Financial Reform: Will Congress Take The Side Of Corporations Or The Public?

The ability of congress to pass financial reform may be no match for the ability of large financial corporations to block it. Political writer Matt Taibbi describes the efforts of Goldman Sachs to shamelessly lobby congressmen to protect the interests of the financial giant. See the following from Economist's View to learn more.

I am not as negative toward naked short-selling as Matt Taibbi (feel free to convince me I'm wrong), but his insights into the lobbying effort against financial reform are useful, and I share his concerns about the distortions (e.g. regulatory capture) this brings to the reform process:

An Inside Look at How Goldman Sachs Lobbies the Senate, by Matt Taibbi: ...Later on this week I have a story coming out in Rolling Stone that looks at the history of the Bear Stearns and Lehman Brothers collapses. The story ends up being more about naked short-selling and the role it played in those incidents than I had originally planned..., but it turns out that there’s no way to talk about Bear and Lehman without going into the weeds of naked short-selling...

It’s the conspicuousness ... that is the issue here, and the degree to which the SEC and the other financial regulators have proven themselves completely incapable of addressing the issue seriously, constantly giving in to the demands of the major banks to pare back (or shelf altogether) planned regulatory actions. There probably isn’t a better example of “regulatory capture” ... than this issue.

In that vein, starting tomorrow, the SEC is holding a public “round table” on the naked short-selling issue. What’s interesting about this round table is that virtually none of the invited speakers represent shareholders or companies that might be targets of naked short-selling, or indeed any activists of any kind in favor of tougher rules against the practice. Instead, all of the invitees are either banks, financial firms, or companies that sell stuff to the first two groups.

In particular, there are very few panelists — in fact only one, from what I understand — who are in favor of a simple reform called “pre-borrowing.” Pre-borrowing is what it sounds like; it forces short-sellers to actually possess shares before they sell them.

It’s been proven to work, as last summer the SEC, concerned about predatory naked short-selling of big companies in the wake of the Bear Stearns wipeout, instituted a temporary pre-borrow requirement...

The lack of pre-borrow voices invited to this panel is analogous to the Max Baucus health care round table last spring, when no single-payer advocates were invited. So who will get to speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a hedge fund that has done the occasional short sale, to put it gently), Credit Suisse, NYSE Euronext, and so on.

In advance of this panel and in advance of proposed changes to the financial regulatory system, these players have been stepping up their lobbying efforts... Goldman Sachs in particular has been making its presence felt.

Last Friday I got a call from a Senate staffer who said that Goldman had just been in his boss’s office, lobbying against restrictions on naked short-selling. The aide said Goldman had passed out a fact sheet about the issue that was so ridiculous that one of the other staffers immediately thought to send it to me. When I went to actually get the document, though, the aide had had a change of heart.

Which was weird, and I thought the matter had ended there. But the exact same situation then repeated itself with another congressional staffer, who then actually passed me Goldman’s fact sheet.

Now, the mere fact that two different congressional aides were so disgusted by Goldman’s performance that they both called me on the same day — and I don’t have a relationship with either of these people — tells you how nauseated they were.

I would later hear that Senate aides between themselves had discussed Goldman’s lobbying efforts and concluded that it was one of the most shameless performances they’d ever seen from any group of lobbyists, and that the “fact sheet” ... was, to quote one person familiar with the situation, “disgraceful” and “hilarious.” ...

This post has been republished from Mark Thoma's blog, Economist's View.

Why Farmland Is A Better Hedge Than Gold

A lot of investors are worried about inflation in the future, which helped Gold prices rally recently as investors sought a hedge against the dollar. However, consider farmland values which outpaced inflation by 2% from 1941 to 2002 and unlike gold has intrinsic value in its ability to produce food. See the following from Daily Wealth to learn more about investing in farmland.

In the past few years, there's been an explosion of investor interest in "hedges."

Investors want to own foreign real estate for a hedge against a big depression in the United States. They want to own gold for a hedge against a dollar crisis. They want to own oil for a hedge against inflation.

But consider this "hedge factor"...

Between 1941 and 2002, average farmland values outpaced the growth of inflation by 2%.

In fact, some call farmland as good as gold with yield – because you clock in steady income from rents while you wait for the value to grow. I can think of no better asset to own during any kind of financial crisis.

In some ways, farmland is even better than gold or silver. At least farmland is an intrinsically useful thing. It provides a tangible yield in the form of good things from the earth. We all have to eat. As consumers trim their sails, they'll give up a lot before they give up their calorie intake.

Governments, particularly in times of crisis – like now – have a tendency to flood the system with money in an attempt to "goose" the economy. Mostly, such efforts have succeeded in destroying the value of the currency in question.

Anyway, if you believe that we will continue to feel the bane of inflation, then farmland's performance in the 1970s will give you some comfort... While you lost half of your money in the S&P 500, your farmland kept its value nicely. Again, I think that's rooted in the fact that farmland is intrinsically useful. It produces useful and needed things.

Now imagine what farmland might do in today's climate, in which you have not only the likely prospect of inflation, but also a tightening supply of farmland and rising demand for crops. You have biofuels eating up more of our grain supply. I imagine you'll do quite a bit better than in the 1970s.

Farmland treated British investors great just last year. As British housing prices collapsed in 2008, British farmland value rose by 21%. Over the last five years, Brit farmland rose a total 135%. Forget commercial property. That's not a bad ROI in my book.

And there's one more way to look at it: This hedge can outperform gold. In Britain, the farmer outpaced the gold owner. Expanding land values rode up 115% since 1983, versus gold at 81%. You can be sure institutional investors are already placing their long-term bets. Almost half the farmland bought there last year was snapped up by banks and funds.

The obvious investment conclusion: If you're worried about the dollar, the economy, or any other problem, buy farmland today. This is hard to do directly through the stock market... so I encourage you to consider a private deal. You can play agriculture through companies that manufacture irrigation equipment, produce fertilizer, or operate grain-handling facilities.

Check these investments out soon. I think we're in for broad farmland/agriculture rally that should be good for hundreds of percent returns. As you can see from farmland's past results, it's a great hedge in all kinds of environments.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

Learn How To Invest Like Warren Buffett With These 6 Essential Books

Reading the right books can help you become a better investor by learning from other's successes and failures. Don Dion from The Street has complied 6 essential books that will teach you how to think and invest like genius investor, Warren Buffett. See the following article to learn more.

Amazon.com recently listed more than 200,000 titles under the keyword "investing." Some of those books are useful. Others are a waste of time. And many, designed to exploit our ignorance and greed, are downright dangerous.

How do you approach this slew of investment information without getting overwhelmed? Every month, financial writers and journalists churn out hundreds of articles that aim to explain the financial world to ordinary investors. The financial media is full of investment picks, ideas, strategies and other advice.

Books still play an important role, however, in mastering the art of intelligent investing. Selecting the right tome can be a daunting proposition. The first place to start is with the basics. The best investment books avoid the sleazy manipulation of the get-rich-quick schemes you'll find in many books, magazines and, newsletters. Instead, they seek to impart the hard-won wisdom of the great investors to readers like us.

Which books should you read?

Books can serve to strengthen your fundamental investing knowledge while providing you with an important historical prospective.

In addition to several guides and anthologies that offer timeless advice, a number of books about Warren Buffett's philosophy provide a valuable foundation for any long-term investor.

While Warren Buffett has never penned his own book of investing advice, several stand-out books have been written about his investing style.

Even if you stick to mutual funds, rather than picking individual stocks, Warren Buffett's method of stock selection can help you evaluate the skills and strategy of a mutual fund manager.

Here are some picks. The best investors, like Warren Buffett, use a strong understanding of the fundamentals to inform their personal investment philosophies. One good place to begin developing your own foundation is an anthology.

Charles Ellis, a money manager himself, compiled Classics: An Investor's Anthology for an audience of students and professional money managers. It includes many short pieces by respected investment thinkers -- the kind of material that has appeared in professional journals over the years.

When it comes to economic trends, history often repeats itself. Familiarizing yourself with the history of investment ideas is one of the most effective ways to prepare for the future.

The Only Investment Guide You'll Ever Need isn't quite what its title claims, but it's one of the books every investor should read. The book was written by Andrew Tobias and first published back in 1978, when very few readers sought out books about personal finance. It became a national best seller for two reasons: the book is funny and creative.

The revised version is worth reading whether you are a novice or an expert. Tobias' ideas about taxes, commodities, stocks, insurance and other financial matters will help you rethink some of the conventional wisdom that gets many investors in trouble.

Want a good story? Have a look at Buffett: The Making of an American Capitalist. This lively, well-researched biography is a great book about his life and his investment methods.

It's also great background for readers who want to dip into The Essays of Warren Buffett: Lessons for Corporate America that is edited by Lawrence A. Cunningham. Buffett has never written a book, but his annual letters to shareholders are famous for their wit and intelligence. Cunningham has compiled some of the best material in this slim book. This book serves as a window onto his methods and his beliefs.

Here's a brief sample: "I've said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. I just wish I hadn't been so energetic in creating examples. My behavior has matched that admitted by Mae West: 'I was Snow White, but I drifted.'"

The Snowball: Warren Buffett and the Business of Life is unique among other Buffett pieces. The author, Alice Schroeder, sits down with the legendary investor to discuss everything from Berkshire Hathaway(BRK.A Quote) to his family life. This book is the closest thing to a Buffett autobiography on shelves today.

To truly understand Buffett, the best place to start is with his inspiration. Buffett got his start as a student of Benjamin Graham, the father of securities analysis. Graham's 1934 classic, The Intelligent Investor, is a wonderful introduction to the master's methods. The book has sold more than a million copies in hardcover; more importantly, it offers insight into how Graham thought about investing -- in particular his notion of a margin of safety. Graham advocated buying cheap stocks of companies with sound financials, establishing a "margin of safety" by purchasing the stock below its intrinsic value.

The Intelligent Investor suggests that stocks can be prudent investments, given the right approach. That idea shocked people who had endured the stock market crash of 1929 and the ensuing Depression. Jason Zweig, a senior writer for Money magazine, has done an excellent job in the latest issue of the magazine of updating the book without undermining its essential wisdom.

It was Graham's lessons that helped Buffett find winning companies such as Coca-Cola(KO Quote), Burlington Northern Santa Fe(BNI Quote), Goldman Sachs(GS Quote) and Nalco(NLC Quote).

For a little hint to readers who may find the 368-page book daunting, Buffett has gone on the record saying that the most crucial chapters in "The Intelligent Investor" are 8 and 20.

Navigating through the sea of investment advice books can be a daunting task. The Buffett basics are a good place to start, and the wisest investors will stay on top of new investing trends while keeping in mind the fundamentals.

Please leave your picks for the best investing books in the comments below.

This post has been republished from The Street, an investment news and analysis site.
Image from Wikipedia Commons.

Time Running Out On Financial Reform

Both Obama and Barney Frank want to see financial regulation passed by the end of the year, but the progress so far is not encouraging. Each day that meaningful reform is delayed makes success tougher, as public interest of the issue continues to fade. See the following discussion from Mark Thoma's blog.

Simon Johnson and James Qwak wonder how much political capital the administration is willing to use to meaningfully reform the financial system:

It's Crunch Time: The Fight to Fix the Financial System Comes Down to This, by Simon Johnson and James Kwak, Commentary, Washington Post: The next couple of months will be crucial in determining the shape of the financial system for decades to come. And so far, the signs are not encouraging.

The Obama administration is trying to refocus our attention on regulation, beginning with the president's speech in New York two weeks ago. ... Barney Frank, chairman of the House Financial Services Committee, says that he still plans to pass a regulatory reform bill before the end of the year.

But in a clear indication of trouble ahead, Frank signaled his intention last week to scale back the proposed Consumer Financial Protection Agency, one of the pillars of the administration's reform proposals. ...

We have criticized the administration's reform proposals, in particular for not going far enough to address the problem of financial institutions that are "too big to fail." But we support much of what was in the original package... The question now is how hard Obama and Geithner will fight for it.

Financial regulation, like health care reform, has entered the phase where speeches and proposals matter less than arm-twisting and horse-trading on Capitol Hill. With health care, President Obama attempted to go over the heads of Congress, directly to the American people. With financial regulation, that is no longer an option, given the extent to which it has faded from public consciousness. Instead, the administration is playing on the home turf of the banking industry and its lobbyists. ... Is Obama up for this fight? ...

Elections have consequences, people used to say. This election brought in a popular Democratic president with reasonably large majorities in both houses of Congress. The financial crisis exposed the worst side of the financial services industry to the bright light of day. If we cannot get meaningful financial regulatory reform this year, we can't blame it all on the banking lobby.

The initial bill needs to be as strong as possible, and I agree that the administration needs to do what it can to prevent the bill from being scaled back. However, the initial legislation won't be as strong as I'd like even if the administration does prevail. But I hope we aren't thinking that we'll take one stab at financial reform and then we'll be done with it. Like climate change and health care, it will require a series of bills to achieve effective reform.

This post has been republished from Mark Thoma's blog, Economist's View.

The Impending Commercial Real Estate Crisis

Commercial real estate may be a ticking time bomb that could create a whole new set of problems for the struggling economy. The commercial real estate market, which is half the size of the residential real estate market, is nearing a breaking point as more tenants leave and refinancing becomes impossible for more landlords. See the following post from Tom Dyson from Daily Wealth for more on this.

This weekend, I had pizza and beer with an executive at a commercial real estate company...

My friend's company is one of the largest office landlords in America, with big investments up and down the East Coast. My friend manages the debt-finance division.

"So is there a commercial real estate crisis coming?" I asked.

"Yes. Absolutely," he said. "It's definitely coming."

"How do you know?"

"Nobody can refinance their loans. You have to be able to roll your debt. But if the property isn't worth as much as the debt, you can't roll it over. And there's a lot of debt coming due soon. We were fine... But we've slowly lost tenants. Now we've got a couple of buildings where rent doesn't cover the mortgage. We're giving these buildings up soon..."

He said his company is sending the keys back to the bank.

"It'll damage our reputation," he said. "We've never given up property before. But we don't have a choice."

Over the last decade, commercial real estate boomed. All over the country, players took on trillions of dollars in debt to buy malls, warehouses, office towers, and industrial parks, believing prices and rents would rise forever.

The recession caused consumers to stop shopping and retailers to stop hiring. Occupancy levels and rents started falling. Commercial real estate prices should have collapsed...

Here's the thing: So far, the commercial real estate market has held up better than the residential market. According to my friend, this is for two reasons. First, commercial real estate is mostly leased to tenants. In the residential market, you walk away as soon as you get underwater. But in the commercial market, you don't mail the keys back to the bank until your tenant leaves. Because occupancy erodes slowly, there's a delay in defaults.

Secondly, the new mark-to-market accounting rules kept the game going. These rules free banks from reporting loan losses until their loans mature. And they free commercial real estate owners from reporting investment losses until they sell the property. In other words, they give banks a huge incentive to extend bad loans and companies a huge incentive to keep holding properties.

Investors and banks hoped if they could hold on for long enough, the turnaround in the economy would rescue them. But it hasn't happened. Now, according to my friend, the reckoning is here for commercial real estate.

One way to play the coming crisis is to short the stock prices of commercial property REITs, like Boston Properties, Simon Properties, Prologis, and Vornado. These companies hold billions of dollars in investment property that needs marking down, and their stock prices have soared in the last six months.

Shorting regional banks is another way. Many regional banks have huge exposure to commercial property.

Finally, you could just short the stock market. When the residential real estate market collapsed, it brought America's financial system to its knees. The commercial real estate market is half the size of the residential market. Its collapse may not cause another credit crunch, but it'll definitely knock a few points off the S&P...

One word of warning: Standing in front of a freight train is never a good idea. These investment ideas are all rising in a powerful uptrend right now. I’d wait for a 10% decline in the S&P before you start placing these short trades.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

Why Financial Innovation Is A Very Good Thing

Destructive financial innovations like derivatives have eroded the public's trust and made financial innovation a bad word. However, there are still financial innovations that can help the average American, and Robert Shiller argues why financial innovation is still needed. See the following post from Economist's View for more.

Robert Shiller defends financial innovation:

In defense of financial innovation, by Robert Shiller, Commentary, Financial Times: Many appear to think that the increasing complexity of financial products is the source of the world financial crisis. In response to it, many argue that regulators should actively discourage complexity. ... They do have a point. Unnecessary complexity can be a problem ... if the complexity is used to obfuscate and deceive, or if people do not have good advice on how to use them properly. ...

But any effort to deal with these problems has to recognize that increased complexity offers potential rewards as well as risks. New products must have an interface with consumers that is simple enough to make them comprehensible, so that they will want these products and use them correctly. But the products themselves do not have to be simple.

The advance of civilization has brought immense new complexity to the devices we use every day. ... People do not need to understand the complexity of these devices, which have been engineered to be simple to operate.

Financial markets have in some ways shared in this growth in complexity, with electronic databases and trading systems. But the actual financial products have not advanced as much. We are still mostly investing in plain vanilla products such as shares in corporations or ordinary nominal bonds, products that have not changed fundamentally in centuries.

Why have financial products remained mostly so simple? I believe the problem is trust. ... People are ... worried about hazards of financial products or the integrity of those who offer them. ... When people invest for their children’s education or their retirement, they ... may not be able to rebound from mistaken purchases of faulty financial devices...

Thus, to facilitate financial progress, we need regulators who ensure trust in sophisticated products. ... They must ... be open to ... complex ideas ... that have the potential to improve public welfare.

Unfortunately, the crisis has sharply reduced trust in our financial system..., people do not trust some good innovations that could protect them better. ... I have proposed ... “continuous workout mortgages”...[to] protect against exigencies such as recessions or drops in home prices. Had such mortgages been offered before this crisis, we would not have the rash of foreclosures. Yet, even after the crisis, regulators seem to be assuming a plain vanilla mortgage is just what we need for the future. ...

Another innovation that is underused is retirement annuities... There are ... annuities that protect people against outliving their wealth,... that protect against inflation,... that protect against having problems in old age... and generational annuities that exploit the possibilities of intergenerational risk sharing. But most people do not make use of any of these.

Ideally, all of these protections for retirement income should be rolled into a unified product. Such products are not generally available yet. Certainly, people might be mistrustful of committing their life savings to such a complex new product at first even if it were available. So, such products are not offered and people often do nothing to protect themselves against most of these risks.

Behind the creation of any such new retail products there needs to be an increasingly complex financial infrastructure... It is critical that we take the opportunity of the crisis to promote innovation-enhancing financial regulation and not let this be eclipsed by superficially popular issues. ... Regulatory agencies need to be given a stronger mission of encouraging innovation. ...

Something has to assure people that these product are safe before they will purchase them. We might have expected the market to regulate risk not so long ago, and trusted it to do so, but that seems like a bad bet now. An "interface with consumers that is simple enough to make [the products] comprehensible" could build trust if people could believe that the person doing the simplifying had considered and understood every possible risk that is attached to the product, but did anybody really comprehend the big picture in our most recent crisis? If there were such people, there weren't very many of them, not enough to inspire confidence and trust more generally.

Another method of building confidence is ratings agencies, but they won't be trusted again any time soon. Regulators that make the public confident that nothing can go wrong would help too, but building that kind of trust in regulators after what just happened is a tall order. Private insurance of some sort is an option, but absent some sort of government guarantee, can private insurance companies be trusted with your life savings if there is a severe financial meltdown? People have even lost faith in government's ability to insure people against medical and financial calamity in old age, so when it comes to providing financial insurance, government is not the solid, trusted institution it was not so long ago.

As you tick down the list of ways trust might be restored, you find one failure after another in terms of providing reliable information on the risks of particular financial products or strategies, and no matter what regulators or anyone else tries to do to rebuild the trust in financial institutions and products that has been lost, recent track records make it likely that this will be a long, drawn out process. Given that forgetting about such risks over time seems to be an ingredient in the development of bubbles, I'll let you decide whether that's good or bad.

This post has been republished from Mark Thoma's blog, Economist's View.

Will You Be Seeing Capitalism: A Love Story?

Will you be watching Michael Moore's new movie that basically argues that capitalism is evil? Or are you outraged that Moore would use the recent financial failures to argue against the American economic system? Glen Hall, Editor-In-Chief of The Street, discusses why he will not be seeing this film.

Capitalism (the movie) came to New York on Monday and I missed the premiere.

I'm not too disappointed, mind you, since I haven't seen any of Michael Moore's movies. I can only take so much faux outrage (how's that for irony?).

I do love a good dose of hyprocrisy, though.

For that, I will turn to Michael Corkery, who did attend the premier of Capitalism: A Love Story at New York's Lincoln Center.

Corkery notes in The Wall Street Journal's Deal Journal blog that "before the film, the crowd sipped champagne and cocktails in the "Morgan Stanley Lobby" and then headed to their seats in the "Citi Balcony." Movie tickets were available at the "Bank of New York Box Office" and there's outdoor seating at the "Credit Suisse Information Grandstand."

So Moore owes the glamour and hype of Monday's event to the very institutions he brands as evil in the film. Let's hope Moore selected the venue on purpose to be ironic.

From what I can tell, the idea that capitalism is evil is pretty much the plot of Moore's film. On the movie's official Web site, Capitalism is described as an exploration of the "price that America pays for its love of capitalism."

I love this line from Kenneth Turan's review in the Los Angeles Times: Moore "lays the ills of American society that he's chronicled over all that time at the feet of an out-of-control free-market system he so detests that he puts priests on camera to talk about capitalism as morally evil."

All this makes me wonder where Moore keeps all the money he earns from his films, considering that he seems to hate banks, Wall Street and capitalism with such passion. Frankly, I don't really buy all that posturing. I think he secretly enjoys the fruits of capitalism.

I recall bumping into Moore at the 2004 Democratic party convention in Boston. He was the officially uninvited hero of the day because of his Bush-bashing film Fahrenheit 911. He was rather full of himself and certainly enjoying the spotlight. Was he engaging in the time-honored capitalist tradition of self promotion?

I didn't see Moore later that summer at the Republican convention in New York, but I'm sure he would have enjoyed the attention of being the anti-celebrity at the event if he could have found a way to get in.

Earlier this year, I almost bumped into Moore again when I unwittingly stepped onto the set of Capitalism as the film crew staged the scene of Moore driving an armored truck in a trumped up gesture to get taxpayer money back from the offices of AIG (AIG Quote) and Goldman Sachs (GS Quote).

I didn't see Moore. In fact, I hardly saw anyone except for the film crew. No one on the streets of lower Manhattan seemed to care. But then again, I'm sure Moore's message isn't for the folks in New York's financial district anyway.

In any event, Capitalism the movie begins a limited engagement for general audiences in New York tonight.

I won't be going. I prefer the real thing.

This post has been republished from The Street.

Why Going Green Doesn't Hurt The Economy

The cap and trade bill that has already passed the House, will undoubtedly lead to more rigorous debate across America. Opponents may argue that the cap and trade bill would have a significant negative impact on the economy. Paul Krugman discusses why this is a falsehood that has been conjured by misguided talk show hosts. See the following post from Economist's View.

The Waxman-Markley cap-and-trade climate bill won't destroy economic growth:

It’s Easy Being Green, by Paul Krugman:, Commentary, NY Times: So, have you enjoyed the debate over health care reform? Have you been impressed by the civility of the discussion and the intellectual honesty of reform opponents? If so, you’ll love the next big debate: the fight over climate change.

The House has already passed a fairly strong cap-and-trade climate bill, the Waxman-Markey act, which if it becomes law would eventually lead to sharp reductions in greenhouse gas emissions. But on climate change, as on health care, the sticking point will be the Senate. And the usual suspects are doing their best to prevent action.

Some of them still claim that there’s no such thing as global warming, or at least that the evidence isn’t yet conclusive. But that argument is wearing thin — as thin as the Arctic pack ice... So the main argument against climate action probably won’t be the claim that global warming is a myth. It will, instead, be the argument that doing anything to limit global warming would destroy the economy. ...

It’s important, then, to understand that claims of immense economic damage from climate legislation are as bogus, in their own way, as climate-change denial. Saving the planet won’t come free (although the early stages of conservation actually might). But it won’t cost all that much either.

How do we know this? First, the evidence suggests that we’re wasting a lot of energy right now...— a phenomenon known ... as the “energy-efficiency gap.” The existence of this gap suggests that policies promoting energy conservation could, up to a point, actually make consumers richer.

Second, the best available economic analyses suggest that even deep cuts in greenhouse gas emissions would impose only modest costs on the average family. Earlier this month, the Congressional Budget Office released an analysis of the effects of Waxman-Markey, concluding that in 2020 the bill would cost the average family only $160 a year, or ... roughly the cost of a postage stamp a day.

By 2050, when the emissions limit would be much tighter, the burden would rise... But the budget office also predicts ... that G.D.P. per person will rise by about 80 percent. The cost of climate protection would barely make a dent in that growth. And all of this, of course, ignores the benefits of limiting global warming.

So where do the apocalyptic warnings about the cost of climate-change policy come from?

Are the opponents of cap-and-trade relying on different studies that reach fundamentally different conclusions? No, not really. ... Instead, the campaign against saving the planet rests mainly on lies.

Thus, last week Glenn Beck — who seems to be challenging Rush Limbaugh for the role of de facto leader of the G.O.P. — informed his audience of a “buried” Obama administration study showing that Waxman-Markey would actually cost the average family $1,787 per year. Needless to say, no such study exists.

But we shouldn’t be too hard on Mr. Beck. Similar — and similarly false — claims about the cost of Waxman-Markey have been circulated by many supposed experts.

A year ago I would have been shocked by this behavior. But as we’ve already seen in the health care debate, the polarization of our political discourse has forced self-proclaimed “centrists” to choose sides — and many of them have apparently decided that partisan opposition to President Obama trumps any concerns about intellectual honesty.

So here’s the bottom line: The claim that climate legislation will kill the economy deserves the same disdain as the claim that global warming is a hoax. The truth about the economics of climate change is that it’s relatively easy being green.

[See also Can Countries Cut Carbon Emissions Without Hurting Economic Growth? by Robert Stavins.]

This post has been republished from Mark Thoma's blog, Economist's View.

Government Stimulus Boosts Wall Street

Despite the major cuts in consumer spending, the stock market is soaring because the government has more than picked up the slack. While consumers have started saving, it is the government who has gone on a shopping spree, buying cars , mortgages, and maybe even health insurance. See the following post from Economist's View for more on this topic.

There's not a populist bone in Robert Reich's body. Not a one:

Why the Dow is Hitting 10,000 Even When Consumers Can't Buy And Business Cries "Socialism", by Robert Reich: So how can the Dow Jones Industrial Average be flirting with 10,000 when consumers, who make up 70 percent of the economy, have had to cut way back on buying because they have no money? Jobs continue to disappear. One out of six Americans is either unemployed or underemployed. Homes can no longer function as piggy banks because they’re worth almost a third less than they were two years ago. And for the first time in more than a decade, Americans are now having to pay down their debts and start to save.

Even more curious, how can the Dow be so far up when every business and Wall Street executive I come across tells me government is crushing the economy with its huge deficits, and its supposed “takeover” of health care, autos, housing, energy, and finance? Their anguished cries of “socialism” are almost drowning out all their cheering over the surging Dow.

The explanation is simple. The great consumer retreat from the market is being offset by government’s advance into the market. Consumer debt is way down from its peak in 2006; government debt is way up. Consumer spending is down, government spending is up. Why have new housing starts begun? Because the Fed is buying up Fannie and Freddie’s paper, and government-owned Fannie and Freddie are now just about the only mortgage games remaining in play.

Why are health care stocks booming? Because the government is about to expand coverage to tens of millions more Americans, and the White House has assured Big Pharma and health insurers that their profits will soar. Why are auto sales up? Because the cash-for-clunkers program has been subsidizing new car sales. Why is the financial sector surging? Because the Fed is keeping interest rates near zero, and ... the government is still guaranteeing any bank too big to fail will be bailed out. Why are federal contractors doing so well? Because the stimulus has kicked in.

In other words, the Dow is up despite the biggest consumer retreat from the market since the Great Depression because of the very thing so many executives are complaining about, which is government’s expansion. And regardless of what you call it – Keynesianism, socialism, or just pragmatism – it’s doing wonders for business, especially big business and Wall Street. Consumer spending is falling back to 60 to 65 percent of the economy, as government spending expands to fill the gap.

The problem is, our newly expanded government isn't doing much for average working Americans who continue to lose their jobs and whose belts continue to tighten, and who are getting almost nothing out of the rising Dow because they own few if any shares of stock. Despite ... all their cries of "socialism" -- big business and Wall Street are more politically potent than ever.

It would have been better if the effort to revive the economy had a stronger trickle up component, i.e. give the tax cuts or transfers to the people who need it rather than those who don't, they will spend the extra money, it will trickle up as profits to the owners of businesses as the money is spent and re-spent through the multiplier process, and the owners will use the profits to hire more workers and to make productive investments (and even if the money doesn't trickle up as expected, at least you've helped people in need, when tax cuts for the wealthy don't trickle down, the consolation prize isn't as attractive).

This post has been republished from Mark Thoma's blog, Economist's View.

No Gold Bubble This Time

With gold reaching an all time inter-day high of $1,033, the skeptics might say this is starting to look like another bubble. However Chris Weber explains why there are simple signs that show that we are not seeing a bubble but rather an opportunity. See the following post from Daily Wealth for more.

When spot gold closed on September 11 in New York at $1,005.10, it was the highest price on record... though by the time you read this, it may have been surpassed.

Gold traded higher than this, back on March 17, 2008. When that day opened in Asia, the early morning Australian and Hong Kong markets pushed gold quickly up from $1,000 to a high – so far an all-time inter-day high – of $1,033.

But as Europe opened later in the day, the price fluctuated between $1,020 and $1,030. As the U.S. markets opened, the price plunged down to $1,000 and ended just three dollars more than this.

So if you are going by the closing trade of that day, which happens to be New York as time zones go, then what happened on Friday, September 11 broke the record.

This breakthrough has drawn a lot of publicity. Hedge funds are now heavily tilted toward the long side of the gold futures market. Many gold stocks sit near all-time highs. Mainstream newspapers and magazines are starting to carry stories about gold.

This bullish sentiment has led many people to ask me if gold is far too popular now... or even in a "bubble."

My answer: I see nothing like a bubble yet. Ask your friends or neighbors these questions:

"What do you think about gold or silver as an investment?" and if they answer in a positive manner, further ask: "What are the best ways to own it? How do you own it? What percentage of your assets do you have in the precious metals area?" If this seems too invasive, ask, "What percentage of a person's assets do you think should be in the precious metals area?"

That's what I do. The people I ask have no idea what I think about gold or silver. I ask just as a sort of person – maybe on the slow side and not that bright – who wants to know about the area.

From what I'm told, almost no one is in gold or silver. Maybe a few shares of Newmont Mining, but as a percentage of their total net worth, we are talking tiny here.

People who think gold is in a bubble are often people who did not see real bubbles when they happened. In the real estate boom, the easy profits were on everyone's lips. Same with the Internet bubble 10 years ago.

When I mentioned gold back in 2001 and 2002, when I accumulated it, I got looks from people as if I were crazy.

These days, the crazy looks are gone. But now I often only get answers that gold or silver may be a good investment, but they don't have any themselves. Try it yourself.

Of course, if you've been mouthing off about how great gold and silver are, you probably want to ask people who don't already know your views: They won't think you are trying to "lay your propaganda" on them.

Granted, the public awareness of gold and silver as investments is much, much higher today than in 2001. No one was buying then, and people thought you were crazy if you told them you were. But things haven't changed in that the average person still does not own any.

When everyone you know is talking about how to make "easy money" buying gold or silver, then we may be in a different era. But right now, I think both metals have more room, and most likely much more room, to go.

This post has been republished from Dr.Steve Sjuggerud's blog, Daily Wealth.

Democratic Presidents Have Better Stock Market Performance

Research suggests that stock market performance can be connected to the election cycle and the party that is in power. Interestingly, one paper found that 1 year after an election, democratic presidents presided over better performing stock markets than republican presidents. See the following post by James Picerno, for more on this.

Studying the election cycle and the stock market isn't new, but that doesn't stop inquiring minds from taking a fresh look at the numbers. CXO Advisory Group offers yet another perspective, albeit with middling results. As this research concludes,

"..there appear to be both long-term and short-term connections between the U.S. national election cycle and stock market performance, with presidential term year 3 (1) the best (worst) and a tendency for a brief election-time rally. However, the subsamples for presidential term year analysis are very small, so confidence in related tendencies is very low."

Meanwhile, a popular research paper from recent history advises that "the excess return in the stock market is higher under Democratic than Republican presidencies." Of course, that was from the vantage of 2003. Will the trend hold over the remaining years for the present incumbent? Based on the year-to-date returns so far, one might argue in the affirmative. But with the election more than three years away, a touch of modesty might still be in order.

SEI came to a similar conclusion last year, writing in a research note that "one year following [an] election, the average return of the DJIA was 2.18%. Here, the advantage goes to the Democrats, who averaged 5.43%, with the best year credited to Franklin D. Roosevelt, at 29.96% in 1944. Roosevelt also had the most negative return here; -28.68 during the first year of his first term in 1936. The average during the 9 Republican administrations was -1.07%."

Of course, some think there's enough of a challenge in predicting election outcomes alone without muddying the waters with adding stock market predictions to the game. If you're of a similar persuasion, Professor Ray Fair of Yale is your man. As one of the leading academics parsing the finer points of forecasting elections, he's well versed in the opportunities and limits of quantitative analysis and politics.

This post has been republished from James Picerno's blog, The Capital Spectator.

How To Stop The Next Financial Crisis

Are financial crises unpredictable or can we put simple financial indicators in place that will warn us before it is too late? An early detection system for financial danger that accurately pinpoints the type of danger we are facing could help prevent the next crisis. See the following post by Mark Thoma for more on this topic.

David Levine "aggressively argues":

our models don't just fail to predict the timing of financial crises - they say that we cannot.

The San Francisco Fed's Bharat Trehan says:

simple indicators based on asset market developments can provide early warnings about potentially dangerous financial imbalances. ... [W]e have taken two simple indicators off the shelf and shown that both would have signaled impending trouble prior to the current crisis. That makes it harder to argue that financial crises are, by their nature, unpredictable. And it shows that such simple indicators can be useful ... as signals of rising levels of risk in the economy.

See here. Or here.

We ought to be able to say, at the very least, something like:

If you keep eating that junky credit instead of a healthier financial diet, your monetary circulatory system is likely to have severe problems at some point in the future.

Many people had a sense things were out of balance and that at some point it would cause us problems, but the indicators most people looked at pointed to a diagnosis involving exchange rate movements and an international unwinding. The discussion centered on issues such as whether we would have a hard or a soft landing as this process unfolded, there was little discussion of the type of crisis that actually occurred.

So we need two things. First, we need indicators such as those identified in the SF Fed article that can tell us when danger is building in the financial sector.

But that is not enough. Though many people had a sense from the indicators they looked at that things were out of balance, the indicators pointed to international financial issues rather than the true problem, and hence most of the analysis and policy discussions were devoted to guarding against problems related to international financial flows.

Thus, the second thing we have a need for is a set of indicators that do a better job of telling us where the problems are likely to occur. That is where we made the biggest mistake, misdiagnosing the type of crisis that was coming. Having indicators that can do a better job of identifying the type of financial crisis we are facing will allow us to design and implement effective policy responses rather than wasting time analyzing and planning for the wrong type of crisis.

This post has been republished from Mark Thoma's blog, Economist's View.

Shiller Says We Need More Research On Economic Bubbles

With the failure of current economic models to give adequate warning of the current financial crisis, Robert Shiller says we need more research of bubbles and what their role should be in economic models. If we had a better understanding of bubbles, could we prevent them from reaching dangerous levels or detect trouble much sooner? The following article summarized by the Economist's View discusses this topic.

Robert Shiller says economists and their models need to take bubbles seriously (compare Dani Rodrik's "Blame Economists, not Economics"):

Economists need to study bubbles, reinvent models, by Robert Shiller, Commentary, Project Syndicate: The widespread failure of economists to forecast the financial crisis ... has much to do with faulty models. This lack of sound models meant that economic policymakers and central bankers received no warning of what was to come. ...

[T]he current financial crisis was driven by speculative bubbles in the housing market, the stock market, energy and other commodities markets. ... You won’t find the word “bubble,” however, in most economics treatises or textbooks. Likewise, a search of working papers produced by central banks and economics departments in recent years yields few instances of “bubbles” even being mentioned. Indeed, the idea that bubbles exist has become so disreputable ... that bringing them up in an economics seminar is like bringing up astrology to a group of astronomers.

The fundamental problem is that a generation of mainstream macroeconomic theorists has come to accept a theory that has an error at its very core — the axiom that people are fully rational. ...

[E]conomists assume that people ... use all publicly available information and know, or behave as if they know, the probabilities of all conceivable future events. ... They update these probabilities as soon as new information becomes available and so any change in their behavior must be attributable to their rational response to genuinely new information. If economic actors are always rational, then no bubbles — irrational market responses — are allowed. ...

In fact, people almost never know the probabilities of future economic events. They live in a world where economic decisions are fundamentally ambiguous, because the future doesn’t seem to be a mere repetition of a quantifiable past. ...

To be sure, the purely rational theory remains useful for many things. ... Economists have also been right to apply his theory to a range of microeconomic issues... The theory, however, has been overextended. For example, the “Dynamic Stochastic General Equilibrium Model of the Euro Area,” developed by Frank Smets ... and Raf Wouters..., is very good at giving a precise list of external shocks that are presumed to drive the economy, but nowhere are bubbles modeled. The economy is assumed to do nothing more than respond in a completely rational way to these external shocks.

Milton Friedman and Anna Schwartz, in their 1963 book A Monetary History of the United States, showed that monetary-policy anomalies — a prime example of an external shock — were a significant factor in the Great Depression of the 1930s. ... To some, this revelation represented a culminating event for economic theory. The worst economic crisis of the 20th century was explained — and a way to correct it suggested — with a theory that does not rely on bubbles.

Yet events like the Great Depression, as well as the recent crisis, will never be fully understood without understanding bubbles. The fact that monetary policy mistakes were an important cause of the Great Depression does not mean that we completely understand that crisis, or that other crises fit that mold.

In fact, the failure of economists’ models to forecast the current crisis will mark the beginning of their overhaul. This will happen as economists’ redirect their research efforts by listening to scientists with different expertise. Only then will monetary authorities gain a better understanding of when and how bubbles can derail an economy and what can be done to prevent that outcome.

This post has been republished from Mark Thoma's blog, Economist's View.

Saving Money Could Become Popular Again

According to a poll by American Express, it looks like Americans have shifted their consumer behavior to be more likely to save extra dollars. However according to Alan Greenspan, this could slow economic growth in an economy driven by personal consumption. For more on this, see the post below by Tim Iacono.

We're all going to be hearing a lot about the "paradox of thrift" in the months (and probably years) ahead, the well worn maxim that economic growth suffers when more people save, due to the fact that more saving means less spending.

This report in the LA Times covers the topic quite well.

After the most punishing downturn in half a century, the U.S. economy has finally begun showing signs of renewed life. Stock prices and factory orders are up. The housing market appears to be stabilizing. Job losses are moderating. Overall, the economy has begun to grow, officials believe.

Welcome as all those developments are, many analysts worry that they may not be enough to offset another trend: the continuing refusal -- or in many cases the inability -- of millions of U.S. consumers to go out and spend money the way they did before the crash.

Yes, conventional economic "wisdom" has it that there was nothing fundamentally wrong with an economy where more than 70 percent of all activity came from personal consumption.

As formerly spendthrift consumers all across the country begin to rebuild their personal balance sheets, now realizing that their home equity isn't going to fund their kids' higher education and their own retirement, more traditional methods of saving (e.g., spending less than you make) are becoming popular again.

No less an economic expert than former Fed chairman Alan Greenspan feared this development not long ago, noting that a higher personal saving rate (after tax income minus spending) could make an economic recovery difficult.

He seems to be right about a lot more things in retirement than when he ran the central bank.

When American Express asked a sampling of 2,032 people late last month what they would do if they found $500, the answers were like a pitcher of ice water in the face of retailers. Survey respondents were offered a list of possible spending choices that included splurging at a restaurant, going on a shopping spree and taking a trip.

But a mere 10% or fewer marked one of those items. Most went down the list and checked off paying regular bills, reducing credit card debt or simply saving the money.

"What we see consumers doing is exhibiting a level of discipline that we didn't know," said Gail Wasserman, a spokeswoman for American Express, which like other card companies has reinforced the reduced- spending trend by issuing fewer cards and slashing credit lines to lower their own risks.

"It's very clear consumers have hit the reset button. They've reevaluated their priorities and separated their wants from their needs," Wasserman said.

Apparently, that's what happens when you reach the maximum level of debt that a system can sustain and asset prices can be pushed no higher - you hit the reset button.

That is an odd analogy - hitting the reset button.

For example, when computers are functioning properly, there is no need to reboot. Normally, it is only when things go awry that a restart is needed. It seems that if the system had been designed a little better, there would be no need to reset it...

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Could China's Government Send Gold Soaring?

As the value of the US dollar goes down, holding dollars could become more of a risk to your portfolio. That is why hedging your investments in gold could be a smart move. The following post from Daily Wealth discusses the possibility of a looming gold bubble.

Inside sources have recently confirmed the Chinese government is actively promoting gold and silver investment to the masses.

Some analysts now contend that China can no longer afford to let the gold or silver price slump.

The rationale behind that contention is that with the Chinese government now telling the general populace to buy precious metals, it would be highly problematic should gold and silver subsequently take a nose dive.

In many cases, what a government wants and what ultimately occurs can be wildly different, due to unintended consequences rarely foreseen by officialdom, and because once the masses get it into their heads to break one way or another, government's desires are largely ignored.

"You shall not smoke marijuana," says the government. "Roll me another," says John Q. Public.

But in the case of gold, interestingly enough, the Chinese government has the means at its disposal to actually do something about prices. Namely, at $1,000 an ounce, the total value of all the gold ever mined comes to about $5 trillion.

Of that amount, less than $1 trillion is held in official reserves, the rest under mattresses, in jewelry and family heirlooms, and in various ETFs – GLD being the biggest, by far, holding about $34 billion worth of gold.

Against these totals, China has foreign reserves in excess of $2 trillion.

In other words, more than enough to push the tiny gold market around in any way it wishes. Given that much of its reserves are now denominated in fragile U.S. dollars that it would sorely love to replace with something more tangible, and that China is the world's largest gold producer, the country's involvement with gold is something more than just a passing fancy.

Simply, there is a new gorilla in the room in global gold markets. The extent to which the broader market hasn't yet figured this out is the extent to which you as an early mover can ultimately profit. Especially in the more leveraged gold stocks, which continue to be strong even as the broader markets show weakness.

That all of this comes before the dollar hits the wall it must hit, or before the inflation that is now baked in the cake arises, lends a lot of credibility to the idea that when the gold bubble begins to expand, it could reach all the way to the moon.

No need to chase gold at these levels, as opposed to buying on dips. But buy.

This post has been republished from Steve Sjuggerud's blog, DailyWealth.

A Closer Look At The $2 Trillion Increase In Household Net Worth

According to the Fed, Americans are $2 trillion richer in the second quarter, but is this an accurate reflection of reality? It turns out that almost all of the gains were in equities and mutual funds which accounted for a $1.6 trillion of the increase, while liabilities shrunk by $35 billion. For more on this, see the following post by Tim Iacono.

The Federal Reserve's Flow of Funds report with data through the second quarter of 2009 was released yesterday and the $2 trillion improvement in household net worth was in all the headlines. As shown in the slight expansion of the green portion of the chart below, it was all about a rising stock market.



The rising value of equities and mutual funds accounted for a whopping $1.6 trillion of the overall increase of $1.9 trillion in assets while liabilities fell by about $35 billion.

Overall household liabilities declined for the third consecutive quarter which, while understandable, given the change in attitude toward debt by the American consumer, does not bode well for an economy where asset prices must be perpetually pushed higher by rising levels of debt in order for us all to succeed.

Clearly, the plan here is that, since consumers can't really handle any more debt (especially since a growing number of them don't have jobs), the government is stepping in to fill the void.

As for real estate, there is some good news for homeowners as the overall value of property ticked up during the second quarter.



While the amount of outstanding mortgage debt owed by households fell by about $30 billion to $10.4 trillion in the second quarter, the value of real estate reportedly increased by 1.8 percent, from $17.949 trillion to $18.272 trillion.

This is largely consistent with the Case-Shiller national home price index that rose 2.9 percent from the first quarter to the second, though it's hard to believe that this is the beginning of a new trend of rising home prices.

Then again, since the Federal Reserve has pushed mortgage lending rates down to freakishly low levels by printing money and the U.S. government now owns or guarantees virtually the entire U.S. mortgage market while Congress appears ready to double the $8,000 home buyer tax incentive ... anything could happen.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Should We Tolerate A Jobless Recovery?

Although the recession may have technically ended, millions are still without jobs and thousands are still losing their jobs. Should the federal government do more to fight the jobless recovery or should we tolerate a slower recovery without jobs? Economist Mark Thoma from Economist's View discusses this topic in the following post.

There is news on weekly jobless claims. Despite all the attempts to paint this as good news, the fall of 12,000 from the previous week is being highlighted in many places, 545,000 new claims is still very high and indicates that the recession is not yet over for workers:

Jobless Claims Decline, WSJ: Initial claims for jobless benefits fell 12,000 to 545,000 in the week ended Sept. 12...

The four-week average of new claims, which aims to smooth volatility in the data, fell by 8,750 to 563,000 from the previous week's revised figure of 571,750.

With claims still at a fairly high level, the data seems to reinforce the idea expressed earlier this week by U.S. Federal Reserve Chairman Ben Bernanke that the recession is most likely over from a technical standpoint but it will take time for the labor and credit markets to recover...

The ... number of continuing claims -- those drawn by workers for more than one week in the week ended Sept. 5 -- rose by 129,000 to 6,230,000 from the preceding week's revised level of 6,101,000.

Amid all the optimism that seems to be pervading the coverage of the economy, a mood that is being intentionally stoked by policymakers eager to rebuild confidence, we'll have to keep reminding everyone that workers still need help (I'm seeing more and more stories, for example, about unemployment benefits running out for some workers even as long-term unemployment continues to rise). As this picture from the SF Fed shows, the employment series does not yet display the "fishhook" shape shown in other series that are the source of the declarations that the worst is behind us. And as the experience of the last recession in the graph below shows, the trough in employment can be far behind the trough in output:

One more note on this. I was pleased to see McClatchy News at least asking the question in "Will Obama, Fed tolerate another jobless recovery?," so it's not completely off the radar and perhaps this will help to get the message to policymakers in congress. As for the Fed, as the futures market for the federal funds rate shows, markets believe rate hikes aren't far away indicating a belief among market participants that as output begins recovering, inflation worries will trump concerns about employment:

Have We Learned Nothing From The Financial Crash?

A year after the Lehman fiasco, it seems as if Wall Street has learned nothing from the financial implosion. Banks are still growing larger and risk taking behavior has returned. Stanley Bing from The Street explains why we should not be surprised.

The news is full of pundits, analysts and even a president opining on the state of the finance business one year after the big plotz. Consensus is that we've all learned nothing. The big banks are getting bigger. Risky instruments are reappearing. The Street is once again getting on its high horse about over-regulation. Thinking people, quite naturally, are worried. We're not even out of the woods yet and here come the same old players starting to sing the same crazy tune.

The critics just don't get it. Wall Street isn't a rational, thinking creature. Oh sure, it's got charts and graphs and metrics and fetrics. But if you want to know the way things really operate, you have to look at a creature that isn't driven by its brain, but by its heart... and by any other organ that responds to that beat.

In short, Wall Street has all the sentience, maturity and emotional self-control of a teenager... or maybe of a 50-year-old guy with a tiny ponytail and a red BMW Z4.

Last year, before the breakup, he was so excited. Love was in the air, and with it lots of money. Love involves risk, of course. But that's at the core of what's so exciting! No risk? No passion. Particularly for an entity whose emotions are quite immature, who needs daily stimulation to remain engaged, who requires the tang of danger to feel fully alive. Those were great days! Ah, to be rich and in love!

Then... the unthinkable happened. The big breakup. Poor Street's heart was broken and what was worse, his belief that the risk was worth taking ever again was smashed to pieces. Poor guy. He languished for months, afraid to grant credit, terrified of incurring debt, sleeping much of the day away, waiting for nighttime when it was permissible to drown his sorrows.

And yet, the heart of the crazy, irrational Street is strong. He can't live without that rush of endorphins that comes with the high-wire act! So now he's coming back, ready to love again, to make the plunge, to take those risks, even the stupid ones he knows will lead to his destruction again.

It this wise? Is this the behavior of a thoughtful, mature person? Certainly not. He's a mad, impetuous fool! He can't live without the thrill of the chase, the agony of anticipation, the ache, the yearning, the oasis of glory and satisfaction in the desert of life! He won't! Step aside, world! Love is in the air! He's apt to do just about anything!

Can't anybody keep an eye on him, for his own good?

This post has been republished from The Street.

We Need Answers On Financial Reform

Daniel Dicker from The Street says we need more specifics about financial reform. With financial reform seeming to have fallen behind health care as the top priority of the Obama administration, Dicker fears that we may be missing an opportunity to regulate potentially harmful financial instruments. See the following post from The Street for more on this.

In the wake of President Obama's speech Monday, one piece of possible finance reform less explored is with derivatives, including credit default swaps, commodities and other over-the-counter issues. Despite the president's inspired speech preaching responsibility on Wall Street, we really haven't come very far in this area in the year since the demise of Lehman Brothers.

Part of the problem I had with his impassioned speech was with the lack of specifics. Despite being a great supporter of the president and having voted for him, I find many of his speeches great oratory events with little substance contained in them.

In his talk of finance reform, Obama made some vague calls for increased capital requirements for the big banks, a requirement that in and of itself wouldn't have prevented the cataclysm we experienced last year.

As to the most important ideas of transparency in markets, Obama focused on the idea of a "consumer czar" or other advocate in Washington who would somehow prevent the sale of mortgages that people couldn't understand or afford. How this would be done, however, remains a mystery.

But derivatives, which clearly exacerbated the financial downturn last year, were left conspicuously out of the president's speech. This is an interesting omission because they had gotten so much interest in their operation and their reform last year, but now seem to be on a very far back burner and not gaining much attention anymore.

This is a shame because I believe that derivatives, much more than shady mortgage practices, create a far greater threat to our financial health going forward.

What's interesting is that the Bush administration had taken the greatest strides in bringing transparency to this market, and the Obama administration, while having public sentiment and great momentum on their side, has really dropped the ball here and squandered a great opportunity.

It was former Treasury Secretary Henry Paulson who issued the ultimatum for transparency in credit default swaps, requiring a clearinghouse structure for clearing of these instruments. But since President Obama was inaugurated, Treasury Secretary Tim Geithner has done nothing to follow up on these initiatives, essentially leaving the market exactly as it was and leaving us open again for another "AIG(AIG Quote)-like" problem.

To the detriment of our economy, especially consumers, oil and other commodity markets have continued to show increased and unceasing volatility. They are being moved by investment capital, hedge funds, uncontrolled ETFs and just about everything except the fundamentals.

Despite our new president's impressive speeches, absolutely nothing has been proposed or undertaken to get a better handle on the roiling commodity markets.

And those markets are just a microcosm of the rest of the enormous over-the-counter markets of specialized and non-standardized forwards and swaps.

While the CDS market with its $26 trillion notional value has been the most visible of the OTC markets because of the trouble they've caused, other markets traded in the shadows of the investment banks pose as much or more of the same kind of risks in the future. In getting a handle on credit default swaps, a model for dealing with systemic risk in all of the OTC markets might be found.

You won't find enthusiasm from the biggest investment banks like Goldman Sachs(GS Quote), Morgan Stanley(MS Quote), UBS(UBS Quote), JPMorgan Chase(JPM Quote) and others, who derive terrific percentages of their profits from OTC trading for reform in these markets, many of which they created.

And other open exchanges that would benefit from transparency in the trading of CDS issues and other OTC swaps like the Chicago Mercantile Exchange(CME Quote), IntercontinentalExchange(ICE Quote) and the NYSE Euronext(NYX Quote) are less apt to push hard for reform because their biggest potential clients in these new markets are those same investment banks. You can't bite the hand that ultimately feeds you.

Good results from the stimulus package, bank bailouts and Fed guarantees of mortgages that halted the stock market slide and a total seizure of the credit markets have also stemmed the interest of market reform that got us into this mess in the first place.

This is a dangerous, if perfectly understandable reaction. Nobody ever thinks of fixing a hole in the ceiling more desperately than when it's raining. But when the rain stops and water isn't dripping on your head, that hole seems far less important to fix.

And Obama may be even less able to tackle these problems than his predecessor, despite his greater natural ease towards reform. The current administration has taken on quite a few issues at once and while the economy was clearly job one immediately after inauguration, it now feels as if it has taken a back seat to health care reform. One visit to Federal Hall yesterday on Wall Street and one speech, no matter how rousing, can change the amount of political capital that any president has and where he spends it first.

So a year after the fall of Lehman, it seems that we are nowhere closer to reforming or even creating new rules for the markets that were the source of all the difficulties last year -- including credit default swaps, commodities and other OTC markets.

I think we will live to regret having missed this opportunity.

This article has been republished from The Street.

Government Stimulus: No Exit In Sight

While most experts are in agreement that we are in the early stages of economic recovery, there is still no signs of a plan to wean the country off the cocktail of stimulus medicine. Is it time for the government to start reducing the monetary and fiscal tools that are artificially propping up the economy, or should it wait until it is obvious that the economy is on solid footing? See the following post from Capital Spectator for more on this topic.


We've been writing for months that the recession appears close to a "technical" finale but that the recovery would be slow, sluggish and generally vulnerable for an unusually extended period of time. Two stories in the latest news cycle echo our long-running commentary. In fact, the pair of stories makes the point better than we could.

First, Fed Chairman Ben Bernanke yesterday stated: "From a technical perspective, the recession is very likely over at this point" but "it's still going to feel like a very weak economy for some time," via MarketWatch.com.

Meanwhile, today's New York Times has a story that raises questions about how soon the housing market can function under its own power. At issue is a key piece of the government's fiscal stimulus—the $8,000 tax credit for first-time home buyers. As the Times observes, "When Congress passed an $8,000 tax credit for first-time home buyers last winter, it was intended as a dose of shock therapy during a crisis. Now the question is becoming whether the housing market can function without it." Although housing is but one piece of the economy, its trials and tribulations capture a core element of the economic turmoil of late. It may be too much to say that the housing market is a bellwether for the general economy, but it's close.

More to the point, the Times story reminds us of one of the potential drawbacks of stimulus, monetary or otherwise: markets may get used to the idea and so taking it away, which can cause secondary problems, depending on the exit strategy. That's not to say that stimulus was unnecessary. But in the rush to smooth over the crisis of the past year, cleaning up the mess born of the emergency financial and economic surgery promises to be the new new challenge in the months and years ahead.

Arguably that's a challenge that's superior to letting an economy implode, if in fact that really was a risk, as it seemed to be at times last fall. But the nature of trying to manage the business cycle imposes costs too. In effect, we're now faced with managing a chronic risk in the economy in exchange for minimizing if not sidestepping the acute risk that arose last autumn. Was the exchange worth it? The default answer is that the outcome will be a wash, when measured over the long run. In the short term, however, the details are messy.

This article has been republished from James Picerno's blog, The Capital Spectator.

Dollar Could Be Weak For Next Six To 12 Months

While the US economy may be on the way up, the outlook for the dollar is tumbling. According to Giles Keating, head of the Credit Suisse Global Economics and Strategy Group, the dollar could be weakened for the next six to 12 months as international investors find themselves with too many dollars. See the following post from HousingWire Buzzpost for more on this.

After beating up on the brokers, let’s give them a rest and bash the greenbacks!

Well, a report from Credit Suisse may do that for us. When the firm sat down with Giles Keating, the head of Credit Suisse Global Economics and Strategy Group, he noted that the dollar would be the first victim of the global economy’s recovery.

So, does that mean we’re recovering? Keating thinks so, even though he states that the resurgence is starting from a very low base and that we still have lots of unused capacity and high unemployment.

He points to the investors who were left behind by the initial pick-up in the stock market and their eagerness to put their money back to work, and he notes that policy makers have signaled that they would maintain a “very expansive economic policy” that will keep interest rates low and continued fiscal spending.

But the dollar could be left behind, he says. In fact, it’s already showing a downturn.

“The dollar has seen some big downward movements over the last couple of weeks, and although we think that this won’t continue in a straight line, we do think it likely that the dollar will continue to weaken over the next six to 12 months,” Keating says.

Russia and China aren’t helping with their push for a new currency at the recent G20 hearings, and Keating points to the low interest rates, almost zero, set in the US. He says the dollar has always needed an interest rate premium greater than that in Europe in order to remain stable or rise in value.

“Another key reason is that, strangely, as financial conditions get less risky and become more stable, people tend to move out of the dollar,” Keating says. “Moreover, a lot of people put money into the dollar during the crisis, and now they have too many dollars.”

This post has been republished from HousingWire Buzzpost.

Commercial Bank Money Supply Falling At Alarming Rate

Ambrose Evans-Pritchard warns that the commercial bank money supply has been contracting by levels comparable to the Great Depression. Futhermore, bank lending has shrunken a worrying 14 percent over the past three months. See the following post from The Mess That Greenspan Made for more on this.

Ambrose Evans-Pritchard writes in the Telegraph of the mounting concern (at least, in some quarters) about the rapid contraction in money supply and credit. Along with his Cheshire grin, Pritchard offers up something that we haven't heard for months now - a few comparisons to the Great Depression.

Both bank credit and the M3 money supply in the United States have been contracting at rates comparable to the onset of the Great Depression since early summer, raising fears of a double-dip recession in 2010 and a slide into debt-deflation.

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

The M3 "broad" money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5pc annual rate.

Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc.

"For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said.

Not having looked at M3 for some time now, the broadest measure of money supply but one that is no longer reported by the U.S. government, the graphic you see below was something of a surprise when recently spotted over at NowAndFutures.

This is not what most cynics thought the Federal Reserve would be trying to hide when they discontinued this data series a few yeas ago.



The inflation/deflation debate is clearly not yet over, though, given the looks of asset markets and commodity prices all around the world, it looks like the former has the upper hand - at least for the time being.

Back to Ambrose...

It is unclear why the US Federal Reserve has allowed this to occur.

Chairman Ben Bernanke is an expert on the "credit channel" causes of depressions and has given eloquent speeches about the risks of deflation in the past.

He is not a monetary economist, however, and there are indications that the Fed has had to pare back its policy of quantitative easing (buying bonds) in order to reassure China and other foreign creditors that the US is not trying to devalue its debts by stealth monetisation.
...
US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.

Mr Congdon said IMF chief Dominique Strauss-Kahn is wrong to argue that the history of financial crises shows that "speedy recovery" depends on "cleansing banks' balance sheets of toxic assets". "The message of all financial crises is that policy-makers' priority must be to stop the quantity of money falling and, ideally, to get it rising again," he said.

He predicted that the Federal Reserve and other central banks will be forced to engage in outright monetisation of government debt by next year, whatever they say now.

That would appear to be a good bet at the moment, however, it is a matter of degree.

In the U.S., the Fed's purchase of up to $300 billion in U.S. Treasuries along with a trillion dollars or so in GSE MBSs and other agency debt hasn't brought the world to an end, however, the Chinese aren't all that happy about it.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Americans Held Hostage By Large Financial Firms

Dylan Ratigan rants about large financial firms who are holding Americans hostage by being too big to fail, forcing the government to bail them out or suffer tremendous financial damage. These same companies have been spending record amounts to prevent government from doing anything to change this. The following post from The Mess That Greenspan Made, discusses why financial companies are making reform very difficult.

Former CNBC star Dylan Ratigan, who now toils away at MSNBC, had these thoughts to share over at the Huffington Post regarding the state of the U.S. financial system.

Americans Have Been Taken Hostage
The American people have been taken hostage to a broken system. It is a system that remains in place to this day.

A system where bank lobbyists have been spending in record numbers to make sure it stays that way.

A system that corrupts the most basic principles of competition and fair play, principles upon which this country was built.

It is a system that so far has forced the taxpayer to provide the banks with the use of $14 trillion from the Federal Reserve, much of the $7 trillion outstanding at the US Treasury and $2.3 trillion at the FDIC.

A system partially built by the very people who currently advise our President, run our Treasury Department and are charged with its reform.

And most stunningly -- it is a system that no one in our government has yet made any effort to fundamentally change.

That seems to be a common theme today, that is, if you're paying attention to that sort of thing rather than being distracted by where (and with whom) President Obama had lunch today after delivering another inspiring speech, this before a Wall Street crowd on the subject of financial market reform on the anniversary of the collapse of Lehman Brothers.

President Obama noted:

I want everybody here to hear my words. We will not go back to the days of reckless behavior and unchecked excess at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.

So far, the odds of reforming health care seem much better than for Wall Street.

If Washington was really serious about changing the way things work in New York, they ought to just nip that "life settlements securitization" business in the bud right now.

But they won't.

Unlike the health care industry, a group that heavily influences what lawmakers do, the financial industry essentially runs some portions of the government, and that makes change all the more difficult.

Back to Mr. Ratigan, who opines on that same topic:

Like health care, this is a referendum on our government's ability to function on behalf of the American people. Ask yourself how long you are willing to be held hostage? How long will you let our elected officials be the agents of those whose business it is to exploit our government and the American people at any cost?

As hostages -- was there any sum of money we wouldn't have given AIG?

Why did we pay Goldman Sachs and all the other banks 100 cents on the dollar for their contracts with AIG, using taxpayer money, while we forced GM and others to take massive payment cuts?

Why hasn't any of the bonus money paid to the CEOs that built this financial nuclear bomb been clawed back?

And more than anything else -- why does the US Congress refuse to outlaw the most anti-competitive structure known to our economy, one summed up as TOO BIG TOO FAIL?

There's much more to this, including something of a mea culpa from Ratigan for contrary views expressed whle in the employ of CNBC.

It's too bad that the public at large doesn't understand the financial system as well as they do health care or they'd be doing things that would make recent health care town hall meetings look quite tame by comparison.

Today, the mood generally seems to be, "Just keep the stocks in my retirement plan going up, not down, and we'll forget about the whole thing."

This article has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Tire Tariffs: Now Is Not The Time To Start A Trade War

With global trade already down 20% as of July, Martin Hutchinson from Money Morning explains why starting a trade war with our most important trade partner could cause catastrophic damage. If the trade dispute escalates, the US may have the most to lose. See the following post for more on this.

When U.S. President Barack Obama late Friday (Sept. 11) signed an order that imposed an additional duty of 35% on tires imported from China, it set up the potential for an old-fashioned trade war.

Currently, global trade is down only 20%. During normal times, worldwide commerce would recover on its own. But as most investors understand all too well, these aren’t normal times.

Global trade fell by 35% after last September’s financial crash. And it plunged 65% between 1929 and 1932 as a result of the Great Depression. With the worldwide economy already in a weakened state, a bare-fisted trade war between the world’s two most important trading partners – the United States and China – would be devastating.

Call it “Great Depression II: The Sequel.”

Courting Trouble
When it comes to trade wars, there are two factors that are important to understand. First, once a trade war starts, everyone tends to join in. And second, once this happens, there’s no percentage in being the only free-trading country left in a totally protectionist world.

That’s what President Obama is risking. The 35% tariff he imposed is in addition to an existing 4% import duty. His action should be met with loud protests – not just from China, but from here in the United States and from Europe, too. We must stop the dreadful downward momentum from building.

The Chinese government has replied by accusing the United States of blatant protectionism as part of a World Trade Organization (WTO) complaint. And China is also threatening to retaliate against imports of U.S. poultry and vehicles. This all sounds arcane, but it isn’t. This escalating tiff over tire tariffs has the potential to damage the global economy much more than the banking crisis ever did.

President Obama’s action comes as a result of an “anti-dumping” investigation by the International Trade Commission (ITC) of the U.S. Department of Commerce. Competitors tip off the ITC about foreign imports that are allegedly being “dumped” – that is, sold below their full costs of production. Why U.S. voters should care about dumping is an interesting question.

Dumped products are effectively being subsidized by China.
However, even if dumping mattered, the ITC is an inadequate body to investigate the alleged trade infraction. The commission has no subpoena powers in China. And it is subject to intense lobbying from advocates on only one side of the controversy.

Not surprisingly, the World Trade Organization (the proper judge of such claims) does not regard unilateral anti-dumping claims as an acceptable excuse for randomly imposing extra tariffs on imports. The whole purpose of trade agreements – several of which the United States promoted and signed – is to prevent that kind of thing.

During the 2008 presidential campaign, there was considerable debate about whether then-U.S. Sen. Obama was a protectionist.

Candidate Obama cheered union audiences by announcing that he wanted to renegotiate the North American Free Trade Agreement (NAFTA). But then his economic spokesman, Austan D. Goolsbee, was accused of holding a meeting with the Canadian embassy, and saying Obama wasn’t serious. The tough talk about NAFTA was only campaign rhetoric, Goolsbee allegedly confided to his Canadian audience. Then Obama’s campaign people said that no such meeting occurred.

Now that he’s in the White House, the fog obscuring President Obama’s views on trade is beginning to clear. In Group of 20 (G20) meetings, he’s paid lip service to free trade. But his actions contradict his statements.

President Obama has done nothing to advance the South Korea and Colombia free trade agreements, stuck in Congress since 2007. He has also done nothing to revive the stalled Doha round of trade talks, though his global prestige is so high he could easily have done so. That would be no small achievement. The World Bank estimates that a deal would add $100 billion a year to global trade.

Worst of all, however, is that President Obama now appears to be doing nothing to enhance trade with China, the country that will be our most important trading partner for generations to come. In the past two weeks alone, he’s twice imposed anti-dumping duties on China. On Sept. 9, the administration said it imposed a 23% duty on $2.6 billion worth of steel pipe from China.

President Obama owes a lot to union support, and it’s pretty clear that he is prepared to go along with Big Labor’s protectionist agenda. But the two cases are very different and one has to question whether the gains will be worth the very real costs.

In terms of the actual dollar value – as well as indirect economic costs – experts say the steel-dumping case may be the biggest case in years to be brought before the nation’s trade-dispute system. It demonstrates that there’s a deep-and-growing concern that Beijing’s industrial subsidies are translating into lost U.S. jobs.

The tire case may be a different story, however. It involves the “low-grade” tire market. The profit margins in that slice of the tire market are virtually non-existent. In fact, U.S. tire manufacturers did not join in the complaint. The reason: They actually lose money in the low-end market. Most had already abandoned it to China-based rivals, reports Irwin M. Stelzer, a columnist and director of economic policy studies at the Hudson Institute.

The One Sequel That Shouldn’t Be Made
None of this would matter much if the global economy were sailing serenely along, as it did before the financial crisis struck. For the 20-year stretch that ended in 2007, world trade advanced at a pace that was slightly faster than global economic growth in general. Against such a relatively healthy backdrop, minor disputes on tires or metal pipes would be of interest only to the tire and metal-pipe industries. And perhaps to the poultry or other industries against which China chose to retaliate.

But the global financial crisis changed the game. For a couple of months immediately following last September’s near-meltdown of the world’s financial system, global trade plunged by an astonishing 35% from its normal levels. That wasn’t really a surprise. U.S. consumption was way down. And the near-freeze-up in the banking system made trade financing very difficult to get.

That 35% drop was not as bad as the 65% plunge in world trade that came during the first four years we during the Great Depression between 1929 and 1933. But let’s face it, a stretch that’s half as bad as the Great Depression – even a relatively short one – is still pretty serious.

Global trade has since recovered somewhat, as trade finance has once again become available. As of July, it appears to be down about 20% on the previous year. However, that’s still a lot: Economic activity on a worldwide basis is down about 5%.

Even U.S. retail sales are down only around 8%. The U.S. consumer is being more careful than before, but still is spending at a pretty rapid clip.

By comparing all these numbers, we can come to only one conclusion: Global trade is still ailing as a result of the financial crisis.

Lower global trade affects all of us. Thanks to a concept called “comparative advantage,” the whole point of trade is that it allows each item to be manufactured in the place that’s most efficient. So if trade is blocked, as it was in the 1930s, the whole world economy becomes less efficient, output declines, and we enter a Great Depression (in which U.S. GDP nose-dived 25%).

There’s no reason a Great Depression has to follow a banking crisis. After all, the world has had lots of banking crises, both before and after 1930. And virtually every one has been followed by only a medium-sized recession.

The one banking crisis that set off a really serious downturn was that of 1837, after U.S. President Andrew Jackson abolished the Second Bank of the United States. The Second Bank’s notes were the main mechanism for financing trade between different parts of this still-young country. So President Jackson’s action effectively wiped out about 25% of the U.S. money supply. Not surprisingly, things got very tough for several years.

As tough as that period was, a 67% freefall in world trade would clearly plunge us into a much more dire period. In fact, were world trade to decline by two thirds, there would be no way of avoiding “Great Depression II – the Sequel.”

And this is one sequel everyone is certain to hate.

This post has been republished from Money Morning. You can also view this article at Money Morning, an investment news and analysis site.

Investors Should Ignore Warnings Of Peak Oil

The proponents of the theory of peak oil would have you believe that oil is becoming a scarce resource that can only increase in price. However, the alternate view, as argued by Bill Smead, is that oil is an abundant resource and will eventually fall in price when the current bubble pops. The following article, from The Street, explains why it is a bad idea to buy into the idea of peak oil.

The rally in oil from $32 a barrel in March to $73 in late June had characteristics very similar to the mania that took oil up to $147 a barrel in July 2008.

I've argued before that we've never seen a bubble burst in the investment markets get put back together in anything less than about five to seven years. And here we are at $72 a barrel today with the U.S. economy appearing to be on the mend, and the same army of energy bulls still out there promoting huge upside in the commodity oil and the energy-related stocks.

My professors in college always criticized me for not providing enough evidence in my writing to back my arguments. Fortunately for me, Michael Lynch, the former director for Asian energy and security at the Center for International Studies at the Massachusetts Institute of Technology, provided all the evidence we need in an Aug. 25 op-ed in The New York Times. In his piece, "Peak Oil Is a Waste of Energy," Lynch backs the argument from an energy consultant's fundamental viewpoint.

Peak oil is a Malthusian argument which states that geological scarcity will at some point make it impossible for global petroleum production to avoid falling. To the Malthusians this could spell economic disaster. Lynch wrote:

"Like many Malthusian beliefs, peak oil theory has been promoted by a motivated group of scientists and laymen who base their conclusions on poor analyses of data and misinterpretations of technical material. But because the news media and prominent figures like James Schlesinger, a former secretary of energy, and the oilman T. Boone Pickens have taken peak oil seriously, the public is understandably alarmed.

Lynch explained that most arguments about peak oil are based on anecdotal information, vague references and ignorance of how the oil industry goes about finding fields and extracting petroleum. As an example, he showed how using pumped water in the Ghawar Field in Saudi Arabia scared Malthusians because the field registered 35% water. However, they failed to mention that the average field is estimated at as high as 75% water!

But those are just the latest arguments -- for the most part the peak-oil crowd rests its case on three major claims: that the world is discovering only one barrel for every three or four produced; that political instability in oil-producing countries puts us at an unprecedented risk of having the spigots turned off; and that we have already used half of the 2 trillion barrels of oil that the earth contained.

Lynch debunks the discovery argument quickly. He describes the fact that at the beginning of a discovery the energy industry chooses to make a conservative estimate of what is in the field. It is almost always revised upward, because of new pockets or improved technology. Those raised estimates are never counted as new discoveries. He says that you hear that all the easy oil is gone. Read Daniel Yergin's, "The Prize," which is a history of the oil business from 1855 to today and you'll realize that there never has been any easy oil.

Once you conclude that the geological claims don't stand up, peak oil folks jump right into the political instability arguments. We all remember the two oil embargoes in the 1970s and Jimmy Carter's wool sweater. The major oil producing companies have diversified themselves around the world and have very much moved away from the Middle East dependence. In the U.S., we currently import more oil and gas from Canada than any other country.

Lynch believes that the most misleading claim of the peak oil advocates is that the earth is endowed with 2 trillion barrels of recoverable oil and we've used half of it already. The consensus among geologists is that there are some 10 trillion barrels out there and based on technological improvements that as much as 35% may be recoverable. Here is Lynch's conclusion:

Oil remains abundant, and the price will likely come down closer to the historical level of $30 a barrel as new supplies come forward in the deep waters off West Africa and Latin America, in East Africa, and perhaps in the Bakken oil shale fields of Montana and North Dakota. But that may not keep the Chicken Littles from convincing policymakers in Washington and elsewhere that oil, being finite, must increase in price.

I argue that the constant enthusiasm displayed for the reflation trade and buying energy based on emerging market economic growth rates is a crowded trade. In my experiences, when investors ignore the law of supply and demand it is at their own peril. Lynch argues that supply is abundant and car buyers are reducing their demand with higher mileage cars. More supply and less demand could spell lower prices and would be very positive for the U.S. consumer, the U.S. economy, corporate profits and owners of quality companies.

This post has been republished from The Street, an investment news and analysis site.

A Consumer Financial Protection Agency Would Fail

Odysseas Papadimitriou argues that a Consumer Financial Protection Agency would do little to address the real problems faced by consumers. For instance, it assumes that consumers will make rational decisions if the terms of financial products are explained to them in plain English, but this is just not the case. The following, from The Street, discusses why creating the CFPA would be a tragic mistake.

As chairwoman of the Congressional Oversight Panel, which has been charged with reviewing the state of financial markets and the regulatory system, Harvard professor Elizabeth Warren has been vocal in her support of the administration's proposal for a Consumer Financial Protection Agency (CFPA).

The CFPA would be the regulatory body that ensures that financial institutions provide clear and simple disclosures, which would ostensibly deter consumers from opting for risky and "exotic" financial products, and would be the eighth agency involved in consumer credit regulation. While I agree that there has been little effectiveness in the regulatory system as far as consumer financial protection is concerned, this is no reason to create yet another agency.

The CFPA, which was actually conceived by Warren several years ago, would separate the regulation that provides consumer financial protection from laws that ensure the banks that serve these consumers are solvent, and do not introduce toxic products to the market. If our hope is for a solid financial system, it must be understood that these two areas of regulation go hand-in-hand. Warren is right in saying "the credit market is broken," but she herself proves that the CFPA won't fix it.

Warren lays out her arguments for the CFPA in two articles that appeared in Business Week and in The Baseline Scenario. While she is spot on in her analysis of the nature of the problems that plague our financial system, her solutions do not address the problems that she identifies. It's true that traditional financial products cannot compete with "exotic" products whose terms seem attractive up front, but hide surprises and changes that are revealed only after the consumer has committed. Further, the more complex these "exotic" financial products become, the less able consumers are to make comparisons. Right now our financial system lacks a level-playing field, transparent in its operation, which encourages competition, and also engenders product innovation.

I am in agreement with Warren about the backwardness of our current regulatory system, which is most ineffective because it is structured by business type rather than financial-product type (i.e., credit cards, home loans, etc.), and allows financial institutions to essentially choose their own regulators, simply by changing their organizational structure. There is also a conflict of interest in the current system that is perpetuated by the fact that the regulatory budget comes, in large part, from the financial institutions that need regulation.

Warren insists that the solution to these problems is the CFPA. This new agency would promote clear disclosure of the risks and costs for everything from mortgages to credit cards, from payday loans to bank overdraft fees. Disclosure is the biggest part of Warren's argument for the CFPA. She believes that, if people were aware of the facts surrounding financial products, they would make rational decisions concerning which product to choose. This is simply not the case.

For instance, in the case of the housing market, it's easy to say that all of the people who took out subprime loans were victims who had no idea what they were getting into, but the reality of the situation is that many got caught up in a bubble mentality. They believed that they could sell their homes at inflated prices if they became unable to afford their mortgage payments once they doubled. This segment of consumers failed to weigh risk properly, because they assumed that housing prices would continue to appreciate. The core of the problem was extensive speculation on the parts of lenders and borrowers, and not insufficient disclosure.

The truth is that regardless of the thoroughness of disclosure, consumers aren't always realistic about their home's future success on the housing market, or their ability to consistently make payments on their credit card accounts on time. It's human nature for people make decisions that are unrealistically optimistic. Full disclosure won't fix this problem.

Moreover, the proposed CFPA fails to address the problem that lies at the core of the misfortunes our financial system faces, and that is product structure and underwriting standards. As a result of her belief that the marketing of and disclosure around financial products can be separated from the design of the products themselves, Warren's conceived CFPA would allow banks and other lenders to continue offering complicated or risky products, so long as the risks are disclosed so that consumers can reasonably understand them. These kinds of products simply should not be allowed to exist. Plans for the CFPA fall short because mandating full disclosure does nothing to mitigate the danger for banks and consumers that exotic financial products represent.

Continuing to allow complex financial products to be sold on the market will, by necessity, imply some complexity in terms and contracts, making "clear disclosure" an extraordinarily subjective term. Additionally, the same regulators who are to be responsible for the terms of disclosure should also be responsible for the structure of financial products. In the financial products market, these two things are intrinsically intertwined.

Lastly, the CFPA does nothing to address the conflict of interest that exists within the current regulatory system. Banks will still be able to shop around for the regulators that best suit their needs even after the CFPA is established, and the agency would do nothing to address the structural deficiencies that make the regulatory bodies that currently preside over financial institutions ineffective.

What is most bothersome is how well and clearly Warren identifies the problems we face. She then proceeds to describe her plan, which has been adopted and endorsed by the administration, as a solution even though it fails to sufficiently address any of the problems that she has described. The result is a disquieting disconnect between what needs to be done, and what Warren and now President Barack Obama are proposing. In my estimation, the Obama administration is being pulled thin as it tries too hard to solve all of America's problems with equal expediency and equal force. The result is that the solutions offered are slap-dash and unproductive.

The tragedy here is that the ways in which the CFPA falls short aren't the result of ignorance, but instead due to the desire for a quick fix. The answer to America's broken markets is a streamlined regulatory system in which financial products are controlled by type and not institution. Further, the regulation that ensures the solvency of each bank, and the regulation of financial products should be combined for the protection of both consumers and financial institutions. Adding another regulatory agency made up of patchwork pieces will only add to the larger regulatory maze, which as we have seen, has completely failed to protect us.

This post was republished from The Street, an investment news and analysis site.

Savings Rates Could Double or Triple

One of the reoccurring questions that keeps popping up is whether the recession has caused a long-term shift in American consumption patterns. Former Federal Reserve economist suggests that a $14 trillion loss in personal net worth and rising long-term costs like health care will lead to much higher savings rates. See the following post from The Street, to learn more.

Paul Ballew is a former Federal Reserve economist. He currently serves as senior vice president of Customer Insights & Analytics for Nationwide Mutual Insurance Co. in Columbus, Ohio. He has also worked as an executive for General Motors and J.D Power.

There's no arguing that the economy is beginning to recover. Green shoots are more numerous and the return to more normal conditions in financial markets is certainly comforting. So 12 months post-Lehman, it appears that there is light at the end of the tunnel.

However, the severe economic contraction was not just happenstance. The structural problems in the economy were substantial and some issues, like the de-leveraging of households, are still working themselves out. In addition, the policy environment complicates the situation and will, in all likelihood, place further restraint on the pace of the recovery and eventually the expansion.

Beyond the headlines about Wall Street and beyond the policy debate in Washington, substantial shifts in consumer behavior on Main Street are going to have the most significant impact on the direction of the economy over the next few years.

Everyone is speculating about how consumer consumption and saving will be altered by the events of the past 18 months. While weak labor markets are an issue for American households, an even more pressing concern involves the fundamental need to rebuild balance sheets under those same roofs in preparation for an uncertain future.

Conventional wisdom seems to conclude that we should expect a few quarters of higher savings and then a return to the pre-recession spend-and-borrow tendencies of the past decade or so. However, the need to rebuild personal savings and portfolios is no small matter. Households have seen their net worth decline by $14 trillion at a time when future obligations like long-term health-care costs continue to increase.

There is good reason to expect household savings rates will have to double, and maybe triple, to support the healing of consumer balance sheets. This process will take years, not months.

In hard numbers, it means going from saving roughly $150 billion a year to $400 billion to $500 billion a year. This assumes asset prices appreciate at a moderate pace over the next few years -- not something that is guaranteed given the pressures coming from Washington.

A shift of these proportions will not only impact the pace of the recovery, it also has implications on sectors of the economy.

Consumer-product companies are likely to face a more frugal consumer even as the recovery picks up speed. The recovery may not be the retail panacea some assume.

Additionally, the retirement-planning business may have never looked better. Now more than ever, there is a tremendous challenge and an opportunity for financial experts to help households navigate the waters and address their anxieties after a decade of underperformance.

And as we all know, Washington remains the most challenging wild card. Changes in tax and regulatory policy by Congress, high deficits absorbing higher personal savings, and future actions by the Fed are all question marks that may alter the operating environment.

We are on the front end of a recovery, but we shouldn't underestimate the depth of the recession's impact on consumer saving nor the consequences for the recovery.

This post has been republished from The Street, an investment news and analysis site.

Breaking Down September's Jobs Numbers

The new filings for jobless benefits are still very high, but both new claims and continuing claims are trending downward. James Picerno from The Capital Spectator breaks down the latest numbers and why the downward trend is not necessarily an indicator of recovery. See the following post for more.

This morning's update on initial jobless claims offers more encouragement for thinking that the economic contraction has bottomed out. That's still distinct from proclaiming the arrival of a recovery worthy of the name, as we've been discussing for months, including here and here. Nonetheless, the downward trend in initial jobless claims—a valuable leading indicator of the business cycle, as we explained back in March—continues to signal that the recession on a broad macro scale is over or nearly over.

Granted, last week's decline in new filings for jobless benefits to 550,000—the second-lowest so far this year—may be skewed because of this past weekend's Labor Day holiday. As always, we'll have to wait for more number crunching by our trusty servants in Washington. Meantime, the chart below doesn't give us any reason to think that initial claims aren't biased toward lower levels in the future, albeit erratically and slowly, but downward nonetheless.



Another encouraging trend in today's unemployment numbers arrives by comparing initial claims with so-called continuing claims, by far the higher number of the two. Indexing this pair to measure the trends on an apples-to-apples basis suggests that we're finally seeing some progress in reducing continuing claims, as our second chart below shows.



Continuing claims reflect the ranks of the unemployed who've previously been collecting jobless benefits. A decline in this series suggests—emphasis on "suggests"—that people who've been on the unemployment rolls are finding work. Generally speaking, a decline in initial jobless claims is all the more persuasive if continuing claims are falling too. As the second chart directly above suggests, there now appears to be greater downward momentum in both series, which is encouraging, at least on its face.

We qualify the last point because it's not yet clear if the decline in continuing claims is a quirk. One possibility is that continuing claims is falling for less than bullish reasons. For example, the shrinking number of continuing claims may reflect that the jobless are falling off the government's radar because their unemployment benefits have expired.

In short, the data looks mildly encouraging as reported but we're still a long way from declaring the Great Recession over as it relates to Main Street. (Wall Street's perspective is another story.) But this much is clear: a recovery of some degree in the labor market is critical in order to repair the damage of the past year or so. Today's numbers tell us there's still a lot of pain, but at the very least today's report suggests that the trend isn't getting any worse and maybe, just maybe, it's getting marginally better.

This post has been republished from James Picerno's blog, The Capital Spectator.

What's More Important: Finance or Health Care Reform?

Barry Ritholtz, author of Bailout Nation, argues that the Obama Administration is missing a once in a lifetime opportunity by putting financial reform on the back burner. The concern is that the window of opportunity to clean up Wall Street is closing as financial lobbyists dig in and public support wanes. For more on this, see the following post from Economist's View.

Barry Ritholtz says the administration should have pursued financial reform before health care reform:

Tactical Error: Health Care vs Finance Regulatory Reform, by Barry Ritholtz: I believe the brain trust behind the Obama White House has made a huge tactical error.

As Rahm Emmanuel likes to say, one should “never waste a crisis” — and the White House has done just that.

There was a narrow window to effect a full regulatory reform of Wall Street, the Banking Industry and other causes of the collapse. Instead, the White House tacked in a different direction, pursuing health care reform.

This was an enormous miscalculation. ... What we got instead, was the usual lobbying efforts by the finance industry. They own Congress, lock stock and barrel, and they throttled Financial Reform. It did not help that the Obama economic team is filled with defenders of the Status Quo — primarily Summers, but it appears Geithner also — the dynamic duo that fiddled while the economy burned.

Such dithering can be fatal to an administration.

This was a colossal blunder. Passing reform legislation successfully would have fulfilled the campaign promise of “Change;” it would have created legislative momentum. It could have provided a healthy outlet for the Tea Party anger and the raucous Town Hall meetings. It might have even led to a “throw the Bums out” attitude in the mid-term elections, forcing the most radical de-regulators from office.

Also wasted: The enormous anti-Bush attitude throughout the country that swept team Obama into office. He should have been “Hooverized,” and O should have tapped into that same wave to force the greatest set of Wall Street and Banking regulatory reforms seen since the 1930s.

Instead, we have a White House that appears adrift, and the most importantly, may very well have missed the best chance to clean up Wall Street in five generations.

Never waste a crisis, indeed . . .

I also believe that the administration should have moved faster on financial reform, but if the cost is to delay and possible endanger health care reform (lobbying efforts would have been in full force there too), then it's less clear. Would it have been impossible to do both? And where does climate change legislation fit into all of this?

This post has been republished from Mark Thoma's blog, Economist's View.

Inflation Of Domestic Versus Overseas Goods And Services

Tim Iacono from The Mess That Greenspan Made, breaks down inflation into domestic inflation and imported inflation and comes to an interesting conclusion. The deflation of goods and services from overseas has made overall inflation appear lower than it really is. If you look at domestic inflation in isolation, it shows much higher inflation than the public has been led to believe.

For some time now, the disparity between price increases for imported goods and price increases for domestic goods and services has been of great interest to me and, after working through all of the applicable Labor Department data on this subject, it quickly becomes clear that there is an interesting story to tell here about two very different types of U.S. inflation in recent years - domestic inflation and imported inflation.



The data in the graphic above will be detailed in the paragraphs ahead because it is deserving of close inspection. To be sure, it is a quite fascinating subject for those not familiar with how dramatically inflation in the U.S. has changed over the years.

But, the more important point to be made here first is that this disparity between domestic and imported inflation was one of the primary reasons why central bank policy in the U.S. had been steering us on a wayward course for so many years. Clearly, two of the major factors that enabled the nation's "easy money" policies for the past two decades have been:

1. The fixation on consumer prices (while ignoring asset prices)
2. The irrational fear of falling prices (today and in 2002-2003)

To a large extent, the Holy Grail of benign inflation and the threat of deflation were not what they appeared to be. In short, the deceptive combination of sharply rising domestic prices combined with falling prices for imported goods has been a major contributor to policy mistakes by the central bank, one of many policy mistakes made over the years that have now come home to roost.

Breaking the Consumer Price Index Apart

The Labor Department breaks consumer prices down into eight major categories, weighted as shown below. This composition is intended to represent a "basket of goods" that consumers purchase and the overall, weighted increases in prices are intended to represent the "rate of inflation" in the U.S.



For the purposes of this discussion and as the source for all the charts that appear here, only original Labor Department data is used and all issues related to such things as hedonic adjustments, geometric weighting, and other factors that contribute to the "reported" rate of inflation almost always coming in lower than the rate of inflation experienced in the "real" world will be ignored.

Importantly, lower "reported" inflation goes a long way in limiting government liabilities for such things as cost of living adjustments and makes central bankers, the stewards of American fiat money, look better than they otherwise might, so, this is not a subject that should be dismissed as inconsequential because, clearly, it is not.

It just won't be part of this discussion.

As for separating the consumer price index (CPI) into "domestic" and "imported" components, in looking at the top-level categories above, one can clearly spot a few that are predominantly domestic - education/communication, food/beverages, and medical care - and, while there are surely some imported goods in each of these groups (e.g., the 0.214 percent weighting for personal computers within the first group), it can safely be said that the "domestic" label fits all three.

Similarly, since the U.S. essentially stopped making their own clothes years ago, it can safely be said that the apparel category consists of primarily imported goods.

But, after that, things get a little trickier.

Making Sense of the Housing and Other Categories

The housing category breaks down as shown below and, as noted here many times before, probably the single biggest blunder of all regarding the consumer price index was the substitution of "owners' equivalent rent" for the cost of homeownership back in 1983.


As far as monetary policy is concerned, this was one of the major "enablers" for the late great housing bubble and its subsequent bursting since there would have been little chance of short-term lending rates resting at one percent back in 2003 and 2004 if home prices that were rising at an annual the rate of eight to ten percent nationally had been included in the calculation of consumer prices rather than the dubious measure of what homeowners think their place might rent for.

In fact, owners' equivalent rent has so distorted consumer prices in the U.S. that they, along with rental costs within the "Shelter" subcategory of the CPI, are completely excluded from the domestic/imported inflation discussion here.

[Note: For a complete breakdown of the CPI categories see this item at the BLS.]

With rents excluded from this list you are left with one sub-category of goods that is mostly imported - household furnishings - and the rest can be safely categorized as domestic.

Moving on to the transportation category we find cars, trucks, and the fuel that is required to run them and, while these are clearly both domestic and imported goods, the task of separating the two is nearly impossible. Since they are primarily made in the U.S., for the purposes of this discussion they are considered domestic.

Similarly, the recreation and other goods and services categories contain a mix of products, however, here they can be easily segregated. For example, nearly all cameras and audio equipment are imported while movie tickets and film processing are domestic services. And in the final "other"category, tobacco products are clearly home grown while personal care products are largely imported.

Prices for Imported Goods are Falling Faster Than you Think

Lo and behold, when only looking at products that are imported (mostly from Asia), one sees that we've had "deflation" for quite a few years now and not just the "one-off" variety where readings come in at minus one percent and persist for only a month at a time.

For example, the apparel category has posted year-over-year price declines in 13 of the last 14 years and clothes cost a cumulative 15 percent less than they did in the 1990s.



Now that's what I call "deflation", though, it has more to do with cheap labor and fixed exchanged rates in Asia than it does with anything else.

Prices for most imported goods have been declining consistently over the last decade, however, you don't hear too much about this as most news reports and analysts cite the headline inflation numbers or, worse, "core" inflation, excluding food and energy.

Falling prices for imported goods have been a key factor in being able to report overall "moderate" rates of inflation in recent years.

Prices for Domestic Goods and Services are Quite High

On the domestic side, when looking past the volatility that somewhat obscures the underlying pattern in the chart below, prices are clearly rising much faster than headline inflation has been indicating, particularly since the turn of the century.

[Note: The scales are the same for the chart below and the one in the previous section in order that the magnitudes can be more easily compared.]



While food price have been rising only modestly up until last year, it probably won't come as a surprise to anyone to learn that medical services costs have more than doubled over the same period of time that apparel prices have plunged, as noted in the previous section.

It is not until you look closely at the individual components of the consumer price index that you realize we really have been living in a world of "two inflations" - tumbling prices for imported goods and rapidly rising prices for domestic goods and services.

Combine these two inflations and throw in the huge "shelter" component that neither rises nor falls much as home prices soar and then plunge and the result is "benign" inflation.

What Does this all Mean?

For years, persistently low and falling prices for imported goods such as electronics and apparel have been masking much higher levels of domestic inflation in areas such as medical services and household energy.

Any economist with a spreadsheet and a web browser could have confirmed that.

But, what is significant about this is that this phenomenon should have been factored into monetary policy over the last decade or so but it wasn't.

Low inflation, regardless of its source, was used as a justification for keeping interest rates too low for too long and the unfounded fear of "de-flation" was the reason cited for keeping rates at "freakishly" low levels for several years in this decade.

Yes, pegged currencies in Asia play a role here, but surely the folks at the Federal Reserve, even with their misguided focus on consumer prices to the exclusion of nearly all other considerations, could have seen that inflation in the U.S. was only as low as it was because of cheap imports.

Had this been understood and had interest rates been kept higher over the last ten years, we probably wouldn't have near the number of problems that we've seen in the last year or two.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Seeking To Explain Why Economists Were So Wrong

Earlier in the decade, no one on the Fed dared to question The Maestro, Alan Greenspan. Well it turns out that Greenspan got a lot of things wrong. Now, as we search the wreckage and try to piece together why economists were so wrong, it is time to re-examine long held beliefs like efficient market hypothesis. James Picerno discusses this in the following post from The Capital Spectator.

The market's taking a beating lately, and we're not talking here about investment returns. Rather, the theory that market prices offer valuable information is on the defensive…again.

The latest assault came over the weekend in Paul Krugman's New York Times Magazine article "How Did Economists Get It So Wrong?" Among the various indictments in the story is the charge that the efficient market hypothesis (EMH) is a principal cause of the economic ills that afflict the U.S.

Attacking EMH has become a popular sport recently, which is to say more popular than usual. Some of these attacks are exaggerated, others are misleading and some are just plain wrong, especially when it comes to interpreting (and often dismissing) EMH as it relates to investing. We've written about such issues regularly over the years and tackle the subject in more detail in our upcoming Dynamic Asset Allocation: Modern Portfolio Theory Updated For The Smart Investor, which will be published in February by Bloomberg Press. Meantime, let's focus on one point in Krugman's story regarding the management of the economy.

Krugman writes that "the belief in efficient financial markets blinded many if not most economists to the emergence of the biggest financial bubble in history. And efficient-market theory also played a significant role in inflating that bubble in the first place."

Among the alleged smoking guns presented are the decisions by former Fed Chairman Alan Greenspan, who ran the central bank until 2006 and embraced a market-oriented approach to monetary policy. But equating the Fed's monetary policy under Greenspan, and currently under Ben Bernanke, with EMH is problematic.

The idea that the Fed's monetary policy and EMH are one and the same is a stretch. Yes, the price of credit is partly set by the market, i.e., supply and demand, although most of the market's influence resides at the medium and long-term points on the yield curve. Meanwhile, the Fed's influence is dominant at the short end of the curve, and the tool of choice is the Fed funds rate. But just because the Fed chooses to set Fed funds at a particular rate doesn't necessarily mean that rate also reflects supply and demand.

The Fed, in other words, manipulates the price of money at times. That may or may not be productive at times, depending on other factors. Even so, one can argue that a central bank is a necessary evil for reasons that start with the idea that the economy needs a lender of last resort. But the question before the house is: Was the Fed remiss in managing the economy in the years leading up to 2008? We can never answer definitively because we don't know how the economy would have fared if the Fed had done something different. Nonetheless, we can look back and consider what happened and review the context for the decisions by the central bank.

On that note we'll present one bit of evidence. In the chart below, we graph the real (inflation-adjusted) Fed funds rate on monthly basis for the past 20 years. Note that the real Fed funds rate has been negative three times since 1989. At such times the question is whether a negative rate is warranted?

Today, one could argue "yes," given the weak state of the economy at the moment. But what about 2001-2005? Allowing Fed funds to remain at negative real rates for nearly four years looks like a crucial error in monetary policy. Such extraordinarily low real rates almost certainly contributed to the excesses that came back to bite the economy in 2008, including an excessive degree of speculation in the housing market.

This is a critical issue for several reasons. One is that economists of the monetarist persuasion argue that monetary policy casts a long shadow over the health of the economy. Accordingly, if the Fed makes poor decisions in managing monetary policy, the economy will suffer sooner or later. In fact, there's a strong case for arguing that the Great Depression was largely a byproduct of poor monetary decisions. The central bank was also responsible for much of the economic troubles in the 1970s. And it looks like the Fed made a poor decision in keeping interest rates too low for too long during 2001-2004. Initially, in the wake of the market correction of 2000-2002, low interest rates were warranted. The problem was one of keeping the price of money too low through 2005.

If flawed monetary policy is a critical reason for recent macro events, it's not clear that this is a direct indictment of the efficient market hypothesis or the idea that market prices generally contain valuable information for investing as well as managing economies.

So, what's the solution? Krugman suggests that we should discard EMH. But there's another answer and arguably a superior one: improve the Fed's monetary policy.

Alas, there's no silver bullet here, although there are some changes that could help. That starts with dispensing with the standard that Greenspan established, which favored the idea of letting one man have an undue influence over interest rates. In short, the maestro approach to monetary policy has some problems.

There are a number of alternatives, and most of the good ones involve letting the market provide more input into the setting of Fed funds. Yes, that's right: we need more of the market's influence in the design and management of monetary policy, not less. Less is what got us into this mess, despite what some EMH critics argue. It's tempting to equate Greenspan's decisions with what an EMH-inspired approach would do, but that's misleading. It's unconvincing to argue that because Greenspan dismissed the idea of financial bubbles that also means that his decisions were defacto EMH-inspired choices. Greenspan was making activist choices that weren't necessarily based on market signals. As it turned out, some of his choices were wrong. The lesson is that individuals make mistakes, and so we should be wary about letting one Fed chairman amass too much influence over the setting of interest rates, regardless of what he thinks or says.

A better approach for setting Fed funds is incorporating more price information from commodities, housing, the stock market, to name a few key variables. There's also a case for setting a stated inflation target that the Fed is routinely targeting and that everyone can judge. There's some of this going on now, but there's still too much mystery surrounding the Fed's operations and how it reaches decisions about monetary policy. In turn, that fosters the possibility of making decisions that stray too far from what the market implies interest rates should be.

Monetary policy is too important to be left solely to a handful of people. Individuals aren't gods, even if they work for a central bank. Meantime, let's also recognize that the further marginalization of market forces isn't an answer either. Prices running skyward during 2002-2007 in a wide range of assets, from homes to commodities (including gold) to stocks and bonds, were telling us something. Unfortunately, it's not obvious that the Fed was listening.
This post has been republished from James Picerno's blog, The Capital Spectator.

Lessons From The Housing Boom And Bust

In an article by Harvard economics professor Ed Glaeser, he discusses the takeaways from the recent boom and bust in the housing market. He also outlines some policy changes that could help prevent future bubbles, if we can learn from our past mistakes. See the following post from Economist's View for more.

Ed Glaeser explains some of the lessons he's learned from the recent crash of housing markets:

What We’ve Learned: Ugly Truths About Housing, by Edward L. Glaeser: ...What have we learned from the great housing bubble and crash of the aughts? Most obviously, we have learned that housing prices can be extraordinary volatile. This was less obvious from previous housing cycles. ...

So let no one ever again say foolish things like housing prices never fall. In the current drop, eight of the 20 Case-Shiller areas had housing price drops of 40 percent of more. ... Buyers and bankers should never again think that an area’s recent price increases are the sign of a strong market where prices have nowhere to go but up. In the long run, price increases are followed by price drops, and special caution, by regulators as well, needs to be taken in booming markets.

In places like Las Vegas and Phoenix, there are no fundamental constraints on building new homes — like a shortage of land or onerous restrictions on construction... I once thought that this obvious lack of limits on building meant that such open areas would sit bubbles out,... but I was wrong. The logic of supply and demand can be ignored for longer than I thought, but it ultimately reasserts itself.

The second lesson of the housing debacle is that there is extraordinary pain in both housing price busts and booms. When housing prices soared, ordinary Americans found it increasingly hard to afford a house. ... [This] logic pushed me to boo when housing became outrageously expensive. During the boom, I hoped that housing prices would stop rising and even decline.

Yet I didn’t understand the terrible impact that declining housing prices would have on our financial sector. While rising housing prices weren’t particularly good for America, declining housing prices were particularly bad for the country. The lesson seems to be that large swings in housing prices, in either direction, can be extremely painful.

The third lesson is that American housing policy has been monumentally foolish. We have used public resources to encourage ordinary Americans to bet all they could on highly risky housing markets. Fannie Mae and Freddie Mac, the home mortgage interest deduction, even the willingness to bail out financial firms..., can all be seen as policies that encourage ordinary people to risk it all on real estate.

I had once thought that these policies were misguided, but not terrible. We now know that encouraging buyers and lenders to bet on housing can impose vast costs on the country. ...

I think that we have not yet fully faced the fact that our tax code encourages people to finance their homes with as much debt as possible, and that our financial regulations abet irresponsible lending.

Now that we have backed away from the abyss, we can consider making much-needed reforms, like reducing the upper cap on the home mortgage interest deduction, that could depress housing prices in the short run, but make future housing bubbles and crashes less likely.

I don't think much of the blame for the crisis can be placed on the home mortgage interest deduction, there was no big change in this deduction that corresponds to the start of the bubble. As for eliminating the deduction, though it's possible to make an argument that there are positive externalities to home ownership such as taking better care of the property, something that benefits surrounding properties, or having more involvement in the community, I don't think the case is very strong, particularly when the inequity between owners and renters is taken into consideration.

This article has been republished from Mark Thoma's blog, Economist's View.

The New Government-Run Mortgage Market

With the government seizing control of Fannie and Freddie and 86 percent of new loans backed by the US government, a government-run mortgage market has quietly emerged. This not only provides added risk to tax payers, but has created a sense of entitlement for some according to Tim Iacono from The Mess That Greenspan Made. See the post below:

Today's must read housing market news comes via this story in the Washington Post where the near total control of the U.S. mortgage market by the U.S. government is detailed.

Mortgage Market Bound by Major U.S. Role
Classes of Borrowers Cannot Find Loans as Publicly Backed Debt Mounts
By Zachary A. Goldfarb and Dina ElBoghdady

In the go-go years of the U.S. housing boom, virtually anybody could get a few hundred thousand dollars to buy a home, and private lenders flooded the market, aggressively pursuing borrowers no matter their means or financial history.

Now the pendulum has swung to the other extreme. Only one lender of consequence remains: the federal government, which undertook one of its earliest and most dramatic rescues of the financial crisis by seizing control a year ago of the two largest mortgage finance companies in the world, Fannie Mae and Freddie Mac.

While this made it possible for many borrowers to keep getting loans and helped protect the housing market from further damage, the government's newly dominant role -- nearly 90 percent of all new home loans are funded or guaranteed by taxpayers -- has far-reaching consequences for prospective home buyers and taxpayers.

While the focus of the article is split between the long-term implications of such heavy government involvement in mortgage lending and how rapidly changing lending standards have caused credit-worthy borrowers to be excluded, you have to wonder why.

This relatively small side-effect of "freezing out" marginal buyers who may, in fact, truly deserve a new mortgage will probably end up working out in their favor as home prices continue to fall over the next year or so - they're probably doing them a favor...

The much more troublesome aspect of this story is the one we've all been reading about lately, particularly since news broke last week that the FHA may be in trouble after zooming from just a few percent of market share a couple years ago to writing nearly a quarter of all new mortgages, most of these loans requiring only 3.5 percent down payments.

At the same time, taxpayers are on the hook for most of the loans that are still being made if they go bad. And they are also on the line for any losses in the massive portfolios of old loans at Fannie Mae and Freddie Mac, which own or back more than $5 trillion in mortgages.

There is growing evidence that many loans being guaranteed by the government have a significant risk of defaulting. Delinquencies are spiking. And the Federal Housing Administration, another source of government support for home loans, is quickly eating through its financial cushion as losses mount.
...
All told, the government now stands behind 86 percent of all new home loans, up from about 30 percent just four years ago, according to Inside Mortgage Finance.

Here's where the writers go awry...

Some people who are no longer eligible for loans elsewhere have turned to FHA, which does not demand top-notch credit scores or sizable down payments. But for some consumers, such as Lisa McCracken of Stafford County, the FHA's minimum 3.5 percent down payment can be a stretch.

McCracken, a traveling nurse, has been scrimping to raise the down payment, living with her parents to save money. "I think I can swing it, but it won't be easy," she said. "I'll be wiping out a lot of my savings to buy a house." The self-employed face difficulties because they tend to have a tough time documenting their income, as required by Fannie Mae, Freddie Mac and FHA loans.

Donald Prieto, who owns a roof contracting business in San Diego, has shelved his plans to buy a new home. Five years ago, he and his wife purchased a small home without having to verify his income. They have made their payments on time, have maintained solid credit scores and have plenty of cash in the bank, he said. Now, they have three children. They want a larger home, but several lenders have turned them away because he does not have two years' worth of paychecks to show.

For that reason, Prieto has incorporated his company and started cutting himself formal paychecks. "No bank wants to take risks anymore, and I understand that," Prieto said. "I just have to wait."

Saving 3.5 percent is a stretch?

It's about one-third of the stretch that it should be and about one-sixth of the stretch it was for most of the 20th century.

Little or no "skin in the game" is a big part of the reason why we're in this mess.

As for the self-employed getting a mortgage, back about ten years or so ago, before mortgage lending went off its rails, even in a place like California you needed to come up with a downpayment of 25 percent if you wanted to finance the purchase of your primary residence while running your own small business.

No ifs, ands, or buts.

We seem to have veered so far away from what seemed to be quite prudent lending standards that worked so well during most of the 20th century that no one remembers what they were.

There's a lot to like in this article, but lamenting the woes of those who are being "frozen out" of new home purchases today is not one of them.

Doug Noland's most recent commentary at Prudent Bear offers a much harsher assessment of the new mortgage lending environment (skip to the end) and is also well worth a look. In fact, that should have been the subject of this post instead of the WaPo story.

Oh well ...

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Loan Modification Not A Fix-All To Credit Crisis

With credit markets still tight, should the government be doing more to loosen lending? One proposed solution that the government is actively pursuing is loan modification for troubled homeowners. But according to the following post from Blown Mortgage, loan modifications will not get to the heart of the US credit problems.

Last year we say yet another bubble pop, the credit industry. That bubble did not pop alone. A whole lot of burst bubble followed including the mortgage industry, construction, stock market and the banking industry as a whole. Countries do start to get nervous when the banking and credit industry that feeds the whole economy starts to shake. Nerves can help us to react and find solutions but it can also make us overreact and come up with inadequate solutions.

How should we rate loan modifications as a solution for the credit crisis?
The answer to that question depends on who you listen to or which economic model you choose to follow.

If you view the economy as a natural process of offer and demand that is best left alone you will probably think that the government’s efforts to bailout home owners is a travesty of governments role in society. I can easily relate to this view. The credit crisis can easily be viewed as an example of consumer’s greed that can be solved by allowing foreclosures and bankruptcies to do their job of balancing the irregularities unwise “investors and borrowers” created.

Deciding if loan modifications as a management tool of the economy is morally or economically acceptable is only part of the issue. Many would say that loan modifications might help if we were dealing with a mortgage crisis but are not the solution to the credit crisis. It is easy to see that something more deeply ingrained than a bad interest rate is behind the credit crisis we are currently living.

Unfortunately the only thing a loan modification can do is modify a mortgage or home loan it can’t help with numerous credit card debts, car loans and other debt issues.

Many would argue is that the current crisis is the market’s way of teaching a lesson of modifying behaviors, of showing that the current spending and borrowing cultures are not sustainable. An interesting fact that backs this view is that many people who are struggling to pay their mortgage shouldn’t be if one were to look at their incomes. This was a problem the HAMP (Home Affordable Mortgage Program), the Government’s mortgage aid program had to deal with. In an effort to reduce bailouts and loan modification breaks to those who really need it, only home owners that pay more than 31% of their wage towards their mortgage qualified for a sponsored loan modification. HAMP managers have since realized that this requirement limits this program to many who really need a loan modification in order to not foreclose their mortgages. This is because their mortgage is only one of the debts they have to deal with.

For people to reap lasting benefits from a government program we will have to dig deeper into the origins of the current credit crisis and that is not secluded to the type of mortgage home owners have.

This post has been republished from Blown Mortgage, a mortgage news and analysis site.

Is Time Running Out On Financial Reform?

With so many issues on the plate of legislators, is financial reform falling down the list of priorities for lawmakers? Economists Alan Blinder and Mark Thoma express concerns that the window of opportunity for financial reform may be closing. See the following post from Economist's View for more.

Alan Blinder is worried that the will to reform the financial sector is fading:

The Wait for Financial Reform, by Alan S. Blinder, Commentary, NY Times: ...We are barely emerging from the greatest financial crisis since the 1930s. From last September to March, it was downright frightening. Yet by the time Congress left town for its summer recess, financial reform appeared to be losing steam. ... Why is the pulse of reform so faint? I see five main reasons:

IT’S YESTERDAY’S PROBLEM People have an amazing capacity to forget. Our financial system is now functioning much better than it was in March or last fall. ... You can see public attention shifting elsewhere... I want to scream, “Stop!” The financial regulatory system needs fixing, and to accomplish it, Congress will have to hold a lot of feet to a lot of fires. It’s not clear that many members have the stomach for that.

LOST IN THE CROWD The problem of short attention spans has a first cousin: the overcrowded legislative agenda... There is a budget to pass, health insurance to reform, energy to cap and trade, schools to overhaul, two wars to watch over and others to avoid — and more. Amid all of this, the Treasury has sent Congress 16 pieces of financial reform legislation... What are the chances that these 16 bills will surface to the top of the legislative agenda?

THE MOTHER OF ALL LOBBIES Almost everything becomes lobbied to death in Washington. In the case of financial reform, the money at stake is mind-boggling, and one financial industry after another will go to the mat to fight any provision that might hurt it. ...

BUREAUCRATIC INFIGHTING Industry lobbyists are not the only problem. Regulatory deck chairs need to be rearranged, and various government agencies are scrambling to maintain or expand their turfs. ..The bureaucratic turf wars have grown intense...

A LACK OF FOCUS Perhaps worst of all, it’s hard to keep the public engaged in something as complex, arcane and — frankly — as boring as financial regulation. ... Today, the electorate has a vague sense that it has been ripped off and that change is needed. But the sentiment is unfocused and inchoate — with these two exceptions: People clearly want greater consumer protection and restrictions on executive pay.

By no coincidence, those are the two pieces of financial reform that seem most likely to survive the Congressional sausage grinder. Don’t get me wrong; we need both. But the two don’t constitute the entirety of reform, or even its most important parts.

I’d attach greater importance to at least three major Treasury proposals that may wind up on the cutting-room floor:

First, we need a systemic risk monitor or regulator. ... In my last column, I explained ... why the Fed should get the job.

Second, we need a new mechanism to euthanize or rehabilitate giant financial institutions whose failure could threaten the whole system. ...

Third, something serious must be done to tame — though not to destroy — the derivatives markets. ...

And there is a great deal more... So let’s get on with the job...

Here's my view on the tension between imposing regulation before the will to do so fades, and delaying to avoid upsetting already unsettled financial markets and to carefully consider the changes before putting them into place:

While it's possible that regulation will go overboard in response to the crisis, there are powerful interests that will resist regulatory changes that limit their opportunities to make money (and Nobel prize winning economists willing to back them up), so my worry is that regulation will not go far enough, particularly with people ... arguing that we should wait for recovery before making any big regulatory changes to the financial sector. They may be right that now is not the time to change regulations because it could create additional destabilizing uncertainty in financial markets, and that waiting will give us time to see how the crisis plays out and to consider the regulatory moves carefully. But as we wait, passions will fade, defenses will mount, the media will respond to the those opposed to regulation by making it a he said, she said issue that fogs things up and confuses the public as well as politicians, and by the time it is all over there's every chance that legislation will pass that is nothing but a facade with no real teeth that can change the behaviors that go us into this mess.

This post has been republished from Mark Thoma's blog, Economist's View.

The Economy's Capacity To Mint New Jobs Still A Ways Off

Since employment numbers are usually a lagging indicator, it may be a while before we see actual improvement in unemployment numbers. For now, we must settle for increasingly "less bad" unemployment. For more on this see the following post from James Picerno's The Capital Spectator.

It's getting better, or at least the pain is lessening. But no one will mistake the labor market as healthy at the moment. Nor is it obvious that salvation's coming any time soon.

Nonfarm payrolls dropped again last month. The good news is that the loss of 216,000 jobs in August was the smallest decline this year and noticeably under July's revised 276,000 retreat, the government advises today. On that basis, August represents a step in the right direction. Certainly the trend has improved considerably since the average 648,000 monthly drop that prevailed in this year's first four months.



Nonetheless, our economic outlook that we've been discussing for months remains intact. On the one hand, the technical end of the recession is imminent if it isn't already here. By that we mean several things, starting with the growing probability that third-quarter GDP will show a small gain when the government issues its first estimate on October 29. But the return of broad economic growth—meager or otherwise—will be accompanied this time by a weak labor market.

Employment growth is always among the last to revive after a recession. The difference now is that the labor market will recover later and remain subpar for longer relative to every post-recession period since World War II. Today's update on August employment offers no reason to think otherwise.

Our second chart below captures our dualist outlook for the technical end of the recession paired with an unusually slow recovery in the labor market. By indexing the trend over the past year for initial jobless claims (red line) and continuing jobless claims (black line) we can compare the two on an equal footing. Briefly, the ongoing decline in new filings for unemployment benefits signals that the recession may be near a technical end. (For some background on using initial jobless claims as one factor in predicting the business cycle's trough, see our analysis published in March.) Meanwhile, continuing claims reflect whether workers are finding new jobs after some period of existing among the ranks of the unemployed. Judging by the trend in this data, there's still no compelling reason for optimism, which suggests the economy's capacity to mint new jobs on a net basis is still a ways off. Continuing claims have come down from the peak set earlier in the year, but it's debatable if the decline is wavering.



The labor market it seems will remain the primary thorn in the economy's recovery. Consider, for instance, that labor productivity jumped sharply higher by 6.6% in the second quarter—the most since 2003, the Labor Department reports. The message here is clear: corporate America is adapting to the times by producing more goods and services with fewer workers.

As we've been writing for some time now (including here, for instance), the biggest economic challenge is still in front of us. It's been tempting to think otherwise. Yes, the worst of the financial crisis appears to be behind us and the economy seems to be on the mend in broad terms. But that good news masks the bigger challenge that awaits: reviving the labor market. Unfortunately, that's going to take more time and effort than simply cutting interest rates to zero, printing money, putting toxic securities on the Fed's balance sheet and passing multi-billion-dollar stimulus bills that create more light and heat than enduring jobs growth.

In sum, the acute problems have passed. Now we're facing the challenge of managing the chronic ailments that afflict the economy.

This post has been republished from James Picerno's blog, The Capital Spectator.

Is The US Headed Toward A Debt Time Bomb?

Harvard Economist Ken Rogoff says we should be very worried about the growing national debt and that the current growth rate of debt could lead to a second wave of financial crises within years. However Mark Thoma discredits Rogoff, arguing that his concerns about debt caused him to advocate raising interest rates and argue against a stimulus in June of 2008. See the following post from Economist's View for more.

Ken Rogoff says the debt crisis he has been warning about for many years is still a risk:

From Financial Crisis to Debt Crisis?, by Kenneth Rogoff, Commentary, Project Syndicate: ...How can policymakers be so certain that financial catastrophe won't soon recur when they seemed to have no idea that such a crisis would happen in the first place?

The answer is not very reassuring. Essentially, there is still a risk that the financial crisis is simply hibernating as it slowly morphs into a government debt crisis.

For better or for worse, the reason most investors are now much more confident than they were a few months ago is that governments around the world have cast a vast safety net under much of the financial system. At the same time, they have propped up economies by running massive deficits, while central banks have cut interest rates nearly to zero.

But can blanket government largesse be the final answer? Government backstops work because taxpayers have deep pockets, but no pocket is bottomless.

And when governments, particularly large ones, get into trouble, there is no backstop. With government debt levels around the world reaching heights usually seen only after wars, it is obvious that the current strategy is not sustainable. ...

We are constantly reassured that governments will not default on their debts. In fact, governments all over the world default with startling regularity, either outright or through inflation. Even the U.S., for example, significantly inflated down its debt in the 1970s, and debased the gold value of the dollar from $20 per ounce to $34 in the 1930s. ...

The ... rate at which government debt is piling up could easily lead to a second wave of financial crises within a few years. Most worrisome is America's huge dependence on foreign borrowing, particularly from China... The question today is not why no one is warning about the next crisis. They are. The question is whether political leaders are listening. ...

How Paul Krugman might respond:

So is there anything to worry about? Yes, but the dangers are political, not economic. ... Over the really long term,... the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.

That shouldn’t be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.

But that won’t happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to “pull the plug on grandma.”

So don’t fret about this year’s deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it’s not because the economy can’t handle the extra debt. Instead, it’s the politics, stupid.

Note also that the bond price data do not show any signs of worry over inflation, default, or crowding out.

One more note. This is Rogoff in June 2008. He argues that there should be no stimulus, the risk posed by deficits is too large, and that interest rates should be raised to prevent inflation:

[P]olicymakers must refrain from excessively expansionary macroeconomic policy ... and accept the slowdown... For most central banks, this means significantly raising interest rates to combat inflation. For Treasuries, this means maintaining fiscal discipline rather than giving in to the temptation of tax rebates and fuel subsidies. In policymaker’s zealous attempts to avoid a plain vanilla supply shock recession, they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater and more protracted downturn.

My own view is that "significantly increasing interest rates" in June 2008 would have been a disaster, and that deficit spending was needed to prevent conditions from deteriorating even further. Opposition to deficit spending from people like Rogoff only served to delay putting this policy in place. (Also: This was prior to Lehman, inflation was being driven by commodity price increases, i.e. by relative price changes which do not pose long-run inflation risks, and had the Fed followed this advice and raised rates, it would have likely reversed course after Lehman further undermining its credibility at a time when credibility was needed the most.)

This post has been republished from Mark Thoma's blog, Economist's View.

$1000 Gold Could Spark A Bull Market

With gold getting ever so close to the $1000 threshold this week, could we be headed toward a bull market in gold? Dr. Steve Sjuggerud from Daily Wealth thinks that once gold hits $1000, it could create a lot of buzz and fuel optimism that would keep gold prices above $1,000. See the following post to learn more.

Aren't you stinkin' tired of it yet? I sure am...

I'm tired of hearing "Inflation is coming!" and "Gold is going to soar!" over the last 18 months... only to see nothing happen.

The inflation argument makes some sense... In the second half of 2008, the bond market essentially froze – so the government started on a binge of "printing" money to help unstick it. As the economy sank, the money-printing continued.

That much new money should have caused the price of gold to soar. But something wasn't quite right...

Gold didn't soar. And it still hasn't. Back in March 2008, when the storied Wall Street firm Bear Stearns went belly up, Gold poked its head above $1,000 per ounce for two days... Then strangely, that was it for gold.

No matter how bad the credit crisis got... no matter how much closer the world got to the Next Great Depression... gold still didn't soar. Gold didn't do anything really, except go to sleep.

For almost two years now, gold has been hovering between about $800 and $1,000 per ounce. It's been a year and a half since gold last closed over $1,000. Quietly, I've been getting worried...

If the Credit Crisis couldn't push gold over $1,000... and if the prospect of the Next Great Depression couldn't push it over $1,000... then what would happen when the economy started to return to "normal"? Would gold crash? It sure could.

And now it seems that "normal" is returning...

In the last few months, the world has come back from the abyss. I've repeatedly said the U.S. recession is over. The crazy fears that the world was ending are behind us for now.

But a funny thing has happened... gold is quietly moving up.

Now this is important – incredibly important. You see, this is exactly the way a REAL bull market works...

In a real bull market, the asset (in this case, gold) hits a new high as optimism over that asset peaks (that was back in March 2008). Then the optimism fades... and so does the price of the asset.

Next, the asset just meanders along, letting people give up on it... But it's just plotting its next move higher. It's shaking off all the nonbelievers before it breaks through to a new high.

My friend Jason Goepfert (of www.sentimentrader.com) is the best in the business at analyzing investor sentiment. So I looked at his recent work to find out if gold is at a peak in optimism (which would mean gold should top out soon) or if we still have farther to go.

Jason says his gold sentiment indicators are "not showing any excessive optimism just yet." In short... we still have farther to go.

If gold closes above $1,000 per ounce a few times in the next few sessions, it could finally hold above the $1,000 level.

People simply haven't been buying gold "hand over fist" lately. But if gold closes over $1,000 a few times, they will. Gold will be all over the news, and the average investor (who hasn't bought yet) will finally start to get in. He'll sell his stocks that have soared but have recently run out of gas... and move his money over to gold.

We could be on the brink of a big move in the price of gold... the next leg up in the gold bull market.

In the last 18 months, the way gold was acting, I wasn't so sure if it was coming. But with this week's action, with gold inching up over $995, I believe a new leg higher in the bull market is here.

We'll know if it's for real in the next few days. If it is, make sure you own some.

This article has been republished from Daily Wealth, a contrarian investment analysis site.

Why We Don't Need A Financial Transaction Tax

Could a financial transaction tax that would help raise $100 billion in government revenue justify throwing sand in the gears of trading markets . While such a tax would discourage bad speculation, it would also discourage good speculation at the same time. The following post from Economist's View discusses the pros and cons of a financial transactions tax.

Is a Tobin tax on financial transactions just what the deficit and efficiency doctors ordered? Dean Baker has been advocating for a financial transactions tax, and here's his explanation for why it is needed:

A Financial Transactions Tax, by Dean Baker, Commentary, Counterpunch: Just like that perfect sweater, a financial transactions tax (FTT) would look just great on those Wall Street bankers and financiers. A modest tax, which would be too small for normal investors to even notice, could easily raise more than $100 billion a year. ...

[A]n FTT makes a huge amount of sense. The basic point is quite simple. A tax of 0.25 percent on the sale or purchase of a share of stock will make little difference to a person who intends to hold the share for 5-10 years as a long-term investment. ... A small increase in trading costs would be a very manageable burden for those who are using financial markets to support productive economic activity. However, it would impose serious costs on those who see the financial markets as a casino in which they place their bets by the day, hour, or minute. Speculators who hope to jump into the market at 2:00 and pocket their gains by 3:00 would be subject to much greater risk if they had to pay even a modest financial transaction tax. ...

The Wall Streeters and their flacks will insist that an FTT is unenforceable and will simply result in trading moving overseas. There is a small problem with this argument call the “United Kingdom.” The U.K. has had a tax on stock trades ... for decades. The revenue raised each year would be equivalent to $30 billion in the U.S. economy. Obviously, the tax is enforceable.

In fact, we can go beyond the U.K. and add other measures to make enforcement more fun. For example, we can give workers an incentive to turn in their cheating bosses by awarding them 10 percent of any revenue and penalties that the government collects. ...

Of course, the prospect of the financial industry moving overseas should not be troubling any case. Why should we be any more bothered by buying our financial services from foreigners than by buying our steel from foreigners? If the industry moved overseas, then it could corrupt some other country’s politics.

The basic point is simple. A FTT can allow us to raise more than $100 billion annually to finance health care or any other budget item that we consider important. It does so in a way that is very progressive and will weaken the financial industry both economically and politically. In fact, even Larry Summers, the head of President Obama’s National Economic Council, even argued that a FTT was a good idea. ...

Here's a bit more on the tax, whether the Obama administration might support it, and Summer's support of the tax in the past:

A Tobin tax for Wall Street?, by Robert Kuttner, Prospect: Now that Adair Turner has opened the door to a forbidden subject—Tobin taxes on financial transactions—could the Obama administration embrace such an idea?

Professor Tobin first proposed his tax to address currency speculation. This was in 1972, when the fixed-rate regime of Bretton Woods had collapsed. His concern was that speculative trades were fundamentally distorting currency values and damaging the real economy. The tax that he proposed was intended to damp down the volatility in currency movements, and take much of the profit out of purely speculative, short-term moves.

The early 1970s was a period ... before the general financial deregulation that followed. Since that time, speculative trading has distorted not just currency markets, but the broad financial market itself. The volume of short-term trades has grown far faster than the value of the stock market or the real economy. The most recent case in point is ultra high-speed computerised trading...

A small tax on very short-term financial transactions would have two immense benefits. It would discourage purely speculative trades, while having no significant effects on long-term investments, and it would thus help restore the legitimate function of financial markets: connecting investors to entrepreneurs. Secondly, it could raise a substantial amount of revenue in a highly progressive fashion—at a time when large deficits loom.

The Obama administration might take a serious look at a Tobin tax for both of these reasons. Early in his career, Larry Summers, Obama’s economic policy chief, was a supporter of the Tobin tax. In a 1989 paper, co-authored with his former wife, Victoria Summers, he wrote that there might be times when it was salutary to throw a little sand in the gears of trading markets. The paper was titled: “When Financial Markets Work too Well: a Cautious Case for a Securities Transaction Tax.”

However, the Obama administration’s regulatory stance is still a long distance away from taking serious measures to discourage speculative trading markets as a general policy goal. The more likely motivation would be concerns about the federal budget deficit. ...

The tax, of course, would be fiercely resisted by Wall Street. For a reform administration, Obama’s government has approached any confrontation with Wall Street very gingerly. ... Even if Obama comes to a Tobin tax via the back door of revenue needs, this would be most welcome, as it would also lead to examination a larger, neglected issue: how to rein in financial engineering for the good of the larger economy.

Since I don't have a strong opinion on this, let's play "he said-he said." Here's Willem Buiter with an alternative view:

Forget Tobin tax: there is a better way to curb finance, by Willem Buiter, Commentary, Financial Times: Lord Turner, chairman of the UK’s Financial Services Authority, has set the cat among the financial pigeons by making highly critical comments about ... financial intermediation... He recommended some drastic remedies, and suggested considering a global tax on financial transactions – a generalised Tobin tax. ...

What problem would a Tobin tax on financial transactions solve? Lord Turner asserts ... that the UK financial sector has grown too big; that some financial sector activity is worthless from a social perspective; that the sector is destabilising...; and that new taxes may be required to curb excessive profits and pay in the sector. ... Even if all these assertions are correct, they do not imply the need for a Tobin tax.

Economics teaches us that taxes and other public interventions to correct distortions and other market failures should be targeted directly at the distortion or failure in question. What distortion is a tax on financial transactions targeted at?

The financial sector is too big throughout the overdeveloped world in part because much of it enjoys a free state guarantee against default on its unsecured debt. ... The cost of capital to the banking sector is subsidised, causing the sector to be too large.

The solution is clear, and it is not a tax on financial transactions: bring default risk back into the calculations of unsecured creditors and other counterparties of the financial sector. This would eliminate the capital subsidy to the industry. The obvious way to do this is through the creation of a “special resolution regime” as an alternative to bankruptcy for all systemically important financial institutions. This would permit their unsecured creditors and other counterparties to be forcibly and swiftly converted into shareholders, until the institutions are adequately capitalised. It must be possible to achieve such a mandatory recapitalisation by unsecured creditors and counterparties for any institution overnight, and without interrupting normal business. A regularly updated “will” for each systemically important financial institution would eliminate any remaining “too big, too interconnected, too complex and too international to fail” obstacles to the Darwinian discipline of the market, which has been sorely missed in the financial sector.

I believe that efficient financial intermediation and a dynamic financial sector are essential for the proper functioning of any decentralised market economy; I also believe that too much financial sector activity is not only socially worthless, but actually harmful. Take financial derivatives. ... To tame the rampant excessive speculation in the derivatives markets, it is sufficient to require that at least one of the parties involved in a derivatives transaction has an insurable interest. The Tobin tax does nothing to achieve this. ...

“Churning” can be a problem for individual savers. Excessive transaction volumes can be caused by perverse incentive systems that link the remuneration of traders – acting as agents for owners of wealth – to trading volumes. Even here, the right solution is not transaction taxes but regulation restricting the undesirable features of these contracts directly. If excessive pay in the financial sector is a problem, tax pay.

I agree with Lord Turner that the UK financial sector – too large to fail and possibly also too large to save – has become a destabilising force for the UK. ... One can share Lord Turner’s diagnosis that the UK financial sector was allowed to grow too large and to get out of control – almost a law unto itself – without accepting the Tobin tax as part of the solution. Tobin was a genius, but the Tobin tax was probably his one daft idea. Creating a viable and socially useful UK financial sector does not require this unfortunate fiscal intervention.

The efficiency properties of the tax depend upon how speculation is viewed. If you believe speculation is efficiency enhancing, and it can be, then reducing speculation would reduce rather than increase efficiency. But if you believe speculation is destabilizing, and it can be this too, then reducing speculation would be beneficial. I am not as negative toward speculation as many, and believe that while it can be both good and bad from a market efficiency perspective, on net, it does good. A general tax would reduce both the good and bad types of speculation, so it is not clear to me that this would be beneficial. I would prefer a mechanism that targets that bad speculation, but leaves the good type alone, but since it is difficult to tell the two apart, even ex-post, it is not practical to levy a tax on just the bad transactions while giving the good ones a free pass. But it may be possible to target the underlying market failures and distortions driving the problems in financial markets, which amounts to the same thing, and these extend far beyond just speculative ventures. Thus, I am somewhat persuaded by Buiter's argument that "public interventions to correct distortions and other market failures should be targeted directly at the distortion or failure in question." It's not clear a financial transactions tax has this property.

From a revenue point of view, the calculation is different. Given the government's spending needs (whatever they are), the question is how to best raise the revenue to pay for that spending. In that regard, the question is whether a financial transactions tax would be the least distortive (and fairest) means of raising the revenue needed to support government spending. Since I am somewhat on the fence regarding speculation, there is good speculation and bad speculation and it's not clear which prevails (though I give an edge to the good type), it may be that a tax of this type creates more distortions than it resolves. However, that also means that it may not create, on net, as many distortions as the next best alternative tax that would raise the same amount of revenue, and hence a financial transactions tax may be a desirable way to provide additional funds to the government.

This post has been republished from Mark Thoma's blog, Economist's View.

Are We On The Path To Another Economic Bubble?

Although we are coming off a recent bubble implosion, could we already be on the way to the next bubble? Tim Iacono discusses why he thinks this is the case. See the following post from The Mess That Greenspan Made to learn why.

It's not hard to imagine how conditions today might look a few years hence. With the interest rate pedal nailed to the floorboard, money continuing to spew from Washington to buy all sorts of things, banks once again trying to figure out how to divide up bonus money, and the price of gold again approaching $1,000, officials are concerned about moving too fast toward restoring a more normal monetary policy environment as reported by Bloomberg.

Geithner: Too Early to Implement Exit Strategies
U.S. Treasury Secretary Timothy Geithner said the Group of 20 nations has been “very successful” in helping to end the global recession and cautioned that it’s too early to remove policies aimed at boosting growth.

“You’re seeing the first signs of positive growth now in this country and countries around the world,” Geithner told reporters in Washington today. “We’ve come a very long way but I think we have to be realistic, we’ve got a long way to go still.”
...
Geithner said talks in London will include the start of a discussion on bank capital standards as well as a “framework” for how the world’s largest industrial and developing economies can cooperate to remove policies to stimulate growth. While it’s “too early” to implement exit strategies, it’s not too soon to talk about them, he said.
...
It is “very important” to the U.S. to “reinforce the progress we are seeing,” Geithner said.

Assuming we navigate the deflationary abyss that continues to beckon from afar, we'll probably find out a couple years from now that we were very well "reinforced" at this point in time, well on the way to inflating an even more enormous bubble ... somewhere, in something ... to replace the one that just burst.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Stanford Alumni Aims To Fix Japan's Economy

There has been a pretty significant shift in the leadership of Japan, with the controlling party being defeated for the first time in more than 50 years. How will this Ph.D. from Stanford (engineering) do at running Japan and fixing the economy? Kathy Lien tells us more about Mr. Hatoyama below.

The Japanese Yen strengthened across the board as investors cheer new leadership in Japan. After more than 50 years of unchallenged power, the Liberal Democratic Party (LDP) has been finally defeated by the Democratic Party of Japan (DPJ). The big question of if and when Prime Minister Aso will announce his resignation was answered almost immediately with Aso conceding defeat and confirming that he will resign as LDP head. Mr. Hatoyama, the current leader of the DPJ is expected to be confirmed as the new Prime Minister of Japan in approximately 2 weeks.

Who is Mr. Hatoyama?

Yukio Hatoyama has politics in his blood. His grandfather was the LDP’s first Prime Minister in 1955 and Hatoyama will be the country’s first non-LDP Prime Minister since 1955. He comes from a weathly family that has made their fortune in the industrial and political sectors. He is a fourth generation politician with a Ph.D in engineering from Stanford University. Although Hatoyama inherited his father’s LDP seat in 1986, he has been reelected to that seat seven times.

Some people in the Japanese political circle have called Hatoyama the “alien” as he can come off as eccentric and aloof. The Prime Minister role of Japan has been a difficult one for anyone to hold down for more than a year since Koizumi left office in 2006. As someone who can sound more like a teacher than a politician and has been criticized for being indecisive, Hatoyama has a tall task ahead of him.

The political landscape has changed dramatically for Japan with the DPJ’s victory. As the new party attempts to announce fresh measures aimed at stimulating the economy, there could be political turmoil. The DPJ does not have practical experience running the country and their goals are ambitious. Unlike the LDP whose initiatives have focused on business and public works, the DPJ’s initatives will focus on increasing disposable income for households. The party expects to pay for their new initiatives by cutting wasteful administration costs. Having previously criticized the Japanese economy for being overly dependent on exports, Hatoyama will be focusing heavily on boosting domestic demand.

Political Change Will Not Have a Lasting Impact on the Japanese Yen

However as happy as Japanese investors are about the change in leadership, the positive impact on the Japanese Yen could be limited. Long term trends in USD/JPY are determined by market fundamentals and overall risk appetite and not Japanese politics. With that in mind, USD/JPY is very weak. The sell-off in global equities and thin trading conditions ahead of the U.S. Labor Market holiday could drive the currency pair to a 6 month low of 91.75.

In terms of Hatoyama and the Democratic Party of Japan, it remains to be see whether they have what it takes to deliver on their promises of turning the economy around. If the global economy continues to recover, the DPJ could benefit from having the wind behind their sails. Either way, it will certainty be a daunting task for Hatoyama as the economy and his party’s legacy now rests on his shoulders.

This post has been republished from Kathy Lien's blog.
Photo from Wikimedia Commons.

Why Employment Should Not Be The Number One Concern

Economist Andy Harless discusses why job loss is not the biggest problem facing the economy right now but a necessary part of the natural cycle of economic growth. He also explains how unemployment will help prevent inflation that many analysts are worried about. For more on this see the following post from Economist's View.

Why has the rate of both job creation and job destruction been falling in recent years?

Job Losses Are Not the Problem, by Andy Harless: It is sometimes argued that recessions benefit the economy by allowing the destruction of old, inefficient economic structures so that newer, better ones can be created to replace them. On the surface, this story might seem to apply to the recent recession: ostensibly, a lot of useless jobs in finance, real estate, and construction were destroyed, as well as perhaps old manufacturing jobs that hadn’t caught up with the latest technology, and jobs in retail trade that needed to be replaced by the Internet, and so on. But there’s one problem with that point of view: overall (at least during the first four quarters of the recession, up through the end of 2008, for which we have the relevant data), there weren’t an unusually large number of total jobs being destroyed.

But...but...but...haven’t we been hearing about large numbers of job losses month after month since the recession began? Sort of. We’ve been hearing about large numbers of net job losses. That is, the number of jobs that have been lost has been a lot more than the number that have been created. And a lot of job losers have ended up collecting unemployment insurance for a long time, sending the figures for continuing claims up to records, instead of getting new jobs. But the gross number of jobs being destroyed has not been unusually large. In fact, relative to the overall level of employment, job destruction was happening at a faster rate during the boom of the late 1990s than it was during the last quarter of 2008.

How can that be? For one thing, when you take out the business cycle, there seems to have been a general downward trend in the rate of job destruction over the past 10 years. More important, the rate of job creation also had a downward trend, and it dropped to new lows during the recession of 2008. If you lost a job in 1999, you weren’t actually all that atypical, but it wasn’t a big problem, because typically, you could find a new job fairly easily. If you lost a job in 2008, you were (typically) out of luck.

Source: Business Employment Dynamics data from the Bureau of Labor Statistics

The fact is, job creation and job destruction take place during booms at rates that are not dramatically different from the rates during recessions. It’s just the difference between the two that changes. In a typical boom quarter, about 7 million jobs are destroyed, and about 8 million are created. In a typical recession quarter, about 8 million are destroyed and about 7 million are created. There just isn’t much support for the idea that recessions give us a special ability to reallocate resources more intensely than we do during a boom or a period of normal growth. “Creative destruction” is a dynamic process that continues all the time, not one that occurs in separate phases of creation and destruction.

And the most salient feature of the current episode is that there has been unusually little creation. From the 1990’s to the 2000’s, the quarterly job creation rate fell from about 8% to about 7%. Since 2006, it has fallen to about 6%.

Some might argue that this type of slowdown in job creation is inevitable during times of structural change and that it is useless to try to oppose it with monetary and fiscal policy. It takes a long time (Arnold Kling, for example, would argue) for the economy to come up with ideas for new, productive uses of resources when the old uses are no longer productive. Monetary and fiscal policies can’t do much to speed up this process. They can’t make entrepreneurs more creative.

I’m skeptical of that view: entrepreneurs were plenty creative during the 90’s, once the booming stock market gave them a reason to apply their creativity. Monetary policy really did help speed up the process of finding new uses for resources: low interest rates led to high equity prices, which made it easy to raise capital and thereby made it advantageous to find new ways of using capital. Some would say the process went too fast in the end, with a large fraction of the uses proving ultimately unproductive, but statistics show aggregate productivity rising rapidly and continuing to rise during the subsequent years, even (atypically) during the recession that immediately followed the boom. There may have been a lot of froth, but there was plenty of good beer underneath, and monetary policy is what opened the tap.

In any case, even if I were to concede that monetary and fiscal policies don’t help speed up the adjustment process, they do help us get the most out of the economy in the mean time. With nearly 10 percent of the labor force unemployed, there are a lot of resources being wasted – people spending their time looking for jobs that many of them just aren’t going to find until we get a lot more economic activity. There are plenty of useful things that those people could be doing in the mean time.

Perhaps more important, monetary and fiscal policies help us reduce the risk that a weak economy – too weak for too long – will fall into a deflationary spiral. As long as job creation remains weak, employers have little incentive to raise wages, and competition will tend to push down prices. Even an “artificial” stimulus, one that doesn’t accelerate the structural adjustment process, will create a demand for labor and force employers to compete somewhat for workers. That competition, in turn, will prevent them from competing too aggressively in product markets and keep prices reasonably stable.

There is, of course (in theory, at least), the risk that policies will go too far and not just prevent deflation but produce excessive inflation. As I have argued before, we are nowhere near that point right now. I made the case against inflation using mostly the unemployment rate, but the case becomes even stronger when you consider the job creation statistics. This unemployment is specifically being induced by a slowdown in job creation. Job creation is specifically what leads to inflation: it’s when companies want to hire aggressively that they start raising wages excessively and competition becomes unable to keep prices in check. If unemployment – which arguably has a more tenuous relationship to inflation – is far, far away from the danger point, job creation – which has a direct relationship to inflation – is even further away.

Quick reaction (I had hoped to say more about the decline in the rates of job creation and destruction, but that will have to wait, so your thoughts on this are welcome):

I think both monetary and fiscal policy can help with restructuring, as noted above monetary policy can increase the return on projects and thus creates an incentive to find "new, productive uses of resources." Fiscal policy can, both literally and figuratively, pave the way for those projects to come to fruition.

But, though fiscal policy in particular could have been devoted more toward helping labor and other resources make the transitions to new industries, and perhaps more could have been done to help with the creation of new opportunities, the main point I want to make is that we should distinguish between cyclical and structural unemployment. Much of the unemployment we are seeing is due to the business cycle, it has little to do with the need to restructure the economy, and both monetary and fiscal policy can be of great help with this problem. I don't know for sure how much of the change we are seeing is structural and how much is cyclical, but I am willing to assert that most of the change in unemployment is a cyclical rather than a structural phenomena. Thus, "even if I were to concede that monetary and fiscal policies don’t help speed up the adjustment process," though I see no reason to concede this, it only speaks to the ability of these policies to help with structural adjustment, monetary and fiscal policy are still very much needed to deal with the unemployment related to the business cycle.

This post has been republished from Mark Thoma's blog, Economist's View.

The Improved US Savings Rate Is False

The US savings rate which was around 1 percent last year, appears to have rebounded to 4.2% in July, which is far below China's saving rate of nearly 40%. However Andrew Kaplan makes a compelling argument of why this number is totally false. While the top 10% of the population earn 50% of the income, the other 90% are struggling with debt, he argues. See the following post from Economist's View to learn more.

Yves Smith suggested this. I don't know if it's correct or not, as noted below most of the numbers are speculative due to data limitations, but the question of how recent changes in saving vary with income does seem like a question worth asking:

Guest Post: The Savings Rate Has Recovered…if You Ignore the Bottom 99%, by By Andrew Kaplan, a hedge fund manager: It has become fashionable among equities managers of the bullish persuasion to argue that a strong recovery in GDP will occur in 2010 because the “structural adjustment period” of moving back to a more normal savings rate has been completed. We’ve gone from a savings rate of barely 1% in 2008 up to 4.2% in July (ok, so the argument sounded better when the number was 6.2% in May, but still…).

The story goes something like, “consumers took a little time to recognize that their home equity had disappeared, but now they’ve adjusted their savings rates toward the desired level to reflect the fact that they need to save a larger proportion of income for retirement…so this effect will no longer be a drag on growth in coming quarters.”

This is the kind of conventional wisdom which could only emerge among folks in the 99th income percentile who spend their time primarily with other folks in the 99th income percentile. You don’t have to look at the data (mortgage delinquencies, foreclosures, credit card defaults, bankruptcies) all that hard to see a very different picture. In fact, it is almost certainly true that the savings rate for 99% of the US population is negative. These people (a/k/a “all of us”) are drowning. And to the extent that our savings rate is less negative than it was one or two years ago, that simply reflects the reality of reduced home equity and unsecured credit lines rather than any conscious effort to reach a “desired level” of savings.

A little data might help here. Unfortunately, there really IS no good data on PCE (personal consumption expenditure) and savings stratified by income percentile. There are a couple of surveys, the triennial “Survey of Consumer Finances” by the Federal Reserve and the “Consumer Expenditure Survey” by the Bureau of Labor Statistics, but the self-reported data is laughable. For 2007, the Consumer Expenditure Survey showed a personal savings rate of 18.4%. In the same year, the Bureau of Economic Analysis, which calculates the savings rate as a residual from actual income and expenditure data, showed a savings rate of 1.7%. Either the Consumer Expenditure Survey does a poor job of sampling, or people who fill out surveys are really big liars.

Fortunately, there IS some pretty good data on income stratification in the United States, and a few assumptions can help shed some light. Economists Thomas Piketty and Emmanuel Saez have made careers of studying US income inequality using IRS data, which goes back to 1913. The most recent data available (for 2007) showed that the top 14,988 households (0.01% of the population) received 6.04% of income, the highest figure for any year since the data became available. The top 1% of households received 23.5% of income (the second highest on record, after 1928), while the top 10% received 49.7% of income (the highest on record).

The fortunate 14,988 had an average income in 2007 of $35,042,705. They had an average federal tax burden, according to Piketty and Saez, of 34.7%, leaving them after tax income of $22.9 million. If you assume a 50% savings rate among this group, you get total savings of $171.5 billion. This is nearly ONE HALF of the total savings for the entire country implied by a savings rate of 4.2% ($365 bn) reported in this month’s Bureau of Economic Analysis data.

I’ve never actually had an after tax income of $22.9 million, so I couldn’t say for sure whether a 50% savings rate is a reasonable assumption, but I’m going to go out on a limb and say that it is, just based on the pure physics of spending money. Buying cars, clothes, and fancy dinners, even at Masa, won’t get you there…the math doesn’t work. Buying a private jet could get you there, but most people, even rich people, don’t buy one of those every year. The only EASY way to spend more than 50% of $22.9 million on an annual basis is to buy lots of houses…but the definition of “personal consumption expenditure” used by the BEA specifically excludes purchases of real estate. They use an imputed rent calculation instead. So I’m going to stick with my 50% number.

If we expand our survey to the top 1% of all households, we find an average income of $1.36 million for 2007. These folks had an average federal tax burden of just under 33%, so their after tax income averaged $916 thousand. If you assume this group had a savings rate of 33%, you get total savings of $452 billion (remember, $171.5 bn of this comes from the top 0.01%, we’re assuming a savings rate of around 25% of after tax income for the “poorer” 99% of the top 1%) This is more than 100% of the personal savings of the entire population, according to the BEA data. It implies that 99% of the US population still has, on average, a negative savings rate of around 1.3%. If you subtract the next nine percent, which likely still has a positive savings rate, the data for the bottom 90% becomes even more depressing, implying a negative savings rate of close to 5%.

This post has been republished from Mark Thoma's blog, Economist's View.

How The Obama Home Loan Modification Program Works

Will Obama's new loan modification program make a significant impact on the housing market? If successful, millions of homeowners would be saved from foreclosure, preventing more foreclosures from flooding the banking and housing sectors. The following article from Blown Mortgage explains how the Obama Loan Modification Program will work.

The objectives of the Obama Loan Modifications program are rather ambitious, to help 7 million people (the number is also quoted as 9 million, depending who you ask) modify their loan in order to afford monthly mortgage payments. In fact the way the program is designed you can save money by modifying your loan. The government is seriously backing this program with their big guns, namely $75 billion of funding. As always with these programs there are technicalities to deal with but the gist is rather simple to understand.

The loan modification program provides incentives to banks and service providers to modify your loan to a more sustainable monthly payment if you qualify through the trial period. The three month trial period tests if you are on time with your payments.

If you are, you receive a bonus that goes towards paying the principal of your loan. After that, every year you pay your mortgage without being delinquent on any payment another bonus is paid towards your mortgage principal.

These bonuses are worth extra because they pay the actual cash you initially borrowed, on which you will not have to pay interest. Who qualifies? This is one of the prickly areas of the program. The Loan modification aid program was designed to be as open as possible. You don´t have to be behind in your payments to qualify, just struggling to meet the monthly payments with your current income.

However the issue gets a little complicated due to a clause that limits a lot of home owners that are struggling. You can only qualify if your mortgage represents more than 30% of your monthly income. If it is less you will not qualify. This clause is actually under revision due to the fact that most borrowers don´t only owe on their mortgage but on their car, their credit cards, etc… This causes some of the most desperate home owners that owe money from various lenders not to qualify for the help they need. There are two main groups that can qualify for loan modification.

Those that want a loan modification but that didn´t qualify because the value of their home dropped and those that are on the brink of foreclosure. Either of these groups can get a loan modification if they comply with the programs requirements.

This post has been republished from Blown-Mortgage, a mortgage news and analysis site.