Thursday, February 24, 2011

Unions and Skinny Dipping

CBS News Clip on Recession Pressure on Teacher's Unions

Economist: Letter in defense of unions

To summarize:

Pro-union argument:
1.  Negotiating wages and benefits is a right.
2.  States are suffering from recession related budget problems - states shouldn't balance their budgets on backs of teachers and firefighters.
3. Workers have accepted lower wages in exchange for their generous benefits - which are now far more generous than those provided in the private sector.

Anti-union argument:
1. Unions are needed when employers have all the negotiating power - but in the public sector, officials are more worried about votes than long term costs.
2. Even if there had not been a recession, states would not be able to afford the promised benefits in the coming years.
3. Comparisons between union and non-union pay need to take into ALL factors including: benefits, schedules (weekends/nights, stress), education level, cost of living per location, and job security. In at least one occupation, teaching, a case could be made that union workers are paid more than their non-union counterparts.

To paraphrase Warren Buffet, you can't tell whose swimming naked until the tide goes out.  The recession has dried up state revenue, i.e. the tide has gone out. This has drawn attention to the states' projected long term budget deficits. It is clear that states cannot afford their long term union obligations unless they substantially raise taxes.

What is needed is a balance of negotiating power. Unions represent their workers, but it is not clear that public officials have represented tax payers. Until now it has been far easier for public officials to get re-elected by agreeing to generous benefits (that payout later) than by reigning in costs (and risking an inconvenient, unpopular strike and losing union votes).

Economist poll: Vote on whether America's public sector unions have too much influence

Saturday, February 19, 2011

Dangers of Deflation

Note this video was filmed in December 11, 2008 - just 5 days before the U.S. Fed lowered the target for the Fed Funds rate (the rate banks charge each other for overnight loans) to [0,.25%].  The Bank of England followed suit shortly thereafter. It lowered rates to .5% (essentially zero) in March, 2009. 

In addition to lowering their target interest rate to near zero, the Fed employed new tools to inject money into the economy to bring up prices. These tools were primarily called "facilities" and involved buying assets with newly created money. 

Fortunately, our economy did not go "Sayounara" (good-bye in Japanese) and the U.S. appears to have escaped deflation (falling prices). By 2010, worry in the U.S. has shifted back to inflation. How will the Fed unwind all its purchases now?

As shown in the video, Japan has been struggling with deflation for decades. To read about deflation in Japan see:

Economist (2-10-2011) "An Old Problem" (deflation in Japan)

NYT (10-17-2010) "Japan goes from Dynamic to Disheartened"

The basic list of dangers of deflation (falling prices) include:

1. Consumers postpone consumption - buying slows. Hence the economy slows further.

2. Borrowers face a bigger burden - they must pay same amount of dollars each month, but those dollars are now worth more. They may cut back on other spending to meet their debt obligations. Hence the economy slows further.

3. Wages are "sticky" downward, meaning wages typically don't fall even if their real value has risen (the same dollar amount buys more with lower prices). When prices fall and wages are sticky downward, firms layoff more workers and/or hire fewer workers. This leads to rising unemployment. The unemployed, and those fearful of becoming unemployed, spend less. Hence the economy slows further.

Note that the problems associated with deflation feed on themselves and make the problem worse. This is often called the "downward spiral of deflation".

One of the reasons most central banks set their target for inflation at 2% and not 0%, is to make sure they don't have to deal with deflation.

For more information about deflation see:
NYT (8-2-2010) "Why is Deflation Bad" by Paul Krugman

Tuesday, February 15, 2011

Who counts as unemployed?

For a serious take on who get counted as unemployed see:

For a fun take on who gets employed see (but it isn't really a conspiracy).

Thursday, February 10, 2011

Merger Mania for Stock Exchanges

The potential merger between the NYSE (New York Stock Exchange) and the Deutsche Borse made headline news today, but it is not the only merger in the works. The Singapore exchange is seeking to take over the Australian exchange. For a brief review of the NYSE and stock exchanges in general see definition at bottom of post.

The possible pros for mergers of stock exchanges include: economies of scale (reduced costs of managing the exchanges) which might lower costs for traders, and a larger pool of traders . The possible cons: less competition among exchanges which might result in higher costs for traders, and challenges getting the deal finalized (regulations, nationalistic public outrage etc.)

For a brief history of exchanges take a look at Zweig's WSJ article (2-10-2011)
Exchanges Pushed By a Need For Speed

Among the interesting tidbits disclosed in this article:  "By some estimates, nearly 300 stock exchanges came, and mostly went, in the U.S. during the 19th century. Many of them died because the stocks they specialized in boomed and then went bust."  Speculation, booms, and the quest for information are nothing new.

Review: Definition of NYSE (from Investopedia):

"What Does New York Stock Exchange - NYSE Mean?
A stock exchange based in New York City, which is considered the largest equities-based exchange in the world based on total market capitalization of its listed securities. Formerly run as a private organization, the NYSE became a public entity in 2005 following the acquisition of electronic trading exchange Archipelago. The parent company of the New York Stock Exchange is now called NYSE Euronext, following a merger with the European exchange in 2007.

Also known as the "Big Board", the NYSE relied for many years on floor trading only, using the open outcry system. Today, more than half of all NYSE trades are conducted electronically, although floor traders are still used to set pricing and deal in high volume institutional trading.

Investopedia explains New York Stock Exchange - NYSE
The origins of the exchange date all the way back to 1792. Because of its long operating history the NYSE is home to the majority of the world’s largest and best-known companies. Foreign-based corporations can list their shares on the NYSE if they adhere to certain Securities and Exchange Commission (SEC) rules, known as listing standards.

The NYSE opens for trading Monday through Friday 9:30a.m. to 4:00p.m. (ET), closing early on rare occasions. The market also shuts down during nine holidays throughout the year."

Tuesday, February 8, 2011

Quick Update on Status of U.S. Economy

For a good quick update read:
Economist (2-3-2011) Turning the Corner

According to this article, "At 3.2%, the rise in [real] GDP is disappointing for this stage in a recovery. At a similar point in the early 1980s business cycle, annual growth was roaring ahead at 7.1%, and employment was growing rapidly."  

To see this more clearly, look at the following graph from the CBO (Congressional Budget Office) Fiscal Year 2011 Outlook. Notice how much steeper the black line for actual GDP was around 1982 (slope about 7.1%, if using regular scale) than it was in 2010 (slope about 3.2%, if using regular scale). This resulted in a quick recovery in the early 1980's and a long recovery now.

                                                   CBO Fiscal Year 2011 Outlook

Borrowing from Aesop's fabled race between the hare and the tortoise - let the blue line represent the path of the tortoise - the fictional economy that grows slow and steady. The y-axis shows distance from the starting line. Let the black line represent the path of the hare - the actual economy which grows in fits and starts. In 2009, the hare turned back in the right direction, but it is not running fast enough to catch the tortoise any time soon. According to the CBO, the hare won't catch up with the tortoise until about 2016.

The slow recovery is not particularly surprising. The U.S. typically recovers more slowly from recessions caused by bursting of financial bubbles (like the housing crisis).

Note that the recent 3.2% growth in real GDP is NOT growth in real GDP per capita. No adjustment was made for changes in population size.

To examine long run growth rates further, consider the following Excel sheet. The numbers for real GDP and population were taken from the front and back flaps of McConnell, Brue and Flynn's  Macroeconomics (18th edition). Computation of average growth rates is always sensitive to the choice of start and end dates. The start and end dates of 1929 and 2007 were chosen because: (1) they both reflect the end of a growth cycle, right before a major recession/depression, and (2) they are the first and last dates listed in the textbook cover tables (students should verify).

Real GDP per capita is calculated by dividing Real GDP by Population. If output were divided equally, each person in the U.S. in 2007 would have had more than 5 times as much "stuff"  as a person in the U.S. in 1929. Note that Real GDP is listed in billions, but population is listed in millions. Therefore Real GDP per capita (Real GDP/population) shown below should be interpreted in thousands. If the real GDP (inflation adjusted) of 1929 was divided equally, each person would receive about 7 thousand dollars (in year 2000 dollars). The same process for 2007 would leave each person with about 38 thousand dollars (in year 2000 dollars).

The average growth rate of real GDP during the 78 year interval between 1929 and 2007 was 3.38% per year (calculated as a geometric mean). This could be used as rough estimate for the slope of the blue line in the CBO graph above (using regular scale).

Population also grew during this interval. So the growth rate of real GDP per capita during this interval was 2.18%. As a rule of thumb, I ask my students to remember that the average annual rate of growth of per capita GDP for U.S. and other early industrializers (England, France, Germany) has been about 2% per year. For the U.S., this rate of growth has been very steady for over one hundred years. 

Using the rule of 70, we would expect real GDP per capital to double about every 32 years (70/2.18).

Wednesday, February 2, 2011

Stocks and Bonds

Video accompanying

WSJ (2-2-2011) Stocks Hit Post-Crisis High

For fun (highly recommended):

1. Warren Buffett (world's greatest investor) on picking stocks (5 min):

2. Warren Buffett talks to students about how to be successful in business (10 min):

For very basic review of stocks and bonds:

Tuesday, February 1, 2011

Housing Market Update

While the Home Affordable Modification Program has so far helped far fewer homeowners than hoped, many homeowners have successfully modified their loans by working directly with their lenders. Mortgage modifications rarely take the form of debt reduction -  instead modifications usually involve lower interest rates or longer repayment periods.  Even after modifications, many homeowners are left "underwater", i.e. owing more than their house is worth.

Banks don't want to set a precedent of writing down mortgage debt - although this does happen for other types of debt in bankruptcies. Banks are concerned with the problem economists' call "moral hazard".  If homeowners know that debt reduction is possible, they are more likely to pay too much for houses they can't afford.

However, just lowering monthly payments may not solve the foreclosure problem. Homeowners who are underwater are less likely to keep up with mortgage payments - even if they have modified their mortgage.

If the problem of moral hazard could be solved, forgiving mortgage debt does offer banks some benefits:
(1) Banks lose lots of money when houses go into foreclosure, and the legal costs are rising. In some cases, banks would lose less money by forgiving debt than by foreclosing on a house.
(2) 25% of all mortgages are underwater so the problem can't be ignored.
(3) Foreclosures are contagious (i.e. create a negative externality). A foreclosure lowers the price of nearby houses and makes their owners more likely to foreclose.

One proposed solution to the moral hazard problem requires homeowners to give banks a share of equity in their home in exchange for debt forgiveness. Homeowners would lose some potential profit from the future sale of their home. At least one mortgage service provider (ISGN) has already introduced a Real Estate Shared Equity Transaction (RESET)  program (see Housing Wire (4-9-2010) ).

It is unclear how many banks would be willing to consider swapping house debt for house equity. This swap could increase the banks' exposure to risk. It is also unclear how the house debt/equity swap would be perceived by bank regulators if it were implemented on a large scale.

Madeline Schnapp estimates it will take at least 5 years for the housing market to recover (see WSJ video below). The number of delinquent mortgages (past-due on payments) was 7 million last year, well above the typical 2 million per year.

Considering that housing accounted for 20% of GDP in 2002-2007, it will be a long time until our economy recovers. The sooner we increase production in other sectors and rely less on housing the better. Unemployed builders and real estate agents might have a different opinion - switching jobs is not easy.

WSJ (2-1-2011) Banks Boost Home-Loan Relief

WSJ Market Watch Video
Madeline Schnapp, director of macroeconomic research at TrimTabs, talks to MarketWatch's Alistair Barr about what that means for the world's largest economy.