Thursday, September 30, 2010

Stimulus more or less? A failure not being acknowledged. PART 6

Sometimes partisan defenses backfire.

Back when this multipart posting was beginning, a friend sent an article entitled “Recovery Act: How Obama's Stimulus Is Changing America” by Michael Grunwald TIME MAGAZINE

The cover email said simply: “This reads like it was written by the Administration, but it gives a good description behind the development of the stimulus package. The package has a significant 'investment in America' slant, maybe at the expense of adding jobs ASAP.”

The nice thing is that the article doesn't shy away from the fact that the Recovery Act was about advancing Obama's agenda, not stimulus. That TIME MAGAZINE considers that great isn’t surprising. Focusing just on the Recovery Act makes sense from a partisan perspective regardless of one’s partisan leanings, but it could just make stimulus a partisan issue. The article makes clear that the stimulus wasn’t about stimulus. That admission by TIME MAGAZINE is surprising. Given their partisan perspective, one would expect them to claim it is all things to all people. Perhaps their shrinking readership has been reduced to such a partisan crowd that they don’t feel that’s necessary. They gave up presenting news years ago.

My concern is that the public will judge the effectiveness of fiscal stimulus by the Recovery Act. Stimulus started with Bush's approximately 200 B tax rebates to middle and lower income tax payers. But, the total over the two administrations is going to come in being well over a trillion dollars, probably in excess of $10,000 per household. Some partisans will also stick in any deficit and come up with multiple trillions.

From my perspective, the issue is whether the multiplier stays linear as the size of the stimulus grows. From the public’s perspective, the issue seems to be how fast the multiplier kicks in. The two perspectives can lead to very different policy prescriptions. Further, the article points out just how hard it will be to evaluate fiscal stimulus when what we got was something else: an investment in America from one man’s perspective or a massive boondoggle from another’s.

In future postings the absolutely nonsensical aspects of some of the defenses this article advances will become apparent, but the postings won’t be on the stimulus. Rather, they’ll address topics like “Green” technology, venture capital and other topics where, for some reason, the author of the TIME MAGAZINE article fails to recognize what’s going on unless it has a partisan label. So, perhaps one might want to read the article simply for what it conveys: a good explanation of why the recovery is slow and anemic.

Wednesday, September 29, 2010

Stimulus more or less? A failure not being acknowledged. PART 5

Sometimes one can’t imagine an explanation for what has been said other than that it’s designed to conceal the failure.

In an article entitled: “Economists agree: Stimulus created nearly 3 million jobs” by David J. Lynch, USA TODAY, it is hard to explain the inaccuracies by any explanation other than personal partisan leanings. This example is used because the author clearly understands something about economics. That can’t be said for every reporter. However, there are unfortunate, almost deceptive, aspects of this report.

For starters: “Economists agree.” You know that’s wrong. Economists never agree on an issue as broad as the impact of the stimulus. The title is either unfortunate or designed to mislead anyone who doesn’t read the article. One of the things that makes Lynch’s article much better than most is that he does the research needed to report on a wide spectrum of opinions (both of economists and politicians). If one ignores the headline, the article is worth reading. He even cites economists who might strongly disagree with his title.

Sticking with the title, the Blinder and Zandi article discussed previously in this series on policy is one source being used for this media report. It states: “The fiscal stimulus created 2.7 million jobs…” (The previous posting pointed out some limitations of that statement). Even ignoring the limitations on that estimate, that’s not 3 million by 300 thousand jobs; 300 over 2,700 or nearly 11%. Doesn’t sound like nearly 3M any more than the Dow was nearly at it’s high for the year; it was down about 800 from its record for the year at the time the article was written; that’s 11,200-10,400 / 10,400 measuring it the same way as the jobs misstatement, or only 8%. Granted Blinder and Zandi might grant that an 11% range for an estimate of the impact isn’t unreasonable, but that is not the way the report is presented. The 3 million is close to the White House’s claim, not a point of agreement among economists.

Lynch points out that roughly one-third of the stimulus came in the form of tax cuts that will “eventually result in related hiring.” His quoting Paul Krugman’s unsupported and incorrect statement that “…tax cuts that would have a less-immediate impact on job creation.” doesn’t help. Timing is the issue. Being dead wrong on this timing issue is important. There is ample evidence tax rebates and cuts that meet certain criteria produce an almost immediate response. The critique is that it is very transitory or temporary. So, if timely and temporary are still criteria for a stimulus, what does that imply about the statement?

The article states “In the partisan war over the economy's performance, the word ‘stimulus’ has become synonymous with ‘boondoggle’…." Perhaps that’s because in the partisan world of journalism stimulus has become synonymous with Recovery Act. Even though, as Lynch points out, stimulus has been a bipartisan approach. The issue cuts across partisan lines. It’s a philosophical issue not a partisan issue. A bipartisan philosophical issue isn’t how Lynch presents it. Partisan isn’t how the Blinder/Zandi article presents it. In fact, a substantial portion of the tax cuts which Lynch implies don’t create jobs fast enough were not a part of the Recovery Act.

Zandi points out that the multiplier (the bang for the buck) is not the same at all points in the business cycle and is less than one over the cycle. Thus, Lynch is given a perfect opening to discuss some of the ridiculous assertion made by Klugman in a competitive newspaper. Instead the assertions are just cited without comment. In this case however, one should give Lynch a pass regarding intentional bias. More than likely he just suffers from journalistic intimidation by the competitive paper. Further, he reports what is being said. One can’t criticize him for not refuting it. He’s doing a good job of reporting and his article deserves credit for that.

It would be interesting to see a similar report surveying economists on the financial measures taken. Lynch cites Blinder and Zandi whose article states that they found the financial measures were “…substantially more powerful…” than the stimulus. Lynch also quotes Rogoff’s comment about the financial measures: “I think it was important for confidence. ... But fiscal stimulus was the least important of the three planks of the government's strategy.” Rogoff might consider the financial measure more important than the stimulus. The financial measures certainly targeted confidence.

The quote is from Harvard University's Kenneth Rogoff, former chief economist of the International Monetary Fund and coauthor of THIS TIME IS DIFFERENT: EIGHT CENTURIES OF FINANCIAL FOLLY by Carmen M. Reinhart and Kenneth S. Rogoff (a book The Hedged Economist strongly recommends). Clearly, Lynch has the contacts and the skill to write an interesting report on the topic.

Further, as Lynch reports “…the spending's impact was dwarfed by other crisis-fighting tools….” But, to do them justice, he’ll have to get past some inaccurate preconceptions. For example, he refers to “…costly efforts to stabilize crippled banks and the Fed's unconventional monetary policy.” Well, if he talks to people who made an honest effort to measure the cost, he might choose alternative wording like “arguably profitable efforts to stabilize crippled banks.”

Further, a broader brush than recent events shows the Fed’s unconventional monetary policy is only unconventional for the Fed. The same policies, even some of the same tactics, have been used for centuries, long before there was a Fed. They show up in many countries even in the pre-Fed monetary history of the US. In fact, one finds some of the policies were pursued in more recent history often over the objections of the Fed.

Tuesday, September 28, 2010

Stimulus more or less? A failure not being acknowledged. PART 4

The economic impact of fiscal stimulus isn’t a partisan issue. But, it is easy to be misinterpreted, intentionally or otherwise.

It’s time to turn to the actual article entitled “How the Great Recession Was Brought to an End” by Blinder and Zandi. While the previous posting focused on what The Hedged Economist thought was most useful (Appendix A of the article), this posting focuses on what is of interest to most people commenting on the article. Clearly, since it is also the focus of the executive summary, it is what the authors thought was most important. Unfortunately, it is also the source of a lot of misunderstanding and spin.

One has to read it closely and not extend the findings beyond the actual results. It is also almost essential to deconstruct how the results were derived. But, if one does, one finds it is fairly free of partisan nonsense. Further, the effort is rewarded by a sharper appreciation of the limitations of the analysis. It is to the credit of the authors that they frequently point out the limitations, but it seems legitimate to fault them for not always emphasizing the most important limitations.

There are aspects of the assessment that some might call methodological biases with partisan implications, but they could also be characterized as methodological assumptions. They will be discussed after pointing out some other reasons for citing just this one analysis.

First, The Hedged Economist has had the opportunity to walk through the details of the Moody’s Macroeconomic Model equation-by-equation and linkage-by-linkage. That’s either masochism or curiosity. It’s time-consuming in any case. The review was probably sufficiently recent to still be relevant. (Models evolve if you didn’t know). Equivalently detailed reviews of others models aren’t as current, and the investment that would be required to review the models used for every other assessment would challenge any realistic time constraint (certainly mine).

Further and probably more importantly, Moody’s Macroeconomic Model is well-documented and available for review. That doesn’t seem to be true of the models used for every assessment. Thus, it isn’t The Hedged Economist review that matters; it is that anyone could do the same thing.

The article contains a description of modifications to the model that were made for the assessment. Given an understanding of the model, they all make sense. If one was evaluating the model itself or wanted to use the Blinder / Zandi simulation as a starting point for their own assessment, one would need the actual equations for the modifications as well as all adjustments, but there’s enough information that is easily available to justify recommending the article. Authors make forecasts and do assessments, but the model is a tool that tells something about how the forecast was made.

Now, on to the article, let’s see what is says and what it doesn’t say. The executive summary of the Blinder and Zandi article provides their expert opinion. Those who only want the expert opinion of the authors should read it, but read it carefully. They never say what the impact of the policy was. Rather, they say what the impact of the policy would be relative to some other policy. Not stressing the unrealistic nature of the other policy is a major deficiency of both the executive summary and the article. With that in mind, one would do better reading the summary than reading most reports on the article. It’s only one page.

Also, a minor point, but the reader should note that in the executive summary some results are presented in terms of “payroll employment.” That is understandable given the accuracy of payroll data. However, it may overlook self-employment dependent on whether the self-employed person takes income as wages or proprietors’ income. It’s a minor point, but in previous postings The Hedged Economist has pointed out that over this cycle self-employment has behaved differently from previous cycles (or at least with a different lag).

The first section of the article is the assessment itself. It contains enough of an explanation of how the conclusions were reached to stand alone. It can stand alone for anyone who has a general understanding of how macroeconomic models work and is prepared to accept Blinder and Zandi’s modeling efforts without questioning. Appendix A was discussed previously, and Appendix B is a summary of the model.

The presentation of findings is only five pages of text and five tables, yet one suspects that many people who comment on the article didn’t even bother to read this section, didn’t realize its implications, or chose to ignore the implications. Maybe they read the Executive Summary and not very carefully. Perhaps they felt they could cite the article to support a conclusion they had already reached.

Most of the five pages of text in the first section of the article are used to explain how the analysis was done. That in itself is a reason to read it. The explanation of the approach provides the basis for an informed judgment about how to incorporate the results into one’s own assessment.

The basic technique is to run multiple scenarios assuming various policy responses. The definitions of the scenarios shed light on the uncertainty associated with the results of the analysis. The scenarios’ definitions also are essential to understanding what results could possibly be achieved and thus how relevant the results could be.

First, let’s look at what the definition of the scenarios says about the level of uncertainty associated with the results. It is worth noting the scenarios are not for a point in time or time from implementation to today. The scenarios are through the cycle. In other words, every scenario includes and element of forecast.

The primary scenario, common to each comment on impact, is the baseline scenario, the Moody’s forecast. The authors are quite open about the fact that “most private forecasters…misjudged how serious the downturn would be.” Although said in a different connection, it indicates the difficulty of forecasting. If the baseline is wrong, every impact assessment is wrong. But, they could all be wrong without their rank order changing. The authors go to some lengths to point out that they are making estimates.

The other scenarios are “counter-factual.” They are based on different policy responses. So, not only is the forecast an estimate, as the authors point out, all the scenarios are estimates. Estimates are what any assessment is about; so, that there are estimates shouldn’t be a great concern. If they are, one should read Appendix A and skip the article. Here we have two experts making estimates for us for free; life’s great. One shouldn’t begrudge them the effort required to understand what is being estimated.

Not defining what is estimated is the source of most of the misinterpretation and misrepresentation. So, let’s dive in. First let’s look at scenarios common to every estimate.

The forecast is one. That’s inherent in any estimate since we are not through the cycle. At best, we are in the recovery phase. Any assessment that clips the estimate at the present would, by definition, be short-changing any positive impact.

A second scenario common to the entire assessment is the “no policy” scenario. But, here’s the problem: “no policy” is NOT a realistic counter-factual. Using a “no policy” alternative comes off as setting up a straw-man in order to make the policy look good.

That impression is only reinforced by not responding to statements citing the article like Treasury Secretary Tim Geithner’s statement: “The combined actions since the fall of 2007 of the Federal Reserve, the White House and Congress helped save 8.5 million jobs and increased gross domestic product by 6.5 percent relative to what would have happened had we done nothing.” (emphasis added). The deceptiveness of Geithner’s use of “we” deserves comment. As the article points out, the policies pursued to stabilize the financial system and stimulate the economy involved two administrations, two congresses, and the Federal Reserve.

However, the flaw isn’t in Geithner’s statement; it is in the “done nothing” counter-factual which he and the authors are both using. Government exists and its very existence is doing something. Not stressing how ridiculously unrealistic the “no policy” alternative is, more than anything else, was a major oversight by the authors. One is inclined to wonder why the authors stress that the assessment involves estimates without emphasizing they are estimates from an unrealistic counter-factual. As an academic exercise, their “no policy” scenario makes sense, but not stressing this specific limitation of the analysis is truly unfortunate.

What is particularly unfortunate is that the authors make passing comments that could have been excellent points of departure for a discussion of a more realistic counter-factual. For example, they note: “Some form of fiscal stimulus has been part of the government’s response to nearly every recession since the 1930s….” They then describe a few without future comment.

Now, one need not be a genius to understand the logical reason for a no policy alternative. It’s easier, more dramatic, and appears less speculative. Why easier? It is easier to compare actual experience with one counter-factual than generate and justify two counter-factual scenarios. Why more dramatic? The difference between another policy response and the actual policy response would be less than between the actual policy and nothing (assuming a positive response to both policies). Why does it appear less speculative? Even if “no policy” is a ridiculous counter-factual that hasn’t occurred in close to a century, and to some extent because it is so ridiculous, one can’t mistake it for an advocacy position. More importantly, it doesn’t require speculation about what might have been the policy. “No policy” was never on the table.

Despite the clean alternative that “no policy” provides, it ducks the important question. The important question is what would have been the performance of the economy under a different policy response? The authors point out: “It is … not difficult to find fault with isolated aspects of the policy response.” They then go on to question some. So, they acknowledge the issue.

One debate that deserves comment is the discussion of whether the stimulus in particular was too much or two little. When looked at in detail, much of the argument for a better response from a larger stimulus is based on the absurd notion that the response to stimulus is dollar-for-dollar the same regardless of the size of the stimulus. It ignores decreasing marginal utility, or, at a minimum, subscribes to the purely ideological notion that decreasing marginal utility never applies to government actions.

The authors aren’t guilty of such absurd reasoning. They point out that as the economy approaches higher levels of resource utilization additional stimulus has a smaller beneficial impact. Similiarly, at the other extreme, in an interview about the analysis (to be discussed in a subsequent posting) Dr. Zandi mentions that the beneficial impact is greatest when there is slack in the economy. However, there is still one of those pesky methodological biases or assumptions lurking in the analysis. Namely, the non-linear response is achieved without addressing whether the actual responses are linear. The difference in the response is due to the state of the economy. It is equally likely the response is NOT independent of the size of the stimulus. But, let’s depart from squabbling over methodological trivia. Linear specifications in simultaneous models are a simplifying assumption that yields tremendous benefits.

There are more basic questions about potential alternative policies. Basically, the underlying philosophy of the entire policy response should be questioned. It is not the need for a policy response, but the assumption inherent in parts of TARP and most of the fiscal stimulus that is questionable. Both are predicated on the assumption a trickle-down approach is best. In essence: give the money to a government, an investor, an automaker, etc., and just count on it to flow to the general benefit of the population.

In the popular media, the trickle-down approach is most likely to be challenged in the area where it actually doesn’t apply: TARP loans. As an example, read postings like Ritholtz’s “2008 Bailout Counter-factual.” Alternatively, one only needs to turn on TV or talk radio (of either conservative or liberal leaning) to witness the total failure of commentators to differentiate between a loan and an out-and-out income transfer. One has to be awfully glad that people who consider a loan a bailout aren’t managing your personal finances. One also suspects their personal finances and certainly their investment advice is something to avoid like the plague.

The actual policies focused on where the problem built up or collected (financial industry balance sheets) and the resulting cash flows in the general economy (consumers forced to cut expenditures). Imagine as a counter-factual that instead of relying on a trickle-down strategy, the government had recognized that the problem had its origin in balance sheets. As a counter-factual let’s have the government focus on the ultimate source. Ultimately, consumers and investors hold the assets and have the liabilities. So, let’s focus on households rather than banks and governments.

As mentioned in the previous posting, a careful analysis of the content of TARP and the stimulus bills can yield a slightly higher estimate of the fiscal stimulus. It works out to just about $10,000 per household using a 2008 household count. So, instead of targeting governments, banks, auto manufactures and their unions, insurers, etc. -- as a counter-factual assume a one time $10,000 rebate to every household.

Since we’re aiming to reduce both TARP and replace the fiscal stimulus, earmark it as only useable to pay off debt. Since elected officials consider themselves such financial wizards, one has to allow them to prioritize which debts get paid first. But, clearly, one priority should be to get non-performing loans out of the system. Therefore, targeting debt in arrears makes sense. Also, since housing finance was a recognized problem, debt secured by owner-occupied residential real estate seems a likely target. Since elected officials are partial to the UAW and automakers, put auto loans as of the enactment date in there, too. Further, the government would have to take steps to ensure the rebates were actually used to shrink balance sheets rather than as a credit substitute. It’s doable.

Now, what about households with no debt? Well, to control the deficit, their rebate could take the form of non-transferable government bonds. Since the government is executing a massive transfer of liabilities from consumers’ balance sheets to their own, the bond idea appeals. However, just plain old money has a certain appeal as a stimulus. Each has its own appeal. Keynesians may prefer money that has to be spent while fiscal conservatives might like the bonds.

This is a weird counter-factual, admittedly, but no weirder than “no policy.” Further, it focuses the discussion where it belongs. Is a trickle-down approach like ARRA and TARP subsidies the best we can do?

Wednesday, September 15, 2010

Stimulus more or less? A failure not being acknowledged. PART 3

The economic impact of fiscal stimulus isn’t a partisan issue. Nor is what was done.

As an example of an analysis let’s use “How the Great Recession Was Brought to an End” by Alan S. Blinder and Mark Zandi. It is available free, often cited by media coverage, and, for a quality economic analysis, exceedingly readable. It achieves a number of other criteria that The Hedged Economist would insist upon before recommending any analysis. Most importantly, it is an analysis.

The article can be recommended for its content regardless of its conclusions. As explained below, one doesn’t have to share the methodological biases/assumptions of the authors or their conclusions to benefit from reading the article. The article includes two appendices in addition to the assessment.

A curious aspect of the article is that Appendix A contains some of the best and most important analysis in the article. Much of it focuses on what was actually done and it’s timing relative to what was going on in the economy. It may seem strange that just separating facts from political posturing could be such a valuable service, but it is.

Part of why stating facts is so powerful is that many commentators are either unable or unwilling to separate their biases from reality. They will report things as true because they think they should be true. Sometimes it’s as stupid as calling a loan a bailout or a rip off depending on whether it’s paid back and who gets it. A loan is a loan. Even when a loan is forced on a borrower as happened with some TARP funds, it’s a loan. Even if it is given to a borrower who doesn’t bother to read the terms or can’t read, it’s a loan.

Letting biases sneak in when discussing the future is unavoidable, and one would be naive to think it doesn’t happen to Blinder and Zandi. However, when discussing the past, Blinder and Zandi seem to have successfully presented the facts without much nonsense. The degree it does sneak in is an unavoidable byproduct of their use of a program by program framework for the discussion. But, to any degree it sneaks into their words it is offset by their liberal inclusion of data and the charts, which they use to present the measures taken during the time period.

To illustrate how a biased perception of what happened leads to erroneous conclusions, consider this quote from a front page article from THE WALL STREET JOURNAL no less. It is from a September 11, 2010 article entitled “Tough Bank Rules Coming” about Basel III. The article isn’t available free so the link isn’t attached.

Following a paragraph discussing increased capital requirements, the article states “…potentially forcing banks to take fewer risks…” Now Basel III will force banks to shed some activities that create risk, but, and this is important, increased capital requirements alone have nothing to do with shedding risk.

One doesn't have to be terribly familiar with what is called a "barbell" portfolio strategy to understand that there is a rational way around this potential impact of having more equity on the balance sheet. Forcing banks to hold more of a conservative asset or a conservative liability can be offset by increasing the holding of an offsetting high risk item. The overall risk doesn’t change. In fact, it’s a rational response if one wants to maintain a given overall portfolio return. One just takes on a high risk, high return positions to offset the low risk, low return position; risk and return stay the same. If the reader doesn’t understand why, consult anything on portfolio theory. Or, just consult Angels, entrepreneurs, and diversification: PART 2. The first few paragraphs provide a quick summary of what is known as modern portfolio theory. It’s actually just common sense.

One might argue the Journal quote is either intentional or unintended deception. But, let’s give the authors the benefit of the doubt. Instead of impugning motives of the Journal’s reporters remember that it could easily result from a biased perception of what caused what. Given that assumption, the telling quote is what follows. Again about Basil III, “It comes nearly two years after the chaotic bankruptcy of Lehman Brothers convulsed the global economy and led to taxpayer-funded bailouts…”

Well, for starters, Basil III was planned; maybe the Basil treaty negotiations had begun before Lehman failed. Lehman may or may not have slowed down the negotiations, but they were unrelated events. But that’s a minor and implied failure to identify what caused what.

The big failure to appreciate what caused what is the rest of the quote. The failure of Lehman Brothers didn’t convulse the global economy. Look at the data not the headlines! Even with the limited data in Appendix A, one can see that something convulsed the financial system in August of 2007, WELL BEFORE LEHMAN. That’s one reason why Appendix A is so important.

Just using the data behind Chart 1 of Appendix A illustrates the point. Lehman’s failure preceded a run up in the spread that was only slightly greater than the run up associated with the collapse of the Bear Stern hedge funds, but only slightly (change from about .5 to 2.4 in August verses 1.2 to 3.1 with Lehman). In fact, the run up in this spread after the initial failure of TARP (3.0 to 4.5) wasn’t different in kind. For that matter the late 2007 period of bank turmoil identified by funding problems also wasn’t different in kind.
The important point is that bank funding problems, bank runs, atypical behavior in all sorts of spreads, increased volatility in spreads, the shape of the yield curve, financial flow other than just bank funding problems, and global stock and bond markets all indicated the global economy and financial infrastructure were being convulsed WELL BEFORE LEHMAN.

Now, let’s look at the second half of the quote: “…taxpayer-funded bailouts…” Looking at what actually happened (i.e., the data) reveals that much of the bailouts were actually loans funded by future earnings of the organizations that were lent the money. That’s what every loan is if it is paid back. In addition to loans, and sometimes accompanying the loans, there were guarantees: basically puts. The puts associated with the loans often turned out to be reasonably profitable for the seller of the puts (i.e., the taxpayer); again based on future earnings of the organizations that had to buy the puts. The puts that were given away are a different story.

Not all the puts or loans were profitable nor were they all treated the same. Appendix A of the Blinder and Zandi article sorts some of that out. A September 13, 2010 “Heard of the Street” column entitled “Where Are the AIG Dividends?” by Peter Eavis is also worth reading. It is especially relevant because of how it indirectly highlights the need to follow the money flows. Politicians will call the AIG loans a success or failure based on ideology, and given the lack of transparancy in government accounting, the ideologues will get away with it by including or excluding flows based on the argument they want to make.

Previously this posting mentioned that in Appendix A “The degree it [i.e., bias] does sneak in is an unavoidable byproduct of their use of a program by program framework for the discussion.” Why is that? It is because the program labels have become synonymous with partisan rhetoric in most minds. Further, deconstructing the programs, as Blinder and Zandi do, shows that most of the programs are such mixed bags of initiatives that the program labels are meaningless other than as hangers for partisan rhetoric. Nevertheless, by deconstructing the programs, Appendix A allows the reader to reassemble them into more meaningful categories.

Interesting thing is that reassigning individual measures shifts some items from a financial measure in TARP into the stimulus category and vies-a-versa. (Retain that idea because it will explain why The Hedged Economist uses a larger number when discussing stimulus than Blinder and Zandi). The reassignment occurs even at the level of identifying measures designed to restore capital flows verses those designed to more directly increase production and employment. So, breaking away from program categories leads to some very different conclusions, but that will be discussed below and in the subsequent posting.

For now, let’s consider some more meaningful categories. This will be broad brush and isn’t intended as a substitute for reading Appendix A. Rather, the reader should view it as a framework for getting the most from the Appendix.

The programs reviewed include loans, guarantees, expenditures, and tax cuts. Each of those can be broken down further. But, even at that high level of categorization, the breakdown is more meaningful than programs.

The loans can be broken down by terms (e.g., market rates, mandated rates, short term, long term, and by collateral provided such as an asset or equity). It is also useful to categorize them by the reader’s assessment of whether they were likely to be paid back (i.e., “probability of default” in street jargon).

Guarantees can be broken down by terms also (e.g., priced put that had to be bought back, priced put that could be bought back, free put options, puts on a specific liability, and whether they were a condition for a loan with the loan classified as above).

Expenditures can be classified by type (e.g., who received the money, who was being subsidized (which isn’t the same as who got the money), what industry or sector benefited, and whether the expenditure was net public expenditure or a substitute for other public expenditures).

Tax cuts can be classified by whose taxes were cut (e.g., business taxes or personal taxes). There’s much more that can be done to categorize the tax cut (e.g., which tax and what groups’ tax), but business and individual is a good start.

Approach the financial measures and fiscal policy during this recession by type of measure rather than program and some really interesting anomalies become apparent. For one, many people will react differently to exactly the same policy response depending on which program it is a part of.

Second, the only legitimate way to identify the actual cost or profit associated with benefits resulting from a measure is to look at the actual measure not what program it was in. It’s the only way to get at the actual cost of the individual measures. Cost can’t be ignored and still hope for a meaningful discussion of cost-benefits. It’s also easier to compare benefits of similar measures if they are identified as such rather than as different programs.

Third, it reveals incredible waste as different policy responses offset each other.
Fourth, it leads to interesting insight into why some responses failed, including the contradictory programs mentioned above.

Fifth, it highlights how effective some approaches were, regardless of which program they were under. Finally, it provides a much more meaningful categorization. A fiscal stimulus is a fiscal stimulus regardless of whether it is in TARP or a “stimulus plan.” A loan guarantee is a loan guarantee. The subsidy value of government measures resulting from loan guarantees are probably more uniform across programs than are tax cuts, expenditures, loans, and guarantees grouped into one program.

One of the conclusions one reaches by abandoning the program by program approach relates to some often quoted investment wisdom. Buffet puts it something like: Be bold when others a scared and scared when others are bold. Bagehot’s version is probably more relevant since he was talking about public policy (although it was for a quasi-private organization at the time). His version is something like: In times of financial panic, lend freely against good collateral at usurious rates and you will always make a profit. There was a fair amount of that approach involved.

Interestingly, some observers object to loans that made a profit, but applaud those that will be written off and vies-a-versa, often with no justification based on differences in benefits. The same inconsistency, perhaps irrationality, surfaces with loan guarantees.

The other conclusion that jumps out when the measures are approached by kind rather than program is that the government did a massive transfer of balance sheet risk. They took the risk associated with ultimate responsibility for a lot of liabilities and potential profit from assets off of private sector balance sheets and moved it to the government’s balance sheet. What’s particularly funny about this is that often it involved off balance sheet items from the private sector and became off balance sheet items for the public sector. It’s telling that the public sector tends to bring the profits from the assets back onto its balance sheet, but leaves the liabilities hanging out there in never-never land.

What’s frightening is that the government also took on ultimate responsibility for some very chancy liabilities without any assets. Some of the loan guarantees are examples of high risk with no potential return while others are extremely low risk.

The big takeaways from this posting are: Read Appendix A of the article even if you don’t read the rest of it. As one reads it, the benefit of re-categorizing the policy responses should be a greater understanding of what was done. Conclusions about the desirability of various policies should be more robust to any bias on the part of commentators in the media. One may not reach the same conclusions as The Hedged Economist, but your conclusions are likely to be more firmly grounded and they will be YOURS.

Tuesday, September 14, 2010

Stimulus more or less? A failure not being acknowledged. PART 2

The economic impact of fiscal stimulus isn’t a partisan issue. But, “experts” need to define their criteria of assessment.

An article in CNNMoney entitled “Economists offer mixed review of U.S. policy” caught my eye recently. Mainly because of the obviousness of the headline, stating that economists disagree isn’t news. There’s a saying among economists: “put two economists in a room and you’re likely to find at least three opinions.” That’s certainly the case on an issue as broad as policy.

One can retrieve the article under a different headline: “Economists: I dunno, man. What do you think?” by Ben Rooney, CNNMoney August 31, 2010: 1:29 PM ET. That’s a more telling headline, but totally inaccurate. Don’t know is nonsense. They all know; they just don’t all know the same thing. “How’s that possible?” you ask. Simple: they are each applying different criteria for assessing policy and may actually be assessing different policies: some assessing past policy, some assessing current policy and some speculating on the impact of future policy.

Most of the article is a report on a survey of opinions about future policy. Problem is: who cares about there conclusions if they haven’t defined the objective?. There is one question about what economists think should be the objective, but it is presented without context. Again, without context, who cares? Economist can be helpful addressing how policy works, but when it comes to what policy should address, the “I dunno” should be an economist’s professional answer. If not “I dunno,” a lot of context should be presented.

There is one statement in the article that is just not true. The article says, “Deflation occurs when both prices and demand fall, creating a downward spiral that can stifle economic growth for years.” Prices can fall without demand falling; think productivity. Further, both can fall while an economy grows; think exports. Prices and demand can fall while savings are flowing into investments that grow exports.

Deflation is, by definition, a price phenomenon. In the US during the twentieth century price declines and economic stagnation often occurred within short timeframes. But, inflation and stagnation also occurred at the same time, also. Further, the worst downward spiral that not only stifled, but destroyed economic growth, was associated with hyperinflation during of the 20’s and 30’s in Germany.

Let’s not confuse things by implying that the link between price and growth is causal. Each can have their own cause. Perhaps fast growth with falling prices and consumption playing a smaller part in demand is an objective worth considering. If one defines them as incompatible, there better be a strong argument why a situation that occurred for long periods in the past can’t be achieved now.

So, there are three takeaways from the article: First, if the criteria aren’t identified, don’t assume others are using your criteria or even uniform criteria. Second, without criteria, assessments are meaningless. Third, don’t let anyone rule out an objective without explaining why to YOUR satisfaction.

Sunday, September 12, 2010

Stimulus more or less? A failure not being acknowledged. PART 1

The economic impact of fiscal stimulus isn’t a partisan issue. Nor should partisan leanings be the criteria for defining stimulus.

“Stimulus more or less?” is a question because there is a question of whether the thing our politicians call “stimulus” was more or less than a stimulus. Also, there’s a question about whether we need more “stimulus.” Finally there is the question of how THE “stimulus” failed, or put differently, what’s the “right” criteria by which to judge the recent stimulus efforts. That’s the subject of this posting and a theme that runs through any discussion of the topic, although many discussions don’t make their criteria explicit.

So many people have asked for an assessment of the stimulus efforts that it deserves a posting. Generally, when the response is given face-to-face, a thought-out response disappoints the questioner. They are really asking a different question. They want a partisan answer. As soon as one defines the stimulus as starting with almost $200 bil in tax rebates during 2008, their disappointment is palpable.

Here’s a guide to discussions of the issue. It applies whether verbal or in the media, and unfortunately, it surfaces in articles that misrepresent themselves as economic analysis. If one takes only a single thing away from this posting, let it be this: if someone dismisses the Bush rebates as irrelevant to the issue, don’t take them serious, at least not as it relates to an assessment of fiscal stimulus. That’s true regardless of whatever smokescreen they throw up to justify it. Bush, Obama, two Congresses and the Fed have endorsed stimulus packages.

For those who value economists’ opinions, PART 2 of this posting will cite an article reporting on a survey. That will be followed by an analysis of an assessment by a couple of economists. That will be PART 3 and 4. It won’t be a report or summary of the analysis. Rather, it will be a discussion of it. It will include a link because the article is worth reading and quite readable. PART 5 will cite an example of media coverage of the same analysis of the impact of the stimulus. Despite major criticism of the coverage, the example cited is worth reading. PART 6 will return to the stimulus itself, and it is a perfect illustration of why it failed as a stimulus.

Before proceeding, let’s address the right criteria for judging whether the stimulus succeeded. This is very hard to do without introducing one’s own judgments about what is right. Fortunately in this case one can avoid that risk. Every part of the fiscal stimulus was introduced with a definition of what it was supposed to accomplish. Without any doubt, each “stimulus,” (e.g., Bush tax rebates or the Obama American Restoration and Recovery Act (ARRA)) failed by its own definition of success. Further, their failures were far more than just politicians over-promising.

If one needs proof of how bad the failures were, watch the scramble to redefine success. This too is far more than just politicians and economists changing their criteria. One of the most absurd efforts to change the goalposts is the effort to define the failure of the ARRA as being that there was a forecast of its impact. Deconstruct the implications of the failure of ARRA to keep unemployment under 8% and one starts to appreciate why the policy failed. The most important lesson to learn from that failure isn’t, “don’t forecast.” It is, don’t propose a solution if you are only going to use the “crisis” to accomplish some different objective. “Don’t waste a good crisis” may be good politics, but it can lead to failed economic policy.

While discussing criteria it is worth noting that one doesn’t even hear mention of the three T’s (Targeted, Timely and Temporary) that were initially used to define a good stimulus. As criteria they were abandoned long ago. But, when they were, there wasn’t an explicit definition of new criteria.

One final point before proceeding, two indicators of just how pathetically the stimulus efforts failed are the continued speculation about a double dip and the number of people who believe we are headed into another great depression. Now, the Hedged Economist believes the chances of either are slim. But, the very fact that they are still possible, or even still on the table for discussion, is a failure of the stimulus efforts. Clearly, by any definition, one objective of the stimulus was to avoid a double dip and eliminate the possibility of a great depression.

Other indications of the failure will be noted in subsequent parts of this discussion. It failed by many criteria, not just its own.

The reader shouldn’t interpret this to mean the stimulus efforts were either wrong or bad. That would be a misinterpretation of objectivity. They had an economic impact. However, if one can’t look at the failure of previous efforts or even acknowledge that they failed based on their own criteria, it is highly doubtful future stimulus efforts will succeed.