The Fed and AIG

Now that the economy has improved. AIG put in an offer (at 53 cents on the dollar) to buy back assets from the Fed. The Fed is instead selling them at auction to get a better deal for the taxpayer. Ironically, this could end up hurting the tax payer in May, when the Treasury tries to sell off its holdings of stock in AIG. For more read:  WSJ (3-31-2011) Fed to Sell Subprime-Mortgage Bonds From AIG Bailout )



For the curious, here is a good recap of the troubles at AIG (American International Group). Basically, AIG is a huge insurance company that in 2008 insured many supposedly safe assets for other financial institutions.  When these assets started looking risky (many were housing market related), it became clear that AIG would not be able to make good on all its insurance payouts. Had AIG failed, it would have taken much of our financial system with it. Hence, AIG was "too big to fail".

Falling Giant: A Case Study Of AIG by Gregory Gethard

Ode to Balance

WSJ (3-26-2011) 'Mommy Track' Without Shame by Virginia Postrel

In the most recent weekend edition of the WSJ, Virginia Postrel rights about 'MBA mothers' and the strategies younger women are pursuing to balance work and family. Since most college students will soon be making these decisions  themselves (with their spouses), I thought it worth a post.

Full disclosure, I find this article gratifying. I switched from a tenure track position (high status in academia world)  to an adjunct position in order to gain more time with my children. This was an unusual move at the time to say the least. I took a leap of faith that when I was ready I could get back on faster path.

I took inspiration from the example of the prominent mathematician Mary Ellen Rudin.  My father is a  mathematician in the same field as Mary Ellen Rudin, and he often talked about her unusual career path.
According to his version of the story, for years she worked in the background while raising her children. Eventually as her publications mounted, she was promoted from adjunct professor to full professor - and became universally recognized as one of the top mathematicians in the world in her field. I am not plotting my ascendance to world domination, but it is nice to know someone else has done it.

I suspect the next generation of men and women going through college now will be even more willing to reshape career paths to fit their needs.

JP Seiden, management consultant, takes a bleaker stance on work-life balance in this clip for college students and interns in 2009 (5 minutes).

Bernanke and challenges facing the Fed

 To read about the policy challenges facing the Fed, click on

WSJ (3-24-2011) Crises Scramble Fed's Inflation Calculus by David Wessel

or watch this interview with David Wessel (3 min)


David Wessels points out that if fears of oil price increases drive up prices (make AS shift left), the Fed will not be able to keep stimulating demand (make AD shift right) without further driving up prices.

Currently the Fed is keeping interest rates low and buying assets, and thereby pumping money into the economy. In the graph below, this policy results in a rightward shift in the aggregate demand curve from AD1 to AD2. This should move the U.S. economy from point 1 (now) to point 2 (by about 2012). If all goes as planned, the U.S. would enjoy higher output (and hence lower unemployment) with only a slight increase in prices.

Unfortunately for the Fed, oil prices increases and inflationary fears may shift the aggregate supply curve left from AS1 to AS2.  If the Fed sticks with its current policies, this decline in the AS curve would send the economy to point 3, with rising prices (i.e. inflation). To fight inflation, the Fed would be forced to stop stimulating demand; AD would stay at AD1 instead of shifting right to AD2.  The Fed would have to raise interest rates and/or stop buying assets. 

So instead of moving from point 1 to point 2, with more output (and less unemployment) and mild price increases, the U.S. could end up at point 4, with less output (and more unemployment) and price increases. The Fed's hands would be tied.  Due to higher inflation, it would not be able to maintain an expansionary monetary policy intended to increase output.

Note: I have simplified Wessel's analysis by  ignoring the possibility that AD could shift left from AD1 due to reduced consumer demand. This would reduce output even further.

Watch Ben Bernanke testify before House Budget Committee,  2-9-2011 (4.5 minutes)

http://www.youtube.com/embed/MXYgwZBIaWY

Bernanke points out that countries can run into trouble when the ratio of public debt to GDP reaches 100% - and that it would be ideal if the U.S. started addressing its long term problems now. He also cautions against drastic cuts right now as that will slow the recovery.

Bernanke also discusses: (1) continued expectations of low inflation for the next few years,  (2) while the Fed's primary objective is stimulating the economy, its efforts have brought in substantial revenue to the Treasury, 125 billion in last 2 years, (3) once the economy recovers, any losses at the Fed should be more than covered by extra tax revenue (due to booming economy) so the Fed will not become a drain on the Federal budget. 

When asked, Bernanke also gives an estimate of the number of jobs saved by the Fed's stimulus actions. He says a credible study by Federal Reserve economists found the Fed saved up to 3 million jobs. To watch more of Bernanke's testimony (1 hour 35 minutes) click on

http://www.youtube.com/watch?v=YibSWTEJ4rc&feature=related

Japan's disaster and the global economy

PBS Newshour interview with Greg Ip, journalist for The Economist on 3-15-2011 (7 min)


Greg Ip concludes that, barring a nuclear accident,

"The bank of Japan has the means to finance plenty of borrowing, the Japanese are very higher savers, .. and it is conceivable that if  done right a really, vigorously financed, executed reconstruction scheme could, in the end, prove to a big boost to Japanese growth."

As long as global supply chains are not disrupted for too long, the disaster should have little economic impact on the global economy.

To read The Economist article on this topic click on:

Economist (3-17-2011) The cost of calamity

For yet more video of reactions of experts
Bloomberg Video Clip (3 min)

Fix the budget or else ... the bond market will make you

Just like students get good grades from their teachers for good performance, countries get good grades from the bond market for living within their means (i.e. expenditures don't greatly exceed revenues).  Good grades from the bond market come in form of low borrowing costs, i.e. low interest rates, on government debt. The U.S. is currently able to obtain low borrowing costs from the bond market - but that will change if we don't tackle our long term spending problem.

To see how the bond market can "school" countries, just look at  Greece in 2010.  The international bond market decided that Greece's economic policies were unsustainable, and began charging Greece a  much higher interest rate when it issued new bonds (to payoff old ones). Greece was forced to make major cutbacks in pay and benefits for public employees, and government programs. There were riots in the streets.


Bloomberg 3-7-2011 Interview of JP Morgan's Chief Economists (5 min)

As a rule of thumb, a country starts getting in trouble with the international bond market once publicly held debt reaches 100% of GDP. The U.S. and many other countries will be there soon.  To read about the latest progress in addressing the U.S. budget problem now (before the bond market makes us) read:

WSJ (3-14-2011) Serious Debate on the Budget has Started

Three Wishes

The other day I played the three wishes game with my daughter.  At first she picked wishes that would help her immediate family. I told her as nice as that sounded, my first two wishes would have to be the eradication of  malaria, and a way to solve problems without war.  Hey, wishes don't have to be realistic. Improvements to education would certainly be a valid candidate for the third wish.

For some news on the malaria and education front - watch this great 20 min speech (2-2009) by Bill Gates. Some might disagree on the relative devastation caused by baldness.

http://www.youtube.com/watch?v=tsgvhP07BC8&tracker=False



In addition to vastly improving quality of life, all three of my wishes would certainly improve the world's economic condition.

As discussed in an earlier post (3-2-2011), the GDP of the U.S. in 2008 would have been at least 9% higher (1.3 billion loss due to low scores, estimate by McKenzie/14.4 billion 2008 GDP from BEA) if the U.S. had closed the achievement gap with the best performing nations. 

Likewise, malaria imposes a big cost on GDP in many African countries. Malaria may have been responsible for more deaths than any other disease in human history. Malaria used to be a problem everywhere, but is now limited to a band around the equator. From the World Health Organization (click on Fact number to go to the WHO site): 

Fact 10: "Malaria causes an average loss of 1.3% of annual economic growth in countries with intense transmission. It traps families and communities in a downward spiral of poverty, disproportionately affecting marginalized and poor people who cannot afford treatment or who have limited access to health care. Malaria has lifelong effects through increased poverty and impaired learning. It cuts attendance at schools and workplaces. However, it is preventable and curable."

Fact 3:  "One in five (20%) of all childhood deaths in Africa are due to malaria. It is estimated that an African child has on average between 1.6 and 5.4 episodes of malaria fever each year. Every 30 seconds a child dies from malaria in Africa."

For an interesting take on the war front as it pertains to the middle east - watch:

http://www.youtube.com/watch?v=yKQnL9Mmgng&tracker=False





What would your three wishes be?

Entrepreneurship and Growth

Great talk (3-2009) by noted Harvard Professor Tarun Khanna - 55 minutes long including Q&A.  Talk starts off with discussion of Slum Dog Millionaire, and touches on political freedom/elections and micro finance. Local money lenders may require over 1000% (on an annual basis) for loans, whereas NGOs (non-government organizations) or for-profit micro finance companies can offer 20%.


The Economist (see article link below) discusses the role of entrepreneurship in creating jobs - and offers it as a solution to the unemployment problems that sparked revolution in the Middle East. They relay the findings of the Kauffman Foundation, that "between 1980 and 2005 nearly all net job creation in America took place in firms that were less than five years old".
Economist (2-26-2011) Uncorking enterprise

Unfortunately, entrepreneurial activity in developing nations is hard to measure. Some is very productive, but some is just a desperate attempt to earn anything in the absence of other alternatives. A new index tries to measure entrepreneurship better.
Global Entrepreneurship and Development Index

A Union Expert Weighs In

Harvard Professor Richard Freeman is an expert on unions and finds that they increased productivity and wealth in the U.S. in the last 20  years.

Excerpt from an interview

For a fun (friendly) poke at Freeman, watch this Stephen Colbert clip:

Prof. Freeman does recommend one change that unions don't like: allowing firms to form committees with workers to improve conditions. Apparently forming such committees can get firms in trouble in the U.S. (violates National Labor Relations Act, see legal stuff). According to Freeman, these committees work well in Canada.

Freeman's critique of current labor union laws: http://economistsview.typepad.com/economistsview/2010/10/richard-freeman-labor-law-is-broken.html

In Praise of Teachers (if not their unions)

To get another perspective on the public union issue, read Chris Farrell's article in Bloomberg Business Week about the real problem with tenure and teachers' unions. Teachers' unions have pushed for job protection and pay raises based on seniority, not ability.

Teachers have valid concerns about capricious principals and the difficulty of measuring good teaching, but firing ineffective teachers would clearly benefit some students. In many states, a teacher who has taught for three years becomes eligible for tenure. Once a teacher has tenure, it is very difficult and costly to fire him/her.

"In New York City, the cost to fire one incompetent tenured teacher is about $250,000, said Education Department spokeswoman Melody Meyer [in 2008]. She said that of 55,000 teachers on staff, 10 were fired last year" 
(http://www.msnbc.msn.com/id/25430476/ns/us_news-education/).


As many others have pointed out, the long term growth and wealth of the U.S. depends on our producing educated workers. Demonizing teachers is not in our own self-interest. We need to draw top graduates into teaching. We also need to be able to fire under-performers, regardless of how long they have been teaching. Top work needs to be rewarded with top pay.  These are the real issues that need to be resolved with the unions. 

Chris Farrell's Bloomberg Business Week (3-1-2011), "Why Teachers and their Critics are Failing"

To take two excerpts from the Farrell's article:

"Consultants at McKinsey figure that if the U.S. had closed the achievement gap with the best-performing nations from 1983 to 1998, America's gross domestic product could have been $1.3 trillion to $2.3 trillion higher than it actually was in 2008. To put this in perspective, during the recent recession the U.S. economy fell about $1 trillion short of its output potential."  So every year, education shortfalls are costing us more than the recession.


"Hanushek figures replacing the bottom 5 percent to 8 percent of teachers with average teachers would move the U.S. toward the top of international science and math rankings."  


The prestigious Teach for America Program has made it cool for graduates of top colleges to become  teachers - and produced impressive results in the classroom. Wendy Kopp, the founder of Teach for America, talks about the importance of recruiting the best students into the teaching profession.



In addition to reforming teaching contracts in public schools, charter schools and vouchers to private schools, are likely to be a part of the policy debate in the next decade.

Ideally, all public sector unions will face pressure for a stronger link between pay and performance. We need to reward qualified workers in government too (and to fire under-performers).  We want bright, well paid Wall Street regulators who aren't waiting to jump ship for lucrative private sector jobs.