Bankers Who Can’t Live Without Multi-Million Salaries

J.P. Morgan was a bit sloppy in their salary offer to Kai Herbert:

The original contract said Herbert’s annual pay would be 24 million rand ($3.1 million). JPMorgan blamed the mistake on a typographical error and said the figure should have been 2.4 million rand, according to court documents.

Herbert is now suing after he realized that he’d make a mere $300,000 a year. As the attorney for J. P. Morgan noted:

How can you possibly suggest that they would pay you so much money for an executive director level job?

This strange story alludes to this lawsuit:

More than 100 bankers claim Commerzbank AG broke a pledge by Dresdner Bank, which it bought in 2009, to set aside about $516 million for bonuses and are asking a U.K. court this week to order that they be paid. In the trial, scheduled to begin Jan. 25 in London, the former Dresdner bankers seek about 50 million euros ($64.5 million), with individual payouts of as much as 2 million euros ... Commerzbank bought Dresdner in January 2009, even though it was forced to seek an 18.2 billion-euro bailout from Germany during the credit crunch. A month after the deal was struck, Blessing had to defend the acquisition when Dresdner posted a full-year loss of $8 billion.

During the Great Recession, these bankers insist they are entitled to 7-figure compensation!

The Lovins Paradox: "this old canard"

Amory Lovins has responded to David Owen's commentary at the New York Times on "Efficiency’s Promise: Too Good to Be True." In his Times comment, Lovins cites his complete response at the Rocky Mountain Institute blog, wherein he asserts: "There is a very large professional literature on energy rebound, refreshed about every decade as someone rediscovers and popularizes this old canard."

Now, "this old canard" -- the Jevons Paradox -- is based explicitly on an even older canard the Sandwichman has dubbed the "Rasbotham rebound", the truism opposite to the so-called lump-of-labor fallacy. Although he may not be aware of it, in trivializing the Jevons Paradox, Lovins is implicitly trivializing the Rasbotham rebound as well. So, in effect (as many economists would claim) he is embracing the lump-of-labor fallacy. You cannot categorically reject both the Jevons Paradox and the lump-of-labor fallacy because the two are diametrically opposing principles. If "A" is absolutely false, then "B" is absolutely true. However is "B" is absolutely false, then "A" is absolutely true.

There is, however, a third possibility, which is that both "A" and "B" are only conditionally true. They are true in some circumstances but false in others. In that case, their relative importance vis a vis each other can only be gauged in context. It is not sufficient to find circumstances where "A" is true and other circumstances where "B" is false. One must examine the relationship between "A" and "B" in a given circumstance. Or -- to bring it back to the language of energy efficiency, energy consumption and employment -- one must look specifically at the energy intensity of employment, not the energy intensity of GDP or the micro-level effects of energy efficient light bulbs on the demand for lighting.

The Lovins Paradox thus can be stated as: even if Amory Lovins is right about the Jevons Paradox (or rebound effect) being an "old canard", the implications for energy consumption are troubling because of the intricate linkage between energy consumption and employment. In other words, dispensing with the rebound still leaves us with what David Owen calls The Conundrum (see video embedded below). The following chart compares the energy intensity of GDP in the U.S. with the energy intensity of employment (energy consumption per worker). The green line shows the index Lovins likes to cite, energy intensity of GDP from 1949 to 2009. The blue line shows energy intensity of employment in the U.S. for the same period. The red line shows the energy intensity of the labor force (because employment data is not available) for the world from 1980 to 2006.

Sources: World Bank, U.S. Bureau of Labor Statistics, U.S. Energy Information Agency

World energy intensity of employment in 2006 was around five percent higher in 2006 than it was in 1980. This is not an improvement, not even a relative improvement.

Bankrupt Rhetoric

I woke up this morning to Paul Ryan, describing his budget proposal, as quoted in the New York Times: “This is about putting an end to empty promises from a bankrupt government.”

Bankrupt government?  Let’s consider this more closely.  The normal meaning of bankrupt is negative net worth, as when your liabilities exceed your assets.  By this standard, the US government is hardly bankrupt, since it has enormous hard assets and an even larger soft one, the legal right to tax the income, transactions and property of all individuals and organizations subject to US law.  We should all be so bankrupt!

So I guess Ryan is not using the normal business meaning of the word.  Perhaps for him bankrupt means having negative earnings over some period of time.  Here is the federal government’s fiscal record since 1929:

So during what periods has the federal government been “bankrupt”?  During every year when outlays exceeded revenues?  That would include nearly all of modern history since the 1960s.  Or when the fiscal deficit exceeded, say, 5% of GDP?  That’s a smaller time frame—basically the past few years since the financial crisis hit and WWII.  But if the government is bankrupt now, how bankrupt was it in the days of FDR and the struggle against Germany and Japan?  And what does it mean to be bankrupt if the US could be really, really bankrupt in the 1940s and then bounce back to fiscal health almost immediately as soon as the troops came home?

And if the US government is bankrupt today, how come it can raise money at approximately a zero real interest rate?

And on a philosophical level, how does Ryan measure the financial health of government when its purpose is not to make itself rich but to support the prosperity of everyone else?

My translation of the way Ryan uses the word “bankrupt” would be “I want to scare everyone about the current fiscal deficit, and the best way to do it is to use a business-sounding term that has no meaning at all in this situation and hope that the public, and especially the journalists, are too dumb to notice.” 

What Did He Say?

The Los Angeles Times has an article about a campaign to get Pete Seeger, now a vibrant 92 years old, back on the Billboard charts.  (Hat tip An Overgrown Path.)  Toward the end I stumbled onto

Arlo Guthrie, at a tour stop in Oklahoma City, Okla., last week on his way to a centennial concert salute to his father, said he had recently invited Seeger, with whom he toured on and off for three decades, to join him for a show, but Seeger declined. 

“Pete said, ‘Arlo, I can’t play as well as I used to play, and I can’t sing as well as I used to sing,’” Guthrie told the audience. “I said, ‘Pete, have you taken a look at your audience lately? They can’t hear as well as they used to hear!’”

The Post-Privacy Era Has Already Begun

You don’t have time to read this long, sober report on the National Security Agency’s program to capture and analyze all data on planet earth, but you should anyway.  The author is James Bamford, the generally recognized authority on the US intelligence establishment.  Thanks to Naked Capitalism for linking this.

Neoliberalism Hits a Speedbump?

The Wall Street Journal has an interesting article today, which begins, " More Asian governments are pressing businesses to hike wages as a way to prevent outbreaks of labor unrest, raising the specter of higher manufacturing costs for global companies -- and the products they sell world-wide."

The problem is that people in Asia lack the necessary naiveté to make capitalism work efficiently; i.e. to maximize exploitation.

"Political leaders say they have little choice but to act, as voters grow savvier about wage gains" elsewhere, which they can research on the Internet. Recent protests by low-income workers in places like Indonesia and Thailand have added to pressure on governments to raise wages."

"There is a genuine feeling that the low-wage segments [of Asia's population] haven't made much progress in recent years" as the gap between rich and poor has widened in some areas, said Edward Teather, an economist at UBS in Singapore."

What is wrong with Americans that they can be bamboozled to think that the current neoliberal policies are constructive of anything more than more of the same?


James Hookway, Patrick Barta, and Dana Mattioli. 2012. "China's Wage Hikes Ripple Across Asia." Wall Street Journal (13 March).

http://online.wsj.com/article/SB10001424052702304450004577279111724105828.html?mod=ITP_pageone_0

MMT Redux

I knew if I stuck my hat on a pole above the trenches, the MMT missiles would come flying.  Specifically, I hear two general arguments whizzing over my head:

1. Loans are not made out of reserves, silly!  Loans are simply made, and if the bank finds itself short of reserves at the end of the day it borrows them from the overnight market.  Lending and the quantity of reserves at any moment in time are decoupled.

2. The CB targets an overnight interest rate.  If an over- or undersupply of reserves puts pressure on that rate, the CB injects or soaks up reserves to maintain its peg.  Implication: the Treasury can borrow as much as it pleases, as long as the CB purchases whatever proportion of the bond issuance it needs in order to maintain its peg.  Notional measurements of “the money supply” have no independent significance.

Responses:

1. It is a fair criticism to say that textbook presentations of fractional reserve banking, including my own, are counterfactual; convenient exposition is, in this case, at odds with observed reality.  It should be borne in mind, however, that the money multiplier model, like conventional supply-and-demand models, operates at an aggregate level and is not truly microfounded.  (In S&D, prices are supposed to equilibrate in a perfectly competitive model, in spite of the definition of perfect competition as a state in which no agent has the ability to influence the market price.)  The money multiplier really specifies a limit at which further loans need to be backed by an infusion of new reserves.  (The MM has been getting fuzzier of late due to changes in financial institutions and instruments, not to mention international capital flows, but we’ll leave that aside.)  If banks were always fully lent, the CB would have sole control over “the” money supply through control over the monetary base: that would be one corner solution.  But banks are not fully lent at all times.  If banks were never fully lent, the CB would have no influence at all on monetary aggregates except through its ability to stimulate or discourage lending, but this is another implausible corner solution.  I take the middle road.

2. If the CB targets a nominal interest rate, it runs the risk of the following scenario: increased borrowing by the Treasury increases inflationary expectations, which reduce the real interest rate, perhaps even below zero.  This leads to ever-reduced lending standards and overheating (including bubblish activity), validating those expectations, disastrously.  Or the CB can target a real rate, but if inflationary expectations rise it is compelled to increase its nominal peg, dumping an increasing share of bonds on the market.  This looks like, and is, contractionary monetary policy.  The notion that a CB can passively accommodate any and all fiscal deficits strikes me as very strange.  To put it differently, there are two dubious corner solutions, one in which any exercise of fiscal expansion is completely vitiated by offsetting changes in inflation, and another in which there are no such changes.  I’ll take the old fashioned Keynesian view that the proportion of fiscal expansion absorbed by inflation roughly increases as the output gap decreases, a sensible—and empirically validated—middle position.

The Difficult Concept of a Global Market

According to poll results published in today’s New York Times,

Over all, 54 percent of poll respondents believed that a president can do a lot to control gas prices, as opposed to 36 percent who believe they are beyond a president’s control.

It appears that a majority of those polled have difficulty with the concept that prices in a global market are set globally.  I’m not surprised, because variations on the same mental hurdle show up in discussions of whether it matters if we import oil from country A or country B, or if oil prices are quoted in dollars or euros.

Since the first and most important step in teaching is deconstructing erroneous priors, I hope those whose job it is to teach economics will address these misunderstandings as explicitly as possible.  Take time to find out what students think about how the global oil market works before launching into your prepared explanation.  Drill down to the underlying assumptions and hold them up for scrutiny.  Minute for minute, time spent on unlearning false knowledge is far more valuable than time spent on developing a more sophisticated grasp of the better stuff.

It was also help enormously if media outlets like the Times would make it clear that there are right and wrong answers to questions like the president’s control over gas prices.

Peter Diamond On The Slow Recovery Of Employment

I have just returned from the Eastern Economic Association meetings held in Boston over the weekend. Peter Diamond delivered the main plenary lecture on Saturday evening (2/10/12) on "Markets with Search Frictions." While I disagree with some things he said (He thinks the "natural rate" equals "NAIRU" [and that these are both meaningful concepts], and as always wants to "fix" social security, but these were not his main topics), he mostly gave a wise and knowledgeable presentation about the search model of unemployment, going back into its routes and noting many of its limitations and problems, as well as how it is useful, reminding everyone in the audience what fools those in the Senate are who think he is not qualified to serve on the Board of Governors of the Fed.

One general point he made that I had not really thought about, although once pointed out it is obvious, is that labor markets are seriously different from textbook supply and demand models in that there is never a really clearcut equilibrium. There are always vacancies, hence some "excess demand," and some official unemployoment, hence some "excess supply." All the imposed definitions of labor market equilibrium are thus arbitrary.

The most interesting remark to me came in reply to a question from the audience. He had stated in his main talk that "the matching mechanism has broken down during the recent recession." He was asked to elaborate. Drawing on research by Davis, Haltiwanger, and others, he broke it down to the micro sectoral level, although saying that more is going on than just that. But at that level, different sectors have different hiring rates. The one with the most rapid hiring rates is the one with the least hiring, construction. Some with slow hiring rates include education, health, and government. Not all of those latter are growing that much, but health is certainly one of the most rapidly growing. So, quite aside from broader macro issues (including possibly reduced mobility from underwater mortgages, although some studies claim this is not a factor), this sectoral pattern of how the recession has hit has slowed down the hiring/rehiring portion of the matching mechanism.

Outgoing president, Duncan Foley, also gave an excellent talk on physical limits to growth related to climate and energy, but, I shall not comment on that at length here and now (title, "Dilemmas of Economic Growth"), other than to say I largely agreed with it and he showed some very interesting statistics on various things that I had not seen before.

Why Larry Kotlikoff Is Not Getting My Vote for President

An economist is running for President with this opening:

Our country is at a critical juncture. Twenty-nine million Americans are out of work or underemployed. For most of those with jobs, real wage growth is a distant memory. Younger Americans are searching for the American dream and finding no-help-wanted signs. And millions of retirees are reeling from massive losses they've taken on their homes and life savings. The few doing well are doing very well, with income and wealth growing more unequal over time.

With such an outstanding diagnosis of the big economic issues, what progressive economist wouldn’t get behind his candidacy? Well this one - after I read his various “purple” plans, which all seem to be about austerity designed to eliminate what he claims is a long-term fiscal gap in excess of $200 trillion.

I’ll concede that we likely need a balanced approach of long-term spending reductions and more tax revenues and his proposal to have a progressive consumption tax is intriguing. Note, however, that extra revenues amounts to only 15 percent of his proposed long-term austerity, whereas Social Security is supposed to make up about 25 percent of the shortfall. This is from someone who correctly notes that retirees have lost much of their life savings while the elite are doing very well. Now putting 60 percent of the burden on health care reforms might sound right – but his website is short on specifics of how he chooses to accomplish this goal.

But none of this constitutes the main reason I’m not voting for Dr. Kotlikoff. The main reason goes to his point that we are far below full employment. So why does his campaign focus on austerity? We might as well be voting for Mitch McConnell for President.

Running on MMT

I’m going to regret this, but here is a short reaction to the Modern Monetary Theory (MMT) uprising, occasioned by reading (after some hesitation) Philip Pilkington’s MMT-inspired attack on IS-LM models over at Naked Capitalism.

1. I agree with the fundamental complaint MMTers have about the LM curve: it assumes a fixed money supply, so that changes in the speculative demand for money (due to i) have to be offset by changes in the transaction demand (due to Y): hence the upward slope.  (The slope is flat during a liquidity trap.)  But the money supply is not fixed; it has a substantial endogenous component.  Note the word “substantial”.

2. But MMT jumps from one corner solution to another.  After rejecting the implausible notion that the money supply is fixed, always at a level determined by the money multiplier times the monetary base, it leaps to the equally implausible notion that the monetary base is completely decoupled from the money supply.  On this view, infusions or withdrawals of liquidity by the central bank influence only interest rates, and the banking system alters its credit creation to meet money demand at the policy-determined price.  Thus the volume of economic activity need have no bearing at all on interest rates; the central bank has a completely free hand.  Do I have this right?

My view is that corner solutions are usually wrong; at least they should be regarded with fierce skepticism.  It would take a lot to convince me that monetary aggregates are completely decoupled from central bank liquidity provision, just as I doubt they can be controlled by monetary policy.  Surely there are limits to credit creation, which we see in a raw form during those episodes in which reserve requirements are reset.  What’s wrong with saying that the money supply is jointly created by the central bank and the private sector as the latter responds to perceived lending (and other asset acquisition) opportunities?

(Note: this post is about just one issue in IS-LM modeling.  There are others, but I am saving them for a day when there is really nothing better to do.)

Libertarians for Social Democracy

Sign up Alex Tabarrok.  He has an excellent piece in the latest Chronicle of Higher Education extolling the apprenticeship systems of Germany, Finland, the Netherlands, Denmark, etc.  As well he should: they offer students from all class backgrounds a real opportunity to earn a middle class income, and they are central to the ability of these countries to maintain high standards of living in an even more open economic environment (Europe) than the one the US has to contend with.

Just one thing though.  What makes these apprenticeships so valuable for the students?  And why are employers willing to pay more for well-trained employees than dumbing down the jobs for minimum wages or simply outsourcing as much as possible?  Each country is different, but they all share part of two answers—labor market regulation and stakeholder corporate governance.  The first of these is especially crucial to mass apprenticeship: to maintain demand for high-end labor, there need to be rules mandating employment rights, credentials and, especially, unions.  To minimize outsourcing, labor and the community need a strong voice in corporate management.  In addition, the whole system is nurtured and nudged with multifarious forms of public subsidy.

To put it simply, if you want the social democratic educational strategy, you’re going to need a social democracy to go along with it.  I’m happy to have Alex on board.

Incidentally, how about this for a political platform: no high school graduate left behind.  There should be a public pledge, backed by dollars and ambitious programming, that every student who graduates from high school in America is guaranteed the opportunity to either earn a college degree or get placed in a job that pays a middle class wage.  All access barriers to education, training and apprenticeship ought to be removed, with students enjoying these benefits as a matter of right.  As long as a kid puts in the effort, public responsibility does not end until he or she has a solid foot in the door.  This is a universal deal, for everyone.

Ethical Conduct for Economists?

Is it an oxymoron?

The first group of papers has been posted for the online WEA conference, Economics in Society: the Ethical Dimension, among them Crisis, Credit and Credulity: the incredible circulation of a counterfeit idea by Tom Walker (AKA Sandwichman):

Abstract: Even as the first warning signs of the global credit crisis were emerging in 2008, the IMF published a working paper that sought to analyze the youth employment effects of early retirement schemes in Belgium but ignored the historical context of those policies as part of the response to an earlier crisis – the "steel crisis" of the 1970s and 80s. Instead, the authors dwelt on a dubious but well-worn fallacy claim that advocates of early retirement policies believe there is a "fixed amount of work to be done", a "lump of labor." In the context of the astonishing history of the fallacy claim, what might seem a questionable paradigm choice for the paper's authors constitutes an inexcusable ethical lapse for the economics profession. Not only is the fallacy claim notoriously unsubstantiated, it originated as a propagandist's forgery and gained currency as a viciously partisan polemic against trade unions. Subsequent textbook versions of the fallacy claim may have toned down the vitriolic rhetoric but their ad hoc rationalizations neglect to offer any substitute for the original's fabricated evidence for the alleged belief. Financial credit depends on trust and today that foundation of trust extends to the scientific knowledge and technical analysis of experts. What does the enduring credulity of economists toward a demonstrably counterfeit fallacy claim suggest about the prospects for the economics profession to confront and remedy its ethical failures?

Meanwhile, the Sandwichman has compiled a list of economists, journalists and a few politicians over the past decade or so who have invoked the fraudulent fallacy claim, either in unvarnished credulity or with malice aforethought:

Peter Antonioni, David Autor, Ryan Avent, Martin Neil Baily, James Banks, Bruce Bartlett, Andrew Biggs, Matthew Bishop, Olivier Blanchard, Walter Block, Richard Blundell, Tito Boeri, Axel Börsch-Supan, Antoine Bozio, Samuel Brittan, Michael Burda, Pierre Cahuc, Laura Carstensen, Philip Coggan, Peter Coy, Diane Coyle, Andrew Coyne, Bruno Crepon, Clive Crook, Ed Crooks, Michael Cuneo, Reginald Dale, Jaap de Koning, Klaas de Vos, Werner Eichhorst, Carl Emmerson, Marcello Estevão, Sean Flynn, Thomas Friedman, Ed Glaeser, Robert Gordon, Jonathan Grubel, Matthew Hancock, Alister Heath, Ruth Hubbard, Jennifer Hunt, Will Hutton, Richard Jackman, Juan Jimeno, Alain Jousten, Adriaan Kalwij, Arie Kapteyn, Laurence Katz, Joshua Katz, Achim Kemmerling, Jacob Funk Kirkegaard, Dylan Kissane, Francis Kramarz, Paul Krugman, Simon Kuper, Jason Kuznicki, Oliver Landmann, Richard Layard, Ruth Lea, Mathieu Lefebvre, Melanie Luhrmann, Landis Mackellar, John Macnicol, Bill McBride, Francois Melese, Giles Merritt, John Micklethwait, Kevin Milligan, Jack Mintz, Casey Mulligan, John Munro, Stephen Nickell, Kristian Niemetz, Gilles Paquet, Jamie Peck, Sergio Perlman, Pierre Pestieau, Christopher Rhoads, Matt Ridley, Nick Rowe, Filipa Sá, Gilles Saint-Paul, Xavier Sala-i-Martin, Thorsten Schank, Amity Shlaes, John Shoven, Robert Simmons, Hans-Werner Sinn, Dennis Snower, Guy Standing, Nigel Stanley, Will Straw, Timothy Taylor, Marian Tupy, Ernst van Koesveld, Matthias Weiss, Niels Westergaard-Nielsen, Alan Wheatley, Charles Wheelan, David Willetts, David Wise, Tim Worstall, Asghar Zaidi, Jeffrey Zax, Klaus Zimmermann, Andre Zylberberg

He who gives credit to the calumny before he has investigated the truth is equally implicated. -- Herodotus

More on Mankiw’s Defense of the Carried Interest Loophole

My take on what Greg wrote is here. It seems Alec MacGillis made the same point much more forcefully finishing with this gem:

If Mankiw is so bothered by the carpenter’s fate after the closing of the carried interest loophole, then he should be pushing for the equalization of the tax rate for investments and earned income.

But Alec does one better by finding a 2007 Mankiw oped that advocated closing this loophole. But give Greg a break as he is advising someone who flip flops on just about everything!

Macro and Micro: The Case of Balance Sheet Recessions

To continue some random thoughts about the role of microeconomics in macro, consider the notion of a balance sheet recession.  Like most others who came to see this as an essential ingredient of the current crisis, my route was via the financial balances framework—for instance, the Wynne Godley version.  I saw the problem in aggregate/net terms: the US household sector in the mid 00's was running up unsustainable debt loads, especially through the medium of the housing bubble.

This is a purely macroeconomic perspective, and one can go a long way with it.  Nevertheless, one can go even further by filling out some of the microeconomic aspects.

One that has attracted a lot of attention is the role of inequality between households.  This takes us from net to gross balances: the accumulation of large debts among some households adds fragility and eventually drag to the system notwithstanding the net wealth accumulation of other households.  The inequality/debt nexus has been examined at a purely macro level, but to dig further we would need to disentangle the threads: which households in particular are going into hock, what motivates them to do this, how are collateral constraints imposed or lifted, etc.  Even with statistical controls, aggregate analysis can only point to association, not causal pathways.

But there are other micro aspects to household balances that are worth exploring.  Some that occur to me are:

1. How can we call the turn?  Through what channels do debtors come to revise downward or upward their reference point for when debt is “too much”?  Most debtors, after all, do not experience default.  What persuades them to shift from debt accumulation to deleveraging?  And what persuades them that they have paid down enough debt and can begin borrowing again?

2. Related to the first question, is the tendency toward overshooting symmetrical?  That is, we know debtors tend to overshoot on the way up, leading to the fabled Wiley Coyote moment.  Is there also a tendency to pay down beyond the level needed for debt sustainability?  If so, there might be interventions that could moderate the contractionary impetus of balance sheet recessions without impinging on needed adjustment.

3. For policy purposes, and here we enter the realm of the Lucas Critique, we should want to know the extent to which household perceptions of actual and desired leverage are intertemporal: do people think about their financial situation only in its immediate state, or do they incorporate some notion of permanent income?  If the latter, do temporary fiscal infusions provide less perceived balance sheet relief than the raw numbers would suggest?  Are these effects of different magnitude for different households?  Note that these questions are entirely empirical and can’t be addressed through armchair speculation, no matter how many clever wrinkles one adds to a textbook intertemporal optimization model.

What I hope this example demonstrates is that it is possible to see a large role for microeconomic research in macroeconomics without making metaphysical claims about foundations or demanding ritual obeisance to general equilibrium.  In fact, freeing macro from these constraints is also freeing micro.