March 2009 Archives

This picture powerfully illustrates the situation we confront. It comes from Paul Krugman's blog on the New York Times.

I'm catching up on my reading, and I just looked at the recent Census Bureau numbers on new residential sales. Can this be right? The median new home price in December, 2008 was $223,200. The median price in January was $201,100. That's a drop of 10%!

An update: No surprise, but Dean Baker at Beat the Press already remarked on this. He says:

This is a truly incredible rate of price decline. While the data is erratic, even if the decline was only half this large, a 5 percent single month decline in house prices is enormous. This suggests that house prices are in a free fall..... One should be always careful about making too much of a single month's data, but it is worth noting that this is the most current series on housing prices.....

This chart put the current market in perspective.

Thanks to Calculated Risk and dshort.com. .

Another good picture from dshort.com

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The economy is sinking fast. The nonfarm payroll employment dropped by 651,000 in February and the unemoployment rate jumped to 8.1%. Since the recession began in December 2007, about 4.4 million jobs have been lost, and over half the increase came in the last 4 months.

But the real number to focus on is the total unemployed figure: It includes the traditional unemployment number, plus all marginally attached workers, plus the total employed part time for economic reasons, as a percent of the civilian labor force. That figure is 14.8%, up from 13.9% in January and 9.5% a year ago.

Going over the industry numbers the decline was brutal--across the board with one big and important exception: Health care continued to add jobs in February, with a gain of 27,000.

In a trend that has been happening throughout the recession the previous months numbers have been revised--and their worse. Total nonfarm employment for December was revised from -577,000 to -681,000 and January was revised from -598,000 to -655,000.

Thanks to Mickey Kaus at Slate I saw this shocking number. The median sales price in the city of Detroit for the three months ending in January was $10,000. You read that right. In a city of $800,000. The data comes from Trulia

Economist Bryan Caplan at the Econolog blog highlights a new paper by Theda Skocpol of Harvard University and Suzanne Mettler at Cornell. It's a worthwhile paper in how higher education is exacerbating income inequality in the U.S.

In 1970, 6.2 percent of the U.S. population in the bottom income quartile had completed a baccalaureate degree by age 24-and that percentage actually declined slightly, to 6 percent, by the year 2000. Lower-middle-income young people from the second (to the bottom) income quartile improved their college completion rates only slightly from 1970 to 2000, from 10.9 percent to 12.7 percent. But note the contrasting trajectories for young people in the upper half of the income distribution. For those in the third quartile-solidly middle-class families-completion percentages rose markedly, from 14.9 percent in 1970 to 26.8 percent in 2000. And for the most privileged young people, those from upper-middle-class and upper-class families in the top quarter of the income distribution, college completion rates rose from 40.2 percent in 1970 to 51.3 percent in 2000. Compared to the mid-twentieth century, higher education is now increasingly exacerbating socioeconomic inequality in the United States.

The high and rising cost of education coupled with declining government support for low income families--until recently--isn't good policy in a knowledge-intensive economy.

Congress is complaining that the Obama Administration is asking too much of it. Fiscal stimulus. Bank rescue. Healthcare reform. Retirement security.

I'm not sympathetic. But I have a solution. Incentives matter.

First, a bit of background. Toward the end of 2006, American RadioWorks producer Sasha Aslanian did a one-hour public radio documentary called Imperial Washington. It was right after the November 2006 election when the voters spoke. They were sick of scandal. They put Democrats back in charge of Capitol Hill after twelve years of Republican rule. Pollsters said voters had had it with crooked lobbyists like Jack Abramoff. He's the Republican operator who bribed public officials and ripped off Indian tribes. Then there were the Republican congressmen convicted of corruption -- Duke Cunningham and Robert Ney.

There was genuine hope for reform with the new Congress. But we wondered how much will Capitol Hill really change? How much can it change?

We looked at how power and money combine to make Washington an Imperial City, where the corridors of power are dominated by insiders intimate with palace rules. One of our questions was whether the privileges and perks members of Congress enjoy go to their heads--and whether that sense of entitlement is an obstacle to change--and the answer is yes, power and privelege is an impediment..

Capitol Hill is like a small city all its own in Washington D.C.--sort of like America's Vatican. Senators and Representatives and their staff have their own subway. They never have to leave their office complex to get a haircut ... or go to the bank ... or visit their kids in day care. Members even have their own elevators.

Congress gets automatic pay raises, while most Americans have watched their wages stagnate after adjusting for inflation. But there's more than automatic pay raises. Members also enjoy a good health care plan and a gold-plated pension. Retired Members even get cost of living adjustments to their pensions, a benefit fewer than one in ten private sector pensions offer. "You run into a situation where they become so insulated, so isolated that they fail to make public policy that is truly in the interest of tax payers, said Pete Sepp of the National Taxpayer's Union, a conservative watchdog group that tracks government spending.

So, here's my idea: Take away the pension plan and healthcare plan of every member of Congress. If they want to save for their retirement they can open up an IRA. After all, about half the workforce doesn't have access to an employer sponsored pension plan at work. They can also buy their health insurance in the open market. Of course, that means they'll have trouble paying for insurance not just because it's expensive but they will then face of being denied insurance because of a pre-existing condition. And their pay should be frozen.

This isn't to be punitive. It's so that Congress can identify with their constituents, what they're going through, the risks they face, the dangers of financial fragility.

Incentives matter. My guess is that we'd have reform quick.

A musing on the stock market....

These are truly scary times. The stock market has lost some $11 trillion in value since its October 2007 peak. Blue-chip companies like AIG and Citigroup are now penny stocks, while General Motors and Las Vegas Sands trade at less than 2 a share.

It seems that everybody is scouring through the numbers, trying to figure out how far down is down--and how long this bear market will last.

And if the stock market train wreck isn't enough, investing icon Warren Buffett has come along with a new warning. "A few years ago, it would have seemed unthinkable that yields like today's could have been obtained on good-grade municipal or corporate bonds even while risk-free governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms," he writes in his latest annual letter to Berkshire Hathaway (BRKA) shareholders. "When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary." Great.

No Longer a Cornerstone

What is the average saver in a 401(k)-type plan supposed to do? Abandon equities? Flee bonds? (Sales of home safes are up, but that's not recommended.) Two simple market stories reinforce a time-honored lesson for all investing seasons. You don't have a clue what investment will do well going forward, and neither do the experts.

You can read the rest of it here.

Steven Pearlstein, business columist of the Washington Post, does a good job of capturing growing frustration. It worth reading the whole article here.

I've snipped out a few paragraphs:

Can you imagine a better way to undercut public support for fiscal stimulus and deficit spending than to report out an omnibus spending bill with nearly 9,000 earmarks totaling $8 billion? But, of course, that is just what the Democratic Congress has done. Americans don't need to be lectured by the House speaker and the Senate majority leader on the spending prerogatives of Congress. What they need are leaders who can demonstrate, in ways symbolic as well as substantive, that they know the difference between spending that is crucial to the country in times of crisis and spending that is not.

It's not just Congress, however. Key regulators have also been slow to respond to the unfolding crisis with the kind of urgency the situation demands.

Take a look at this chart on the personal savings rate. In about a year, the savings rate has gone from a fraction above 0% to a fraction above 4%.

To be sure, there are flaws to the personal savings rate figure. Nevertheless, it highlights just how hard people are trying to save.

How much longer can education and health services jobs jobs continue to grow?

Confidence is in short supply these days. But Tyler Cowan at Marginal Revolution points to an article that shows there is an unusual source of long-term optimism in the U.S. economy: Nouriel Roubini of New York University....

... who has a reputation as the most pessimistic economist in academe. He deserves it. His most recent paper, published last week, is entitled: "Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not." Nobody is more aware of the gravity of the financial situation, and nobody has done more to point out the risks of a systemic crisis. So how are Roubini's own funds invested? They are 100 per cent in equities. In the long run stocks do best and he is not yet close to retirement, so he keeps putting more money into index funds each month. Fully aware of the gravity of the financial situation, he is also aware of the futility of trying to take action or to time the market. Those tempted to make the investing equivalent of a goalkeeper's despairing dive should take note.

Development economist William Easterly writes:

In the midst of the general doom and gloom, fears about how the crisis will affect poor countries, and fierce criticism of markets, states, and aid agencies, perhaps it's healthy to step back to the big picture, to recognize there has already been some very real good news. The graph below shows some overall statistics for the developing world:

Easterly's blog is here. For anyone interested in global poverty, it's well worth checking in on regularly.

Thanks to Mark Thoma for highlighting Easterly's post.

Peter Morici is a professor at the Smith School of Business, University of Maryland School. He asks about those AIG bonuses:

So Mr. Geithner, instead of being outraged at AIG's last revelations, perhaps you can explain to all of us why a UAW worker earning $29 dollars an hour must give back wages and benefits to keep their company alive, while the architects of the biggest financial disaster in history get to keep their gold plated contracts.

Mr. Geithner, we are waiting for your answer.

Yes, we're waiting.

I was on Midday this morning to talk about AIG and the economy with host Gary Eichten and economics professor Louis Johnson. The Federal Reserve meets this week. You can listen to it here.

I'm in Muncie, Indiana doing some reporting on the impact of the economic downturn. The "throw the kitchen sink" plan by the Fed to stem the economy's downward momentum carries enormous risk. But the bold move is also smart. It just might work, and it doesn't require asking Congress for more money at a time when anger at AIG, the bailout, financiers, etc. is justifiably roiling the political waters.

So, it's a bold, smart move. A couple of questions, however

On the economic front, I wonder what is the difference between fiscal and monetary policy at this point. Aren't the two blurring in reality?

On the wager front, if the Fed's move doesn't work, I'd expect stocks to fall and interest rates to rise, with investors anticipating the simultaneous nightmare of inflation and depression.

If the economy continues to falter, how much credibility will institutions at the commanding heights of the economy retain? Wall Street has no credibility. Congress has little legitimacy at the moment. The White House still has legitimacy, but it's under strain. The Fed is still considered a premier actor on the global stage, but for how much longer. CEOs are losing their reputations by the day.

We're in Muncie, Indiana. Marketplace and American Radio Works are working together on an hour long documentary on Muncie.

Why Muncie? It's America's most famous "typical American city": Middletown. In 1924, Sociologists Robert S. and Helen Merrell Lynd wrote two classic books, Middletown (1929) and Middletown in Transition (1937). The books are fascinating, and they capture a town during the roaring '20s and during the Great Depression. Here's one intriguing finding in the books. The Middletown/Muncie culture celebrated a thrifty pay-as-you-go mentality in the 1920s yet its citizens rushed to buy on credit. In their follow-up study in the 1930s, belts were tightened and debts days paid off. Still, "[p]eople give up everything in the world but their car," was a refrain the Lynd's heard over and over again.

Even before the current crisis the town grappled with problems many people identify with, such as factories leaving, BorgWarner, which makes parts for GM and Ford, is closing its Muncie plant next month and moving the work to Mexico. That's the last of the great factories in Muncie. the two main employers now are Ball State University and the medical complex. In a sense, that's the story of the U.S. economy, right? Manufacturing is shrinking and education and health care are expanding.

What does this mean for the middle class? How vulnerable are the incomes and aspirations of the "brittle class" with this dramatic economic transformation from an economy based on tangibles to an economy based on intangibles. What about the poor?

These are the kinds of questions we're pursuing.

Kai comes in today to do some reporting, too.

On the face of it, the Geithner plan is a disappointment. Economist Paul Krugman is right: It's really just another version of the proposal put forward months ago by former Treasury Secretary Hank Paulson.

But it could work, and I am cautiously optimistic.

For one thing, the three-pronged private-and-public investment partnership is only one part of the Administrations economic rescue plan. We have the fiscal stimulus, the homeowners renegotiation plan and Geithner's approach toward getting the toxic assets off the books of the banks. In combination the three could work.

My suspicion is that Congressional and popular fury over the AIG retention bonuses further convinced the Administration that a straight forward nationalization ala Sweden wouldn't work. It's a good idea, but I'm betting they were afraid of what might be unleashed, the law of unintended consequences.

Last, there probably is some value to the toxic assets, or at least a portion of the portfolio. Right now, there is no market in them and investors are extremely risk averse. But with the public/private partnership buying there may still be some value there.

In reporting on poverty in Memphis, Chicago and Muncie it struck me that there may be a change in the nature of poverty. It's striking how well understood is the message that the way to get ahead in society is to get a college education--community college, junior college, a public four year university degree. That's the good news. Take a look at the vast numbers of high school graduates that go on to higher education in the first year after graduation.

The bad news is how many people I've interviewed that went to a community college for a year, a year and a half, maybe 2 to 3 years at a public university, but never finished. They didn't get a degree. So, they didn't get any of the job or career benefits of higher education. Take a look at the numbers that don't graduate in 4 years (or even in 6) and don't complete community college.

What the low income students do get is student loans--lots of student loans (at least relative to income). And you can't discharge public or private student loans in bankruptcy. The student loan debt burden is real. All you then need to happen is a medical illness, a lay off, some sort of setback, and the person is back in poverty and the student loans simply make the situation worse.

In the 1990s and 2000s a consensus emerged that homeownership was the best anti-poverty program. Or at least it was an anti-poverty program that could garner bi-partisan support. And there were genuine gains made through homeownership. Problem is, the predatory lenders took advantage of the situation. I still think with more thoughtful regulation the abuses could have been minimized.

To some extent, we have an education boom going. It isn't a stupid idea. Education is the way out of poverty. Education pays. But the details of how that is accomplished matter a lot. We don't want a situation where low income students end up with lots of debt and no degree--the educational equivalent of equivalent creating subprime mortgage neighborhoods. Public policy needs to be aware of the debt dangers.

I'm going to look into this more closely. At this point it's a suspicion and a concern.

James Montier is an economist and global strategist, and very smart. In a recent newsletter on inflation and deflation he looked at TIPS, Treasury Inflation Protected Securities. The 10 year TIP currently yields about 2.1% compared to a 10 year nominal bond yield of 3%.

He notes that this suggests investors are anticipating that the U.S. inflation rate will be only 1% a year for the next decade. He's skeptical. But what if the market is right?

TIPS.bmp

My suspicion is that disinflation-to-deflation is the normal condition in the evolving global economy. Plus, central banks know how to tame inflation. They have the tools and the knowledge. (The same can't be said about managing bubbles and the nasty aftermath.) Of course, investors can be wrong--really wrong. But I find it intriguing that investors aren't that concerned that the Fed is printing money.

After our joint Marketplace/American Radio Works trip to Muncie to report on poverty, I suspected that the average cumulative student loan debt burden for low income and first generation students that go to college but don't finish is high. Some figures published in the Pell Institute report "Moving Beyond Access: College Success for Low-Income, First Generation Students," confirms that suspicion.

The amount of loan debt for low-income, first-generation students (and their peers for that matter)who leave before graduation is staggering. Low-income, first generation students who left during their first year owed $6,557 on average while those leaving in their fourth year owed an average of $16,548. These students must pay back their loans without the extra earnings power associated with attaining their degrees--and without the parental or family resources that might be available to their more socioeconomically advantaged peers who leave in debt.

You can read the full report here.

The quality of management matters. One of the disturbing aspects of the Iraqi rebuilding projects was incompetent management. Far too many of the people in charge got the job because they were party members in good standing and for their ideological fervor. They weren't chosen because they know how to run large organizations overseeing multiple suppliers building schools, roads, electric grids and the like. The results were--and remain--a disgrace.

There is no evidence that the Obama Administration is seeking to stack the fiscal stimulus managers with political loyalists. From what I can see they're looking for organizational and technical competence.

Here's the rub: Are there enough people around to handle this kind of enormous spending package? I've heard that the Administration is bringing high level former government managers out of retirement. They have the needed knowledge and skills. Congress is also working on voiding or temporarily suspending the law that prohibits retirees from drawing on their federal pension at the same time that their earning a federal paycheck. Hopefully, the law is changed so that experienced technocrats can join the effort.

Anyway, the devil is always in the details. Organization and talent matter a lot with this much money and effort flowing from the federal government to the states.

We had received many emails from listeners intrigued by high yields on CDs offered by Millennium Bank in the Caribbean. We didn't like it. It was too good to be true. The risks were too high. Now, the SEC tells us that our instincts were right. It was a Ponzi scheme

Here's the SEC's complaint:

SEC Halts $68 Million Ponzi Scheme Involving Caribbean-Based Bank and Swiss Affiliate
FOR IMMEDIATE RELEASE
2009-68
Washington, D.C., March 26, 2009 -- The Securities and Exchange Commission has obtained an emergency court order halting a $68 million Ponzi scheme involving the sale of fictitious high-yield certificates of deposit (CDs) by Caribbean-based Millennium Bank.

The SEC alleges that the scheme targeted U.S. investors and misled them into believing they were putting their money in supposedly safe and secure CDs that purportedly offered returns that were up to 321 percent higher than legitimate bank-issued CDs. The SEC's complaint alleges that William J. Wise of Raleigh, N.C., and Kristi M. Hoegel of Napa, Calif., orchestrated the scheme through Millennium Bank, its Geneva, Switzerland-based parent United Trust of Switzerland S.A., and U.S.-based affiliates UT of S, LLC and Millennium Financial Group. In addition to Wise and Kristi Hoegel and these entities, the SEC has charged Jacqueline S. Hoegel (who is the mother of Kristi Hoegel), Brijesh Chopra, and Philippe Angeloni for their roles in the scheme.

"As alleged in our complaint, the defendants disguised their Ponzi scheme as a legitimate offshore investment and made promises about exuberant returns that were just too good to be true," said Rose Romero, Director of the SEC's Fort Worth Regional Office. "This case demonstrates that investors need to be especially cautious when placing money with entities that may be outside the reach of U.S. regulators."

According to the SEC's complaint, at least $68 million was raised from more than 375 investors since July 2004. Millennium Bank, a licensed St. Vincent and the Grenadines bank, solicited new investors for its CD program through blatant misrepresentations and glaring omissions in its online solicitations and in advertising campaigns targeting high net-worth individuals. For example, in offering materials, Millennium Bank claimed that its parent, United Trust of Switzerland S.A., provides Millennium Bank with "over 75 years of banking experience, correspondent banking relationships, decades of knowledge in privacy and confidentiality as well as extensive training for our customer services professionals." In fact, the SEC alleges, United Trust of Switzerland S.A. is not a Swiss-licensed bank or securities dealer. Potential investors visiting Millennium Bank's Web site also were falsely informed that Millennium Bank is not affected by the global financial crisis and has a 100 percent client satisfaction record going back close to 10 years, and has its own affiliate asset management company with highly seasoned professionals who invest meticulously.

The SEC alleges that investor funds were not used for legitimate banking or investment activities. Instead, to create the appearance of a legitimate offshore investment, investors purchasing the CDs were instructed to deliver their investment checks to the offshore bank. The SEC alleges that the checks were then packaged and delivered to UT of S LLC's office in Napa, Calif., where the checks were electronically deposited by a remote deposit machine into a UT of S, LLC account. The account, which is held at a U.S. financial institution, also received millions of dollars of investor funds via wire transfer. From that account, the SEC alleges, the defendants misappropriated a vast majority of the investor funds to enrich themselves and pay personal expenses, while making relatively small Ponzi payments to investors.

Judge Reed O'Connor, in the U.S. District Court for the Northern District of Texas, granted the SEC's request for an asset freeze and emergency relief for investors.....

I've waded into the CEO pay debacle once again:

The opening sentence of Alexis de Tocqueville's Democracy in America, the social philosopher's magisterial epic investigation into early 19th century America, highlights how central the idea of equality has been in society: "No novelty in the United States struck me more vividly during my stay there than the equality of conditions."

But a visit to 21st century America might give de Tocqueville pause.

The era that the French author chronicled and the periods that followed were indeed a time of unparalleled opportunity. Immigrants swarmed to the U.S. to make a better life for themselves and their families. Americans looked at themselves as middle class, neither aristocrats nor working class, just common folk trying to get ahead, making a better life for their children. "Ordinary Americans came to believe that no one in a basic down-to-earth and day-in-and-day-out manner was really better than anyone else," writes Gordon S. Wood in The Radicalism of the American Revolution. "That was equality as no other nation has ever quite had it."

A Society Open to Talent

Of course, equality, so appealing in theory, was hard to obtain in practice. African Americans were excluded. So were the people who lived here before the European settlers. Society divided along the lines of money, power, and education. The gulf was wide between first class and steerage on the Titanic or the gilded mansions of Newport and the crowded tenements on New York's Lower East Side.

Nevertheless, the American economy was more egalitarian and open to talent than anywhere else. Horatio Alger's working boy heroes and Charles Foster Kane are fictional characters, but for Daniel Boone and Andrew Carnegie the climb from rags to riches was very real.

Indeed, it's striking that Americans have long tolerated greater income inequality than other major industrialized nations. One reason is the powerful belief in equality of opportunity, that society rewards merit, pluck, risk-taking, and luck. Another factor is that for long periods of time the economic gains of rising productivity and increased innovation were widely shared.

A Small Few Have Benefited

A less savory influence on the acceptance of greater inequality is a cottage industry of consultants, lobbyists, and think-tank entrepreneurs that justified the extraordinary gains at the top of the income spectrum as the just rewards for brains and merit.

Problem is, none of these arguments hold anymore. Corporate America's productivity gains of the past three decades or so have largely gone to a relatively small number of executives. The ominous combination of recession and credit crunch makes it hard to argue that the gains have been the returns to "talent" in the 2000s.

Perhaps most disturbing, Corporate America is becoming a pay-for-failure economy for its top executives and a Darwinian existence for everyone else. There's something wrong in a world where former chief executives like Stanley O'Neal of Merrill Lynch, Charles Prince of Citigroup (C), and the retention bonus bunch at AIG (AIG) and others lose billions of dollars of shareholder money yet pocket millions on the way out.

I go on to argue that there is a good model to emulate: The Entreprenuer. You can read the rest of the argument here.

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