Archive for June, 2013

One Place Where Mankiw Makes Absolutely No Sense at All

June 28th, 2013 Comments off

In his Defending the One Percent paper, Greg Mankiw is rather grudgingly acknowledging rent-seeking (and -getting) in the financial industry, and the allocation of top talent to that industry. He sez:

The last thing we need is for the next Steve Jobs to forgo Silicon Valley in order to join the high-frequency traders on Wall Street. That is, we shouldn’t be concerned about the next Steve Jobs striking it rich, but we want to make sure he strikes it rich in a socially productive way.

Talk about turning straightforward logic on its ear. The whole point is that if somebody makes their money by financial-industry rent-seeking, they by definition will not be the next Steve Jobs.

So yes: we should be concerned if lots of people are striking it rich in the financial industry, because the lure of those rent payments will prevent potential Steve Jobs from creating real value in real businesses. Incentives matter.

Cross-posted at Angry Bear.


What Caused the (Next) Housing Bubble? (Six Graphs)

June 27th, 2013 2 comments

Political Calculations gives us this chart of median new home prices versus median incomes over the last 46 years. The rising tip at the upper right (!) is May 2013. What do you think: sustainable?

Here’s the zoomed-in version of recent years, from inside the red dashes:

As they say,

…new homes are, virtually by definition, at the margin for all real estate markets. Their prices are therefore especially sensitive to changes in the levels of both supply and demand in the overall market.


They suggest it was “money leaving the U.S. stock market” and flowing into the housing market, which is no doubt somewhat true. But:

1. A great deal of that dot-bomb money didn’t “go” anywhere; it simply vanished. You gotta ask: this would result in more money going into real estate, with the off-the-charts results we see above?

2. Have we ever seen a stock-market crash causing a real-estate bubble? I can’t think of an instance, but I could be wrong…

3. That’s your typical lump-of-money/loanable funds incoherence, ignoring the fact that the financial system creates new money and lends it to the real sector to buy houses.

I’d suggest that there was a sudden increase of availability of new money. Yeah, Greenspan spiked the punch bowl at the same time, so the money was cheaper. But I’m thinking that lending standards plummeted starting in 2001.

The Fed asked loan officers if they were loosening their standards in that period. They said no:

Screen shot 2013-06-27 at 8.32.12 PM

But — surprise — the rate of loan denials tells a very different story:*

Screen shot 2013-06-27 at 8.24.10 PM

This is in the midst of a massive stock-market crash. Denials declined? Those loan officers apparently didn’t even know they were loosening their standards.

Here’s another Fed graph that’s less dramatic, and that doesn’t seem to match the ’99-’00 Conventional Mortgage numbers in the data I graph above, even though they’re drawing from the same data set. (Je ne sais pas.) But the 2001-2003 trend’s the same, and even more pronounced for refinancing:

Screen shot 2013-06-27 at 8.20.00 PM

So what could possibly cause this sudden decline in lending standards? I’ve got a guess; again, it’s about the fundamental rules of the game being changed. Nothing else could cause such a radical shift. Here’s my guess:

Wikipedia: Commodity Futures Modernization Act of 2000

Pushed through by Lindsey Phil Graham in the dark Christmas-recess nights and signed over Clinton’s powerless, almost-dead body in the midst of the Lewinsky crisis (signed December 21st, 2000), this act empowered and deregulated all the collateralized debt vehicles that stood behind the runup, and emasculated any putative regulators. (It apparently took the financial players most of a year to take advantage of the new rules.)

AIG and its ilk were given free rein to sell any default-insurance contracts (CDSes) on banks’ bundles of mortgage loans (CDOs) that contributed to their personal bonuses– no matter that they could never fulfill those insurance contracts if the S hit the F.

The ratings agencies (for their pieces of silver) issued their blessings on those CDOs, which meant the CDS insurance on the CDOs was ridiculously cheap.

The main-street loan-shark mortgage brokers had no problem foisting their shitty loans off to the banks for bundling into CDOs, which were “insured” by AIGers who  never intended to pay off anyway. They figured they’d never have to, based on their self-serving models, crafted under intense pressure from their sales and executive (what’s the difference?) teams.

Is it any wonder that lending standards plummeted? I’ve heard it said that incentives (and institutions) matter.

So where are we now, with the home-price/income ratio trending up off the charts again, and even higher now? Maybe it’s just that home builders aren’t building any inexpensive homes anymore, because the people who buy those homes have been eviscerated:

If that’s true, that scary runup in the upper-right corner of the first graph is the top .1% — having extracted everything they can from the 90% who have no money, really — finally going all Willy Sutton on us and going where the real money is: the top 10%. I wonder: how will those ten-percenters will feel about the glory and wonder of “free markets” a few years from now?

* You’d be amazed how hard it was to dig up these numbers. Even though the Fed’s been collecting this data for decades, the report I found it in didn’t include the data in the tables (and said so, explicitly, in the text). The micro-level data is available through the FFIEC interface to the HMDA data, but you have to be a serious wonk to download and crunch it. And nobody else seems to have compiled this time-series on percentage of loans denied. All the research is about comparing denials for different income classes and races. Liberals are looking at just one thing (the wrong thing, for what I’m describing), and conservatives are just ignoring the whole thing.

Cross-posted at Angry Bear.

Steve Randy Waldman for Treasury Secretary

June 15th, 2013 Comments off

Michael Woodford and Adair Turner Agree: CBs Won’t (and Shouldn’t) Sell the Bonds Back

June 13th, 2013 1 comment

Old news: April 3. But still: Following up on yesterday’s post, see here from Ambrose Evans-Pritchard in The Telegraph (emphasis mine):

“All this talk of exit strategies is deeply negative,” [Woodford] told a London Business School seminar on the merits of Helicopter money, or “overt monetary financing”.

He said the Bank of Japan made the mistake of reversing all its money creation from 2001 to 2006 once it thought the economy was safely out of the woods. But Japan crashed back into deeper deflation as soon the Lehman crisis hit.

“If we are going to scare the horses, let’s scare them properly. Let’s go further and eliminate government debt on the bloated balance sheet of central banks,” he said. This could done with a flick of the fingers. The debt would vanish.

Lord Turner, head of the now defunct Financial Services Authority, made the point more delicately. “We must tell people that if necessary, QE will turn out to be permanent.”

The write-off should cover “previous fiscal deficits”, the stock of public debt. It should be “post-facto monetary finance”.

Lord Turner knows this breaks the ultimate taboo, and that taboos evolve for sound anthropological reasons, but he invokes the doctrine of the lesser evil. “The danger in this environment is that if we deny ourselves this option, people will find other ways of dealing with deflation, and that would be worse.”

A breakdown of the global trading system might be one, armed conquest or Fascism may be others – or all together, as in the 1930s.

Taboos are made to be broken. The Fed should just burn all those bonds. Welcome to MMT World.

Also some very interesting history in that article that I wasn’t aware of, a great counterpoint to the standard-issue What-About-Weimar!? hyperhysteria:

Less known is the spectacular success of Takahashi Korekiyo in Japan in the very different circumstances of the early 1930s. He fired a double-barreled blast of monetary and fiscal stimulus together, helped greatly by a 40pc fall in the yen.

The Bank of Japan was ordered to fund the public works programme of the government. Within two years, Japan was booming again, the first major country to break free of the Great Depression. Within three years, surging tax revenues allowed Mr Korekiyo to balance the budget. It was magic.

Cross-posted at Angry Bear.

Defining “Reserves”

June 12th, 2013 5 comments

I’ve run into quite a bit of confusion in conversations discussing bank reserves, and found occasion to get precise on the usage in recent comments. I thought I’d share it with others. This has been vetted by several who are more worthy than I, so I feel quite confident in offering it up.

1. “Reserve balances.” These are banks’ deposits at the Fed. Similar to your credit balance in your checking account (except in “bank money”). They’re liabilities of the Fed, assets of the banks. They appear and are identified as such on banks’ (and the Fed’s) balance sheets.

2. “Required reserves.” A regulatory amount (percentage of deposits) that banks are required to hold in specified “safe” assets — significant examples being treasuries, vault cash, gold (in their vaults or the Fed’s), and…reserve balances. The term “required reserves” does not appear on banks’ balance sheets.

3. “Excess reserve( balance)s.” I add “balances” because this explicitly refers to that particular type of holdings — deposits at the Fed. A bank could (in theory) have sufficient required reserves held in treasuries and vault cash, so all of its reserve balances at the Fed could be “excess reserves.” (Depending on which of the bank’s assets you might want to point to and arbitrarily call its “required reserves.” That thing is a regulatory (pro)portion, not a specific set of financial assets, or a balance-sheet entry.)

What’s funny here: Excess Reserves are explicitly not reserves in the sense of “funds that are required to be ring-fenced under law so depositors can withdraw their money or transactions can clear.” By definition, they’re the banks’ deposits at the Fed that are not ring-fenced.

So excess reserves are not actually “reserves.” That’s what “excess” means. No wonder people get confused.


Required reserves aren’t necessarily held in the form of reserve balances.

Reserve balances are not necessarily required reserves.

(Which is why I would prefer a better term than “reserve balances.” Fed deposits?)

Cross-posted at Angry Bear.


About that “Wealth Effect”: Not so Much…

June 12th, 2013 Comments off

Economists like to say that their discipline is the study of scarcity, or even the science of scarcity. But I’d like to suggest that — acknowledging that it’s a behavioral, social “science” — it’s actually the study of human reaction functions: If X happens, how do people (individually and as groups) react?

But unlike other scientists, rather than studying these reaction functions — human behavior — economists are prone to stating their results as a priori assumptions (and that, absent any solid quantification). You’ll be hard-pressed, for instance, to find Kahnemann and Tversky’s quite detailed empirical numbers on human risk-aversion incorporated into mainstream economic models (even though that research — from psychologists — earned the Nobel Prize in economics).

The wealth effect is a great example of this approach: “If people have more money, they’ll spend more.” Okay, that seems to make sense as an armchair proposition, but how much more, and what’s the likelihood across a heterogenous population?

Which leads me to share the rather eye-popping empirical result that prompts this post, a finding in a Royal Bank of Canada survey, reported by Pedro da Costa:

(Apparently the RBS research is proprietary, as da Costa doesn’t provide a link and I can’t find the study.)

If it’s true that U.S. monetary policy these days is achieving its effect largely or purely through the wealth effect, given these findings it’s not surprising that monetary policy isn’t having the profound effects that one might hope for.

Cross-posted at Angry Bear.


The Market Doesn’t Think the Fed Will Ever Sell Those Bonds Back

June 12th, 2013 Comments off

You know the trillion dollars a year of Treasury and GSE bonds that the Fed’s buying up? (And the $3-trillion+ it’s already holding?) It’s driving up bond prices and suppressing yields, right? And if it starts selling them back, it will drive down prices and increase yields, right?

The market should be front-running that, right? They should be driving down prices in expectation of the Fed eventually selling.

But they’re not, are they? They must not expect the Fed to ever do that. The market must think that if anything, the Fed will just let those bonds retire naturally (which will reduce the future stock of bonds held by the private sector, but not the flow to/from that sector — that already happened when the Fed “retired” the bonds onto its balance sheet).

Welcome to the brave new world where:

o Total reserve balances and the size of the Fed’s balance sheet are immaterial to interest rates or lending to the real sector.

o The policy rate is purely a function of the Fed-specified IOR (interest on reserves) floor.

o Open-market operations/QE only affect asset prices via the flow effect (with bond spreads based on what maturities the Fed’s currently buying/selling).

o Fed buying/selling pushes bond and equity prices in the same direction (because high bond prices/low bond yields push investors into equities, and vice versa).

o The Fed’s push/pull on all asset prices only affects real-economy spending via the wealth effect.

Cross-posted at Angry Bear.

Do Collateral Chains Create Real Value?

June 12th, 2013 4 comments

Some of the keenest monetary thinkers out there, over at FT Alphaville — Izabella Kaminska, Cardiff Garcia, etc. (I’ll even throw in Tyler Durden at Zero Hedge, with qualifications) — have been pointing us for years towards the work of IMF Senior Economist Manmohan Singh on collateral chains in financial markets. He provides wonderfully cogent explanation of the shadow-banking system and how it creates “money” for the financial system.

Start here:

The other deleveraging: What economists need to know about the modern money creation process

In brief, banks create debt securities collateralized by other debt securities, which in turn are used to collateralize yet more debt securities. This creates an upside-down pyramid of debt securities, all balanced upon a very small amount of real collateral (ultimately, the real economy’s future ability to produce human-valuable surplus through real effort, skill, and knowledge, hence their future ability to pay off their loans plus interest to the financial system from that surplus).

Singh speaks in terms of the “velocity of collateral” when referring to the lengths of these collateral chains, and equates it to the “velocity of money” in the real economy. During the financial crisis these collateral chains shortened (and in individual cases evaporated), resulting in a huge decline in the financial system’s “money supply.”

Emphasis mine:

When market tensions rise – especially when the health of banks comes under a shadow – holders of pledged collateral may not want to onward pledge to other banks.

  • With fewer trusted counterparties in the market owing to elevated counterparty risk, this leads to stranded liquidity pools, incomplete markets, idle collateral and shorter collateral chains, missed trades and deleveraging.

  • In practical terms, the ratio of pledged-collateral (which is a measure of the credit thus created) to underlying assets falls as this onward pledging, or interconnectedness, of the banking system shrinks.
  • While acknowledging the excellence of Singh’s shadow-banking-mechanics explanation, I have to question his economic conclusions as embodied in the first bullet point, and the enthusiasm of the aforementioned monetary sages for those conclusions.

    “Incomplete markets.” “Missed trades.” He’s claiming that shorter collateral chains result in inefficient allocation of financial capital.

    I’ve got to ask (as Durden does, in a somewhat self-contradictory manner): Do those pyramids of collateralized debt securities actually result in more (and more sensible) lending to real-economy ventures? Absent such a massive pyramid, would real-economy borrowers be unable to get loans for promising projects? Is he suggesting that “savers'” money would never find its way to borrowers absent that labyrinthine pyramid?

    Is Singh simply invoking the tired old money-multiplier/loanable-funds/savers-fund-borrowers silliness (but here on steroids) that has been so resoundingly discredited by so many over so many decades?


    Plainly this re-use of pledged collateral creates credit in a way that is analogous to the traditional money-creation process, i.e. the lending-deposit-relending process based on central bank reserves. Specifically in this analogy, the Indonesian bonds are like high-powered money, the haircut is like the reserve ratio, and the number of re-pledgings (the ‘length’ of the collateral chain) is like the money multiplier.

    Given the appropriate disdain that Kaminska, Garcia, et. al. have for that incoherent model, I have to wonder why they give so much credence to identical economic conclusions — even if they are attached to an admirable understanding of the system mechanics.

    In particular, I have to wonder why Garcia lavishes such gushing praise on a Credit Suisse paper whose lead-off bullet points begin with this a priori assertion:

    • Liquid collateral is the lifeblood of the modern economy

    And end with this:

    • Don’t throw the baby, a highly evolved financial system, out with the bath water, a credit bubble and recession.

    “Lifeblood”? Even if that were apt, you don’t make a body healthier by simply pumping more blood into it. To repeat my own analogy, finance is better understood as lubrication. You’ve gotta have enough, but if there’s too much, the shop-room floor gets very, very slippery. Ditto: bubbly bathwater.


    Adair Turner, Andrew Haldane, et. al. (2010):

    There is no clear evidence that the growth in the scale and complexity of the financial system in the rich developed world over the last 20 to 30 years has driven increased growth or stability, and it is possible for financial activity to extract rents from the real economy rather than to deliver economy value.

    And Paul Volcker (2009):

    “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence,” said Mr Volcker, who ran the Fed from 1979 to 1987 and is now chairman of President Obama’s Economic Recovery Advisory Board.

    Mr Volcker said that the biggest innovation in the industry over the past 20 years had been the cash machine. He went on to attack the rise of complex products such as credit default swaps (CDS).

    Cross-posted at Angry Bear.

    If Interest Rates Rise, We Can Plummet the National Debt!

    June 10th, 2013 6 comments

    Dean Baker makes what seems to be a stunningly obvious point, one that I haven’t seen discussed anywhere. Condensed and with emphasis added for your consideration:

    …the value of our [government] debt will plummet if interest rates rise… we could buy back long-term debt issued today at interest rates of less than 2.0 percent for discounts of 30-40 percent. This would sharply reduce our debt-to-GDP ratio at zero cost.

    This is not some kind of magic bullet, of course:

    we would still pay the same interest

    Buy back $100 billion of 2% bonds at their new market value of $66 billion. Pay for it by issuing $66 billion of 3% bonds. Either way, interest: $2 billion.

    But (if we did this with all the outstanding 2% bonds) our debt/GDP ratio would plummet by 33%! That’s a magic bullet, right? Growth would skyrocket!


    Read Dean’s whole piece for all the appropriate snarks on Reinhart-Rogoff, debt-kills-growth hysterians, and economists’ general financial innumeracy.

    Extra credit questions: How would this future buyback-and-borrow compare to 1. Treasury, today, issuing $33-billion in platinum coins and using it to buy back (retire) 2% bonds from the Fed (with the coins sitting in the Fed’s vault…forever), or 2. the Fed just burning those bonds, and Treasury zeroing out the obligations?

    Show your work, in particular specifying the balance-sheet perspective(s) you’re speaking from. Treasury (on balance sheet or unified)? Fed? Both consolidated? Private sector? Financial sector? Real sector?

    Or don’t bother, because it’s a somewhat pointless set of arithmetic problems, balance-sheet prestidigitation with little ultimate import.

    And even if you do think the government debt/GDP ratio is an important driver (cause) of growth or non-growth, do some more arithmetic and you’ll come to some rather striking conclusions, here courtesy of Josh Mason:

    …interest, income growth and inflation rates also affect debt-income ratios, and movements in these other variables often swamp any change in …borrowing… government borrowing and government debt are not equivalent, or even always closely linked… What we have here is a kind of morality tale where responsible policy — keeping government spending in line with revenues — is rewarded with falling debt; while irresponsible policy — deficits! — gets its just desserts in the form of rising debt ratios. It’s a seductive story… But it’s mostly false, and misleading. More precisely, it’s about one quarter true and three quarters false.if you do think debt is a problem, then you are looking in the wrong place if you think holding down government borrowing is the solution. What matters is holding down i – (g + π) — that is, keeping interest rates low relative to growth and inflation. And while higher growth may not be within reach of policy, higher inflation and lower interest rates certainly are.

    Compounding interest and all that…

    Cross-posted at Angry Bear.