Changing the Goalposts

The Senate Foreign Relations Committee vote today (10-7) in favor of an amended resolution in favor of military action against Syria contained significant changes from the original draft. At the insistence of Sen McCain the resolution now includes language committing the US to changing the balance of power on the battlefield in Syria. The resolution now goes beyond what the President indicated as his goal, punishing Assad for the use of Chemical weapons. The process is now thoroughly confused as to the goal.

It didn't make much sense to me to have the US military kill people because Assad killed people. Now the goal of launching military force to bring Assad to the negotiating table with the rebels sounds like a significant escalation, even with the restriction of no US troops on the ground. Worse, it is a continuing line of thought that I have heard since Vietnam about the vain hope for a democratic element between bad choices at either end of the spectrum. Through military action we can encourage democratic elements that will (miracle of all miracles) come into line with US values and foreign policy objectives. If you buy that I have a unicorn to sell you.

In the mean time there are two million refugees from Syria that could use significant help. The situation is so bad people are leaving Syria to go to iraq.

How Wrong Can One Column Be?

In Saturday's NY Times Roger Cohen has a column bemoaning the threat to the so-called "special relationship" between the US and the UK because of the Parliamentary vote against PM Cameron's proposal to support military action against the Syrian regime because of their use of chemical weapons. Who is the villain in this set piece by Cohen? Well it turns out it to be Ed Miliband the leader of the opposition Labor Party. Why? Because Miliband does not want to give carte blanche to the US for determining the direction of the British foreign policy.

Syrian refugees fleeing to Turkey from the NY Times

Cohen, whose newspaper played a sorry role in promoting the lies of the Bush Administration in the run-up to the Iraq War, passes off the lies that infuriated the British public (particularly Labor Party supporters who left the party in droves for the anti-war Liberal Democrats) as "cherry picking". Cohen is sharp enough to understand that the British people are a bit skeptical of US claims (of anything really) that seem to justify war. Yet he ignores the evidence he suggests, and which as a Political Scientist I can see is rather damning for the chance of the US convincing these folks of anything. He also makes reference to disagreements in the past, such as the Suez Crises, but why did those disagreements (the UK left Iraq long before the US) not end the special relationship? Considering the history from colonial times obviously the US and the UK have managed to work together pretty well all things considered. So what if there are different approaches to the value of military intervention with respect to the horrid Assad regime (which has existed through two generations).

Perhaps the weirdest part of the column was his attack on Miliband. He claims that Ed's brother, David, would have supported the motion. He may have but I wonder how much of the labor party would have been left after such an action. Cohen seems to forget that the Blair government went out of their way to deceive the world about the intelligence on Iraq. They sent representatives to DC just before the release of their deceptive dossier and had it edited by the Bush Administration before they released it to the British public. It is entirely understandable that politicians of all stripes (many Tories and LibDems voted against the motion or abstained as well) would be reluctant to go down the road to war. Just a few months ago, Blair in a BBC interview brushed off the lies, justifying the war on the basis of the horror of the Hussein regime. Apparently Cohen and Blair do not find democratic processes more than niceties to be subverted. I wonder how Cameron feels about it today?

(There was some comic relief in his column as he claimed that Miliband's problem was that he had no connection to the US. Apparently he neglected to look at his CV which showed time living in Boston as a child and adult. Ed is a Boston Red Sox and NE Patriots fan to boot. So perhaps this is all Yankee fan claptrap.)

Happily today President Obama decided that the constitutional process could work in the US and he will share decision-making with Congress. Perhaps the discussion will be an honest one and members will point out to the world that their will be innocent loss of life in these strikes. The terrible irony is that   because of the constraint on international action Assad can't be held responsible directly. So civilians will die so we can protect civilians from attrocity. Is this the best way? It would be a good conversation to have as we and the civilian population of the country still pay the price for the Iraq War. Sorry Mr. Cohen but they still are related and we live in a country that has deep suspicion about these types of pronouncements.

Other sources

http://www.theguardian.com/world/2013/aug/30/syria-us-intelligence-dossier-prelude-strike

http://www.theguardian.com/politics/2004/may/09/davidkelly.uk

Capital Flows and QE

There is significant discussion among economists and media observers about the growing momentum of capital flows leaving emerging economies particularly in Asia. In recent weeks we have seen a major drop in the values of currencies such as the Indian Rupee and the Indonesia Rupiah.

US Dollar Value of Indonesian Rupiah

To some extent this is predictable. Because the US Federal Reserve has signaled a winding down of its latest Quantitative Easing (QE) effort, US interest rates have started to rise. The rise in interest rates indicate an expected increase in the rate of return on funds invested in the US. Therefore, funds will flow from other parts of the world into the US. This is seen in the appreciation of the value of the dollar versus the currencies who might have strengthened during the period when interest rates were near 0 in the US.

US Dollar Value and Indian Rupee

This pattern is reproduced in India, Malaysia and Singapore over the same period. Is there a danger to their economies from the depreciation in their currencies? In the capital outflows? Part of the answer comes from the analysis of the source of the capital inflows in previous years. In today's Financial Times there is an in depth analysis of this question and concludes...

"Mr Lai makes a broader point about Asian foreign exchange reserves as a whole. Between 2008 and 2012, the total accumulated by China, India, Korea, Taiwan, Hong Kong, Singapore, Indonesia, Malaysia, Thailand and The Philippines almost exactly matches the growth in the US Federal Reserve’s balance sheet due to quantitative easing. As he says, the correlation appears very high."

It will take a bit of time to make sure this correlation reveals causality but it does match theory. The flood of cash used to prop up the banks in the US and other advanced economies flowed to emerging economies which had potentially higher rates of return. Unlike the 1990's when that flow represented loans denominated in dollars recent capital flows have been int he form of FDI (Foreign Direct Investment) which might not be so destabilizing unless there is wholesale divestment. So far there is a split in this analysis with Krugman saying it is a natural rebalancing and not much of a problem and others saying a new crisis could be on the horizon.

The issue that comes to mind is whether these countries have the capability of protecting their currency and their capital basis from these runs. Economists hate capital controls and see them as an impediment to further investment and inevitably ineffective. But if the recent depreciations herald a major outflow with consequences (stagflation on a major scale say) then the emerging countries will need to examine these tools to control capital in and out.

Constraints II - College Loans

This summer we went to the brink on the student loan bill and the Congress eventually passed a version that had overwhelming support. The President signed the bill into law and said, "our job is not done". The President is correct because due to the self imposed constraints on the discussion, the result is a bill which potentially leaves higher education in significant financial straits. The goal for reasons unknown, was to allow college loan rates to fluctuate with the market. Apparently members of Congress and the President think there is a market for interest rates. The public justification was this would get "politics" out of setting the rates, apparently Congress couldn't be trusted to balance the concerns of affordability of education, "costs" and interest rates.

Since 2007 Congress had fixed interest rates which reached a level on Stafford loans at 3.4% for undergrad and 6.8% for graduate loans. We will skip the obvious question as to why there is a surcharge for graduate students (obviously causing bigger interest costs hopefully offset by higher lifetime earnings, unless you are a public school teacher who is required to take the classes and pay the money). As you can see from the following graphic, interest rates in recent years have been very low as a result of extraordinary efforts by the Federal Reserve to keep the economic implosion from getting worse. So the federal government   has been taking in more money than they have been lending as a result of the fact that the Feds can borrow at far less than the rates charged to students.

One important constraint is the justification for the surcharge in the form of a claim of high collection costs for student loans. The theory goes that because there is a default rate for student loans there should be a recovery in the form of higher rates for all borrowers? Why should a diligent repayer have to shoulder the burden of a higher cost because a small number of students default? How is that their fault exactly? In essence the government is increasing the likelihood of default by making students pay higher interest rates as a result of some other students defaulting (many of whom never graduate and never get to benefit from the higher lifetime earnings). 

The major issue is the contention that somehow the market sets interest rates. Nothing could be further from the truth. Go back to the graphic which shows the Federal Funds rate over the past six decades. This is the rate set by the Federal Reserve s a result of their open market operations. Notice the large fluctuations? It is because they set the rates in response to the goals of monetary policy. Higher rates, less demand in the economy. So how does the market set 10 year government debt rates? The market determines whether the rate is 2.8% or 2.9%. The Federal Reserve determines whether it is 2.8% or 4%; what does this have to do with a fair rate for student loans?

Since Congress has rarely used fiscal policy in recent decades, monetary policy has become more salient. So why should college student loans be tied to the tool of monetary policy? Wouldn't a more rational policy based on some idea of fairness and the acknowledgement that market mechanisms overprice college loans (the whole reason we have government loans and guarantees in the first place)? If the societal return is such that permanent rates of 3.4% work why not leave them there permanently instead of the possibility of huge fluctuations causing problems for the higher education sector? 

The NYTimes and Math

My internet friend Dean Baker (whose blog is a daily breakfast treat) was a bit busy to take on this whopper from Thursday's NYTimes on economic growth. Apparently the reporter was bound and determined to show that growth in the advanced countries (US, Europe and Japan) was taking over the BRIC's as an engine of worldwide economic growth. After telling us that the EU posted a 1.2% annual growth rate for the second quarter over the first, Nathaniel Popper claimed that economic acceleration is coming from the "old world".

Perhaps the most invidious aspect of the article was the info graphic here which shifted to nominal dollar figures to compare the four BRIC countries against the US, the 27 European Union Countries and Japan. Outside of comparing 29 countries (with larger economies) with 4 (with larger populations) and the fact that the graphic still showed the 4 with nominal increases greater than than the 27, and ignoring whatever index they use for the various currencies, they then slip in a pretty picture about relative stock market performance. Apparently they didn't read any of the many articles in the NYTimes about the huge injections of liquidity into the economies of Japan and the US, and to a lesser extent Europe, which have helped propel the stock markets to new highs. The BRIC's haven't been participating in the same manner. In fact, what they have showed is that stock market performance looks to be a function of central bank activity (that would be an interesting article).

Now the reporter might be forgiven for all of this if he wasn't very adept at simple excel formulas where he could have compared the relative sizes of the US and China economies and their growth over the past year. Basically China and 7% is bigger than the US and 1.4%, even given that the US economy is a bit bigger than that of China. The punch line of course is the press release from the EU indicating that year over year growth for the EU was a NEGATIVE 1.4%. They will not be much help to the global economy until they get off the austerity kick which has decimated the economies of Spain, Portugal, Greece, Ireland, Latvia, Cyprus, Italy, etc... Need more proof, check out the shrinking workforce in these countries, here. I get that the newspaper business is a bit stretched these days which is why we have seen such rapid changes in ownership, but I would hope the NYTimes could invest in some editors that could force their reporters to do some basic math.

Constraints I - Home ownership

I am outlining a work on public policy focusing on a theory of public policy constraints, meaning what limits are placed on the discussion of policy solutions based on what is acceptable within the political, economic and social environments. I want to illustrate this with a discussion here of homeownership policy. In a subsequent post I will use the same framework to discuss the last phase of the debate over college loans.

Gretchen Morgenson has a piece in Saturday's NY Times (August 11) on the Administration's proposals related to the secondary mortgage market. She makes the point (primarily that there are many details still to be revealed by the Admin and the Senate which is working on a bipartisan solution), that in mortgages there are two primary types of risk; default risk and interest rate risk. Fannie Mae and its little cousin Freddie Mac are in the business of providing secondary support for the mortgage market. As banks provide mortgages that meet the underwriting requirements of the firms, they purchase the mortgages which provides a fee for the banks and further liquidity to make more home loans.

The firms went public and had a Board and management that operated them in a "for-profit" manner. They got into serious trouble last decade as their portfolio of Mortgage Backed Securities (MBS) ballooned. Apparently the Board was concerned that they were losing market share to firms actively engaged in the sub-prime market. Since they were prohibited from purchasing loans from that segment they instead purchased MBS which tanked in value as the housing bubble burst. To compound the problem, Fannie and Freddie were highly leveraged and nobody thought to point out the difficulty of a business model that involved borrowing money to buy risky bonds. As they went under in 2008, the Bush Administration stepped in and seized the firms resulting in overwhelming government ownership of the entities. Even though there was no explicit government backing of the firms, the government determined that the impact on the housing market and the economy would be too bleak if they were left to fail. The government injected significant capital into the firms; and after a few years the firms are now repaying the government at a fast enough pace that there is a good chance of a profit.

The fate of the firms has improved because of the decrease in the default rate on loans as shown in the figure above. The firms have a commitment to repurchase mortgages that they package into securities if the mortgages fall into delinquency. With less delinquencies and stronger numbers in the housing market the firms are strengthened and profitable. This is despite the fact that with the crash of the housing bubble Fannie and Freddie were responsible for almost 90% of the underwriting of the market. The credit crunch after the crash meant that the private market for secondary mortgages dried up. With Fannie and Freddie under government control the mortgage market was able to recover even after the devastation of MBS and other forms of securitization.

Given strong quarterly results they are paying substantial dividends to the government. Yet, the President and Congress are working on proposals to return control to the private sector. It is not entirely clear how much of the slack the private sector will be able to absorb. The interesting question is why? Given the progress and stability of Fannie and Freddie under government control (which is how they started many years ago) why is there concern about ending that steady hand? This is the point of the concern about constraints. In US policy discussions and the development of solutions, why have the government do it if the private sector is willing?

This prejudice against government activity smacks more of ideology rather than analysis of what works for the public. The US Government supports the market for homeownership in a thousand ways big and small. The imputed rental value of owner occupied housing (wonkish), the deductibility of mortgage interest, the deductibility of property taxes, some purchase expenses, the capital basis of housing investment, etc... are all valuable means the government has for participating in the market. They represent a subsidy for the ownership of housing at the expense of those that rent (and the benefits largely to those with high incomes that can itemize). There are some small programs that subsidize and encourage the development of affordable housing, but the major constraint in this area, as well as others, is the prejudice against overt government action. It is fine if government support comes through tax expenditures, just don't have government do something where there is a potential profit to be made by the private sector. And oh by the way, it is fine if you keep the government in the business of guarantees so they can help insure the private sector risk. As Joe Nocera of the NY Times points out, Fannie and Freddie are very effective at both the underwriting risk and the interest rate risk. They can afford to hold the mortgages and hedge risk so the value of their binds does not crater as interest rates rise. Why foist this problem on the private sector only to come to their rescue when the trouble starts?

Resources

http://finance.fortune.cnn.com/2013/08/08/fannie-freddie-mortgages/
http://www.cbo.gov/publication/43691

Perspective on youth unemployment

The World Economic website which provides economics commentary and research has an interesting piece on youth unemployment. They compare the experiences of Germany and Singapore with that of the rest of the advanced world. They are particularly interested in the variables of education, meaning do the standard western universities prepare students for todays jobs (with the emphasis on ICT) or they based on an outdated model? They find that Germany has much less of a problem of youth unemployment than the rest of Europe (7.9% versus 22.6% in the rest of the EU). Singapore, which wins raves for its efforts to promote innovation, rates highly in their index for Global Competitiveness.

Yet they seem to miss the point. Germany and Singapore have lower unemployment rates in general compared to the EU and most all advanced economies. Why? Is it because of their specific policies related to innovation? Or rather their efforts to promote exports which allow them to run a decided current account surplus. I conclude it is more the latter than the former, and as always it can't be sustainable or rather transferable to other economies.

The observation is not unique and has been commented on by other economists such as Krugman. If you want to lower unemployment you need to generate demand. While not everyone can do that through exports (for every surplus dollar in places like Germany, Singapore and China there must be a deficit in the US, Greece, Spain, and elsewhere), everyone can do it through fiscal and monetary policy. Instead of using the "race to the bottom" wage policies advocated by Tse, Esposito, et al which will only displace unemployment from children to parents, why not generate enough demand to increase employment across the board?

Of course doing that implies you end austerity.