Opinion

Felix Salmon

Why ZIRP doesn’t work

Felix Salmon
Dec 21, 2011 22:52 UTC

Bill Gross has a wonky column in the FT, saying that setting interest rates at zero doesn’t boost economic growth:

With policy rates at or approaching zero yields and QE facing political limits in almost all developed economies, it is appropriate to question not only the effectiveness of historical conceptual models but entertain the possibility that they may, counterintuitively, be hazardous to an economy’s health.

Certainly the record will show that countries with persistently low interest rates tend to have sluggish growth, and although the obvious causality there runs the other way — central banks cut rates in response to slow growth — it’s never been clearer than it is now that such policies don’t always work.

Gross’s point is that zero rates, far from encouraging people to borrow more, actually encourage deleveraging instead, at both the short and the long end of the curve.

Why wouldn’t people want to borrow at ultra-low interest rates? In part, because no one wants to lend at ultra-low interest rates:

A good example would be the reversal of the money market fund business model where operating expenses make it perpetually unprofitable at current yields. As money market assets then decline, system wide leverage is reduced even if clients transfer holdings to banks, which themselves reinvest proceeds in Fed reserves as opposed to private market commercial paper.

On top of that, if central banks commit to keeping rates at zero for an extended period, then interest rates don’t just come down at the short end — they come down all across the curve. And if you have a flat yield curve, like we do now, then banks and shadow banks can’t make money the old-fashioned way, through maturity transformation. Taking in money overnight and lending it out for five years doesn’t look particularly attractive when five-year interest rates are themselves under 1%.

“When the financial system can no longer find outlets for the credit it creates,” says Gross, “then it de-levers”. And deleveraging tends to cause economic contraction.

On the other hand, “outlets for credit” are also known as “borrowers”. It seems to me that the real problem here is on the demand side: if there were lots of companies and people wanting to borrow money, then there wouldn’t be a problem. And as Paul Krugman says, “there’s nothing stopping banks from making loans at profitable rates to firms that want more credit”.

The question is whether reducing interest rates actually boosts demand for credit, at the margin. Certainly it does in normal times, when central banks cut rates from, say, 6% to 5.25%. But borrower calculus is different when rates get cut from 1% to 0.25%. If a semi-permanent ZIRP is a sign of a country in a prolonged economic slump, then one can see how it could act to discourage potential borrowers rather than get them flocking to their banks to demand credit.

In any case, Gross doesn’t actually have any solutions to the problems of zero interest rates. He simply writes that “all central banks should commonsensically question whether ultra-cheap money continually creates expansions as opposed to destroying liquidity, delevering and obstructing recovery”. Well, fine — they can disappear off into their ivory towers and do all the commonsense questioning they like. But say they come to the conclusion that he’s right, and that they’re obstructing the recovery. Then what? Should they raise interest rates?

This is where Gross suddenly goes very quiet: it’s pretty hard to see how demand for loans would go up just because the Fed was raising rates. The problem isn’t that Bernanke is doing the wrong thing: the problem is that Bernanke is powerless. ZIRP might well not be working. But higher Fed funds rates wouldn’t help in the slightest — except perhaps to give Bill Gross and his short-Treasuries position, a boost in the bond-fund league tables.

Update: I forgot to mention Gross’s timing: right on the eve of the ECB discovering €489 billion of demand for three-year money at 1%. Which doesn’t sound like deleveraging to me.

Update 2: And as Joe Weisenthal points out, if Gross is worried about a flat yield curve, higher short-term interest rates are hardly going to help: they’re just going to bring short-term rates even closer to long-term rates.

COMMENT

The point of ZIRP is to allow banks to recapitalize in the face of declining(I should say already wiped out) asset values on their balance sheets. The alternative to ZIRP is to mark assets to market immediately, close the banks which are bankrupt, move the marked down assets to other institutions and let the market set rates for interest thereafter.

Posted by Jardinero1 | Report as abusive

Unreliable housing statistic of the day

Felix Salmon
Dec 21, 2011 17:52 UTC

How many existing homes (as opposed to new homes) were sold between 2007 and 2010? The job of counting such things is outsourced to the National Association of Realtors, which up until yesterday said that the number was 20,629,000. Today, however, it released revised figures, saying that the true figure is 17,680,000 — a difference of 3 million homes. At an average of say $250,000 apiece, that means the economy saw $750 billion less in economic activity, over those four years, than the NAR had given us to believe. That’s real money.

Here’s the NAR’s official chart of the old and new numbers:

page.jpg

In one sense, this shows that the housing slump was much worse than we were told. But in another sense, what we’re seeing here is fewer people selling their homes at a loss. And what that says to me is that it’s going to take a very long time yet before we get a healthy, clearing housing market.

There are three factors making today’s housing market highly artificial. The first is historically unprecedented interest rates: the average 30-year fixed rate mortgage in November was taken out at just 3.99%. That creates a temporary speculative lift for the housing market, and raises serious questions about whether today’s housing prices can withstand a return to normality in the mortgage market. The connection between mortgage rates and house prices is by no means simple or predictable. But insofar as houses are being bought — and house prices are being supported — by investors looking to make money by renting them out, we could well see another downward lurch if and when today’s insanely low mortgage rates go away.

The second factor, related to the first, is that no sensible banker will lend money for 30 years at 3.99% — you just can’t make money that way. Which means that the US government has essentially become the sole lender to Americans looking to buy houses. At the same time, Democrats and Republicans are agreed that the current situation can’t be allowed to continue indefinitely. But the private sector has no interest whatsoever in stepping in where it was so badly burned in the past — neither banks nor bond investors want to buy mortgages these days, and it’s hard to think of what would make them change their mind. Except for a tiny sliver of jumbo mortgages, the private mortgage market in the US is dead, and showing no signs of being resuscitated. How much would you pay for a house today if you had no assurance that, when you come to sell it, most potential buyers of your home will be able to get a mortgage? It’s a real worry, and it’s going to become increasingly salient.

Finally, there’s the well-known phenomenon that house prices are very sticky on the way down. If you can’t sell your house without bringing a check to the closing, you’re likely to delay selling your house for as long as possible. And there are millions of houses on the market which have just been sitting there at unrealistic prices for well over a year — the owner won’t take less, but no buyer would dream of paying that much. That has created an unhappy overhang of unsold houses — and an even greater number of houses which people would love to sell, if only there were a decent market to sell them into. It’s the very definition of a non-clearing market, and today’s revisions only go to show just how few houses have been clearing the market for years now.

How all these factors are likely to play out over the next few years is impossible to predict; Neil Irwin, for one, reckons that housing “finally seems to have found its bottom — and may even be starting to bounce back.” Today’s news from the NAR, if nothing else, serves as an important reminder that housing data is messy, and prone to very large errors. Which means that anybody crunching numbers to come to a considered conclusion has to build in a large amount of GIGO risk.

COMMENT

bankers may not make 30 year loans at these rates, but what makes you think governments are, and which governments? fannie and freddie are up against portfolio caps and buy almost none of their own new product. treasury hasn’t bought mortgages in over a year, and the fed was out of it until just recently, when they got back in to a fairly small extent. so what governments do you think are buying all of this mbs that we’re producing?

Posted by mortie22 | Report as abusive

Immigration datapoint of the day, entrepreneurship edition

Felix Salmon
Dec 20, 2011 23:37 UTC

I love this idea from the National Foundation for American Policy, a pro-immigration think-tank. Take the WSJ’s list of the top 50 venture-backed companies, complete with the names of all the founders — and then calculate how many of those founders are first-generation immigrants. The results?

46 percent, or 23 out of 50, of the country’s top venture-funded companies had at least one immigrant founder… Through the companies they started the immigrant founders and co-founders have created an average of about 150 jobs in the United States…

37 of the top 50 companies, or 74 percent, had at least one immigrant helping the company grow and innovate by filling a key management or product development position.

As Alex Tabarrok says, letting more high-skilled immigrants into the country is the “no-brainer issue of the year”. Because most of the immigrants on this list are despite rather than because of US immigration policy. For instance:

Zoosk co-founders Alex Mehr and Shayan Zaden met in Iran as students back in the 1990s…

Getting a visa to the United States was not easy. Since America does not maintain an embassy in Iran, Alex and Shayan needed to go to Turkey. With no air travel at the time between Iran and Turkey the two young men had to cross into Turkey on foot…

Along with two other friends, they put together a prototype for a new business software project.. “Up until this point we had ignored the immigration aspects,” said Alex. The “immigration aspects” soon became clear to them: an international student possesses no right to stay in the United States and work…

The attorney advised them: “I think you guys should stop doing this company and get a job.” Alex and his friends were devastated by the news. “It was one of the worst days of my life,” said Alex. “We almost cried.”

The four young men dissolved the company and went their separate ways.

Eventually, Alex managed to win the green-card lottery, “gaining permanent residence through luck where starting a business had failed (due to U.S. law)”. This can’t possibly be good public policy. But the law doesn’t even pretend to make much sense:

How many visas are allocated to people of extraordinary ability from China, a country of over 1 billion people? Exactly 2,803. The same number as are allocated to Greenland.

The most startling fact in the latest paper is that the number of entrepreneurs from China — which is one of the most entrepreneurial countries in the world — is exactly zero. There are quite a few Iranians, and lots of Indians and Israelis — but no one from China or even, for that matter, from Japan or Korea or Taiwan. (There’s movement the other way, however.)

So let’s make America much more welcoming again, especially to the kind of people who will build the country of the future. In this nation of immigrants, I’m always astonished at how immigration-unfriendly the U.S. has become.

COMMENT

In the 1960s, there were 100 slots open for immigrants from China. Of course, there weren’t all that many entrepreneurial Chinese during Mao’s Cultural Revolution.

I have nothing against immigration, but it has nothing to do with improving the economy or solving our economic problems. That can only be addressed by increasing regulation and raising taxes. Still, consider that there was a major immigration shut down from the 20s through the 70s, a period of serious income growth and rising living standards, and that this growth ended around the same time immigration was increased.

FifthDecade: Fish and chips was another immigrant food introduced to England by eastern European Jews.

Posted by Kaleberg | Report as abusive

Counterparties

Nick Rizzo
Dec 20, 2011 22:41 UTC

EU governments are propping up their banks in unusual ways — WSJ (paywall)

Why China is the “Michael Jackson” economy — Streetwise Professor

Companies are manufacturing in Puerto Rico, while off-shoring their taxes — Bloomberg

No-brainer issue of the year: let high-skill immigrants stay — The Atlantic

After all, immigrants founded almost half of the top US startup companies — Reuters

But that doesn’t mean we’re in favor of this development cash for visas scheme — NYT

Hedge funds can — legally! — pay for tips on laws before they’re passed — WSJ (paywall)

Mets and poker enthusiast David Einhorn explains why he’s short Green Mountain — Reuters

The new migrant workers: seasonal Amazon employees living in RVs — WSJ (paywall)

And VCs earned an average of 1.3%  for their investors over the last decade — Entrepreneur

COMMENT

KenG_CA, you obviously have not been paying attention to what is happening to China’s trade flows – they have been NEGATIVE for at least the last two months, they were also negative in Feb but that is probably because of chinese new year.

You also apparently have not been paying attention to how they are financing themselves, ie securing a large portion of the debt in USD – the Dim Sum market being rather tiny at the mo. Nor, apparently, are you aware of the huge stresses they are having in non-performing loans. This year China spent 10% of its GDP bailing out local governments and those governments after that bailout are STILL insolvent. This was a hard cash, money down the drain bailout, not the fake outrage “1.2trillion wholely collateralised loans to banks which they immediately paid back with interest” bailout that the US but the real McCoy.

As for “influence”, sure. So do unions. In China, big business don’t have “influence”, there ARE the goverment. The government in China is effectively a few families running the country for their own enrichment. Anyone paying the slightest attention to the news will know about a protest going on in Wukan, where the former mayor – and whose daughter is now the 11th richest person in China – is head of the property development company that buys land from the local government and magically seems to always immediately flip it for a 70% profit. Despite all evidence to the contrary, I find it hard to believe that anyone is dumb enough not to see the huge difference.

Posted by Danny_Black | Report as abusive

Income distribution charts of the day, middle-class edition

Felix Salmon
Dec 20, 2011 19:54 UTC

Ian Ayres has an excellent post at Freakononomics today, explaining some of the background thinking behind his inequality tax proposal:

An important goal of our op-ed was to suggest a new unit of measure, “medians” to help us think about what it means to be rich. In 1980, if you earned 3.8 medians, you were in the top 1 percent, but by 2006 even the poorest in the 1 percent club earned 6.9 medians.

What we call the “Brandeis Ratio,” the average income of the richest 1 percent (which includes the billions earned by the lucky few) has grown even more disproportionate. As shown in the chart below, in 1980, one-percenters on average made 12.5 medians, but in 2006 (the latest year in which data is available) the average income of our richest 1 percent was a whopping 36 medians.

brandeis-ratio.png

Ayres makes a strong case that there’s a real societal interest in capping this ratio somewhere — “it would be bad for our democracy,” he writes, “if 1-percenters started making 40 or 50 times as much as the median American.” So let’s not tax income; let’s instead tax inequality, and increase taxes on the 1% if and only if inequality is going up rather than down.

But here’s the thing: 36 times median income corresponds to an annual income of $1,780,020. I think we can agree that anybody earning over a million dollars a year is rich: that’s just 20 times median income. The 1% on average hasn’t earned that little since 1995.

Meanwhile, what does it mean to be middle class? Here, Ayres found a fascinating survey from 1997, which I’ve put into chart form:

md.png

What’s fascinating here is that in a survey of Americans, fewer people think that a household earning $100,000 a year is middle class than think that a household earning $40,000 a year is middle class. (The actual question was “Would you consider a family of four making (INSERT AMOUNT) a year to be middle class?”)

Most people agree — although not by an overwhelming margin — that households earning somewhere in the $50k-$60k range count as middle class. But once you get to $80k, the number of people considering that to be middle class becomes a minority, and once income hits six figures, only one American in three still thinks that the household in question is middle class.

Now I can assure you that, to a first approximation, every household in America with an annual income of $100,000 considers itself to be middle class. But already those households are earning twice as much as the median family. And it turns out that from the perspective of the bottom 60% or so, an annual income of $100,000 is so big that it’s not even middle class any more.

Why doesn’t the bottom 60% of the US population seem to have any real political voice any more? As Ayres points out, even Barack Obama says that anybody earning less than $150,000 is “basically middle class”, while “rich” doesn’t kick in until $250,000 or more.

What does seem pretty clear is that there’s a gap, in the popular imagination, between “middle class” and “rich”. What do you call people earning $200,000 a year? If they’re not rich, they’re not really middle class, either. “Affluent”, perhaps? No one wants to raise taxes on this group. But they’re still winners in the modern economy, and they’re not struggling in the way that most Americans are.

Here’s Tim Harford, on the situation in the UK:

The Joseph Rowntree Foundation, which uses a thoughtful and innovative methodology to estimate the minimum income necessary to achieve a “socially acceptable” standard of living, reckons that a family of five with one breadwinner – my situation today and my father’s at the time – needs £690 a week before tax. Since 80 per cent of employees earn less than that, it is easy to see why many families require two incomes, and why many struggle at Christmas.

I’m sure that the situation in the US is even worse, given that inequality here is greater than it is over there. But let’s say that it’s the same: we’ve reached the point at which 80% of workers don’t earn enough to support a good-sized family. How much further can that ratio rise, before we say “enough”?

COMMENT

I think the whole income discussion is misguided – it bundles together people on the make starting from the bottom – say an MD making 200k working 100hrs weeks with 400k in student loans vs wealthy making 200k of investment income on $5m in assets (who for that matter tend to pay less due to lower cap gain taxes, estate taxes etc). Tax system should support social mobility and meritocracy and not cement existing class structure as it seems to be doing and with some of the policies from both left (tax on “rich) and right (“no estate tax, low dividend taxes etc”) it would undermine mobility even more.

It would be great if someone for a change raised this issue – if a young ambitious person is trying to make it society should be helping not hindering the progress, on the other hand, someone with millions in assets can certainly afford to pay more tax than his income would indicate. Wealth tax anyone? Deductions phaseouts tied to wealth not income? Make taxes on capital higher than taxes on earned income?

Posted by KrzysW | Report as abusive

The plight of the 1%

Felix Salmon
Dec 20, 2011 15:19 UTC

Max Abelson has a fantastic column today from simply asking prominent members of the 1% about their embattled status. There’s Home Depot co-founder Bernard Marcus, who characterizes any potential critic of his wealth by asking the timeless question “who gives a crap about some imbecile?”. There’s BB&T‘s John A. Allison IV, who says that any rule requiring public companies to disclose the ratio between the compensation of their CEO and their median employee would constitute “an attack on the very productive”. And then there’s Steve Schwarzman, displaying his legendary deftness of touch in a TV interview:

Asked if he were willing to pay more taxes in a Nov. 30 interview with Bloomberg Television, Blackstone CEO Stephen Schwarzman spoke about lower-income U.S. families who pay no income tax.

“You have to have skin in the game,” said Schwarzman, 64.

This isn’t an “I see what you did there” moment so much as it’s a brazen decision to go on the attack against “the 47%”: Americans who earn so little money that they don’t pay federal income tax. (Of course, they still have “skin in the game”: they still pay sales tax and payroll taxes and local taxes.) 61% of these families — let’s call them the 29% — are earning less than $20,000 per year.

Let’s say that Schwarzman has been working for 40 years and is now worth $6 billion: that works out at $20,000 an hour, every hour of every day, even when he was sleeping, since the day he started working.

But never mind the fact that Schwarzman is earning more per hour than the people he’s criticizing make in a year. There are other billionaires just itching to weigh in. Like Paychex founder Tom Golisano:

“If I hear a politician use the term ‘paying your fair share’ one more time, I’m going to vomit,” said Golisano, who turned 70 last month, celebrating the birthday with girlfriend Monica Seles, the former tennis star.

Remember that, people. If you start agitating to reduce inequality, there might be vomiting in the neighborhood of Monica Seles. And we wouldn’t want that.

And then — just for comic relief — there’s Peter Schiff, who probably needs to bone up a bit on his medieval history:

Schiff, 48, disclosed assets of at least $64.7 million before losing the 2010 Republican primary for a Connecticut U.S. Senate seat, according to filings. He’s wealthier now, even though his taxes are “more than a medieval lord would have taken from a serf,” he said.

Abelson plays all of this for laughs, which is reasonable enough, given his Wall Street audience. But out there in real America, it isn’t funny, it’s tragic. And so it’s worth hearing from a multi-millionaire who can explain the class dynamics of America without trying to defend the indefensible. Here’s Bruce Springsteen, in his introduction to a new book by Dale Maharidge and Michael S. Williamson:

It is the story of the deconstruction of the American dream, piece by piece, literally steel beam by steel beam, broken up and shipped out south, east and points unknown, told in the voices of those who’ve lived it. Here is the cost, in blood, treasure and spirit, that the post-industrialization of the United States has levied on its most loyal and forgotten citizens, the men and women who built the buildings we live in, laid the highways we drive on, made things and asked for nothing in return but a good day’s work and a decent living.

It tells of the political failure of our representatives to stem this tide (when not outright abetting it), of their failure to steer our economy in a direction that might serve the majority of hard-working American citizens and of their allowing of an entire social system to be hijacked into the service of the elite. The stories allow you to feel the pounding destruction of purpose, identity and meaning in American life, sucked out by a plutocracy determined to eke out its last drops of tribute, no matter what the human cost.

A lot of the decline of industrial America was probably inevitable — although not all of it. But rather than sitting on their billions and gloating about their fat-cat status (I’m looking at you, Ken Langone), it surely behooves America’s plutocrats to remember the plight of people who actually produce stuff. I’d love to know how John A. Allison IV measures his own personal productivity and determines that it’s extremely high. Because, speaking as someone who earns a very healthy salary myself, I have no idea where I’d even start on such a quest. I could measure words written per day, I suppose, but how much is a word worth?

The fact is that the ultra-rich really aren’t productive, and instead mostly collect rents from people who are. This is what capital always does, of course: it buys labor (some people call that “job creation”, even if the jobs being created are mostly in China), and then extracts dividends from it.

So let’s not kid ourselves that the men with the billions (or, for that matter, the 22-year-old Monaco residents with $88 million pied-à-terre apartments in New York City) are in any way hard done by. Not when there’s so much real hardship in America.

COMMENT

I have no problems with the inflation tax or inheritance tax. :-)

Posted by KenG_CA | Report as abusive

Missouri, payday-lending haven

Felix Salmon
Dec 20, 2011 04:19 UTC

Is there an expert out there on the subject of payday lending in Missouri? It certainly seems to be something of a haven for payday lenders, despite the state’s attempts to paint itself as a strict regulator:

Sections 408.500-408.505 subject this type of lender to a host of consumer safeguards, i.e., places a 75% cap on interest and fees on the initial loan and renewals, limits renewals to no more than six, limits the term of the loan to 14-31 days, applies daily interest calculations, etc. These sections contain some provisions which go well beyond most “consumer protections”.

I’m not sure why the Missouri Division of Finance is so defensive, here, or why it feels the need to put the phrase “consumer protections” in scare quotes. But the fact is that in 2011, some 2.43 million payday loans were made — this in a state with a population of less than 6 million — and the average APR on those loans was an eye-popping 444%.

So it’s easy to see why consumer groups are pushing a law capping interest rates at 36%, and why payday lenders are opposing it.

The details here aren’t pretty. First of all, look what’s been happening to the payday lending industry over the past eight years, according to the state’s own figures.

payday.tiff

There’s been a steady rise in average APR, but that’s pretty much the only trend that can be seen in these figures. The total number of loans is actually down by 15% from its 2007 peak, while the number of active payday lenders has fallen by 18% in just two years. And borrowers seem to be getting smarter, too: they’re borrowing more money at a time, and rolling it over fewer times, thereby incurring fewer fees.

Meanwhile, the payday-loan default rate has been hovering steadily in the 6% range — reaching its peak before the financial crisis, interestingly enough — and acting as a silent rebuke to anybody who would dare to argue that interest rates in the triple digits are necessary to make up for the fact that so many payday loans go bad. (In fact, they’re reasonably safe, if only because they’re secured by a future paycheck.)

But the most interesting thing about the Missouri debate, for me, is the role of a group calling itself Stand Up Missouri, which has promulgated a particularly tasteless video which implies that standing up for high-interest-rate lenders is somehow analagous to the acts of the “poor people who followed Dr. King and walked with him hundreds of miles because they believed in civil rights that much”.

Stand Up Missouri is at pains to say that it does not represent payday lenders, and indeed that payday loans, which “do not include a budget review to determine if the borrower has the ability to repay the loan at the two-week or one-month maturity”, “can be difficult for a borrower to manage”.

Yet according to Scott Keyes at Think Progress, Stand Up Missouri “is funded – to the tune of $216,000 – by just seven payday lending corporations”.

The truth, I think, is a bit more complicated. There are payday lenders — and then there are Consumer Installment Lenders, as defined by Section 408.510 rather than 408.500 of the Missouri code:

In 2001, the “traditional” small loan companies and the “payday” lenders separated themselves at $500 with the payday lenders authorized for very short-term loans of up to $500 and traditional lenders able to make any loan from a minimum amount of $500 on up. The consumer installment lender provisions were needed to cover a gap: the borrower of a very small amount who needed more time than the 14-31 day limit on payday lenders… These loans are very much like Consumer Loans, but with some notable exceptions. For instance, the loans may be in any amount, secured or unsecured, but must be repayable in at least four (4) equal installments over a period of 120 days.

Stand Up Missouri represents these installment lenders, who are distinct from payday lenders: I think that Keyes is wrong that it’s just a bunch of payday lenders who “prefer the phrase ‘traditional installment loan’”. In the biennial report of the Missouri Division of Finance, payday lenders are listed over the course of 32 pages (119-150), while the installment lenders fill up just over 19 (160-179).

Installment loans are bigger than payday loans, and they’re not subject to biennial surveys in the same way that payday lenders are. But just eyeballing the sheer number of these entities, and the money they’re putting into opposing the current bill, I think it’s fair to assume that they’re more or less the same size as the payday lenders, in aggregate.

Which means that the number of loans made in Missouri every year at an interest rate of more than 36% is actually much greater than 2.43 million: it could be more like 4 million. Which is crazy, given the size of the population.

Even the Missouri Better Business Bureau has come out swinging against the abuses of the payday-loan industry. In a hard-hitting report dated July 2009, it noted that Missouri uniquely among nine contiguous states allows payday loans to be rolled over; that at least two Missouri nursing-home groups own payday lenders designed to lend money to their own employees; and that, in general,

Missouri’s weak payday loan laws have attracted major out-of-state lenders to engage in predatory lending, costing Missourians who can least afford it millions of dollars a year. Because the continually increasing debt owed to payday loan companies is so onerous, some consumers are caught in the “debt trap,” unable to pay the loan off or meet other needs such as utilities, rent and food. Bankruptcy is the only answer for some of these consumers.

All of which is to say that I’m no fan of facile columns defending payday lending in principle without getting too caught up in the way that it’s used in practice. Yes, as Tim Harford says, it’s possible that taking a loan at an interest rate of 1,350% could be a rational thing to do. But it’s simply not possible that most or indeed many of the recipients of those loans are doing the economically rational thing — even if you take into account the cost of a bank overdraft as the alternative source of funds.

The dreadful conceit of the Stand Up Missouri video is that a college professor who didn’t use credit cards and therefore didn’t have a credit history walked into her local credit union and was turned down for a loan — and that the credit union officer pointed her to an installment-loan shop instead, where she happily got a loan at an interest rate of somewhere well north of 36%.

Well, here’s my challenge for Stand Up Missouri: name that credit union. Credit unions exist to serve precisely this kind of person: I simply don’t believe that any credit union would turn her away and deliberately send her to a usurious lender.

And here’s my other question for Stand Up Missouri: we know the average APR on payday loans, so will you publish the average APR on your loans? These loans are all, by definition, over $500, so it’s hard to make the case that the APR has to be low just to make up for the small dollar amounts involved. And if New Mexico is any indication, it’s the lenders with 120-day term loans which are the very worst — worse than the payday lenders whose regulations they successfully skirt.

Finally, here’s a question for the Consumer Financial Protection Bureau: can you at the very least collate information on nonbank lenders in the 50 states, and the interest rates they charge consumers? One of the problems in Missouri is that while the payday lenders have their activities monitored in biyearly reports, the installment-loan shops seem to be acting without any need for any disclosures at all. And if we don’t know how big the problem is, it’s very hard to tell what kind of solutions might be necessary.

COMMENT

If payday loans are lenders of last resort for so many Missourians, what happens if these lenders are run out with a rate cap? Surely, our state’s “lax” lending laws would have facilitated better options by now… Instead of nixing the businesses doing the only lending, I’d rather see payday loan opponents present a better way to loan to the people that use these loans. But chances are they can’t, and they’d rather have these folks begging for welfare and food stamps than making their own way.

Posted by Sameoldsameo | Report as abusive

Counterparties

Nick Rizzo
Dec 20, 2011 01:10 UTC

To survive, Italy must drastically reduce wages — VoxEU

Warren Buffett’s already down $1.5 billion on his BofA investment — WSJ Deal Journal

Romer on on Reinhart and Rogoff: not all recessions are created equal — NYT

The WSJ says there’s a dividend bubble — WSJ (paywall)

Romney is fully expecting to discuss “that picture” in the general election — Bloomberg

Romney still collections millions from Bain — NYT

And here’s an interesting look at how North Korea makes money: drugs, counterfeiting, and smuggling — NPR

COMMENT

The market seems to think there is, or reasonable enough to trade into the $5′s again.

I think muddling through is the existence for BoA in the near future. Can’t be an exciting time to be there, either.

Posted by McGriffen | Report as abusive

Adventures with the new plutocracy, wealth-beta edition

Felix Salmon
Dec 19, 2011 16:53 UTC

Robert Frank — the WSJ writer, not the Cornell economist — had a fascinating column about what he calls “wealth beta” this weekend. If you’re a member of the 1%, it turns out, you don’t just have a lot of money; you’re also likely to be seeing a huge amount of volatility in your wealth and your income. And this volatility has been measured according to the familiar scale where the broad stock market has a beta of 1:

The new rich have become the high-betas of our economy. With their dependence on financial markets, their leverage and their hyperspending, the top 1% have income swings that now are more than twice as high as those of the rest of the population.

A study by Jonathan A. Parker and Annette Vissing-Jorgensen of Northwestern University found that the beta of the top 1% nearly quadrupled between 1982 and 2007 to 2.39. The top 0.01% had a beta of 3.96, making even the riskiest tech stocks look safe by comparison. Economists and wealth managers say the betas of the rich have likely soared even higher in recent months as markets gyrated sharply.

Frank’s column is based pretty unquestioningly on the idea that this is a bad thing, and he quotes a few wealth-management executives talking about how very rich people can stay rich for decades, and avoid losing all their money.

But my feeling is that high-beta wealth is something to be celebrated — it’s one of the few silver linings to the current rise in inequality. People might become stupendously wealthy, but we’re not really creating a new class of dynasts here. Instead, the money comes, and then, almost as fast as it came, it goes.

One reason is just that the idea of preserving wealth in one’s own family for many generations to come has rather gone out of fashion. If you inherit a fortune which has been in your family for hundreds of years, then you do generally feel a responsibility for maintaining it and passing it on to future generations. But families are smaller now than they used to be, and self-made billionaires don’t necessarily consider multi-generational wealth preservation as a particularly top priority. Indeed, it’s more common to see billionaires swing the other way: Warren Buffett, for instance, likes to say that he wants to leave his children “enough money so that they would feel they could do anything, but not so much that they could do nothing”.

And some billionaires, of course, are childless, which means they can and should do exactly what they want with their money. They’re basically forced to give it away to charity, since it’s pretty much impossible to spend that kind of money.

The fact is that if you’re hugely wealthy, you’ll almost certainly live very well for the rest of your life no matter how much of your money you risk and lose. Short of going to jail, the rich very rarely find themselves completely impoverished. And in any case, self-made plutocrats tend to have extremely healthy egos: they’re confident that if they lose everything, they’d be able to pick themselves up by their bootstraps and do it all over again.

Wealth, at these stratospheric levels, is a way of measuring who’s winning the game; if it’s not rising, you’re not winning. And of course the things that Frank prescribes — like taking on less debt and diversifying your holdings — tend to go directly against the very strategies which created all that wealth in the first place.

We live in a world where millions of people are pursuing dreams and careers which have some small chance of being hugely successful. The number of people who have a chance of achieving such success has never been greater — and when it arrives, that success is increasingly lucrative for those who get there. That’s the game; its winners change from year to year and decade to decade. But the glory goes only to the person who makes the money, not to anybody who inherits it — unless they, too, display a similar knack.

So let’s not encourage the uber-wealthy to squirrel away their money and keep it in their families. It’s a good thing that today’s wealth has high velocity and that if it doesn’t get lost in the marketplace it’s more likely than ever to end up somewhere philanthropic. Even if that frustrates executives at private banks and wealth management companies.

COMMENT

Wouldn’t we expect the income of the top 1% to be extremely volatile because at higher income levels recognizing income is to some degree a voluntary act?

Many mechanisms for creating great wealth rely on creating assets of value. As such, there is no income realized until one chooses to do so.

Those pre-IPO Facebook shares don’t generate any income until they are actually sold.

Posted by clf | Report as abusive
  •