Those marked with * are identified as especially worthy of reading.
 

*1. Inflation is looming on America’s horizon
2. U.K. Retail Prices Fall for First Time Since 1960
3. U.K. Government to Adopt More Active Role in Economy
*4. Geithner Defends Bank-Lending Decline
5. A Backdoor Nationalization
*6. Henry Kaufman: What the Fed Missed
7. Not All Large Institutions Are Too Big to Fail
8.  Reform, Backdoor Nationalization, Regulation
9. Corporate Welfare, Negative Rates, Accountin
10. Why Capital Structure Matters By MICHAEL MILKEN
11. Europe's Forceful Response to the Financial Crisis The ECB and euro-area governments are acting boldly.
*12. What’s a Global Recession?
13. Secretary Timothy F. Geithner Remarks before The Economic Club of Washington
*14. Will Crony Capitalism Produce Strong Growth? By Lawrence Kudlow
.*15. ..and socialism By Bernie Sanders
*16. IMF Says Recession Is Deepening
*17. Erin Go Broke  By PAUL KRUGMAN
*18. Europe's Grim Outlook Challenges World Recovery
*19. Financial Reforms We Can All Agree On Rating agencies should use numbers, not letter grades.
20. Long Odds? Three Scenarios for the Economy's Path
21. Preferences for redistribution: The crisis, reduced inequality, and soak-the-rich populism
22. Economists React: ‘Plunge Is Over’ in Existing-Home Sales
23. FDIC Chief Says Banking Sector ‘Past the Crisis Stage’
24. IMF Protestors Getting Leaner and Meaner
*25.Doctor Doom The Global Economy In The Next Year
*26. Europe's Grim Outlook Challenges World Recovery
*27. Financial Reforms We Can All Agree On Rating agencies should use numbers, not letter grades.
28. Preferences for redistribution: The crisis, reduced inequality, and soak-the-rich populism
29. Economists React: ‘Plunge Is Over’ in Existing-Home Sales
30. FDIC Chief Says Banking Sector ‘Past the Crisis Stage’
31. IMF Protestors Getting Leaner and Meaner
*32. The Global Economy In The Next Year  Nouriel Roubini, 04.23.09, 12:00 AM EDT
**33. Monetarism Defiant Legendary economist Anna Schwartz says the feds have misjudged the financial crisis.
*34. Japan Girds for Record Contraction
35. JAPAN PAYS FOREIGN WORKERS TO GO HOME
36. The world economy A glimmer of hope?
37. GM Offers U.S. a Majority Stake Bondholders Balk at Plan; UAW Poised to Get Big Stakes in General Motors, Chrysler
38. Free Trade: Not So Bad
39. Nation’s Goods-Producing Sector Continues to Shrink
*40. How libertarian dogma led the Fed astray By Henry Kaufman
*41. Henry Kaufman's Narrative of the Crisis Arnold Kling
42. Brace Yourselves For First-Quarter GDP
*43. Financial Crisis and the Panic of 2008
*44. U.S. Economy Shrank at 6.1% Rate in First Quarter
*45. Citi Seeks Approval to Pay Out Bonuses
46. Economists React: ‘Obvious Glimmers of Hope’ in GDP
47. Secondary Sources: Long Recession, Continued Troubles, Bear and AIG
48. Views on the Economy and the World
*49. 12 Reasons To Be (Economically) Optimistic
*50. OBAMA'S 100 DAYS: MODELING ROOSEVELT by Amity Shlaes
 
 
 
 
 
 
 
 
 

1. Inflation is looming on America’s horizon

By Martin Feldstein
http://www.ft.com/cms/s/0/ae436dbc-2d09-11de-8710-00144feabdc0.html?nclick_check=1
 

Published: April 19 2009 18:54 | Last updated: April 19 2009 18:54

The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.

The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.
EDITOR’S CHOICE
In depth: US downturn - Mar-13
US to put conditions on Tarp repayment - Apr-19
Recession turns heat up for men - Apr-19
Fed chief warns against stifling new ideas - Apr-17

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.

The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.

So the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases.

A primary example of this was the sharp fall in inflation in the US in the early 1980s at the same time that fiscal deficits were rising rapidly. Inflation fell because the Federal Reserve tightened monetary conditions and allowed short-term interest rates to rise sharply.

But now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. The broad money supply (M2) is already increasing at an annual rate of nearly 15 per cent. The excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now.

The money supply consists largely of government-insured bank deposits that households and businesses are holding because of a concern about the liquidity and safety of other forms of investment. But this could change when conditions improve, turning these money balances into sources of inflation.

The link between fiscal deficits and money growth is about to be exacerbated by “quantitative easing”, in which the Fed will buy long-dated government bonds. While this may look like just a modified form of the Fed’s traditional open market operations, it cannot be distinguished from a policy of directly monetising some of the government’s newly created debt. Fortunately, the amount of debt being purchased in this way is still small relative to the total government borrowing.

The Fed is also creating a massive increase in liquidity by its policy of supplying credit directly to private borrowers. Although these credit transactions do not add to the measured fiscal deficit, the unprecedented Fed purchases of more than $1,000bn of private securities have led to the enormous $700bn increase in the excess reserves of the commercial banks. The banks now hold these as interest-bearing deposits at the Fed. But when the economy begins to recover, these reserves can be converted into new loans and faster money growth.

The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.

This will not be an easy task since the commercial banks may not want to exchange their reserves for the mountain of private debt that the Fed is holding and the Fed lacks enough Treasury bonds with which to conduct ordinary open market operations. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.

The writer is professor of economics at Harvard and president emeritus of the National Bureau of Economic Research. He chaired the Council of Economic Advisers under President Reagan and is a member of President Obama’s Economic Recovery Advisory Board

  WSJ   * April 17, 2009, 3:36 PM ET
 
 

  WSJ  * APRIL 21, 2009, 5:46 A.M. ET

2. U.K. Retail Prices Fall for First Time Since 1960
 

By JOE PARKINSON

LONDON -- U.K. retail prices fell on a year-to-year basis for the first time in nearly 50 years in March, while consumer price inflation continued to show more resilience than had been expected, the Office for National Statistics said Tuesday.

The March retail price index, the broadest measure of price pressures, was flat on a monthly basis and fell 0.4% year-to-year, the ONS said. That marks the lowest annualized rate since March 1960.

The decline was expected by most economists as the measure incorporates mortgage-interest payments, which have fallen heavily in recent months as the Bank of England has slashed interest rates to get the British economy back on track.

Falling prices in March could raise the specter of sustained price falls and wage cuts as the U.K.'s shaken economy faces its worst recession since World War II. It also spells more bad news for Prime Minister Gordon Brown's government ahead of Wednesday's crucial budget statement.

Economists said the falls would likely continue in response to declining global demand. "U.K. inflation is still set to drop a lot further and the threat of a broader bout of deflation has not yet evaporated," Capital Economics said in a research note.

Meanwhile, the March consumer price index again showed more resilience than expected, rising 0.2% month-to-month and 2.9% on an annualized basis, after gaining 0.9% on the month and 3.2% on the year in February.

Economists had expected consumer prices to rise 0.1% month-to-month and 2.7% year-to-year as part of a rapid decline in inflationary pressures amid a sharp economic downturn. The higher-than-expected data could prove troubling to the Bank of England, which has aggressively used monetary policy to combat the downturn.

Inflationary pressures in the index were fairly broad-based. Many categories revealed solid price pressures, with the biggest increases coming from food and nonalcoholic beverages, recreation and culture, and clothing and footwear.

ONS officials said there was some evidence that businesses had experienced the impact of exchange-rate weakness and import prices in pushing prices higher.

Core inflation pressures also remained elevated. Stripping out food, energy, alcoholic beverages and tobacco, core CPI rose 0.4% on the month and 1.7% on the year.
—Associated Press contributed to this article.
 
 
 
 
 
 

  WSJ   * EUROPE NEWS
    * APRIL 21, 2009

3. U.K. Government to Adopt More Active Role in Economy
 

By LAURENCE NORMAN and ALISTAIR MACDONALD

LONDON -- The U.K. government promised a new, more activist approach to industrial policy Monday, signaling it was readying action to support firms in key sectors.

The new strategy, which was announced by Business Secretary Peter Mandelson, could represent a sharp shift in U.K. policy, bringing it more in line with interventionist strategies employed by the likes of France and Germany.

With the budget statement due Wednesday, the report lays out a number of areas for "immediate action and reform," he said.

It includes support for small high-growth, high-innovation firms -- possibly through a new private-public organization to channel venture capital. Other actions under consideration include using government buying power to bolster innovation and skills and "concerted action" to help specific sectors, like pharmaceuticals, aerospace, life-science firms and the low carbon sector.

The government also signaled more support for exporters, possibly through export guarantees.

Since his return to the government in October, Mr. Mandelson has spoken several times about bolstering the government's role in industry as a means of helping the U.K. recover from its worst downturn in decades. The government has also offered a broad package of guarantees for U.K. companies and targeted support to troubled sectors, like the auto industry.

It isn't clear yet how much, if any money, the government will put behind the plans. A spokesman at the business department declined to comment on whether any measures will be specifically introduced in the budget.

One project that has been specifically mentioned by Mr. Mandelson in the past is the creation of a new public-private partnership which would channel venture capital into small, up-and-coming firms. The new entity would be modeled on the post-World War II Industrial and Commercial Finance Cooperation, which provided investment capital to some 11,000 companies in its five-decade history.

The ICFC was privatized in 1994, becoming private equity group 3i.

Officials made it clear the new approach isn't about creating national winners or seeking to revise European state aid law. Mr. Mandelson said the U.K. government can no longer afford a hands-off approach.

"To succeed in this hi-tech, low carbon economy of the future, to drive growth and to secure more high-value jobs in the U.K., we need to act. It's not about picking winners or ignoring market signals, but removing barriers which hold business back," he said in a statement.

The government's announcement was welcomed by the Confederation of British Industry.

"Business will need the right conditions if it is to flourish after the recession and the CBI would welcome a more active government approach to help foster them," said CBI Deputy Director John Cridland.

He said it is also encouraging that "the benefits of smart procurement have been recognized and that new ideas to increase the supply of risk capital for innovative businesses are being explored."

Write to Laurence Norman at laurence.norman@dowjones.com and Alistair MacDonald at alistair.macdonald@wsj.com
 
 
 
 
 
 
 
 

  WSJ  * APRIL 21, 2009, 11:21 A.M. ET

4. Geithner Defends Bank-Lending Decline
 

By MEENA THIRUVENGADAM and JEFF BATER

WASHINGTON -- U.S. Treasury Secretary Timothy Geithner on Tuesday defended a decline in lending by a selection of the nation's largest banks.

"In normal recessions, demand for credit falls. In recessions that are following a long period of substantial borrowing, demand for credit falls much more sharply. This is such a moment," he said in remarks prepared for an appearance in front of the Congressional Oversight Panel, one of several entities overseeing government bailout efforts.

Still, Mr. Geithner pointed to improvements in the credit markets such as a drop in credit spreads and a rise in corporate-bond issuance. Asset-backed-securities issuance also is up, he said, noting that, "Despite these improvements, the cost of credit is still very high."
More

    * Read the complete report from the Special Inspector General for TARP.

Mr. Geithner in his remarks outlined steps Treasury has taken to combat the financial crisis and spoke about the need for revamped regulation of financial institutions.

"This financial crisis has shown that the largest financial institutions can pose special risks to the financial system as a whole," he said.

Mr. Geithner reiterated that Treasury has been aiming to resolve the financial crisis at a minimum cost to taxpayers.

Treasury estimates nearly $110 billion in Wall Street bailout money is available from the $700 billion originally authorized, Mr. Geithner said in a letter Monday to Elizabeth Warren, the head of the oversight panel. In the letter, Mr. Geithner also gave a breakdown of Troubled Asset Relief Program funds.

TARP was created by Congress under the Emergency Economic Stabilization Act of 2008 to save Wall Street from financial crisis. One part of TARP is a preferred stock-and-equity-warrant purchase program known as the Capital Purchase Program.

"Today, Treasury estimates there is at least $109.6 billion in resources authorized under EESA still available, but we anticipate that $25 billion will be paid back under the CPP over the next year -- for a total of $134.6 billion," Mr. Geithner said in the letter.

Treasury projects use of funds under the previous administration's programs is at $355.4 billion, including $218 billion under the CPP. Projected use under Obama administration programs is $235 billion.

Write to Meena Thiruvengadam at meena.thiruvengadam@dowjones.com and Jeff Bater at jeff.bater@dowjones.com

  WSJ   * APRIL 21, 2009

5. A Backdoor Nationalization
The latest Treasury brainstorm will retard a banking recovery.
 

Just when you think the political class may have learned something in months of trying to fix the banking system, the ghost of Hank Paulson returns to haunt the Treasury. The latest Beltway blunder -- and it would be a big one -- is the Obama Administration's weekend news leak that it may insist on converting its preferred shares in some of the nation's largest banks into common equity.
[Review & Outlook] AP

Timothy Geithner.

The stock market promptly tumbled by more than 3.5% yesterday, with J.P. Morgan falling 10% and financial stocks as a group off 9%, as measured by the NYSE Financials index. Note to White House: Sneaky nationalizations aren't any more popular with investors than the straightforward kind.

The occasion for this latest nationalization trial balloon is the looming result of the Treasury's bank strip-tease -- a.k.a. "stress tests." Treasury is worried, with cause, that some of the largest banks lack the capital to ride out future credit losses. Yet Secretary Timothy Geithner and the White House have concluded that they can't risk asking Congress for more bailout cash.

Voila, they propose a preferred-for-common swap, which can conjure up an extra $100 billion in bank tangible common equity, a core measure of bank capital. Not that this really adds any new capital; it merely shifts the deck chairs on bank balance sheets. Why Treasury thinks anyone would find this reassuring is a mystery. The opposite is the more likely result, since it signals that Treasury no longer believes it can tap more public capital to support the financial system if the losses keep building.

Worse, wholesale equity conversion would mean the government owns a larger share of more banks and is more entangled than ever in their operations. Giving Barney Frank more voting power is more likely to induce panic than restore confidence. Simply look at the reluctance of some banks -- notably J.P. Morgan Chase -- to participate in Mr. Geithner's private-public toxic asset sale plan. The plan is rigged so taxpayers assume nearly all the downside risk, but the banks still don't want to play lest Congress they become even more subject to political whim.

A backdoor nationalization also creates more uncertainty, not less, by offering the specter of an even lengthier period of federal control over the banking system. And it creates the fear of even more intrusive government influence over bank lending and the allocation of capital. These fears have only been enhanced by the refusal of Treasury to let more banks repay their Troubled Asset Relief Program (TARP) money.

As it stands, banks and their owners at least know how much they owe Uncle Sam, and those preferred shares represent a distinct and separate tier of bank capital. Once the government is mixed in with the rest of the equity holders, the value of its investments -- and the cost to the banks of buying out the Treasury -- will fluctuate by the day.

Congress is also still trying to advance a mortgage-cramdown bill that would hammer the value of already distressed mortgage-backed securities, and now the Administration is talking up legislation to curb credit-card fees and interest. Both of these bills would damage bank profits, but large government ownership stakes would leave the banks helpless to oppose them. (See Citigroup, 36% owned by the feds and now a pro-cramdown lobbyist.)

We've come to this pass in part because the Obama Administration is afraid to ask Congress for the money for a meaningful bank recapitalization. And it may need that money now in part because Mr. Paulson's Treasury insisted on buying preferred stock in all the big banks instead of looking at each case on its merits. That decision last fall squandered TARP money on banks that probably didn't need it and left the Administration short of funds for banks that really do.

The sounder strategy -- and the one we've recommended for two years -- is to address systemic financial problems the old-fashioned way: bank by bank, through the Federal Deposit Insurance Corp. and a resolution agency with the capacity to hold troubled assets and work them off over time. If the stress tests reveal that some of our largest institutions are insolvent or nearly so, it's then time to seize the bank, sell off assets and recapitalize the remainder. (Meanwhile, the healthier institutions would get a vote of confidence and could attract new private capital.)

Bondholders would take a haircut and shareholders may well be wiped out. But converting preferred shares to equity does nothing to help bondholders in the long run anyway. And putting the taxpayer first in line for any losses alongside equity holders offers shareholders little other than an immediate dilution of their ownership stake. Treasury's equity conversion proposal increases the political risks for banks while imposing no discipline on shareholders, bondholders or management at failed or failing institutions.

The proposal would also be one more example of how Treasury isn't keeping its word. When he forced banks to accept public capital whether they needed it or not, Mr. Paulson said the deal was temporary and the terms wouldn't be onerous. To renege on those promises now will only make a bank recovery longer and more difficult.
 
 
 
 
 
 

6. Henry Kaufman: What the Fed Missed

By David Wessel

What did the Federal Reserve miss that contributed to today’s crisis? “That financial deregulation still facilitates the creation of debt because it spurs competition and reinforces the drive for new markets and enlarged market standing. Monetary policymakers neither anticipated these realities, nor incorporated them into its policy calculations,” Henry Kaufman, the former Salomon Brothers economist, now president of Henry Kaufman & Co, told a conference today sponsored by the Levy Economics Institute of Bard College.

“The Federal Reserve also failed to grasp early (or, with sufficient clarity, later on) the significance of financial innovations that, by their very nature, facilitate the creation of new credit — innovations that could not have been financed at all using earlier techniques. Perhaps the most far-reaching of these innovations was the securitization of non-marketable obligations. This tended to create the illusion that credit risk could be reduced if the instruments become marketable,” Kaufman said.

“Moreover, elaborate new techniques employed in securitization (such as credit guarantees and insurance) blurred credit risks and — from my perspective many years ago — raised the vexing question, “Who is the real guardian of credit?” Instead of addressing these issues, the Federal Reserve actually was highly supportive of securitization. Alan Greenspan, when he was Fed Chairman, stated that securitization was very beneficial because it helped spread risk over a broader spectrum of the financial markets.”

“One of the Federal Reserve’s biggest blind spots when it comes to structural changes has been its failure to recognize the problems that huge financial conglomerates would pose for financial stability — including their key role in the current debt overload,” he added.

And that’s not all: “My second major concern about the conduct of monetary policy is the Fed’s prevailing philosophy of economic libertarianism. At the heart of this economic dogma, as it pertains to monetary policy, is the belief that markets know best and that those who compete well will prosper while those who do not will fail.” Kaufman said, according to a text distributed by his office.

This belief, he said,

    * explains to a large extent why the Fed did not strongly oppose the removal of the Glass-Steagall Act, which in turn contributed to a massive consolidation of the financial system.
    * helps explain why the Fed failed to recognize that abandoning Glass Steagall created more institutions that were “too big to fail.”
    * diminished the supervisory role of the Fed, especially its direct responsibility to regulate bank holding companies.
    * contributed, as hands-on supervision slackened, to a trend towards making quantitative risk modeling increasingly acceptable.
    * inhibited the Fed from using the bully pulpit or moral suasion to constrain market excesses.
      underpinned its view that it couldn’t recognize a credit bubble in advance, though knew what to do when one burst.

Kaufman called for a new Federal Financial Oversight Authority to oversee too-big-too-fail institutions, and said the head of the new agency should sit on the Fed’s interest-rate setting committee. The new agency would assess capital adequacy and soundness of trading practices as well as set limits on derivatives.
 
 

7. Not All Large Institutions Are Too Big to Fail
Posted by Deborah Lynn Blumberg

http://blogs.wsj.com/economics/
 

Certain firms are not too big to fail and must be allowed to do so to help the U.S. economy and financial markets heal, Federal Reserve Bank of Kansas City President Thomas Hoenig said Tuesday.

hoenig_blog_20071031153330.jpgHoenig said that protecting the country’s largest institutions from failure risks prolonging the current crisis and increasing its cost. Of particular concern, he said, is that financial support provided to these firms gives them a competitive advantage over other firms and subsidizes their growth and profit with taxpayer funds.

“The United States currently faces economic turmoil related directly to a loss of confidence in our largest financial institutions because policymakers accepted the idea that some firms are just “too big to fail,’” the central banker said. “I do not.”

The central banker was delivering a prepared statement before the Joint Economic Committee of the U.S. Congress. Also appearing at the hearing were former IMF chief economist Simon Johnson and Nobel laureate Joseph Stiglitz. Hoenig is currently a nonvoting member of the interest-rate setting Federal Open Market Committee.

Hoenig said that pouring more money into large firms in hope of a turnaround may be tempting, but despite record levels of spending, confidence and transparency have not returned to financial markets. Key for a full economic recovery is restored confidence, Hoenig said.

Hoenig added that in “the rush to find stability,” no clear process was used to allocate TARP funds among the largest firms. That created further uncertainty, he said, and is impeding a recovery.

The central banker said that systemically important financial firms should be triaged based on their current condition. Well-capitalized firms should be left as is. Viable firms that need more capital should privately raise the capital or seek government assistance, with the taxpayer put in the senior position and the government determining the circumstances of the senior managers and directors. Nonviable institutions should be allowed to fail.

Nonviable institutions could be put into a negotiated conservatorship, as was done in 1984 with the holding company Continental Illinois, he said.

“Such a resolution process is equitable across all firms, has worked in the past, and favors taxpayers,” Hoenig said.

Past experience also suggests the approach costs much less than the alternative of not recognizing losses and allowing forbearance, he said, as Japan initially did with its problem banks during the “lost decade” and as the U.S. initially did with thrifts in the 1980s.

In his remarks, the central banker also said that regulatory reform is key as the crisis subsides and old habits remerge. Because they are complex and politically influential, “too big to fail” firms cannot be supervised on a sustained basis without a clear set of rules constraining their actions, he said. He said history has shown strong limits on leverage ratios work.

Hoenig also noted that the structure of the Federal Reserve System is not the problem, as has been recently suggested.
 
 

Secondary Sources:8.  Reform, Backdoor Nationalization, Regulation
Posted by Phil Izzo

A roundup of economic news from around the Web.

    * Education, Health-Care Reform: On his blog, OMB Director Peter Orszag makes the case for reforming education and health care. “This slowdown in the growth rate of educational attainment is a problem both in terms of attenuated economic growth (the hard head part) and increased economic disparities (the soft heart part). As Claudia Goldin and Lawrence Katz have shown, both effects are traceable to a decline in the relative supply of highly educated workers – which dampens economic growth while also increasing the wage premium for being a college grad. Said differently, the fewer college grads we produce, the slower overall economic growth and the higher the salaries for those fortunate enough to go to college. And since we know that those from lower-income families are less likely to go to college and graduate (as compared with students from higher-income families with similar test scores), the overall result is that we perpetuate inequality.”
    * Backdoor Nationalization: Writing for the Stash, Noam Scheiber looks at whether the latest comments from Treasury will amount to backdoor nationalization. “The relevant question isn’t whether converting the preferred shares into common stock moves us closer to nationalization. It clearly does, if only very literally–in the sense that the government is gaining a more explicit ownership claim in the process. The question is closer relative to what. My sense is that Treasury is considering this step only in the case of banks that do poorly on the stress tests. Now, for such a bank, I can imagine three options other than the conversion that’s on the table: One is to urge it to raise money from private investors, which seems extremely unlikely to happen. How attractive is a bank going to be when Treasury has effectively proclaimed it a stress-test flunkie (even if it doesn’t quite put it that way). Option two is to inject more TARP money, which would presumably be in the form of equity, since Treasury apparently considers preferred shares to be debt and wouldn’t want to increase the bank’s debt burden. (And because additional injections of capital without giving taxpayers a share of the upside is probably tougher to justify politically these days.) Option three would be to seize the bank outright, FDIC-style. So, of the three options other than conversion, the first is a non-starter and the second and third would mean an even bigger role for the government than conversion. If those are the relevant choices, it seems hard to interpret the conversion idea as a sign Treasury is bent on nationalization.”
    * Self Regulation: Mark Thoma writes that self regulation doesn’t work. “I’m not ready to throw up my hands and say this is too hard, and either the private sector finds a way to take care of itself or it doesn’t get done at all. We have the capacity to learn from our mistakes, to drop ideologies and theoretical constructs that led us astray, and I have faith we will do just that. Greenspan’s conversion is a prime example. But if we fail to take the steps that are needed and rely too much on private markets to regulate themselves, we are setting ourselves up for this to happen all over again.”
 
 
 

Secondary Sources: 9. Corporate Welfare, Negative Rates, Accounting
Posted by Phil Izzo

http://blogs.wsj.com/economics/

A roundup of economic news from around the Web.

    * Corporate Welfare: Writing for the Economix blog Nancy Folbre compares welfare programs to corporate bailouts. “Robert Rector and Katharine Bradley of the Heritage Foundation, a conservative research organization, estimate that federal welfare spending amounted to $491 billion in fiscal 2008. (They don’t explain what specific programs they included in this estimate, and I’ll try to unpack it in a future post.) Even their extremely high estimate remains far below estimates of the total of $2.5 trillion spent on financial bailouts this year. The libertarian Cato Institute often emphasizes the issue of corporate welfare, but it’s remained remarkably quiet so far on the topic of bailouts.”
    * Negative Rates: Greg Mankiw writes about the possibility of negative rates in a New York Times column. “In many ways today, the Fed is in uncharted waters. So why shouldn’t the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3 percent? At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand. The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less. Unless, that is, we figure out a way to make holding money less attractive… There is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.” Also read a followup post that Mankiw put on his blog.
    * Accounting Games: James Kwak of the Baseline Scenario is skeptical about the usefulness of the government converting its preferred shares in banks into common equity. “If you don’t give a bank any more money, it doesn’t have any more money. By converting preferred into common, you haven’t changed the chances of the bank going bankrupt, because its assets haven’t changed, and its liabilities haven’t changed. If it had enough money to cover its liabilities, but it couldn’t buy back its preferred shares from Treasury, it’s not like the government would have forced it into bankruptcy anyway. If you accept the idea that converting preferred into common creates new capital, then you are implying that those preferred shares weren’t capital in the first place. From a capital perspective, then, the initial TARP “recapitalizations” did nothing, and nothing happens until the conversion. You can’t say that JPMorgan got $25 billion of capital last fall and it’s going to get another $25 billion now just by virtue of the conversion.”
    * How Bad Is It?: On Econbrowser, Menzie Chin posts graphics from the IMF’s latest World Economic Outlook that charts the severity of the recession. The charts are especially interesting when juxtaposed against a blog posting made 18 months ago. “We know this for sure: It could be a lot worse, recessions used to last almost two years during the 1854-1919 period, and 1.5 years in the 1919-1945 period. Since WWII, the average recession lasted 10 months, and the last two recessions (1990-1991 and 2001) lasted only 8 months. With the support of a booming world economy, we could expect a short and shallow 2008 recession, IF it happens. If futures trading is correct, there’s a 29% of NOT having a recession, so don’t give up hope.”

Compiled by Phil Izzo

    * APRIL 21, 2009

10. Why Capital Structure Matters By MICHAEL MILKEN
Companies that repurchased stock two years ago are in a world of hurt.

By MICHAEL MILKEN

Thirty-five years ago business publications were writing that major money-center banks would fail, and quoted investors who said, "I'll never own a stock again!" Meanwhile, some state and local governments as well as utilities seemed on the brink of collapse. Corporate debt often sold for pennies on the dollar while profitable, growing companies were starved for capital.
[Commentary] Chad Crowe

If that all sounds familiar today, it's worth remembering that 1974 was also a turning point. With financial institutions weakened by the recession, public and private markets began displacing banks as the source of most corporate financing. Bonds rallied strongly in 1975-76, providing underpinning for the stock market, which rose 75%. Some high-yield funds achieved unleveraged, two-year rates of return approaching 100%.

The accessibility of capital markets has grown continuously since 1974. Businesses are not as dependent on banks, which now own less than a third of the loans they originate. In the first quarter of 2009, many corporations took advantage of low absolute levels of interest rates to raise $840 billion in the global bond market. That's 100% more than in the first quarter of 2008, and is a typical increase at this stage of a market cycle. Just as in the 1974 recession, investment-grade companies have started to reliquify. Once that happens, the market begins to open for lower-rated bonds. Thus BB- and B-rated corporations are now raising capital through new issues of equity, debt and convertibles.

This cyclical process today appears to be where it was in early 1975, when balance sheets began to improve and corporations with strong capital structures started acquiring others. In a single recent week, Roche raised more than $40 billion in the public markets to help finance its merger with Genentech. Other companies such as Altria, HCA, Staples and Dole Foods, have used bond proceeds to pay off short-term bank debt, strengthening their balance sheets and helping restore bank liquidity. These new corporate bond issues have provided investors with positive returns this year even as other asset groups declined.

The late Nobel laureate Merton Miller and I, although good friends, long debated whether this kind of capital-structure management is an essential job of corporate leaders. Miller believed that capital structure was not important in valuing a company's securities or the risk of investing in them.

My belief -- first stated 40 years ago in a graduate thesis and later confirmed by experience -- is that capital structure significantly affects both value and risk. The optimal capital structure evolves constantly, and successful corporate leaders must constantly consider six factors -- the company and its management, industry dynamics, the state of capital markets, the economy, government regulation and social trends. When these six factors indicate rising business risk, even a dollar of debt may be too much for some companies.

Over the past four decades, many companies have struggled with the wrong capital structures. During cycles of credit expansion, companies have often failed to build enough liquidity to survive the inevitable contractions. Especially vulnerable are enterprises with unpredictable revenue streams that end up with too much debt during business slowdowns. It happened 40 years ago, it happened 20 years ago, and it's happening again.

Overleveraging in many industries -- especially airlines, aerospace and technology -- started in the late 1960s. As the perceived risk of investing in such businesses grew in the 1970s, the price at which their debt securities traded fell sharply. But by using the capital markets to deleverage -- by paying off these securities at lower, discounted prices through tax-free exchanges of equity for debt, debt for debt, assets for debt and cash for debt -- most companies avoided default and saved jobs. (Congress later imposed a tax on the difference between the tax basis of the debt and the discounted price at which it was retired.)

Issuing new equity can of course depress a stock's value in two ways: It increases the supply, thus lowering the price; and it "signals" that management thinks the stock price is high relative to its true value. Conversely, a company that repurchases some of its own stock signals an undervalued stock. Buying stock back, the theory goes, will reduce the supply and increase the price. Dozens of finance students have earned Ph.D.s by describing such signaling dynamics. But history has shown that both theories about lowering and raising stock prices are wrong with regard to deleveraging by companies that are seen as credit risks.

Two recent examples are Alcoa and Johnson Controls each of which saw its stock price increase sharply after a new equity issue last month. This has happened repeatedly over the past 40 years. When a company uses the proceeds from issuance of stock or an equity-linked security to deleverage by paying off debt, the perception of credit risk declines, and the stock price generally rises.

The decision to increase or decrease leverage depends on market conditions and investors' receptivity to debt. The period from the late-1970s to the mid-1980s generally favored debt financing. Then, in the late '80s, equity market values rose above the replacement costs of such balance-sheet assets as plants and equipment for the first time in 15 years. It was a signal to deleverage.

In this decade, many companies, financial institutions and governments again started to overleverage, a concern we noted in several Milken Institute forums. Along with others, including the U.S. Chamber of Commerce, we also pointed out that when companies reduce fixed obligations through asset exchanges, any tax on the discount ultimately costs jobs. Congress responded in the recent stimulus bill by deferring the tax for five years and spreading the liability over an additional five years. As a result, companies have already moved to repurchase or exchange more than $100 billion in debt to strengthen their balance sheets. That has helped save jobs.

The new law is also helpful for companies that made the mistake of buying back their stock with new debt or cash in the years before the market's recent fall. These purchases peaked at more than $700 billion in 2007 near the market top -- and in many cases, the value of the repurchased stock has dropped by more than half and has led to ratings downgrades. Particularly hard hit were some of the world's largest companies (i.e., General Electric, AIG, Merrill Lynch); financial institutions (Hartford Financial, Lincoln National, Washington Mutual); retailers (Macy's, Home Depot); media companies (CBS, Gannett); and industrial manufacturers (Eastman Kodak, Motorola, Xerox).

Without stock buybacks, many such companies would have little debt and would have greater flexibility during this period of increased credit constraints. In other words, their current financial problems are self-imposed. Instead of entering the recession with adequate liquidity and less debt with long maturities, they had the wrong capital structure for the time.

The current recession started in real estate, just as in 1974. Back then, many real-estate investment trusts lost as much as 90% of their value in less than a year because they were too highly leveraged and too dependent on commercial paper at a time when interest rates were doubling. This time around it was a combination of excessive leverage in real-estate-related financial instruments, a serious lowering of underwriting standards, and ratings that bore little relationship to reality. The experience of both periods highlights two fallacies that seem to recur in 20-year cycles: that any loan to real estate is a good loan, and that property values always rise. Fact: Over the past 120 years, home prices have declined about 40% of the time.

History isn't a sine wave of endlessly repeated patterns. It's more like a helix that brings similar events around in a different orbit. But what we see today does echo the 1970s, as companies use the capital markets to push out debt maturities and pay off loans. That gives them breathing room and provides hope that history will repeat itself in a strong economic recovery.

It doesn't matter whether a company is big or small. Capital structure matters. It always has and always will.

Mr. Milken is chairman of the Milken Institute.
 
 

 WSJ   * APRIL 21, 2009, 5:47 P.M. ET

11. Europe's Forceful Response to the Financial Crisis The ECB and euro-area governments are acting boldly.
 

By JüRGEN STARK From today's Wall Street Journal Europe

The world economy faces its greatest challenge in modern times. The repercussions of the financial crisis are severe and have led to a synchronized global downturn. The euro area is not at the epicenter of the crisis. It has not contributed to global imbalances. However, it has been affected via the financial channels and is suffering from the collapse of global trade and the significant adverse impact on output and employment.

This year will be a year of adjustments in balance sheets across all sectors of the economy: banks, nonfinancial firms and private households. These adjustments are needed to eventually stabilize and improve economic conditions. I am confident that, after a severe economic downturn, we will witness a gradual economic recovery in the course of 2010. Both global and domestic demand will increasingly benefit from the effects of the significant economic stimulus under way and the enormous efforts undertaken to restore confidence and the functioning of the financial system inside and outside the euro area.

The single monetary policy of the European Central Bank and the national fiscal policies in the euro area have reacted in a forceful and timely manner to the abrupt change in both the financial markets and economic conditions with the main aim of restoring confidence. In particular, there has been no failure of a major bank in the euro area.

Since the intensification of the financial crisis in fall 2008, the ECB has acted in a timely, decisive and adequate manner. It has taken a series of measures that are unprecedented in nature, scope and timing. Against the background of rapidly receding inflationary pressures, the key policy rate has been reduced by 300 basis points over this period. The ECB's liquidity support to the banking system has also been unprecedented since the very beginning of the crisis in August 2007. These liquidity operations, which are highly nonstandard, have been tailored to the needs of the euro area, where the banking system plays a decisive role in funding the economy. Under the new "fixed-rate full allotment" procedure for all our open-market operations, banks have been granted essentially unlimited access to central-bank liquidity at the ECB's key policy interest rate. These measures have eased the banks' balance-sheet constraints, thereby avoiding a sudden stop in the supply of credit and the emergence of a systemic crisis.

As a consequence, money-market rates in the euro area have decreased substantially. The six-month and 12-month Euribor rates are below the respective pound sterling and U.S. dollar Libor rates. Although the most recent cuts in the ECB's key policy rate have not yet been fully transmitted to bank rates, bank lending rates are either at a similar level as those in the U.K. and the U.S. or even lower.

Overall, the ECB's decisions -- in particular the "nonstandard measures" which have been applied since October 2008 -- have been tailored to the specific financial structure of the euro area. The ECB has followed its own approach to nonstandard measures and is considering further steps in this direction, taking into account the fact that the transmission mechanism in the euro area functions primarily via the banking system.

The fiscal authorities in the euro area have also demonstrated their willingness and capacity to act rapidly in exceptional circumstances. In a coordinated and effective effort, euro-area governments provided support to the banking system, most notably through offering recapitalization, guarantees for interbank credits and asset support schemes. The total amount of resources committed so far by euro-area governments for the purpose of stabilizing the financial sector amounts to about 23% of euro-area GDP.

The broader economy in the euro area has benefited from fiscal support through discretionary policy measures and the significant operation of automatic stabilizers. The change in the budget balance serves as an indicator for the overall fiscal stimuli through these channels. The fiscal impulse for the euro area amounts to 3.6 percentage points of GDP cumulatively for the years 2009 and 2010. This is a very high figure, also in comparison to other major economic regions.

While these measures were necessary to support the functioning of the financial system and thus to prevent harm to euro-area economies, they also imply a considerable fiscal burden. Public debt and deficit ratios may increase substantially, and fiscal sustainability may come under undue pressure. The crisis mode should not lead to the temptation to increase the sheer size of the stimulus measures further.

There are two important questions. First, do the measures have the potential to restore confidence? Second, are those measures effective? As regards the first question, those measures designed for the financial sector in particular have the potential to solve the confidence crisis at its roots. As regards the second issue, it is important to recall that many euro-area countries did not take the opportunity in good times to consolidate their public finances. As a consequence, they have entered the current crisis with high fiscal deficit and debt ratios. In this respect, overloading fiscal policy will certainly undermine confidence and reduce effectiveness.

It remains essential that euro-area countries credibly stick to their commitments to return to sound fiscal policies and thereby fully respect the provisions of the Stability and Growth Pact. It is now important not to repeat the mistakes of the past and to maintain the public's trust in the soundness of fiscal policies. This requires that fiscal sustainability is guaranteed. Compliance with the principles of the Stability and Growth Pact will be key to promote confidence in the medium term and thereby to ensure that the economic recovery is based on sound foundations and that long-term economic growth is supported.

In summary, the government and ECB measures have been timely, effective and adequate, taking into account the specific situation of the euro-area economy. It is a response customized for the euro area.

During the continuing financial turmoil, the euro area and the EU as a whole have proved their capacity to act decisively and promptly under difficult circumstances. National measures have been coordinated in a pragmatic manner in the EU and the euro area with a view to enhancing their effectiveness through mutual reinforcement.

I am confident that the measures which have been taken in the context of a medium-term macroeconomic policy framework for the euro area will allow for an adequate and orderly exit from the bold decisions taken once the economy recovers, in order to prevent possible longer-term inflationary risks from materializing.

Mr. Stark is a member of the Executive Board and the Council of the European Central Bank.
 
 
 
 
 
 
 
 
 
 
 
 

12. What’s a Global Recession?
Posted by Bob Davis

http://blogs.wsj.com/economics/

The International Monetary Fund was slow to apply the word “recession” to the current global downturn, partly because it didn’t have a good definition (and partly because it didn’t want to spook markets and IMF members).

Informally, past IMF chief economists have called global growth lower than either 3% or 2.5% — depending on who was the chief economist — a recession. But that didn’t pass muster with Olivier Blanchard, the IMF’s current chief economist, who on Oct. 8, 2008 said “it is not useful to use the word ‘recession’ when the world is growing at 3%.”

At that time, that was the IMF’s forecast for 2009 global growth was 3%. Its latest forecast, released this morning, now forecasts a 1.3% contraction for this year. (It’s been a lousy year for forecasters all over the world.)

Now, IMF economists have cranked through the numbers and come up with a more precise way to measure global recessions: a decline in real per-capita world GDP, backed up by a look at other global macroeconomic indicators. Those indicators include industrial production, trade, capital flows, oil consumption and unemployment.

By that definition, this is the fourth global recession since World War II, and deepest by a long shot. The earlier recessions were in 1975, 1982 and 1991. All were one-year recessions when measured by purchasing power parity, which the IMF favors for global comparisons. Those stats take into account the different cost of goods and services in different countries — for instance, a haircut costs a lot less in Beijing than Boston. Looking at global GDP by the more traditional method using exchange rates, the 1991 recession lasted until 1993.

In 2009, the IMF estimates per-capita GDP will decline 2.5%, using purchasing power parity, compared to a 0.4% contraction, on average, during the three previous recessions. Industrial production, trade, capital flows and oil consumption in the 2009 recession will fall much more sharply than in the previous global recessions, while unemployment will increase more.

What about 2010? The IMF’s current forecast estimates a small per-capita GDP decline, when measured by market exchange rates, and a tiny increase when measured by purchasing power parity. By either of those measures — the IMF didn’t release forecasts for the other macroeconomic indicators it used in this exercise — the world will be hovering around recessionary territory next year too.

Click Continue Reading to see a sortable chart of global recessions.
How Bad Is It?
Posted by David Wessel

Here’s how Treasury Secretary Timothy Geithner puts it: “Only 17 of the 182 economies followed by the IMF are expected to grow faster this year than they did last year. Some 71 — including 30 of the world’s 34 advanced economies — are expected to shrink. The collapse of world trade is will likely be the worst since the end of World War II.” He made the observation at a speech today at the Economic Club of Washington, D.C.

Or, as the IMF itself puts it, ““By any measure, this downturn represents by far the deepest global recession since the Great Depression.”

April 22, 2009
TG-97

13. Secretary Timothy F. Geithner Remarks before The Economic Club of Washington
As Prepared for Delivery

Thank you, David. I appreciate the chance to speak to the Economic Club of Washington.

I want to talk today about the global nature of the current financial and economic crisis.  I will offer an update on our efforts to bring the crisis to a close and set the stage for a new, more balanced prosperity in the future.

The world economy is going through the most severe crisis in generations.  We each face somewhat different challenges and thus are not all in the same boat.  But we are all in the same storm.

We now have in place a strong framework of policies to confront the crisis.  Our challenge is to put those commitments into action, and to make sure that our actions are proportionate to the challenge.

The Global Nature of the Crisis

Although this crisis in some ways started in the United States, it is a global crisis. It is global in the sense that the damage has spread widely. It is global in the sense that the challenges we see in the United States today are common to many countries around the world.

We bear a substantial share of the responsibility for what has happened, but factors that made the crisis so acute and so difficult to contain lie in a broader set of global forces that built up in the years before the start of our current troubles.

Never before in modern times has so much of the world been simultaneously hit by a confluence of economic and financial turmoil such as we are now living through.

The International Monetary Fund now expects the world economy to decline this year for the first time in more than six decades. The 1.3% decline forecast by the IMF represents a sharp deterioration from the roughly 4% annual rate at which the world economy normally would be expected to grow. The lost output could be as high as three to four trillion dollars this year alone.

And those numbers mask grave damage to economies around the world.

Only 17 of the 182 economies followed by the IMF are expected to grow faster this year than they did last year. Some 71--including 30 of the world's 34 advanced economies--are expected to shrink. The collapse of world trade is will likely be the worst since the end of World War II.

Several crucial lessons flow from the simultaneous nature of this crisis.

The rest of the world needs the U.S. economy and financial system to recover in order for it to revive.  We remain at the center of global economic activity with financial and trade ties to every region of the globe.

Just as importantly, we need the rest of the world to recover if we are to prosper again here at home. Before the crisis, U.S. exports were among our economy's fastest-growing sectors, accounting for more than 6 million American jobs, or about 5% of total private sector employment in the U.S.  Now, they are one of its fastest-shrinking.

As a consequence, the community of nations must work together--and that work has already begun--to revive economies around the world and to lay the groundwork for a new, more stable and more sustainable pattern of growth in the future.

During the boom years, we marveled at how globalization was speeding the pace of economic activity and integrating national economies.  Now, we are learning that in times of contraction globalization transmits trouble with enormous speed and force, affecting economies around the world – the relatively strong as well as the more vulnerable.

This crisis is not simply a more severe version of the usual business cycle recession, the typical downturn in which economies ultimately adjust and stabilize.  Instead, it is an abrupt correction of financial excesses that has overwhelmed economies' and markets' self-correcting mechanisms, and so can only be ended by extraordinary policy responses.

The Policy Framework for Recovery

Over the last three months, President Obama has moved quickly to put in place a comprehensive framework of policy initiatives to restore growth and create jobs at home, and to build consensus with other nations on a coordinated global response.

 This response reflects the three critical imperatives of the crisis:

 First, it requires very strong actions to increase demand through fiscal actions--investments and tax incentives--alongside the actions undertaken by central banks to reduce interest rates.

Second, it requires a sustained effort to repair the financial system, so that we get credit flowing again to those who can use it most effectively.

Third, it requires the mobilization of financial resources to help directly address the challenges facing emerging and developing economies.

Spurring Growth

 Within weeks of assuming office, the President worked with Congress to enact the largest economic recovery plan since World War II. By the time the plan has been fully implemented by the end of next year, we will have injected nearly $800 billion into the U.S. economy, saved or created 3.5 million jobs and raised our real gross domestic product over where it would otherwise have been by more than 3%.

In just over 60 days since its passage, funds are already at work in communities across the country as highway projects break ground and people see more money in their paychecks.

In tandem with our expansion plan, we and the other nations in the G-20 agreed during our Summit meeting in London earlier this month to muster an unprecedented, cooperative program of fiscal stimulus .  The IMF estimates that our combined efforts add up to a $5 trillion dollar fiscal boost over the three years ending in 2010 and will raise global output by four percent  over where it would otherwise have been.

What makes this global program so powerful is not simply its size, but the fact that nations are acting alongside each other to support demand with fiscal policy, which increases the effectiveness of each of our actions. Central banks started earlier in the crisis to move together to reduce interest rates, and those actions are now being matched on the fiscal front.

Repairing Financial Systems

Alongside these macroeconomic policy steps to support growth, the Administration has put in place a comprehensive plan to restart lending and the flow of credit.  These initiatives include programs to bring more capital into the banking system; to help keep mortgage interest rates low and restructure mortgages and thereby reduce the magnitude of potential further declines in home prices; to help revive securitization markets critical to small business, consumer and corporate lending; and to re-start the market for legacy real estate assets.

Governments around the world are pursuing similar strategies.  Although these programs are tailored to the specific challenges of each country, they have the common objective of stabilizing the financial system, providing capital where necessary, catalyzing securities markets, and facilitating the clean-up of legacy assets.

Mobilizing Global Resources

These two types of programs--to revive economic growth here and in other nations, and to repair our respective financial systems--are necessary conditions for restoring growth among the world's major economies.  But these actions need to be complemented by other steps to support trade and to mobilize resources for emerging markets and developing economies.

During our London Summit, we and our G-20 partners agreed that we will make more than $1 trillion in financial resources available to support global growth and trade. Much of that total will go to the emerging and developing countries, which as recently as the fall of last year accounted for fully 42% of all U.S. exports.  That will improve their economic and financial health which, in turn, will help improve ours.

As part of our agreement, the IMF is seeking to immediately raise $250 billion in temporary financing from a group of countries that does not include the U.S. That amount will eventually be wrapped into a $500 billion increase in its New Arrangement to Borrow (NAB), a permanent back-up mechanism that provides the IMF with supplementary lending resources which the IMF can lend to countries, such as Mexico and Poland, to mitigate the effects of the crisis.

We are seeking congressional approval to increase our NAB participation by up to $100 billion, which because of the way it is structured will have no consequences for the federal budget and will not cause any increase in the deficit.

In addition, we have proposed that the IMF make a $250 billion general allocation of SDRs that will be distributed to all member nations including the U.S. in proportion to their IMF quotas. About $100 billion of this will go to emerging and developing nations. They, in turn, can use this liquidity as necessary to meet their foreign exchange obligations.

And the G-20 countries have agreed to provide a backstop for the private market financing of trade by providing at least $250 billion in short-term trade financing over the next two years.

These programs provide immediate benefits in terms of confidence.  They will make it possible for the governments of emerging economies to act more quickly to support growth, to repair their own financial systems, and to avoid the type of dramatic falls in exchange rates that were the feature of financial crises of the late 1990s.

And these programs act as a form of insurance policy for the world economy and, thus, for the U.S. economy.

Limiting Future Crises

As we have moved to put in place this global framework of actions to address the immediate crisis, we have also tried to ensure that we are laying the foundation for a more stable, more balanced and more sustainable recovery.

This requires several things.

First, it requires attention to the composition and quality of growth, within and across nations.

Second, it requires a cooperative effort to lay the foundations for more stable national financial systems--systems less vulnerable to recurrent crises.

And finally, it requires that we commit now to unwind and reverse the extraordinary actions we have been compelled to take to address the crisis, once the risks have receded and a recovery is firmly in place.

We need to keep focused on these broader imperatives so that our actions now lay the foundation for a future with fewer dangerous booms and fewer destructive busts. We must ensure that as our economies recover, growth will be on a firmer foundation, more stable and more sustainable.

Balanced Expansion

A major lesson of the crisis is that the remarkable overall performance of the global economy between 2003 and 2007 contained within it the seeds of its own undoing.  Our goal now must be a sustained expansion of our own and the world economy, but that expansion must be better balanced. We must set ourselves on a path so that one country, or group of countries, does not consume in excess while another set of countries produces in excess.

A more balanced recovery and expansion must be one where each nation is more focused on growth that is sustainable and not dependent on the U.S. consumer.  It will require a stronger focus on investments and incentives to improve productivity growth. It will require a deep commitment to ensure that the gains of expansions are more broadly shared and that inequality is reduced.

Each of the major economies, including the United States, as well as the largest emerging economies, share a responsibility for achieving this objective. And the IMF has a special responsibility to help us all fulfill our collective obligations by offering independent assessments of our policy efforts, and their impact on a more balanced and sustainable recovery.  Financial Reform

We are collectively committed to reform our 20th century financial regulatory system to match our 21st century financial system.

That means that even as we reform our own financial regulatory systems, we must also reform the global financial regulatory system in tandem. The financial system must perform its task of efficiently allocating capital without promoting excessive risk taking.

We and our G-20 partners have taken an important first step toward these goals by committing to establish and implement much stronger standards for oversight over the financial system in order to limit risk-taking and improve our capacity to prevent and manage future crises.  Our aim is to promote a race to the top in global regulatory standards and supervisory practices.

Macroeconomic Stability

We have employed extraordinary fiscal, monetary, and other governmental policies to deal with this crisis. These are temporary and exceptional measures, and they need to be reversed when they have accomplished the immediate objective of generating recovery.

With this in mind, this Administration has presented a budget plan that charts a path to achieving to sustainable deficits in the medium term, so that recovery is not impaired by concerns about excessive borrowing in the future. We are designing our financial programs so that we can reverse them as soon as practical, and avoid the risks that come with sustained government intervention in the financial system.  And we must make critical investments in health care, energy and education to lay the groundwork for a more productive economy in the future with the gains more broadly shared.

Conclusion

Our fortunes are now more closely tied to the rest of the world than ever before. Our interests as a nation depend critically on the broader economic health of the world economy.

In the years leading up to the crisis, U.S. exports of goods and services grew in real terms at an annual rate of almost nine percent, nearly triple that of the overall economy.  But by the end of last year, our exports were declining at a rate of almost 25 percent per year, the sharpest decline since the end of the Second World War.  Our recovery depends in part on reversing this decline.  American workers are the most productive in the world but we need the world to provide growing markets for our goods and services.

This is not just an economic imperative.  Our Director of National Intelligence, Admiral Dennis Blair, recently testified that the global financial crisis is the greatest near-term threat to this nation's security. He said: "The longer it takes for the recovery to begin, the greater the likelihood of serious damage to US strategic interests."  When economies decline, credit dries up, people lose their jobs and children are unable to stay in school, hard-won gains for democracy and political stability are threatened.

As I said at the outset, we may not all be in the same boat, but we're surely in the same storm.  The bottom-line lesson of the last 18 months is that we as nations are in this crisis together. Collectively, we are weathering this storm but we must also build a better global system.

Today's crisis is unlike any we have experienced for seven decades. The balance-of-payments crises of the 1950s and 1960s, the oil crisis of the 1970s, the debt crisis of the 1980s, or the Asian financial crisis of the 1990s all pale by comparison. Those crises were localized and had their winners as well as their losers. As a result, international cooperation was slower to come and less powerful.

In this crisis, by contrast, we have acted together to put in place a strong framework of policies to confront the crisis on a coordinated basis.

The actions now in place and in the pipeline offer the strongest basis for confidence that we will begin to lay the foundation for global recovery.

The rate of decline in global growth and trade has shown some signs of easing.  Some measures of spending and output have started to stabilize.  Financial conditions are starting to improve modestly. We have started to see some signs of stabilization of declines in output and trade.

These are encouraging signs, but progress is going to take time, and we still face significant risk and challenge.  For this reason, it is critically important that we continue to act to strengthen the basis for recovery.  We may have to adapt our policies further as conditions evolve, and we need to make sure we provide a scale of support that matches the intensity of the challenge.

The financial world comes together in Washington later this week. This will give us a chance to build on the commitments made by the G-20 in London, and to underscore the commitment of our country to work with other nations to bring the crisis to an end and to put in place a more stable, balanced foundation for growth in the future, not only for the United States but also for the world of which we are a part.

April 22, 2009
14. Will Crony Capitalism Produce Strong Growth? By Lawrence Kudlow

How far will the Obama administration move to assert regulatory control over key sectors of the economy? Are we moving away from democratic capitalism, and toward some sort of corporatist state-directed economy? That could be the biggest stock market and economic-growth issue facing us today.

Stocks plunged almost 300 points on Monday over new fears of bank nationalization. On Tuesday shares recovered about 100 points after Treasury man Tim Geithner testified that repayment of TARP loans would be okay in some cases. But Geithner added that the decision to let banks repay the federal government will largely depend on the credit needs of the broader economy.

So while some investors believe Tim Geithner backed away from the prospect of government-controlled banks, it's really not clear that he did so.

The issue at hand is the possible conversion of the TARP money now held by banks in the form of non-voting preferred stock into common stock with full voting rights. White House and Treasury officials have spoken of this possibility in recent days, and it plainly raises the issue of government ownership and backdoor nationalization of the banks -- or at least the major banks.

To wit, Goldman Sachs and JPMorgan look to be recovering their health. They want to de-TARP, and perhaps Geithner will let them. But if he doesn't, these institutions might be forced to convert their preferred TARP shares into common stock, thereby giving Team Obama tremendous sway over their operations. As for the less-healthy big banks, one suspects the government will increase its 36 percent ownership in Citigroup and take a new ownership position in Bank of America.

The results of the government's economic "stress tests" -- due early next month -- will complicate these calculations. And at the end of the day I think Team Obama will interpret the stress tests in whatever manner serves its larger purpose, which I suspect is backdoor nationalization.

Just to confuse matters more, the congressional strings attached to TARP might not only apply to the banks, but could apply to participants in TALF and PPIP -- the new government-lending programs designed to detoxify bank balance sheets. I don't know this is the case, but it could well be the case.

This is why most private investors have stayed away from the two early TALF auctions. And JPMorgan CEO Jamie Dimon says his bank won't play in PPIP because "we've learned our lesson." He calls TARP a "scarlet letter." But what he's really saying as America's leading banker is that he doesn't want his bank or shareholders to be run by the government.

An old friend e-mailed me this week about how to characterize Obama's economic interventions into the banking and auto sectors (with health care next on the list). He says it's not really socialism. Nor is it fascism. He suggests it is state capitalism. But I think of it more as corporate capitalism. Or even crony capitalism, as Cato's Dan Mitchell puts it.

It's not socialism because the government won't actually own the means of production. It's not fascism because America is a democracy, not a dictatorship, and Obama's program doesn't reach way down through all the sectors, but merely seeks to control certain troubled areas. And in the Obama model, it would appear there's virtually no room for business failure. So the state props up distressed segments of the economy in some sort of 21st-century copy-cat version of Western Europe's old social-market economy.

So call it corporate capitalism or state capitalism or government-directed capitalism. But it still represents a huge change from the American economic tradition. It's a far cry from the free-market principles that governed the three-decade-long Reagan expansion, which now seems in jeopardy. And with cap-and-trade looming, this corporate capitalism will only grow more intense.

This is all very disturbing. For three decades supply-siders like me and my dear friend Jack Kemp talked about democratic capitalism. This refers to the small business that grows into the large one. It means necessary after-tax incentives are being provided to reward Schumpeterian entrepreneurship, innovation, and risk-taking.

At the center of this model is the much-vaunted entrepreneur who must be supported by a thriving investor class that will provide the necessary capital to finance the new economy. But also necessary for the Schumpeterian model is a healthy banking and financial system that will provide the necessary lending credit to finance new ideas.

Do we truly believe that raising tax rates on investors and moving to some sort of government-controlled banking system will sufficiently fund the entrepreneur and sustain democratic capitalism? Do we really believe that a federal-government-directed economic system will generate a sufficient supply of capital and credit to produce a strong economy?

I doubt it.
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Lawrence Kudlow is host of CNBC's The Kudlow Report and co-host of The Call. He is also a former Reagan economic advisor and a syndicated columnist. Visit his blog, Kudlow's Money Politics.
Page Printed from: http://www.realclearpolitics.com/articles/2009/04/22/the_end_of_democratic_capitalism_96101.html at April 22, 2009 - 09:01:10 AM PDT

.15. ..and socialism By Bernie Sanders
April 22, 2009

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http://www.boston.com/bostonglobe/editorial_opinion/oped/articles/2009/04/22/and_socialism/

REPRESENTATIVE Spencer Bachus is one of the few people I know from Alabama. I bet I'm the only socialist he knows, although he darkly claims there are 17 socialists lurking in the House of Representatives.
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COMMENTS (45)

I doubt there are any other socialists, let alone 17 more, in all of Congress. I also doubt that Bachus understands much about democratic socialism.

Of course, Washington brings people like us together to fight for our principles and work things out for the good of the country. Spencer and I used to serve together on the House Financial Services Committee. But Washington is often a place where name-calling partisan politics too often trumps policy. A standard refrain in John McCain's presidential stump speeches was a claim that Barack Obama's Senate voting record was more liberal than the Senate's only socialist, yours truly. Even as political hyperbole, the attack didn't work out that well for my colleague from Arizona.

Still, branding someone as a socialist has become the slur du jour by members of the American right, from Newt Gingrich to Rush Limbaugh. Some, like Mike Huckabee, intentionally blur the differences between socialism and communism, between democracy and totalitarianism.

If we could get beyond such nonsense, I think this country could use a good debate about what goes on here compared with places with a long social-democratic tradition like Sweden, Norway, and Finland, where, by and large, the middle class has a far higher standard of living.

I was honored last year to show Ambassador Pekka Lintu of Finland around my home state of Vermont. There was standing-room-only at a town meeting, where people came to hear more about one of the world's most successful economic and social models.

And what we learned impressed us. Finland is a country that provides high-quality healthcare to all its people with virtually no out-of-pocket expense; where parents and their young children receive free excellent childcare and/or parental leave benefits that dwarf what our nation provides; where college and graduate education is free and where children in the public school system often record the highest results in international tests. Eighty percent of workers belong to unions, all employees enjoy at least 30 days paid vacation, and the gap between rich and poor is far more equitable than in the United States.

One reason there was so much interest in the Finnish model was that even before Wall Street greed drove the world economy into a deep recession, more and more Americans were wondering why the very rich were becoming richer while the economy failed our working families. They wanted to know why the middle class was shrinking, poverty was increasing, and the United States was the only major country without a national healthcare program.

Despite all the rhetoric about "family values," US employees now work the longest hours of any people in a major country. Our healthcare system is disintegrating. At last count, 47 million Americans had no health insurance.

We have the highest rate of childhood poverty in the industrialized world. Our childcare system is inadequate. Too many children drop out of school, and college is increasingly unaffordable. We have more people in jails and prisons than any other country in the world.

Let's be clear. Finland is no utopia. Its economy today is not immune to what is happening in the rest of the world. There also are, to be sure, important differences between the United States and Finland. Finland has a very homogenous population of only 5.2 million; we are extremely diverse. Finland is the size of Montana; we stretch 3,000 miles.

Despite the differences, there are important similarities. Both countries share many of the same aspirations for their people. When one thinks about the long march of human history, it is no small thing that democratic countries like Finland exist that operate under egalitarian principles, which have virtually abolished poverty, which provide almost-free healthcare to all, and free education through graduate school.

Whether we live in Burlington, Vt., or Montgomery, Ala., we should be prepared to study and learn from the successes of social-democratic countries. Name-calling and scare tactics won't do.

Bernie Sanders is an independent US senator from Vermont.

 WSJ    * APRIL 22, 2009, 2:16 P.M. ET

16. IMF Says Recession Is Deepening
Fund Presses G-20 for Added Stimulus; Turnaround in 2010

By TOM BARKLEY and BOB DAVIS

WASHINGTON -- The global economy is in the grips of a deepening recession that isn't likely to turn around until sometime next year, the International Monetary Fund said on Wednesday. The IMF, which had been slow to apply the word to the current downturn, also released a new definition of global recession.

Overall, the world economy is now expected to contract 1.3% this year -- a sharp reduction from the IMF's January estimate of 0.5% growth for 2009 -- and then register just 1.9% growth in 2010, well below the global growth rate before the economic crisis hit.
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    * Real Time Econ: What's a Global Recession?

"By any measure," the IMF's twice-yearly World Economic Outlook concluded, "this downturn represents by far the deepest global recession since the Great Depression."

Examining the results, U.S. Treasury Secretary Timothy Geithner said that "only 17 of the 182 economies followed by the IMF are expected to grow faster this year than they did last year. Some 71 -- including 30 of the world's 34 advanced economies -- are expected to shrink."

Ahead of a gathering of Group of Seven finance ministers and central bankers later this week, as well as the spring meetings of the IMF and the World Bank, the IMF urged global leaders to keep up the momentum that began at the Group of 20 summit earlier this month.

The fund is anticipating that G-20 countries will pursue fiscal stimulus measures totaling about 2% of gross domestic product this year and 1.5% next year, but said that may not be enough.

"It is now apparent that the effort will need to be at least sustained, if not increased, in 2010, and countries with fiscal room should stand ready to introduce new stimulus measures as needed to support the recovery," the IMF said.

That's likely to be a subject of debate at the G-7 meeting; European leaders thus far are resisting U.S. pressure to pursue additional stimulus measures.

Advanced economies, which are expected to contract 3.8% this year and experience no growth in 2010, should also continue to pursue rate cuts and unconventional monetary measures to support demand and counter deflationary pressures, the fund said.

The U.S., which remains the "epicenter" of the crisis, is expected to contract 2.8% this year, with no growth next year. Much of the expectation for a U.S. recovery to begin by the second half of 2010 hinges on the success of the government's plan to partner with private-sector investors to remove bad debts from bank balance sheets, the fund said.

The euro area is forecast to experience an even deeper recession, declining 4.2% this year and 0.4% in 2010, as the drop in exports increasingly takes a toll on domestic demand. The U.K. is expected to contract 4.1% in 2009 and 0.4% next year.

Jörg Decressin, the IMF's chief of world economic studies, said that Germany is better poised than other major European economies to add more stimulus measures and should consider getting a package ready. "Germany stands out as the one which has the most room," he said, when compared with Spain, Italy and France.

Japan is expected to suffer the most among advanced economies this year, contracting 6.2% on the back of falling exports. A 0.5% recovery is anticipated for 2010.

Meanwhile, emerging economies overall are expected to remain in positive territory, growing at a 1.6% pace in 2009 and 4% next year as a group. But an increasing number are sliding into recession, with Eastern European countries faring the worst.

China is expected to post a solid 6.5% growth rate this year and 7.5% in 2010, but those are still slightly lower than January's forecasts of 6.7% and 8.0%, respectively -- and much lower than China has chalked up in recent years.

Informally, past IMF chief economists have called global growth of lower than either 3% or 2.5% -- depending on the chief economist -- a recession. It hadn't called the current downturn a global recession yet, partly because it didn't have a good definition and partly because it didn't want to spook markets and IMF members.

Now, IMF economists have a precise way to measure global recession: a decline in real per-capita world GDP, backed up by a look at indicators such as industrial production, trade, capital flows, oil consumption and unemployment.

In terms of the new definition, this is the fourth global recession since World War II, and the deepest by a long shot. The earlier recessions were in 1975, 1982 and 1991. All were one-year recessions when measured by purchasing power parity, which takes into account the different cost of goods and services in different countries; for instance, a haircut costs a lot less in Beijing than in Boston. Looking at global GDP by the more traditional method, using exchange rates, the 1991 recession lasted until 1993.

In 2009, the IMF estimates per-capita GDP will decline 2.5%, using purchasing power parity, compared to a 0.4% contraction, on average, during the three previous recessions. Industrial production, trade, capital flows and oil consumption in the 2009 recession will fall more sharply than in the previous recessions; unemployment will increase more.

For 2010, the IMF's current forecast estimates a small global per-capita GDP decline measured by market exchange rates, and a tiny increase when measured by purchasing power parity. By either of those metrics, the world will be hovering around recessionary territory next year too.

Write to Tom Barkley at tom.barkley@dowjones.com and Bob Davis at bob.davis@wsj.com
 
 
 

17. Erin Go Broke  By PAUL KRUGMAN

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Published: April 19, 2009 NYTimes

“What,” asked my interlocutor, “is the worst-case outlook for the world economy?” It wasn’t until the next day that I came up with the right answer: America could turn Irish.
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What’s so bad about that? Well, the Irish government now predicts that this year G.D.P. will fall more than 10 percent from its peak, crossing the line that is sometimes used to distinguish between a recession and a depression.

But there’s more to it than that: to satisfy nervous lenders, Ireland is being forced to raise taxes and slash government spending in the face of an economic slump — policies that will further deepen the slump.

And it’s that closing off of policy options that I’m afraid might happen to the rest of us. The slogan “Erin go bragh,” usually translated as “Ireland forever,” is traditionally used as a declaration of Irish identity. But it could also, I fear, be read as a prediction for the world economy.

How did Ireland get into its current bind? By being just like us, only more so. Like its near-namesake Iceland, Ireland jumped with both feet into the brave new world of unsupervised global markets. Last year the Heritage Foundation declared Ireland the third freest economy in the world, behind only Hong Kong and Singapore.

One part of the Irish economy that became especially free was the banking sector, which used its freedom to finance a monstrous housing bubble. Ireland became in effect a cool, snake-free version of coastal Florida.

Then the bubble burst. The collapse of construction sent the economy into a tailspin, while plunging home prices left many people owing more than their houses were worth. The result, as in the United States, has been a rising tide of defaults and heavy losses for the banks.

And the troubles of the banks are largely responsible for putting the Irish government in a policy straitjacket.

On the eve of the crisis Ireland seemed to be in good shape, fiscally speaking, with a balanced budget and a low level of public debt. But the government’s revenue — which had become strongly dependent on the housing boom — collapsed along with the bubble.

Even more important, the Irish government found itself having to take responsibility for the mistakes of private bankers. Last September Ireland moved to shore up confidence in its banks by offering a government guarantee on their liabilities — thereby putting taxpayers on the hook for potential losses of more than twice the country’s G.D.P., equivalent to $30 trillion for the United States.

The combination of deficits and exposure to bank losses raised doubts about Ireland’s long-run solvency, reflected in a rising risk premium on Irish debt and warnings about possible downgrades from ratings agencies.

Hence the harsh new policies. Earlier this month the Irish government simultaneously announced a plan to purchase many of the banks’ bad assets — putting taxpayers even further on the hook — while raising taxes and cutting spending, to reassure lenders.

Is Ireland’s government doing the right thing? As I read the debate among Irish experts, there’s widespread criticism of the bank plan, with many of the country’s leading economists calling for temporary nationalization instead. (Ireland has already nationalized one major bank.) The arguments of these Irish economists are very similar to those of a number of American economists, myself included, about how to deal with our own banking mess.

But there isn’t much disagreement about the need for fiscal austerity. As far as responding to the recession goes, Ireland appears to be really, truly without options, other than to hope for an export-led recovery if and when the rest of the world bounces back.

So what does all this say about those of us who aren’t Irish?

For now, the United States isn’t confined by an Irish-type fiscal straitjacket: the financial markets still consider U.S. government debt safer than anything else.

But we can’t assume that this will always be true. Unfortunately, we didn’t save for a rainy day: thanks to tax cuts and the war in Iraq, America came out of the “Bush boom” with a higher ratio of government debt to G.D.P. than it had going in. And if we push that ratio another 30 or 40 points higher — not out of the question if economic policy is mishandled over the next few years — we might start facing our own problems with the bond market.

Not to put too fine a point on it, that’s one reason I’m so concerned about the Obama administration’s bank plan. If, as some of us fear, taxpayer funds end up providing windfalls to financial operators instead of fixing what needs to be fixed, we might not have the money to go back and do it right.

And the lesson of Ireland is that you really, really don’t want to put yourself in a position where you have to punish your economy in order to save your banks.
 

*WSJ  APRIL 23, 2009

18. Europe's Grim Outlook Challenges World Recovery
 

By MARCUS WALKER and JOELLEN PERRY

Europe's economy faces a deeper recession and a slower recovery than the U.S. or other parts of the world, making it the region that is most hurting prospects for an early end to the global economic slump.

The EU's economy is set to contract 4% this year, even worse than the 2.8% drop projected for the U.S., according to new forecasts published Wednesday by the International Monetary Fund.
[Londoners seek work] Reuters

People look at job listings at a career fair in London.

Those figures came as the U.K. released a budget that includes its biggest jump in the national debt since World War II. Germany, Europe's biggest economy, shrank by 3.3% in the first quarter -- a steep slide from a 2.1% contraction in the last quarter of 2008.

German Finance Minister Peer Steinbrück on Wednesday said it was "not unlikely" that the country's economy will shrink by 5% or more this year, and leading German economics institutes said GDP is set to contract 6%, which would be its worst recorded performance since 1931.

European banks' losses from the global financial crisis are now projected to overtake U.S. banks' losses, according to IMF figures, which could hurt the banks' ability to lend liberally to help the bloc out of its crisis. More than half of the losses on continental Europe are homemade, the IMF said, reflecting bad loans to European firms and households rather than toxic U.S. securities.

The worsening outlook for the 27-nation EU is a blow for many of the region's governments, who have argued that the U.S. is the center of the global economic storm and that Europe's problems are smaller. Because of that, plus fear of rising inflation and public debt, authorities in much of Europe have been slower than those in the U.S. or leading Asian economies to cut interest rates or adopt ambitious fiscal-stimulus measures.
"At some deep level the European banks and policy makers don't get it: that they helped cause the crisis, that their slow response is part of the reason that the economy is bad, and that more is on the way," says Simon Johnson, a former IMF chief economist.

Europe's poor prospects are likely to rebound on the U.S., Asia and other regions, given that the EU's $18.4 trillion economy makes up 30% of the world economy.

In a sign of such spillover, Peoria, Ill.-based equipment maker Caterpillar Inc. said its first-quarter sales to Europe fell 46% from a year ago, significantly more than its sales declines in the U.S., Asia or Latin America, as it announced a first-quarter loss on Tuesday.

Even European firms' hopes are pinned on other regions where countries are spending more on stimulus plans. At Munich-based engineering firm HAWE Hydraulik SE, owner Karl Haeusgen is hoping that signs of life in the U.S. and China will lead to new export orders. In recent months, his orders have fallen as much as half from a year ago.

HAWE is holding on to its workers at idle German factories only because the government is helping to pay their salaries -- a policy many European countries use to damp unemployment figures. "That we have a downturn is not surprising, but the intensity is unexpected and abnormal," says Mr. Haeusgen.
[Workers walk past a guard post at the entrance to Continental AG's tire factory in northern France Wednesday. The building was damaged by rioting workers after a French court rejected an attempt to block the plant's closure.] Associated Press

Workers walk past a guard post at the entrance to Continental AG's tire factory in northern France Wednesday. The building was damaged by rioting workers after a French court rejected an attempt to block the plant's closure.

In France, labor protests became more violent this week as workers stormed and ransacked a government building near Paris, after they failed in court to prevent the shutdown of their tire factory, owned by German auto-parts company Continental AG. German Trade Union Federation head Michael Sommer warned his country's industrialists this week that such social unrest could spread to Germany if mass layoffs multiply.

On Tuesday, credit-rating agency Standard & Poor's predicted that debt defaults among high-risk European companies would overtake defaults among low-rated U.S. companies.

Some business surveys and economic data suggest the pace of Europe's contraction might be easing. But signs of a recovery in coming months appear weaker than in other regions, such as Asia and the U.S., where economists say more aggressive government efforts are starting to show some effect.

Tentative signs of relief in Asia include Chinese factory output and auto sales, which improved in March. Japan is also seeing some hope, as exports in March nearly halved from a year earlier but rose from February, the first monthly gain since May last year.

Policy makers are partly to blame for the severity of the euro zone's slowdown, say some analysts. "When you think of the broader monetary and fiscal policy mix, it's clearly been more aggressive in the U.S.," says David Mackie, economist at J.P. Morgan in London.

The European Central Bank cut its key interest rate to 1.25% from 4.25% in October, and is expected to trim the rate to 1% in May. That's still well above comparable rates in the U.S. and U.K.

Governments in Europe also have been slower to use fiscal policy to support demand.

Fiscal stimulus measures over a three-year period of 2008-2010 are equivalent to 4.8% of last year's gross domestic product in the U.S. and 4.4% in China, according to the IMF -- but only 3.4% in Germany, 1.5% in the U.K., and 1.3% in France.

The weakening of Europe's banking sector is potentially more damaging for the wider economy than woes at U.S. banks, because Europe's financial system relies more on bank lending and less on securities markets. Although Europe's banks have bigger balance sheets than U.S. lenders, so that their losses are smaller as a proportion of total assets, they will need more fresh money than the U.S. to repair their capital buffers, the IMF said.

An IMF report published Tuesday said that write-downs at Western European banks outside the U.K. will total $1.109 trillion for 2007-2010, topping the U.S. total of $1.049 trillion. Banks in the euro zone have so far written down only 17% of their losses, compared with roughly 50% at U.S. banks, the IMF said. U.K. banks have written down about a third of their $310 billion in expected losses, the report said.

Restrictive lending by banks trying to repair their capital ratios is holding back European businesses. At French racing-bicycle maker Look Cycle International SA, sales are suffering because the bicycle stores and distributors it deals with in markets including France and Italy can't get enough financing, says Look Chief Executive Thierry Fournier. "Dealers and distributors have problems with their banks, so everybody is more cautious about placing orders or holding stocks," he says.

Fixing the banking system is particularly tricky in the EU, where 16 of the 27 countries share the euro currency and a central bank, but where banking regulation mostly remains the preserve of the national governments.

"In Continental Europe, there is basically no prospect of any coordinated policy action to identify the weaknesses in the banking system," says Nicolas Veron, a research fellow at Brussels think tank Bruegel.

Europe's economy also faces a greater risk of further deterioration than other regions because of the deep economic and financial crisis in the formerly communist East. Austria-based banks, for example, have some $278 billion in exposure to those countries, equivalent to over 70% of Austria's gross domestic product.

The IMF expects Continental European banks' losses on emerging-market assets to reach $172 billion by 2010, more than four times the emerging-market losses it expects for U.K., U.S. or Asian banks.

Write to Marcus Walker at marcus.walker@wsj.com and Joellen Perry at joellen.perry@wsj.com
 
 
 
 
 
 
 
 
 
 

  WSJ  * APRIL 23, 2009

19. Financial Reforms We Can All Agree On Rating agencies should use numbers, not letter grades.

 
By CHARLES W. CALOMIRIS

By now we all know how the subprime mortgage market, government policies that encouraged riskier mortgage lending, and overleveraging led to the current financial crisis. But what do we do now to lower the odds of a similar financial meltdown in the future?

Here are some sensible policy reforms, many of which have been advocated by Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke and members of Congress, and are also reflected in the recent G-20 declaration on regulatory reform:

1) Limit the incentives for large, complex institutions to take advantage of their too-big-to-fail position. This can be accomplished by employing regulatory surcharges (e.g., requiring higher capital or liquidity for large, complex institutions), and by giving a financial regulator the authority to intervene and resolve the problems of large, complex, distressed financial institutions (banks and nonbanks), rather than simply bail them out.

Some critics are legitimately concerned that this could lead to incompetent or politically motivated interventions. Others worry that defining an institution as "large and complex" might actually encourage bailouts. The answer to both problems is to require such financial institutions to devise detailed and regularly updated plans to resolve their own problems.

Those plans would specify how control would be transferred to a prepackaged bridge bank if the institution became severely undercapitalized. They would also specify formulas for loss-sharing among the institution's international subsidiaries (and the arrangements would be preapproved by regulators in the subsidiaries' countries). Credible, preapproved plans would discourage financial institutions from taking advantage of their large size and complexity to avoid discipline.

2) Establish a "macro" prudential regulator. This regulator would vary capital and liquidity requirements over time in response to changes in macroeconomic and financial-system circumstances. For example, capital requirements during booms could be raised to discourage a protracted bubble from forming, and to create a larger equity cushion for banks if a bubble should burst.

3) Replace housing leverage subsidies with subsidies that carry less risk to low-income, first-time homebuyers. Democrats in the House, Senate and White House have not yet supported concrete measures that would reduce the vulnerability of housing finance going forward. Many Democrats have, however, stopped claiming that Fannie Mae and Freddie Mac were mere victims of the crisis. The Dec. 9, 2008, hearings in the House resulted in a bipartisan consensus that Fannie and Freddie had been major contributors to the crisis, and that these institutions (which are currently in conservatorship), must be reformed.

4) Use regulatory surcharges (capital or liquidity requirements) to encourage clearinghouses for over-the-counter (OTC) transactions in derivatives. For example, OTC exposures that are not cleared through clearinghouses could result in higher capital and liquidity requirements for participating counterparties than similar exposures cleared through a clearinghouse. The point here is to simplify and render transparent counterparty risk in the OTC market. Some derivatives products, like plain vanilla interest-rate swaps, are good candidates for centralized clearing; other, customized products are not. Regulatory surcharges, rather than mandates, allow the market to decide when the benefits of customization and clearing outside of clearing houses warrant paying those regulatory costs.

5) Reform the regulatory techniques for measuring risk. More capital alone is not an effective means of lowering the risks of overleveraging. Financial institutions can raise asset risk to offset higher capital requirement using various means, some of which are hard to detect. (For example, using complex derivatives contracts or leveraging positions in subsidiaries.) Existing techniques for measuring risk are based on rating-agency estimates and internally developed corporate models. But the current approach depends on bank reporting, supervisors' observations, and rating agencies' opinions. None of those three parties has a strong interest in accurate, timely measurement of risk. Bank employees on both the buy-side and the sell-side may prefer to hide risk to make their performance seem better than it is (which may lead to higher bonuses). Rating agencies earn fees from serving buy-side agents within and outside banks, and when those agents have incentive conflicts that encourage the hiding of risk, rating agencies tend to play along. Supervisors are often less skilled than the agents they supervise, have no direct stake in the proper estimation of risk, and may even face political pressure to hide risk.

But even if supervisors were extremely skilled and diligent, how could they successfully defend high-risk estimates that were entirely the result of their own models and judgment? Part of the solution is to bring objective information from the market into the regulatory process and to bring outside (market) sources of discipline in debt markets to bear on bank risk-taking. For example, some countries' prudential regulations use loan interest rates as measures of loan risk. That approach would have forced regulators to increase their risk assessments of subprime mortgages during the boom. Also, there is a large body of empirical literature showing that the yields of uninsured bank debts contain useful information about the overall riskiness of a bank. Many academics argued for incorporating such market measures into U.S. regulatory measures, but the Fed and Treasury blocked that approach in 1999 (in response to lobbying pressure from the big banks). To their credit, Fed officials seem more amenable now.

6) Avoid grade inflation in rating agencies' opinions. Lots of bad ideas are surfacing about how to accomplish that goal, one of which is to require that buyers, not sellers, pay for ratings. This would not improve the reliability of ratings. Regulated, buy-side investors (banks, pensions, mutual funds and insurance companies) pushed for ratings inflation of securitized debts to loosen restrictions on what they could buy. Giving these buyers more power would not discourage ratings inflation. Another bad idea gaining ground in Europe is to have regulators micromanage the ratings process, which would be destructive to the ratings' content.

There are better alternatives, one of which is to force ratings to be quantitative. Letter grades have no objective meaning that can be evaluated or penalized for inaccuracy. Numerical estimates of the probability of default (PD) and loss given default (LGD), in contrast, do have objective, measurable meanings.

The Nationally Recognized Statistical Rating Organizations (NRSROs) whose ratings are used by regulators should provide specific estimates of the PD and LGD for any rated instrument (they already calculate and publicly report the necessary statistics). Requiring these organizations to express ratings using numbers could alter the rating agencies' incentives dramatically. If they were penalized for systematically underestimating risk over a significant period of time -- say, with a six-month "sit out" from having their ratings used for regulatory purposes -- they would have a strong self-interest in correctly estimating risk.

7) Change corporate governance rules to encourage better discipline of bank management. Rather than deal with the symptoms of poor governance (e.g., compensation structures), it would be better to improve the ability of stockholders to discipline management. One such reform would be to eliminate ownership concentration limits imposed on regulated institutional investors who are stockholders of bank holding companies, and limits on which other investors are permitted to own controlling interests in bank holding companies. This would significantly improve the corporate governance of large bank holding companies.

While sensible legislative action may seem a long way off, one encouraging fact is the absence, so far, of truly terrible ideas. Even the discussion on regulating compensation has so far focused on the need to align management incentives with long-term performance, rather than trying to limit the overall size of compensation.

Mr. Calomiris is a professor of finance at Columbia Business School and a research associate at the National Bureau for Economic Research. This op-ed is adapted from a chapter in the forthcoming book "Change We Can Afford?" -- a collection of essays on President Obama's policies published by the Hoover Institution Press.

    *WSJ APRIL 23, 2009

20. Long Odds? Three Scenarios for the Economy's Path
    *
      By DAVID WESSEL
 

There is no doubt where the economy is now. "By any measure, this downturn represents by far the deepest global recession since the Great Depression," the International Monetary Fund declared Wednesday.

But there's more than the usual uncertainty about where it is going. The key is the U.S. Even though its slice of the world economy is smaller than it once was, it's still huge. The U.S. led the world into the abyss, and it will lead the world economy out of it.

But how fast and when?

The alphabet can help to imagine the possibilities and the path of the economy. There's the letter V: the kind of quick rebound that usually follows a deep recession. Or U: a longer recession and slow recovery. There is L: years of painfully slow growth. And W: a temporary upturn as the economy feels the jolt of fiscal stimulus that quickly wears off. Finally, there's the big D, not the shape but another Great Depression.

With history a guide, consider three starkly different scenarios.
The V

The late Victor Zarnowitz, a student of the business cycle, had a rule: "Deep recessions are almost always followed by steep recoveries." The mild recession of the early 1990s and early 2000s were followed by mild recoveries. But the U.S. economy grew faster than a 6% pace in the four quarters after the deep 1973-75 recession and faster than a 7.75% pace after the even deeper 1980-82 downturn.
video
What's On the Other Side of the Recession?
2:09

The IMF says this is the worst recession that the world has seen since the Great Depression. So what will happen next? Economics Editor David Wessel discusses three possible scenarios.

"In deep recessions," says Michael Mussa of the Peterson Institute for International Economics, "there is usually a growing sense of gloom as the recession deepens." Then the forces that triggered recession -- say, plunging home prices -- abate. The adrenaline of tax cuts and government spending kicks in. With inventories so lean, the slightest uptick in demand prompts a sharp increase in production, and the natural dynamism of capitalism reasserts itself.

"Experience suggests all of this should work, and I believe it will," Mr. Mussa predicts. Governments have administered huge doses of fiscal and monetary stimulus. Home-building and car-buying are so low they can't fall much further. Many consumers shy away from buying because they're frightened, not broke, and that state of mind can change quickly and liberate pent-up demand.

But the Federal Reserve caused the deep recessions of the 1970s and 1980s when it put its foot on the brake to stop inflation; it ended them when it let up. This time, Fed has its foot to the floor and the economy is still slowing. And so much stock-market and housing wealth has evaporated that a quick turn in consumer spirits seems unlikely. Plus, the repair of the banks remains far from complete, restraining lending.

The odds of the V: 15%.
The Big D

If one asked a roomful of economists two years ago to put odds on a repeat of the Great Depression, nearly all would have said zero. In early March, The Wall Street Journal posed the question to about 50 forecasters -- defining depression as a decline in output per person of more than 10%, four times worse than the decline the IMF anticipates. On average, they put odds at one in seven; several put them above one in four.
[Deeper Decline]

"This is a Depression-sized event," says economic historian Barry Eichengreen of the University of California at Berkeley, citing the global decline in industrial production and world trade. The big difference: In 1929, governments dithered, or worse. In 2009, they've rushed to the rescue.

To go from today's deep recession to a depression something would have to go wrong. It could be a financial catastrophe on the scale of last fall's bankruptcy by Lehman Brothers or another panic-inducing event. Or a crash in the dollar, one that forces interest rates up at just the wrong moment. Or it could be political gridlock that stops governments in the U.S. or Europe from spending enough to fix the banks before a big one fails, or keeps them for doing more on the fiscal or monetary fronts as the economy deteriorates.

Or it could be virulent deflation that pulls down prices and incomes, making debts, which don't fall when prices do, a heavier burden. The textbook remedy is easy money and big government deficits. But so much of that has been tried it's easy to question its efficacy or to imagine resistance around the world to doing.

The odds of the big D: 20%.
The L

For a decade after its stock market and real-estate bubble burst in 1990, Japan bumped along at an annual growth of just 0.5%. It was dubbed the Lost Decade, and it could happen here. The recession ends but the economy plods along, growing too slowly to bring down unemployment for years.

As the IMF observed this week, recoveries following recession caused by financial crises are "typically slower." Those following recessions that occur simultaneously across the globe "have typically been weak." Back in the 1990s, as U.S. banks struggled, the Fed talked a lot about "financial headwinds." Those were zephyrs compared to the gale-force winds that the economy confronts today.

If financial markets stabilize but don't improve steadily, or if housing prices continue to drift down, or if confidence remains shaky, the U.S. economy could languish for a time. American consumers, once known for spending in the face of prosperity or adversity, could finally decide to prepare for retirement by saving more, having just learned that neither 401(k) retirement accounts nor home values rise inexorably. And the U.S. can't count on increasing exports, the solution when emerging-market economies run into financial trouble and the reason Japan didn't do even worse in the 1990s. The rest of the world is in no shape to buy.

An unfolding depression could scare Congress to act boldly, but the L is less ominous -- and perhaps more likely as a result. There would be months when the economy appeared to be strengthening so the temptation to wait-and-see would be strong.

Put the odds of the L at 55%. That adds to 90%. So put 10% odds on the U, less pleasant than the euphoric V but far less painful than a Lost Decade. That's the rough consensus of economic forecasters; it means U.S. unemployment grows for another year and a half.

Bottom line: The odds favor a long slog.
 
21. Preferences for redistribution: The crisis, reduced inequality, and soak-the-rich populism

Alberto Alesina   Paola Giuliano
23 April 2009 http://www.voxeu.org/index.php?q=node/3488
 
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Will Americans turn into “inequality intolerant” Europeans? Such a radical shift is unlikely, but this column argues that this crisis may be a turning point towards more government intervention and redistribution in the US. More and more Americans believe that hard work is insufficient to climb the income ladder and are expressing anger against “unfairly” accumulated wealth. Politicians should prefer wise policies but may be tempted by populist outbursts.

The current financial crisis will reduce income and wealth inequality. The rich who heavily invested in financial and stock markets have lost much more than the less wealthy. The relatively poor “young” may face the sale of the century. Go and tell a young (and poor) just-married couple that the collapse of housing prices is a problem; mention to a young worker just beginning to accumulate retirement money that low stock prices are a problem!

Many will consider this reduction in inequality the silver lining of the crisis and a welcome development. This is especially the case because many people are acutely aware of the increase in income inequality that occurred in many (especially English-speaking) countries in the last three decades and perhaps tend to think of it as “unfair”. Those who became rich from complicated financial instruments and sophisticated investments in derivatives are now seen as undeserving of their wealth. The extraordinary bonuses of certain incompetent managers, especially those bailed out by the taxpayers, have certainly not helped gain them sympathy. Nevertheless, a frontal attack on the finance world is pure populism; finance serves a very productive purpose. One cannot mix criminals like Bernie Madoff with unlucky or even excessively leveraged, overly risk-taking, sometimes incompetent, and overpaid managers. Politicians should not throw fuel on any anti-finance or anti-Wall Street sentiments. There is enough anger against “unfairly” accumulated wealth; we do not need more.

The increase in income inequality of the last three decades in the US is not extraordinary if viewed from a very long-term perspective. The thirty years after the Second World War were the period of the “Great Compression” – a sharp reduction in income inequality (Piketty and Saez 2003). A few months ago, just before the crisis, we were back to roughly to the level of the 1920s, which was the norm in previous decades, not to mention the level of inequality and of social immobility of pre-capitalist societies. But the perception that this increase in inequality was unfair will greatly weigh on the way it will be handled and the political backlash it will create.

Our research (Alesina and Giuliano 2009) suggests that this is a situation in which voters will demand especially strong action to reduce inequality, even in a country like the US, where inequality is much more tolerated than in Europe. All over the world, the poor favour more redistribution than the rich, which is not surprising. But beyond that basic fact, the attitude towards what is the right amount of redistribution varies greatly and is affected by many more variables than just current income. In particular, when people perceive that the income ladder is the result of differences in hard work, effort, and creativity, even the relatively poor may accept large differences in income. This is partly because their sense of justice tells them that these are fair inequalities and partly because they feel that the income ladder can be climbed if it really depends only on effort and hard work. This is true both when comparing individuals within a country and comparing average attitudes across countries.

For instance, according to the World Values Survey, a large majority of Americans (around 60%) used to believe that the income ladder could be climbed and the poor could make it if they tried hard. Only a minority of Europeans (less than 40%) had the same view. That explains a lot of the difference in the generosity of the welfare state in the two places. Americans think that they live in a socially mobile society with less need for active public redistributive policies. Europeans, by and large, have the opposite feeling. Now Americans may feel that the social mobility that they cherished was not so large after all; investing in derivatives hardly has the same “feeling” in the popular sentiments as, say, working a late shift in a shop.

Therefore, this crisis may have changed American attitudes toward inequality a bit. If they perceive inequality as unfair they will demand more redistribution. The traditional aversion to taxation of Americans may give way to a “soak the rich” feeling. Higher taxes will be needed to handle the booming budget deficits. We would predict that the progressivity of the tax system will also increase, as the median voter will demand it. Politicians should resist such populist measures. Increasing the tax base rather than the brackets is the best way to increase taxes on the rich. A simplification of the byzantine tax code, where the wealthy can often hide income, is way overdue.

Will Americans turn into “inequality intolerant” Europeans? Probably not, but this crisis may imply a turning point towards more government intervention and towards redistribution.
References

Alberto Alesina and Paola Giuliano (2009) Preferences for redistribution, NBER Working Paper 14825.
Piketty, Thomas and Emmanuel Saez. 2003. “Income Inequality in the United States, 1913-1998.” Quarterly Journal of Economics, 118(1): 1–39.

This article may be reproduced with appropriate attribution. See Copyright (below).
 
 
 
 

22. Economists React: ‘Plunge Is Over’ in Existing-Home Sales
Posted by Phil Izzo

Economists and others weigh in on the decline in existing-home sales.

    * Home sales have stabilized following the post-Lehmans plunge and remain above January’s trough of 4,490,000. March’s fall is probably just noise rather than a renewed downward trend. Admittedly, around 50% of sales are now related to distressed properties, which is hardly a sign of strength. But at least these sales are helping to reduce the inventory overhang… Overall, with the housing market having led the economy into the recession, it is no surprise that it might be the first sector to stabilise. Nonetheless, we suspect that prices have yet to reach their floor. –Paul Dales, Capital Economics

    * This is a bit disappointing but the big picture is still clear; the plunge in sales following the Lehman blowup is over. Unfortunately … prices will continue to fall rapidly for the foreseeable future, though at least the rate of decline should not get any worse. The floor for prices is probably a late 2010 story. –Ian Shepherdson, High Frequency Economics
    * The report was very disappointing, particularly given the broad-based nature of the declines… With the backdrop for U.S. households continuing to deteriorate on account of the worsening labor market conditions and weakening economy, we expect the housing market correction to continue well into this year. Nevertheless, the pace of decline is likely to ease as improved housing affordability conditions begin to spur housing demand. –Millan L. B. Mulraine, TD Securities
    * The weaker-than-expected result does not change the broad trend in sales, however, which continues to point to a tenuous stabilization… Sales in the western United States, where foreclosure activity is most prevalent, show a distinctly different pattern than those in other regions. Total existing sales (single family sales plus condos and co-ops) are up 19% year-to-year in the West… The improvement in sales in the Western region is an encouraging sign that discounted prices, record low mortgage rates and various tax incentives are stimulating new demand. –Nomura Global Economics
    * Although home resales were down in March, one can make a reasonable argument that resales are bottoming (albeit as a result of steep cuts in price as distressed and foreclosure sales make up a large share of existing home sales) as the average level of sales in the first quarter was similar to the fourth quarter’s average. –RDQ Economics
    * After dropping by 11% in October and November combined, likely reflecting the fallout from the financial meltdown in September, resales have held between 4.49 million and 4.74 million units, pointing to some stabilization in housing demand. With housing affordability rising dramatically thanks to lower prices and lower mortgage rates, demand from first-time homebuyers seems to be on the rise and is clearly supporting the market. Indeed, the NAR pointed out that first-time buyers accounted for just over half of all existing home sales in March. Still, first-time buyers typically purchase at the lower end of the market, which could help to explain why half of all resales last month were distressed properties. –Omair Sharif, RBS
 

23. FDIC Chief Says Banking Sector ‘Past the Crisis Stage’
Posted by Damian Paletta

Federal Deposit Insurance Corp. Chairman Sheila Bair said on Thursday that some parts of the banking sector were recovering but could still face pain on the horizon, as delinquencies could keep rising due not to exotic mortgage products but rising unemployment and tougher economic conditions.

“I think we are past the crisis stage,” she said in a speech to the Bretton Woods Committee in Washington. “I think we are in the clean up stage now.”

Some of her observations:

    * 1) “The Federal Reserve in particular has been heroic in the various facilities they have implemented to provide stability and increase liquidity in the system…Treasury obviously has also played a very strong leadership role with their ever unpopular TARP program, but a necessary program, to make sure that banks have the capital buffers that they need to keep lending and support the economy.”
    * 2) She said a FDIC’s new “Public-Private Investment Program” would be tested during a trial phase in June. She said they would be “very careful with that program. Very transparent.” She said they wanted to “kick the tires” to ensure” that it “is a clean process without conflicts.”
    * 3) The FDIC’s Temporary Liquidity Guarantee Program, which backs debt issued by banks, hasn’t lost any money since being implemented last Fall. “WE don’t expect to have losses,” she said. “We’ve actually collected over $7 billion in premiums for that program.”
    * 4) She reiterated her call for the power to break down a large nonfinancial company, being careful to distinguish that her agency could do it but they weren’t necessarily angling for it. “I think we would be a logical place for that. We aren’t asking for it, but we know how to close an institution. And we’re equipped for it.”
 
 

24. IMF Protestors Getting Leaner and Meaner
Posted by Bob Davis

This year’s crop of anti-globalization protestors plan to buff up while they try to shut down (or at least delay a little) this weekend’s meetings of the International Monetary Fund and World Bank.

On Friday, Global Justice Action, a Washington D.C., activist group that bills itself as having “New Ideas After the Capitalist Casino Goes Bust,” is sponsoring a 5K jog to the World Bank around lunch time. (“5K Run on the Bank,” the group calls it.) On Saturday there is an “Aerobics Themed Roving Dance Party” that begins at 7 a.m., and street baseball and soccer games scheduled for 10 pm.

There are also assorted marches during the weekend – some with required permits, some not — and a Saturday morning effort to somehow blockade the bank and IMF, all of which can burn off calories

Why the heavy exercise? “We’ve found that people want more creative forms of resistance than just marching in the streets,” e-mails Lacy MacAuley, a Global Justice spokesperson. “Every time we empower ourselves through promoting our personal health, every time we express our own creativity rather than just absorbing what the billion-dollar entertainment industry hands down to us… we build that better world we know is possible.”

It’s not all heavy lifting. On Saturday afternoon, the protestors plan to meet for “vegan milk and cookies” at a library not far from the bank and IMF.

25.Doctor Doom The Global Economy In The Next Year
Nouriel Roubini, 04.23.09, 12:00 AM EDT
More contraction in growth--and more job losses.
pic

http://www.forbes.com/2009/04/22/depression-recession-growth-job-losses-opinions-columnists-nouriel-roubini.html

The global economy is in the middle of a synchronized contraction that will push global growth into negative territory in 2009 for the first time in decades. This will be the worst financial crisis since the Great Depression and the worst global economic downturn in decades. Global trade volumes face their sharpest contractions of the postwar era--trade is expected to contract 12% in 2009 due to the severe and prolonged slump in global demand, excess capacity across supply chains and the continued crunch in trade finance.

Many analysts and commentators are pointing out that the second derivative of economic activity is turning positive (i.e., economies are still contracting, but at a slower rather than accelerated rate) and that the green shoots of an economic recovery are peeping out. My analysis of the data suggests that the global economic contraction is still in full swing with a very severe, deep and protracted U-shaped recession.
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Last year's economic consensus forecast of a V-shaped short and shallow recession has vanished. While the rate of economic contraction is slowing compared to the free fall rates of the fourth quarter of 2008 and the first quarter of 2009, we are still a long way away from the economic bottom and from a sustained recovery of growth. In particular, in Europe and Japan there is little evidence of a positive second derivative of economic activity.

However, by the end of the first quarter of 2009, there were some signs that the pace of contraction had slowed in many economies, especially in the U.S. and China, where policy responses have been more significant and leading indicators in the manufacturing sector may have bottomed before they did in Europe and Japan. However, major economies, including all of the G7, will continue to contract throughout 2009, albeit at a slower pace than at the beginning of the year.

Moreover, the global recovery might be sluggish at best in 2010 given the overhang of the credit losses of financial institutions, the lingering credit crunch, the need for retrenchment by overstretched and over-indebted households in current-account-deficit countries, and a slow resumption of demand prompted by extensive government stimulus.

Some key elements of my outlook include:

--Global economic activity is expected to contract by 1.9% in 2009. Advanced economies are expected to contract 4% in 2009. Japan and the eurozone will suffer the sharpest downturns. U.S. gross domestic product will continue to contract, albeit at a slower pace throughout 2009, with negative growth in every quarter.

--Emerging markets will slow down sharply from the stellar growth rates of the past few years, with the BRIC economies growing at half their 2008 pace.
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--Deteriorated terms of trade, slower capital flows and tighter credit will push Latin America into recession from the 4.1% growth of 2008. Argentina, Brazil, Chile, Colombia, Mexico and Venezuela will all shift to negative territory on a year-over-year basis, while smaller economies, like Peru, will experience a significant slowdown.

--Countries in Eastern Europe and the sphere of Russia will experience some of the sharpest contractions given the withdrawal of foreign credit and the risk of a severe financial crisis. The reduction in oil revenues and financial stress will contribute to a 5% year-over-year contraction in Russia, and some countries--especially in the Baltics--are at risk of double-digit contractions

--Export-dependent Asia's growth will slow significantly to less than 3% in 2009. China will have a hard landing with GDP growth falling to 5.5% while India will slow sharply to 4.3%. All four Asian Tigers (Singapore, Taiwan, South Korea and Hong Kong) as well as Malaysia and Thailand will experience recessions.

--The Middle East and Africa will mark much slower growth, at half of their 2008 pace, given the reduction in capital inflows, reduced demand from the U.S. and E.U., and decline in commodity prices and output. Israel and South Africa will suffer slight contractions.

--The unprecedented fiscal and monetary stimulus may help alleviate the substantial contraction in private demand and reduce the risk of a global L-shaped near-depression. Debt financing may be a challenge for many countries though, especially emerging markets or the most vulnerable Western European economies.

--Job losses during the current global recession might exceed those in recent recession, contributing to increases in defaults and posing additional risks to banks. The unemployment rate in developed countries will reach double-digits by 2010 (as early as mid-2009 in the U.S.) and push more people in developing countries into poverty. Moreover, despite new funding from multilateral institutions, severe contractions will raise the risk of social and political unrest.

--Commodities, as a class, are likely to come under renewed pressure in 2009, despite some support from production cuts. I expect the West Texas Intermediate (WTI) oil price to average about $40 a barrel in 2009, as demand destruction continues to outweigh crude supply destruction.

Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes. (Analysts at Roubini Global Economics assisted in the research and writing of this piece.)

 *WSJ  APRIL 23, 2009Europe's Grim Outlook Challenges World Recovery

  WSJ  * APRIL 23, 2009 Financial Reforms We Can All Agree On Rating agencies should use numbers, not letter grades.
 

    *WSJ APRIL 23, 200926.  Long Odds? Three Scenarios for the Economy's Path
 

Preferences for redistribution: The crisis, reduced inequality, and soak-the-rich populism

Economists React: ‘Plunge Is Over’ in Existing-Home Sales

 Chief Says Banking Sector ‘Past the Crisis Stage’

Doctor Doom The Global Economy In The Next Year
 
 

 *WSJ  APRIL 23, 2009

26. Europe's Grim Outlook Challenges World Recovery
 

By MARCUS WALKER and JOELLEN PERRY

Europe's economy faces a deeper recession and a slower recovery than the U.S. or other parts of the world, making it the region that is most hurting prospects for an early end to the global economic slump.

The EU's economy is set to contract 4% this year, even worse than the 2.8% drop projected for the U.S., according to new forecasts published Wednesday by the International Monetary Fund.
[Londoners seek work] Reuters

People look at job listings at a career fair in London.

Those figures came as the U.K. released a budget that includes its biggest jump in the national debt since World War II. Germany, Europe's biggest economy, shrank by 3.3% in the first quarter -- a steep slide from a 2.1% contraction in the last quarter of 2008.

German Finance Minister Peer Steinbrück on Wednesday said it was "not unlikely" that the country's economy will shrink by 5% or more this year, and leading German economics institutes said GDP is set to contract 6%, which would be its worst recorded performance since 1931.

European banks' losses from the global financial crisis are now projected to overtake U.S. banks' losses, according to IMF figures, which could hurt the banks' ability to lend liberally to help the bloc out of its crisis. More than half of the losses on continental Europe are homemade, the IMF said, reflecting bad loans to European firms and households rather than toxic U.S. securities.

The worsening outlook for the 27-nation EU is a blow for many of the region's governments, who have argued that the U.S. is the center of the global economic storm and that Europe's problems are smaller. Because of that, plus fear of rising inflation and public debt, authorities in much of Europe have been slower than those in the U.S. or leading Asian economies to cut interest rates or adopt ambitious fiscal-stimulus measures.
"At some deep level the European banks and policy makers don't get it: that they helped cause the crisis, that their slow response is part of the reason that the economy is bad, and that more is on the way," says Simon Johnson, a former IMF chief economist.

Europe's poor prospects are likely to rebound on the U.S., Asia and other regions, given that the EU's $18.4 trillion economy makes up 30% of the world economy.

In a sign of such spillover, Peoria, Ill.-based equipment maker Caterpillar Inc. said its first-quarter sales to Europe fell 46% from a year ago, significantly more than its sales declines in the U.S., Asia or Latin America, as it announced a first-quarter loss on Tuesday.

Even European firms' hopes are pinned on other regions where countries are spending more on stimulus plans. At Munich-based engineering firm HAWE Hydraulik SE, owner Karl Haeusgen is hoping that signs of life in the U.S. and China will lead to new export orders. In recent months, his orders have fallen as much as half from a year ago.

HAWE is holding on to its workers at idle German factories only because the government is helping to pay their salaries -- a policy many European countries use to damp unemployment figures. "That we have a downturn is not surprising, but the intensity is unexpected and abnormal," says Mr. Haeusgen.
[Workers walk past a guard post at the entrance to Continental AG's tire factory in northern France Wednesday. The building was damaged by rioting workers after a French court rejected an attempt to block the plant's closure.] Associated Press

Workers walk past a guard post at the entrance to Continental AG's tire factory in northern France Wednesday. The building was damaged by rioting workers after a French court rejected an attempt to block the plant's closure.

In France, labor protests became more violent this week as workers stormed and ransacked a government building near Paris, after they failed in court to prevent the shutdown of their tire factory, owned by German auto-parts company Continental AG. German Trade Union Federation head Michael Sommer warned his country's industrialists this week that such social unrest could spread to Germany if mass layoffs multiply.

On Tuesday, credit-rating agency Standard & Poor's predicted that debt defaults among high-risk European companies would overtake defaults among low-rated U.S. companies.

Some business surveys and economic data suggest the pace of Europe's contraction might be easing. But signs of a recovery in coming months appear weaker than in other regions, such as Asia and the U.S., where economists say more aggressive government efforts are starting to show some effect.

Tentative signs of relief in Asia include Chinese factory output and auto sales, which improved in March. Japan is also seeing some hope, as exports in March nearly halved from a year earlier but rose from February, the first monthly gain since May last year.

Policy makers are partly to blame for the severity of the euro zone's slowdown, say some analysts. "When you think of the broader monetary and fiscal policy mix, it's clearly been more aggressive in the U.S.," says David Mackie, economist at J.P. Morgan in London.

The European Central Bank cut its key interest rate to 1.25% from 4.25% in October, and is expected to trim the rate to 1% in May. That's still well above comparable rates in the U.S. and U.K.

Governments in Europe also have been slower to use fiscal policy to support demand.

Fiscal stimulus measures over a three-year period of 2008-2010 are equivalent to 4.8% of last year's gross domestic product in the U.S. and 4.4% in China, according to the IMF -- but only 3.4% in Germany, 1.5% in the U.K., and 1.3% in France.

The weakening of Europe's banking sector is potentially more damaging for the wider economy than woes at U.S. banks, because Europe's financial system relies more on bank lending and less on securities markets. Although Europe's banks have bigger balance sheets than U.S. lenders, so that their losses are smaller as a proportion of total assets, they will need more fresh money than the U.S. to repair their capital buffers, the IMF said.

An IMF report published Tuesday said that write-downs at Western European banks outside the U.K. will total $1.109 trillion for 2007-2010, topping the U.S. total of $1.049 trillion. Banks in the euro zone have so far written down only 17% of their losses, compared with roughly 50% at U.S. banks, the IMF said. U.K. banks have written down about a third of their $310 billion in expected losses, the report said.

Restrictive lending by banks trying to repair their capital ratios is holding back European businesses. At French racing-bicycle maker Look Cycle International SA, sales are suffering because the bicycle stores and distributors it deals with in markets including France and Italy can't get enough financing, says Look Chief Executive Thierry Fournier. "Dealers and distributors have problems with their banks, so everybody is more cautious about placing orders or holding stocks," he says.

Fixing the banking system is particularly tricky in the EU, where 16 of the 27 countries share the euro currency and a central bank, but where banking regulation mostly remains the preserve of the national governments.

"In Continental Europe, there is basically no prospect of any coordinated policy action to identify the weaknesses in the banking system," says Nicolas Veron, a research fellow at Brussels think tank Bruegel.

Europe's economy also faces a greater risk of further deterioration than other regions because of the deep economic and financial crisis in the formerly communist East. Austria-based banks, for example, have some $278 billion in exposure to those countries, equivalent to over 70% of Austria's gross domestic product.

The IMF expects Continental European banks' losses on emerging-market assets to reach $172 billion by 2010, more than four times the emerging-market losses it expects for U.K., U.S. or Asian banks.

Write to Marcus Walker at marcus.walker@wsj.com and Joellen Perry at joellen.perry@wsj.com
 
 
 
 
 
 
 
 
 
 

  WSJ  * APRIL 23, 2009

27. Financial Reforms We Can All Agree On Rating agencies should use numbers, not letter grades.

 
By CHARLES W. CALOMIRIS

By now we all know how the subprime mortgage market, government policies that encouraged riskier mortgage lending, and overleveraging led to the current financial crisis. But what do we do now to lower the odds of a similar financial meltdown in the future?

Here are some sensible policy reforms, many of which have been advocated by Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben Bernanke and members of Congress, and are also reflected in the recent G-20 declaration on regulatory reform:

1) Limit the incentives for large, complex institutions to take advantage of their too-big-to-fail position. This can be accomplished by employing regulatory surcharges (e.g., requiring higher capital or liquidity for large, complex institutions), and by giving a financial regulator the authority to intervene and resolve the problems of large, complex, distressed financial institutions (banks and nonbanks), rather than simply bail them out.

Some critics are legitimately concerned that this could lead to incompetent or politically motivated interventions. Others worry that defining an institution as "large and complex" might actually encourage bailouts. The answer to both problems is to require such financial institutions to devise detailed and regularly updated plans to resolve their own problems.

Those plans would specify how control would be transferred to a prepackaged bridge bank if the institution became severely undercapitalized. They would also specify formulas for loss-sharing among the institution's international subsidiaries (and the arrangements would be preapproved by regulators in the subsidiaries' countries). Credible, preapproved plans would discourage financial institutions from taking advantage of their large size and complexity to avoid discipline.

2) Establish a "macro" prudential regulator. This regulator would vary capital and liquidity requirements over time in response to changes in macroeconomic and financial-system circumstances. For example, capital requirements during booms could be raised to discourage a protracted bubble from forming, and to create a larger equity cushion for banks if a bubble should burst.

3) Replace housing leverage subsidies with subsidies that carry less risk to low-income, first-time homebuyers. Democrats in the House, Senate and White House have not yet supported concrete measures that would reduce the vulnerability of housing finance going forward. Many Democrats have, however, stopped claiming that Fannie Mae and Freddie Mac were mere victims of the crisis. The Dec. 9, 2008, hearings in the House resulted in a bipartisan consensus that Fannie and Freddie had been major contributors to the crisis, and that these institutions (which are currently in conservatorship), must be reformed.

4) Use regulatory surcharges (capital or liquidity requirements) to encourage clearinghouses for over-the-counter (OTC) transactions in derivatives. For example, OTC exposures that are not cleared through clearinghouses could result in higher capital and liquidity requirements for participating counterparties than similar exposures cleared through a clearinghouse. The point here is to simplify and render transparent counterparty risk in the OTC market. Some derivatives products, like plain vanilla interest-rate swaps, are good candidates for centralized clearing; other, customized products are not. Regulatory surcharges, rather than mandates, allow the market to decide when the benefits of customization and clearing outside of clearing houses warrant paying those regulatory costs.

5) Reform the regulatory techniques for measuring risk. More capital alone is not an effective means of lowering the risks of overleveraging. Financial institutions can raise asset risk to offset higher capital requirement using various means, some of which are hard to detect. (For example, using complex derivatives contracts or leveraging positions in subsidiaries.) Existing techniques for measuring risk are based on rating-agency estimates and internally developed corporate models. But the current approach depends on bank reporting, supervisors' observations, and rating agencies' opinions. None of those three parties has a strong interest in accurate, timely measurement of risk. Bank employees on both the buy-side and the sell-side may prefer to hide risk to make their performance seem better than it is (which may lead to higher bonuses). Rating agencies earn fees from serving buy-side agents within and outside banks, and when those agents have incentive conflicts that encourage the hiding of risk, rating agencies tend to play along. Supervisors are often less skilled than the agents they supervise, have no direct stake in the proper estimation of risk, and may even face political pressure to hide risk.

But even if supervisors were extremely skilled and diligent, how could they successfully defend high-risk estimates that were entirely the result of their own models and judgment? Part of the solution is to bring objective information from the market into the regulatory process and to bring outside (market) sources of discipline in debt markets to bear on bank risk-taking. For example, some countries' prudential regulations use loan interest rates as measures of loan risk. That approach would have forced regulators to increase their risk assessments of subprime mortgages during the boom. Also, there is a large body of empirical literature showing that the yields of uninsured bank debts contain useful information about the overall riskiness of a bank. Many academics argued for incorporating such market measures into U.S. regulatory measures, but the Fed and Treasury blocked that approach in 1999 (in response to lobbying pressure from the big banks). To their credit, Fed officials seem more amenable now.

6) Avoid grade inflation in rating agencies' opinions. Lots of bad ideas are surfacing about how to accomplish that goal, one of which is to require that buyers, not sellers, pay for ratings. This would not improve the reliability of ratings. Regulated, buy-side investors (banks, pensions, mutual funds and insurance companies) pushed for ratings inflation of securitized debts to loosen restrictions on what they could buy. Giving these buyers more power would not discourage ratings inflation. Another bad idea gaining ground in Europe is to have regulators micromanage the ratings process, which would be destructive to the ratings' content.

There are better alternatives, one of which is to force ratings to be quantitative. Letter grades have no objective meaning that can be evaluated or penalized for inaccuracy. Numerical estimates of the probability of default (PD) and loss given default (LGD), in contrast, do have objective, measurable meanings.

The Nationally Recognized Statistical Rating Organizations (NRSROs) whose ratings are used by regulators should provide specific estimates of the PD and LGD for any rated instrument (they already calculate and publicly report the necessary statistics). Requiring these organizations to express ratings using numbers could alter the rating agencies' incentives dramatically. If they were penalized for systematically underestimating risk over a significant period of time -- say, with a six-month "sit out" from having their ratings used for regulatory purposes -- they would have a strong self-interest in correctly estimating risk.

7) Change corporate governance rules to encourage better discipline of bank management. Rather than deal with the symptoms of poor governance (e.g., compensation structures), it would be better to improve the ability of stockholders to discipline management. One such reform would be to eliminate ownership concentration limits imposed on regulated institutional investors who are stockholders of bank holding companies, and limits on which other investors are permitted to own controlling interests in bank holding companies. This would significantly improve the corporate governance of large bank holding companies.

While sensible legislative action may seem a long way off, one encouraging fact is the absence, so far, of truly terrible ideas. Even the discussion on regulating compensation has so far focused on the need to align management incentives with long-term performance, rather than trying to limit the overall size of compensation.

Mr. Calomiris is a professor of finance at Columbia Business School and a research associate at the National Bureau for Economic Research. This op-ed is adapted from a chapter in the forthcoming book "Change We Can Afford?" -- a collection of essays on President Obama's policies published by the Hoover Institution Press.

    *WSJ APRIL 23, 2009

27. Financial Reforms We Can All Agree On Rating agencies should use numbers, not letter grades.

    *
      By DAVID WESSEL
 

There is no doubt where the economy is now. "By any measure, this downturn represents by far the deepest global recession since the Great Depression," the International Monetary Fund declared Wednesday.

But there's more than the usual uncertainty about where it is going. The key is the U.S. Even though its slice of the world economy is smaller than it once was, it's still huge. The U.S. led the world into the abyss, and it will lead the world economy out of it.

But how fast and when?

The alphabet can help to imagine the possibilities and the path of the economy. There's the letter V: the kind of quick rebound that usually follows a deep recession. Or U: a longer recession and slow recovery. There is L: years of painfully slow growth. And W: a temporary upturn as the economy feels the jolt of fiscal stimulus that quickly wears off. Finally, there's the big D, not the shape but another Great Depression.

With history a guide, consider three starkly different scenarios.
The V

The late Victor Zarnowitz, a student of the business cycle, had a rule: "Deep recessions are almost always followed by steep recoveries." The mild recession of the early 1990s and early 2000s were followed by mild recoveries. But the U.S. economy grew faster than a 6% pace in the four quarters after the deep 1973-75 recession and faster than a 7.75% pace after the even deeper 1980-82 downturn.
video
What's On the Other Side of the Recession?
2:09

The IMF says this is the worst recession that the world has seen since the Great Depression. So what will happen next? Economics Editor David Wessel discusses three possible scenarios.

"In deep recessions," says Michael Mussa of the Peterson Institute for International Economics, "there is usually a growing sense of gloom as the recession deepens." Then the forces that triggered recession -- say, plunging home prices -- abate. The adrenaline of tax cuts and government spending kicks in. With inventories so lean, the slightest uptick in demand prompts a sharp increase in production, and the natural dynamism of capitalism reasserts itself.

"Experience suggests all of this should work, and I believe it will," Mr. Mussa predicts. Governments have administered huge doses of fiscal and monetary stimulus. Home-building and car-buying are so low they can't fall much further. Many consumers shy away from buying because they're frightened, not broke, and that state of mind can change quickly and liberate pent-up demand.

But the Federal Reserve caused the deep recessions of the 1970s and 1980s when it put its foot on the brake to stop inflation; it ended them when it let up. This time, Fed has its foot to the floor and the economy is still slowing. And so much stock-market and housing wealth has evaporated that a quick turn in consumer spirits seems unlikely. Plus, the repair of the banks remains far from complete, restraining lending.

The odds of the V: 15%.
The Big D

If one asked a roomful of economists two years ago to put odds on a repeat of the Great Depression, nearly all would have said zero. In early March, The Wall Street Journal posed the question to about 50 forecasters -- defining depression as a decline in output per person of more than 10%, four times worse than the decline the IMF anticipates. On average, they put odds at one in seven; several put them above one in four.
[Deeper Decline]

"This is a Depression-sized event," says economic historian Barry Eichengreen of the University of California at Berkeley, citing the global decline in industrial production and world trade. The big difference: In 1929, governments dithered, or worse. In 2009, they've rushed to the rescue.

To go from today's deep recession to a depression something would have to go wrong. It could be a financial catastrophe on the scale of last fall's bankruptcy by Lehman Brothers or another panic-inducing event. Or a crash in the dollar, one that forces interest rates up at just the wrong moment. Or it could be political gridlock that stops governments in the U.S. or Europe from spending enough to fix the banks before a big one fails, or keeps them for doing more on the fiscal or monetary fronts as the economy deteriorates.

Or it could be virulent deflation that pulls down prices and incomes, making debts, which don't fall when prices do, a heavier burden. The textbook remedy is easy money and big government deficits. But so much of that has been tried it's easy to question its efficacy or to imagine resistance around the world to doing.

The odds of the big D: 20%.
The L

For a decade after its stock market and real-estate bubble burst in 1990, Japan bumped along at an annual growth of just 0.5%. It was dubbed the Lost Decade, and it could happen here. The recession ends but the economy plods along, growing too slowly to bring down unemployment for years.

As the IMF observed this week, recoveries following recession caused by financial crises are "typically slower." Those following recessions that occur simultaneously across the globe "have typically been weak." Back in the 1990s, as U.S. banks struggled, the Fed talked a lot about "financial headwinds." Those were zephyrs compared to the gale-force winds that the economy confronts today.

If financial markets stabilize but don't improve steadily, or if housing prices continue to drift down, or if confidence remains shaky, the U.S. economy could languish for a time. American consumers, once known for spending in the face of prosperity or adversity, could finally decide to prepare for retirement by saving more, having just learned that neither 401(k) retirement accounts nor home values rise inexorably. And the U.S. can't count on increasing exports, the solution when emerging-market economies run into financial trouble and the reason Japan didn't do even worse in the 1990s. The rest of the world is in no shape to buy.

An unfolding depression could scare Congress to act boldly, but the L is less ominous -- and perhaps more likely as a result. There would be months when the economy appeared to be strengthening so the temptation to wait-and-see would be strong.

Put the odds of the L at 55%. That adds to 90%. So put 10% odds on the U, less pleasant than the euphoric V but far less painful than a Lost Decade. That's the rough consensus of economic forecasters; it means U.S. unemployment grows for another year and a half.

Bottom line: The odds favor a long slog.
 
28. Preferences for redistribution: The crisis, reduced inequality, and soak-the-rich populism

Alberto Alesina   Paola Giuliano
23 April 2009 http://www.voxeu.org/index.php?q=node/3488
 
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Will Americans turn into “inequality intolerant” Europeans? Such a radical shift is unlikely, but this column argues that this crisis may be a turning point towards more government intervention and redistribution in the US. More and more Americans believe that hard work is insufficient to climb the income ladder and are expressing anger against “unfairly” accumulated wealth. Politicians should prefer wise policies but may be tempted by populist outbursts.

The current financial crisis will reduce income and wealth inequality. The rich who heavily invested in financial and stock markets have lost much more than the less wealthy. The relatively poor “young” may face the sale of the century. Go and tell a young (and poor) just-married couple that the collapse of housing prices is a problem; mention to a young worker just beginning to accumulate retirement money that low stock prices are a problem!

Many will consider this reduction in inequality the silver lining of the crisis and a welcome development. This is especially the case because many people are acutely aware of the increase in income inequality that occurred in many (especially English-speaking) countries in the last three decades and perhaps tend to think of it as “unfair”. Those who became rich from complicated financial instruments and sophisticated investments in derivatives are now seen as undeserving of their wealth. The extraordinary bonuses of certain incompetent managers, especially those bailed out by the taxpayers, have certainly not helped gain them sympathy. Nevertheless, a frontal attack on the finance world is pure populism; finance serves a very productive purpose. One cannot mix criminals like Bernie Madoff with unlucky or even excessively leveraged, overly risk-taking, sometimes incompetent, and overpaid managers. Politicians should not throw fuel on any anti-finance or anti-Wall Street sentiments. There is enough anger against “unfairly” accumulated wealth; we do not need more.

The increase in income inequality of the last three decades in the US is not extraordinary if viewed from a very long-term perspective. The thirty years after the Second World War were the period of the “Great Compression” – a sharp reduction in income inequality (Piketty and Saez 2003). A few months ago, just before the crisis, we were back to roughly to the level of the 1920s, which was the norm in previous decades, not to mention the level of inequality and of social immobility of pre-capitalist societies. But the perception that this increase in inequality was unfair will greatly weigh on the way it will be handled and the political backlash it will create.

Our research (Alesina and Giuliano 2009) suggests that this is a situation in which voters will demand especially strong action to reduce inequality, even in a country like the US, where inequality is much more tolerated than in Europe. All over the world, the poor favour more redistribution than the rich, which is not surprising. But beyond that basic fact, the attitude towards what is the right amount of redistribution varies greatly and is affected by many more variables than just current income. In particular, when people perceive that the income ladder is the result of differences in hard work, effort, and creativity, even the relatively poor may accept large differences in income. This is partly because their sense of justice tells them that these are fair inequalities and partly because they feel that the income ladder can be climbed if it really depends only on effort and hard work. This is true both when comparing individuals within a country and comparing average attitudes across countries.

For instance, according to the World Values Survey, a large majority of Americans (around 60%) used to believe that the income ladder could be climbed and the poor could make it if they tried hard. Only a minority of Europeans (less than 40%) had the same view. That explains a lot of the difference in the generosity of the welfare state in the two places. Americans think that they live in a socially mobile society with less need for active public redistributive policies. Europeans, by and large, have the opposite feeling. Now Americans may feel that the social mobility that they cherished was not so large after all; investing in derivatives hardly has the same “feeling” in the popular sentiments as, say, working a late shift in a shop.

Therefore, this crisis may have changed American attitudes toward inequality a bit. If they perceive inequality as unfair they will demand more redistribution. The traditional aversion to taxation of Americans may give way to a “soak the rich” feeling. Higher taxes will be needed to handle the booming budget deficits. We would predict that the progressivity of the tax system will also increase, as the median voter will demand it. Politicians should resist such populist measures. Increasing the tax base rather than the brackets is the best way to increase taxes on the rich. A simplification of the byzantine tax code, where the wealthy can often hide income, is way overdue.

Will Americans turn into “inequality intolerant” Europeans? Probably not, but this crisis may imply a turning point towards more government intervention and towards redistribution.
References

Alberto Alesina and Paola Giuliano (2009) Preferences for redistribution, NBER Working Paper 14825.
Piketty, Thomas and Emmanuel Saez. 2003. “Income Inequality in the United States, 1913-1998.” Quarterly Journal of Economics, 118(1): 1–39.

This article may be reproduced with appropriate attribution. See Copyright (below).
 
 
 
 

29. Economists React: ‘Plunge Is Over’ in Existing-Home Sales
Posted by Phil Izzo

Economists and others weigh in on the decline in existing-home sales.

    * Home sales have stabilized following the post-Lehmans plunge and remain above January’s trough of 4,490,000. March’s fall is probably just noise rather than a renewed downward trend. Admittedly, around 50% of sales are now related to distressed properties, which is hardly a sign of strength. But at least these sales are helping to reduce the inventory overhang… Overall, with the housing market having led the economy into the recession, it is no surprise that it might be the first sector to stabilise. Nonetheless, we suspect that prices have yet to reach their floor. –Paul Dales, Capital Economics

    * This is a bit disappointing but the big picture is still clear; the plunge in sales following the Lehman blowup is over. Unfortunately … prices will continue to fall rapidly for the foreseeable future, though at least the rate of decline should not get any worse. The floor for prices is probably a late 2010 story. –Ian Shepherdson, High Frequency Economics
    * The report was very disappointing, particularly given the broad-based nature of the declines… With the backdrop for U.S. households continuing to deteriorate on account of the worsening labor market conditions and weakening economy, we expect the housing market correction to continue well into this year. Nevertheless, the pace of decline is likely to ease as improved housing affordability conditions begin to spur housing demand. –Millan L. B. Mulraine, TD Securities
    * The weaker-than-expected result does not change the broad trend in sales, however, which continues to point to a tenuous stabilization… Sales in the western United States, where foreclosure activity is most prevalent, show a distinctly different pattern than those in other regions. Total existing sales (single family sales plus condos and co-ops) are up 19% year-to-year in the West… The improvement in sales in the Western region is an encouraging sign that discounted prices, record low mortgage rates and various tax incentives are stimulating new demand. –Nomura Global Economics
    * Although home resales were down in March, one can make a reasonable argument that resales are bottoming (albeit as a result of steep cuts in price as distressed and foreclosure sales make up a large share of existing home sales) as the average level of sales in the first quarter was similar to the fourth quarter’s average. –RDQ Economics
    * After dropping by 11% in October and November combined, likely reflecting the fallout from the financial meltdown in September, resales have held between 4.49 million and 4.74 million units, pointing to some stabilization in housing demand. With housing affordability rising dramatically thanks to lower prices and lower mortgage rates, demand from first-time homebuyers seems to be on the rise and is clearly supporting the market. Indeed, the NAR pointed out that first-time buyers accounted for just over half of all existing home sales in March. Still, first-time buyers typically purchase at the lower end of the market, which could help to explain why half of all resales last month were distressed properties. –Omair Sharif, RBS
 

30. FDIC Chief Says Banking Sector ‘Past the Crisis Stage’
Posted by Damian Paletta

Federal Deposit Insurance Corp. Chairman Sheila Bair said on Thursday that some parts of the banking sector were recovering but could still face pain on the horizon, as delinquencies could keep rising due not to exotic mortgage products but rising unemployment and tougher economic conditions.

“I think we are past the crisis stage,” she said in a speech to the Bretton Woods Committee in Washington. “I think we are in the clean up stage now.”

Some of her observations:

    * 1) “The Federal Reserve in particular has been heroic in the various facilities they have implemented to provide stability and increase liquidity in the system…Treasury obviously has also played a very strong leadership role with their ever unpopular TARP program, but a necessary program, to make sure that banks have the capital buffers that they need to keep lending and support the economy.”
    * 2) She said a FDIC’s new “Public-Private Investment Program” would be tested during a trial phase in June. She said they would be “very careful with that program. Very transparent.” She said they wanted to “kick the tires” to ensure” that it “is a clean process without conflicts.”
    * 3) The FDIC’s Temporary Liquidity Guarantee Program, which backs debt issued by banks, hasn’t lost any money since being implemented last Fall. “WE don’t expect to have losses,” she said. “We’ve actually collected over $7 billion in premiums for that program.”
    * 4) She reiterated her call for the power to break down a large nonfinancial company, being careful to distinguish that her agency could do it but they weren’t necessarily angling for it. “I think we would be a logical place for that. We aren’t asking for it, but we know how to close an institution. And we’re equipped for it.”
 
 

31. IMF Protestors Getting Leaner and Meaner
Posted by Bob Davis

This year’s crop of anti-globalization protestors plan to buff up while they try to shut down (or at least delay a little) this weekend’s meetings of the International Monetary Fund and World Bank.

On Friday, Global Justice Action, a Washington D.C., activist group that bills itself as having “New Ideas After the Capitalist Casino Goes Bust,” is sponsoring a 5K jog to the World Bank around lunch time. (“5K Run on the Bank,” the group calls it.) On Saturday there is an “Aerobics Themed Roving Dance Party” that begins at 7 a.m., and street baseball and soccer games scheduled for 10 pm.

There are also assorted marches during the weekend – some with required permits, some not — and a Saturday morning effort to somehow blockade the bank and IMF, all of which can burn off calories

Why the heavy exercise? “We’ve found that people want more creative forms of resistance than just marching in the streets,” e-mails Lacy MacAuley, a Global Justice spokesperson. “Every time we empower ourselves through promoting our personal health, every time we express our own creativity rather than just absorbing what the billion-dollar entertainment industry hands down to us… we build that better world we know is possible.”

It’s not all heavy lifting. On Saturday afternoon, the protestors plan to meet for “vegan milk and cookies” at a library not far from the bank and IMF.

Doctor Doom
32. The Global Economy In The Next Year  Nouriel Roubini, 04.23.09, 12:00 AM EDT
More contraction in growth--and more job losses.
pic

http://www.forbes.com/2009/04/22/depression-recession-growth-job-losses-opinions-columnists-nouriel-roubini.html

The global economy is in the middle of a synchronized contraction that will push global growth into negative territory in 2009 for the first time in decades. This will be the worst financial crisis since the Great Depression and the worst global economic downturn in decades. Global trade volumes face their sharpest contractions of the postwar era--trade is expected to contract 12% in 2009 due to the severe and prolonged slump in global demand, excess capacity across supply chains and the continued crunch in trade finance.

Many analysts and commentators are pointing out that the second derivative of economic activity is turning positive (i.e., economies are still contracting, but at a slower rather than accelerated rate) and that the green shoots of an economic recovery are peeping out. My analysis of the data suggests that the global economic contraction is still in full swing with a very severe, deep and protracted U-shaped recession.
Article Controls
 

Last year's economic consensus forecast of a V-shaped short and shallow recession has vanished. While the rate of economic contraction is slowing compared to the free fall rates of the fourth quarter of 2008 and the first quarter of 2009, we are still a long way away from the economic bottom and from a sustained recovery of growth. In particular, in Europe and Japan there is little evidence of a positive second derivative of economic activity.

However, by the end of the first quarter of 2009, there were some signs that the pace of contraction had slowed in many economies, especially in the U.S. and China, where policy responses have been more significant and leading indicators in the manufacturing sector may have bottomed before they did in Europe and Japan. However, major economies, including all of the G7, will continue to contract throughout 2009, albeit at a slower pace than at the beginning of the year.

Moreover, the global recovery might be sluggish at best in 2010 given the overhang of the credit losses of financial institutions, the lingering credit crunch, the need for retrenchment by overstretched and over-indebted households in current-account-deficit countries, and a slow resumption of demand prompted by extensive government stimulus.

Some key elements of my outlook include:

--Global economic activity is expected to contract by 1.9% in 2009. Advanced economies are expected to contract 4% in 2009. Japan and the eurozone will suffer the sharpest downturns. U.S. gross domestic product will continue to contract, albeit at a slower pace throughout 2009, with negative growth in every quarter.

--Emerging markets will slow down sharply from the stellar growth rates of the past few years, with the BRIC economies growing at half their 2008 pace.
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--Deteriorated terms of trade, slower capital flows and tighter credit will push Latin America into recession from the 4.1% growth of 2008. Argentina, Brazil, Chile, Colombia, Mexico and Venezuela will all shift to negative territory on a year-over-year basis, while smaller economies, like Peru, will experience a significant slowdown.

--Countries in Eastern Europe and the sphere of Russia will experience some of the sharpest contractions given the withdrawal of foreign credit and the risk of a severe financial crisis. The reduction in oil revenues and financial stress will contribute to a 5% year-over-year contraction in Russia, and some countries--especially in the Baltics--are at risk of double-digit contractions

--Export-dependent Asia's growth will slow significantly to less than 3% in 2009. China will have a hard landing with GDP growth falling to 5.5% while India will slow sharply to 4.3%. All four Asian Tigers (Singapore, Taiwan, South Korea and Hong Kong) as well as Malaysia and Thailand will experience recessions.

--The Middle East and Africa will mark much slower growth, at half of their 2008 pace, given the reduction in capital inflows, reduced demand from the U.S. and E.U., and decline in commodity prices and output. Israel and South Africa will suffer slight contractions.

--The unprecedented fiscal and monetary stimulus may help alleviate the substantial contraction in private demand and reduce the risk of a global L-shaped near-depression. Debt financing may be a challenge for many countries though, especially emerging markets or the most vulnerable Western European economies.

--Job losses during the current global recession might exceed those in recent recession, contributing to increases in defaults and posing additional risks to banks. The unemployment rate in developed countries will reach double-digits by 2010 (as early as mid-2009 in the U.S.) and push more people in developing countries into poverty. Moreover, despite new funding from multilateral institutions, severe contractions will raise the risk of social and political unrest.

--Commodities, as a class, are likely to come under renewed pressure in 2009, despite some support from production cuts. I expect the West Texas Intermediate (WTI) oil price to average about $40 a barrel in 2009, as demand destruction continues to outweigh crude supply destruction.

Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes. (Analysts at Roubini Global Economics assisted in the research and writing of this piece.)
 
 
 
 
 
 
 
 

 
*********************

http://www.city-journal.org/2009/19_2_economist-anna-schwartz.html

Guy Sorman
33. Monetarism Defiant Legendary economist Anna Schwartz says the feds have misjudged the financial crisis.
Spring 2009

Anna Schwartz must be the oldest active revolutionary on earth. Born in 1915 in New York, she can still be found nearly every day at her office in the National Bureau of Economic Research on Fifth Avenue, where she has been tirelessly gathering data since 1941. And as her experience proves, data can transform the world. During the 1960s, with Milton Friedman, she wrote A Monetary History of the United States, a book that forever changed our knowledge of economics and the way that governments operate. Schwartz put ten years of detective work into the project, which helped found the monetarist theory of economics. “Not only by gathering new data but by coming up with new ways to measure information, we were able to demonstrate the link between the quantity of money generated by the banks, inflation, and the business cycle,” she explains.

Before the monetarist revolution, most economists believed that the quantity of money circulating in the economy had no influence on prices or on growth. History showed otherwise, Friedman and Schwartz argued. Every time the Federal Reserve (and the central banks before it) created an excess of money, either by keeping interest rates too low or by injecting liquidity into banks, prices inflated. At first, the easy money might seem to boost consumers’ purchasing power. But the increase would be only apparent, since sellers tended to raise the prices of their goods to absorb the extra funds. Investors would then start speculating on short-term bets—whether tulips in the seventeenth century or subprime mortgages more recently—seeking to beat the expected inflation. Eventually, such “manias,” as Schwartz calls them, would begin replacing long-term investment, thus destroying entrepreneurship and harming economic growth.

By contrast, by removing excess liquidity, the central bank can cause the sudden collapse of speculative excess, and it can also hurt healthy recovery or growth by constricting the money supply. There is now a near-consensus among economists that lack of liquidity caused the Great Depression. During the severe downturn of 1930, the Fed did nothing as a first group of banks failed. Other depositors became alarmed that they would lose their money if their banks failed, too, leading to further bank runs, propelling a frightening downward economic spiral.

To encourage steady growth while avoiding the pitfalls of inflation, speculation, and recession, the monetarists recommend establishing predictability in the value of currency—steadily expanding or contracting the money supply to answer the needs of the economy. “At first, central bankers and governments did not accept our theory,” recalls Schwartz. Margaret Thatcher was the first to understand that the monetarists were right, following their rules when she came to power in 1979, taming inflation and reinvigorating the British economy. The U.S. followed during the early 1980s, led by Paul Volcker, a Friedmanite then at the head of the Federal Reserve, who, with Ronald Reagan’s strong support, ended raging inflation, though not without a lot of short-term pain. “It was a strenuous experience,” Schwartz remembers. As Volcker tightened the money supply, making credit harder to come by, unemployment spiked to about 10 percent; many firms failed. But starting in 1983, the inflation beast defeated, a new era of vigorous growth got under way, based on innovation and long-term investment.

This lesson of the recent past seems all but forgotten, Schwartz says. Instead of staying the monetarist course, Volcker’s successor as Fed chairman, Alan Greenspan, too often preferred to manage the economy—a fatal conceit, a monetarist would say. Greenspan wanted to avoid recessions at all costs. By keeping interest rates at historic lows, however, his easy money fueled manias: first the Internet bubble and then the now-burst mortgage bubble. “A too-easy monetary policy induces people to acquire whatever is the object of desire in a mania period,” Schwartz notes.

Greenspan’s successor, Ben Bernanke, has followed the same path in confronting the current economic crisis, Schwartz charges. Instead of the steady course that the monetarists recommend, the Fed and the Treasury “try to break news on a daily basis and they look for immediate gratification,” she says. “Bernanke is looking for sensations, with new developments every day.”

Yet isn’t Bernanke a disciple of Friedman and Schwartz? He publicly refers to them as mentors, and, thanks to their scientific breakthrough, he has famously declared that “the Great Depression will not happen again.” Bernanke is right about the past, Schwartz says, “but he is fighting the wrong war today; the present crisis has nothing to do with a lack of liquidity.” President Obama’s stimulus is similarly irrelevant, she believes, since the crisis also has nothing to do with a lack of demand or investment. The credit crunch, which is the recession’s actual cause, comes only from a lack of trust, argues Schwartz. Lenders aren’t lending because they don’t know who is solvent, and they can’t know who is solvent because portfolios remain full of mortgage-backed securities and other toxic assets.

To rekindle the credit market, the banks must get rid of those toxic assets. That’s why Schwartz supported, in principle, the Bush administration’s first proposal for responding to the crisis—to buy bad assets from banks—though not, she emphasizes, while pricing those assets so generously as to prop up failed institutions. The administration abandoned its plan when it appeared too complicated to price the assets. Bernanke and then–Treasury secretary Henry Paulson subsequently shifted to recapitalizing the banks directly. “Doing so is shifting from trying to save the banking system to trying to save bankers, which is not the same thing,” Schwartz says. “Ultimately, though, firms that made wrong decisions should fail. The market works better when wrong decisions are punished and good decisions make you rich.” She’s more sympathetic to Treasury secretary Timothy Geithner’s plan, unveiled in March, to give private investors money to help them buy the toxic assets, but wonders if the Obama administration will continue to support the plan if the assets’ prices turn out to be so low, once investors start bidding for them, that they threaten the banks.

What about “systemic risk”—much heard about these days to justify the government’s massive intervention in the economy in recent months? Schwartz considers this an excuse for bankers to save their skins after making so many bad decisions. “The worst thing for a government to do, though, is to act without principles, to make ad hoc decisions, to do something one day and another thing tomorrow,” she says. The market will respond positively only after the government begins to follow a steady, predictable course. To prove her point, Schwartz points out that nothing the government has done to date has really thawed credit.

Schwartz indicts Bernanke for fighting the wrong war. Could one turn the same accusation against her? Should we worry about inflation when some believe deflation to be the real enemy? “The risk of deflation is very much exaggerated,” she answers. Inflation seems to her “unavoidable”: the Federal Reserve is creating money with little restraint, while Treasury expenditures remain far in excess of revenue. The inflation spigot is thus wide open. To beat the coming inflation, a “new Paul Volcker will be needed at the head of the Federal Reserve.”

Who listens to her these days? “I’m not a media person,” she tells me. She rarely grants interviews, which distract her from her current research: a survey of government intervention in setting foreign exchange rates between 1962 and 1985. Never before have these data been combined to show what works and what doesn’t. In her nineties, she remains a trendsetter.

Research for this article was supported by the Brunie Fund for New York Journalism.

Guy Sorman, a City Journal contributing editor, is the author of numerous books, including the forthcoming Economics Does Not Lie.

    * APRIL 27, 2009, 12:12 A.M. ET

34. Japan Girds for Record Contraction

By TAKASHI MOCHIZUKI

TOKYO -- The Japanese government now expects the economy to contract a record 3.3% in the fiscal year that started in April, it said Monday, as plunges in overseas demand are hurting the export-reliant economy more than it initially thought.

The government had forecast in its initial estimate last December that domestic growth in fiscal 2009 would be flat. The new figure is much worse than a 1.5% decline recorded in fiscal 1998, which was the worst performance since the government began taking growth data in fiscal 1955.

The government usually compiles an economic forecast in December and revises it in the summer. An unusually early and pessimistic review this year underlines the government's aggressive approach to pulling the economy out of what appears to be its deepest slump in the postwar era.

"To make an earlier-than-usual revision was necessary to show our honest view of quickly-changing conditions in the economy amid the global depression, which has been called a once-in-a-century event," a Cabinet Office official briefing reporters said.

The government on Monday also finalized a supplementary budget bill to fund the fourth stimulus package since last summer, which includes ¥15.4 trillion in fresh fiscal spending. It will submit the bill to parliament for approval.

Since last summer, Prime Minister Taro Aso and predecessor Yasuo Fukuda have compiled three stimulus packages with a combined headline figure of ¥75 trillion, including fresh spending and other measures such as loan guarantees.

Based on this headline basis, the fourth package, announced earlier this month, is worth ¥56.8 trillion. Of the ¥15.4 trillion spending, ¥14.7 trillion will be paid out of the extra budget and ¥700 billion will come from the government's special account funds.

"It is very unusual to submit an extra budget as early as April, the first month of a fiscal year," a Finance Ministry official said. We can't imagine what lies ahead now; let's just hope that the announced measures will save the economy."

The MOF said the latest package will require the country to issue an additional ¥10.8 trillion worth of bonds. ¥7.3 trillion in so-called "construction bonds" and ¥3.5 trillion in "deficit-covering bonds."

Without the stimulus, the economy could contract by 5.2% in fiscal 2009, the government said. The International Monetary Fund said last week that the Japanese economy may contract by 6.2% in 2009, the sharpest contraction among industrialized nations.

Japan's GDP contracted at an annualized pace of 12.1% during the October-December period, and the Cabinet Office said it may shrink by about 14% -- the worst pace on record -- during the January-March period.

If the January-March forecast is correct, the economy will have contracted by 3.1% in fiscal 2008 ended March, the first contraction since 2001. And if the economy also contracts this fiscal year, it would be the first time since fiscal 1997 and 1998 that the economy has contracted for two years in a row.

The revised forecast also showed that Japan's exports may fall by 27.6% on year, and imports by 9.7%. Industrial production is expected to plunge by 23.4% and capital expenditure by 14.1%. All these figures are the worst on record, the Cabinet Office said.

"We are also worried about a return of severe deflation," the Cabinet Office official said, because it will make the recession more severe by damping consumer spending.

The government expects a record 1.3% price drop this year due to a reaction to last year's high energy prices, as well as decreasing domestic demand. The nation's unemployment rate may rise to 5.2%, it also said. The highest jobless rate on record is 5.4% logged in 2002.

Write to Takashi Mochizuki at takashi.mochizuki@dowjones.com

35. JAPAN PAYS FOREIGN WORKERS TO GO HOME
------------------------------------------------------------------------

Japan has a new program: it will pay to relocate foreign workers.
Japan's offer, extended to hundreds of thousands of blue-collar Latin
American immigrants, is part of a new drive to encourage them to leave
the recession-racked country.  So far, at least 100 workers and
their families have agreed to leave, but critics denounce the program
as shortsighted, inhumane and a threat to what little progress Japan
has made in opening its economy to foreign workers, says the New York
Times.

   o   In 1990, Japan -- facing a growing industrial labor shortage
       -- started issuing thousands of special work visas to
       descendants of these emigrants.
   o   An estimated 366,000 Brazilians and Peruvians now live in
       Japan.
   o   But the nation's manufacturing sector has slumped as demand
       for Japanese goods evaporated, pushing unemployment to a
       three-year high of 4.4 percent.

Manufacturing output could rise as manufacturers start to ease
production cuts.  But the numbers could have more to do with
inventories falling so low that they need to be replenished than with
any increase in demand.

While Japan waits for that to happen, it has been keen to help foreign
workers leave, which could ease pressure on domestic labor markets and
the unemployment rolls, says the Times:
   o   But those who travel home on Japan's dime will not be allowed
       to reapply for a work visa.
   o   Stripped of that status, most would find it all but
       impossible to return; yet, they could come back on three-month
       tourist visas.
   o   Or, if they became doctors or bankers or held certain other
       positions, and had a company sponsor, they could apply for
       professional visas.

However, Japan is under pressure to allow returns.  The aging
country faces an impending labor shortage.  The population has
been falling since 2005, and its working-age population could fall by a
third by 2050, says the Times.

Source: Hiroko Tabuchi, "Japan Pays Foreign Workers to Go
Home," Yahoo/New York Times, April 23, 2009.
For text:
http://finance.yahoo.com/career-work/article/106964/Japan-Pays-Foreign-Workers-to-Go-Home
 
 

For more on Economic Issues:

http://www.ncpa.org/sub/dpd/?Article_Category=17

36. The world economy A glimmer of hope?

Apr 23rd 2009
From The Economist print edition
The worst thing for the world economy would be to assume the worst is over

Illustration by Jon Berkeley

THE rays are diffuse, but the specks of light are unmistakable. Share prices are up sharply. Even after slipping early this week, two-thirds of the 42 stockmarkets that The Economist tracks have risen in the past six weeks by more than 20%. Different economic indicators from different parts of the world have brightened. China’s economy is picking up. The slump in global manufacturing seems to be easing. Property markets in America and Britain are showing signs of life, as mortgage rates fall and homes become more affordable. Confidence is growing. A widely tracked index of investor sentiment in Germany has turned positive for the first time in almost two years.

All this is welcome—not least because the slump has been made so much worse by panic and despair. When the financial system was on the brink of collapse in September, investors shunned all but the safest assets, consumers stopped spending and firms shut down. That plunge into the depths could be succeeded by a virtuous cycle, where the wheels of finance turn again, cheerier consumers open their wallets and ambitious firms turn from hoarding cash to pursuing profits.

But, welcome as it is, optimism contains two traps, one obvious, the other more subtle. The obvious trap is that confidence proves misplaced—that the glimmers of hope are misinterpreted as the beginnings of a strong recovery when all they really show is that the rate of decline is slowing. The subtler trap, particularly for politicians, is that confidence and better news create ruinous complacency. Optimism is one thing, but hubris that the world economy is returning to normal could hinder recovery and block policies to protect against a further plunge into the depths.
Luminous indicators

Begin with those glimmers. It is easy to read too much into the gain in share prices. Stockmarkets usually rally before economies improve, because investors spy the promise of fatter profits before the statisticians document a turnaround. But plenty of rallies fizzle into nothing. Between 1929 and 1932, the Dow Jones Industrial Average soared by more than 20% four times, only to fall back below its previous lows. Today’s crisis has seen five separate rallies in which share prices rose more than 10% only to subside again.

The economic statistics are hard to interpret, too. The past six months have seen several slumps, each with a different trajectory. The plunge in manufacturing is in part the result of a huge global inventory adjustment. With unsold goods piling up and finance hard to come by, firms around the world have slashed production even faster than demand has fallen. Once firms have run down their stocks they will start making things again and the manufacturing recession will be past its worst.

Even if that moment is at hand, two other slumps are likely to poison the economy for much longer. The most important is the banking crisis and the purge of debt in the bubble economies, especially America and Britain. Demand has plummeted as tighter credit and sinking asset prices have exposed consumers’ excessive borrowing and scared them into saving more. History suggests that such balance-sheet recessions are long and that the recoveries which eventually follow them are feeble.

The second slump is in the emerging world, where many economies have been hit by the sudden fall in private cross-border capital flows. Emerging economies, which imported capital worth 5% of their GDP in 2007, now face a world where cautious investors keep their money at home. According to the IMF, banks, firms and governments in the emerging world have some $1.8 trillion-worth of borrowing to roll over this year, much of that in central and eastern Europe. Even if emerging markets escape a full-blown debt crisis, investors’ confidence is unlikely to recover for years.

These crises sent the world economy into a decline that, on several measures, has been steeper than the onset of the Depression. The IMF’s latest World Economic Outlook expects global output to shrink by 1.3% this year, its first fall in 60 years. But the collapse has been countered by the most ambitious policy response in history. Central banks have pumped out trillions of dollars of liquidity and, in rising numbers, have resorted to an increasingly exotic arsenal of “unconventional” firepower to ease credit markets and loosen monetary conditions even as policy rates approach zero. Governments have battled to prop up their banks, committing trillions of dollars in the process. The IMF has new money. Every big rich country has bolstered demand with fiscal stimulus (and so have many emerging ones). The rich world’s budget deficits will, on average, reach almost 9% of GDP, six times higher than before the crisis hit.

The Depression showed how damaging it can be if governments don’t step in when the rest of the economy seizes up. Yet action on the current scale has never been tried before and nobody knows when it will have an effect—let alone how much difference it will make. Whatever the impact, it would be a mistake to confuse the twitches of an economy on life-support with a lasting recovery. A real recovery depends on government demand being supplanted by sustainable sources of private spending. And here the news is almost uniformly grim.
Searching for new demand

Take the country many are pinning their hopes on: America. The adjustment in the housing market began earlier there than anywhere else. Prices peaked almost three years ago, and are now down by 30%. Manufacturing production has been falling at an annualised rate of more than 20% for the past three months. And the government’s offsetting policy offensive has been the rich world’s boldest.

As the inventory adjustment ends and the stimuli kick in, America’s slump is sure to ease. Cushioned by the government, the economy may even begin to grow again before too long. But it is hard to see the ingredients for a recovery that is robust enough to stop unemployment rising. Weakness abroad will crimp exports. America’s banks are propped up with public capital, but their balance-sheets are clogged with toxic assets. Consumer spending and firms’ investment will be dragged lower by the need to pay back debt and restore savings. This will be a long slog. Private-sector leverage, which rose by 70% of GDP between 2000 and 2008, has barely begun to unwind. At 4%, the household savings rate has jumped sharply from its low of near zero, but it is still far below its post-war average of 7%. Higher unemployment and rising bankruptcies could easily cause a vicious new downward lurch.

In Britain, given the size of its finance industry, housing boom and consumer debt, the balance-sheet adjustment will, if anything, be greater. The weaker pound will buoy exports, but fragile public finances suggest that Britain has much less scope to use government spending to cushion the private sector than America does—as this week’s flawed budget made painfully clear (see article).

The outlook should in theory be brighter for Germany and Japan. Both have seen output slump faster than in other rich countries because of the collapse in trade and manufacturing, but neither has the huge private borrowing of the sort that haunts the Anglo-Saxon world. Once inventories have adjusted, recovery should come quickly. In practice, though, that seems unlikely, especially in Germany. As the output slump sends Germany’s jobless rate towards double-digits, it is hard to see consumers going on a spending spree. Nor has the government shown much appetite for boosting demand. Germany’s fiscal stimulus, although large by European standards, falls well short of what it could afford. Worse, the country’s banks are still in trouble. Germans did not behave recklessly, but their banks did—along with many others in continental Europe. New figures from the IMF suggest that European banks face some $1.1 trillion in losses, hardly any of which have yet been recognised (see article). This week’s German plan to set up several bad banks was no more than a down payment on the restructuring ahead.

Japan has acted more boldly. Its latest package of tax cuts and government spending, unveiled in early April, will provide the biggest fiscal boost, relative to GDP, of any rich country this year. Its economy is likely to perk up, temporarily at least. But its public-debt stock is approaching 200% of GDP, so Japan has scant room for more fiscal stimulus. With export markets weak, demand will soon need to be privately generated at home. But the past two decades offer little evidence that Japan can make that shift.

For the time being, the brightest light glows in China, where a huge inventory adjustment has exaggerated the impact of falling foreign demand, and where the government has the cash and determination to prop up domestic spending. China’s stimulus is already bearing fruit. Loans are soaring and infrastructure investment is growing smartly. The IMF’s latest forecast, that China’s economy will grow by 6.5% this year, may prove conservative. Yet even China has its difficulties. Perhaps three-quarters of the growth will come from government demand, particularly infrastructure spending.
Not much to glow about

Add all this up and the case for optimism fades quickly. The worst is over only in the narrowest sense that the pace of global decline has peaked. Thanks to massive—and unsustainable—fiscal and monetary transfusions, output will eventually stabilise. But in many ways, darker days lie ahead. Despite the scale of the slump, no conventional recovery is in sight. Growth, when it comes, will be too feeble to stop unemployment rising and idle capacity swelling. And for years most of the world’s economies will depend on their governments.

Consider what that means. Much of the rich world will see jobless rates that reach double-digits, and then stay there. Deflation—a devastating disease in debt-laden economies—could set in as record economic slack pushes down prices and wages, particularly since headline inflation has already plunged thanks to sinking fuel costs. Public debt will soar because of weak growth, prolonged stimulus spending and the growing costs of cleaning up the financial mess. The OECD’s member countries began the crisis with debt stocks, on average, at 75% of GDP; by 2010 they will reach 100%. One analysis suggests persistent weakness could push the biggest economies’ debt ratios to 140% by 2014. Continuing joblessness, years of weak investment and higher public-debt burdens, in turn, will dent economies’ underlying potential. Although there is no sign that the world economy will return to its trend rate of growth any time soon, it is already clear that this speed limit will be lower than before the crisis hit.
Start preparing for the next decade

Welcome to an era of diminished expectations and continuing dangers; a world where policymakers must steer between the imminent threat of deflation while countering investors’ (reasonable) fears that swelling public debts and massive monetary easing could eventually lead to high inflation; an uncharted world where government borrowing reaches a scale not seen since the second world war, when capital controls ensured that savings stayed at home.

How to cope with these dangers? Certainly not by clutching at scraps of better news. That risks leading to less action right now. Warding off deflation, for instance, will demand more unconventional steps from more central banks for longer than many now seem to foresee. Laggards, such as the European Central Bank, do themselves and the world no favours by holding back. Nor should governments immediately seek to take back the fiscal stimulus. Prolonged economic weakness does far greater damage to public finances than temporary fiscal activism. Remember how Japan snuffed out its recovery in the 1990s by rushing to raise taxes.

Japan also put off bank reform. Countries facing big balance-sheet adjustments should heed that lesson and nudge reform along, in particular by doing more to clean up and restructure the banks. Countries with surpluses must encourage private spending at home more vigorously. China’s leaders are still doing too little to boost private citizens’ income and their spending by fostering reforms, from widening health-care coverage to forcing state-owned firms to pay higher dividends.

At the same time policymakers must give themselves room to change course in the future. Central banks need to lay out the rules that will govern their exit from exotic forms of policy easing (see article). That may require new tools: the Federal Reserve would gain from being able to issue bonds that could mop up liquidity. All governments, especially those with the ropiest public finances, should think boldly about how to lower their debt ratios in the medium term—in ways that do not choke off nascent private demand. Rather than pushing up tax rates, they should think about raising retirement ages, reining in health costs and broadening the tax base.

This weekend many of the world’s finance ministers and central bankers will meet in Washington, DC, for the spring meetings of the IMF and World Bank. Amid rising confidence, they will be tempted to pat themselves on the back. There is no time for that. The worst global slump since the Depression is far from finished. There is work to do.
 

    * APRIL 28, 2009

37. GM Offers U.S. a Majority Stake Bondholders Balk at Plan; UAW Poised to Get Big Stakes in General Motors, Chrysler

 
By JOHN D. STOLL and SHARON TERLEP

General Motors Corp. outlined a new turnaround plan that would leave the U.S. government controlling the auto maker, as it set up a showdown with bondholders that could determine whether the company lands in bankruptcy court.
[shrinking workforce]

Under the plan, GM is asking the Treasury Department for an additional $11.6 billion in loans, on top of the $15.4 billion it has already received. It envisions giving the government at least half ownership of the company as payment for half of the loans.

At the same time, GM said it would use stock instead of cash to pay off half the $20.4 billion it owes a United Auto Workers fund to cover retiree health care. That stock would leave the union owning about 39% of GM.

The upshot would be the transformation of a troubled American icon, leaving it in the hands of the government and its main union. The situation, fraught with complications and potential conflicts, comes on top of the U.S. government taking stakes in banks and insurer American International Group Inc.

Also Monday, the UAW and Chrysler LLC disclosed that the union would own 55% of that restructured car maker, while Fiat SpA would get 35% and the U.S. and lenders would own the rest.

GM told bondholders it wants to swap up to $27 billion in unsecured debt for a 10% company stake. If bondholders tender less than 90% of the debt, GM is prepared to file for bankruptcy protection, Chief Executive Frederick "Fritz" Henderson said.
[GM] Associated Press

General Motors CEO Fritz Henderson talks with reporters after addressing the company's viability plan in Detroit on Monday.
More

    * UAW to Get 55% Stake in Chrysler
    * Plan Sees a Smaller, Profitable GM
    * Deal Would Create Conflicts for Government
    * GM Dealers Await Word on Deeper Cuts
    * GM Debt-Exchange Plan Faces Hurdle
    * MarketBeat: What Is GM Worth?
    * Heard on the Street: GM Spins Its Wheels
    * Video: GM's Survival Plan
    * GM statement on updated plan

A group representing bondholders rejected the plan and said it would make a counteroffer.

GM also said it would cut thousands more jobs than originally planned, shutter another plant, and reduce its U.S. dealers to 3,605 by 2011, down 42% from 2008. The company confirmed it would kill its Pontiac brand.

The smaller, more focused car maker that would result would see its U.S. market share shrink to 18.5% in 2014 from 22.1% last year -- a comedown for a company that once controlled more than half the U.S. market. But GM says it finally could turn a profit after posting billions of dollars in losses in recent years.

The new plan was conceived in cooperation with an Obama administration team that rejected a Feb. 17 GM revamping plan, saying it didn't go far enough.

Write to John D. Stoll at john.stoll@wsj.com and Sharon Terlep at sharon.terlep@dowjones.com

WSJ
    * April 28, 2009, 3:19 PM ET

38. Free Trade: Not So Bad

Real Time Economics HOME PAGE »

By Bob Davis

The economy is as bad as it’s been since the Great Depression, the International Monetary Fund tells us. Protectionism is on the rise, the World Trade Organization warns.

Nevertheless, reports the Pew Research Center for the People and the Press, Americans are feeling more positive about free trade. By a 44% to 35% margin, Americans said that free-trade agreements are good for the country, according to a poll of 3,013 adults conducted by Princeton Survey Research Associates. That’s almost precisely the opposite of a year ago, when the survey found that Americans by a 48% to 35% margin said that the deals were bad for America.

Why the difference? Pew argues that the April 2008 findings may have been an outlier. Polls conducted for Pew annually between 2004 and 2007found at least 40% of Americans backed free trade. Then the numbers dipped in 2008 and rebounded this year. The current poll was based on telephone interviews made between March 31 and April 21, 2009. The margin of error was between 2.5 percentage points and 3.5 percentage points depending on the question asked.

According to the latest poll, Democrats were the most positive about the deals, another counter-intuitive finding. About 47% of Democrats said the pacts were good for the U.S. compared to 41% of Republicans and 43% of Independents –another counter-intuitive finding.

However, Pew reports, support for free trade diminishes when the questioner specifically mentions the words “Nafta” (North American Free Trade Agreement) and “World Trade Organization” in the telephone interview. When the question was asked without the offending words, those polled backed the free-trade deals by a 52% to 34% margin.
 
 

39. Nation’s Goods-Producing Sector Continues to Shrink
Posted by Kelly Evans

Buried in this morning’s release of gross domestic product by industry in 2008 was this nugget: The goods-producing sector’s share of GDP last year fell to 18.9%, a new low since the government began tracking these statistics in 1947.

This isn’t exactly surprising: the nation’s goods-producing sector has essentially been shrinking since World War II, partly due to technological progress, as the U.S. continues to make more with less, and partly due to the outsourcing of manufacturing to lower-cost parts of the world. In recent years, that shift was seen as something of an economic stabilizer, making the U.S. less susceptible to booms and especially busts.

But that stabilizing effect also relied in large part on Americans’ willingness to spend, which until recently seemed ironclad. Way back in 1965, in a book titled “The Growing Importance of the Service Industries,” Victor Fuchs, now a professor emeritus at Stanford University, cautioned that as the service sector grows, the economy’s growth becomes more reliant on consumer preferences.

“At some point in the past decade, the United States became the first ‘service economy’ in the history of the world, that is, the first economy in which more than half of the employed population is not involved in the production of tangible goods,” he wrote. “One lesson that our study…keeps forcing upon us is the importance of the consumer as a cooperating agent.”

Some 40 years later, that lesson is finally being learned. Amid an $11 trillion loss of wealth last year, growth in U.S. consumer spending declined for the first time in a quarter-century, and the back-to-back declines were among the most severe in postwar history. Now, the U.S. is embroiled in its lengthiest recession since the Great Depression, and global output is sinking like a stone, as consumers have switched to savings mode.

Meanwhile, another question Mr. Fuchs raised remains to be answered. “Gross national product” (now GDP) “is becoming increasingly less useful for studies of productivity and growth,” he wrote, as production becomes a shrinking part of the economy. “In the future, we shall probably find it necessary to develop auxiliary measures of ‘output’ and economic welfare.”

One possibility? Gauging the economy in terms of income rather than production, a measure that seems to be gaining popularity given its prominent mention by the National Bureau of Economic Research in dating the current recession. Income isn’t as well-measured or tracked as production, but if the nation’s goods-producing sector continues to shrink it wouldn’t be surprising to see it take on additional importance.
 

 
40. How libertarian dogma led the Fed astray By Henry Kaufman
http://www.ft.com/cms/s/0/705574f2-3356-11de-8f1b-00144feabdc0,s01=1.html

Published: April 27 2009 19:16 | Last updated: April 27 2009 19:16

The Federal Reserve has been hobbled by at least two major shortcomings that were primarily responsible for the current and several previous credit crises. Its failure to spot the importance of changing financial markets and its commitment to laisser faire economics were big mistakes and justify a fundamental overhaul of the Fed.

The first of these shortcomings was its failure to recognize the significance for monetary policy of structural changes in the markets, changes that surfaced early in the postwar era. The Fed failed to grasp early on the significance of financial innovations that eased the creation of new credit. Perhaps the most far-reaching of these was the securitisation of hard-to-trade assets. This created the illusion that credit risk could be reduced if instruments became marketable.

Moreover, elaborate new techniques employed in securitisation (such as credit guarantees and insurance) blurred credit risks and raised – from my perspective, many years ago – the vexing question, “Who is the real guardian of credit?” Instead of addressing these issues, the Fed was highly supportive of securitisation.

One of the Fed’s biggest blind spots has been its failure to recognise the problems that huge financial conglomerates would pose for financial stability – including their key role in the current debt overload. The Fed allowed the Glass-Steagall Act to succumb without appreciating the negative consequences of allowing investment and commercial banks to be put together. Within two decades or so, financial conglomerates have come to utterly dominate financial markets and financial behaviour. But monetary policymakers failed to recognise that these behemoths were honeycombed with conflicts of interest that interfered with effective credit allocation.

Nor did the Fed recognise the crucial role that the large financial conglomerates have played in changing the public’s perception of liquidity. Traditionally, liquidity was an asset-based concept. But this shifted to the liability side, as liquidity came to be virtually synonymous with easy borrowing. That would not have happened without the marketing efforts of large institutions.

My second major concern about the conduct of monetary policy is the Fed’s prevailing economic libertarianism. At the heart of this economic dogma is the belief that markets know best and that those who compete well will prosper, while those who do not will fail.

How did this affect the Fed’s actions and behaviour? First, it explains to a large extent why the Fed did not strongly oppose the removal of Glass-Steagall restrictions.

Second, it also helps explain why the Fed failed to recognise that abandoning Glass-Steagall created more institutions that were “too big to fail”.

Third, it diminished the supervisory role of the Fed, especially its direct responsibility to regulate bank holding companies. To be sure, the Fed’s supervisory responsibilities have never been very visible in the monetary policy decision-making process. But its tilt toward an economic libertarian approach pushed supervision a notch down just at a time when financial market complexity was on the rise. Fourth, as hands-on supervision slackened, quantitative risk modelling became increasingly acceptable. This approach, especially quantitative modelling to assess the safety of a financial institution, was far from adequate. But it worked hand in glove with a philosophy that markets knew best.

Fifth, adherence to economic libertarianism inhibited the Fed from using the bully pulpit or moral suasion to constrain market excesses. It is difficult to believe that recourse to moral suasion by a Fed chairman would be ineffective. Such public pronouncements about financial excesses are hard to ignore, reaching the broad public as well as market participants.

Sixth, the Fed’s increasingly libertarian philosophy underpinned its view that it could not know how to recognise a credit bubble but knew what to do once a bubble burst. This is a philosophy plagued with fallacies. Credit bubbles can be detected in a number of ways, such as rapid growth of credit, very high price/earnings ratios and very narrow yield spreads between high- and low-quality debt.

By guiding monetary policy in a libertarian direction, the Fed played a central role in creating a financial environment defined by excessive credit growth and unrestrained profit seeking. Major participants came to fear that if they failed to embrace the new world of securitised debt, proxy debt instruments, and quantitative risk analysis, they stood a very good chance of seeing their market shares shrink, top staff defect, and profits dwindle.

Ironically, the problem was made worse by the fact that the Fed was inconsistently libertarian. The central bank stuck to its hands-off approach during monetary expansion but abandoned it when constraint was necessary. And that, in turn, projected an unpredictable and inconsistent set of rules of the game.

We should, therefore, fundamentally re-examine the role of the Fed and the supervision of our financial institutions. Are the current arrangements within the Fed structure adequate – from its regional representation to its compensation for chairman and governors to its terms of office for governors? How can the Fed’s decision-making process be improved? If we were to create a new central bank from the ground up, how would it differ? At a minimum, the Fed’s sensitivity to financial excesses must be improved.

The writer is president, Henry Kaufman & Company

APRIL 28, 2009
41. Henry Kaufman's Narrative of the Crisis Arnold Kling
http://econlog.econlib.org/

He blames libertarianism at the Fed. But his history is a bit selective. For example, he writes
 

    the Fed was highly supportive of securitisation.
 

Actually, the Fed was quite worried about Freddie Mac and Fannie Mae.

In general, I think that Kaufman offers contradictory advice. On the one hand, he thinks that banks should have been closely regulated. On the other hand, he thinks that the growth of non-bank financial institutions should have been thwarted. You cannot have it both ways. Either you hamstring the banks, in which case non-banks will expand at their expense.* Or you allow banks to remain relevant by giving them room to compete against non-banks. In practice, the Fed compromised between those two approaches.

On the whole, I would rather see banks regulated more closely, in order to protect depositors. But one has to recognize that such a policy implies that the non-bank financial sector will be free to take advantage of regulatory restrictions on banks. If this approach is adopted, one has to be willing to let these uninsured competitors fail, rather than treat them as too big to fail. Since we have not demonstrated an ability to allow large financial institutions to fail, I cannot make any claims that my preferred approach is feasible.

*For example, when banks are not allowed to "abuse" credit card customers, the result will be fewer credit cards issued. This will allow alternative non-bank intermediaries, including loan sharks, to step into the vacuum, probably to the detriment of the alleged victims of credit card "abuse."
CATEGORIES: Finance: stocks, options, etc.

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42. Brace Yourselves For First-Quarter GDP
Brian S. Wesbury and Robert Stein, 04.28.09, 12:01 AM EDT

http://www.forbes.com/2009/04/27/first-quarter-gdp-opinions-contributors-economy-consumption.html
We break down our forecast.
pic

Get ready, first-quarter gross domestic product data will be released on Wednesday, and it will show the second sharp quarterly contraction in a row. We expect an annualized 4.2% decline in Q1, after a 6.3% drop in the last quarter of 2008.

But judging this book by its cover will be a little misleading. There is a stark difference between the economic pain of late 2008 and the economic pain in Q1. A huge drop in the velocity of money pulled consumption down by an annual rate of 3.8% in the third quarter of 2008, and then by 4.3% in the fourth. The panic was so widespread that food consumption fell at the fastest pace since the late 1940s--a very strange occurrence. Anecdotal reports suggested that some consumers with solid credit ratings, like FICO scores above 700, were turned away from car dealerships because their credit wasn't quite good enough.
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This changed in early 2009 as velocity apparently picked up. Food sales rose, and our models show consumer spending increased at a 1.5% annual rate in Q1, which would be its best showing since 2007. Even auto sales started to bounce in March from unsustainably low levels.

But this consumer rebound will be more than offset by weakness on the business side of the economy. Businesses, in a reaction to the consumer pullback, dropped investment spending, slowed production and cut inventories. Despite the rebound in consumer spending this year, businesses are still not certain that velocity has returned.

But businesses can't contract forever if consumers are bouncing back. With Fed policy super easy, velocity reviving and inventories shrinking, a revival on the business side of the economy is on tap for later this year.

In addition, it is important to remember that quarterly real GDP reflects a moving average of economic activity. It shows the three month production average versus the previous three month average. As such, real GDP is most heavily influenced by economic performance early in the quarter. Recent data show the recession is rapidly losing steam, but that shift will not show up in real GDP until the Q2 GDP report arrives in late July.

Below, we set out the components of real GDP that comprise our forecast for the first quarter.

Personal Consumption: We already have full consumption data for January/February as well as auto sales and retail sales for March. The only piece missing is March services. We estimate real consumption grew at a 1.5% annual rate in the first quarter. With consumption accounting for 70% of GDP, real personal consumption expenditures will contribute 1.1 points to real GDP growth (1.1 equals 70% of 1.5).
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Business Investment: Data through February suggest weakness in both investment in equipment and software as well as in business construction. We estimate that overall business fixed investment shrank at a 27% annual rate in Q1. With business investment accounting for 10.5% of GDP, this translates into a drag of 2.8 points for real GDP growth (-2.8 equals 10.5% of 27).

Housing: Data on home building suggest a decline at about a 36% annual rate in Q1. Given that the sector now makes up only 3% of GDP, this translates into a drag of 1.1 points on real GDP growth (-1.1 equals 3% of 36).

Government: Defense spending and public construction were unusually weak, suggesting that government spending will be a 0.2 point drag on real GDP rather than the usual positive 0.3 or 0.4 point boost. Stimulus spending doesn't yet show up in first-quarter measures.

Trade: The inflation-adjusted trade deficit shrank rapidly in Q1, suggesting net exports will add about 1.3 points to real GDP growth.

Inventories: We assume businesses around the country reduced stockpiles at an annual rate of $111 billion, the largest drop on record, resulting in a drag of 2.5 points on GDP.

That gives us our forecast for first-quarter GDP: A contraction of 4.2%. While this is a relatively sharp contraction, it is actually a good sign that most of the weakness is in business investment and inventories. With consumption rising again, and as velocity returns, producers will find themselves behind the curve. This means that they will have to play catch up in the months ahead, and a sharp uptick in economic activity should occur. As a result, the U.S. could post a positive GDP report for the second quarter.

To be safe, we are forecasting a flat second quarter, with a 3% real GDP growth rate in the third quarter. In other words, when first-quarter GDP is released on Wednesday, it will be easy to argue that the economy is still suffering. But judging this economy by its cover (the GDP data) risks missing the underlying story of improvement.

Brian S. Wesbury is chief economist and Robert Stein senior economist at First Trust Advisors in Wheaton, Ill. They write a weekly column for Forbes.
 

April 28, 2009
43. Financial Crisis and the Panic of 2008

http://www.realclearmarkets.com/articles/2009/04/financial_crisis_and_the_panic.html
By Steve Hanke

The panic of 2008 has sent the political classes into fits of hyperactivity. Their favorite ploy has been to scare the public into supporting gigantic interventionist policies designed to inflate government budgets and re-regulate economic activity.

These scare tactics were on display as world leaders prepared for the London meeting of the Group of 20 on April 2. The countries represented in this grouping account for two-thirds of the world's population and 90% of its gross national product.

After failing to predict a slow-down, let alone a panic, the International Monetary Fund finally issued a scary forecast on March 19 — just in time for the G-20 meeting. This forecast allowed the IMF to peddle its prescriptions. Once the G-20's communiqué was released, doom and gloom were temporarily swept aside. The political classes had just struck a mother lode.

The G-20 winner was the IMF. The IMF's managing director Dominique Strauss-Kahn — a seasoned French socialist politician — could hardly believe the IMF's good fortune. At a press conference on April 2, Strauss-Kahn had this to say:

"Maybe some of you were in the IMF press conference at the end of the Annual Meeting last October. And if some of you were there, then you may remember that what I said at that time is that IMF is back. Today you get the proof when you read the communiqué, each paragraph, or almost each paragraph — let's say the important ones — are in one way or another related to IMF work."

If the G-20 summiteers come through with their pledges, the IMF's resources will be increased by over $750 billion (USD).

To put that in perspective, consider that the IMF's credits and loans outstanding at the end of 2008 were only $27 billion. As politicians confront a new crisis, the opportunists are playing the system and exploiting it for their own ends.

Much of the growth of government in the US and elsewhere occurs as a direct or indirect result of national emergencies such as wars and economic slumps. Laws are enacted, bureaux are created and budgets are enlarged. In many cases these changes turn out to be permanent.

As Robert Higgs verified in his 1987 classic, Crisis and Leviathan, crises act as a ratchet, shifting the trend line of government's size and scope up to a higher level. History provides many illustrations of how damaging this fallout can be.

Take the Great Depression. At that time, the organized farm lobbies, having sought subsidies for decades, took advantage of the crisis to pass a sweeping rescue package, the Agricultural Adjustment Act, whose title declared it to be "an act to relieve the existing national economic emergency."

Seventy-six years later, the farmers are still sucking money from the rest of society and agricultural policy has been enlarged to satisfy a variety of other interest groups, including conservationists, nutritionists and friends of the third world. Indeed, even though agricultural prices hit record highs last year, the river of government farm subsidies kept flowing.

Then, during the second world war, when government accounted for nearly half the US's gross domestic product, virtually every interest group tried to tap into the vastly enlarged government budget.

Even bureaux seemingly remote from the war effort claimed to be performing "essential war work" and to be entitled to bigger budgets and more personnel.

Even smaller crises have sent the opportunists into feeding frenzies. Let us return to the classic case of ever-opportunistic IMF. Established as part of the 1944 Bretton Woods agreement, the IMF was primarily responsible for extending short-term, subsidised credits to countries experiencing balance-of-payments problems under the postwar pegged-exchange rate system.

In 1971, however, Richard Nixon, then US president, closed the gold window, signalling the collapse of the Bretton Woods agreement and, presumably, the demise of the IMF's original purpose. But since then the IMF has used every so-called crisis to expand its scope and scale.

The oil crises of the 1970s allowed the institution to reinvent itself. Those shocks required more IMF lending to facilitate, yes, balance-of- payments adjustments. And more lending there was: in the 1970-1980 period, IMF lending increased by 123%.

With the election of Ronald Reagan as US president in 1980, it seemed the IMF's crisis-driven opportunism might be reined in. Yet with the onset of the Mexican debt crisis, more IMF lending was "required" to prevent future debt crises and bank failures.

That rationale was used by none other than President Ronald Reagan, who personally lobbied 400 out of 435 congressmen to obtain approval for a US quota increase for the IMF. IMF lending ratcheted up again, increasing 108% in real terms during Reagan's first term in office. With the fall of the Soviet Union in 1991, the IMF reinvented itself again. According to the IMF, a temporary lending facility was needed "to facilitate the integration of the formerly centrally planned economies into the world market system."

The 1990s ended with the Asian Financial crisis (among others) — one that was misdiagnosed and made worse by the IMF's medicine. Never mind. The Asian crisis was yet another justification for more funding. During the 1990- 1999 period, IMF lending increased by 99% in real terms.

Not surprisingly, the events of September 11, 2001 did not catch the IMF flat-footed. On September 18, Paul O'Neill, the then US Treasury Secretary, had breakfast with Horst Kohler, the then IMF's managing director, to discuss the financial needs of coalition partners.

The IMF received a bit of a post-September 11 bounce. Then the IMF experienced a free fall, when the Federal Reserve (along with other central banks) pushed interest rates to record lows. The flood of new global credit was drowning the IMF until the credit bubble burst. That is when the IMF seized its opportunity.

The ratchet, of course, has many deleterious dimensions that reach well beyond public budgets. For example, on the same day the G-20 met in London, the US Financial Accounting Standards Board caved in to pressure exerted by the US Congress and altered the accounting rules for banks and other financial institutions.

Instead of valuing assets at prices they can fetch in the market (mark-to-market), banks will be allowed to use their own valuation models to value assets.

This accounting change brings to mind the fallout from another panic — the US panic of 1873. It was then that the publication of bank statements was suspended on the hope that "what you don't know won't hurt you."

Let's hope the current tidal wave of interventionism fades and a modicum of reason kicks in.
Steve Hanke is a Professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C. April 27, 2009
http://chronicle.com/news/index.php?id=6387&utm_source=pm&utm_medium=en
Higher Education Price Index Is Estimated to Drop but Still Exceeds Inflation

The organization that calculates the inflation rate for higher education said today that it estimates that the Higher Education Price Index for the 2009 fiscal year will be 2.8 percent.

While the figure for 2009 would be the lowest since 1999, when the increase was 2.4 percent, cost increases in higher education this year still appear to be on track to exceed those in the economy as a whole. For the 12 months ending March 31, the latest for which figures are available, the Bureau of Labor Statistics said that the Consumer Price Index decreased by 0.4 percent. It was first 12-month decrease since August 1995.

The Higher Education Price Index, commonly known by its acronym, HEPI, is based on costs for eight categories of goods and services on which higher education spends money. Personnel and related costs account for about 85 percent of those costs.

The estimated increase in those costs for 2009 is lower than the 3.6-percent rate of increase for the 2008 fiscal year that the Commonfund Institute published last July. A week later, it issued an addendum, citing a higher rate of 4.6 percent, which it said was a better reflection of colleges’ utility costs that year.

In announcing the 2009 HEPI estimate, Commonfund said it also planned to change the methodology it uses to calculate its index so that the statistics it relies on are all aligned to a June 30 fiscal year, which is typical for colleges. The organization plans to release its final HEPI figure for 2009 in July. —Goldie Blumenstyk
Posted on Monday April 27, 2009 | Permalink |
 
    * APRIL 29, 2009, 10:36 A.M. ET

44. U.S. Economy Shrank at 6.1% Rate in First Quarter

   By JEFF BATER

WASHINGTON -- The slumping U.S. economy barely improved early this year, with businesses slashing spending and inventories, according to a surprising report indicating the recession didn't ease as much as expected.

Gross domestic product decreased at a seasonally adjusted 6.1% annual rate January through March despite rising consumer spending, the Commerce Department said Wednesday in its first estimate of first-quarter GDP.
video
GDP Drops, But Data Indicates a Shift
2:45

The U.S. economy contracts 6.1% in the first quarter, a greater drop than expected. But as WSJ's Kelly Evans tells colleague Phil Izzo, although the numbers look bad, there are some positives.
MORE

    * Economists React: 'Obvious Glimmers of Hope'
    * Real Time Econ: More City Jobless Rates Top 15%
    * Real Time Econ: 12 Reasons to Be Optimistic

The 6.1% drop was much bigger than Wall Street expected and hardly different than a 6.3% plunge in the fourth quarter, when the recession that began in December 2007 deepened.

Economists surveyed by Dow Jones Newswires expected a 4.6% drop in GDP during the first three months of 2009. With a 0.5% drop in the third quarter, GDP has now fallen three consecutive quarters. That hasn't happened in 34 years, since third-quarter 1974 through first-quarter 1975.

Price indicators within Wednesday's report suggested inflationary pressures rose in first-quarter 2009, easing fears of deflation. For instance, the price index for personal consumption expenditures fell by 1.0%, a decline much smaller than the fall of 4.9% in the fourth-quarter 2008. The PCE price gauge excluding food and energy rose 1.5%, after increasing 0.9% in the fourth quarter.

Weaker investment in housing combined with the enormous inventory adjustment to pull the economy downward. But the aggressive drawdown of stockpiles of goods, while hurting the economy in the short run, is beneficial because it is an important step toward bringing inventories under control and ending a production freefall. U.S. industrial production retreated a fifth straight month in March, recent data show. Over the past 12 months, output was down nearly 13%. Capacity use by industries receded to 69.3%, a historical low since records began in 1967.

First-quarter GDP would have fallen farther if not for improvement in trade. Exports fell -- but imports dropped even more.

GDP acts as a scoreboard for the economy by measuring all goods and services produced. Its biggest component is consumer spending, which accounts for about 70% of GDP. First-quarter spending increased 2.2%, after dropping 4.3% in the fourth quarter.

Purchases of durable goods rose 9.4% in the first quarter, after decreasing by 22.1% October through December. First-quarter non-durables spending climbed by 1.3%. Services spending rose 1.5%.

Overall, consumer spending contributed 1.50 percentage points to GDP; it had dropped 2.99 percentage points in the fourth quarter.

But another component of GDP, housing, took a large bite out of the economy. Residential fixed investment fell by 38.0%, reducing overall GDP by 1.36 percentage points. Fourth-quarter investment had fallen 22.8%, taking 0.80 of a percentage point out of GDP.

International trade boosted the economy early this year, adding 1.99 percentage points to GDP. U.S. exports plunged 30.0% and imports decreased 34.1%. In the fourth quarter, trade deducted 0.15 of a percentage point out of GDP; exports in that period were 23.6% lower and imports fell by 17.5%.

First-quarter business spending dived 37.9%. Investment in structures went down 44.2%. Equipment and software outlays decreased 33.8%. Overall fourth-quarter outlays by businesses retreated 21.7%.

Businesses dumped inventories by $103.7 billion. Inventories fell $25.8 billion in the fourth quarter and $29.6 billion in the third quarter. The big deceleration siphoned 2.79 percentage points out of January-March GDP.

Real final sales of domestic product, which is GDP less the change in private inventories, fell at a 3.4% annual rate in the first quarter. Fourth-quarter sales fell by 6.2%.

Federal government spending decreased 4.0%, after rising in the fourth quarter by 7.0%. State and local government outlays fell 3.9%, after going down by 2.0% in the fourth quarter.

Other price inflation gauges in the report include the price index for gross domestic purchases, which measures prices paid by U.S. residents. It fell 1.0%, after decreasing 3.9% in the fourth quarter. The chain-weighted GDP price index increased 2.9%, after increasing 0.5% in the fourth quarter.

Write to Jeff Bater at jeff.bater@dowjones.com

    * APRIL 29, 2009

45. Citi Seeks Approval to Pay Out Bonuses

 
By DAVID ENRICH and ANN DAVIS

Citigroup Inc., soon to be one-third owned by the U.S. government, is asking the Treasury for permission to pay special bonuses to many key employees, according to people familiar with the matter.

The request comes as Citigroup is grappling with broad government pay restrictions that could break apart its legendary energy-trading unit. People at that unit, Phibro, are threatening to leave because of pay caps tied to the U.S. bailout of Citigroup. Phibro has been the source of hundreds of millions of dollars in profits for the bank, and has paid out hefty compensation, including a roughly $100 million windfall last year for the unit's leader, Andrew Hall.

Citigroup is looking for ways to free Phibro from the federal restrictions, including a spinoff of the unit, according to people familiar with the matter. Separately, Sumitomo Mitsui Financial Group and Citigroup reached a deal in which the Japanese bank will acquire a large chunk of Citigroup's operations in Japan. (See related article.)
[Andrew Hall]

Andrew Hall

Citigroup is trying to get U.S. approval for special bonuses for many of its employees. In a meeting earlier this month with Treasury Secretary Timothy Geithner, Citigroup CEO Vikram Pandit made the case for the stock-based bonuses. Executives are describing the bonuses as "retention" awards to perk up demoralized employees who the company worries are vulnerable to poaching by rival firms, people familiar with the matter said.

A person familiar with Mr. Geithner's thinking said the Treasury hadn't made a decision on whether to allow the bonuses. It is unclear how much Citigroup would pay out in bonuses if the government approved the move. A Citigroup spokesman declined to comment on details of the proposed compensation plans.

Citigroup's request comes after Congress, the public and the president blasted pay practices on Wall Street. Bonuses at American International Group Inc. and Merrill Lynch & Co. ignited political infernos in Washington.

Citigroup has already gotten its own share of criticism for excessive spending, thanks in part to its aborted plans earlier this year to buy a new corporate jet. The company has received $50 billion in taxpayer aid, and the U.S. government is protecting Citigroup against most losses on $301 billion of its assets. The Treasury is poised next month to become Citigroup's largest shareholder, owning as much as 36% of its common stock.

All this essentially gives the government veto power over the New York banking giant's employee-pay plans. The Treasury late last year signed off on a 2008 bonus pool that was smaller than in past years and more heavily weighted toward performance-based stock awards instead of cash bonuses.

Citigroup executives say they are worried that employees, who have seen much of their past bonuses wiped out by the collapse of Citigroup's share price, will jump to U.S. and foreign financial institutions that aren't tethered by federal pay restrictions.

In the Phibro situation, Mr. Hall, who runs the energy-trading unit, has been agitating to leave Citigroup to avoid the pay curbs, people familiar with the matter said.

Phibro has long been an autonomous unit within Citigroup, and its employees are paid based on how much revenue they produce. The government pay restrictions, however, put a ceiling on that compensation.

Citigroup is looking for ways to free Phibro from federal pay constraints so it can hold on to the staff of the lucrative unit, the people said. The bank is discussing plans to either spin off Phibro into an independent hedge fund or open it to outside investors, the people said. The unit currently only invests Citigroup's capital.

Phibro has been a lean and largely hidden profit center within Citigroup's investment bank. For 2008, Citigroup reported $667 million in pretax revenues in commodities trading, saying Phibro was the primary contributor to that figure.

New federal pay limits are forcing banks that received aid to rethink their compensation structures. One recent law requires banks to limit bonuses to no more than one-third of their overall compensation pools.

Top Citigroup executives, including Mr. Pandit and John Havens, who runs Citigroup's giant investment-banking division, have been briefing managers on the possible one-time bonuses, according to people familiar with the matter. Citigroup hasn't settled on a specific bonus plan, with several possibilities currently on the table, the people said.

Under one scenario presented to some managers, the payouts would be composed largely of stock that vests over at least three years, and the awards likely would be worth the equivalent of at least 50% of an employee's cumulative pay over the past three years, said one person briefed on that plan.

Citigroup's stock price has lost about 95% of its value since peaking around $55 in May 2007. That has taken a severe toll on the fortunes of employees, who hold a total of about 245 million stock options, warrants and rights to buy shares, with a weighted average exercise price of $41.84, according to Citigroup's latest proxy statement. With the stock below $3 a share, most of those awards are essentially worthless.

Citigroup isn't the only Wall Street firm looking for exemptions to pay restrictions. At Morgan Stanley, which has received $10 billion in federal aid, executives are considering a plan to spin off the company's proprietary-trading business to insulate it from federal pay limits.

Write to David Enrich at david.enrich@wsj.com and Ann Davis at ann.davis@wsj.com
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46. Economists React: ‘Obvious Glimmers of Hope’ in GDP
Posted by Phil Izzo

Economists and others weigh in on the worse-than-expected decline in gross domestic product.

    * The bottom line of this report is simply that the U.S. economy remains rather weak as the ongoing housing correction and financial sector crisis continue to weigh heavily on the domestic economy. However, there were some obvious glimmers of hope in the report as the improvement in consumer spending (which remains the lynch-pin of U.S. economic activity) during the quarter suggests that U.S. household spending may be on the rebound. Also of note is the fact that the massive draw-down in inventory may mean that this component could add favorably to output in the near future. –Millan L. B. Mulraine, TD Securities

    * The downward momentum continued into the first quarter. However, the economy was not as soft as the GDP number indicated. Businesses stopped producing goods for a while slashing inventories by a whopping $104 billion. Without the inventory runoff, the economy would have contracted by 3.4% instead of 6.1% as reported. This is good news. With lean inventories, production will be cranked up in order to restock the depleted shelves in coming months. –Sung Won Sohn, Smith School of Business and Economics
    * Consumers came out guns a’blazin, but even that wasn’t enough to overcome the downward pressure of the corporate sector. Personal consumption expanded at a surprisingly robust 2.2%, on the combined strength of greater demand for both durable and non-durable goods. This result stands in stark contrast to talk — including that from yours truly — of diminished credit availability leading to lower consumer demand. Still, the first-quarter consumer performance is likely a matter of a bounce from low late 2008 levels, and with a savings rate in the 4% range, significant consumption growth will remain a long run challenge for the domestic economy. –Guy LeBas, Janney Montgomery Scott
    * The upside surprise in first-quarter consumption largely reflected higher then anticipated spending on services. This will show up as either an unusually sharp gain in March and/or an upward revision to Jan/Feb when the monthly breakdown is released tomorrow as part of the personal income report. From a broader perspective, the modest rebound in first-quarter consumer spending following back to back declines in the second half of 2008, was driven by the upside surprises in the previously reported results for retail control in January and February. However, given the significant fall-off that was seen in March retail control, the ramp points to a renewed decline in consumer spending in second quarter. –David Greenlaw, Morgan Stanley
    * On the surface, 2009’s first quarter doesn’t look much different than did 2008’s fourth quarter, as real GDP contracted at an annualized rate of 6.1% in the first quarter after contracting by 6.3% (annualized) during 2008’s final stanza. The details, however, of the GDP data in the respective quarters are markedly different, and despite the dismal headline number, the details of the first-quarter report suggest a much smaller contraction, if not a modest advance, in real GDP during the second quarter. This should not, however, be taken as a sign that the recession has run its course. Clearly this is not the case, and there are plenty of downside risks still facing the U.S. and global economies. –Richard F. Moody, Forward Capital
    * The broad picture of the economy painted by this report makes sense. The output declines in terms of real GDP were almost as severe in the first quarter as that seen in the fourth quarter (private sector hours worked would have suggested a larger decline — productivity continues to hold up well in the recession), however the declines in both final demand and nominal GDP were much less severe. The baton of demand declines was passed firmly from the consumer to the producer. –RDQ Economics
    * Arguably the most negative feature of this report was the unprecedented 37.8% plunge in business fixed investment. That decline underscores the lagged feedback effect of the collapse in consumer spending during the second half of last year. If consumer spending stabilizes, a stabilization in capital spending would further improve the near term outlook. –Nomura Global Economics
    * The downside surprise to our -3% forecast is almost all in capital spending on equipment and nonresidential structures, down 33.8% and 44.2% respectively, and government spending, down by 3.9%… The capital expenditure numbers are hard to square with the monthly data, and we think there is scope for upward revision… Overall, horrible. The second quarter will be less bad. –Ian Shepherdson, High Frequency Economics
    * Surprising was a -0.35 percentage point contribution from federal defense spending and little change in federal nondefense spending. Presumably, federal spending will boom in coming quarters as fiscal stimulus begins to manifest itself. However, with the budget positions of states and localities suffering (-0.49 percentage point contribution from state and local government spending to overall GDP growth in first quarter following -0.25 percentage point in the fourth quarter), a good chunk of the stimulus is merely going to blunt declines in those categories of spending. –Joshua Shapiro, MFR Inc.
 
 
 
 
 
 
 

47. Secondary Sources: Long Recession, Continued Troubles, Bear and AIG
Posted by Phil Izzo

A roundup of economic news from around the Web.

    * Longest Recession: Writing on his blog, Jeff Frankel writes that in the wake of the first-quarter GDP numbers the current recession is tied for the longest postwar downturn. Frankel knows what he’s talking about, being a member of the NBER’s business cycle dating committee, which calls the beginning and end of recessions. “It is highly unlikely that future revisions will change this morning’s negative number into a positive one. The NBER also keeps a more precise monthly chronology. The postwar record is 16 months, again shared by the 1973-75 and 1981-82 recessions. To match this monthly benchmark, the current downturn would have to have continued into April. Our best single indicator as to whether it did so will be the employment number to be released by the Bureau of Labor Statistics next Friday, May 8. It almost certainly will show that there were further job losses in April. If so, it will further confirm the dismal conclusion: one would have to go back 80 years, to the disaster of 1929-1933, to find a longer recession.”
    * Depression Similarities: On voxeu, Thomas Helbling writes about the similarities of the current crisis to the Great Depression. “Despite the stunning contraction of industrial production and trade across the globe, the global economy is still a far cry away from the calamities of the Great Depression. However, if the economic damage of the current global crisis may have been contained so far, worrisome parallels to the early 1930s remain and preventive policy actions must be kept up.” Also on voxeu, Willem Buiter writes that the economy hasn’t turned a corner. “Analyzing the situation across the globe, this column concludes that the only reasonably convincing evidence of ‘green shoots’ comes from China – but even that recovery is unlikely to be sustainable due to China’s dependency on exports. A global flu pandemic, if it were to occur, would act as a negative supply and demand shock.”
    * Fixing Finance Not Enough: Martin Wolf of the Financial Times writes that fixing the financial system isn’t enough to restore the economy. “For better or worse, the authorities have decided to bail out their financial systems with taxpayer money. Almost all the affected countries should be able to afford to do this, at least on the IMF’s numbers. So now, having made the fundamental decision to prevent bankruptcy, they must return their financial systems to health as swiftly as they possibly can. Even so, that will prove to be a necessary, not a sufficient, condition for a return to robust economic health. The overhang of debt makes deleveraging inevitable. But it has hardly begun. Those who hope for a swift return to what they thought normal two years ago are deluded.”
    * Fed Holdings: The New York Fed published detailed information yesterday on the holdings of the three Maiden Lanes, its vehicles that hold the troubled assets it got from Bear Stearns and AIG. “The information released on Maiden Lane LLC, Maiden Lane II LLC and Maiden Lane III LLC includes transaction overviews, significant transaction terms and certain asset and liability information. The information on each entity’s assets includes a portfolio breakdown by investment type, ratings and, in the case of Maiden Lane III LLC, vintage information on the CDO securities included in the portfolio.”
 
 

Jeff Frankels Weblog
48. Views on the Economy and the World

    * About

RSS FEED
Recession is Now Tied for Longest Since the Great Depression
Apr 29th, 2009 by jfrankel |

The Commerce Department this morning announced its advance estimate of last quarter’s real GDP. As expected, the estimate shows that GDP fell in the first quarter of 2009 — by a hefty 6.1 per cent at an annual rate. An implication is that the current recession has just tied the post-war record for longevity.

The previous record-holders were the recessions of 1973-75 and 1981-82, each of them four quarters in length according to the official NBER chronology.  In the current downturn, the NBER’s Business Cycle Data Committee determined that the economy peaked in the 4th quarter of 2007. Although the Committee won’t declare the trough of the recession until well after the fact, and the trough could well be a ways off, a negative 1st quarter of 2009 almost certainly means that the four-quarter benchmark has now been attained.  (The Commerce Department often revises its GDP figures substantially between the advance estimate and the final number, and we are due for major backward-looking revisions in July.  Indeed that is one reason why the NBER always waits so long to issue its findings.  In the past, the size of the average revision has been just over 1 percentage point, whether up or down.   It is highly unlikely that future revisions will change this morning’s negative number into a positive one.)

The NBER also keeps a more precise monthly chronology. The postwar record is 16 months, again shared by the 1973-75 and 1981-82 recessions. To match this monthly benchmark, the current downturn would have to have continued into April. Our best single indicator as to whether it did so will be the employment number to be released by the Bureau of Labor Statistics next Friday, May 8. It almost certainly will show that there were further job losses in April. If so, it will further confirm the dismal conclusion: one would have to go back 80 years, to the disaster of 1929-1933, to find a longer recession.

Posted in recession |

49. 12 Reasons To Be (Economically) Optimistic
Posted by David Wessel

Ed Yardeni, the loquacious economist offers a dozen happy thoughts about the economy “while we are waiting to see how the swine flu pandemic plays out.”

His list, distributed in his daily email to clients:

    * (1) In the U.S., consumer confidence rebounded during April.
    * (2) The percentage of consumers who say that jobs are hard to get edged down in April after rising thirteen of the previous fourteen months. This tends to confirm the recent downticks in weekly initial unemployment claims.
    * (3) The home price story isn’t all bad news recently. Indeed, after more than a year and a half of declines, California’s median home price finally managed a meager gain, rising 2.2% month over month.
    * (4) Corning is bringing back some laid off workers on stronger-than-expected demand for glass used in making flat-screen televisions.
    * (5) Sharp is forecasting a strong recovery in profits and sales in all its business divisions during the second half of the year.
    * (6) IBM said Tuesday that it will increase its quarterly dividend by 10% and will repurchase an additional $3bn of its stock.
    * (7) The 4/28 Financial Times reported that the high yield bond market may be starting to open up again. About $7 billion was raised in April, the highest volume since last July.
    * (8) The stock market held up remarkably well on Monday and Tuesday despite nervousness over bank stress tests, swine flu, and the forced downsizing of the U.S. auto industry.
    * (9) The first quarter earnings season is off to a good start as 64% of the 235 S&P 500 companies reporting so far have a positive surprise and all 10 sectors are beating their first-quarter forecast too.
    * (10) Our Fundamental Stock Market Index rose during the week of August 18 as jobless claims edged lower and the Consumer Comfort Index moved higher.
    * (11) Condé Nast has decided to shutter Portfolio after two years of struggle. The introduction of the glitzy magazine about Wall Street launched in the spring of 2007 marked the end of the bull market. Now its demise may mark the end of the bear market.
    * (12) Confidence in the Euro Zone rose in April from a record low in March. The European Commission’s economic sentiment indicator jumped up to 67.2, from a revised 64.7 in March, but remains well below its long-term average of 100. Households and firms are less pessimistic about the outlook.

50. OBAMA'S 100 DAYS: MODELING ROOSEVELT

http://www.nypost.com/seven/04292009/postopinion/opedcolumnists/obamas_100_days__modeling_roosevelt_166686.htm?page=0
Last updated: 4:46 am
April 29, 2009
Posted: 1:13 am
April 29, 2009

PRESIDENT Obama is now thinking about what comes after his "Hundred Days." Although the president's first legislative period was modeled on Franklin D. Roosevelt's original "Hundred Days," Obama, a big FDR fan, may find more in FDR to emulate.

But to make the next period smoother, Obama will want to look at what caused him trouble in those early Roosevelt-redolent months. Three market-depressing factors stand out:

The president's willingness to spend. Obama doesn't have the temperament of a big spender. But he has proven himself willing to go along with spending once economists or reformers justify it -- witness his $787 billion stimulus package, and the multitrillion-dollar budget. Markets, however, recognize that federal spending is a relatively inefficient way to promote growth. That's one reason for the Dow's painful drops after Obama's election.

Through packages like the stimulus law, the administration has put us on the course Japan followed in the '90s. Japanese leaders implemented stimulus after stimulus; when one didn't work, they tried another. The '90s came to be known as the "lost decade," for at the end Japan had higher unemployment. The nation's stock market had not recovered and national debt ranked up there with war-torn Lebanon's. The danger for America is that we replicate the sad pattern.

Obama says he'll curtail the deficits that his stimulus package and budget portend. This promise doesn't seem keepable. The economy must grow if deficits are to narrow, and Obama has taken too few measures to create growth. Tax cuts for capital, a commitment to lower income taxes, assurances that property rights matter as much as income distribution -- these would create an environment in which new businesses might start and old ones revive. But such concepts are not yet welcome in the presidential salon.

His comfort with economic redistribution. The president seems to see no consequences from imposing heavier taxes on higher earners and eroding their tax deductions. This, even though those rates and deductions make the difference between choosing to work or invest and choosing not to do so. Given that London is also raising tax rates, this policy may not necessarily drive job creators to Britain. But the administration's pro-tax policy will drive them somewhere -- into a pout at home or to tax havens abroad.

Another disturbing movement has been the administration's bid to control more student loans. Some have argued that this policy may make for cheaper loans in the shorter term. Long-term, however, it would give government tighter control of the loan market, providing yet more opportunity for redistribution. Under the guise of good government, the loan proposal is a credit-market power grab.

The uncertainty the administration has generated with its stimulus package and bank bailouts. President George W. Bush and Treasury Secretary Hank Paulson did much to strengthen crisis-related market uncertainty by treating the economic downturn as a problem requiring Executive Branch action. In this sense, Obama's first "Hundred Days" were Bush's. But the Obama administration signaled early on it would sustain the Bush posture when the president's chief of staff, Rahm Emanuel, spoke of using the economic crisis as an opportunity to promulgate long-planned reform. What Emanuel was saying is that anything is on the table, from health-care reform to . . . who knows what? As long as investors aren't sure what government will do, they sit tight.

Why should this past matter if the market goes up and unemployment's rise slows, as may happen this year? Even the dollar seems to suggest we're on the right course. With every bit of unsettling news, from Mexican drug raids to swine flu, world investors are fleeing to the dollar, not from it.

One answer is that the quality of growth we get from stimuli will disappoint. The other is that this dollar dynamic could reverse. The world now makes the dollar its reserve currency less by choice than because there's no alternative. In the longer run, alternatives may arise -- monies of other lands or even of companies (imagine Visa or Nokia dollars). China has made it clear that it's deeply disappointed in the dollar's instability. Its withdrawal from our currency would be a Katrina, making our current troubles look like a shower.

As he learns on the job, Obama is likely to look for models beyond Roosevelt and his other hero, Abraham Lincoln. They do exist, including among Democrats: the later Bill Clinton, who ended welfare, Harry Truman, who helped create the state of Israel, and even Jimmy Carter, who put Paul Volcker at the head of the Federal Reserve. Sure, talk about "Hundred Days" plans stirs nostalgia. But the reality is that one "Hundred Days" session per president is more than enough.

Amity Shlaes, a senior fellow at the Council on Foreign Relations, is author of "The Forgotten Man: A New History of The Great Depression."
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Teacherspet wrote:
Amity Shlaes is right on target. Her book, "The Forgotten Man" is the best explanation I have read about what the Obama administration is doing to our country. Voters were charmed by him and they did not investigate his background. He is capable of inflicting unlimited damage to this country. If he knew his history, he would know that his plans will not work.
4/29/2009 10:44 AM EDT
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