Tuesday, April 28, 2009

What Is Going On In This Country?

"What is going on in this country? The government is about to take over GM in a plan that completely screws private bondholders and favors the unions. Get this: The GM bondholders own $27 billion and they’re getting 10 percent of the common stock in an expected exchange. And the UAW owns $10 billion of the bonds and they’re getting 40 percent of the stock. Huh? Did I miss something here? And Uncle Sam will have a controlling share of the stock with something close to 50 percent ownership. And no bankruptcy judge. So this is a political restructuring run by the White House, not a rule-of-law bankruptcy-court reorganization."


If you are wondering about the flu, then you might find this WSJ COMMENTARY useful reading.

Wednesday, April 22, 2009

President Obama's Fiscal Policy

Look what I found over at GREG MANKIW'S BLOG.

The picture shows federal government revenues and outlays as a percentage of GDP. This does look like significant change to me. But, I am not in favor of the national government's outlays being in the neighborhood of 25% of GDP or more. Nor can I applaud the significant borrowing by the national government which is depicted in this picture, especially since it seems that so much of this debt will be incurred for current consumption.

Wednesday, April 15, 2009

Happy Tax Day!

"In sum, please refund the taxes collected fraudulently for services never provided. If you need additional evidence, please do not hesitate to ask: there’s plenty more where this came from."
Her letter is kind of fun. Read the whole thing.

Beer Taxing

"Today is the dreaded April 15, but at least in Oregon it's even going to cost you more to drown in your tax sorrows. In their sober unwisdom, the state's pols plan to raise taxes by 1,900% on . . . beer. The tax would catapult to $52.21 from $2.60 a barrel. The money is intended to reduce Oregon's $3 billion budget deficit and, ostensibly, to pay for drug treatment."

And, according to this commentary, taxes are already the most expensive "ingredient" in beer.

Is there a bright side in this? Perhaps in the future economists will have an example of price elasticity of demand that Econ 101 students can relate to. Is beer demand price elastic?

Monday, April 13, 2009


Economists STEVEN GJERSTAD AND VERNON SMITH take a look at the reasons for this economic crisis. They are interested in why the collapse of one bubble would lead to a crisis for the financial system while another would not.

Gjerstad and Smith provide a very interesting chart that shows 3 bubbles in housing prices over the past 40 years.

The first housing price bubble over this time period ended in 1979 and the second ended in 1989. Gjerstad and Smith explain that for various reasons pricing bubbles happen and can be expected to collapse at some point. The collapse of a pricing bubble does not have to portend grave implications for the rest of economic activity. The chart suggests the earlier 2 housing price bubbles were rather modest in size and in impact when they collapsed, at least when compared with the most recent housing price bubble.

The housing price bubble that recently collapsed began in 1997. Gjerstad and Smith believe there were 2 basic reasons for this recent price bubble. There was an increase in household income (beginning around 1992)which would have increased the demand for owning homes. There was also a significant change in income tax law that allowed a capital gain of $1/2 million in a home. This would also have increased the demand for owning homes. The first of these reasons would be a "natural" economic explanation, i.e., increased income and increased demand resulting from an increased standard of living due to a prospering economy. The second of these reasons was the result of a specific government action.

Gjerstad and Smith suggest that this most recent housing price bubble might well have ended with the recession of 2001, and if that had been the case it looks to me like this recent bubble would have looked very much like the other two price bubbles we see in the chart. Why did this housing price bubble continue?

Gjerstad and Smith point to one of the reasons in their chart. The Federal Reserve "decided to pursue and unusually expansionary monetary policy." The increased liquidity was then utilized by the rapidly expanding housing sector of the economy, and the bubble continued to inflate. During the earlier two bubbles the Federal Reserve acted in a way that worked against and that mitigated the increase in the bubbles. In contrast, for the latest bubble the Federal Reserve's actions enhanced the bubble.

Gjerstad and Smith also explain that explicit government policy actions also contributed to the expanded housing price bubble. Both the Clinton and the Bush administrations acted to aggressively increase home ownership and this government policy was translated into decreased mortgage credit standards.

There was another interesting government action that Gjerstad and Smith point out. In 1983 government changed the way it calculated inflation. The result was that in 2004 for example the reported inflation rate was about 1/2 the actual inflation rate. The Federal Reserve was choosing an expansionary monetary policy with an inaccurate view both of inflation and the real interest rate. The real interest rate was near zero, and of course "household borrowing took off."

So, the latest housing price bubble peaked in early 2006. We probably remember that the deflating housing price bubble didn't really enter our public consciousness until around Labor Day and the Presidential election in 2008. It took nearly 3 years for the crisis to become a crisis.

Gjerstad and Smith note that the downturn in the equities market from about December 1999 until about September 2002 saw a loss of about $10 trillion of asset value. In contrast the lost asset value for housing was only about $3 trillion of asset value. They wonder why the smaller loss in asset value led to our current financial crisis, when a larger loss in asset value did not.

The answer they suggest is that the people who lost the asset value in the equity market downturn were largely individuals and were not financial businesses/institutions themselves. In contrast, the current financial crisis involves a large number of households who were unable to continue to pay off their mortgage loans. This is alot like saying the losers in the equity market downturn were individuals, but there are important differences.

When households default on their mortgage loans the real asset, the home, becomes owned by a financial business/institution. The lenders were of course making their business decisions in loaning money for the original mortgage based on the knowledge that if the borrower failed in making payments the real asset would become part of the lender's assets. Unfortunately, as the housing price bubble began to deflate, the housing prices across the country began falling very rapidly. In many cases, the loans which were in default apparently involved properties who had decreased in value by 50% or more, and most of these properties had been purchased on 90% to 100% margins.

Gjerstad and Smith suggest that the earlier and larger asset value losses in the equity markets had relatively little impact on our financial system because the lost asset values did not get into the financial institutions and system itself. In contrast, the very inflated recent housing price bubble relatively quickly was moved into losses for the financial institutions themselves.

Perhaps if the housing price bubble had not been overwhelmingly large in historical terms, the losses for the lenders would not have led to the current crisis. So, I think it is important to keep in mind the reasons noted above that government actions and policies have much to do with explaining the existence and the size of the third housing price bubble in 40 years.

Tuesday, April 07, 2009

The Real City

"A city is not a man-made thing. Rather, it emerges from the actions of its inhabitants, who interact in unpredictable yet orderly ways. Under the right conditions – the right “rules of the game” – what arises is vital, creative, radically unpredictable, and profitable: the living city.

The modern demand to rationalize the city and to make it “more efficient” is misplaced. A living city cannot be efficient. Efficiency, in the economic sense, presupposes an overarching plan against which measured outcomes can be evaluated. A living city, however, follows no such plan. It is itself the unplanned, collective result of the countless individual plans executed continuously in it, day after day.

[ . . . ]

Earnest attempts to preserve large parts of the city or to consciously direct its evolution, like trying to preserve or control any complex living thing, will drain the life from it."
Ikeda is one of my economist heroes.