December 04, 2007
Are The Borrowers At Fault?
Ryan Avent argues that, though some loan officers may have been unscrupulous, the real cause of the housing crash was stupid, greedy, borrowers, who wanted more loan in order to buy more house. This, Ryan says, is why so many ended up in the subprime market when they qualified for fixed rate mortgages. And maybe so.
Neither Ryan nor I have any data on how these conversations actually went. But whether it was the loan officer pushing the borrower off the variable-rate cliff or the borrower begging for a bit more rope with which to hang herself or, most likely, a bit of both, doesn't much matter. It is perfectly well understood that borrowers, by and large, know nothing of loans. It's a market that operates with a huge asymmetry of information. And though we know that loan officers are, in fact, loan salesmen, they are not presented that way -- instead, they're offered up as helpful experts waiting to guide you to a safe and secure financial solution. They're presented, in other words, like loan doctors.
What's supposed to govern their behavior isn't merely basic morals and business ethics, but a sense of concern for their company. If too many individuals enter into loans they can't afford, defaults will rise and the bank will suffer. Which is exactly what's happened. The loan officers, and above them, the banks, and above them, the regulators, were the ones with the knowledge, power, and authority to head off this mess. This market works, it exists, because we trust them to run it in such a way that does not massively exploit the ignorance of individuals, and does not put the entire economy at risk. They failed. But, unlike with the individual borrowers, they failed when their whole mission in life was to not fail, when they were paid to have the tools and information to not fail, and now, in reconstructing this market, we need to figure out what regulations will keep them from failing again. The behavior of the borrowers, financially stupid though it may have been, is simply not equivalent. This whole banking superstructure has supposedly evolved to help them -- to suddenly turn and say that it was a self-interested enterprise they had to outthink the whole time is quite strange.
November 19, 2007
Speaking of Stiglitz's article in Vanity Fair, his scoring of the last few decades is about as concise a summary of the liberal's take on recent economic history as I've seen:
The Clinton years were not an economic Nirvana; as chairman of the president’s Council of Economic Advisers during part of this time, I’m all too aware of mistakes and lost opportunities. The global-trade agreements we pushed through were often unfair to developing countries. We should have invested more in infrastructure, tightened regulation of the securities markets, and taken additional steps to promote energy conservation. We fell short because of politics and lack of money—and also, frankly, because special interests sometimes shaped the agenda more than they should have. But these boom years were the first time since Jimmy Carter that the deficit was under control. And they were the first time since the 1970s that incomes at the bottom grew faster than those at the top—a benchmark worth celebrating.
By the time George W. Bush was sworn in, parts of this bright picture had begun to dim. The tech boom was over. The nasdaq fell 15 percent in the single month of April 2000, and no one knew for sure what effect the collapse of the Internet bubble would have on the real economy. It was a moment ripe for Keynesian economics, a time to prime the pump by spending more money on education, technology, and infrastructure—all of which America desperately needed, and still does, but which the Clinton administration had postponed in its relentless drive to eliminate the deficit. Bill Clinton had left President Bush in an ideal position to pursue such policies. Remember the presidential debates in 2000 between Al Gore and George Bush, and how the two men argued over how to spend America’s anticipated $2.2 trillion budget surplus? The country could well have afforded to ramp up domestic investment in key areas. In fact, doing so would have staved off recession in the short run while spurring growth in the long run.
But the Bush administration had its own ideas.
Stiglitz, as you might imagine, goes on to detail what those were, and why they might have fallen short of the optimal policy path open to the country. But then, you wouldn't want to read such spurious slanders of this administration's wise economic management, would you?
November 14, 2007
The Dangers of Performance Pay
James Surowiecki lays it out:
a recent study of almost a thousand companies by the management professors W. Gerard Sanders and Donald Hambrick found that C.E.O.s whose compensation was made up mostly of stock options tended to “swing for the fences,” making investments and acquisitions that were riskier than those made by other executives. As a result, the performance of the companies run by the risk-takers was far more volatile, and not for the good of the companies: the risky strategies were more likely to end in a big failure than a big gain. Generous options grants may also encourage fraud; the business professors Jared Harris and Philip Bromiley, who have made a study of hundreds of firms forced to restate earnings after accounting irregularities, found that companies that paid out most of their compensation in stock options were far more likely to end up restating earnings. And, as with hedge funds, the perverse effects of performance pay are exacerbated by the fact that big bonuses are often based on short-term performance. Stanley O’Neal, who was recently forced to resign as the C.E.O. of Merrill Lynch, made eighty-four million dollars in 2005 and 2006, a figure based in part on the huge profits that Merrill booked as a result of its forays into the subprime market. This gets to larger issues with so-called "performance pay."
Depending on what metrics you're using to evaluate performance (and thus dictate pay), you risk distorting a worker's incentives to approach their job in a balanced, prudent, way. If a teacher's whole compensation is based on test scores, for instance, you'll not only have a lot of teaching to the test, you may simply see the test -- or at least past versions of it -- being taught. That may make for comfortingly high test scores, but it may also lead to less actual learning, less critical thinking, less adaptive educations, etc. If a CEO's pay is based on stock options, amping up the price of the stock -- even in the short-term -- becomes more attractive. If a journalist were to be paid on a per word rate, you'd get a lot of block quoting and very few contractions. And so on, and so forth. This stuff isn't as easy as people would like it to be.
November 12, 2007
Towards a Better Globalization
Does big government actually act as a facilitator of globalization, free trade, and open economies? The answer on this one is supposed to be no, of course not. Government mucks everything up, and burns your money in their big money chimney, and blah blah blah. But Denmark, Sweden, and other Nordic countries have, in recent times, acted as contrary evidence to this thesis. Their model, where an expansive social safety net reduces economic insecurity and thus reduces public fear of a dynamic economic system, has acted as a useful social democratic alternative to our system, where the losers of globalization are unprotected and uncompensated, and globalization is kept politically viable mainly through the support of elites. Among these two alternatives, the Nordic model has been painted as quirky and unsustainable. New research, however, suggests that the Nordic model is actually the historic norm for globalizing countries, while our approach is actually something of an aberration.
Which makes sense. Individuals are risk averse. When offered a new economic system which will increase their risk, but offer random and concentrated economic gains to people who likely aren't them, they're not generally terribly interested in switching over. If those economic gains however, were channeled into programs or institutions that protected them, and even made their lives better, things might be a bit different. That's what the Nordic countries have found, where social spending creates the political environment that facilitates a dynamic economy. America's found that elite support can trump popular anxiety, and so globalization can be furthered that way. But it' sprobably not the most sustainable approach.
October 29, 2007
Of Markets and Tomatoes
Far be it for me to argue with Brad DeLong about economics, but his response to a commenter bemoaning the absence of fresh, taste-driven produce during his childhood seems a bit off-base. Rubber tomatoes, the commenter writes, were all the stores carried, because they were all that would survive the trip, all that would endure throughout the entire year, all that seemed profitable. In reply, Brad says, "Why didn't you taste a tomato worth eating for the first twenty years of your life? What stopped you? Was some commissar standing over your parents waving a kalishnikov? Or did your parents just not think it was worth the extra money?"
Or maybe there weren't any around. As I said above, I would never argue with Brad about economics. But I will let Joel Waldfogel do so, by way of his new book The Tyranny of the Market. As he argues, the market often makes decisions much as a crude central planner would make them, advantaging majority preferences to the point that minority products just about vanish from the market. So it may well be that in the days of the rubber tomato's hegemony, in the place where Brad's commenter lived, there simply weren't any delicious, flavorful, tomatoes. There wasn't a farmer's market, or a specialty produce store. There was just the type of tomato that the local grocery thought would make them the most money. And that was a rubbery tomato. In recent years, Whole Foods and others have shown that consumers will pay for better produce, and eating seasonally has come into vogue, so minority preferences in food have grown large enough to give most urban and upscale customers access to finer products. But that's hardly a universal situation even now, and it certainly wasn't then. You could go through life never tasting a good tomato because you simply didn't know there was any type of tomato beyond what you bought at Safeway.
October 22, 2007
What Makes An Economist?
David Kennedy, reviewing Paul Krugman's book, framed his essay with an old quote from Francis Amasa Walker:
maybe Krugman is not really an economist — at least not according to the definition offered more than a century ago by Francis Amasa Walker, the first president of the American Economic Association, who wrote that laissez-faire “was not made the test of economic orthodoxy, merely. It was used to decide whether a man were an economist at all.”
Sadly, particularly for a historian who later accuses Krugman of getting his history wrong, Kennedy botches it. Walker was mocking that view, asserting its hollowness and bankruptcy, just as Krugman does. But Krugman/Kennedy contretemps aside, the Walker speech is worth excerpting, and marveling at how current it sounds for an address given in 1888:
Yet, while Laissez-Faire was asserted, in great breadth, in England, the writers for the reviews exaggerating the utterances of the professors in the universities, that doctrine was carefully qualified by some economists, and was by none held with such strictness as was given to it in the United States. Here it was not made the test of economic orthodoxy, merely. It was used to decide whether a man were an economist at all. I don't think that I exaggerate when I say that, among those who deemed themselves the guardians of the true faith, it was considered far better that a man should know nothing about economic literature, and have no interest whatever in the subject, than that, with any amount of learning and any degree of holiest purpose, he should have adopted views varying from the standard that was set up....
The abandonment of Laissaz-Faire, as a principle of universal application, however strongly individuals may still maintain it as a general rule of conduct, at once makes communion and cooperation, not merely possible. but desirable among economists. When it is confessed that exceptions, not few or small, are to be admitted, every thinking man has a part to take in the discussion; every interested and intelligent person becomes a possible contributor; every class of men, whether divided from others by social or by industrial lines, have something to say on this subject, which no other class can say for them, and which no other class can afford not to hear from them. The characteristic institutions of every nation, the experiences of eyery distinct coinmunity not only become pertinent to the subject, but constitute a proper part of the evidence which is to be gathered, sifted and weighed.
September 06, 2007
How Bad Is The Wall Street Journal?
Will Wilkinson takes unsurprising issue with my characterization of The Wall Street Journal editorial page as "mendacious, extremist, and intellectually sloppy." So let's look into it: On August 24th, they published an editorial entitled "How To Raise Revenue." In it, they promised to defend further tax cuts on grounds of equity. They did so by arguing that "The supply-side revenue effects on the rich are remarkable: Tax rates on higher incomes have been halved, but the federal tax share of the top 1% has nearly doubled." They even produced a helpful graphic:
Can't argue with a graphic. But you can mention what it leaves out. According to the Pikkety and Saez data, in 1980, the income share of the Top 1% was 8.18% of the national total. In 2004, it was 16.08%. For those playing along at home, that's a 96% increase.
During the same period, their share of federal income taxes went from 19% to 36% -- a 89% increase. So controlling for the increase in income, the tax burden on the rich fell. That's some remarkable supply side effect: As the incomes of the rich go up, their tax liability goes down. And it didn't just drop a few percentile points: Because we have progressive tax rates, as more income pooled at the top, their tax liability should have increased substantially, as they'd pay more on that income than less wealthy families would.
The Wall Street Journal editorial page either couldn't figure this out -- in which case they're innumerate -- or they didn't want to tell their readers, in which case they're mendacious. Either way, why does Will believe this is an institution worth supporting?
September 05, 2007
Should Economists Rule The World?
In stark contradiction to Bryan Caplan's thesis that we should all slowly back away from our government and let trained economists take over, a new paper by Anil Hira examines leaders from across the world and admits that "we cannot conclude that leadership training in economics leads to better economic outcomes." I chalk it up to the fifth and most deadly type of anti-market bias: Anti-economist-bias...
Update: Speaking of anti-economist bias, Matt suggests I have some. I don't! Honest! Some of my best friends are economists! Rather, I appropriate the Rick Perlstein line on conservatism and say: Economics cannot fail. It is only failed. A lot. For instance: Matt writes:
The ideas the Bush administration, The Wall Street Journal, and all the rest are working with are marginal, crackpot notions that are being mainstreamed through relentless message discipline. There isn't some army of orthodox neoclassical economists out there who think that returning to Clinton-era levels of taxation would wreck the economy, that retirement security can best be provided to all by expanding tax breaks for rich people, that health care can best be improved by expanding tax breaks for rich people, that sound education policy requires expended tax breaks for rich people etc.
That's correct. But nor is there some army of orthodox economists out there saying that. Indeed, highly respected orthodox economists like Greg Mankiw, who knows the supply siders are peddling quackery and said so in his textbook, happily contributed his voice and legitimacy to the quackery in 2003.
Jon Chait is right that the supply siders are maniacs, but they aren't marginalized maniacs, and that's in part because that economics profession hasn't seen fit to marginalize them. Mankiw may say, in his textbooks, that they're charlatans, but when push came to shove he joined their cause, disagreeing, he says, with some of their nuttier claims, but nevertheless lending them and their claims -- which included, in the Bush administration, such ideas as "returning to Clinton-era levels of taxation would wreck the economy, that retirement security can best be provided to all by expanding tax breaks for rich people, that health care can best be improved by expanding tax breaks for rich people," etc -- his name and credibility. And it wasn't a one-off: Mankiw is now a prominent advisor to Mitt Romney, who says discredited things like "“If you lower taxes enough, you create more growth."
Meanwhile, there's no outlet in the world that publishes as many economists -- and good ones, too, Nobel Prize winners -- as The Wall Street Journal editorial page. We know, and many of those economists know, that that editorial page is mendacious, extremist, and intellectually sloppy. But they nevertheless publish there, lending their titles and credibility to an outlet that continually promotes a fundamentally poisonous and empirically laughable ideology. This is, in large part, how supply-siderism survives. Not because economists believe it. But because the Right is very good at setting up incentives so it's good for the careers of otherwise credible individuals to seem like they're promoting it. And it's a shell game many economist happily participate in, and that grievously harms the country.
August 17, 2007
Fed Cuts the Discount Rate to 5.75%
By Deborah Newell Tornello
Not that this was entirely unexpected (though I read plenty of self-assured speculation that Bernanke would hold out--for a while, at least). But still.
With risks to the economy from financial market turbulence rising "appreciably," the Federal Reserve on Friday lowered the rate it charges banks on loans they receive from the Fed's discount window, though it opted not to cut its primary policy tool, the federal funds rate.
The Fed's decision to lower the discount rate and ease the terms of discount borrowing but not to cut the fed funds target suggests that for now it believes the problems in the markets are mostly related to the availability of cash, not the price of cash. (Read the Fed's statement.)
One wonders if (and when) the interest rate might be treated similarly, and how long it will be before the nasty I-word fully rears its head. Economic reporters may be great looking--some even earn nicknames like The Money Honey--but economic realities tend to be rather less attractive, at least in the opinion of this observer.
August 16, 2007
Government and Markets Sitting in a Tree...
The New York Times editorial page gives in to its inner progressive today:
You would think that we were living in the lap of the Nanny State. One of the most puzzling facts of the political debate is how much traction Republicans still get from their calls to cut taxes and public spending, and how timorous Democrats are in arguing against them.
The United States has long had one of the most meager tax takes in the industrial world. America’s social spending — on programs ranging from Medicare and Social Security to food stamps — is almost the stingiest among industrial nations. Among the 30 industrialized countries grouped in the Organization for Economic Cooperation and Development, only four — Turkey, Mexico, South Korea and Ireland — spend less on social programs as a share of their economy.
Long a moral outrage, this tightfisted approach to public needs is becoming an economic handicap. Shortchanging public health impairs America’s competitiveness. If the United States is to reap the rewards of globalization, the government must provide a much more robust safety net — to ensure public support for an open economy and protect vulnerable workers.
This is sort of the point my Richardson article hinges on: More social spending can actually be a growth-accelerant. There are certain things the market can't provide efficiently, and many things the government can't provide efficiently. Only a few of those are in the overlapping part of the venn diagram. And you improve your economy -- not to mention the lives of your citizenry -- when you move goods that could be better provided by the government out of the market's grasp. In the Joseph Stiglitz talk I reference in the Richardson piece, Stiglitz said:
Yesterday, I was talking to the former Finance Minister of Sweden. And Sweden has been one of the countries that has been most successful in facing the challenges of globalization. It’s a small economy, very open, with a significant manufacturing sector. In terms of some of the rhetoric that you hear in Washington and elsewhere, it should have been a disaster case. They have one of the highest tax rates. And it’s not only true in Sweden: Finland and all the other Scandinavian also have very high tax rates. If you only looked at tax rates, you would say these countries would be a disaster. And we had a discussion in which the view was that their success was in spite of. No, it’s not only in spite of, it was because of the high tax rates.
Why is that? It sounds counterintuitive. Well, the answer is it’s how the money is spent. Again, looking at both sides of the balance sheet. It was spent in ways that led to a stronger economy, enabling the economy to face some of the challenges of globalization. The net result of this is that, for instance, Sweden and the other Scandinavian countries do much better than the United States on broader measures of success like human development indicators that look at not just GDP per capita, but also look at health and longevity in terms of labor force participation. They’re doing very well.
The government can complement and enhance the market. The Right's desire to set the two in constant opposition actually holds us back.