1:27:42 No, might go wrong. – Allan Meltzer
Doom Transcripts: Index & Guide
Housing Doom is pleased to present a complete unauthorized annotated transcript III.B for the American Enterprise Institute’s April 28, 2008 event "What Lies Beyond the Credit Crunch? Part II".1 The event site has a variety of resources including a summary and both an audio and a video of the proceedings. There is an official transcript, but the link to it does not seem to be currently working.
Table of Contents
[link navigation works best when full article displayed]
- 0:00:00 – Peter Wallison Intro
- 0:07:43 – Charles Calomiris presentation
- 0:24:33 – Kevin Hassett presentation
- 0:36:53 – (interruption for computer problems)
- 0:39:20 – Desmond Lachman presentation
- 0:55:22 – John Makin presentation
- 1:15:02 – Allan Metzer presentation
- 1:36:04 – Vincent Reinhart presentation
- 1:55:20 – Panel discussion
- 2:12:34 – Q&A
- 2:28:54 (end)
Peter Wallison: [0:00:00] OK, I think we’ll get started. Everyone take his or her seat. I want to welcome you all on a pretty raining and nasty day. I’m delighted that all of you came out. This should be one of the more interesting conferences of the year, and I can understand why you’re all here.
This is the 2nd conference on exactly the same subject. The last time these esteemed AEI economists got together to discuss the future of the credit crunch and the US economy was in December of 2007. At that conference there was sharp disagreement at to whether the US, as a result of that housing meltdown, the credit crunch and other factors was headed for a deep recession, a shallow recession, or merely a slowdown for a quarter or two.
The data presented at that conference showed a serious breakdown in trading in the credit markets, and major losses in housing values. These factors would suggest a serious recession. But at that point there was no clear evidence of a recession, during the 4th quarter of 2007, at least. The Dow, which opened at 13,339 that morning, was down from its high of 14,000, but certainly was not signaling a serious recession.
All the participants in the December conference thought that their predictions would be proved correct when several months of additional data was available, so we scheduled this conference to see [laughs] whether in fact their positions have changed, and whether things have become any clearer to our AEI economists.
From the perspective of a non-economist, I must say things still look pretty cloudy. The Dow Jones is about 500 points lower than it was in December, but it has risen recently. It’s up again marginally today, when I last looked. Friday’s Wall Street Journal noted this with the headline: "Dow Rises 85.73 points, as Some Investors Shed Fear."2 Since much of the buying was of financial stocks, banks and brokers, the fear that investors shed was probably that the credit crunch would deepen.
If in fact the credit markets are returning to normal, it would take … that would be one reason for taking a deep recession off the table. In this connection, it is useful to note that the 3-month Libor is 40 percent down from it’s 52-week high.
This first chart shows [Figure3 1] that the spread of mortgage-backed securities over the 10-year treasury has declined substantially since the Fed’s moves in conjunction with bailout of Bear Stearns in March, but it is still 50 percent higher than it was last April, and 10 percent higher than it was at the time of our December meeting. And the very high Jumbo mortgage rates haven’t come down at all since December.
Nevertheless, it does look as though we are beginning to deal with the credit market fallout from the subprime meltdown.
Attached is table 2. [Figure 2] It’s a very interesting chart that shows recapitalization that has been going on among the banks. This indicates, it seems to me, that we are not headed for what we have, or what various people have called, a Japan Problem. What you see there is that the banks, in the last few months since January, have recapitalized by raising about $212 billion in new money, against about $308 billion in written down losses.
Recapitalizations will enable banks to begin lending faster, without concern that their loans will further reduce their regulatory capital. Sustained bank lending will shorten and reduce the severity of any recession.
In you materials is an article4 that I wrote a couple of months ago arguing that the real question of the subprime meltdown was whether the taxpayers or the shareholders would bear the loses. At the moment it looks very much as though it is the shareholders, and that’s the way it should be.
The issue, as I saw it, was whether the banks would recapitalize, [0:05:00] diluting their shareholders, or hold back in the hope that the government would pick up the losses.
The bank recapitalizations, which are probably forced by regulatory jawboning, seems to be answering that question. Nevertheless, there are indications that some banks will not be able to recapitalize, and will fail. That will produce a market shock that could send the market reeling again, because things are really quite fragile.
At the same time, the votes last week in the House Finacial Services Committee significantly narrowed the number of subprime, or other, borrowers who are likely to be eligible for bailouts. What this means, I think, is that the decline in home prices will be sharper, but will end sooner. You can take your choice about whether this is good or bad. The important thing, in my view, is that the losses are recognized by the financial institutions and appropriate actions are taken, and that appears to be happening.
Finally, a few weeks ago, the Business Roundtable published a summary … [Figure 3] of the views of the CEO members at the Round Table about the future. And the best summary of this summary is: "A slightly better economy in their veiw, in the months to come." As you can see, that 1st sector at the top on the left, "How do you expect your company sales to change in the next 6 months?" 70 percent of them believe there will be an increase in sales.
So overall, there is a modest improvement, but the key issues –
- How far will home prices fall? and,
- Whether there will be failures among the banks, and
- Other intermediaries,
– these are still major unknowns.
And this is just right for commentary by our economists.
We’ll go in alphabetical order, as it turns out, which is probably the best way to get these people to talk anyway, given what there positions are likely to be.
And so we’ll start with Charles Calomiris. …
I’m not going to introduce them at any length, because I think all of you know them, either by watching television or reading the stuff that they write, so I’ll just say a sentence or two about what they’re doing now.
Charlie is a Visiting Scholar at AEI, and he’s Codirector of AEI’s Program on Financial Market Deregulation. He’s the Henry Kaufman Professor of Financial Institutions at Columbia Business School, and a Research Associate at the National Bureau of Economic Research. … Charlie.
Charles Calomiris: Thanks, Peter. Welcome everybody. It’s a pleasure to be here.
What I’ve done for the presentation today is used exactly the same slides5 that I used before, except I updated the data. And I didn’t change — I don’t think I changed 10 words in the slides. And I guess what that’s meant to indicate is that I think that probably I was right before. [laughter]
Although, I want to emphasize that I agree with Peter. I learned a saying as a young man, "Today’s peacock, tomorrow’s feather duster." [laughter]
And so I don’t want to be too effusive in my self-praise, except to say that I do think it was forecastable — of course there’s uncertainty in the economy, but I do think that there were elements of this turmoil from the very beginning that gave us reason for optimism and that set it apart from the experience in 1989-92, and of course very far apart from the 1930s.
I’m not going to discuss it, I’ve already discussed it. I’ll highlight a few of those issues, because I’ve only got 15 minutes.
What I want to do though is say that I very much underline my view last time was explicitly the forecast that banks would be raising capital. And not just that the regulators would try to get them to. Remember regulators don’t actually regulate capital. They regulate capital ratios.
Regulators really pretty much can’t make banks raise capital. What they can do is make banks either raise capital or shrink assets. And when banks are faced with severe problems of asymmetric information in markets, that make it very difficult to raise capital, they choose to shrink. That’s what happened in the ’30s, that’s what happened in ‘89-’92.
What I was forecasting — which I think has turned out to be true — is that despite much of the confusion in the markets, that the banks were in sufficiently good position, and that there would be sufficient ability to resolve that confusion, that they would be able to significantly access capital markets. That was the real prediction, the real uncertainty, the biggest uncertainty [0:10:00] in my mind, and as you saw from Peter’s slide, all of that capital was raised since December.
So that’s the sense in which there really has been a significant piece of news. And that’s what is very gratifying for me, since I stuck my neck out and predicted it would happen.
I’m not going to review this slide, except to point you toward it. This was exactly the same slide I used last time, except I added a line here, which I think was missing before.
Just to explain how we got to where we are — I’m going to skip over that [Figure 1] — remind you of how abrupt the financial innovations of the last 5 years had been in terms of CDO issuance, mortgage-backed securities making use of subprime, and I spent a lot of time talking last time about how inappropriate the risk measurement was, and how it had been inappropriate ex ante, and many of us had confused it, (… I’m sorry, confused it, …) had criticized it and saw it, particularly the ratings agencies confusing use of triple-B or double-A or single-A to mean completely different things when they were looking at structured products and at normal corporate securities as one of the key contributing problems. And also the way the rating agencies had failed to do appropriate stress testing of subprime.
One of the things we pointed out last time was that the crisis has been very localized. It hasn’t affected everyone. Even financial commercial paper issuers have been — that is, the ones who aren’t directly related to subprime — were not really very hard hit by it. And non-financial commercial paper issuers weren’t affected at all. But we had about half a trillion dollars of runoff, in the first stage of the crisis, coming from subprime-related problems and working capital manangement by the large banks in the form of SIVs or Asset Backed Commercial Paper conduits, that had to run off a lot of commercial paper. That was the first part, and I think I correctly forecast last time that we wouldn’t have a return of that, and we haven’t. That was a one-time shot.
Why this happened? One of the things I want to emphasize for those of you who weren’t here last time is: part of the problem here was that the financial system learned the wrong lesson in 2001 and 2002. Actually, it may surprise you that — just look at this graph. [Figure 7] You can’t see it very well, but the top line here shows you that the peak foreclosure experience in the subprime mortgage market was in 2001 / 2002. We still haven’t gotten back up there. And that’s going to be a surprise if you haven’t heard that before.
Of course it was a much smaller market, but it experienced very high foreclosure rates. But since the housing market was booming, the Loss Given Default in subprime in that experience was only 6 percent. That’s how you got liar mortgages, no-docs mortgages; from a perception that it didn’t matter what peoples’ creditworthiness was, because "housing prices can’t fall." Sounds a lot like Japan in the 1980s, right? "Real estate prices never go down." That was the mentality then in Japan, and it was very much the mentality here about subprime. And that was built into the rating agencies’ assumptions, and in some instances it was known to be wrong.
The other thing built into them was grade inflation. It was very self-conscious. A triple-B CDO, as of 2005, triple-B debt coming off of a CDO, as of 2005, had a 5-year default probability of 20 percent. A triple-B CDO corporate bond had a 5-year default rate of 2 percent. Obviously triple-B did not have a meaning that was common to all securities.
From last time again, what are the likely macroeconomic consequences? I stressed two different likely transmission mechanisms of adverse consequences –
- credit supply contraction,
- the other, housing price decline.
And I argued, and remain with those arguments, that the credit supply wouldn’t be severe because banks would be able to raise capital, that they had continuing profit sources, they were much better diversified, and that the losses would not undermine their ability to grow, and that they would be bringing capital from outside and growing their loan portfolios rapidly.
And of course, in fact, the last 4 months have been among the fastest growth periods in US bank lending in post-War history, as I’ll show you in just a minute.
What about housing prices? I argued that the Case-Shiller index is a flawed index, that the median home sales index is a flawed index, and that in fact, there are reasons from a macro perspective to prefer the OFHEO index, which gives us a much brighter picture. [Figures 3,4,5] And I talked a little bit about some of the problems in the construction of some of these indices. I still believe that, and I also believe that the wealth effects are over-estimated by most macroeconomists when they think about the effects of housing price decline, and that they’re probably more like half the size that most people estimate.
That led me to the conclusion that this would not be 1989-’91, and that the … for both of those reasons, and one additional reason, and this is something again that needs to be emphasized. The Bush 2003 dividend tax cuts had an affect that was exactly what they intended, [0:15:00] which was to reduce leverage, excessive leverage that was there to try to take advantage … tax advantages of debt.
And leverage, corporate leverage has fallen since 2003 like a rock. [Figure 15] This is very important to bear in mind as we go forward. What it means is that debt positions of US corporations are back to where they were prior to the 1980s, giving huge debt capacity to those corporations, and we’re seeing a lot of debt being raised right now, and that again takes the pressure off of the banking system for large corporate borrowers. That’s another very important fact to bear in mind.
These are pictures of the growth of bank lending, [Figure 18] whether you looked at the large weekly reporting commercial banks, or the overall banking system, and you can see huge growth. And that has been made possible by that continuing growth in profits, and also outside capital raising.
This gives you the Jumbo and the conventional mortgage rates. [Figure 10] The key point here I would make is, yes it’s true that the Jumbo rate has edged up, but let me take you down to Latin America when a financial crisis causes interest rates to go up a little bit more. What’s really been happening here, of course, is — that bottom line shows — the Fed has been targeting this mortgage rate effectively and just reducing interest rates as need be to keep that mortgage rate from going off into the sky. That’s one way to look at this graph.
So money-market rates have come way down. We’re currently at, I think, too low a Fed Funds Rate at 2 1/4 percent.
I’ll skip this in the interest of time, but the point here is how interesting some of the new patterns in money-market spreads have been in this crisis. Maybe during Question & Answer we can come back to that.
What’s the meaning of some of these very unusual spread movements that we’ve seen? [Figures 11,12] Some of these unusual movements have persisted, they’re the part of this crisis that has surprised me, that they haven’t corrected themselves more, particularly the overnight Libor relative to overnight Fed Funds, which I will point to in just a minute.
How accommodative is monetary policy right now? When you look at real Fed Funds rate we’re at a position that we’ve only seen about 5 times in the post-World War Two period in terms of the real Fed Funds Rate, and in my view, actually, that is … it’s even worse, because my expectations of inflation are higher than the market consensus. So I think we’re in an extremely accommodative position in monetary policy.
My view is that the Fed has done the right thing on the Discount Window consistently, and I praise them for it. I think they’ve overdone it on the Fed Funds Rate, and that, by the way, I noticed, was the theme that came out of today’s Wall Street Journal lead editorial.
This is the graph [Figure 13] of the spread between the overnight Libor and Feds Funds, reflecting the fact that large banks, in lending to each other, still are not lending at very low rates. That reflects a combination of counterparty risk perceptions among the large borrowers, because the Libor market is a big bank to big bank market, as well as just a general hoarding going on by large banks still, to get back to their equilibrium liquidity positions.
So we’re still seeing a stubborn persistence of high Libor rates that makes us think that we’re really not done with the money market part of the adjustment, the liquidity part of the adjustment of this.
Credit spreads, which is the bottom graph here, have risen. That’s good news, they were way too low, they’re back to about normal. I’ll predict that that triple-B spread will fall to below 3 percent, let’s say within 6 months, but shouldn’t fall much more than that.
The good news is the stock market has kept itself fairly high, …
Credit spreads … You can sort of see the turmoil as happening in 3 waves. [Figure 14] And I have two spreads here, one of them is the credit default cost, as indicated by the CDS spread, Credit Default Swap costs, and you can see the 3 waves there. We’re now in a position that is much lower than it has been during any of the 3 waves.
The orange graph, though, is Fannie & Freddie’s spreads over Treasury, [Figure missing?] and you can see those have actually gone up recently. And the reason for that is that we’ve expanded … Fannie and Freddie’s roles since this point, and expanded their riskiness. So this is a concern. It’s not a concern about the crisis so much as it’s a concern about how long term policy toward Fannie and Freddie has now given us a new long term risk, because we’ve given up on capital regulation and portfolio restrictions that we shouldn’t have given up on.
This is the point I was making about how much post-2003 corporate leverage has fallen like a rock, and those of you who are thinking it’s a good idea to repeal the Bush tax cuts, take a good close look at this graph, and think how much worse off we would be if we hadn’t gotten all of that excess debt capacity since 2003.
How much time do I have, Peter?
Peter Wallison: … [undecipherable] …
Charles Calomiris: … OK … Housing prices, I’ll just be very brief and say I think the last 2 months [0:20:00] have given us a brighter picture of housing prices in the data, but it doesn’t surprise me. I think that I’d like to talk a lot more about housing prices. I have another paper which I’d like to present here, actually, at some point maybe in a month, on the relationship between foreclosures and housing prices going forward. And I’ll stay with the prediction I made last time, which was, according to the OFHEO combined resale and refinance index that peak to trough we won’t see a nationwide decline in excess of 10 percent, and I’ll stay with my 5 to 10 percent range.
Nothing like the very irresponsible and really almost crazy statements by some economists. None of them are on this panel, by the way. And I mean that sincerely. By people like Nouriel Roubini or a Bob Schiller who .. Bob Schiller I think said housing prices might fall by 50 percent in the US. Just ridiculous. And nothing like that … and actually, last time, even though we were differing … we differed in our interpretation, many of us, I thought, I think John and I specifically said we thought about a 10 percent decline was about what we would expect. Maybe John will revise that view, but that’s still my view. …
Case-Shiller is a very untrustworthy index, regionally it’s not constructed in a way that gives us the kind of indications that we want for the whole economy, or for the segment of the population that’s most subject to wealth effects coming from house price declines, so I won’t say any more about it except just to say that I’m not a big fan of that index.
There is real concern about the connection between foreclosures and house price declines, and that’s what my next paper is all about. There is going to be a continuing pressure on house prices to decline because of foreclosures. But there’s a good news story too. Which is that housing starts have been in decline for a very long time prior to this crisis. And so the pipeline has … is not … has not been increasing for over a year. What we’re going to see is that by September we will be back to a more-or-less equilibrium in terms of inventory, and I think that this is the reason for that. So the good news is that the housing price slump — I’m sorry — that the housing slump in housing starts long predated the crisis. And that’s helping us a lot looking forward, and what we’re going to end up with with housing prices.
So, severe recession risk is minimal for all the reasons I’ve said before, and I think that this is so far been true.
I’ve already talked about the Fed policy …
Foreclosure relief — I’ve said before I think and I’ll stay with it — I think we should be doing more. I think it’s a waste of money. We’ve spent $160 billion on this completely useless fiscal relief package, it’s all politics. We should have spent $20 billion on encouraging efficient foreclosure avoidance. We could have done it, we still may do it, and I’ll leave that for the Questions & Answers.
Bank regulatory response — of course I wish I’d spent all of my time on this topic, because it is one of my favorites. I think it’s taught us how bad the Basel II standards really are, and it’s taught us a lot of other things. We need to increase capital substantially, phased in over time, for US banks, I think, among other things.
Reforming the GSEs — this is one of the tragic aspects of this crisis, is how far we’ve gone from the right direction on that policy.
Inflation is really worrying me here. You can see … I’m a fan of the Discount Window, I’m not a fan of the Fed Funds Rate reduction. Look at commodity price acceleration, industrial commodity prices have been booming. Look at the spread between the Fed 10-year TIPS and nominal Treasury showing you inflation expectations are rising substantially, and if you look at … it’s not just the US that’s experiencing this, especially countries that have tied themselves to a dollar exchange rate, but more generally all the world is seeing much higher inflation, so for this sample of countries: Panama, Saudi Arabia, Hong Kong and China, inflation now approaching more than 8 percent.
So I think that we do have some corrective policies to do, and I hope the Fed doesn’t keep expanding the mistake, which I would put at about 75 basis points too much expansion so far. Thanks.
Peter Wallison: Very good, Charlie. Thank-you. Now Kevin. Let me first say a few words about Kevin, everyone knows him, of course, but he’s the Director of Economic Policy Studies here, and a Resident Scholar at AEI. He’s also a weekly columnist for Bloomberg, and for Kevin and everybody else, there’s quite a lot of biographical material in your kits. … Kevin.
Kevin Hassett: Thanks a lot, Peter. If we go back through the WayBack machine to the last conference, then my humble contribution was to discuss an article I’d just written in the New York Times, which is the … it was the real-time output of a book that’s now in editing here at AEI that I’ve been writing with Jim Hamilton [0:25:00] at the University of California San Diego, and Marcelle Chauvet at Cal Riverside.
And what we’ve been doing is developing, especially Marcelle going all the way back to her dissertation, was working on this area, was developing real-time models that help you call when you’re in a recession or not. And the basic idea is that the National Bureau of Economic Research [NBER] is the official arbitrator of whether we’re in a recession, and they very often tell you you’re in a recession, on average I guess it’s about 7 to 11 months after the recession begins, and since a recession lasts, on average, about 11 months, then you can sometimes find out you’re in a recession after the recession’s over.
And when we were meeting … late last fall or early in the winter, I guess, I forget whether … which side of the Solstice it was, but it seemed to me at the time that everyone had made up their mind that we were in a recession. And this model that Marcelle and I drew upon in our New York Times piece is a very effective model of a recession, that takes the data and then reproduces calls that the National Bureau of Economic Research would make, although many months later. In fact the model had called every recession correctly, reasonably precisely, down to the month, in post-War history without ever giving a false signal.
And the message as of last December, but then we were talking about hard data through October, as I recall at that point, was that there was no recession as of October, and I had about half the data for November, and I said it doesn’t look like November either, and so the conclusion of my talk was that I’m not nearly as able as my colleagues who do it for a living to think about what the future might hold, but I’m pretty good at forecasting the past in this case, and that I was reasonably comfortable saying that we didn’t … weren’t in recession at the time, and if a recession was going to begin, then it would have to be in December, and that was the punch line.
Well, subsequently we’ve had, … some time has passed, and we’ve drifted down the river, and we’ve had a few more months of data. I now have complete data for December and January, or we do, Marcelle ran the numbers last week, and either it’s absolutely not a recession in December, absolutely not a recession unless we kind of change the definition, in January.
In February, the data took a marked turn for the worse, and we’re at that point now that’s most frustrating for econometricians, the point that’s most, I guess, annoying to be at, which is that the model says that the probability of a recession for February is about .5, OK?
So the last time I talked, how have things changed? The last time I talked said, "Well I don’t know if we’re going to have one next year or not." I think that some of the things that the folks over here to the left of me, are going to say are pretty disturbing, and may give you pause, but on the other hand Charlie was kind of pumping me up, and I wasn’t sure, but I was really sure that we weren’t in a recession yet.
And so I’ve changed quite a bit, because I’ve gone from being really sure we weren’t in a recession yet to now suspecting that when I end up having my complete data for February that it will show that a recession began in February, but the 2nd New York Times piece hasn’t been written yet, because … we don’t have enough, … February’s not a complete story, and it’s right at a point that’s frustrating. And so if it finishes February at .5 then we’ll have to wait for March to see.
And so, again, though, note that this is a remarkably different place to be than it seems like the popular culture has taken us too, wherein if we call a recession the same sort of thing that happened before when we called it a recession, then it’s not obvious that we’re in one yet, despite all of the awful things that have happened. And that’s, to me actually, pretty remarkable.
Now looking forward, I think that we have to think about what it … where we’re going to go from here. I think that are a number of new factors, as the tax policy person that one needs to point out as we think about, let’s assume that the model does end up convincing us that the recession starts in February, so then that means that, well, if it’s typical, then it’ll probably last through to about the end of the year, so we’ll have a bad year.
It’ll be the … a really opportune time for the next President to arrive, because if you arrive right at the trough, then every growth comparison of you to anyone else will always be favorable, but … so we’re looking at something like it could run towards the end of the year, and then the question is, what is policy done to make it so that it will be shorter or longer? And in that regard, I’ll leave the discussion of monetary policy to people who are [0:30:00] far more able than me to discuss that, but it looks like there’s been a heck of a lot of stimulus since our last meeting.
And if we’re basically riding about flat last year, not quite in recession, and riding about flat, as near as we can tell, right now, I asked some economist friends of mine who do this for a living what 1st quarter GDP was — the highest one I got was about 1.3, and the lowest was about 0, and so 1st quarter GDP, it could end up negative, but it’s a little bit positive, it’s not really negative, which is one of those things you’re looking for for a recession. So we’re running about flat, and then we’ve thrown all this stimulus in.
And so what’s the risk going forward? Well it could be that finally the bad things we’ve been fearing really happen, or it could be that inflation gets really out of control, and certainly commodity markets are fearing the latter.
What has policy done outside of monetary policy? Well the stimulus package is going to have, probably, a small effect. If we use back-of-the-envelope approaches to think about how much … [crosstalk] … No we have to do the add for Windows, isn’t that part of … [laughs] … [crosstalk] …
So the stimulus package is probably worth maybe 1/2 a percent of GDP the 2nd half of the year. And that’s if you’re optimistic about people consuming from a temporary tax cut. The literature on that, I think, is mixed. People inaccurately have cited a paper6 by Jonathan Parker which looked at the last tax cut and found that people consumed it, and then concluded that the stimulus would be large. … The comparison is weak, because the last time we did this we gave people a permanent tax cut, and so even Milton Friedman would concede that they would consume a lot of it, because … at least permanent as long as the Byrd Rule applies, or you get your 10 years of Bush tax cuts.
But this time it’s really explicitly temporary. So you might expect to see a very, very small effect. Though the last policy thing that I think we have to start thinking about, in terms of what’s going to happen in this recession, if we do kick in in February, is that there are a heck of a lot of policy variables on the table, both for the next President, and also, I guess, to be discussed during the campaign. And those policy variables, I guess there are 2 main ones –
- One is the deficit; and,
- the other is the marginal tax rates.
If you crank the numbers for Senator Obama, assuming he’s the nominee, I guess nobody really knows for sure, then the marginal, the top marginal tax rate on labor income from Mr. Obama is, after you account for interactions of things, about 52 percent. Goes from the current rate to about 52 percent. He gets that high rate on labor income because he removes the cap on the payroll tax.
The top marginal tax rate on non-labor income for wealthy people is about 10 points below that, so it’s a lot higher than where we are, but not nearly the big marginal tax hike, up to 52. That difference however, is exacerbated, like the gap between where we are and where we might be under Mr. Obama, is exacerbated by the fact that he’s going to argue for an increase in the capital gains tax rate, and it seems a repeal of the dividend tax cut, although I find the positions at times murky on these things.
But if the dividend tax were to go up to, back up to, say, a top rate of 42 percent or something, then we’d be talking about the kind of change that would have really a pretty dramatic effect, I believe, on equity markets. I think if we go back and look at the dividend tax cut before, then you could sort of back out that maybe be about a 7 or 8 percent celebration occurred in equity markets because of the dividend tax reduction. In this case where we might be more than reversing it, and with a 50 percent probability, if you think that it’s a coin-flip election. And so that means that as we head into the fall, there is a significant amount of tax policy uncertainty that you might really begin to see in financial markets.
Now the last time around, I had a paper in the American Economic Review with Alan Auerbach where we looked at the behavior of futures markets in response to … options markets in response to Presidential futures, [laughs] and teased out that there are really big and significant effects of tax policy on equity markets around the election, and that basically with higher taxes being more likely when Kerry’s future was very [0:35:00] positively traded.
And so what that means is that as we think about how we get through this recession, the policy thing that I want to add is that we’re about to enter a fall where there are going to be some pretty big policy stakes, potentially, that might really move markets around as markets change their priors about how Mr. Obama’s doing.
I guess I have to have a full revelation, I’m not speaking in any way for a campaign at the moment, but I do advise, informally, Mr. McCain from time to time, but I think that this policy uncertainty has the potential to be really big in financial markets, and not just that, but another one, another area where you might see it would be in municipal bond markets, because if marginal tax rates are going up a lot, then that has a big impact on the relative price of muni bonds, and it’s something else to look for.
… What did you do, Charles? …
Charles Calomiris: … I didn’t do anything.
Kevin Hassett: … I told you not to touch that computer, did I not?
[laughter]
And so then, to summarize, I think that last time I was sure that we weren’t in a recession, and yet. This time it’s close. And I guess if you’re a betting person you might argue that getting all the way up to 50 means that with a little bit of more data revision we’ll be over the top, and it will look like February would be the start of the recession. I think that policy, on the one hard might make … might give us a half a percent or so from a not-so-bad level over the rest of the year, but that uncertainty about future policy, which would be a much larger scale might have an effect in the opposite direction.
And so, for me the way I am feeling right now is it’s a little bit worse than the flatness that we’re been riding, and maybe lasting a little bit longer than we might have thought.
Peter Wallison: Thank-you very much, Kevin. We’re having a little bit of difficulty with the computers, so you all should have in your packages Des’ slides. Des, I think you’re going to be talking from slides? Is that right?
[start 2 1/2 minute technical interruption]
Desmond Lachman: … until Charlie was here … [laughter]
Peter Wallison: Well, we still have your slides, so … oh, is it back? Is it coming back?
In any event, let me talk about Des a moment while we’re waiting for something to happen. Des joined AEI as a Resident Fellow after serving as the Managing Director and Chief Emerging Market Economist … Economic Strategist, at Salomon Smith Barney. He was previously the Deputy Director in the International Monetary Fund’s Policy and Review Department, and was active in the staff formulation of IMF policies toward emerging markets. Now you’ve got an emerging … set of slides, so go ahead.
Desmond Lachman: … try to start … [dead air] … [cross talk] … I was quite prepared for this. I’ve worked in New York for a while at Salomon Brothers, and the first thing that I was told at Salomon Brothers was you didn’t have to worry about anybody stabbing you in the back, at Salomon Brothers they’d stab you right up the front.
So that’s how I’m feeling right now.
Thanks …
[end 2 1/2 minute technical interruption]
Desmond Lachman:Thank-you very much, Peter, and thank-you very much for arranging this seminar. And as I said at the last seminar, I hope that you do this in 6 month’s time, but I hope that we don’t have reconstructionist versions of what we said at the time.
My recollection is that I was very clear that we were headed for recession, that there would be a lot of problems in the financial system, and my recollection is also that I didn’t get much support at this table for those views.
So let me be quite clear about what I’m thinking right now. I think that [0:40:00] I take quite a different view from the previous speakers, in that I think that the outlook is not very bright, to use a euphemism.
I think that what we’ve got here is a recession that is going to be very much longer than the normal recession, and that what we’re going to get is we’re going to get a recurrence of problems in credit markets. This time around, what’s going to be occurring is that the weakness in the economy is going to be feeding back into the credit markets.
Just to begin [slide7 1] with my slide presentation, I thought it would be useful just to take stock of how things have changed since we were here in December, and in particular to take note of a couple of people who seem to be coming around to my point of view.
Let me start with Alan Greenspan, [slide 2] who’s perhaps the architect of the mess we’re in, who’s now describing the situation as "the most wrenching credit crisis in the post-War years." Wanting to outdo him we’ve got Paul Volcker describing the present crisis as the Mother of All Crises.
Ben Bernanke has recently acknowledged that output in the 1st half of 2008 could have contracted in the United States, but more importantly, what he has done is he’s led the Fed to adopt measures that they haven’t resorted to since the Great Depression.
Just to round this out, we’ve got Marty Feldstein, who has some influence on the National Bureau of Economic Research, [NBER] who dates these recessions and will tell us how long it is, who’s talking about this being very likely to be a severe recession.
And then finally there’s the minor issue of the data. We’ve lost 230,000 jobs in the 1st quarter of the year, and consumer sentiment now is at its lowest level in the past 25 years.
What I did in December was (the reason that I had a pessimistic view of the outlook) was that I thought that there was a confluence of 3 factors [slide 3] that were impacting the economy.
When I asked myself, "Where we are going now?" I asked myself, "Are those 3 factors still in play? Have some of those factors perhaps got worse?" and my answer is, "Indeed those 3 factors are in play and a number of them have certainly got worse."
What I’m referring to, of course, is the housing bust. I just refer you to a chart [slide 4] which shows that house prices now, in real terms, have probably fallen by something like 14 / 15 percent the past year, and that when we look at the rate at which they’re falling now, [slide 5] (this is from the much maligned Case-Shiller index) that the last quarter we’ve got house prices now falling at 20 percent. So in terms of the housing market, I would suggest that not only have we got a bad situation, which I’m wanting to talk about a little bit more, but it’s accelerating. The pace, if you like, the 2nd derivative is positive, which is problematic.
We’re seeing that also, just in terms of Mortgage Equity Withdrawal, [slide 6] which was a big support of consumption. That is now just evaporating.
So that is the first part of the crisis that bothers me. The second is the credit crunch, and some of the slides that have been shown before would suggest that despite the Fed cutting interest rates by 300 basis points, borrowing rates are, for the most part, above where they were in August last year. So I’m not sure how stimulative the monetary policy … I’m not sure why one would look at the Federal Funds Rate, adjusted for inflation, when what we’re getting is we’re getting the long end of the curve not coming down so much, and spreads widening, so that the borrowing rates are at … high.
In addition what we’re getting is we’re getting contraction of balance sheets. And once again I wouldn’t look at the banking sec– simply at the banking sector, I’d be looking at the whole financial system. Banks today only intermediate something like 30 percent of overall credit, as opposed to something like 50 percent 15 years ago.
The third shock that I would suggest has got a lot worse than when we were here last time is international oil prices. My recollection is in December they were at $85/bbl. Today that’s round about $120 dollers / barrel. So when I take those 3 shocks together and see [0:45:00] that they’re still in play, still … some of them getting worse, I’m not sure that I see what the case is for thinking that this is going to be a short, shallow recession.
I would add that what we’ve had is we’ve had stock prices declining, we’ve had debt prices declining, which is a further drain on wealth; and, a point I’ll come back to, which I think is rather important is that we’re now getting very clear signs that the commercial real estate [CMBS] market, which was booming last year, is now entering into a bust. So there are very many reasons, I think, to be concerned.
Let me just go through the housing market rather quickly. [slide 7] The reason why I’m concerned, and the reason that I’m doing this, is twofold. I’m suggesting that if we don’t get stabilization in the housing market, that could be very important for consumption, which after all is 70 percent of aggregate demand. And the reason it could be important for consumption is that housing is the largest asset — largest component of wealth — in private portfolios. And secondly it makes it difficult for people to borrow against their homes, which is the the way in which they were financing their consumption.
The second reason, I think, that one wants to focus on the housing market, is that the bigger the bust that can get in the housing market, if it’s true, as I would suggest, that housing prices are probably going to decline another 20 percent before this is all over, what we get is we get an amplification of the losses that we’re going to be getting in the financial system. Those losses [unintelligible] are already estimated fairly widely at something like $1 trillion, of which only something like $250 billion has been recognized by the financial system, so I’m not sure that I see that we’re at the end of the tunnel.
Let me now just run through quickly the part of my reasoning why we’re going to get housing prices declining by 20 percent. This chart [slide 8] is just showing you, using the OFHEO index, how much we’ve got away from equilibrium during the boom, that you can see that there’s a trend line that that looks it looks like it’s something like 30 / 40 percent above what the trend is. If I do this in relation, if I scale it as I correctly should in relation to income … If I look at a house to income ratio, I come to the same conclusion, that that ratio rose from something like 3.2 to 4.5. So that alone would tell you that coming back to equilibrium would require a rather big change.
But I’d rather focus on — what are the facts on the ground? If I look at the housing market, inventories of unsold homes are now something like a million units above what is a normal level of inventories, [slide 9] or if you want to look at it in terms of rato to sales, [slide 10] we’ve got the ratio to sales, housing inventories to sales, at something like 10 / 11 months supply, which is the largest that it’s been the last 30 years.
So we’ve got a situation where we’ve got excess supply on the market, and what I would suggest is — that is only going to get worse, for at least 3 reasons.
First is, just in terms of the financing of the house market, if you look at what occurred in 2001 … 2006. [slide 11] In 2006 something like 40 percent of the financing was coming from subprime lending and Alt-A lending. You fast forward to the 4th quarter of 2007, what we’ve got is 90 percent of the lending is coming from the GSEs, and that the amount of lending has contracted from a rate, an annual rate of $3 trillion in 2006 to $1.8 trillion in the 4th quarter of 2007. So the financing side is going to make less demand for houses. You see it also if you just look at the lending condition index, [slide 12] the survey that the Fed does, that really is just going through the roof, that is back in January. I’d expect the next quarter to be even worse than this. So we’re going to get less demand.
We’re going to get, also, the question of resets. [slide 13] That might not be as serious as it was when I was talking in December, because we’ve had some interest rates coming down, but nonetheless, it’s going to come into play on the reset.
What I’m really concerned about is the story on the foreclosures. [slide 14] Foreclosure procedures that have already been initiated in 2007 are literally going off the chart. What we’re getting is we’re getting something like double the rate. We’re now running, instead of 900,000 units a year, which was the story in 2006, we are now [0:50:00] at something like 1.8 million units in 2007, and there’s a lag of something like 12 months, 18 months before those houses hit. So we’ve got a real problem on the foreclosures side. Foreclosures are going to come onto a saturated market.
Another way of looking at it, which I find rather scary, is that the equity in people’s homes has now dropped. [slide 15] The average household has only got 47 percent equity in his home. It’s the lowest it’s been in the post-War period, and the chart [slide 16] that I’ve constructed is that if house prices fall by 10 precent in 2008, this histogram just shows that you’re going to have a third of households having negative equity in their homes, and this great land of ours with non-recourse loans, people have got every incentive to walk away from their houses.
So I’m not sure that we stop foreclosure problems even if we have the Frank-Dodd bill in place.
If you don’t want to take my word for it, just take a look at the forward market in the Cass-Shiller Index. [slide 17] We’re just looking around — major cities in the US, something like Los Angeles, over 30 percent decline the next 2 years in house prices. Just eyeballing that, it doesn’t seem to me unreasonable to expect house prices to fall this year by something like 10 to 15 percent, and probably fall by a similar amount next year.
As I mentioned, I’m not only concerned about the housing sector, I’m concerned about the non-residential construction sector. [slide 18] What you’ve got in 2007 was that as housing was busting, you were getting a boom in commercial real estate. All of the indications are telling you that that has turned. The last 3 months have been pretty negative for commercial real estate, and looking forward, when you see what’s happening with lending conditions on the commercial real estate, [slide 19] the expectation is that that’s going to be busting further, which I think just compounds the story on the credit crunch.
Let me just briefly say a word or two about the credit crunch, [slide 20] that as I’ve mentioned, my read of the credit crunch is, because of the credit crunch, we’ve had spreads widening. This has been going on since August last year. Borrowing rates are no different than they were August of last year, so we’ve really got a situation that I would not describe as accomodative.
And the 2nd point that I would make is that balance sheets are being shrunk, not simply on the banking side, but outside of the banks. We’re really getting a process of deleveraging occurring, that my expectation is that that continues.
I just thought I’d put up one or two more slides. This slide [slide 21] just suggests that … the line in black [red?] is the way in which credit conditions have tightened as measured by the Federal Reserve survey for the banks. And what it does is it just pushes it forward by 4 to 6 quarters, which is the lag. One doesn’t expect, as credit conditions tighten in the banks, one doesn’t expect bank credit to fall immediately, because what happens is people either draw their lines, or else if they can’t be borrowing, if they can’t be placing their bonds in the market with a high degree of securitization, they go to the banks. But what occurs 4 to 6 quarters later is what we’re going to be getting, is we are going to be getting, at least in my view, a contraction of credit.
Some of these other charts [slides 22,23,24] have been [unintelligable] just in terms of interest rates, not being very different than before. This is the chart that I just think just needs some attention paid to. [slide 25] It’s really just looking at the amount of intermediation through banks and through the securities markets, and what you see, the last 25 years, is that basically, the action is really in the security markets rather than in the banks, [slide 26] so that if you’ve got problems … if you’ve got shrinking of balance sheets on Wall Street, I think you’ve got a problem for the economy.
So where I am is that the recession is going to be longer, deeper than before. I think that it’s not too early to be thinking of additional stimulus measures, [slide 27] and I think that we might have to resort to the non-orthodox kind of measures that are being talked about to put a floor under the housing market if we’re not going to get a really deep recession.
Peter Wallison: Thanks. Does anyone wonder why he says all that with a smile? [laughter] [0:55:00] The sedatives are in the back, incidentally, if you’re …
Our next presenter is our colleague John Makin. John is a Visiting Scholar at AEI, he’s also a Principal at Caxton Associates. He’s been an advisor to numerous US goverment agencies, the Federal Reserve system and the Bank of Japan. John?
John Makin Thank-you, Peter. Well the … I don’t have slides, because Desmond’s are so good I don’t really need to go through them again.
But the title of the Outlook that’s in the package that you have is called "Denial, Hope and Panic," and we certainly have heard some denial up here today, not from Desmond but from my colleague Charles Calomiris, who — I often wonder, Charles, what planet you’re living on, but let me try to make that case.
Peter Wallison: We don’t get personal here, do we? [laughs]
John Makin: Oh, sorry. Well your numbers, I don’t know where they came from, because I have data from the bank credit analysts on capital infusions, and they are somewhat below yours, but anyway …
Look, … I’m concerned here because we have an audience in front of us that’s probably trying to figure out where the economy’s going, and when they get through listening to this panel, I expect they’ll probably be very confused, because they’re hearing very different interpretations of what are supposed to be a set of facts.
So what I’m going to try to do is suggest a very basic theme that economists have looked at over at least a century, and that is — two centuries really — that you have a big … you have two things going on, you have the financial sector and you have the real economy.
And in this particular episode that the United States is in, you have a crisis in the financial sector that’s being driven by a rapid drop in housing prices, and you’re having a crisis in the financial sector because it is chock full of securities that were written conditional on the assumption that house prices don’t go down. And the value of those securities is very difficult to ascertain, and they have a huge bearing on the financial wellbeing of many of the institutions that we’re looking at — the commercial banks and the investment banks.
The reason that I am a little bit surprised to hear the idea that everything really is OK and we never had a problem, or bad things might happen — bad things did happen in March, and let me tell you that if the Fed had not stepped in (I’m trying to kind of go through this is The Outlook) if the Fed had not stepped in on Sunday, March 16th to … and I don’t know how to put this, did they rescue Bear Stearns? No, they rescued the investment banks.
That day Fed essentially stepped in in order to stop a run on the investement banks from their counterparties. The counterparties to investment banks are analogous to the depositors in commercial banks, and I know that most institutions in the financial sector on Sunday March 16th were sitting around their conference tables watching the screens, waiting to see what the Fed was going to do. And if the Fed had elected to do nothing, Bear Stearns would have failed, and a list of investment banks that I will not name would also have failed.
And so the Fed really had no choice but to take the extraordinary measure, really, to do two things:
- they opened the discount window to investment banks, which is almost unprecedented;
- and secondly, they took $30 billion of toxic crap from Bear Stearns’ balance sheet onto their balance sheet,
and then turned it over to Black Rock to manage for them, and of course the head of fixed income at Black Rock is none other that Peter Fisher, the former manager of the desk at the New York Fed.
And I suppose … I mean my own nervousness about financial markets is probably driven somewhat by my intimate involvement in this, and the days I spent in early March moving funds out of Citibank and into Treasury bills, [1:00:00] while Treasury bill yields reached as low as 60 basis points.
So if nothing was really happening in the credit sector, I wonder why there was such a run into absolutely safe assets, that the yield on Treasury bills went to 60 basis points.
If everyone was sitting around saying, "heh, it’s going to be fine, no problem," there would not have been a virtual panic run out of banks and into Treasury bills.
Now, but part of what happened on March 16th is very important. The Fed took away the downside. That is the Fed took away the incipient run and collapse of the investment banking system by opening the discount window to those institutions. And I think the analogy is, when someone’s beating you over the head with a two-by-four, which is you have an incipient collapse of the investment banking system, when they stop beating you over the head you feel better.
So one of the things that happened was that the Fed, … I would argue the Fed never should have been putting itself in the position they were in on March 16th, and had they not been so casual about how bad the ecomony was, and had they not been so slow too move on remedying those problems, had they not been so complacent, they wouldn’t have been in that position. But given that they were, they had no choice but to try to stop a run on the investment banking system, and they succeeded.
And so when you say, well, people are now raising capital, they are. Lehman Brothers and other investment banks are raising capital because the Fed has essentially put the safety net under these otherwise aggressive institutions so that they can raise capital. In effect they’re diluting common shareholders by doing so, but they are raising capital. I would point out, however — and this is in the bank credit analyst last week — that Level 3 capital, which is basically the junk bin that banks and investment banks use to put assets that they choose not to value into — is still running about $568 billion out of $1 trillion of total equity capital in the banking system.
And equity 3 capital is basically stuff that they don’t want to value, and so it suggests to me that some of the incipient risks that Desmond’s talking about are still there.
SO I think one of the reasons — and I’m trying to account for my own different view here — one of the (how shall I say?) metrics for being concerned about the financial system and the economy is probably how close you are too it. And maybe I’m too close, but in my view, we were too close to where I didn’t want to go, which was to watch Bear and a bunch of other investment banks go under.
By the way, the rules were pretty well followed with Bear. The rule is, let the shareholders go, and protect the depositors. The depositors in this case were the counterparties who were protected. Most counterparties had already abandoned Bear, and were preparing to abandon all the other investment banks and the Fed essentially came in and said, "Don’t worry, you’ll be OK." That was a very important step.
The shareholders at Bear probably were treated a little too well, and I think maybe JP Morgan had a little too much leverage at the time, because they were well aware of the need, literally, for an announcement to be made by whatever it was, 7PM on that evening, 7:45 give or take, I think it was. I was too busy sweating to watch the clock, but there it was.
So we had a near-meltdown in the credit sector, which was averted by aggressive Fed action, and that took the … some of the wide tails off of some of these financial markets that … and some of the instruments have improved considerably. In other words, if you’re not having to price credit derivatives, swaps, for the possible, possible meltdown of the financial system, you can be a good deal more aggressive in buying those things. And we have seen a nice comeback in the credit markets.
So my shorthand is, and I think it may help to bridge some of the gaps here, not all, and we’re not going to agree on everything is that … Credit … We had a credit near-panic averted. That’s good. Now we have the real economy, which is slowing rapidly, and I kind of agree that the numbers starting in February [1:05:00] would … if you look at all of the numbers, and I’m very plodding. I look at the number and I say, "Ooo, what happened in the last 6 sessions? and how does consumer confidence look, and how does employment look?" It’s probably what your computer does very systematically. How does … how does housing look? How do all these things look? And everything looks like we went into a recession in the 1st quarter, and whether …
By the way, I … First quarter growth was 0.6, which is not exactly a rip-roaring economy, and so probably your model was starting to wonder, and we’ll get a report on the 1st quarter numbers probably, what is it? on Thursday, and we’re probably going to see a number around 0 to .5, a headline, but the domestic final sales, which is really the demand growth part, I think the important, arguably the important part of the number because, … it’s probably going to be negative. And the difference will be we’ll probably have an inventory accumulation, and the inventory accumulation in an environment where growth is slowing, is not a good sign going forward, it’s a sign that momentum is being lost.
So one of the things that concerns me as I talk to people about the economic outlook is, "Yes I know it feels good that we’re not going to have a collapse of the 5 major investment banks, I’m really happy about that, and you should be too." However that doesn’t mean that the real economy is going to do wonders, and this month I tried to look at that in kind of a long run sense, and the deleveraging — we’re going to see deleveraging in the financial sector, and we have begun to see that. Many of those who thought that they had home equity lines of credit with the major banks have discovered that they don’t, because the boss at the bank says, "We don’t want any more exposure to households, so if they haven’t used their home equity line, cancel it." And if they have used it, we’re stuck, because home equity lines are second liens, and banks find that people walk away from those lines and say, "Come and get me, but you’ll have to foreclose on my mortgage first," which may have something to do with the rise in foreclosure rates we’re having.
The housing sector — again I hate to argue about numbers, but the Case-Shiller futures index is a market. People buy and sell those contracts, it’s not the biggest and best market in the world, but it is numbers people are willing to bet on. And house prices are falling, and they’re falling at an accelerating rate. OFHEO, again, we had this discussion in December, we’ll have it again. OFHEO is conforming mortgages only. It excludes the most vulnerable part of the housing market.
Be that as it may, real estate markets everywhere are weakening rapidly, and not only that, but the rates don’t … rates which haven’t come down much don’t fully tell the story. I invite you to go to your bank and ask for a loan, be it a regular loan or a Jumbo loan, and see how much the down payment requirement is, relative to what it was a year ago. It will be substantally larger — 20 to 30 percent.
So you have rates at the same level with higher down payments, and so credit conditions are more difficult for prospective homebuyers, and will probably continue to get more difficult, because banks are deleveraging. They don’t want exposure to households, because they’re trying to deleverage while they raise capital, and they have been in effect asked by the authorities, various authorities, to do so.
So, what about the longer run? Well I went back and looked at the Fed’s data on household wealth, and … because I’m trying to get a sense of how much do households have to delever. And what I discovered was that … in the 1990s, from 1990 to 2000, household real net worth, which is kind of the bottom line of the flow-of-funds data, rose at an annual rate, compounded at an annual rate of over 5.4 percent. So households, at the same time, the household saving rate, which excludes those … the mirror image of this, was … the household savings rate went from about 8 percent to 2 percent.
So households were developing the notion, at least the way the broad numbers looked that, "I don’t need to save out of measured income, I simply will [1:10:00] be able to save by virtue of wealth accumulation."
In the current decade, wealth accumulation, that is household real net worth, has compounded at about a 2.3 percent annual rate through 2000 … 2000 to 2007. But as we look at household balance sheets now, we see that equity prices are down — no too much, maybe 10 or 11 percent from the highs, but they’re not going up any more. And house prices are down, and we can argue about how much, but house prices are certainly down from their highs, and the availability of credit that has been tied to the rise in house prices has sharply curtailed.
So probably, as households face sharply higher energy prices, deleveraging by the financial sector, their own need to deleverage (the data on State tax collections show that reak incomes are dropping, have to be dropping unless people are avoiding taxes), we’re going to have a sharp slowdown in consumption, which is already started, it’s in the data. Beyond that we’ve also seen investment spending start to slow. One of the things that we suggested back in December was that that would be what you would expect to see as we get closer to a recession, and that’s what we’ve seen.
So again, it seems to me it’s playing out exactly as we … the big wrinkle was the crisis in March, which none of us actually envisioned. We did not envision a …
voice: … you and I did … I’ll remind you of that …
John Makin: … OK, well I didn’t envision something quite that intense, but we had it, we got through it, it’s a good thing the Fed performed their job.
But now I think the problem is we have this underlying deleveraging in the finacial sector and the household sector that’s going to slow consumption growth, and probably pretty rapidly. We throw in a little bit of a curveball here because, as everyone’s mentioned, Treasury will be sending out checks with a total up to about $100 billion over the next several months, and it’s very hard to figure out how much are people going to spend. I do know that if you annualize the increase in energy costs over the past month, it’s $60 billion, simply because gasoline and other energy prices have gone up so rapidly. That maybe will go away, it may not. But it’s not a plus for households’ disposible income.
So where do I come down on this? On the financial crisis, the financial sector is better than it was six weeks ago, and we dodged a very serious bullet, and that feels good, and it’s given financial markets a nice lift. By the way, this is the 13th 5 percent bounce in the stock market that we’ve seen since last summer, as I checked, Alan Ableson pointed it out over the weekend, and sure enough, we’ve had [undecipherable] … And actually I’m surprised that it’s not a little bit better, given that, again, they’ve stopped hitting us over the head with this 2-by-4 called an incipient credit crisis.
But the underlying picture in the real economy, which is tied to a persistent and accelerating drop in home values, which is the major balance sheet item of most households, continues. And I suspect, again I suspect that if we gather again in 6 months we will say, "Gee, consumption slipped quite rapidly, investment slipped rapidly, and the 2nd quarter growth rate was … somewhere around zero, because we got a boost from the stimulus checks." But when the stimulus checks go away, the 2nd half of the year actually could be more difficult.
So it’s not as dramatic as the onset of a credit crisis, but it’s kind of a steady grind down, which I think probably adds up to a fairly lengthy recession. I’ll stop there.
Peter Wallison: Thank-you very much, John. There isn’t actually any pattern to these presentations, except alphabetical order. So you think it’s been arranged in some way, it hasn’t been.
OK, our next speaker is someone who was not here for the one in December, for our meeting in December, so he’s an entirely new participant, and that’s our esteemed colleague Allan Meltzer. Allan is the Visiting Scholar at AEI, and he’s also the Allan H. Melter [laughs] University Professor of Political Ecomony at Carnegie Mellon University. He was a member of the President’s Economic Policy Advisory Board during the Reagan Administation, and he has been an Acting Member of the President’s Council of Ecomonic Advisors and a consultant to the Treasury and the Fed.
I should mention that he received the first annual Irving Kristol Award, and delivered the Irving Kristol Lecture at AEI’s Annual Dinner in February 2003. And Volume 2 of his History of the Federal Reserve is forthcoming from the University of Chicago. [1:15:00] Allan.
Allan Meltzer: Thank-you. Having watched recessions over something like a 50 year career, I must say that one of the things that stikes me most about this one is the enormous exaggeration that characterize the comments that were being made.
People were talking about … people as smart as Larry Summers were talking about depression and how we were on the verge of depression. And the media was just full of talk about how the 6 percent — at the time 6 percent default rate on housing was the worst since the Great Depression. Well in the Great Depression it was 50 percent, and if you can’t see the difference between 6 percent and 50 percent, you have to be as blind as many of the people who write the newspapers.
Another example is the hand wringing over the decline in house prices. House prices have to fall. The problem won’t end until house prices fall. We have to see house prices fall. A quick fall will be hard, but it will also get it over somewhat faster.
Sure, they may overshoot, but what will signal, for me and many other people, the end of this problem, the housing problem, the beginning of the end of the housing problem, will be when the expectation in the market of a housing price stabilizes. When they know what the housing price, or think they know what the housing price is going to be, they will be able to value the securities in their portfolio, they’ll be able to raise more capital. People will have more confidence in what their assets are.
If you look at the market now you see that people — banks are willing to lend to each other, money market people are willing to lend to each other, for one night or two nights. They’re not willing to lend for 30 days, because they don’t know what kind of junk is in the portfolio of other people. And that junk is characterized by the fact that we don’t know what the value of the underlying assets are, and we can’t know that until the expected housing price settles.
So that has to happen, and that will be a signal of the fact that we’re approaching the end of this financial crisis.
I share the view that this slowdown, it’s not yet a recession, it may be a recession, but it’s not yet a recession, that the slowdown in the economy will be prolonged, not so much because of the housing price problem, although that certainly contributes, but more important for consumers is the fact that gasoline and energy prices are way up, and they are really pressing on individual family budgets.
I mean, take a person at the median income of around $40,000 / year. Every week, when he fills up his SUV to go to work, and he needs to fill the SUV [laughs] to get to work, he spends $80, approximately, for gasoline. That’s a big slug out of his weekly income, monthly income, annual income. It only amounts to maybe an additional $500 or $600 a year, but that’s a big bite in costs, and food costs add to that problem.
So the reason I think that that’s affecting more people than housing, the gas and energy prices are affecting more people, is because … I don’t inhabit Wall Street, and so I don’t … I can see what I think is playing from the data. That is, that this crisis which is very localized. The worst of it is in southern California, southern Nevada, Arizona, southern Florida and, for very different reasons, in the area around Detroit.
The rest of the country, housing prices may be falling, but most of the people who own those houses are not going to move, and many of them are not going to default. They know that housing prices can go up, or they believe that prices can go up or down, and they’ve lived through the uncertainty that that creates.
Now a friend of mine, who is the Chairman / CEO of a very large bank says to me, "I should read the number on foreclosures with a certain amount of skepticism. Why?" he said, "because my customers default on their loans, they give back the house, they don’t pay their mortgage, they go across the street, and buy the exact same house at a lower price." So the defaults are going to be overstated for that reason.
How important that is, he can’t tell me. He tells me it’s important for his bank, whether it’s universally important or not [1:20:00] we’ll find out eventually.
Second, let me talk about, so … I think that they’re a great deal of exaggeration about the disaster in the housing market. I believe that people on Wall Street saw a disaster because their positions in mortgages were underwater, and so what they saw was something they have, if they have anything on Wall Street, they have hubris, and they believe, "If things are bad for me, then they’ve got to be bad for everybody." But that isn’t true. They were talking their position.
I agree with those who say that the Fed, one of the Fed’s responsibilities is to act as lender of last resort. I have believed for, maybe forever, that the Fed is the lender of last resort to the financial system, not to the banking system, not to the member banks. And I have nothing … I have mostly praise for what they did in their lender-of-last-resort role. They said, "We have an obligation to protect the payment settlement system. We can’t allow the settlement system to fail. What we did for Bear Stearns was essentially what the Congress instructed us to do for banks when it passed FedICIA." It said, "Get rid of the management, wipe out the stock holders, and keep the institution running, because we don’t want a to eliminate what economists call ‘network externalities.’ " The fact that people were trading with each other and depend on each other to trade, that they get hurt when one of their trading partners goes down. Sure they can find somebody else, but there’s going to be a bad period while they search around. So keep them operating, wipe out the equity and wipe out and eliminate the management. And basically that’s what the Fed did.
Now in order to do that under the gun of waiting for the Japanese market, or wanting to get it done before the Japanese market was open, they said, [laughs] "We’ve got to have a deal by 7:45 on Sunday evening." That’s the same as telling a shrewd operator like Jamie Dimon, "You name the terms," and he did.
That … maybe there was no other way to do it. In any case, that’s what they did. So I have nothing to criticize about the bulk of their policy of maintaining the payment and settlement system. It’s been, for the most part, successful. The biggest problem that seems to remain shows up in the rate on the London Interbank Borrowing Rate, the Libor rate. No one, as far as I know, knows quite why that rate doesn’t come down. My own conjecture is that it has much more to do with Europe than it does with the United States. That is, that is has to do with the fact, rumors, that the Landesbanken, the German Landesbanken, or at least some of them, are deeply troubled by the bad loans that they haven’t yet announced in their portfolios, and that this affects the London … the European credit markets more than the United States. There may be other reasons, I don’t think anyone knows for sure. But the Fed’s policy seems to me to have worked reasonably well.
I disagree with my colleague Desmond on many things, but especially on the fact that he uses nominal rates to point out that they haven’t brought them down. But the inflation rate is now the expected inflation rate looking forward is about 4.8 percent for the year ahead, and I’m going to say a few things about that.
The part of the Fed policy that I don’t like is the inflationary policy which has led to a severe devaluation of the dollar, to an increase in desire for protection, to bring back a lot of the problems that we have had, and make them worse.
In you folder you’ll see 2 pieces of paper that sent to you from the web site of the Federal Reserve Bank of St Louis. One shows the extraordinary, and it is extraordinary, growth of M2. It has really taken off since the Fed began its severe easing in January. You can see that if you look in your packet. The other is a statement which … If you look at, [1:25:00] from the same source, if you look at bank credit, all banks, large banks, C&I loans (Commercial and Industrial loans) you’ll see that there’s hardly a break in the rate of increase.
In spite of all the talk that you hear over and over again on radio and TV about the credit crunch and how you can’t borrow and no one can borrow, just look at what’s happening and you’ll see that people are borrowing. And that while there’s been a slight decline in the last couple of weeks, that the rate of growth of loans and leases and bank credit, and especially all banks, banks outside of New York, that’s now …
Why do we get this news? Well because New York plays an important role in the financial system, and the Fed, in its history … throughout its history, has always been very sensitive to the attitudes and feelings of the New York bankers. They are an important part of the economy, not quite as important as they think, but important.
Second, I would add to the discussion of the possible recession the fact that if we you look at the unemployment rate, it’s risen, and it will probably rise more, but it’s still below the long-term average of the post-War period. So people are working, not in New York perhaps, but they’re working. And a measure which is more contemporaneous than the unemployment rate, which is a lagging indicator, is … how long it takes a person, on the average, who loses his job to find another job. Currently, the median for that is 8 weeks, a year ago it was 10 1/2 weeks. So it’s improved. Now it will get worse, but …
How I would describe the situation is, as I said, I think that there is a real problem for households and consumers because of the increase in gas and energy prices and food. There’s the possibility of all sorts of shocks that could happen. The German Landesbanken may fail, the Bundesbank may not bail them out, very unlikely, but possible. There are all sorts of things that could go wrong.
If you want to look for a list of things that can go wrong, talk to Desmond. [laughter]
John Makin: … have gone wrong …
Allan Meltzer: No, might go wrong.
The Fed’s policy, what I dislike about the Fed’s policy is it strikes me as a return to the mistakes of the 1970s. In the 1970s the members of the Open Market Committee [FOMC] were not stupid, they knew that they were producing inflation. What they told themselves and each other over and over and over again was, "We will stop the inflation before it gets bigger, or before it gets worse." And then the time came, and they did it, and the unemployment rate ticked up, and that was the end of the anti-inflation policy.
So fine tuning, stop-and-go policies failed. And they’re going to fail again. That’s my biggest concern, and we have seen, in the Euro market, M3 growth, which is what the Euro central bank watches, is up 12 percent. You can look at the chart of M2 growth for the United States and you’ll see that it has really ballooned. And as I said, the expected rate of inflation one year ahead is now 4.8 percent. That’s getting up there.
The Fed, when you listen to Bernanke, others from the Fed, Don Kohn, talk about the problem of inflation. They say, essentially, without using the words, say, "we’re relying on the Phillips Curve." That’s a weak reed on which to lean. It failed them. Athanasios Orphanides wrote a number of very good papers pointing out how that policy failed in the 1970s. It failed because, he said, pointed out, because we don’t know what the expected rate of growth is going to be. We can only guess at that, and we usually, often guess wrong. And it moves around more than the Phillips Curve, which assumes it’s constant, would like us to believe.
We see, in forward looking markets, traded good prices up, [1:30:00] depreciation of the dollar up, lots of signs that the market is anticipating continued inflation and at a higher rate. The Fed thinks, and says, that when the economy slows, inflation rate will come down. Maybe. That’s a weak bet on the Phillips curve, or strong bet on the weak Phillips Curve.
The lesson that I draw from reading and writing the history of the Fed is that most of the time, the Fed is not independent. Really isn’t independent. It’s whipped around by the Congress, and that’s what’s happening now, and Mr. Bernanke is not standing up to the Congress, not … at least negotiating with them, but in a sense giving in to them. They also are very much under the gun from Wall Street. People who hold bonds and mortgages are underwater, they’d like to see interest rates lower, in the hope that those bond prices and their losses will get smaller. And, although I don’t know this for certain, I would be surprised if Mr. Bernanke’s telephone doesn’t ring with phone calls from the Administration as well.
So I sympathize with him. I mean he’s under pressure all the time. He’s yielded to that pressure and he’s gone back to doing, to making the mistakes that got us into trouble in the ’70s. I hope I’m wrong, we’ll see what happens. At least we begin to see that expectations in the market that were, a few weeks ago were called for a 1 1/2 percent Federal Funds Rate by June have now come back up. So the Fed may stop cutting, but I don’t want to see them stop cutting. I believe the policy that they have to pursue is one which says, "We cannot run the economy from quarter to quarter. Our influence — we know for a long time that what monetary policy does, it does over a period of uncertain length, but at least 9 months or more on average."
So we should run the monetary policy as if that were a fact. As if what we can influence is the average at which the economy moves. The Fed’s best policy was the policy … the best policy over its history was the period from 1985 to about 2004. It essentially followed, not deliberately, but it followed in effect John Taylor’s Rule. And that policy worked very well on average. It kept down unemployment, it kept down inflation. It deviated from that policy now, and it ought to get back to it. It ought to pursue a policy which aims at the middle course.
I want to close with one last comment, which is — why did we get into this mess? and what do we have to do to prevent future messes of this kind? I believe that there are two reasons, which very few people talk about, but which need to be discussed more. One is the bad regulation, which Charlie Calomiris mentioned, Basel. The Basel agreement said to banks, "If you hold more risky assets, you’d better hold more reserves." So you’ve got what is the usual thing. Lawyers make the rules, the market figures out how to circumvent them.
The incentives were all wrong. The incentives were, take it off the balance sheet and put it in these strange instruments that we invented. And then we don’t have to hold more reserves, and we didn’t. That was a silly, foolish policy. Regulation, if there is to be regulation, has to worry about, what are the incentives that are being created? It isn’t easy, but if you’re going to have regulation, you’d better worry about it. What are regulators going to do when they see the regulation?
Second and last, the incentives in the market are geared to making short-term profits. You have to ask yourself, why do the MBAs, my former students, students from all the best business schools in the world, why were they buying and selling pieces of paper that they had to know were worth not much? The answer is, because if they didn’t do it, in most firms they lost their jobs, and if they did do it, they got big bonuses. That’s not a very good system, that’s how we got the dot com problem, [1:35:00] and that’s how we got the housing problem.
So what we need to do is to change those incentives, and an easy way to do it would be to average them over 5 years … average their returns over 5 years. Do something other than what we’re now doing.
If we don’t do that, we’re dealing with a market in which people borrow short and lend long. So it’s always going to be subject to some kinds of ups and downs. They’re unavoidable, but we can make them much less … more more avoidable if we change the incentives, both the regulatory incentives and the incentives of the participants.
Peter Wallison: Thank-you very much, Allan. OK, our last speaker is Vince Reinhart. He’s the newest member of this team. He’s a Resident Scholar at AEI and a former Director of the Federal Reserve Board’s Division of Monetary Affairs, and he’s spent more than two decades working on domestic and international aspects of US monetary policy. … Vincent.
Vincent Reinhart: Thank-you Peter. [speaker was obviously using a slide deck, but this was apparently not uploaded to the event site] Those thanks, of course, are tinged with regret [laughter] that you couldn’t see past the tyrrany of the alphabet, and so I have to speak 6th, after so many disparate views were expressed. And actually, it reminded me of something F. Scott Fitzgerald wrote, which was, "the test of a first rate mind is an ability to hold opposing ideas at the same time while retaining the ability to function." Perhaps it could also be said about a panel, although I would note it was in a book called "The Crack-Up."
I’m going to talk about 3 things in terms of what lies beyond the credit crunch. The current state of the US economy, that is the current conjuncture, the outlooks for the US economy, and then I’m going to argue is that there are really two distinct possibilities, and then the financial world after March 14th. I date the changing not at 7:45 on the 16th, but 8:15 on the 14th.
First, in terms of the the current conjuncture, the ongoing house price … housing correction is posing 3 drags on US economic activity. First, there’s the direct inventory correction as builders cope with excess stocks. And I would point out like Des, they’re chasing a moving target in that they are cutting back production even as sales fell ever faster, and we see the inventory / sales ratio rise.
The good news is, that sector is getting arithmetically smaller and smaller, so the contribution to the drag should lessen over time. But in addition, reductions in house prices are reducing wealth, slowing the growth of consumption. There you have the 2 favored house price indices on the right of our panelists; either the OFHEO index, the solid line, that Charlie prefers, or the thin line of the Case-Shiller. But the main point being that house … households, of about $23 trillion worth of housing wealth on their balance sheets are feeling less wealthy, and will have less wherewithall to support consumption.
You might argue that’s not a bad thing, given the saving rate being so low. That adjustment needed to happen. The question is, that it happens in too narrow a window, you’ll slow total aggregate demand.
And then third, a deterioration of the balance sheets of large complex financial institutions has made credit more expensive and difficult to get. The last panel is the net stardards on C&I lending, which moved up sharply; but nowhere nearly as sharply as the right panel, which is net standards on mortgage loans, that just took off in the last survey in January. And I look forward to seeing what the results of the survey are next week because presumably there’s one in the field.
The obvious question is, is this a recession? It’s not an an obvious answer for, I think, the reasons Kevin talked about. What I’ve plotted there is my favorite contemporaneous indicator of recession, and that’s the contribution to the unemployment rate of short to intermediate spells of joblessness, that is, the unemployment rate for people who have been unemployed under 26 weeks.
What you note about that indicator is, it moves very asymmetrically between recessions and expansions. In recessions, the yellow area, it goes up about 3 tenths of a percentage point a month. In expansions it mostly moves sideways, actually it declines on average by a tenth ever 6 months.
We have had [1:40:00] a weak job market, we’ve had a string of declines in employment, but that indicator, as most indicators of the labor market, haven’t moved sharply in the manner that we would normally associate with recessions.
Hence you get the ambiguous conclusion that we’re either in or about to enter a recession, or we’re probably in the third month of … third quarter of real GDP growth averaging something like a half percent.
In either case, it feels pretty badly, and I think in some sense it’s a consequence of the Great Moderation and the economic growth. If you look in the upper left panel, that plots real GDP growth since 1930, and quite clearly, from 19… around 1983 onwards, something happened, and that is, the growth or real magnitudes (and nominal magnitudes as well) became much less volatile. Ecomonists called that the Great Moderation.
What has accompanied it is what I would call the Great Whining, in which public sensitivity to a slowing economy has increased. In some sense the total amount of news is about unchanged, you just need a bigger response to each basis point of slowing associated with the moderation in economic activity. And one place you can see that is if you look at … go to Google Labs and look at Google Trends. That just looks at the number of hits, and number of newspaper articles in the bottom panel, using the word "recession." What’s striking is you can actually extract it from Google, is they do that for longer periods of news articles alone. And you see that the increase in references to the word "recession" this year is about … made up about 2/3rds of the increase in 2000 / 2001, and even more now than was the case in 1990 and 1991. I think that all that’s supposed to mean is you should filter what we hear, commensurate with the reduced volatility in macro aggregates.
Now what I’d like to do next is so … in terms of the current conjuncture you get your choice. We’re either in the 3rd quarter of growth averaging something like 1/2 percent, or after the fact, a few of those numbers will be revised down, and we will be technically in a recession. Going forward, I’d like now to talk about the economic outlooks, and that’s actually not a typo. Much of financial market behavior depends on expectations. Markets with an important role for expectations have really interesting theoretical properties, like you observe herd behavior where people follow the first movers, they have the possibility of self-fulfilling prophecies where just the thought of something going wrong makes that … makes something go wrong.
You also have the possibility of multiple equilibriums. That chart on the right is something out of a Brookings paper I wrote with Brian Sack, and it gives this little example of … consider a market where Agent A’s participation in market trading depends on the participation of Agent B. And similarly Agent B’s participation in market activity depends on the participation of … expected participation of A.
What you get in that particular case are two outcomes … potential outcomes. A high trade equilibrium and a low trade equilibrium. If everybody goes to the restaurant with long lines, one could imagine if not enough people show up, you crash. A lot of people show up, you’ll succeed with the long lines.
Same thing in market participation. If a lot … if it’s expected a lot of people will participate in market activity, then you’ll participate in market activity and get a high trade outcome. If, however, you fear that not much of your competitors will participate in market activity, you wind up with a low trade outcome.
I’m talking about that because financial markets do pose right now a quite distinct set of risks. We’re seeing, back when macroeconomics were fun, we’d … people would talk about fallacies of composition, that is, individual behaviors don’t necessarily aggregate up to good behavior at the macro level.
What we’re seeing now is the paradox of deleveraging. It is in the individual interest of every large complex financial institution to shrink their balance sheet so it’s … so that they have balance sheet ratios [1:45:00] more commensurate with the lower capital they have after they’ve realized the losses on their mortgage portfolio. And it is in each one’s interest to do so, but if everybody does it at once, you wind up, potentially, in the low trade equilibrium where there is no market clearing, because everybody’s trying to sell at once.
So I take that to mean, in the high trade outcome, the large complex financial institutions come to grips with that problem by getting more capital. That would allow financial markets to improve, financial conditions would improve, allowing the substantial easing of monetary policy, that is, the reduction in short rates in the upper right panel, to show through and support economic activity. At the same time, there’ll be additional impetus associated with the 5th … the tax rebates and, not inconsequential, the dollar depreciation, which has encouraged net exports, as you see the dollar depreciation in the middle panel, and the net contribution of real net exports of goods and services in the right panel.
So in the high trade outcome, it works because firms get more … trading firms get more capital, that supports better market functioning, and the considerable policy ease by the Federal Reserve will show through.
[crosstalk -- Peter replenishing Vince's water glass]
Let me go on record as saying, "The glass is one third full."
In that high trade outcome, in fact, the Federal Reserve’s problem will be to remove excess accomodation as quickly as possible. You see in the upper right panel, the solid line, core PC inflation is in the neighborhood here of 3 1/2 percent and, rather … the total PC inflation is in the neighborhood of 3 1/2 percent, and the core PC inflation, the dashed line, is hovering at 2 percent. And we know from the central tendency forecast published in the minutes [of the FMOC] both in October and March, that the committee’s implicit inflation goal is an outcome for that index somewhat less than 2 percent.
So if they want to satisfy their own internal goal, they’ve got a problem with inflation, and it is a problem with inflation that could be more serious given, as you see in the bottom 2 panels, the considerable increases in commodity and oil prices.
So in the high trade outcome, the Federal Reserve is going to have to show that its policy of … in this new post-gradualist world, is symmetric. That is, it’s got to be willing to tighten policy as quickly as it eased policy.
That might not be as hard as you think, because if in fact, in that high trade outcome, financial markets improve; that is, spreads narrow, t would be a natural thing to remove the policy accomodation put in place because of the unusual circumstances in markets, once those unusual circumstances lift. And they’d be able to show that they learned the lesson of 1998 and 1999; they learned the lession of 2004.
So in that high trade outcome, what we’re witnessing is a price discovery process. The people who have capital are holding out for a better price. Some have already moved, some more will move, and we’ll get a recapitalization in the banking system. …
But there’s a low trade outcome too. You can align your balance sheet ratios to what is desired either by getting more capital, or, with your depleted capital, shirk your asset … the asset side of your balance sheet sufficiently.
So the alternative in the low trade outcome is that capital doesn’t come in from the private sector. Large complex financial institutions have to shrink their balance sheets in order to bring them in better alignment with their depleted capital. Financial conditions do not improve. Now they don’t get worse, because the Federal Reserve has established a floor on market functioning with the primary dealer credit facility. If no primary dealer is allowed to fail, then there’s no reason to have runs on primary dealers, and market functioning doesn’t get worse.
But in that environment, there is no financial stimulus to show through the economy, because spreads are still high. And you have to worry about other parts of spending, including [1:50:00] non-residential construction, and the willingness of households to continue to spend in an environment in which there’s obvious turmoil.
And so the economy moves sideways or weakens if in the end the way large complex financial institutions deal with their balance sheet problems is by continuing to shrink their balance sheets.
Now we’ve talked about the primary dealer credit facility as establishing a floor on market functioning. I’ve got to consider, just a little bit, the world after March 14th, and I would agree with the other panelists that the Federal Reserve is to be commended for using both the size and its composition of its balance sheet to affect the economy. It’s the size of the balance sheet that determines the Federal Funds Rate, which has been eased aggressively to offset weakness.
It’s the composition of the balance sheet that influences market functioning. Essentially the Federal Reserve has been swapping with the private sector for illiquid assets, their mortgage related securities, for which there is no effective market, in return for either reserves, through long term RPs[ph] or the term auction facility, or for Treasury securities, through the Term Securities Lending Facility.
And that is, in an imaginative way, to use, to expose the Federal Reserve’s balance sheet to credit risk, to stem the deterioration in market functioning, to buy time until that capital comes. And recognize, however, your central bank doesn’t provide capital, your central bank provides temporary credit, and they’re buying time for that capital to come.
I would argue that the decision to lend to Bear Stearns, and extending lending to all primary dealers through the primary credit dealer, primary dealer credit facility really was the worst policy mistake in a generation. And I think it will be comparable and longer … with longer term consequences to the Great Contraction and the Great Inflation. And part of the reason we don’t see this is we tend to jump over the range of possibilities. And that is, if you give me the choice between Bear Stearns failing setting off a cascading multiple failures of other financial institutions, or the Federal Reserve providing them funds, I can understand the argument for the Federal Reserve providing funds.
The problem with that is the excluded middle — the possibilities that we don’t really … that we haven’t talked about. Like, would it be possible to have a tougher line with JP Morgan? Were there other suitors that could have been pursued? Was it possible to lift out the troublesome part of Bear Stears’ portfolio? Would it have been possible to do an on-the-spot term securities lending facility? All those things, short of lending to the dealer, could have been possible, but weren’t obviously pursued, and we’re going to live with the consequences.
What are those consequences? I think it eliminated forever the possibility that the Federal Reserve could serve as an honest broker. What’s that mean? Well, think back into September 1998, when 17 large firms were brought together in the Director’s Room of the Federal Reserve Bank of New York, and told, "You’ve got a problem, find the capital to solve it."
I think after March 14th, the … the reasonable question any one of those people in the room would now ask is, "and how much will you contribute to that solution?" And I think that’s changed what we think of our central bank.
It’s also tilted the political playing field toward direct mortgage relief. Why? Well, most households either own their home outright, or [are] meeting their mortgage payments, or [are] renting. And when asked the question, "Do you want to help the people down the block who got overextended?" As really a statement of fairness, say "No." However, if you reframe the question and say, "Now that the government has helped an investment bank, do you also think it’s appropriate to help the household down the street," and I think the answer is much clearly, more likely going to be "Yes." Because a question of fairness … unfairness among households has been translated into a question of unfairness between households and investment banks.
I think it also legitimized increased supervision and regulation [1:55:00] of a much wider portion of financial activity, and so the irony here is that concern about a prior mistake, the Great Contraction, may usher in a period of re-regulation that’s going to change the way the financial systems work for a very long time.
Peter Wallison Thank-you very much, Vince. OK, this is an opportunity for people on the panel who have disagreed, if that can be imagined, with others on the panel to have their say. … We can go down the line? And why don’t we start with Charlie?
Charles Calomiris: I know there are a lot of us, so I’ll try to be quick.
What I want to do is try to recast our discussion a little bit. Instead of nitpicking, because obviously there are a lot of data that we could all argue about, …
When I gave my presentation in December, and actually in September at the FDIC it was the same one, more or less, and now, the point that I was making was that we do have a benchmark of comparison to talk about. And that benchmark of comparison is — the 1989-92 capital crunch and credit crunch and recession, which Ben Bernanke made his reputation on, by the way. And my point was, things are different now in a lot of ways, and most of the ways in which things are different are better, and that if you’re looking, as many people of the time then, and still are now, if you’re looking at that experience, from the standpoint of the way the banking system is likely to affect the real economy, that we should think that it’s not going to be nearly so bad.
And so all along I’ve been saying –
- Is there going to be a contraction in credit? Yes.
- Are credit terms worse and likely to get worse? Yes.
- Will housing prices fall? Yes.
- Will there be a recession? Possibly, but if so a fairly shallow one, and not a very long one.
So I’ve not been arguing that we will necessarily avoid a recession, but rather that if we have one it’s going to look more like 2001 in terms of its cost relative to potential GDP than 1989-92.
So I want to be clear, that’s my benchmark of analysis. And if you look at all the things that were going wrong during that cyclical experience, whether you’re looking at the stock market, or whether you’re looking at credit conditions generally — not just in terms of percentage of people who believed it’s getting tighter — I find that a ridiculous statistic. If things are tighter, we all know they’re getting tighter. But how much, how bad?
Or if you look at the amount of capital being raised. Peter put up over $200 billion. By what I’ve got here from the FT [Financial Times of London], John questioned the number, it’s about $180 billion. By any measure, the 1989-92 was effectively zero.
This is very different from 1989-92 already, by everything we can look at. Now does that mean that we’re going to get out without a recession? Maybe not. But that’s not really the point, and so people are dancing a little on this, in my opinion, right now — economists. And I want to be clear, I’m not dancing. What I said is what I’m still saying, and I think that’s the metric that needs to be used here.
So I don’t really disagree, and I thought last time John and I agreed that by OFHEO’s measure we might find a 5 or 10 percent decline. I still think that’s true. Case-Shiller’s a different measure. You can trade futures on it, it’s a well defined measure, I don’t think it’s as useful for us in thinking about the macro economy.
I would also say, at the last meeting, right after it, actually, John and I talked about Bear Stearns. And we both believed, and this was in December, that Bear Stearns was likely to go. Do you remember that? And why? Because Bear Stearns had a uniquely high asset-side exposure to the subprime crisis, and it’s gearing was higher — that is, its leverage ratio — was higher than any other investment bank. And when Bear Stearns went, on the day that it went I was asked, and I publicly said, no other invest- … Now that the Fed has come in with liquidity, no other investment banks will go, because none of them has that exposure.
Lehman Brothers was much better diversified and was less geared, and nobody else was even close to their exposure. There really was a difference between Bear Stearns and the other investment banks.
So I just want to emphasize, the Fed’s response was predictable, and I predicted it, and I think it should have happened. It’s not like things have happened between December and now. That’s why my story hasn’t changed, because I thought it was going to be a severe crisis, in some respects, it still has been, but is this going to be 1989-92? That’s the question people at the Fed were asking me, and the people at the FDIC were asking me in September, and I said, "No." And I still say no. And everything that we’ve learned between then and now still says no. That’s the metric. Not say, "Do I think we’re going to have a recession? Is it going to be a little flat for 2 or 3 quarters?" That’s really kind of … you can waffle. And I … Frankly I think Des and John are waffling.
Of course [2:00:00] there’s going to be some weakness in the economy, but the real question is — put down your stake and say: cumulative GDP decline’s going to be worse than it was in ‘89-92.
Basically I say, "Put up or shut up."
Peter Wallison: Well … Kevin …
Kevin Hassett: Gosh. I have two questions for my colleagues. The first is that … I saw a little bit of dancing around — I saw a little bit of sleight of hand in the charts that I’d like to address, which is that on one hand, the folks who wanted to … who want to argue that it’s going to be really bad will show that prices have declined in they’ll show the Case-Shiller index and say, "Oh, look, it went down a lot." And so there’s a lot of trouble coming. But then when we look ahead, then we got a chart that said, "Oh, the prices haven’t gone down nearly enough." And that was the OFHEO index, which is the one that hasn’t gone down.
And so the OFHEO / Case-Shiller — there’s been a very complex argument going up here between these guys on this thing. And I’d just like to know — if we looked at the Case-Shiller index, and the decline that we had, then has that gone closer to trend, or I guess it hasn’t been around that long, so maybe we can’t tell. Is the gap between the Case-Shiller index and the trend about the same as OFHEO. That’s my question for Des.
My question for Vincent is that he had very strong language about catastophic policy errors, the worst … But after you said that, I didn’t really follow what was so catastroph– like we’re going to have to have more regulations, I guess that … right? … we’re really, you know, wearing your AEI badge proudly to make that … But you didn’t really say, you know, what’s … I didn’t see the catastrophe. And I’d like you to flesh it out a little bit for me.
And I’d like Allan to just weigh in on the historical judgment that it really is one of the biggest policy blunders that we’ve had.
Peter Wallison: Des …
Desmond Lachman: I’ve been accused of many things in my life, but waffling I don’t think is one of them. But that’s always a first, so I’d be rather clear that I think that we’re going to get several quarters of negative growth going forward, and cumulatively we’re going to see GDP, I think that the IMF forecast is pretty accurate in that we’ll see GDP declining by something like 3/4s of a point before this is all over, and we’ll get a really modest recovery.
I’m just … would agree with Vince that if one could solve the capital problem of the banks, I think that I wouldn’t be that concerned. My concern is that this might be a moving target, that as we get the economy slowing, what we’re going to get is we’re going to get larger losses, we’re going to get greater need for capital. So I’m not sure that this is that easy a task. And I don’t think that one can really look to the sovereign wealth funds to solve that.
Just with Vince, I’ve really got a question. I cannot understand his saying that the consequences of the Fed’s decision are really awful, and I would share that view. But I’m not sure that I understand what their alternative was, particularly with the size of the credit to swap … credit default swap market, that derivative market, is now something like $62 trillion, and what I’ve been reading is that Bear Stearns had enormous exposure to that market, and that really underlay the reason why they had to do that, otherwise they’ve just got counterparty risk running right through the system.
So I’m really not sure what the alternative was for the Fed.
Peter Wallison: John
John Makin: Yes. You know, you can read what I think every month in the Economic Outlook. I’m afraid Charlie hasn’t been doing his homework, but the rest of you can read it. On September 8, 2007, I wrote an Op-Ed in the Wall Street Journal that said, "Well, we’ll have a recession starting early in 2008." And since then I have tried to follow along with that and suggest where we might be going. And so far so good as far as that goes.
And it … As I recall, in our December meeting, there was a pretty strong conviction among many on the panel that there wasn’t going to be a recession. But it’s not … it’s not productive to go back and look at these things. I suppose, yes …
I think the Bear episode is an interesting one, and I do remember my conversation with Charlie. I would point out that there’s one thing that we didn’t anticipate, and that is that the Bear problems would spread to other investment banks, and that were Bear allowed to go under, and it would have been perhaps the right thing to do, other investment banks [2:05:00] would have been next, because counterparties with the investment banks would have had very little choice other than to withdraw their lines and those investment banks would have been compromised and would have gone under as well.
So it got a lot worse a lot faster than I anticipated, and than most of us anticipated.
My last comment is a question to Vincent, which I … I think the Fed got into a position that they ought not to have been in. That is, where they had no choice but to do what they did. And part of the reason they got there was the Fed’s staff consistently, consistently failed to foresee a recession or near-recession, and they have since played rapid catch-up.
And the FOMC consistently mischaracterized the economy. And they were complacent. Having been complacent, they got behind the curve, and they got to a position where, had they not taken extraordinary action, we would have had a financial meltdown.
My question to Vincent is this: Maybe one of the Fed’s options would have been to expand its balance sheet, rather than rearrange its balance sheet as part and parcel of some of the activities that it undertook on that day. Does that strike you as a good idea? Because that was the point that I was trying to make in the Wall Street Journal 2 weeks ago, where I basically said, "If we don’t contemplate an expansion of the Fed’s balance sheet, the housing disaster will be so bad that we will get … we’ll essentially nationalize the mortgage market. And that’s not a good thing.
Peter Wallison: I think we’d agree. Allan, do you have any comments you’d want to make?
Allan Meltzer: Couple of quick comments. Thank-you Vincent [for the mic] …
It’s not quite true that the Fed had no choice. It had a choice, it could follow what Bagehot advised them to do long ago. That is, let Bear Stearns go, promise to lend to the market, and if there’s a big run on the CDOs, buy what you have to. Lend at a penalty rate. That was Bagehot’s advice. I think it’s still … it might have worked under those circumstances.
In any case, what the Fed did was in my book not necessarily the best thing they could do, but it was a good thing to do.
People talk about the wealth effect. One the first papers I ever heard as a graduate student was Milton Friedman talking about the permanent income theory. How much of the wealth loss is permanent, how much of it is temporary? That’s a big question. To people who see the value of their houses go down, do they assume that they’re going to stay down, or do they assume that they never should have risen as much? And therefore they’re not going to allow their long term behavior to be affected.
On the same score, I think that (I’m on the side of the permanent income view by the way) On the same score, I think the Fed is making a mistake by talking about the core rate of inflation. The core rate of inflation is a good idea, normally, because it separates our transitory movements from permanent movements. But to me, the oil price increase, the food price increase, look like permanent movements. And therefore, the core is not going to be … it’s going to be misleading to them. And it is misleading them, because they think that the Phillips Curve is going to affect the core and prevent the inflation [undecipherable] …
Finally, policy blunders. Oh, gee! I have a 1,300 page manuscript full of policy blunders. [laughter] I mean, you’d be amazed …
voice: … forthcoming …
Allan Meltzer: Forthcoming. You’d be amazed at the number of blunders there are.
Where does this one stack up? Well, depends on how draconian the regulation’s going to be, and how adept the market will be at circumventing it. My bet will be on the market.
I would like to see a very much less regulation that we’re going to get, but some, some would says[ph], which I’ve talked about before, which ties the compensation of the market participants to something like their long-term performance, rather than their quarterly performance, because that seems to me to be an invitation to problems of this kind.
You have to remember that underlying all of this is the fact that all these financial institutions borrow short and lend long, so when something goes wrong, there’s always the possibility of a big problem.
And finally, I don’t try to forecast, and I don’t think, having studied forecasts that other people make, looked at how the Fed reports its forecasts, their forecasts, which have been [2:10:00] very good during the period of the Great Moderation, still made an average error of about 40 percent. That’s not something you want to rely on a lot. As I’ve said before, try to aim for an average policy. We did very well with that in 1985-2003, we would be well advised to get back to it, and to teach people in Congress and the marketplace that that’s what we’re doing.
Peter Wallison: Vincent.
Vincent Reinhart: I do agree that there is certainly the opportunity for well designed financial regulation to curb the multiple incentive problems that have shown up in the mortgage market, from the mortgage brokers who were compensated by volume as opposed to performance of loans to the rating agencies who were paid by the underwriters to the underwriters who were paid by volume and could shop for ratings to the final investors who were often … were sometimes in these collateralized securities who were taking advantage of regulatory arbitrage, or the special status and accounting rules given by … the stamp of approval from S&P and Moody’s.
I mean there’s certainly lots of scope for that. I’m not predicting whether there’s a recession or where inflation will be next year. What I am going to predict is — when that reregulation comes, it will not be the well designed, appropriately scaled to the problem. I believe that the great moderation owed importantly to deregulation and the marketization of more and more economic activity associated with advances in financial markets and financial engineering.
And so I worry that if the capital doesn’t come to the financial sector, that we have an extended period in which the economy is weak and moving sideways, that we will have a new President and a new Congress who will take the opportunity to reregulate and we will step back from those gains. And I think if we do this in 18 months, which we probably … 3 more times … [laughter] and that happens, then I think that we would move that up … move that policy action, the actions of March 14th, up in the list of your all time blunders.
[crosstalk]
Peter Wallison: OK, I think we want to get some time for questions from the floor, so let’s see a show of hands … people who are interested. Karen, we’re going to ask people to identify themselves, and then ask a question, not make a statement, because we don’t have a lot of time. Karen …
Jeff Wrase: I’m Jeff Wrase with the Joint Economic Committee. Jim Hamilton has this conjecture that the Fed, by keeping the real funds rate essentially negative right now, is adding pressure on things like the world food prices, commodity prices, because people aren’t storing wealth in these financial vehicles, they’re putting it in real things like commodities and wealth. Do you think that channel’s operating?
Peter Wallison: John.
Peter Wallison: Anyone else? Anyone else want to respond to that?
voice: Anyone not think that’s the case?
Peter Wallison: … apparently not. Let me ask a question, because, … No one asked this question, or talked about it, but it seems fairly clear to me that there’s something that’s a real disconnect going on here. When we had the recession in 1998 to 2001, or the 2001 recession, I guess, is what I’m talking about, the market fell from [about] 11,500 (this is the Dow) to about 7,500. And it fell pretty quickly, as I recall. Why is it that right now, with this terrible things happening in the credit markets (and we have to agree they’re terrible, they’re unprecedentedly terrible), yet the stock market has not fallen substantially, and if it is falling, it is falling very, very slowly. In other words, investors don’t seem to be particularly worried about this unprecedented credit problem.
What’s the reason for this?
Charles Calomiris: I want to answer that, because you could have said in December, because the stock market made the same mistake in the 1989-92 period. That is, it didn’t adjust right away, it took its time. And that would have been a correct thing to say in December. I don’t think you can say that anymore. That is, the market has a pretty persistent consensus view that’s much more optimistic than some of the view’s we’re hearing on this panel.
And that’s also, … And I think [2:15:00] it’s optimism grounded in fact. This has already been a different experience.
So I think, … And the consensus forecasts, … Actually my views on the economy are not … I just sort of think the consensus forecast makes sense, which is … which I think is underlying the stock market price, that flat growth, which is pretty much what I expected and said, … I think it’s unlikely, still think it’s less likely than: yes, for us to end up in a recession, as I define it, which is 2 consecutive quarters of negative growth.
Now of course recessions get redefined, but that’s how I define it. I don’t think we’re going to have one of those, but if we do, it’s not going to be very severe.
So I think the market is saying that’s what it thinks.
Peter Wallison: Des?
Desmond Lachman: I can partially agree with Charlie, but I think that the market’s doing a lot more; is what the market is doing is it’s anticipating that your’re going to have a very sharp V-shaped kind of recovery, and you see that in the analysts’ estimates of what corporate earnings are going to be doing in the second half of the year. They’ve got corporate earnings really recovering remarkably in the end[ph] of the year.
So if you don’t get … If my view of the recovery is right, that you get a prolonged recession, there’s going to be a [laughs] reappraisal of those equity prices.
Just to go back to that question before, I think that was an important question that there hasn’t been discussed on this panel, and that is a risk is that the Federal Reserve reducing the interests rates is really reducing the interest rate differential in favor of the dollar, and what you’ve had is the last 5 years you’ve had movement out of dollars, and that looks like, since August, it looks like that that is a serious problem, and that could get worse, which has obvious implications for the way in which financial markets might behave.
Peter Wallison: Anyone else have any comment on the stock market?
John Makin: … You started by commenting about what happened in 2001. That was an investment led recession that investment dropped very sharply at the end of 1999, and then the stock market collapsed in the first quarter of 2000 because there was obviously excess capacity in the Tech sector. And then the recesion followed. This is just a different situation where it’s probably going to be a consumer led recession. The stock market is 11 percent off its highs. It’s discounting a mild recession and if we have a mild recession it’s priced right, if we have another leg down it will go down another 20 percent.
Peter Wallison: That could be right, John, but that’s why I put up that survey of the CEOs from the Business Roundtable. Because maybe they’re not, maybe they don’t represent the entire economy, but they don’t think there’s going to be a consumer led recession. They see sales going up. So what’s going on here?
John Makin: The consensus among CEOs at the Business Roundtable has zero predictive power [laughter]
Peter Wallison: Well same is true of economists at AEI [laughs]
voice: … not this one …
Peter Wallison: OK, let’s see, right here? Where’s Karen? … Oh, there’s Bert. OK, Bert? A question, Bert.
Bert Ely: Quick question. Bert Ely, banking consultant. This question is directed primarily to Charlie. Others might want to pitch in. There’s been a number of references to overleveraging and the need for banks to raise their capital standards. Charlie, can you tell us a little bit more about how high you think bank capital standards should go, particularly in light of how you were quoted8 in a Peter Coy article in BusinessWeek a week or so ago?
I thought I read something about a 20 percent capital ratio? (Which struck me as a little high) And if that’s where you think it ought to go, what effect do you think that that will have on the incentives within the marketplace to securitize even more bank assets than has been the case in the past.
Charles Calomiris: It’s hard to answer that quickly, but let me try.
The costs … The social costs of high regulatory capital ratios are pretty much zero if the regulatory capital ratio can be met over a sufficiently long period of time. Because it gives the banks the ability to raise capital when it’s very inexpensive to do it, and there are lots of reasons for that.
So my first point, which was underlined in last week’s BusinessWeek article, was that if you raised capital in gradual way, if you phase in the increase, it has virtually no social cost. And so, yes, I was arguing for a 20 percent [2:20:00] phase-in.
The other advantage of doing that is that … then during recessions you could do what Charles Goodhart suggested, which is you can allow the minimum capital ratio to come down.
So my point is, if you phased in a 20 percent — 8 percent is a magic number that came from politics in the Basel committee. If you go back and look at historical bank ratios with the kinds of risk that our banking system probably has, I think 20 percent is a reasonable number to phase in, but then to allow during recessions for it to come down to a number like 15. That’s a very rough number.
Pieter Bottelier: Pieter Bottelier at Johns Hopkins SAIS. None of the panelists explicitly spoke about possible connections between the financial crisis and the external imbalances of this country and global current account imbalances. Professor Meltzer identified two good causes of the current financial crisis. Is there one that is even deeper than that, namely current account balances? Can a sustained recover be achieved without very substantial reductions in US external deficits?
Allan Meltzer: My answer to the question would be: Yes, we can achieve a recovery. You can speculate all day on the demise of the dollar, but you’ve got to think about what takes its place. And the answer to that question isn’t very obvious. I mean, there are people who say, "Well the future currency’s going to be the Chinese yuan." Bet against it. There’s no financial market there, there’s no regulation there. I mean, the banks are undercapitalized, I mean that’s just a crazy idea.
The euro? I think the big question for the euro is going to be whether it can hold together if in fact it falls, … if in fact they have a recession in Europe. Will the euro hold together? I don’t see that as a currency. They don’t have a lender of last resort function to speak of. I mean they depend on each individual country to take care of its own, they don’t have a harmonized policy about that. That would be … And they don’t have a capital market like ours.
It’s true that they like to boast about the fact that … how many bonds they sell, and they do sell a lot of bonds. But that’s it. The capital markets don’t go beyond bonds. The US capital market, with all its problems, is deeper and more resilient, and you don’t want to pick a currency where that isn’t true.
No it is true that we do everything to discourage the dollar as a long run problem. I mean, reading more Federal Reserve minutes than any human being ought to ever be required to read, [laughter] I can say you can probably count on the fingers of one hand, and cut off a couple of fingers, about the number of times that they actually worried about the dollar.
Employment is the thing, most of the time. Employment, and then, in the 1980s, Volcker brought inflation. And throughout, unemployment. But it’s unemployment, and its unemployment now that the Fed worries about. And why is it unemployment that they worry about? Because that’s what Congress worries about. And Congress leans on them very hard.
So my answer is, I think there are lots of reasons why you’d want to give up the dollar, why people want to give up the dollar, but give it up for what?
Peter Wallison: John? … and then Des, did you want to … comment on this?
John Makin: With the US current account deficit, it is endogenous. That is, it’s determined by the desire to store wealth in the United States. And if that desire goes down, the current account deficit will go down, and to some extent it has gone down.
But I would turn it around and say, "How could the world economy grow if the US saves 6 percent more?" which is what it would take to get rid of the current account deficit.
The world economy would collapse, because US net spending is very important to support the global economy.
So I … I don’t quite understand — I mean, I know Larry Summers harps on this all the time — I don’t quite understand how a reduction in the US current account deficit has anything to do with a recovery.
Steve Entin: [2:25:00] I’m Steve Entin with the Institute for Research in Economics and Taxation. I was in the Reagan Treasury. Let me ask: Are we making a fundamental mistake in the allocation of the roles of the fisc [fiscal] versus the monetary authorities? It seems to me that we’ve been relying on the Fed to promote growth and to worry about unemployment, but as expectations catch up with inflation, and as inflation raises tax rates on capital, we tend to slump into stagnation or recession.
Meanwhile, the fisc doesn’t want to cut the taxes permanently, and least of all on capital formation, because of its class warfare arguments. So we keep hitting investment over the head with a 2-by-4. And I’m just wondering, if this crisis, which was met with great glee in the Capital, because it gave them an excuse to do something and break the budget and thrash around the way they have. It’s just going to lead to more inflation, and a worse economic outlook.
Peter Wallison: This is one for you Allan, I think.
Allan Meltzer: Nothing is certain in this world, but we’re certainly headed in that direction. The Fed believes, I think, that they’re going to stop it before it really gets underway.
I don’t believe that will happen, but who knows? You only know you pay your money and you take your choice. Markets, you can bet on the markets. Markets have the expected inflation rate at close to 5 percent a year from now. That seems to me to be a reasonable forecast, but subject to change.
I mean, if they don’t cut interest rates at this next meeting, if they raise interest rates as soon as they think they can, then I think [unintelligible] that will change.
The fiscal policy? The Fed fiscal policy has really been supportive of growth during most of the post-War period. Why is that? Well, there’s something called voters. They evidently like what they get. As the Vice President said to Paul O’Neill, Ronald Reagan showed deficits don’t matter.
We forgot to add, as long as the Chinese are willing to buy them.
Peter Wallison: Des.
Desmond Lachman: Yeah, I think that an important point in this discussion is whether it’s appropriate for the Federal Reserve to do the bailout of the housing market. You know, that it strikes me as odd that by taking on $400 billion of mortgage related securities of dubious worth, that that is the appropriate way for a decision to be made as to whether or not to bail out … you know, whether taxpayers’ money should be put at risk through a decision of the Federal Reserve rather than through the US Congress.
Peter Wallison: Well, we’ve … Yes? Vince?
Well we’ve reached 4:30, and I’m sure you’ve all now understood perfectly well what is going to be happening in the economy in the future. But we’ll come back again in September and we’ll ask our esteemed group here to explain their positions more fully, and I hope all of you will come back, because this has been very interesting and I think you’ll find it even more interesting then. Thank-you very much for coming. I want to thank the panel for a wonderful set of presentations. [applause] [2:28:54]
[1]: "What Lies Beyond the Credit Crunch? Part II", AEI event homepage, April 28, 2008.
[2]: "Stocks Finish Higher: Good earnings news from Ford, a drop in jobless claims, a rally in the U.S. dollar, and lower oil prices helped boost the major indexes", by Ben Steverman, BusinessWeek, April 24, 2008.
"The [stock] market is ready to move higher," says Chris Johnson of Johnson Research Group. "A lot of the bad news out there is priced into stocks."
On Thursday, the Dow Jones industrial average closed up 85.73 points, or 0.67%, to 12,848.95. The broader S&P 500 added 8.89 points, or 0.64%, to 1,388.82. The tech-heavy Nasdaq composite index rose 23.71 points, or 0.99%, to 2,428.92.
[3]: "What Lies Beyond the Credit Crunch? Part II" (PDF — with Figures), by Peter Wallison, April 28, 2009.
Figures
- Progress In Narrowing The Spread, Which Is The Target Of Fed Liquidity Moves, Has Slowed: 30Yr Conventional MBS rate and its spread over 10Yr Treasury
- Worldwide Bank Asset Writedowns, Credit Losses, and Capital Raised
- Summary of the views of Business Roundtable’s CEO members about the year ahead
[4]: "Capital Ideas: Lawmakers should turn their attention to persuading banks and other financial intermediaries to raise more capital." (PDF), by Peter J. Wallison, The American, March 19, 2008.
[5]: "Not (Yet) a ‘Minsky Moment’ " (PDF — with Tables and Figures), by Charles W. Calomiris, AEI, Revised: from October 5, 2007.
Tables
- Mortgage Originations by Product and by Originator
- Absorption Capacity of Three Largest U.S. Banks, June 30, 2007
Figures
- Annual Cash CDO Issuance
- U.S. Home Price Appreciation
- OFHEO HPI: Disaggregated by Case-Shiller Coverage
- Annual Home Price Appreciation (OFHEO & Case-Shiller) vs. Share of Homes Valued Above $500,000
- State-Level Annual Home Price Appreciation (OFHEO) vs. State-Level Changes in Foreclosure Inventory Rates
- Foreclosure and Delinquency Rates
- Foreclosure and Delinquency Rates (cont.)
- Residential Investment by Household Sector Relative to GDP
- Commercial Paper Outstanding
- Commercial Paper Rates, LIBOR, and Mortgage Rates
- Commercial Paper Rates vs. Federal Funds Rate
- LIBOR, Treasury Bill, and Fed Funds Rates
- Overnight Libor-Fed Funds Spread
- S&P 500 vs. 10-Year Treasury Yields vs. Spread Between Moody’s Seasoned Baa Corporate Bonds and 10-Year Treasury Yields
- Corporate Leverage
- Real Household Net Worth Per Capita
- Household Leverage
- Commercial and Industrial Loans
[6]: "Household Expenditure and the Income Tax Rebates of 2001" (PDF), by David S. Johnson, Jonathan A. Parker and Nicholas S. Souleles, Princeton U, August 2004.
[7]: "What Lies Beyond the Credit Crunch? Part II" (PDF slide deck), by Desmond Lachman, AEI, April 28, 2008.
- Title
- The U.S. Economic Outlook Has Darkened
- A Confluence of Negative Shocks Still Impact the U.S. Economy
- US real house prices
- Home Prices
- Mortgage Equity Withdrawal
- The Housing Bust Has a Long Way to Go
- Real Home Price Index
- A Large Inventory Overhang Remains with the Housing Market
- Unsold Housing Inventories (in months’ supply)
- Subprime and Alt-A Shares Quadrupled Between 2001 and 2006, then Fell in 2007
- Ever Mor Stringent Mortgage Lending Conditions
- Adjustable Rate Morgage Reset Schedule
- Number of Foreclosures Started
- United States: Equity Share of Residential Real Estate Values
- Falling Prices Leave Homeowners with Negative House Equity
- House price Declines Implied by Case-Shiller Future Contracts
- Residential and non-residential construction spending
- Measures of Demand for Commerical Real Estate Loans
- The Credit Crunch Shows No Sign of Letting Up
- U.S. Bank Credit and Lending Conditions
- Speculative-grade bonds
- Jumbo Mortgage Spread
- CDX North America Inv Grade 5y
- Share of Intermediation through Banks and Securities Markets
- Face Value of Credit Default Swaps Outstanding
- Policy Response Needs Strengthening
[8] : "How New Global Banking Rules Could Deepen the U.S. Crisis", Peter Coy, BusinessWeek, April 17, 2008.
… In an interview with BusinessWeek, Charles Calomiris, a finance professor at the Columbia University Graduate School of Business, put forward the idea of giving the banks a decade to sell more shares in stages and gradually raise their total capital to perhaps 20% or even 25% of risk-adjusted assets, up from the current Basel standard of 8%.
