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January 07, 2009
Will tax stimulus stimulate investment?
Update: Reader Doug Lee points out that the fixed investment series above is dominated by the extraordinary decline in residential investment over the past several years. For that sector, the questions posed above are in a bit sharper focus. Are firms in the residential investment sector pessimistic about future prospects? Absolutely. Are compromised credit markets behind the low investment levels? Quite possibly, though given the large inventory overhang in housing it is improbable that activity in the sector would be robust in any case. Is the low investment/net worth ratio symptomatic of a general deleveraging within the nonfinancial business sector? Not so clear, as it is pretty hard to see through the effect in residential category.
Here, then is a chart of the history of nonresidential fixed investment relative to corporate net worth:
The recent decline in the ratio, while still there, is much less dramatic and, in fact, seems to be part of a more persistent trend that commenced prior to the 2001 recession (and which may have been temporarily disguised by the housing boom that followed).
Was the nonfinancial nonresidential business sector ahead in the deleveraging game—ahead of residential construction businesses, financial firms, and consumers? And could this bode well for this sector when the recovery begins? Unfortunately, I have more questions than answers.
By David Altig, senior vice president and research director at the Atlanta Fed
On Monday, the form of potential fiscal stimulus, 2009-style, took a step forward detail-wise. From the Wall Street Journal:
“President-elect Barack Obama and congressional Democrats are crafting a plan to offer about $300 billion of tax cuts to individuals and businesses, a move aimed at attracting Republican support for an economic-stimulus package and prodding companies to create jobs.
“The size of the proposed tax cuts—which would account for about 40% of a stimulus package that could reach $775 billion over two years—is greater than many on both sides of the aisle in Congress had anticipated.”
The plan appears to make concessions to both economic theory—which suggests that consumers will save a relatively large fraction of temporary increases in disposable income—and recent experience—which seems to suggest that what works in theory sometimes works in practice. Again, from the Wall Street Journal:
“Economists of all political stripes widely agree the checks sent out last spring were ineffective in stemming the economic slide, partly because many strapped consumers paid bills or saved the cash rather than spend it. But Obama aides wanted a provision that could get money into consumers’ hands fast, and hope they will be persuaded to spend money this time if the credit is made a permanent feature of the tax code.”
As for the business tax package:
“… a key provision would allow companies to write off huge losses incurred last year, as well as any losses from 2009, to retroactively reduce tax bills dating back five years. Obama aides note that businesses would have been able to claim most of the tax write-offs on future tax returns, and the proposal simply accelerates those write-offs to make them available in the current tax season, when a lack of available credit is leaving many companies short of cash.
“A second provision would entice firms to plow that money back into new investment. The write-offs would be retroactive to expenditures made as of Jan. 1, 2009, to ensure that companies don’t sit on their money until after Congress passes the measure.”
A relevant question here is really quite similar to the one we ask when the tax cuts are aimed at households: Will the extra cash be spent? This graph provides some interesting perspective:
Relative to net worth (of nonfarm nonfinancial corporate businesses), private fixed investment has been in consistent decline since the second quarter of 2006. (The level of fixed investment has declined in each quarter, save one.) In fact, the investment/net worth ratio is currently at a postwar low.
Why? A couple of hypotheses come to mind. (1) Firms are extremely pessimistic about the outlook and see relatively few worthwhile projects in which to commit funds. (2) Credit markets are so impaired that the net worth of firms—a critical variable in mainstream models of the so-called “credit channel” of monetary policy—is supporting increasingly smaller levels of lending. (3) Nonfinancial firms, like financial firms, are deleveraging and hence not expanding.
Of course, even if one of these hypotheses is true, it need not be the case that marginal dollars sent in the direction of businesses will go uninvested. But it makes you wonder.
By David Altig, senior vice president and research director at the Atlanta Fed
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November 06, 2008
Saving and taxes
I hope you will excuse me for trading in a bit of old news, but I’ve been thinking about a post by Greg Mankiw from last week. Titled “My Personal Work Incentives,” the item takes published details of the McCain and Obama tax proposals. The essence of the post was to point out how these details impact the return to working for higher-income individuals, assuming that a marginal dollar earned is a marginal dollar saved (for the children, of course):
“Let t1 be the combined income and payroll tax rate, t2 be the corporate tax rate, t3 be the dividend and capital gains tax rate, and t4 be the estate tax rate. And let r be the before-tax rate of return on corporate capital. Then one dollar I earn today will yield my kids:
“For my illustrative calculations, let me take r to be 10 percent and my remaining life expectancy T to be 35 years…
“Under the McCain plan, t1=.35, t2=.25, t3=.15, and t4=.15. In this case, a dollar earned today yields my kids $4.81. That is, even under the low-tax McCain plan, my incentive to work is cut by 83 percent compared to the situation without taxes.
“Under the Obama plan, t1=.43, t2=.35, t3=.2, and t4=.45. In this case, a dollar earned today yields my kids $1.85. That is, Obama's proposed tax hikes reduce my incentive to work by 62 percent compared to the McCain plan and by 93 percent compared to the no-tax scenario.”
Since the election is over, I trust that fact will keep the focus on the essential economic point, which is that tax policy does indeed affect incentives.
Which brings me to my point. Using Mankiw’s interest rate assumption, the present value of McCain’s $4.81 is $0.17 (which is implied directly by the 83 percent marginal tax rate). The comparable figure for Obama’s $1.85 is $0.07.
Mankiw’s point is that these sorts of numbers would substantially change his incentives to work. If the whole point is to leave a little nest egg for the kids, that is surely true, but there is another choice.
Here is another possibility: Suppose I forgo provisioning for the children altogether and simply consume that extra dollar of income. That way I avoid the corporate tax, dividend and capital gain tax, and the estate tax altogether. Under the McCain plan I get to enjoy $0.65 worth of extra consumption, or $0.57 worth under the Obama plan. I would have to value my children’s consumption an awful lot to trade $0.65 (or $0.57) of my own for $0.17 (or $0.07) of theirs.
As I think about this example, I am naturally drawn to the fact that savings rates in the United States are, in an historical context, pretty darn low.
There are almost certainly multiple reasons for the pattern shown in this chart. It would be tough to make the case that tax policy is the only culprit, but it would be equally tough to argue that it is irrelevant.
The distortion on saving from capital-income taxation could be eliminated, of course, by simply eliminating taxes on saving, but doing so would have exactly the sort of distributional consequences that account for a good deal of difference in the Obama and McCain tax plans in the first place. My training as an economist gives me no special expertise in determining how to value the trade-off between “fairness” and efficiency—and beware of any economist who pretends otherwise. But as you contemplate the distortions presented by your favorite tax proposal—a required step in any complete analysis—you might consider putting disincentives to save fairly high up on the list.
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September 11, 2008
Will automatic enrollment boost 401(k) savings?
In August the Congressional Budget Office updated its annual long-term projection for Social Security and noted that “future Social Security beneficiaries will receive larger benefits in retirement—and will have paid higher payroll taxes—than current beneficiaries do, even after adjustments have been made for inflation and even if the scheduled payments are reduced because the trust funds are exhausted. However, CBO estimates that “under both scenarios, those benefits will represent a smaller percentage of beneficiaries’ preretirement earnings than is the case now.”
Looking ahead, it seems certain future retirees will increasingly rely upon defined contribution 401(k)-type plans upon retirement. That means that millions of workers, with a wide range of preparation and financial literacy, are expected to make sophisticated investment decisions that will shape their future financial well-being. Policymakers are focusing greater attention on ways to increase worker participation in 401(k) type plans. The 2006 Pension Protection Act (PPA) included measures to increase contributions by creating safe harbor provisions that permit employers to offer automatic enrollment in 401k plans. For employers to qualify, contribution rates for those enrolled automatically must be at least 3 percent of salary the first year of participation, rising one percentage point per year to at least 6 percent in the fourth year.
These measures incorporate insights from behavioral economics that 401k default options have a tremendous impact on how much workers will ultimately save for retirement. In the new edited volume Lessons from Pension Reform in the Americas, Beshears, Choi, Laibson and Madrian examined the impact on worker savings when workers are automatically enrolled by their employers compared to when they must actively opt in to a retirement savings plan. They found that when automatic enrollment in retirement plans is the default option, participation rates are much higher than when workers have to opt-in. Furthermore, many workers view the employer default savings option as an implicit endorsement of both the contribution rate and the distribution of funds. They find that default choices are not neutral; they play an important role in every stage of the lifetime savings cycle, including savings plan participation, contributions, asset allocation, rollovers, and decumulation. Default options become even more crucial as defined contribution plans in the United States and the rest of the world introduce more investment options for workers.
Since the Pension Protection Act was just passed in 2006, it is still too soon to know what long-range impact it will have on retirement savings. However, a new paper by VanDerhei and Copeland models the results of automatic enrollment under PPA rules and finds that it will have a significant impact, especially for low-income workers. For the lowest-income quartile, total 401(k) balances would be only 0.1 times final earnings at age 65, compared to 2.5 to 4.5 final earnings (depending on the assumptions used) under automatic enrollment. For the top 25 percent of earners, the jump would be from 1.8 times final earnings to between 6.5 to 10.4 times final earnings.
These automatic enrollees will of course need to decide how to invest their 401(k) savings. Target-maturity date lifecycle funds, where participants select a fund based on a projected retirement date and fund managers rebalance the portfolio over time, offer one solution to problems arising from financial illiteracy, naïve portfolio diversification, and inertia. In a new working paper, Mitchell, Mottola, Utkus, and Yamaguchi find that lifecycle plans will have a more substantial impact if they are designed as the default option, with adoption rates being higher still if employers actively shift participants from existing portfolios to age-based lifecycle funds.
Automatic 401(k) enrollment and lifecycle funds can potentially boost retirement savings. The extent to which employers and workers will embrace these options from the 2006 Pension Protection Act is an open question, but the early signals are positive. At a May 2008 Employee Benefit Research Institute forum on the 2006 PPA, participants noted that an increasing number or employers, especially large ones, are adopting automatic enrollment.
By Stephen Kay, coordinator of Latin American analysis at the Atlanta Fed
Note: Macroblog will not feature postings on monetary policy issues during the Federal Open Market Committee meeting blackout period, which runs from the week before the FOMC meeting until the Friday after it. Also, David Altig, senior vice president and research director of the Atlanta Fed, will not post during this timeframe.
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August 19, 2008
Did the stimulus package actually stimulate?
One of the big questions of the policy season is surely “Did the $100 billion of tax rebates distributed to households in May, June, and July actually work?” “Work” in this case means “stimulate consumer spending.” You may want to sit down before I tell you this, but so far economists disagree. In one corner you have Christian Broda at the University of Chicago and Jonathan Parker at Northwestern University:
The Economic Stimulus Act of 2008 was aimed at increasing disposable income temporarily through tax rebates in the hope this would stimulate spending and end or at least mitigate the severity of a U.S. economic slowdown. We find that to a significant extent they succeeded. The stimulus payments are initially being spent at significant rates. These rates are slightly higher than those observed in 2001 when fiscal policy has been credited with helping end the 2001 recession.
Although press stories emphasizing that the rebates induced additional consumer spending were technically correct, they missed the important point that the spending rise was very small in comparison to the size of the tax rebates.
A recent, widely reported academic study by Christian Broda and Jonathan Parker showing that the rebates led to increased spending on nondurable items (like food and drugs) does not contradict the implication of the more comprehensive data—on national retail sales and total consumer spending—that the induced rise in consumer outlays was small relative to the size of the rebate.
Oh boy. Let’s back up a step. Before the fact, here is what people said they were planning to do with their rebates (by at least one report):
So what did the people receiving the rebates do with them? Well, if we could answer that one, it would be easy to resolve the Feldstein vs. Broda-Parker dispute. It does seem undeniable that a pretty good piece of those rebates was saved, at least in the first two months.
Can those elevated saving rates recorded in May and June reflect an outbreak of thriftiness? The real answer is “who knows?” but we can do a little back-of-the-envelope arithmetic to put things in perspective. Ignoring the Katrina-related dip in August 2005, the average saving rate from the beginning of 2005 through this past April was about 0.61 percent.
So, here’s the question: Assuming that consumers saved out of nonrebate income at the rate of 0.61 percent, how much would they have had to save out of the sums distributed in May and June to raise the overall saving rates to the observed values of 4.9 and 2.5 percent?
If you do the annualized calculation for the $43 billion of rebates in May and $28 billion in June you get some pretty striking numbers: An implied saving rate out of the rebates of somewhere in the neighborhood of 83 percent in May and 63 percent in June.
You can argue that there is a sense in which even these figures are understated. Durable goods purchases, for example, are theoretically a form of household saving, and the Broda-Parker survey respondents did indicate that about 20 percent of their rebates went toward the purchase of durables. However, if that is so durable expenditures without the tax rebates would have been really low. Though expenditures on durables grew at an annualized rate of 5.8 percent in May—not bad—they shrank by 17.4 percent in June.
These back-of-the-envelope calculations are pretty rough, of course, but they are broadly consistent with evidence from the 2001 tax rebates. That evidence also suggests that about one-third of the rebates were spent in the quarter following their disbursement, so the spending effects of this year’s model may yet have legs.
On the other hand, even if the rebates do prop up consumer spending in the short run, that would hardly settle the debate about whether they were the best way to spend $100 billion. But that’s a different debate for a different time.
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» Failure of the Stimulas Package from Newshoggers.com
By Fester: The point of a short term stimulus package is to encourage people to spend money. The reason is to kick-start demand because the problem is primarily seen as a short term crisis of confidence. An effective stimulus package [Read More]
Tracked on Aug 21, 2008 7:44:56 AM
June 21, 2007
Dark Matter By Any Other Name
... The United States miracle of the 1990s was that our productivity began growing faster than that of other countries, even though we were the richest to start with...
To explain the experience in the United States, one would have to believe that Americans have some better way of translating the new technology into productivity than other countries. And that is precisely what [London School of Economics] Professor [John] Van Reenen’s research suggests.
His paper “Americans Do I.T. Better: U.S. Multinationals and the Productivity Miracle,” (with Nick Bloom of Stanford University and Raffaella Sadun of the London School of Economics) looked at the experience of companies in Britain that were taken over by multinational companies with headquarters in other countries. They wanted to know if there was any evidence that the American genius with information technology transfers to locations outside the United States. If American companies turn computers into productivity better than anyone else, can businesses in Britain do the same when they are taken over by Americans?
And in the huge service sectors — financial services, retail trade, wholesale trade — they found compelling evidence of exactly that. American takeovers caused a tremendous productivity advantage over a non-American alternative.
When Americans take over a business in Britain, the business becomes significantly better at translating technology spending into productivity than a comparable business taken over by someone else. It is as if the invisible hand of the American marketplace were somehow passing along a secret handshake to these firms.
Sound familiar? If you can't quite put your finger on it, here's a refresher from Ricardo Hausmann and Federico Sturzenegger:
There is a large difference between our view of the US as a net creditor with assets of about 600 billion US dollars and BEA’s view of the US as a net debtor with total net debt of 2.5 trillion. We call the difference between these two equally arbitrary estimates dark matter, because it corresponds to assets that we know exist, since they generate revenue but cannot be seen (or, better said, cannot be properly measured)...
At least three factors account for the accumulation of dark matter. The first refers to foreign direct investment (FDI). Consider a simple example. Imagine the construction of EuroDisney at the cost of 100 million (the numbers are imaginary). Imagine also, for the sake of the argument that these resources were borrowed abroad at, say, a 5% rate of return. Once EuroDisney is in operation it yields 20 cents on the dollar. The investment generates a net income flow of 15 cents on the dollar but the BEA would say that the net foreign assets position would be equal to zero. We would say that EuroDisney in reality is not worth 100 million (what BEA would value it) but four times that (the capitalized value at our 5% rate of the 20 million per year that it earns). BEA is missing this and therefore grossly understates net assets. Why can EuroDisney earn such a return? Because the investment comes with a substantial amount of know-how, brand recognition, expertise, research and development and also with our good friends Mickey and Donald. This know-how is a source of dark matter. It explains why the US can earn more on its assets than it pays on its liabilities and why foreigners cannot do the same. We would say that the US exported 300 million in dark matter and is making a 5 percent return on it. The point is that in the accounting of FDI, the know-how than makes investments particularly productive is poorly accounted for.
That story might only go so far, as the Federal Reserve Bank of New York's Matthew Higgins, Thomas Klitgaard, and Cedric Tille claim...
... we review the argument that the United States holds large amounts of intangible assets not captured in the data—assets that would bring the true U.S. net investment position close to balance. We argue that intangible capital, while a relevant dimension of economic analysis, is unlikely to be substantial enough to alter the U.S. net liability position.
... but it's apparently more than a fairy tale.
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Tracked on Jun 22, 2007 12:46:50 AM
June 09, 2007
Like Ben Said
The trade deficit, ex-petroleum, appears to have peaked at about the same time as Mortgage Equity Withdrawal in the U.S.
"Interestingly, the change in U.S. home mortgage debt over the past half-century correlates significantly with our current account deficit. To be sure, correlation is not causation, and there have been many influences on both mortgage debt and the current account."
Alan Greenspan, Feb, 2005
... Declining MEW is one of the reasons I forecast the trade deficit to decline in '07. And a declining trade deficit also has possible implications for U.S. interest rates; as the trade deficit declines, rates may rise in the U.S. because foreign CBs will have less to invest in the U.S.. This is why I forecast rates to rise in '07.
I think that CR has the causation running from the housing market to the trade deficit, but as always there is another interpretation. I take you back to one of my favorite Fed speeches of all time, from the current Fed chairman:
What then accounts for the rapid increase in the U.S. current account deficit? My own preferred explanation focuses on what I see as the emergence of a global saving glut in the past eight to ten years...
The current account positions of the industrial countries adjusted endogenously to these changes in financial market conditions. I will focus here on the case of the United States, which bore the bulk of the adjustment...
After the stock-market decline that began in March 2000, new capital investment and thus the demand for financing waned around the world. Yet desired global saving remained strong. The textbook analysis suggests that, with desired saving outstripping desired investment, the real rate of interest should fall to equilibrate the market for global saving. Indeed, real interest rates have been relatively low in recent years, not only in the United States but also abroad. From a narrow U.S. perspective, these low long-term rates are puzzling; from a global perspective, they may be less so.
The weakening of new capital investment after the drop in equity prices did not much change the net effect of the global saving glut on the U.S. current account. The transmission mechanism changed, however, as low real interest rates rather than high stock prices became a principal cause of lower U.S. saving. In particular, during the past few years, the key asset-price effects of the global saving glut appear to have occurred in the market for residential investment, as low mortgage rates have supported record levels of home construction and strong gains in housing prices. Indeed, increases in home values, together with a stock-market recovery that began in 2003, have recently returned the wealth-to-income ratio of U.S. households to 5.4, not far from its peak value of 6.2 in 1999 and above its long-run (1960-2003) average of 4.8. The expansion of U.S. housing wealth, much of it easily accessible to households through cash-out refinancing and home equity lines of credit, has kept the U.S. national saving rate low--and indeed, together with the significant worsening of the federal budget outlook, helped to drive it lower...
The direct implication, of course, was that the reversal of U.S. current account deficits would likely be associated with higher real interest rates, a weakening of foreign-capital financed investment, and higher saving in the U.S. (of which a slowdown in mortgage equity withdrawals could be a part). It is worht noting that Chairman Bernanke was decidedly less than sanguine about the consequences of such adjustments:
... in the long run, productivity gains are more likely to be driven by nonresidential investment, such as business purchases of new machines. The greater the extent to which capital inflows act to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt is likely to be.
Whether or not Mr. Bernanke believes that we find ourselves in the process of meeting those burdens I cannot say. But those who buy the global saving glut story -- as I do -- have acknowledged all along that the day of adjustment would look pretty much like it does at the moment.
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Tracked on Jun 23, 2007 5:39:32 AM
April 26, 2007
A Credit Crunch It's Not
It does appear that Wall Street is pretty happy with the way the world looks this week. U.S. macroeconomic data is only part of that picture, of course, but to the extent that it is I think Dean Baker makes good sense:
The Commerce Department's data did show better than expected durable good orders in March, but this was following very weak reports in January and February. Year over year, durable good orders are still down by more than 3 percent in nominal terms... Against a backdrop of serious weakness, a better than expected month is always good news, but it seems a bit excessive to make too much of this very erratic data.
The other cause for celebration was a 22,000 increase in the rate of new home sales in March, measured against a downwardly revised February level. The basis for the celebration here escapes me. The consensus forecast was for a considerably larger bounceback from the weak February level. Even with the uptick, March sales were the slowest since the recession, excluding February. And the small uptick was almost certainly driven by weather...
After years of piling debt on their homes, Americans are becoming more cautious about using them as a piggy bank.
A cooling housing market and higher interest rates have made homeowners more reluctant to tap the equity they may have built up in their residences...
Now, the slowdown in home-equity borrowing is leading to weaker sales in some markets for autos, building materials and electronics, says Mark Zandi, chief economist of Economy.com.
Barry Ritholtz sounds off on that last theme, and Calculated Risk is beginning to worry about a consumer-led recession. So why would I feel encouraged? The WSJ article continues:
Lenders are responding to slowing demand for home-equity borrowing by boosting their marketing, unveiling special offers and focusing on traditional uses of home equity, such as home improvement and debt consolidation. Wells Fargo this week rolled out a "Home Improvement Program" that gives home-equity customers discounts at retailers such as Best Buy, Brookstone and LampsPlus.com and access to a network of third-party local contractors.
J.P. Morgan Chase & Co. is running its first cable-television advertising campaign for home-equity borrowing, focusing on the product's flexibility. It's also rolling out a training program designed to help bankers in Chase branches do a better job of selling home-equity products. Bank of America, has launched a "green" home-equity card program, in which the bank will make a $100 donation to environmental group Conservation International on behalf of new home-equity customers who use their equity-line Visa card for purchases of $2,500 or more.
In my view, the biggest threat from housing-sector woes has all along been the possibility of spillovers into credit markets -- the kind that can restrain economic activity even after consumers and businesses shake off some of the caution that the stress of uncertainty inevitably brings. Several posts back I offered the opinion that a lack of available credit does not seem to be the driving factor behind weak growth in business investment. Today's story suggests that the same may be true of consumers. And that may just be the difference between a soft patch and downright ugliness.
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April 12, 2007
Capital Spending Concerns On The Chart With A Bullet
Barry Ritholtz said it yesterday...
It is increasingly apparent from the many economic signals we have seen that business spending is fading, and is unlikely to replace consumer spending anytime soon. This is one of the reasons are recession expectations keep ticking higher, beyond 50%.
... and in an article dated tomorrow but posted online today, the Wall Street Journal reports that its own survey of economists reveals a similar concern, if not quite the same degree of pessimism:
Weakness in business capital spending is edging out housing as the dark cloud on the U.S. economic horizon.
A new WSJ.com survey found that 20 of 54 economic forecasters responding to a query cited soft capital spending as the chief risk to their forecast that the U.S. economy will grow slowly but avoid recession this year.
It is pretty clear from whence the worry comes:
The Commerce Department says overall business investment fell an inflation-adjusted 3.1% in the fourth quarter, the first drop since early 2003. And government measures of orders for and shipments of capital goods so far this year have been unexpectedly weak...
The Fed, in minutes of its March meeting released this week, said that "financing conditions and other fundamentals remained favorable for a pickup in capital spending."
But the current softness comes as a surprise to many analysts. Indeed, the Fed minutes noted, "Investment in goods and services other than transportation and high-tech equipment softened more than fundamentals had suggested."
The consensus, however, remains on the side of continued expansion:
Economists responding to the WSJ.com survey were slightly gloomier about the prospects for the U.S. economy than they were a month ago. On average, they now estimate the economy grew at a 2% annual rate in the first quarter, down from the 2.3% estimate they made in March. They predict the economy will grow at a 2.2% pace in the current quarter and pick up momentum in the second half...
On the whole, economists see limited risk of recession over the next 12 months, putting the probability at 26%, near the same level of risk they've forecast since last summer. When asked to identify the one economic indicator they would watch to determine if the economy will slip into recession, 23 of 58 named the Labor Department's monthly employment report...
Although I think Barry was correct in his warnings to not get carried away with the March employment report, the jobs picture is still the best reason to stay calm.
UPDATE: Not surprisingly, The Big Picture notices this story too. Mr Ritholtz, however, seems to think tight monetary policy is the root cause:
When your growth is dependent upon cheap money and easy credit, guess what happens when credit tightens and money becomes less easy?
I don't know about that take -- "money" doesn't seem to me to be the problem. I'd worry about something more fundamental being afoot.
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March 20, 2007
Where The Risk Is
And so it appears that the moment of truth is near, when we will finally see beyond the immediate fate of the housing market and determine the magnitude of the collateral damage (no pun intended). I think that there is a consensus that, if the worst is to come, some sort of substantial disruption to financial markets will be in the middle of it all. Nouriel Roubini covers about every inch of territory you can on this theme, even managing to juxtapose Alan Greenspan and Ben Bernanke with foreign-policy neo-conservatives. In somewhat more measured tones, Kash Mansori and Calculated Risk have begun to fret about the potential for spillover into the commercial banking sector. Says Kash:
In my previous post I explained why I think that the quantity of bad mortgages in the US economy may actually be enough to significantly affect the non-performance and write-off rates for the US banking system as a whole. Yesterday, Calculated Risk followed this up with a discussion of why he thinks that the health of commercial real estate loan portfolios may soon suffer the same fate that residential loan portfolios are currently experiencing.
Some of that is not speculation, as this story from own neck of the woods so clearly shows:
The quaking U.S. market for subprime mortgage loans is rattling National City Corp. too.
The parent of National City Bank of Pennsylvania has decided it won't try to sell $1.6 billion in subprime loans after all, due to "adverse market conditions," National City said in a securities filing Thursday. The loans "are currently not saleable at what management considers an acceptable price," the bank said.
Instead, Cleveland-based National City took a write-down of $11 million in February, and sometime this month will return to its portfolio the loans it had intended to sell. "A further write-down is likely," the filing said. Spokeswoman Kristen Adams would not elaborate...
Additionally, National City expects to add "on the order of $50 million" to its reserves for possible loan losses, the filing said.
But here's how the story ends:
National City shares closed yesterday at $35.99, up 30 cents.
Hmm. Frankly, I just don't think the traditional banking sector is where be the dragons. Instead, I worry about the answers to three questions: 1. Will a growing perception of risk begin to choke off lending to investment projects that are otherwise economically viable? 2. Will a growing perception of risk cause businesses to forgo or defer an increasingly large quantity of investment projects? 3. Have hedge funds, private equity funds, and specialty financial corporations become such important parts of the credit channel that there is scant relief to be found from a relatively unscathed traditional banking sector?
To question 1, we have this, from Bloomberg:
Risk premiums on investment-grade corporate bonds are at their highest level in more than three months on concern rising delinquencies by subprime borrowers will slow the U.S. economy...
"This period of volatility is likely to continue as long as there is divided opinion about the magnitude and resulting financial impact of the subprime problem,'' said Edward Marrinan, head of North American credit strategy at JPMorgan Chase & Co. in New York. "Subprime risks and accompanying fears of a spillover into the broader consumer sector are the catalysts for the heightened volatility currently exhibited by all risky asset classes,'' he said in an interview...
The 7-basis-point increase in investment-grade spreads is the index's worst three-week performance since the period ending May 20, 2005, Merrill data show. The increase means a company would pay $70,000 more in annual interest for every $100 million borrowed.
We might hold on to the belief that firms are partially insulated from rising borrowing costs (or restrictions on loan availability) due to the fact the corporate cash-flow to investment ratio remains relatively high...
... but there are two problems with seeking shelter in that picture. First, we have data only through the third quarter of 2006, which is pretty stale information at this point. Second, and more importantly, a high cash-flow to investment ratio may itself be a symptom of business's unwillingness to commit to fixed investment spending.
To question number 3, I have no idea what the answer is. And I wish I did.
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March 19, 2007
Are We Panicking Just A Bit Too Soon?
If there was any doubt about it before, that groaning sound from the residential housing market definitely has our attention now. A woefully incomplete list of blogger commentary from the past several days would include items at Alpha.Sources blog (here, with some international perspective here), at Angry Bear, at Beat the Press, at The Big Picture, at Bizzy Blog, at Brad DeLong's, at Daniel Gross, at Economic Dreams - Economic Nightmares (here and here), at Economics Unbound, at Economist's View (here and here), at Euro Intelligence, at Felix Salmon, at The Housing Bubble Blog (here and here), at Mish's Global Economic Trends Analysis, at the Skeptical Speculator, and at The Street Light. I won't even bother to list individual items from Calculated Risk or Nouriel Roubini. Just head on over and start reading.
In the midst of this, let me make one brief plea for a little perspective: It might be good to remember that this was not entirely unexpected. Since at least summer I have been giving "economic outlook" speeches with the same basic message: Weakness in the residential housing market will continue for some time -- the bottom in prices seems unlikely until at least mid-year. Adjustments of this sort are never easy, there will be some pain, and probably a disruption in the pace of economic expansion as things sort themselves out. The punch line is always something like, "but things do sort themselves out, and there is no reason to expect that the economy will fail to return to a normal pace of growth after a sluggish quarter or two."
Anything yet make that projection look wrong? Not within my confidence intervals. Forecasters, economic pundits, and other human beings are congenital slaves to the latest surprises in the data, so confidence has ebbed and flowed and ebbed again as the news has surprised to the downside, to the upside, and back again. But would anyone really want to argue that we aren't in the neighborhood of where most informed observers thought we would be about now?
Trouble, of course, often looks worse when it arrives than it did when we were merely contemplating its arrival. It is understandable that we feel a little wobbly now that the shake-out among certain mortgage lenders is here at last. And there are parts of the "soft-landing" scenario that look a bit tenuous at the moment -- I would put the worrisome signs of weakening business investment expenditures, emphasized by pgl at Angry Bear and Jim Hamilton at Econbrowser, at the top of my list. But for the time being, I'm going to go easy on the panic button.
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