able to refinance their homes, or to obtain new mortgage loans. These are also the households who seem to be especially cautious in their spending these days. For these households, the days of extracting "free cash" from their homes are over. It is now mostly households with ample savings that spend and save as they normally would.
Another development that could lead to tighter credit conditions in the future involves the secondary mortgage market. The outlook for the government-sponsored enterprises Fannie Mae and Freddie Mac is uncertain. The GSEs, as they are known, had to be rescued after the financial crisis and Congress is weighing reforms that might greatly reduce the government's large position in housing finance. The housing market today is being heavily supported by Fannie and Freddie. Without the government guarantees on mortgage-backed securities, the amount of credit available for mortgage originations would be substantially smaller today.
To sum up my remarks, it was the housing bust that got us into this situation. And the lasting consequences of the bust continue to hold back the housing market and broader economy. The big picture is that many households are still adjusting to the large shock to their net worth that occurred during the financial crisis and are dealing with uncertainty over their future earnings prospects. For these reasons, consumer spending will likely continue at a moderate pace. But over time, I expect these effects to fade and credit conditions to improve.
Why? Let me see a show of hands. How many think financing conditions will come around and make housing boom again. No fair saying in ten years. The Fed has put all its efforts into financing, with the QE's, bank bailouts, and so on. None, or virtually none, have gone into the condition of the demand side of the market.

I don't see any hands.

You are seconded by a report out that says even though banks are easing lending standards, there is little demand for the loans.

Housing is an important illustration of Hyman Minsky's three financing structures:  hedge, speculation, Ponzi. In the beginning, when housing is purchased as a place to live, you have hedge financing, what we think of as investment. The investment is paid back by the services of the house. When equity increases, and home equity loans cash it out, you have a form of speculative financing (say you take out the equity to pay the mortgage), what we think of as rollover financing. When the boom comes, it becomes Ponzi financing. The house is a play on the future rise in house prices. This is the reason people bought bigger than they needed. The bigger the play, the bigger the return. There at hand was the requisite easy credit. Collateral was no problem because the house was worth more each year. No Ponzi bubble can exist without the credit. Then there was the bust. House prices receded leaving the debt exposed.

Now we have too much debt and incomes that are sagging, and no prospect of jobs taking off.

Let's be clear, an economic downturn can turn hedge into rollover into Ponzi. But let us also be clear, there is no problem with hedge financing. Investment that creates value from which the investment is repaid is exactly what we want. Workers can do it, business can do it, the government can do it. If the government does not invest, but chooses instead to return taxes to the public to promote consumption, and in the presence of over-capacity, we are no closer to recovery. It does not take all workers to create all consumption goods. That is a zero sum game, and it becomes negative when profits are necessary.

Profits that are simple rents on market control, like in health care, for example, or even technology patents, do not create jobs, do not grow economies, do not prepare for the future.

It is absolutely absurd to favor the one percent so they can make profits on rents, as if that is going to in any way, form or fashion create jobs.

Since we're taking pot-shots at the banks and the wealthy, we have to remark on the $13 billion settlement by JP Morgan.

In a Ponzi bubble, particularly one where credit is so easy, it is literally being forced on all those who don't willfully refuse it, there will be fraud. What is curious to us is that there are these cases where banks -- JP Morgan, Bank of America, Barclays, and their ilk, who settle without admitting fraud. Or like SAC Capital Advisers, where fraud is admitted by the company, but not by the chief fraudster, Stephen Cohen.

Does anybody really believe, as Elliott Morss says, that when JPM can afford the best lawyers in the world, the company would settle without there being solid evidence of fraud. $13 billion is a lot of money. Health care for kids was vetoed by Bush because $2.5 billion was too much.

Morss goes into detail, which I will excerpt here:
First, he asks 
"whether the buying and selling of mortgage packages could constitute fraud/solid evidence when they buyers and sellers were all quite knowledgeable and “playing the same game”. Fraud is defined as “deceit or trickery perpetrated for profit”. But what if both parties to an alleged fraud know what is up? That is, they all knew there were very risky mortgages in the packages they were buying and selling.
The key players:
"There are two types of mortgage writers: those with their own money and those that must sell off their mortgages (mortgage companies). Banks have their own money (deposits) as do private equity, hedge, and other funds. In contrast, mortgage companies don’t have their own money and are dependent on their being buyers for the mortgages they write. It turns out the vast majority of mortgages originated in banks are not held by the banks that originated them but are instead securitized and sold as securities to investors.
So both the banks and the mortgage companies use the same financial model: earn commissions by selling off mortgages they write. One can draw two inferences from such a model: Banks won’t care as much about the quality of the mortgages as they would if they planned to hold them to maturity; and a certain amount of misrepresentation can be expected when the banks sell off mortgages and mortgage packages.
So who are the buyers? Back in 2005-2007, the biggest buyers were the Feds – Freddie Mac and Fanny Mae who both work under the Federal Housing Finance Agency (FHFA) umbrella. Under law, they are not allowed to purchase mortgages or mortgage packages that do not have well-documented income with upper limits on mortgage size based on income. So what happened? The Feds ended up buying high-risk packages and according to news reports, are only now are suing for misrepresentation.
 It is hard to believe the Feds did not know what they were getting at the time. One would hope they were doing some sampling of the packages they were buying to insure they were as represented. Maybe not. But I just cannot imagine working for one of these agencies where all you were doing was buying this stuff and not asking what you were getting.

A piece by Piskorski, Seru, and Witkin[1] (PSW) identifies two types of misrepresentation.

“More than 6% of mortgage loans reported for owner-occupied properties were given to borrowers with a different primary residence, while more than 7% of loans (13.6% of loans using a broader definition) stating that a junior lien is not present actually had such a second lien. Alternatively put, more than 27% of loans obtained by non-owner occupants misreported their true purpose and more than 15% of loans with closed-end second liens incorrectly reported no presence of such liens.”
Lehman Brothers was in a class by itself on misrepresentations. But when the misrepresentations of the financial firms acquired by Bank of America (BAC) and JPM are included, JPM tops the list. However, the precedents for misrepresentation suits are increasing. That means Barclays, HSBC, Citigroup, Deutche Bank, UBS, Nomura, RBS , and Morgan Stanley can also expect misrepresentation lawsuits soon. And it won’t just be the Feds initiating lawsuits. Other levels of government and private firms are watching the growth of precedents with great care.
[These could] well be the “tip of the iceberg” in terms of misrepresentations, as the piece notes, because the authors looked only at two types of misrepresentations, this number likely constitutes a conservative, lower-bound estimate of the fraction of misrepresented loans.”
It is quite likely that even greater misrepresentations were made by mortgage writers on borrowers’ income and by assessors on real estate values. And misrepresentations on these items could also constitute grounds for legal actions. And there are real grounds for damages. For example PSW pointed out that on the misrepresentations uncovered, delinquencies were 60% higher “when compared to otherwise similar loans”.
Were Both Parties to These Transactions Aware of the Risks?
PSW: “Lenders seem to be partly aware of this risk, charging a higher interest rate on misrepresented loans relative to otherwise similar loans, but the interest rate markup on misrepresented loans does not fully reflect their higher default risk”.

Brought to you by:


Rethinking Economics is a network of young economics students, thinkers and writers who are organizing to create fresh economic narratives to challenge and enrich the predominant neoclassical narrative. The organizing aims and principles are on the website, where they say:

We aim to demystify and diversify economics in the public eye; to educate ourselves and other students in a more reflective economics; to inspire divergent economists to engage with one another in debate; and to promote a politics of responsibility with academic economists.