Twenty best independent financial blogs 24/7 Wall St reports March 31, 2010:

The Angry Bear www.angrybearblog.com. Half a dozen professionals, including a tax law expert, a historian, PhDs in economics, business consultants and financial professionals provide perspectives on the financial world. Despite their expansive coverage of economic issues, their articles are as deep as their coverage is extensive. Topics include world trade, industrial production, U.S. Government programs, and major regulatory issues.

by Bruce Webb

And I could add honest definitions and honest framing to that.

In Dec 2005 three former staffers to Bill Clinton, John McCain and GW Bush respectively released the Liebman-MacGuineas-Samwick Non-Partisan Social Security Reform Plan (9 pg PDF) or LMS. The authors proposed a package of changes to Social Security comprised of a 1.5% across the board payroll tax increase, an adjustment of the payroll gap back to the 90% level (it had drifted down to 84%) for the equivalent of another 1.0% of payroll, and adjustment in retirement age scored at 0.62% of payroll, and a change in indexing of initial benefits that scored at 2.08% of payroll for a total worker financed 'fix' of 5.2% of payroll. Interestingly enough in that year the total 75 year actuarial gap was scored at 1.92% of payroll, meaning that an immediate hike of that amount would deliver 100% of scheduled benefits over the 75 year window traditionally used to score Social Security solvency. So why a 5.2% solution to a problem scored 1.92%?

Well therein lies a tale, and an important one when we are faced with a so-called Deficits Commission whose leaders make it clear that Social Security is front and center, as workers and future retirees we owe it to ourselves to understand what problem 'reformers' are actually addressing. Because LMS at least is not focused on retirement security, not at least in the dollars and cents sense. Much more under the fold. (It wouldn't hurt to bring along your tin-foil hat).

More below the fold...

by Linda Beale

Maybe at this juncture, when Congress is beginning to talk about what to do about the sunsetting Bush tax provisions, it's an appropriate time to remind ourselves about our historic commitment to progressivity in our tax system. A good source for thinking about this is an article by Tom Piketty and Emmanuel Saez, How Progressive is the U.S. Federal Tax System? A Historical and International Perspective, 21 J. Econ. Perspectives 3 (2007).

What they show by looking at income and taxes over the period from 1960 to 2004 is revealing. While our system remains progressive to some extent, the progressivity has declined significantly. This is primarily, they say, because of the cuts in the corporate tax and the estate tax--taxes that impact the very wealthiest more than others because of their high ownership of financial assets. Our concept of distributive justice has always demanded that we should determine the tax burden based on individuals' relative abilities to pay--that means that those with lots more should pay proportionately more of their income, since those with very little need all of their income just to meet daily needs, and those with considerable wealth won't even notice whether they have another few dollars or not.

The decades since Reagan took office have taken a huge toll on that sense of shared commitment. Fueled by a religious-like belief in the mathematically elegant but unrealistic assumptions of the "free market" economists from the Chicago School (see Yves Smith's book, Econned, for a good take-down of the freshwater economists), the GOP in Congress passed huge tax cuts for the wealthy accompanied by increasingly heavy payroll taxes for others at the same time that spending continued apace--in fact, Reagan, Bush1 and Bush2 all greatly increased the military budgets and the Bushes embarked on wars of choice that imposed significant budgetary demands. The wealthy have fought for laws that favor them--deregulation, zero capital gains taxation, lower corporate taxes, the ability to offshore businesses and assets freely, privatization of social security and other programs (that would put more dollars under direct control of investment bankers and insurers), and lowering of individual tax rates and provisions that phased out deductions for the wealthy (like the phase out of the itemized deduction, which was repealed under Bush, etc.).

There are some really great graphs in the article--so look at it rather than just reading these excerpts. But if you only have time for excerpts, here are some key ideas.

More below the fold...

by Rebecca Wilder

Today I digress from my recent Eurozone obsessions to compare the U.S. Consumer Confidence report (released today) to the PMI production surveys, a "soft" comparison of supply and demand. According to the Conference Board today:

The Conference Board Consumer Confidence Index, which had decreased in February, rebounded in March. The Index now stands at 52.5 (1985=100), up from 46.4 in February. The Present Situation Index increased to 26.0 from 21.7. The Expectations Index improved to 70.2 from 62.9 last month.
...
Consumers’ assessment of current-day conditions was less negative in March. Those claiming conditions are "bad" decreased to 42.8 percent from 45.1 percent, while those claiming business conditions are "good" increased to 8.6 percent from 6.8 percent. Consumers’ assessment of the labor market was also less pessimistic. Those saying jobs are "hard to get" declined to 45.8 percent from 47.3 percent, while those saying jobs are "plentiful" increased to 4.4 percent from 4.0 percent.

This report is nothing to write home about. Consumer confidence remains at excruciatingly low levels.

In a post back in September, I argued that the expectations index is a better indicator of consumer spending. As such, the expectations component remains stronger than the composite, having rebounded to its level at the onset of the recession. However, like the composite index, the expectations index is moving rather laterally since May 2009.

More below the fold...

lifted from Bruce's e-mail

Hi Bruce,

I really enjoyed your recent post to OpenLeft about the war on Social Security. I wrote a related piece deconstructing Obama's latest picks to the Debt Commission:

Alternet: Obama Packs Debt Commission with Social Security Looters?

Any feedback about the article or thoughts on the matter would be greatly appreciated.

I run a watchdog website called LittleSis.org that tracks ties between corporate and government elites, with an emphasis on Wall Street. We're gearing up for a sustained investigation into the networks of funding and influence behind the latest attack on Social Security, and I wanted to just say hello and touch base. It seems that there could be more coordination happening between various folks keeping watch on this.

Best,
Matthew

I have Matthew's full contact info if serious people want it. But the piece is very good regardless.

(Update: Lifted from comments:
Movie Guy: "Matthew Skomarovsky wrote an excellent piece. It strikes me that it deserved a stronger presentation at Angry Bear. I doubt that many casual drive-by readers bothered to click on the main post sublink. But what a piece")

Worth saying twice. Click and read.

I was asked by Periódico Diagonal to answer a few questions related to the Eurozone, based on several articles that I wrote (here, here, and here). I don't know if these will be published, but "enquiring minds want to know". Here we go:


1. In a recent article you announced that the next cycle of crisis in Europe will be determined by the struggle for exports. Does that mean that the country which lags behind in this struggle for exports will suffer from falling wages?

Rebecca: What I meant was that the Eurozone might find itself in a “race to the bottom”. The prescript coming out of the IMF and the European Union is one of harsh and deep reductions in nominal income (wages) and prices in order to reduce relative prices enough to drive export income. Normally, downward pressure on internal prices via recession occurs alongside a sharp devaluation in the currency, where external demand pulls the economy back onto its feet. But the main problem across the Eurozone IS ITS CONSTRUCT, one currency “to rule them all”. Greece, nor any of the other GIIPS countries – Greece, Italy, Ireland, Portugal, and Spain – can devalue the currency in order to drive export growth.

The problem is that without proper export growth, the internal devaluation would more accurately take the form of “infernal devaluation”. Cuts to nominal income, wealth (via pensions), and other labor variables will restrict current consumption and aggregate spending to a point where such measures then pressure government deficits. It’s a vicious circle, not to mention a fallacy of composition to think that the aggregate can export its way out recession if wages are falling – spending, by definition, must be falling, too.

More below the fold...

by Linda Beale

Banks, repos and transparency in accounting

A repo transaction is essentially a collateralized financing. For tax purposes, everybody knows that it will be treated as a loan, no matter that it is called a "sale" with an agreement for a repurchase later. For accounting purposes, though, some repo transactions have been able to slide by and look like a "real" sale rather than debt on the financial statement. That's a perfect example of the fact that tax theory pays attention to economic substance, whereas accounting somehow sets up rather arbitrary categories that may end up letting a repo count as a sale instead of a loan on an entity's financial statement.

As most everybody is aware by now, the 2000+ page report on the Lehman breakup found that the firm had engaged in repo transactions to make its capital position look better than it actually was by reducing the leverage showing on its books. It concluded that the Lehman executives and the company's outside auditor (Ernst & YOung) had improperly allowed the repos to temporarily reduce leverage on the firm's books, which contributed to the company's ultimate downfall.

Now the SEC is asking 24 large financial institutions and insurance companies to provide information about their accounting and disclosure practices in connection with their use of repos. The sample SEC letter is available here.

Financial institution reform needs to deal with a myriad of factors--over-leverage is one of them. Transparency in accounting, and focus on economic substance rather than form, should be high on the list of reforms needed.

crossposted with ataxingmatter

by cactus

Last week I wrote A Simple Explanation of How The Use of Derivatives Created The Great Recession.

I want to clarify things with an analogy that at first glance may seem unrelated. Let's talk about poker. Its a game that seems to have grown in popularity in the last decade, especially with the advent of on-line poker, even if the rate of increase seems to me (and I haven't had time to pay much attention lately so take it for what it is) to have slowed in recent years.

Poker is different from most casino games in that you only play against other players, not against the house. The casino - online or glitz and mortar takes a rake, which is a piece of each pot. In a tournament, the casino's rake comes off the sum total of the entry fees ("buy-ins"); what is left after the rake is the prize pool.

When the rakes are small enough, and they usually are, a good player can have a positive expected return. So... investors willing to risks can finance players by covering the buy-ins of the players in exchange for a percentage of their winnings. Though poker is a game of skill, luck still matters a great deal, so it probably makes sense to spread one's investment either across a large number of tournaments by the same player, or across a large number of entrants in the same tournament. I know of examples where this is being done informally, and I have seen business plans for web-based versions of these approaches on a wider scale, but the market, as such, is currently very unsophisticated. Its good for the players - they can enter more tournaments, at lower risk. Despite giving up a share of their winnings, they stand to make more money by being able to play more tournaments and tournaments with more expensive buy-ins. I understand that one well-known professional player, Chris Moneymaker (and yes, that is his real name) produced a monster return both for himself and his backer by qualifying for and winning the World Series of Poker with this sort of financing scheme.

Its not difficult to imagine how such a market could evolve... if the money is there. Over time, buying shares of a player's winnings in a package of tournaments (say ten) in exchange for a share of the player's winnings might become common for good players. Over time, some enterprising individuals who know and are trusted by many of the better players might find themselves a niche aggregating players together. The result - instead of being able to buy into the earnings of a single individual in a ten tournament package, you could buy into the earnings of ten or fifteen players over ten (or more) tournaments. It diversifies the risk a bit for all involved, especially if there was some sort of limited prize sharing among the players in the package. Of course, that's a lot more expensive than financing one player... so that would lead to two additional developments.

Development 1 - exchange markets would develop. That would allow for liquidity (investors could more easily get into and out of investments). It would also allow securities to change value over their lifetime. (If none of the players cashed in the first tournament or two, the value of the security would drop, for instance.)

Development 2 - margins. Some deep pocket entities would be willing to loan investors money in order to buy into such packages.

If the market got to this point, perhaps some really sophisticated investors would jump in. They might find - using sophisticated math - that it pays to pepper each package of players with a long shot or two. They might notice other thing - perhaps their models would show that a given security contains too many players with a similar style, or who likely to knock each other out of a given tournament. Short it.

Meanwhile, the aggregators might notice the growth in demand, and start packaging more marginal players together. Its all good though - someone with a Ph.D. in econ (or even better, Math or Physics) could demonstrate that a bunch of marginal players put together do, on average, do almost as well as the top players, and hey, its Poker, all you need is a chip and chair. And a bunch of MBAs could put that proof on 17 powerpoint slides and sell it to the county treasurer in any number of locations in this country (and elsewhere), and we're not just talking the sticks either.

If the money keeps flowing in, and the story resonates like tulips, Florida swampland or Pets.com, eventually you have rubes all over the country who think they're going to finance a comfy retirement by plonking down for the buy-ins for some slicks who will draw to an inside straight every time. And you can even get insurance on your expected winnings, so what could possibly go wrong? Especially when every taxi driver and waiter in the country, not to mention every editor at the National Review, will happily give you advice on how best to play the derivatives market for poker. Heck, the guy in the Oval Office starts suggesting that this is probably what the country should be doing with its Social Security - everybody could direct their own account.

That's about when the doo-doo will hit the fan. And here's how it starts... a big investor loses big time. His package of "Poker Geniuses from Blowing Rock, North Carolina, Class B-7" comes up a dud. Unfortunately, the dude is leveraged up 50 to 1. Which makes sense, because he couldn't lose so it was guaranteed money. Unfortunately, he did lose. So he's gotta pay his creditors, and he does so by liquidating some other positions. Due to leverage, a lot of positions. That pushes down the value of those positions, and similar securities. But it does something worse... for some reason, it makes a few people re-evaluate the likely pay-offs of the securities that they themselves are holding. And if "Poker Geniuses from Blowing Rock, North Carolina, Class B-7" can come up empty, what about the "Potted Plant Poker Playas of Playa del Rey, L Team?" The folks holding the last tranche to pay off on something they just realized is a dog, and which has already lost value on the market when the big guy started selling left and right to meet his obligations - what are they going to do? Bear in mind, Goldman beat them out the door by six months, and they're leveraged up. 50 to 1. And a payment is due at the end of the week and nobody is answering their calls.

So the market collapses. In fact, a few other markets collapse - who knows who has lost so money on Poker derivatives that they are going to go under, and that big multinational that wants a bridge loan does have a division that plays in this kind of thing, right? No bridge loan for you. It turns out that some of the big guys - the folks who aggregated the players in the first place, and thus understood what sort of dogs were being financed in the first place - bought into their own sales pitch and are holding piles of this crud. Inevitably, there's a bail-out for some of the big boys. The Fed or the Treasury takes the crud off their hands, and gives them top dollar to boot. After all, they've convinced the government that without that market, nobody is going to finance a company that manufactures patio furniture in Indiana. Of course, none of them does get around to loaning money to that company that manufactures patio furniture in Indiana, but that's a trivial detail. Enough of the big boys are made whole that everyone who counts is happy. And there is little thing called blackjack...

So, what did I miss?

by cactus

reads Ezra Klein and Matt Yglesias (between the two of them they have more years than I do).

Klein thinks the FDIC works well. Yglesias notes that it keeps eating banks every Friday and has doubts about the quality of its prudential regulation. I will argue that the FDIC has more of an incentive to make banks prudent than the SEC, the Fed, the Treasury or the comptroller of the currency.

The key point is that the FDIC has a trust fund and wants to keep it. This is the reason that Stiglitz, Sachs, and Krugman were totally wrong and the PPIP was not a huge give away (Tom Bozzo and I explained it to them at the time but they don't read this blog). So long as the FDIC doesn't run out of money, it doesn't have to go begging to Congress.





Robert Waldmann



The SEC and the comptroller don't put their own money on the line. They regulate but they don't bail out. Failures mean they have more egg on their face but no less cash on hand. The Treasury has broad responsibilities and has to explain economic policy to Congress in any case. The FED can just print all the money it wants. The FDIC is independent so long as it stays within its means.

This makes a difference. It is true that the FDIC has had to spend some of its money lately. IIRC it hasn't had to ask congress for any extra appropriations – at all. This in spite of the fact that the FDIC agreed to insure money market funds which therefore got insurance without paying for it. The scale of failures of FDIC insured institutions are tiny compared to the scale of failures of non FDIC insured institutions.

See the secret is to have an intertemporal budget constraint. That tends to cause forward looking behavior.

Robert Waldmann

told Paul Krugman so

About 21 months ago Paul Krugman had a question

lower and middle-income Americans would be substantially better off under the Obama plan. But where is the money for health care reform?

I proposed an answer

there are two puzzles in Obama's proposals
1) How does he plan to pay for both health care reform and his middle class tax cut ?
2) Why is he raising the social security tax even though it is probably not needed to pay old age and disability pensions ?

I think the two questions answer each other. I think that Obama is planning to pay for health care reform with the donut FICA increase (taxing individual labor income over $250,000).

Now we know. Yes most of the money for health care reform came from planning to have the CMS squeeze hospitals and nursing homes, then much from eliminating the Medicare advantage boondoggle (not eliminating the program just paying private insurance companies the same per policy holder as the CMS spends), then from the tax on expensive health plans.

However, when cutting that unpopular tax, expanding subsidies, making the special deal for Nebraska universal and making the special deal for collectively bargained health insurance benefits universal, Obama was short a few hundred billion. So in the Obama compromise proposal (the first proposal from the Obama administration) the donut tax returned.

The bill imposes new taxes on wealthier people. Individuals making more than $200,000, and families making more than $250,000, will have to give up more of their paycheck to the Hospital Insurance payroll tax. Instead of paying 1.45 percent like most workers, they’ll pay 2.35 percent. And a new 3.8 percent tax will be added to income from interest, dividends, annuities, royalties, and rents.

OK so it's described as an increase in the Medicare plan A tax not the social security old age and disability pension tax. It starts at income of 200,000 or family income of 250,000. It applies to capital income too. The rate is lower than I guessed way back then (I just assumed it was 6.25%). Still I now type "I told you so."

It was always there in his mind in case it was needed.

by Rebecca Wilder

This is a post about my confusion, rather than my reporting, of the Eurozone saga. Here are some pieces worth reading if you want to catch up:

The NY Times (the basics); Ed Harrison (via Naked Capitalism); From the billy blog; The Financial Times (Martin Wolf, a must read); The Economist (will reference below).

Okay, a conditional guarantee for possible lending, maybe, with consultation from the IMF has been agreed upon by the Eurozone countries (Germany and France, really). But what I don’t understand is pretty well stated in the Economist article:

The Greek government has somehow to keep its economy on an even keel while pushing through a huge fiscal tightening. Countries that seek IMF help generally have to endure brutal cuts in public spending, which deepen recessions. To counter that effect, the IMF typically counsels a weaker currency. Sadly, this is not an option for Greece. Stuck in the euro, its exchange rate with its main trading partners is fixed. Greece cannot devalue, so it needs more time to adjust than the three years it has agreed with its EU partners—and a bigger safety net while it does.

Sadly? This is not an option? The Economist completely skips over the VERY LARGE issue of a singular currency and on to the competitiveness story, one that must be derived through internal devaluation, i.e., dropping wages and other nominal variables.

Financial crises, especially those in small-open economies (Sweden, for example), generally end with a massive currency devaluation that drives export growth (provided there is external demand to suffice). I honestly don’t see how a sufficient export-generated rebound is even a possibility, given that the rest of the Eurozone is essentially trying the “internal devaluation” bit simultaneously (chart above).

And who’s going to pick up the slack? In 2008, 64% of Greece’s export income was derived by the EU 27 countries, 70% for Spain, and 74% for Portugal. If the Eurozone as a whole is using this same internal deflation mechanism to spur export growth, only the “zone” as a whole really benefits, not any one country.

WIHTOUT a massive surge in export-driven GDP growth no "zone" country can drop its financial deficit without incurring behemoth debt burden growth (in the case of the Eurozone, the term “burden” actually applies since Greece, nor any one economy, can print its own money).

Look at the government’s period budget constraint (left), where the lower-case letters "d" and "p" stand for the debt and primary deficit as a share of GDP, respectively. r is the nominal interest rate, and (1+g) is the rate of NOMINAL GDP growth (including price appreciation). (Email me if you want the algebra.)

When Greece starts dropping p (the primary deficit), the fundamentals of the economy (i.e., nominal gdp growth (1+g)) must be robust enough to prevent a surging debt burden. And here's the cycle: to drop the primary deficit, it does so by reducing G and raising T, which drags Y (as of Y = C + I + G + Ex - Im) and growth of Y, (1+g), since export growth is unlikely to be there to offset the decline in private spending; these effects then flow back to the primary deficit to raise p.

And likewise, only under the circumstances of heroic export growth can the government reduce its fiscal deficit to 3% WITHOUT the private sector levering up their balance sheets and contributing to a larger default risk (of the depressionary type). I’m confused.

All I’m saying is that this plan, in its current form, is really not much of a plan at all. The internal devaluation model has a lot of holes.

Rebecca Wilder crossposted with News N Economics

by Bruce Webb

Well some things are coming clear about the Presidents Deficit Commission. One its Chairmen have made it clear that its business starts and stops with Entitlements, the concerns some Republicans had that this would be Obama's way of boosting taxes on the General Fund side or slashing military spending have been shown to be misplaced. Moreover it is clear from the NYT article cited by Jack yesterday plus many other indications that Social Security is front and center, after all the GOP has used the prospect of cuts to Medicare as a centerpiece to their opposition to HCR.

So the ground in being prepared for a grand debate on Social Security. But the question I want to throw out today is this: Who will be the scorekeeper? And the answer to that has huge implications.

There are three main governmental actors who score Social Security and they are not lined up neatly in either methodology or timing. First and foremost are the Trustees of Social Security. They release their Annual Report typically on March 31st though it can come out, as it did last year, as late as May. When it does come out it will be available here: Trustees' Reports and of course in short order via a link in a post here at AB.

At that point we will be able to compare its numbers to those of the Congressional Budget Office. The CBO gives ten year numbers for Social Security with its standard Budget Outlooks and updates of its Baseline but its main analysis of Social Security comes each August in the form of a document entitled 'CBO's Long-Term Projections for Social Security'. The 2009 version of this is available here: CBO Publications: Social Security and Pensions

A third scorekeeper is the White House Office of Management and Budget which releases its own 10-year numbers on Social Security with its release of the President's Budget. Normally these numbers would not be front and center in a Social Security discussion, but this is after all a Presidential Commission and moreover the current top two at OMB are themselves authors of prominent Social Security plans: Diamond-Orszag and Liebman-MacGuineas-Samwick (LMS).

So we are faced this year with our own Clash of the Titans. And it matters because the data sets are incongruent, where CBO in August projected a 75 year actuarial gap of 1.3%, SSA put it at 2.01% in May. Whereas SSA tells us that the Trust Fund will likely go to depletion in 2037 based on the best available information they had a year ago, CBO using updated information from last Spring/Summer still would have that date be 2043. And that time gap is very significant, it is the difference between mid-point Boomers being 82 or just crossing the average projected mortality date and 88 when most of that cohort will have shuffled off to Buffalo (and points beyond).

A couple of days ago it was announced that the Executive Director of the President's Commission would be former top Clinton advisor and DLC Chair Bruce Reed and presumedly Bruce is staffing up as we speak. We don't know when the Commission will actually hold its first hearings but certainly those will be shaped and informed by the numbers in the soon to be released SSA Trustees Report. But the time-table established would have the Commission issue recommendations in December presumedly to be acted on by the next Congress in Spring 2011. Which means that the Commission and then Congress are going to be dealing with four sets of numbers in succession: 2010 Social Security Report (April), Presidents 2011 Budget (Summer), CBO's Long-Term Projections (August), and then in all likelihood the 2011 SS Report (April 2011).

So it should be interesting, because the set of policies you need to address a 2% of payroll gap in 2037 are very different from those needed to address a 1.3% gap in 2043. And the reality is that the situation on the ground has moved significantly since even those numbers were produced.

I addressed the question SSA? or CBO? to a big group of policy experts. And one of the biggest, and one with a long resume of top jobs at both SSA and CBO firmly answered 'CBO'. But some people closer to the current action said essentially 'Not so fast, that decision has not been made'. Well it makes a huge difference because coincidentally some of the major proposals out there like changes in retirement age and cap increases typically score right at 0.7% of payroll and so very close to the difference between SSA and CBO, if we adopt the former they might have to be included in a proposal, if we adopt the latter they could be scrapped without damage.

By and large the Press reporting in years past and most policy discussion generally has revolved around the Trustees numbers and until the debate over HCR few people even understood the role of CBO is scoring legislation. Now that the focus is turning squarely on Social Security commenters who have been content to deal with issues like Trust Fund Depletion in terms of 'will run out' are suddenly going to be confronted with an amount of ambiguity and varying datasets that they just are not prepared for. But at least Angry Bear readers will have had a little heads up.

by Reader Jack

From the NY Times yesterday:
"Social Security to See Payout Exceed Pay-In This Year"

That's the headline.

The interesting parts are buried deep. In the print edition one has to go not just below the fold, but to the inside pages to find the meat of the story. Superficially it would appear the the Times is reporting new and dramatic findings, but the article soon makes it quite clear that while current benefits are beginning to out pace payroll (FICA)taxes those outlays are still not a deficit because of the interest earned yearly by the Trust Fund.

More below the fold...

by Linda Beale

why taxes are important
from ataxingmatter

When I started this blog several years ago, I wrote in my inaugural post that I thought it was important for people to be informed about taxes--how they work, who pays them, and why we need a tax system to support our governmental programs. I thought it might be worth repeating parts of that, given all the misinformation abounding now about taxes. For just a tip-of-the-iceberg indicator of the misinformation and lack of understanding that many Americans have about taxes, see Mark Thoma's Economist's View posting on Bruce Bartlett's analysis of the tea partiers' views about taxation: The Misinformed Tea Party Movement. (In short, they think that the average American with $50,000 in income pays between 20-25% of gross income in federal taxes, whereas the actual amount is much less--less than 7% in federal income taxes and less than 15% in federal income taxes and social security taxes; they think that taxation raises revenues equal to about 40% of GDP, whereas in reality it is less than 1/4th that, they think taxes have increased under Obama whereas in fact they went way down because of the economic stimulus package that Obama and the Democratic Congress pushed through right after Obama took office.)

More below the fold...

I mentioned I would be going into the archives to re-post some of Angry Bear's explanatory writing in the 2004/05 time period. The first was written by Kash in early 2005 on the coming dilemma in paying for health care and how to use measures to think it through.

Here is a post by CR describing early thinking on the housing bubble, and not from hindsight:

Housing: Speculation is the Key
Posted by CalculatedRisk | 4/04/2005 on Angry Bear
Re-posted with permission of the author

I have taken to calling the housing market a "bubble". But how do I define a bubble?

A bubble requires both overvaluation based on fundamentals and speculation. It is natural to focus on an asset’s fundamental value, but the real key for detecting a bubble is speculation - the topic of this post. Speculation tends to chase appreciating assets, and then speculation begets more speculation, until finally, for some reason that will become obvious to all in hindsight, the "bubble" bursts.

Speculation is the key.

A recent report by the National Association of Realtors (NAR) reported that 23% of all homes nationwide were bought by investors. Another 13% of homes were purchased as second homes. In Miami, it was reported that 85% of "all condominium sales in the downtown Miami market are accounted for by investors and speculators". This is clear evidence of speculation.

The following supply demand diagrams illustrate this type of speculation.

Click on diagram for larger image.

The above diagram shows the motive for the speculator. If he buys today, at price P0, he believes he can sell in the future at price Pf0 (price future zero), because of higher future demand. The speculation would return: Profit = Pf0-P0-storage costs (the storage costs are mortgage, property tax, maintenance, and other expenses minus any rents).

More below the fold...

Krugman writes:

Andrew Leonard has a good point: if Obamacare is such a disaster for the economy, where’s the market reaction?

Silly Krugman. And silly Andrew Leonard. Sure, the S&P 500 is up a few percentage points. But it would be up many, many times that amount if not for the healthcare bill.

Update: Sarcasm alert!

Jamie Galbraith writes in The Nation:

In Defense of Deficits

The Simpson-Bowles Commission, just established by the president, will no doubt deliver an attack on Social Security and Medicare dressed up in the sanctimonious rhetoric of deficit reduction. (Back in his salad days, former Senator Alan Simpson was a regular schemer to cut Social Security.) The Obama spending freeze is another symbolic sacrifice to the deficit gods. Most observers believe neither will amount to much, and one can hope that they are right. But what would be the economic consequences if they did? The answer is that a big deficit-reduction program would destroy the economy, or what remains of it, two years into the Great Crisis.

A big deficit-reduction program would destroy the economy two years into the Great Crisis. For this reason, the deficit phobia of Wall Street, the press, some economists and practically all politicians is one of the deepest dangers that we face. It's not just the old and the sick who are threatened; we all are. To cut current deficits without first rebuilding the economic engine of the private credit system is a sure path to stagnation, to a double-dip recession--even to a second Great Depression. To focus obsessively on cutting future deficits is also a path that will obstruct, not assist, what we need to do to re-establish strong growth and high employment.

To put things crudely, there are two ways to get the increase in total spending that we call "economic growth." One way is for government to spend. The other is for banks to lend. Leaving aside short-term adjustments like increased net exports or financial innovation, that's basically all there is. Governments and banks are the two entities with the power to create something from nothing. If total spending power is to grow, one or the other of these two great financial motors--public deficits or private loans--has to be in action.

More below the fold...

The Dan Rather interview also reminded me of the many Senators and House members outright retirements or "running for another office" that affect the nature of incumbent advantage in more regular elections. From a cursory google of sources I believe there are 9 senate retirements (4 R, 5D) and 17 (6R,11D) House members retiring outright, and the numbers sort of even out overall when those "seeking other offices" are added to the list.

Maggie Mahar at Health Beat Blog gives a historical perspective to the passage of Healthcare Reform 2010 and Medicare 1965. Maggie’s comments are in the parenthesis in red on transcripts of Rathers and Maddow’s exchange.

Dan Rather on Presidents Obama, LBJ and HCR:

I saw Dan Rather on the Rachel Maddow show. Some people have suggested that today, the country is polarized the way it was in the 1960s. But Rather reminds us that when Congress passed Medicare in 1965, President Johnson was operating in a very different landscape. Reading this interview, one realizes what President Obama has been up against. He beings by observing that, if he succeeds, President Obama will be making history.

RATHER: “It will be the signature achievement of this first term, perhaps the only term, but a signature achievement of President Obama`s this term. And whether one likes it or not, disagrees with it or not, it takes up the line that started with Social Security, ran through Medicare and Medicaid, which was passed more than 40 years ago, 45 years ago, and it will be put in that category. [Rather is not saying that Obama will be a one-term president. But he is suggesting that even if he only has four years, he will have accomplished more than the vast majority of two-term presidents.-mm]

“And if it passes, and if it is put into effect, I expect it will be in the first paragraph of President Obama`s obituary, that he passed health care reform, partly because so many presidents — President Johnson was successful, but President...

MADDOW: When Lyndon Johnson was able to get Medicare passed in 1965, is there any useful comparison to make or contrast to draw between the political environment in which he was able to make that happen in `65, and the way — and the environment in which Obama has been able to presumably make this happen if he does it?
RATHER: Well, there are certainly a lot of contrasts. First of all, remember that President Johnson got this landmark legislation, Medicare and Medicaid, passed in the wake of the assassination of President Kennedy. He ascended to the presidency. And the country was aching to not only appear to be, but to be united. [this is very true--mm]

More below the fold...

by Bruce Webb

Well me neither. I read through the Tri-Committee and HELP Bills and the Senate Finance Committee's Chairman's Mark and then both the Pelosi and Reid versions as introduced and followed as best I could the last minute revisions introduced by the Team of Ten but as I type I have yet to actually slog through the text as passed on Sunday night. I think I know what is in the bill and what was signed into law a few minutes ago but I don't actually know. But I will. And you can too. And then maybe follow up with the proposed text of the reconciliation fix.

H.R.3590 - Patient Protection and Affordable Care Act
Given that this is the same bill as was passed by the Senate on Dec 24th some of you may be ahead of me here. But this is the law as it stands this morning Tuesday March 23

Health Care Bill - H.R. 4872 - Reconciliation Act of 2010
Hmm, I didn't realize until just now that the Reconciliation Bill was in the form of a Substitute, meaning that absent any changes mandated by the Parliamentarian or other amendments approved by the Senate this would be the actual final version of the law to be sometime later this month.

Links to our friends (or at least my friend) at Open Congress.org. I am going to take some time and read through the bill and settle out what I think I know from reading all the previous iterations and what we are really dealing with going forward: 300% of FPL or 400%, 11% max out of pocket or 12% or 8.5%? It has been a blizzard of changing numbers. But soon enough it will be what it will be, time to dig down into the data in the true Angry Bear spirit.

Bon appetit!! And consider this an open topical Health Care thread.

by cactus

A Simple Explanation of How The Use of Derivatives Created The Great Recession

In comments to a post by fellow Angry Bear Robert Waldman, reader Cantab writes:

Nobody here has come up with a believable story on how derivatives hurt the economy or were the cause of the recession. All we really get is a claim that they happened together and the further assertion that derivates [sic] caused the recession rather than the more likely story that derivatives were the victim of the recession.

I'm pretty sure Cantab is wrong but I don't have the time to find the various posts that described the issue. But I can summarize:

1. Derivatives are about magnifying bets. A $2 bet on a derivative can be the same thing as a $100 bet on the asset that underlies the security. Thus, if the asset doubles in value, instead of taking home an extra $2 on your bet, you take home an extra $100. But if the price of the asset falls in half, instead of losing $2 on your bet, you lose $100.
2. On Wall Street, everyone leveraged up. After all, the worst that can happen when you gamble with monster leverage is that you go bankrupt. But if you win your bets, you make humongous profits.
3. Inevitably, when everyone is leveraged up, at least some of those who are leveraged must sooner or later make some bad bets. But the losses associated with these leveraged up bad bets was much bigger than in the past. Instead of losing $2 on their $2 bets as would have happened in the past, they lost $100. In the past, the losers' assets would simply have been liquidated, and those assets would have been enough to cover a substantial part of the losses. With derivatives, liquidation covers an insignificant piece of what is owed.
4. Result: massive, and I mean massive, losses to the firm's creditors. Perhaps big enough to drive their creditors out of business too. And those creditors have creditors too...
5. As a result of 4, a firm could win all its bets and still be driven out of business, simply by virtue of being stupid enough to bet against another firm who realized point 2. (And every firm on Wall Street, apparently, realized point 2.) In fact, a firm could be driven out of business despite winning its bets if one of its counterparties was stupid enough to bet against another firm who realized point 2. Being twice or three times removed from a loser might not be enough to keep a firm from being pulled under.
6. Derivatives are also opaque. There's no way of knowing who took out which bets with who until someone declares bankruptcy.
7. Very quickly, it became apparent that any of the firms on Wall Street might already be on the inevitable path toward bankruptcy, but there was no way at all to tell the difference between those that were on that path and those that weren't, or even if there were any firms that weren't headed toward bankruptcy.
8. All deals ceased. The real world, that had gotten used to unlimited amounts of cheap money sloshing around, abruptly and without warning found itself cut off from its fix. Expansions plans, hiring, etc. were put on hold. And companies that were teetering on the edge that earlier would have found some savior on Wall Street found themselves having to shut down or scale back instead.

I have to admit, its taken me a while to come to terms to how big the derivative market was. I had no idea, no inkling of its size back in March of 2008 when I began asking what was different about the current recession. As a result, though I noted the possibility of a "major downturn", I was surprised by exactly how big the downturn would really be. What scares me is that that I'm not seeing anything, anything at all that prevents or even makes the 8 steps I described above any less likely to occur. The bail-outs were madness. Those who knowingly go out of their way to play with dynamite should be allowed to blow themselves up, and the job of government should be to prevent the rest of us from having to deal with the consequences.

Which brings me back to something else I wrote in 2008. We need a public option... in the financial system. Let the public bank at the Fed the way the banks bank at the Fed. If given a choice between keeping my money at B of A or the Fed, I know which I'll pick.

by Rebecca Wilder

This morning there was an abundance of links evidencing the building anxiety over U.S.-China relations. Edward Harrison at Credit Writedowns links to a Reuters article, China vows to hit back if targeted by U.S. on yuan. Calculated Risk refers to commentary at the Financial Times and the Washington Post referencing China Losing Support of American Business Community.

Let's think about the currency from a U.S. auto exporter's viewpoint. The China Daily looks at China's relatively “young” automotive market compared to its developed U.S. counterpart. But what if the yuan appreciates more than expected against the U.S. dollar? This market would develop much quicker than the article portends, and the room for revenue growth is vast.

Deutsche Welle also reports the benefits that Europe would incur from a stronger yuan compared to the U.S. dollar, which gives me pause: why exactly would Europe profit from an appreciation of the Chinese yuan against the U.S. dollar? The U.S. export industry, yes, but Europe? Deutsche Welle tells us:

"But Europe stands to benefit a lot, because with a revaluation, European products would become more affordable for Chinese consumers and companies alike and we would definitely feel the benefits in terms of better exports," said Schularick.

This is an entirely one-sided argument: if the Chinese yuan appreciates, then export income would be diverted away from Chinese exports and toward Chinese imports, paving the way for Europe to reap the benefits. Same story as in the U.S. auto maker case, but with a twist: China has options.

First, China drops the currency peg, allowing its exchange rate to float (appreciate) against the U.S. dollar (USD). In this situation, the USD will depreciate not only against the Chinese yuan (CNY), but more likely against all currencies to which the USD is implicitly pegged via the yuan.

It’s pretty simple, really, if you think about cross rates: USD:CNY / EUR:CNY = USD:EUR. If USD:CNY falls (i.e., the U.S. dollar depreciates against the Chinese yuan), and that depreciation is not matched by an equal increase of the EUR:CNY (appreciation of the Eurozone euro against the Chinese yuan), then you get a depreciation of the U.S. dollar against the euro (the USD:EUR falls).

Point 1: as the Chinese yuan floats, it’s very likely that all else equal, the U.S. dollar depreciates against the euro. This improves the near-term prospects for U.S. exports to Europe, and reduces those for European exports to the U.S. (given sticky prices). Therefore, the increased demand for European exports to China will be offset somewhat by the decline in demand for those to the U.S.

Second, given that the Chinese do not allow the yuan to float (much more likely), who’s to say that the Chinese will not simply substitute one peg for another, i.e., target the euro to a larger degree? This would be very simple; and frankly, a euro peg would make more sense, given the trade flows between Europe and China.

Europe is a natural market for Chinese exports: in 2007, 24% of China’s exports landed in Europe, while 21% shipped to North America. All else equal, a euro peg would be quite an effective “export growth tool” if the Chinese shifted their asset base from U.S.-denominated assets toward Euro-denominated assets.

Point to 2: Europe would be very much worse off if China simply increased the weight of the euro in its currency target basket. The biggest economy in the Eurozone, Germany, is an “exporter” itself. Talk about trade wars!

U.S.-China bi-lateral relations SHOULD BE TREATED as a multi-lateral story; they're interconnected.

Rebecca Wilder crossposted with News N Economics

Note: This is “what I believe I said,” not“what I would have said” and is presented here solely to document the confluences that were, perhaps, clearer in my head than they were in the presentation itself.  As such, several references here are echoes of earlier pieces of the presentation. (Links to same will be updated as soon as possible.)

To review, there are three standard methods of reducing a fiscal debt: default, inflate, and taxation and/or budget cutting.  I believe it is clear that default is not desirable; the historic examples of 1917 Russia and the State of Louisiana are clear indicators that issues persist long after the act itself, and the recent suffering of the Argentineans in 2002 and 2003 clearly shows that, even at the time, default is at best a problematic solution, more an amputation than a lancing.

The second, moderate inflation, has the collateral issue that some of the assumed benefits of an inflationary policy—especially an inflationary policy in an environment with a relatively low savings rate—do not accrue to the country whose currency is the dominant one in the world.  As I noted earlier, David Beckworth is doing some research in this area, and I look forward to seeing the results.It seems safe to assume that the benefits of inflation will not accrue in the way a model might predict, and therefore “solving” the problem with inflation will require a suboptimal level to achieve optimal policy.  The chance of having to repeat “the Volcker experiment” would not be small, while the likelihood of success would not be so large.

Budget cutting is an abiding idea. While I’m perfectly willing to stipulate that one might be able to cut around 1% of GDP from the US defense budget, and that some direct consumption—though much of this is a State and Local issue more than a Federal one—might be reducible, this appears unlikely to have more than a marginal effect. While we like—indeed, make a living from identifying—marginal effects, the magnitude of the issue at hand requires more.  Since we generally can stipulate that transfer payments are at worst neutral (or, by Jim Baker’s “supply-side/conspicuous consumption” theory presented earlier, likely beneficial to both the velocity of money and overall tax revenues), gains from there will, at best, not help the team.

This leaves taxation, and it is perfectly reasonable to assume that taxation can be increased. Except that, as you can see from the graphic I have left on the screen, we have a large deadweight loss in health care spending. We spend approximately 6% more, on a percent-of-GDP basis, than the next country, with no noticeable economic value-added.  Having that deadweight loss hanging over the economy limits options—possibly as much or more than being the dominant currency.  And since the basic premise of this panel appears to be that we would prefer that the US Dollar remain the dominant world currency—that is, becoming the 21st century equivalent of 20th century Britain not being a desired outcome—we are left to the reality that we cannot solve the budget crisis without reducing or eliminating much of the deadweight loss in the health-care system.

Were we to solve only half of the difference and transfer that amount to tax revenues, we would solve the budget deficit without adding any drag to the economy, effectively substituting tax revenues for cost overruns. We would, in short, have produced a better team: a better engine for growth and a greater potential for entrepreneurial opportunity, even if a groundskeeper becomes underutilized in the process.

The most viable alternative to addressing the deficit by addressing the deadweight loss in the health-care system appears to be to yield our place as the world’s Reserve currency of choice. There does not appear to be much of an appetite for that, even if there were a clear mechanism to do so.

As economists we look for the suboptimal.  In this case, we can identify the areas where the returns are low—defense spending—the areas where spending growth might be moderated—Government Direct Consumption, although that is a very nominal portion of the Federal budget—and areas where there are clear deadweight losses—health care spending.  Only the latter shows much promise as a direct, not just a marginal, way to address the problem.

by Bruce Webb

Whence Teabaggery?

Opponents of Health Care Reform vow to keep up their efforts and sweep Republicans to victory in November. But where do they take their stand? Up to now they have been opposing potential legislation that existed mostly in their own imagination: Socialized Medicine, Obamacare, Government Bureaucrats between You and Your Doctor. But now that the die is cast, because in the bigger picture the reconciliation bill is just tinkering around the edges, what will actually change for the average Teabagger?

Will they have to get government approval to see a doctor? Well no. Will there be dramatic changes in their out of pocket expenses? Well no, if anything the change will be in the other direction. Will insurance or the hospital start denying them categories of care? Well no, same thing. The fact is that if you already have insurance, and from the looks of most of the Teabag crowd they already do, you will see zero change between now and November. At least negative change.

Will the passage of Obamacare put us on the path to Socialized Medicine? Well maybe, personally I believe that the changes in this bill will over the long-term drive change in that direction. But will anyone notice any big changes in the interim? Well no. And what changes they do notice will be positive, at least in the short run, because the sweeteners in the bill are front-loaded. More under the fold.

More below the fold...

by cactus

A Brief Review of Econned

I have read the first few chapters of Econned by Yves Smith, that's about where I re-evaluate and decide whether its worth reading through the first 80% of the book. When the answer is yes, I usually re-evaluate the 80% mark. As a result, I don't always get all the way through a lot of books I pick up. Time is a valuable commodity.

Anyway, I've gotten far enough to decide that not only is it worth going forward, I will be finishing this one. I also believe I've gone far enough to know this book is worth recommending if you're looking at a book to tell you about the causes of the Great Recession. What I've seen so far - Smith covers a lot of ground that is well trodden, but she does it well, and smoothly, entertainingly, and she connects the dots. Its fairly clear that a) the models of the world that much of the economics profession had were wrong (and here Smith pulls no punches - Paul Krugman, an ideological ally, is one of many targets) and b) many (most?) economists simply refuse to give up on models even if they don't conform at all to the facts.

Now, its impossible to avoid discussion of the people involved in making the meltdown process happen, and little bits of gossip are what make a book readable. But unlike other books about the Great Recession I've picked up recently, such as David Wessel's In Fed We Trust, Charles Gasparino's The Sellout, and Andrew Ross Sorkin's Too Big to Fail, the book is more about the ideas than the people, and more about what's wrong with bad models or CDSs than the people peddling them. If you think knowing which big player puked on the way to which boardroom while Bear Stearns was imploding, or where a given CEO summered in 2008, this is probably not the book for you. If you want a good idea of what happened to get us to the period from 2007 to 2009, this book will help you understand.

In that regard, its like Barry Ritholtz' Bailout Nation, another book worth reading. The difference is, Ritholtz' language is a bit more colorful, and Bailout Nation is the story of a bunch of crooks and idiots and idiot-crooks run wild. Smith's focus is more on the BS that pervades the economic profession that aided and abetted Ritholtz' bunch of crooks and idiots and idiot-crooks run wild. The two books complement each other very nicely.

Robert Waldmann

Was just talking to his mom and dad (Dr Waldmann and Dr Waldmann). They had CNN on. I couldn't see my screen from where I was talking on the phone, so I heard from Dr Waldmann (Thomas) that Stupak had said yes and that someone who is very pro-choice said she had no problem with the executive order because it adds nothing to the Hyde amendment. So he asked what's going on and is this a fig leaf for Stupak

I said, no dad, a figleaf covers more. This is a maple leaf. The reference to Canada was inadvertant. We don't have Medicare for all, but at least Stupak caved and got much to little to cover up his uhm leadership ability.

The text of the executive order here.

I'll just quote the key parts after the jump.

More below the fold...

by Bruce Webb

Well it has been a relatively quiet winter on the Social Security front, but we are fast coming up on what I only half-jokingly call the "Bestest Day of the Year", the release of the Annual Report of the Trustees of Social Security. The Report has in many recent years come out reliably on the last day of March but can be as late as May (as it was last year, perhaps because the Trustees were not all in place). When it does come out it can be found, viewed and downloaded at SSA: Trustees Reports. The first thing I look at is of course the bottom line, what the number is for the actuarial gap and the date for Trust Fund exhaustion, but the second thing I look at is the magnitude of the change from 2009 and more importantly the reasons for that change. For example a couple of years ago the outlook brightened more than I expected, and a few years before that had darkened more than expected. Well it turned out that changes in assumptions about immigration in the first case and interest rates in the latter accounted for almost all the difference, very little was actually due to short term economic projections. So if there is anyone out there really prepared to dig into the tables it might be worth your time to review the 2009 Report, or at least the 15 page Summary, both available at the link.

The Report takes on some new urgency this year because of the appointment of the President's Deficit Commission, which really should be called the Entitlements Commission. Because its leadership has made it clear that taxes and military spending will NOT be on the table, this will all be about what Co-chairman Alan Simpson calls the Big Three: Social Security, Medicare, and Medicaid. And the deck has been stacked. For those who haven't been following the Commission will have 18 members, six appointed by the President, only four of whom can be Democrats, six by the House and six by the Senate. And although there is a requirement for a 14 vote super-majority to advance a recommendation, something that would normally insure gridlock, it appears that Obama is appointing five people favoring 'reform' and only one firm defender of Social Security (Andy Stern of SEIU). Since it is a given that all six Republican Congressional members will be in favor of gutting Social Security, and knowing that of the three Senate Dems Durbin, Baucus and Conrad only the first is a lock to support Social Security as currently configured, blocking 14 votes means getting all 3 of Pelosi's representatives, and we are already seeing reporting of intense pressure to appoint "at least one" Blue Dog. Meaning there is great risk of having 'reformers' walk in the door with 14 votes locked down. And the only way supporters are going to be able to fight back is to make sure they are using real numbers, and that their proposals don't play tricks like applying a 5.2% worker paid fix to a problem scored 1.92% (as has been done before with LMS).

And along with posts dealing with the Report release and the Commission expect some re-caps of the ins and outs of Social Security finance itself. Familiar territory to some here, but necessary for people just entering the fray. But enough for today, the basketball is starting. Arrivederci.

Robert Waldmann

Yves Smith discusses how investment bankers get their sense of entitlement. Just read it.

Robert Waldmann

A punk staffer is a staffer who laughs when you say “A repo man spends his life getting into tense situations.”

John Boehner makes it clear. He agrees with Senator Durbin that, frankly, bankers own that place. However, he thinks that’s the way it should be. Why the constitution says right in article 1 of the constitution that congress may ”regulate trade between the several states so long as the masters of the universe approve of the regulations.” Boehner told bankers to protect the constitution and not let congress aka “punk staffers” deprive them of their legitimate authority to legislate.

Extensive efforts at achieving inter-generational communication follow the jump.

More below the fold...

Ken is here today. The conference will be webcast, and you can submit questions here.

I have been asked to repeat some of my past post on the stock market. In particular they wanted to see this long term chart of the S&P 500 price/earnings ratio. Until the 1990s bull market a PE of over 20 on trailing earnings was always a signal of an impending bear market as a PE of over 20 was never sustained. There is a long pattern of the market PE swinging from over 20 to under 10. Moreover, even though many Wall Street strategist talk about the long term average PE of about 15, there is no central tendency for the market to converge on the average of 15 and it really does not stay around 15 any longer than around any other value. Prior to 1926 the data is from Robert J. Shiller's Irrational Exuberance . From 1926 to 1989 it is from S&P and after 1989 I calculate it from S&P's estimated operating earnings data.



I use operating earnings because it is what most professional investors use and I believe that the estimate of on going operations is the most relevant measure to value future earnings. Of course, right now it does not make much difference as operating EPS and reported EPS are about the same. Last year's big difference between the two measures stems largely from the massive write-offs by financial firms . Moreover, much of the recent big snap back in earnings is the write-offs rolling out of the four quarter trailing earnings data.

But as these write-offs rolled out of the data is generated a big drop in the market PE based on trailing earnings to about 19. In my valuation model that makes the market fairly valued to cheap.
In a highly cyclical environment as we are now experiencing many people like to use an estimate of "normalized earnings" to eliminate cyclical earnings distortions. So if you use the 7% trend growth in the above chart of operating vs reported earnings to estimate the market PE you get very similar results. Shiller, and some commentators at this blog use the 10 year trailing earnings. When you are dealing with an individual company where the long term earnings growth trend can change, that rule is a very good practice and builds in a measure of safety. But the long term earnings growth for the entire market is unlikely to change rapidly, so I feel comfortable with this approach.
If the economy is in a Japaneses deflation trap of course the trend earnings would be lower.

In my experience the impact of rising interest rates depends on whether of not the market is expensive or cheap. Over the long run the relationship between the PE and interest rates is roughly that a 100 basis point change in yields will generate about a 100 basis point drop in the market PE. But if the market is overvalued like it was in 1987 -- my estimated PE was 14 and the market PE was 22 before the crash -- the market tends to rapidly close that gap. But if the market is cheap it can withstand the pressure of rising rates much better.

So maybe we should look at the prospects for earnings. The recent productivity report received much attention. But I did not see anyone point out that the spread between nonfarm corporate prices and unit labor cost was 5.25%, the widest spread on record.
This spread is the single most important variable driving corporate profit margins and implies that you should expect major positive earnings surprises.


In addition, corporate profits are very much a function of deviations from trend in real GDP growth. So with margins extremely wide and reasonable prospects for above trend growth, profits should continue to rebound strongly.


With the big margins improvement profits in the national accounts have already rebounded to above trend.



The other thing investors worry about that could be a major threat to the market is inflation. I'm in the school that believes sufficient excess capacity in the economy, whether measured by the output gap, the unemployment rate or capacity utilization, to keep inflation under control for the time being.
However, there may not be as much excess capacity as many believe. Much of the unemployment is structural . Moreover, the Fed estimates that industrial capacity is actually contracting and the growth of potential real GDP is at record lows.
For this year, I do not expect this to impact many prices outside of basic commodities, but in the out-years it could become a significant problem.


Contrary to many claims, the reason capacity creates a potential problem is weak business fixed investment. Despite low marginal tax rates and record profits real
business fixed investment was extremely weak over the last cycle. I will not go into a whole litany of reasons for weak investments, but I will just point out that in the 1960s, 1980s, 1990s, and the 2000s that capital spending was inversely proportional to marginal tax rates.

So, I've given everyone a wide range of topics to discuss and debate. Have fun.

More below the fold...

T.R. Reid hosts a Presentation of Money-Driven Medicine on Link TV (see reception information) As taken from Maggie Mahar’s Health Beat Blog. A special investigative TV program is being aired detailing healthcare costs and the healthcare system. The topic is timely and well worth the time watching in order to gain a greater understanding on what is wrong with healthcare in the US.

Robert Waldmann

Let me join Brad DeLong in Saying

Let Me Join Pete Davis in Saying: "Thank You Marjorie Margolies-Mezvinsky"
Pete Davis expresses the sentiment very well:

Thank You Marjorie Margolies-Mezvinsky: I've always wanted to thank Marjorie Margolies-Mezvinsky (D-PA) for her courageous deciding vote for President Clinton's 1993 deficit reduction bill. Her Republican colleagues jeered her as she walked down the aisle to cast her vote with shouts of "Bye, Bye Marjorie!" Her crime -- voting for the Omnibus Budget Reconciliation Act of 1993 that reduced the FY94-FY98 deficits by an estimated $496 b., with $241 b. of tax increases and $255 b. of spending cuts. The bill capped a 12-year deficit reduction effort, leading to the budget surpluses of FY98-FY01. She paid the political price, losing her seat in suburban Philadelphia after her first term in office, but she set the U.S. economy on course for its strongest decade since the 1960s.

Unhappy is the country which needs heroines.

So she lost her seat, but who else's service in Congress do I remember with such gratitude ? Answer, Senator George [ed] Mitchell*.

It is important that Marjorie Margolies-Mexvinsky's political heroism is not forgotten. The fact that it is remembered might help some current Representatives find some courage.

* He turned down a seat on The Supreme Court and didn't run for re-election so that he could concentrate on passing Clintoncare. No good deed goes unpunished. For his virtue he was sent to try to solve the damnable question of Northern Ireland. He succeeded. No great deed goes unpunished either and he is now in charge of mideast negotiations. In a just world, Newt Gingrich would be trying to get Israel and Hamas to make peace, and Mitchell would be cashing in** and appearing on TV to pontificate. But, in a just world we wouldn't need Marjorie Margolies-Mezvinsky or George Mitchell.

** Of course he has cashed in, but that was long ago, and in another country (the USA).

Recently the Wall Street Journal editorial page and numerous conservative/libertarian bloggers have shown charts comparing the last few years spike in the teen age ( 16-19 year olds) unemployment rate with the rise in the minimum wage in an attempt to blame rising teen unemployment in 2008 and 2009 to the minimum wage hike. But more detailed data from the BLS shows that teen employment at the minimum wage rose 46.1% in 2008 and 50.1% in 2009. This detailed data implies that the rise in the teen unemployment rate from around 15% in 2007 to over 25% in late 2009 was entirely due to the great recession, not the rising minimum wage. This data is so compelling that I think at a minimum these conservative/libertarian at least owe us an explanation as to why it does not disprove their argument.


On 9 February--Minimum wage disinformation --I published a chart that showed since 1960 there have been 18 increases in the minimum wage. Nine of those increases were accompanied by a falling teen unemployment rate and nine were accompanied by a rising teen unemployment rate. The difference was that the nine times teen unemployment rose were also associated with a recession while the other nine occurred in an economic expansion. This chart and regression analysis clearly implied that the bulk of the increases in teen unemployment since 1960 was due to recessions, not rising minimum wage.

Now the BLS has published more detailed data on teen employment at and above the minimum wage in recent years. This data contains several surprises that tend to strongly contradict the standard theory of teen employment and the minimum wage taught in most economic textbooks.

First it shows that during the years 2002 to 2007 when the nominal minimum wage was unchanged, teen employment at the minimum wage was less than 10% of teen employment. Over 90% of teens were paid more than the minimum wage.

Second, over this period of a flat nominal minimum wage the real minimum wage was falling and each drop in the real minimum wage was associated with a drop in the number of teens employed at the minimum wage. Teens clearly though that school work, public service -- so important in college applications -- sports or leisure activity like video games was a more valuable use of their time than working at a minimum wage job. Consequently, firms had to offer a higher wage than the minimum wage to induce teens to work for them. This is why the share of teens paid more than the minimum wage rose from 2002 to 2007. This should not be any great surprise to an economist. It is standard economics 101 that if you want more of something you offer a higher price. I have never really understood why most economics instructors spend much of an economics course teaching that if you want more of something -- raise prices. Than they turn around and teach that you will get more teen minimum wage employment if you offer a lower price. YEAH RIGHT -- and they wonder why the students have trouble getting it.

More below the fold...

Angry Bear Ken Houghton will be a panelist, and other participants in the conference include Mike Shedlock, Mark Thoma, Paul Romer, Alex Tabborak.

Economics Bloggers Forum
8:30 a.m. - 4:00 p.m. CDT
Friday, March 19, 2010

Watch leading economics, technology, and finance bloggers discuss key policy issues and cutting-edge research on topics related to entrepreneurship, innovation, and growth.

View Webcast

Agenda (all Central Times) includees:

9 a.m. Keynote Speaker
David Warsh, author of the online economics column www.economicprincipals.com, will discuss his experiences in and assessment of the nascent business of blogging in the context of the evolving print journalism industry. Warsh was a long-time economics columnist for the Boston Globe where he wrote online weekly for seven years. He is the author of three books, most recently Knowledge and the Wealth of Nations: a story of economic discovery.

9:30 a.m. Panel 1-Great Recession: Impact on America's Future?
Moderator: Paul Kedrosky
Panelists: Bob McTeer, Megan McArdle, Mark Thoma

1:00 p.m. Persuasion and Norms
Paul Romer

1:30 p.m. Panel 2-Is Growth a Mystery? Haiti, Afghanistan, Africa...
Moderator: Tim Kane
Panelists: Alex Tabarrok, Allison Schrager

2:30 p.m. Panel 3-U.S. Fiscal Mess: How Does It End?
Moderator: Robert Litan
Panelists: Donald Marron, Ryan Avent, Ken Houghton, Mike Shedlock

3:45 p.m. Closing Remarks
Carl Schramm, president and CEO, Kauffman Foundation

Robert Waldmann

I am very glad that John Quiggin has found a group even less worthy or respect than us macroeconomists. He writes

It seemed for a little while as if the delusionists had scored another win, when Phil Jones, the scientist who has been most viciously target by the hackers/harassers gave an honest answer to a deliberately loaded question prepared by them and put to him in a BBC interview

BBC: Do you agree that from 1995 to the present there has been no statistically-significant global warming?

[kip]

Looking at the responses of ’sceptics’ to this episode we can distinguish four or five sets (depending on your views about set theory)

[skip]

5. Those genuine sceptics who pointed out the dishonesty of the claim, and called out those on their own side of the debate who promoted it. Obviously, members of this set deserve some serious respect and attention in the future. Unfortunately, the intersection between this set and the set of “sceptics” in the currently prevailing sense appears to be the empty set[2]

That's 5 sets Professor Quiggin. It's also statistically significant evidence that global warming skeptics are, on average, either more clueless, more dishonest or both than the general population. Also the data set does not contain statistically significant evidence against the hypothesis that all global warming skeptics are incapable of understanding basic statistics, recklessly irresponsible and total liars.

Quiggin assumes that most are only one or two of these things, but there is no evidence for his belief in the data set he analyses.

Thin comfort for macroeconomics. What Quiggin has shown is that climate science is science, just as he has shown that macroeconomic science is not science in "Zombie Economics."

by cactus

A Tale of Two Clients - And Lessons Lehman Learned Late or Not at All

My first "real" job (i.e., after grad school) was at what was then a Big 6 accounting firm (and is now a Big 4 accounting firm) doing "transfer pricing." I wasn't right for the job (or the environment), nor was the job (or the environment) right for me. But I did learn a lot about how the world works.

One of the big clients serviced by the transfer pricing group from the office I was working is a household name. Other than North Koreans and people with some form of mental impairment, I doubt there's anyone anywhere in the world over age eight who would fail to recognize the company name or its logo. And to be honest, I'm not sure about the North Koreans. Another big client has a name that is only slightly less recognizable. I'll call them Co. 1 and Co. 2.

Now, when I was there, Co. 1 was very aggressive on tax issues - which means it was willing to push the envelope and see how far it could push the IRS. The odd fine or two for going too far was just a cost of doing business, and it expected its highly priced Big 6 accounting firm to produce, ahem, tax plans that fit the bill. Essentially that meant coming with, ahem, tax plans that were cutting edge enough that the IRS hadn't seen them yet but that on the face of it resembled something that had in the past gotten an official OK, either through a regulation or some court decision. That would be enough to get a law firm to write a letter saying it was their opinion this was OK, no matter how much what was being done might sound, to the uninitiated, to be questionable or even illegal. Incidentally - on the rare occasions when the firm came up with a scheme on its own, it was the job of its advisers (i.e., accounting firms and law firms) to get the client to make sure that whatever changes were necessary to keep things on the right side of the blurry line were made.

Co. 2 took more the pussycat approach with the IRS. They seemed to feel that if they didn't push too hard, they'd avoid a lot of hassle from disputes with the IRS. They were, of course, right, and it cost the Big 6 accounting firm, but then the Big 6 accounting firm wasn't exactly losing money on this client so it was happy to oblige.

In other words, accounting firms are like criminal attorneys - they represent the client and try to do what their client believes is in their best interest. They advise their client when they think their client has taken a suboptimal turn, but when the client wants to do X, if its not explicitly illegal, the firm finds a way to make it happen.

All of which is to say, if the allegations that came out last week about Lehman's accounting schemes are true, and if as those stories indicate, Lehman was forced to find a non-American law firm to sign off on what they were doing, one of the following must be true:
a. Ernst & Young personnel working on the account had no idea what Lehman was doing.
b. E & Y personnel working on the account knew what Lehman was doing (perhaps having peddled the scheme to Lehman themselves) but had no idea it was an obvious no-no to the IRS.

Either way, it looks to a casual outsider like me that E & Y had a B-team made up of PONIs (partner of no importance) on the job, and that should have been obvious to Lehman. Now Lehman should have been a big enough client to warrant a few POGIs (partner of great importance). If Lehman did not seek out out or deliberately avoided the best possible representation, they were guaranteeing an eventual disaster. Deliberate ignorance or deliberate evasion (the allegations would imply one of these two to be true) of the law doesn't go over well when the doo-doo hits the fan.

But it goes the other way too. E & Y's POGIs should have realized that Lehman's business model involved taking big risks. Why would they have assumed that Lehman was going to be satisfied with orthodox accounting practices? And as the old saying goes, you don't send a boy to do a man's job. The Anderson/Enron debacle is a clear demonstration that if some partners certify a client's shenanigans, and those shenanigans come to light, the entire firm will take a hit. (And that, of course is the flip side of everyone benefits from the shenanigans as long as they haven't been forced to a complete halt.)

So, what do you think about the situation?

Cactus

American Conservative Magazine considers who is feeling the the new anger against 'liberals' from the Feb.17 Mt. Vernon statement of the Conservative statement of principles:

One of the things that many people have noticed since the release of Mount Vernon statement on Wednesday is the sharp contrast between the youth of the creators (my link) of the Sharon statement and the notable absence of students and young people from the latest gathering. Christopher Buckley quotes Sam Tanenhaus on this point, “The new/old submission seems more like Geriatrics Against Obama.” Fifty years ago, one could have written, as Nile Gardiner does today, that “conservatism is the future” with some reason for believing the claim to be true, and in the decades that followed there was a significant conservative political coalition that seemed to be growing in strength over time. Today it is increasingly difficult to believe anything of the kind.
....
On average, Millennials’ underlying social and political views put them well to the left of their elders. If you dig into the full report, you will see that the recent Republican resurgence owes almost everything to the dramatic shift among members of the so-called “Silent Generation,” whose voting preferences on the generic ballot have gone from being 49-41 Democrat in 2006 to 48-39 Republican for 2010. There have been small shifts in other age groups toward the Republicans, but by far it is the alienation of voters aged 65-82 that has been most damaging to the Democrats’ political strength*. As we all know, these are the voters who are far more likely to turn out than Millennials, which is why Democratic prospects for this election seem as bad as they do even though the Pew survey says that Democrats lead on the generic ballot in every other age group. Among Boomers, Democrats lead 46-42, and among Gen Xers they barely lead 45-44. In other words, the main reason why the GOP is enjoying any sort of political recovery is that many elderly voters have changed their partisan preferences since the last midterm. Republicans remain behind among all voters younger than 65. That does not seem to herald the future revival of movement conservatism of the sort Gardiner is so embarrassingly praising.