Armed Robbery with a Loaded Fountain Pen

An article today in the front page of the Sacramento Bee's business section quotes a director of a community development fund it works in low income neighborhoods on the subprime crisis: "I want to know how many people are going to jail."

At the same time, Jeffrey Skilling, late of Enron, judging from what I read in the papers, seems to have a shot at getting out of jail.

I do not know much about the risk that JPMorgan Chase is taking on over and above the first billion dollars. But if the Bear Stearns bailout is not a gift to JPMorgan Chase, then it is certainly very charitable towards the people who let money to Bear Stearns. Were they widows and orphans?

Who is going to jail?

Employment Recessions.

Awhile back, there was a lot of controversy about whether or not the U.S. is in a "recession" at present. Officially, we're not (as far as we know) while most economists now seem to think that the current period will be likely to be dubbed a recession when the NBER gets around to it. Most of the non-economists seem to thin we're in one.

One generally-ignored dimension concerns the actual definition of a "recession." The "official" definition of a "recession" comes from the very-mainstream National Bureau of Economic Research's Business Cycle Dating committee. Journalists summarize their (relatively complex) definition by saying that having real GDP fall during two or more quarters in a row defines a recession.

The problem with these definitions -- especially the journalistic one -- is that the emphasis is totally on production sold through the market. That's what GDP is all about, and no more. This might be thought of as a totally capitalist definition of a recession.

Most workers, on the other hand, instead care about the growth of paid employment, i.e., the availability of jobs. So I decided to find "employment recessions" in the U.S. since World War II. As I define these animals, these are quarters where employment figures fall for two or more quarters in a row.

This is like the standard journalistic definition of a recession in terms of ease of calculation. The the NBER one is so hard to calculate. That version also reflects employment measures, I believe. My version also coincides with the common or "oral tradition" idea of a growth recession, in which GDP growth slows but does not turn negative, hurting employment.

I added one adjustment: the fall of employment is measured relative to the trend growth in employment in order to get a sense of the cycle, not the trend. (The trend rate has been falling over the decades, but that's another topic.)

Below, I listed "employment recessions." But let's jump to my conclusions:

1) There are several employment recessions that do not coincide with NBER recessions: in 1951/2, late 1959, late 1962, and early 1986. Somehow these receive much less press than the official ones do.

2) Employment recessions often begin before NBER recessions: in early 1957, late 1979, early 1981, early 1990, late 2000.

3) Employment recessions almost always end after NBER ones. The exception was in 1980. (It's possible that President Carter, who was running for re-election, begged Volcker to cease and desist.) This problem has gotten worse, with the "jobless recoveries" that followed the two Bush recessions that have occurred so far.

4) We're already in an employment recession, starting in the fourth quarter of 2006.

Here's The Complete List. Since 1951, we get the following "employment recessions" listed by year/quarter: dated by start and finish. In each of these quarters employment fell relative to trend growth, either preceded by or followed by another fall in employment relative to the trend. Note: the measures do not indicate the _depth_ of the employment recession, only its length.

1951/3 - 1952/3 -- does not coincide with an NBER recession.

1953/2 - 1954/4 -- coincides with an NBER recession, but ends two quarters after it.

1957/1 - 1958/3 -- begins 2 quarters before the NBER recession, while ending one quarter after it.

1959/3 - 1959/4 -- does not coincide with an NBER recession.

1960/2 - 1961/2 -- coincides with an NBER recession, but ends one quarter after it.

1962/3 - 1963/1 -- does not coincide with an NBER recession.

1969/4 - 1971/3 -- coincides with an NBER recession, but ends three quarters after it.

1973/4 - 1975/2 -- coincides with an NBER recession but starts one quarter after it and ends one quarter after it.

1979/4 - 1980/3 - coincides with an NBER recession but starts one quarter before it.

1981/1 - 1983/1 - starts 2 quarters before the NBER recession and ends 1 quarter after it.

1986/1 - 1986/2 -- does not coincide with an NBER recession.

1990/2 - 1992/4 -- starts 1 quarter before the NBER recession and ends 1 3/4 year after it. This is Bush the Father's famous "jobless recovery."

2000/3 - 2004/1 -- this one starts 2 quarters before the NBER one and ends 2 1/4 years after it. This is Bush the Son's repeat of the "jobless recovery." He outdid his father's example.

2006/4 - present. So far, it does not coincide with an official NBER recession.

Jim Devine

Humorous, but Insightful Take on the Economy

I usually do not appreciate when people send me a video clips. This one was an exception. It takes about 10 seconds before the humor becomes apparent. Please do not get impatient if you watch it, because, besides being humorous it is an interesting commentary on the economy.

Tiny Margins, Mega Leverage

Two trends have dominated financial markets in recent decades. First, there is an arms race going on in instruments and trading algorithms. Math jocks are going braino-a-braino to devise increasingly sophisticated strategies, to the point where even specialists are unsure how to value portfolios. At the same time, there has been an escalation of leverage; unregulated investment funds are lending to the tune of 30 or more times their equity base. Maybe these developments are related.



The current argument is that over-the-top leveraging is the consequence of a regulatory breakdown, and there is certainly truth to the extent that the failure of oversight has enabled investment banks and hedge funds to do whatever they want — but why did they want to extend themselves so far?

Here is one possibility: the new math-intensive strategies are chasing tiny margins. The trading programs are designed to perceive opportunities for arbitrage a nanosecond before anyone else, taking advantage of the slightest misalignment of related prices. We have also witnessed ever more elaborate strategies involving complex tradeoffs between risk and return to create composite positions whose alpha is perceived to be a shade higher in relation to its beta.

The profit margins on these strategies are minuscule, but if everything goes as programmed, predictable. This means that they can be turned into respectable earnings only through intense leverage. By investing in positions at the rate of 3000% of capital, you turn 1% annualized margins (which correspond to much smaller margins on any given trade) into 30%. And the geniuses who devise these opaque instruments tell you that the risk is small relative to the return.

What the risk jockeys always seem to miss is that estimates of portfolio risk depend on covariances among the individual elements, and these in turn are determined by the structural properties of the system in question. And no one can know what they are, because the system is too complex, there are too few data points, and the structure keeps changing. So the models work, trade after trade, until there is an unforeseen systemic event, after which all hell breaks loose.

Then the high degree of leverage, which was necessary to make the strategy pay sufficient dividends, magnifies the risk instead of the return.

If this analysis is correct, it suggests that putting a ceiling on leverage may also slow down the drive toward unfathomable financial complexity. That would be a good thing, and not just for us dummies.

Bush says "Normalcy" Returns to Iraq

Using that famous neologism of Warren G. Harding, President Bush has declared that "normalcy" has returned to Iraq. Indeed, he is right. The recent period of low conflict and violence, claimed to be due to the surge by many, has now reverted to the more "normal" pattern of greater conflict and violence that we have seen over the last five years. The question arises: why on earth is the US supporting this attack by the al-Maliki government on the followers of Moqtada al-Sadr, whose long-in-place truce has been credited by most with being a major factor in the lowered level of violence?

Juan Cole claims it is that ragamuffin madman Cheney again, whispering in al-Maliki's ear that since the Iraqis have agreed to have serious provincial eletions this fall so that the Sunnis of violent Diyala Province can get rid of their Shi'i government, al-Maliki should take the Sadrists down in Basra so that they do not take over the government there, Iraq's second largest city, and its main export point for oil. Control of oil revenues are clearly a key in this. Of course the part of this that is a big lie has been the claim that the Sadrists are allies of Iran rather than al-Maliki and his ally, al-Hakim. In fact, it is al-Hakim, leader of Iraq's largest party, whose Badr Corps militia has reputedly been the largest recipient of Iranian military aid, and who spent most of the Saddam years in Tehran, whereas al-Sadr, the nationalist, never was in Tehran ever. But, he opposes US troops being in Iraq. So, the US must have lots of troops in Iraq so that we can help defeat those who do not want us to have troops in Iraq, and so that the truly close allies of Iran can remain in control, especially of all the oil revenues from the exports out of Basra.

My New Ambition

I have been teaching for almost 40 years at a modest, but comfortable salary. I have been thinking that I should figure out a way to lose a few billion dollars so that I can get rewarded with a few million for my efforts.

If anybody wants to contribute to my new career, please send me your checks ASAP. Get in on the ground floor.

I Was Right About Iraq

Given the flurry of commentary on the anniversary of our invasion of Iraq and the reaching of the 4000-dead-US-soldiers milestone by people who were wrong about Iraq, my egomania pushes me to point out how right I was. I was not blogging then, but on the day that Tikrit fell, the end of any semblance of the Saddam regime and just when the first looting began in Baghdad, a point more than any other when it looked like the US had "won," I wrote a column that was published about a week later in our very conservative local paper, the Harrisonburg Daily News-Record. I made six forecasts, three "positive," three "negative." All have proven to be correct. I did not forecast the nature of the future Iraqi government, nor did I forecast that there would be an insurgency nor how serious it would be. My forecasts, and brief commentary.

The "positives"
1) Saddam would no longer violate anybody's human rights (I did not foresee that US troops would be engaging in torture subsequently).
2) US troops in Saudi Arabia to oversee the no-fly zones could be removed, thereby removing one of Osama bin Laden's leading propaganda tools (more than offset by the length and severity of our occupation of Iraq).
3) That whatever regime would come to power in Iraq, the ending of economic sanctions would be a positive (more than offset by the negative impact of the insurgency on the Iraqi economy).

The "negatives:
1) Women's rights would be reduced (Laura Bush likes to say they are enhanced, but women must wear veils and stay at home in a majority of Iraq, although not in the Kurdish-ruled areas; there they may be better off, my only possible mistake here).
2) Christians would be persecuted (about half the Christian population of Iraq, some of which has been there for nearly 2000 years, has left the country).
3) The invasion would serve as a recruiting tool for al Qaeda, in my mind the most important and overwhelming of all these. Indeed, the fact that there was no al Qaeda in Iraq before the invasion but it is now the US's worst enemy there proves this. Indeed, the only reason they have for existing is our presence there. If we pulled our troops out, they would be reduced to near zero very soon thereafter, another forecast from me!

Social Security Looking in Better Shape

The Social Security Trustees released their annual report today. Even though Bush has appointed people like Andrew Biggs of Cato, a confirmed privatizer and hysterian, to be Deputy Director during a Congressional recess, the current report moves to a somewhat more reasonable and less hysterical position. It is available at
http://www.ssa.gov/OACT/TR/TR08/tr08.pdf.

The inimitable and careful Bruce Webb has pointed out to me personally that even though they are still projecting by their intermediate projections program exhaustion in 2041, the consequences and longer run gaps are now reduced. So, the projected 75-year deficit is now to be 1.70 percent of taxable payroll rather than 1.95%, a decline of 0.25% and total actuarial deficit over 75 years is now supposed to be $4.3 trillion rather than $4.7 trillion, down $400 billion. Also, if the system were to go "bankrupt" in 2041, the payments would be cut to 78% of then existing receipts rather than 75% (this number was 71% back when Bush gave his doom scenario in his SOTU speech in 2005 when he made his push to "reform" SS). So, bit by bit, the reality that social security is really not in such bad shape is creeping in.

Capital on the Runway

Readers of the latest missive from Brad Setser may not realize the full implications of his numbers, so we will do the math here. Brad crunches the latest Treasury International Capital (TIC) survey from our friends at the US Treasury Department, adds some other sources, and comes up with the estimate that central banks and sovereign funds pumped over $100B back into the US financial system during the month of January. He worries about the apparent shift away from agencies — our public creditors are reluctant to prop up our crumbling housing sector — but I worry about the implication for private capital flows.



The most recent estimate for last year’s current account deficit is around $740B. To make things simple, assume it remains the same this year. (Recession at home will push it down; recession abroad, if it begins to happen, and oil prices, if they remain higher, will push it up.) If the January rate of official finance continues, it would stand at more than $1200B for the year. The difference, $460B would represent net private capital outflows from the US. If this isn’t capital flight, it’s at least a pretty substantial exodus. My instincts tell me that a full-bore capital flight is the big risk lurking in the shadows. What is the cutoff point between where we are today and a dollar crisis? The answer is, a rate of private outflow that central banks are unable or unwilling to offset. And how much is that?

We are conducting a global experiment right now to find out.

DEPRESSION ,YOU SAY?

by the Sandwichman

Nothing restores a sandwichman's optimism like a pep talk from "economists" about how they've arranged things so there can't be "another depression like the 1930s"!

Case in point: an article by Charles Duhigg in the New York Times today assures readers that economists say "the odds of a full-blown depression are almost nonexistent."

Why? "incomes are more stable. Many more Americans hold jobs in service sectors, like medicine or education. And more Americans work for the government, which is less inclined to fire people just because the economy turns gloomy."

"Moreover, there are safety nets that can be traced to the Great Depression, like Social Security, unemployment benefits, food stamp programs..."

"Today, we have a lot more flexibility and we can prop up banks and the economy to give us enough time to let things stabilize..."

"... whatever name economists give the current downturn, we are unlikely to see the bread lines, shantytowns and dust bowl of the Great Depression. More likely, these economists say, would be a sudden increase in the number of people selling belongings on eBay."

For sure there won't be another depression like the 1930s. There also will not be another war like World War I or even World War II. But there already is the Iraq War and there already is homelessness, "foodbanks" and social economic exclusion. No breadlines? What about the ones that have been there throughout the boom years? Are they going to abolish those? How long those folks "selling their belongings on eBay" will have to wait for a free terminal at the public library is another question.

The public policy priority of the last 35 years has been to whittle away at the "safety nets", both regulatory and personal security. I see nothing in the NYT article about recent enthusiasm for "reforming" Social Security. Is that because those reform proposals relied on perpetually rising financial markets? Let me get this straight: Social Security, which a few years ago was headed for "bankruptcy", is the safety net that will spare the economy from the consequences of the credit crunch. Could you explain the logic again S L O W L Y, please, Mr. Duhigg?

In a word, ladies and gentlemen, BULLSHIT! Another thing that has changed since the 1930s is the carefully-orchestrated refusal to entertain progressive policy responses to emerging economic
difficulties. And economists have been at the forefront of the neoliberal gatekeeping. Policy ideas have to pass through the wringer of the market-friendly test. The result: wasteful bloat-is-growth policies that enrich the wealthiest and leave the rest to stagnate.

On cue, all the hacks and charlatans who have been clapping and chanting, "FREE MARKETS! FREE MARKETS!" will continue clapping and but begin chanting, "GOVERNMENT SAFETY NETS! GOVERNMENT REGULATIONS!" And all will be well, children.

Swift Boating Obama: Can Hillary Still Get the Nomination?

So, the Right Wing has decided to ignore the jab at them in his eloquent speech about endlessly showing clips of Rev. Wright's more egregious moments. Last night I saw Hannity complaining that efforts by Obama to talk about Iraq, the economy, health care, or how the State Department has illegally raided his passport file to be "efforts to distract us from his problems with Reverend Wright," accompanied of course by yet more playing of the obnoxious clips. They seem to have found that this is a chink in Obama's armor that is open and that they can use to swift boat him down to defeat by endless repetition, along with distorted interpretations of his speech.

As for Hillary, the key will not be how she does in upcoming primaries (although losing in PA would really shut her down immediately), but how she stacks up against Obama in the head-to-head polls of each against McCain. As of last weekend, for the first time ever, she was doing better than Obama against McCain. If that develops to be a consistent pattern, then those superdelegates, most of them Dem officeholders worrying about reelection, might well surge to Hillary, her only chance. However, as of yesterday, the most recent Rasmusen tracking poll had McCain slaughtering both of them, but Hillary a bit worse: McCain 51% Hillary 41%, McCain 49% Obama 42%. Ugh.

Financial Markets Getting Really Weird: Negative Nominal Interest Rates

Textbooks and most theoretical papers tell us that zero is the floor on nominal interest rates. But news reports in the last few days, noted by both Paul Krugman and Brad DeLong, have announced that some repurchase agreements in New York have had negative nominal interest rates attached to them, parties paying to lend money to others. This seems to be tied to very low short term rates on US Treasury bills, barely above zero, pushed down by TED risk spread so that one month bill rates are about 2% below the 2.25 overnight federal funds rate, which is private interbank loans. Negative nominal rates were last seen in the US on repos when the ffr was at 1%, especially during August to November, 2003, as reported in a paper by Michael J. Fleming and Kenneth Garbade in the April, 2004 Current Issues in Economics and Finance, of the New York Federal Reserve Bank.

It is not just the occasional repos that have had negative nominal interest rates. Barrons in 2006 has reported on a curious financial instrument issued by Berkshire-Hathaway known as "squarz." These have had negative nominal rates on them. Also, in 1998 for a brief period very short term government securities in Japan had negative nominal interest rates, during the pit of their deflation, as reported in the Monetary Trends column of Daniel Thornton from the St. Louis Fed in January, 1999. And, finally, although this has never been reported in print, I was personally told by the individual who handled dealings between the Fed and Freddie Mac that on Dec. 31, 1986, the last day of the old tax code before the Reagan simplification, when many were trying to close a lot of deals, the federal funds rate itself briefly went into negative territory down to about - 1/2 percent, although it also soared as high as about 18% on that rather wild ride of a day. In any case, things are getting weirder and weirder in the current frenzy of the financial markets.

The Iranian Majlis election

Commentary has been muffled on the important Iranian parliamentary (Majlis) election. Most reports have said that Ahmadinejad's group, the Principalists, won and "reformers" lost, but with warnings of splits in the Principalists over economic issues. This is essentially correct, although things are more complicated. First, the pro-reform Khatami group appears to have gained seats from about 30 to about 50 (out of 290), despite being limited by the Council of Guardians to only running 120 total (and the Rafsanjani group did not run at all), see http://news.bbc.co.uk/2/middle_east/7299733.stm. The Principalists are reported to have gotten 71% of the seats, http://www2.irna.ir/en/news/view/line-24/0803166580104449.htm,
however a substantial block of these are "reformist" or "pragmatic" conservatives who are critical of Ahmadinejad on economic policy.

Most of the little commentary in the West has been scary, that Ahmadinejad has been backed. But the real subtext is the domination by Supreme Jurisprudent Ali Khamene'i, who encouraged the pragmatic conservatives while blocking the Khatami group, with the somewhat moderate former nuclear negotiator, Ali Larijani winning big in Qom, and poised to become Speaker of the Assembly. The key point is that Khamene'i has been very clear in supporting a civilian nuclear power program while opposing a military one, just what the US NIE reported this past fall. Thus, while many in the US do not like these guys, there is every reason to believe that they are not pursuing nuclear weapons, the underpinning of the Bush approach to Iran (and apparently that of McCain as well, who has just bizarrely announced that Iran has been training and supporting al Qaeda in Iraq, on which point Joe Lieberman had to correct him by whispering in his ear).