Opinion

Felix Salmon

The default has already begun

Felix Salmon
Oct 14, 2013 22:23 UTC

The big question in Washington this week is whether, in the words of the NYT, we’re going to see “a legislative failure and an economic catastrophe that could ripple through financial markets, foreign capitals, corporate boardrooms, state budget offices and the bank accounts of everyday investors”. In this conception — and I have subscribed to it just as much as anybody else — the sequester is bad, the shutdown is worse, and the default associated with hitting the debt ceiling is so catastrophic as to be unthinkable.

This frame is a useful one, not least for the politicians in Washington, who seem to have become inured to the suffering caused by the shutdown, and downright blasé about the negative consequences of the sequester. Both of them could last more or less indefinitely were it not for the debt ceiling, which is helpfully providing a hard-and-fast deadline: Congress is going to have to come up with a deal before the ceiling is reached, because the alternative is, well, the zombie apocalypse.

There’s more than a little truth here: I’m a firm believer, for instance, that the president both can and should prioritize debt repayments in the event that the debt ceiling is reached. If we’re going to be so stupid as to hit the ceiling, then prioritizing debt service is the least-worst outcome. But at the same time, the situation is less binary than it looks, not least because the US government is already in default on its obligations.

The best way to look at this, I think, is that there’s a spectrum of default severities. At one end, you have the outright repudiation of sovereign debt, a la Ecuador in 2008; at the other end, you have the sequester, which involves telling a large number of government employees that the resources which were promised them will not, in fact, arrive. Both of them involve the government going back on its promises, but some promises are far more binding, and far more important, than others.

Right now, with the shutdown, we’ve already reached the point at which the government is breaking very important promises indeed: we promised to pay hundreds of thousands of government employees a certain amount on certain dates, in return for their honest work. We have broken that promise. Indeed, by Treasury’s own definition, it’s reasonable to say that we have already defaulted: surely, by any sensible conception, the salaries of government employees constitute “legal obligations of the US“.

Conversely, if you really do expect zombies to start roaming the streets the minute that the US misses a payment on its Treasury obligations, you’re likely to be disappointed. Yes, the stock market would fall. But the price of Treasury bonds would remain in the general vicinity of par, and it might even go up if Treasury announced that past-due interest would be paid on all debt at a statutory rate of 8% per annum. Even when it’s Treasury bonds themselves which are the instruments in default, Treasury bonds remain the world’s flight-to-quality trade, and the expected recovery on all defaulted Treasury obligations would be 100 cents on the dollar — or more.

The harm done to the global financial system by a Treasury debt default would not be caused by cash losses to bond investors. If you needed that interest payment, you could always just sell your Treasury bill instead, for an amount extremely close to the total principal and interest due. Rather, the harm done would be a function of the way in which the Treasury market is the risk-free vaseline which greases the entire financial system. If Treasury payments can’t be trusted entirely, then not only do all risk instruments need to be repriced, but so does the most basic counterparty risk of all. The US government, in one form or another, is a counterparty to every single financial player in the world. Its payments have to be certain, or else the whole house of cards risks collapsing — starting with the multi-trillion-dollar interest-rate derivatives market, and moving rapidly from there.

And here’s the problem: we’re already well past the point at which that certainty has been called into question. Fidelity, for instance, has no US debt coming due in October or early November, and neither does Reich & Tang:

While he doesn’t believe the U.S. will default, Tom Nelson, chief investment officer at Reich & Tang, which oversees $35 billion including $17 billion in money-market funds, said that the firm isn’t holding any U.S. securities that pay interest at the end of October through mid-November because if a default does take place, “we’d be criticized for stepping in front of that train.”

The vaseline, in other words, already has sand in it. The global faith in US institutions has already been undermined. The mechanism by which catastrophe would arise has already been set into motion. And as a result, economic growth in both the US and the rest of the world will be lower than it should be. Unemployment will be higher. Social unrest will be more destructive. These things aren’t as bad now as they would be if we actually got to a point of payment default. But even a payment default wouldn’t cause mass overnight failures: the catastrophe would be slower and nastier than that, less visible, less spectacular. We’re not talking the final scene of Fight Club, we’re talking more about another global credit crisis — where “credit” means “trust”, and “trust” means “trust in the US government as the one institution which cannot fail”.

While debt default is undoubtedly the worst of all possible worlds, then, the bonkers level of Washington dysfunction on display right now is nearly as bad. Every day that goes past is a day where trust and faith in the US government is evaporating — and once it has evaporated, it will never return. The Republicans in the House have already managed to inflict significant, lasting damage to the US and the global economy — even if they were to pass a completely clean bill tomorrow morning, which they won’t. The default has already started, and is already causing real harm. The only question is how much worse it’s going to get.

COMMENT

The posturing of the egocentric leadership “on the Hill” is despicable. They make too much money to do too little work and are only interested in promoting their private agendas (Reelection, Power, Money, Reelection,….) As an active constituency (NOT Tea Party), we MUST take back our government by voting out all incumbents and create “Term limits by the People, for the People and of the People” to remove the decaying odor of those gluttonous relics who have been feeding at the trough for far too long. We need people to lead our great nation out of this quagmire through compromise and respectful dialog with a genuine desire to serve the interests of the American People First & Foremost through reinstatement of the core values of The Declaration of Independence and The Constitution of the United States of America (51% Rules)!

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How Janet Yellen should embrace the Fed’s dissenters

Felix Salmon
Oct 9, 2013 21:42 UTC

The Fed Whisperer, John Hilsenrath, had a great insidery article yesterday about forward guidance, and about the Fed’s ability — or lack thereof — to effectively signal its future actions. And it was timely, too, coming as it did a day before the official nomination of Janet Yellen as the new Fed chair.

The job that Yellen inherits is very different from the job which faced all of her predecessors. They focused almost exclusively on the question of where to set the Fed funds rate; that’s a non-issue for Yellen, who is certainly going to keep that rate at zero for the foreseeable future. Instead, Yellen has two other tools at her disposal. One is QE: the Fed can continue to pump money into the economy for as long as it likes, although no one on the committee loves the idea of doing so indefinitely. And the second is forward guidance, or what is sometimes called “federal open mouth operations”: the ability of the Fed to set expectations by being very clear about what it intends to do in the future.

As Hilsenrath details, the Fed’s new commitment to transparency — something Yellen strongly believes in — has not gone entirely smoothly. As Fed governor Jeremy Stein said in a speech last month, there’s clear “room for improvement” when it comes to the Fed acting transparently and predictably.

The problem is that transparency and predictability are incompatible goals. Look at the minutes of the September FOMC meeting, which were released today: they reveal a tortured meeting, spread over two days, with more than its fair share of meta-worries about desirable and undesirable feedback loops between the markets, the Fed’s statement, and the minutes themselves. Frankly, the more transparent the Fed is, at times like this, the less predictable it becomes.

This is one area where I think that Yellen could be a real improvement over Bernanke. Think of Fed communication as starting with the studied opacity of Volcker and Greenspan, who once famously told reporters that “if I seem unduly clear to you, you must have misunderstood what I said”. As Binyamin Appelbaum says, central bankers historically have “regarded secrecy as a virtue and obfuscation as a prized technique”.

The Fed then evolved, as serious academic work managed to find strong evidence for the idea that transparent communication can and should be an important part of monetary policy. This was one of the great innovations of the Bernanke era: an unprecedented degree of specificity about how the Fed intended to behave in the future.

The problem is that the Fed and the markets both conceived of the forward guidance in terms of what economists might call the “stylized fact” that the Fed is a single actor making a single decision. There is a series of monetary-policy actions that the Fed is going to take in the future, and everybody started behaving as though (a) the FOMC had a pretty good idea what it was going to do; and that (b) the only question was how much leg the FOMC would show, in terms of revealing what it knew.

In reality, however, the tail soon started wagging the dog: when the Fed announced that it would keep interest rates at zero until at least mid-2015, for instance, that was not a simple expression of a decision which they had already made internally. Instead, the FOMC came to the conclusion that the announcement, in and of itself, would have a desired effect on economic conditions, and therefore said something which was carefully calibrated to have that specific effect (while also being consistent with what they thought they would probably want to do in terms of interest rates).

This was where tensions started setting in: it’s one thing for a Fed chairman to rally his FOMC troops and get them all to agree on a certain course of action at a certain meeting. It’s another thing entirely to try to get those troops to agree to a future course of action, stretching out as far as mid-2015, despite the fact that no one really knows what the economy is going to look like then. Promises can be broken, of course. But if you’re trying to build consensus, then the best way to do so is always to keep things narrow, rather than asking people to make broad, long-lasting commitments.

On top of that you have the fact that QE is an unproven experiment — and one which is pretty explicitly opposed by various FOMC members, especially some of the regional bank presidents. Making promises about the future of QE is dangerous, because those promises will be very hard to keep — but then again, not making any promises is also dangerous, since it results in markets throwing around terms like “QE infinity” or “QEternity”. And that’s a message the Fed very clearly does not want to send.

Enter Janet Yellen — someone who’s incredibly good at economic forecasting and academic analysis, and who is (I think) more comfortable with tension and conflict than Bernanke. Yellen has often been in the minority on the FOMC, and nearly always, when she has been in the minority, she was ultimately proved correct. She has far more FOMC experience than Bernanke did, when he became Fed chair — which means that she’s deeply familiar with the kind of personalities who populate the board, the range of opinions they hold, and the degree to which the chairman can nudge those opinions in a certain direction.

I suspect that when Yellen gives her post-meeting press conferences, we’re going to see something very different from what we’ve been used to with Bernanke. The current chair is patient, avuncular, friendly, eager to help people understand what he’s saying. He has a specific message, and he wants to get that message across as clearly as he can. Yellen, by contrast, is going to be more scripted, more empirical — and, I hope, more honest about the fact that the FOMC is a diverse group of people, with a range of opinions. Markets are naturally comfortable with probability distributions: they don’t need to be told with great specificity exactly what is going to happen.

What I’d like to see from Yellen is less of an attempt to artificially move markets by saying the right words at the right time, and more of an attempt to be honest and clear about the full range of opinions on the FOMC. Where Bernanke always just attempted to get across a single consensus view, Yellen should instead be more open about the full spectrum of opinions on the FOMC, and how that spectrum ultimately ended up being reduced to a consensus about what to do and say.

We live in a world where both the legislative and the judicial branches of government are racked with very open dissent — and yet where the Fed likes to pretend that it somehow manages to always rise above such things. It doesn’t; it can’t; it shouldn’t even really aspire to doing so. The most effective communication is honest communication: if Yellen can be open about disagreements within the FOMC, then that will have three positive long-term effects. Firstly, it will make market misunderstandings less likely, since there will be less of a feeling of “you said you would do this, but then you did that”. Secondly, it will give the FOMC more credibility in terms of the committee binding itself to future actions: if Yellen can show that the full spectrum of opinion falls in a certain range, then the market will be more comfortable expecting that outcome. And thirdly, it will allow Yellen to be an effective chairman even in the face of certain future dissents. She could even be an effective chairman if she found herself in the minority, once or twice — something which could never be said about Greenspan or Bernanke.

Yellen gets on very well with ultra-hawkish FOMC members: she should make that her not-so-secret superpower. If she can effectively represent the views of someone like Richard Fisher when she gives her press conferences, she will effectively move the markets from a naive expectation that Bernanke will simply tell them what he’s going to do, to a much more effective and sophisticated expectations that Yellen will be genuinely open about the full range of views on the committee. Which would be a genuine and important improvement.

COMMENT

I don’t quite agree that the Fed shouldn’t make forward pronouncements. Expectations are commonly modelled explicitly, with their own variable. A classic example is getting inflation expectations down. It’s going to cause pain; the Fed just needs to announce it and then do it. If it announces it and then doesn’t follow through, it loses credibility, and even members who were against the original announcement should understand that. Sometimes, bold talk is required, and it’s not a matter of “here’s what we think we will do in a year’s time;” the announcement IS the plan itself.

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Felix Salmon smackdown watch, debt prioritization edition

Felix Salmon
Oct 7, 2013 21:45 UTC

On Thursday I said that the US is not going to default on its bonded debt, even if the debt ceiling is reached: “with Jack Lew (or anybody else, really) as Treasury secretary, you can be sure that debt service payments would be priority number one”.

This is not a popular view within the blogosphere, maybe because it’s generally associated with Republicans trying to say that hitting the debt ceiling wouldn’t be that bad. Both Cardiff Garcia and Dylan Matthews have come out with sterling attempts to answer the question of whether debt prioritization is even possible; Danny Vinik, for one, says that there’s “pretty good evidence to demonstrate that prioritizing debt payments is not possible”. The problem, however, as Garcia says, is that most of the primary sources you’d want to go to on a question like this “are vague and unhelpful”.

It’s worth stipulating up front that hitting the debt ceiling would be disastrous even with prioritization: Garcia calls it “breaking the economy’s knees with a fiscal crowbar”, while Paul Krugman says that it would be “a catastrophe”. But it would be much better than the truly apocalyptic state of affairs that we would see in the event of a Treasury bond default. Deutsche Bank says that in that event, the S&P 500 would fall some 45% — and, boldly, puts a 0% probability on that actually happening.

It’s also worth stipulating that before the debt ceiling is hit, a lot of very sensible politicians want to make prioritization seem as unlikely as possible, because that maximizes the incentive to avoid hitting the ceiling at all. On the other hand, after the debt ceiling is hit, the very same politicians should be willing to move heaven and earth to ensure those bond coupons get paid.

So, why is Matt Yglesias so convinced that prioritization is impossible? He gives four reasons.

The first is that prioritization is illegal: “Treasury is not authorized to unilaterally decide to pay certain bills and not others”. This is true — but also a bit irrelevant. Treasury is under unambiguous Congressional orders to pay lots of bills — all of them, in fact. If it fails to pay those bills, it will be violating the law as laid down by Congress. Hence the 14th Amendment argument that the president should simply ignore the debt ceiling entirely, if it comes to that. But underneath it all, it’s hard to credit any argument which says “Treasury isn’t allowed to pay its own bonds”. If that’s what Treasury wants to do, then surely it can do so. Besides, who would even have standing to sue?

Yglesias’s second reason is that prioritization is just not feasible: it can’t be done in the real world. Both he and Matthews cite the Treasury inspector general, who does indeed say what they say he says:

Because Congress has never provided guidance to the contrary, Treasury’s systems are designed to make each payment in the order it comes due.

It’s worth reading the whole letter, however, because the inspector general says a lot more than that. And while the systems are designed to make payments in the order they come due, they have also been designed so as to effectively insulate bond repayments from all other payments. Bond repayments are made through a system called Fedwire, while all other payments are made through the standard banking ACH system. Logistically, it’s entirely possible to keep up to date on all Fedwire payments without making any ACH payments at all.

And the inspector general was very careful to keep all options open:

Ultimately, the decision of how Treasury would have operated if the U.S. had exhausted its borrowing authority would have been made by the President in consultation with the Secretary of the Treasury.

What’s more, the inspector general does rather fudge the central issue of prioritization, which is whether debt repayments can carry a higher priority than everything else. “Treasury officials determined that there is no fair or sensible way to pick and choose among the many bills that come due every day,” he said — but that’s false on its face: prioritizing debt repayments is very sensible, since defaulting on Treasury bonds would be much more harmful than simply paying all bills as they come due, whether they’re a bond coupon or a fighter jet.

There is an argument from the left that prioritization constitutes “paying China first”, and would “require the government to cut large checks to foreign countries, and major financial institutions, before paying off its obligations to Social Security beneficiaries and other citizens owed money by the Treasury”. Well, yes. But I don’t think anybody in Treasury is swayed by such arguments: they know that in the grand scheme of things, all Social Security beneficiaries would be much better off receiving their money in arrears than they would be if Treasury defaulted on US sovereign bonds.

Yglesias then rolls out the timing argument, which is further developed by Zero Hedge: debt repayments are lumpy things, and it would be hard to “save up” enough money before the big repayments were due, if you were paying any other bills at all. Zero Hedge improbably says that “Treasury will simply halt new Bill issuance” if the debt ceiling is reached, but I don’t buy it: no one’s requiring that the national debt go down. And investors generally want to be able to roll over their short term debt: failure to be able to do so would be better than default, but not much.

Could Treasury decide to prioritize Fedwire payments, and then turn on the ACH payments sporadically, only insofar as they didn’t eat up enough cash to endanger bond repayments? I don’t see why not. Treasury wouldn’t like it, of course. And as Yglesias says in his final point, such a scheme might well be so messy that the markets would have to end up assigning some kind of credit risk to Treasury bonds anyway. Still, doing so would send a very clear message to markets, that Treasury cares about them more than it cares about the sick, the elderly, or any other recipients of government funds. And the markets, in return, would probably reward Treasury with lower interest rates on Treasury bonds. After all, in a crisis, money always flows into Treasuries — even when it’s a Treasury-bond crisis.

COMMENT

“Because Congress has never provided guidance to the contrary, Treasury’s systems are designed to make each payment in the order it comes due.”

Yup, we’re on total auto-pilot. The system cannot be stopped, re-booted, intervened – its all hard-coded. Its a doomsday machine. Its a like a shark – if it stops swimming we all die.

“…speaking as someone who covered federal civilian ADP — and who has a spouse who worked in federal civilian ADP for many years — the idea that Treasury would be able to improvise those procedures on the fly doesn’t even come close to passing the laugh out loud test.”

Really? Just how close to the mainframes did they let you get, anyway? Here’s the bottom line: We’re being told not to touch the “concentrated evil” because if we do the entire world will explode. If THAT is the case then the systems group at Treasury has been run by legions of incompetents for literally decades.

Nobody, but NOBODY, engineers systems that poorly. This is classic progressive hyperbole and I discount it in it’s entirety.

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Making sense of the market in US CDS

Felix Salmon
Oct 3, 2013 14:53 UTC

Matt Levine had an excellent post last week on the bizarre market in credit default swaps on the USA — a market which people only ever look at during times of crisis or potential crisis. The nihilists are out in force today, using this market to confirm their priors, but the problem is that it’s very, very hard to look at US CDS, or to look at the yield on short-dated Treasury bills, and draw anything much in the way of meaningful conclusions.

One reason why is that Treasury bills are unique in many ways, including the weirdest way of all: as worries about the creditworthiness of the US government increase, the price of Treasury securities tends to go up, rather than down. Even if the US hits the debt ceiling, that won’t hurt the price of US debt; instead, general nervousness will only cause investors to flow into Treasuries and out of riskier assets. Which is to say, out of everything else.

And although Levine has managed to piece together a scenario under which a temporary technical default on US debt could cause a real payout for holders of US CDS, I don’t think that scenario really explains the price action either. The problem with it is that the government would still need to miss an interest payment on its Treasury securities, and there’s no way that it’s ever going to do that, whatever happens to the debt ceiling.

Think about it this way: if I roll over my debts, then my total debt does not actually increase. So if a T-bill is coming due today, then the government can pay it off in full, and issue a new T-bill, without increasing its total indebtedness. It’s true that a failure to raise the debt ceiling would prevent the government from funding its expenditures with new borrowing — although John Carney makes a good case that the government could just issue Obama Bonds instead.

The government still receives substantial tax revenues every week. So although the government would have to live within its means, spending no more than it got in revenues, its revenues would still be far greater than the total amount of debt service. And with Jack Lew (or anybody else, really) as Treasury secretary, you can be sure that debt service payments would be priority number one. US government payroll — especially for the president and Congress — would probably be the first thing to get cut; the armed forces might be next, just to place maximum pressure on House Republicans. Then Medicare and Medicaid, maybe — the doctors and hospitals providing those services would just have to wait until the debt ceiling got raised before they received their checks. Failing to meet any of those obligations would not be considered a debt default, and would not trigger CDS.

So what’s going on in the odd corners of the financial markets which are suddenly receiving so much attention? The simple answer is that they’re trading markets. They don’t only go weird when the debt ceiling approaches: something similar happened back in January 2009. And here’s what I wrote back then:

Anybody who bought protection at, say, 25bp is now sitting on a very nice profit if they close out their position. Maybe this is just a form of black swan insurance: buying US government CDS is a way of making money when everything else plunges in value. You’re not really insuring against an actual default, you’re just betting that if the world starts to implode, the price of your CDS is going to rise even higher.

No one knows exactly how high CDS rates would go if we pierced the debt ceiling, but it’s a reasonable assumption that they would go higher than they are now, even if (as is almost certain) they never pay out a penny. The US CDS market is a speculative, greater-fool market: the trick is to buy at a low level, and then sell at a higher level. A bit like bitcoins, really. If you think that the debt ceiling is going to be hit, then it makes sense to buy CDS today, just because spreads are going up rather than down. The only trick then will be trying to time the perfect moment to sell.

COMMENT

At this time the areas getting the most activity are shady areas. Trying to protect the casino bets. Buying delusional insurance to pay for a bet on which way a particular market will fall. Then create the situation you want to happen (or rigging) the market to collect on the insurance that is bought and paid for buy USA workers. It is like a cheater at a casino who knows how to count cards allowing him to rob the house. At this point, money is just binary symbols bouncing around a cow casino.

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The surprising value of not tapering

Felix Salmon
Sep 19, 2013 04:48 UTC

I’m very late to this — I was a bit distracted by other things today — but the big storyline of the day seems clear: the Fed didn’t taper, and markets surged in response.

So here’s my question. If you take the amount of tapering that the market expected yesterday, and the amount of tapering that the market expects today, what’s the difference, in dollar terms? In other words, by the time tapering ends, and the Fed is no longer engaging in quantitative easing, how much extra money will it have spent buying bonds, if current market expectations hold, compared to what the market expected on Wednesday?

Then comes the next question, which is this: how much did the value of US fixed-income assets rise on Thursday? And, for that matter, how much did the value of US stocks rise on Thursday?

I don’t know the exact answers to the questions, but I’m pretty sure that the latter numbers are much larger than the former — that the market reaction, in dollar terms, was hugely greater than the extra amount of QE that the market now expects.

If that is indeed the case, then what we’re seeing is what you might call the QE multiplier — the amount by which every dollar of QE effects the markets as a whole. I don’t know what we thought the QE multiplier was on Wednesday, but in light of Thursday’s market action we might need to revise our guesses: the QE multiplier is, I suspect, much larger than most of us would have pegged it at.

And that, in turn, is surely a reason to keep on easing. If QE does no good, then you might as well not do it. But the lesson we learned on Thursday is that the markets really, really love QE. And insofar as robust markets feed through into a healthier economy, the logical conclusion is that we should retain current policy well into 2014. The downside is limited — and the upside is much bigger than we thought it was.

COMMENT

Casinos really like it when you keep putting dollars in the slot machines, it pays out nicely for the house and a few winners.

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Jobs: The summer’s over

Felix Salmon
Sep 6, 2013 13:39 UTC

If you wanted to engineer the strongest possible recovery in the US economy, you would try to create two things. First, and most important, you would want robust jobs growth, with employers adding positions, the unemployed — and especially the long-term unemployed — finding new jobs, and the proportion of Americans with jobs rising steadily. Secondly, you would want to introduce errors into the monthly jobs report. You would try to make jobs growth seem weaker than it really was, and unemployment higher. By doing that, you would keep monetary policy — and market expectations for future monetary policy — as accommodative as possible. That in turn would keep both short-term and long-term rates low, which would provide extra fuel for the recovery.

What we saw this summer was the exact opposite of that scenario. The monthly payrolls reports were positive, which seemed like good news — except we learned today that the jobs gains they reported were overstated. Meanwhile, the Fed started talking explicitly about tightening monetary policy (the so-called taper), which resulted in a massive spike in long-term interest rates: the 10-year Treasury bond hit 3% yesterday. That move was also, partially, fueled by talk of Larry Summers becoming the next Fed chairman rather than the more dovish Janet Yellen.

On top of that, to make things even worse, the Fed started targeting unemployment at exactly the point at which the headline unemployment rate has never conveyed less information. With today’s employment report, I hope we just stop taking it seriously: the small drop, to 7.3%, came entirely for the wrong reasons. This is the chart we should all be looking at instead:

This is, literally, the very picture of a jobless recovery: the recession ended at the end of the last light-blue column, but the participation rate just kept on falling, while the overall employment-to-population ratio stubbornly refuses to rise from its current miserable levels. Both of them are lower than at any point before women had finished their big move into the jobs market, and the Fed must surely take its “full employment” mandate to refer as much to this number as it does to the unemployment figures. (The unemployment statistics in general, and the headline unemployment rate in particular, are misleading mainly because they don’t include discouraged workers who have given up looking for work.)

Today’s jobs report was bad, no two ways about it: no matter how far you reached into the data, there was very little in the way of silver linings. That said, however, the market can look at the data too — with the result that long rates are on their way back down: traders no longer expect tapering to start imminently. On top of that, the most prominent skeptic of quantitative easing, Larry Summers, might not be the lock that we thought he was for Fed chair.

To put it another way: this report is something of an unwind of what we saw this summer. It shows that the reality of the economy was not as good as we thought it was, and that the market probably got ahead of itself in anticipating a taper beginning very soon. We can’t take any solace in the mediocre economy. But if you’re desperate for good news, here it is: at least we know, now, how mediocre the recovery is, especially on the jobs front. And we’re going to stop hobbling ourselves by pushing long-term interest rates inexorably upwards, thereby making that recovery even harder.

COMMENT

Foppe –

No, BLS revisions tend to be pretty noisy, and they go upward as well as downward. Stats here:

http://www.bls.gov/web/empsit/cesnaicsre v.htm

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The White House’s anti-Yellen sexism, cont.

Felix Salmon
Aug 20, 2013 21:22 UTC

Neil Irwin is not going to have made many friends in the White House with today’s piece on the problems the Obama administration has with Janet Yellen. It makes the White House economic team seem insular, sexist, and deeply mistaken about what the right and proper role of the chairman of the Federal Reserve Board should be. Worse, there’s every reason to believe that Irwin’s piece is entirely accurate.

Irwin enumerates three main reasons why the White House is underwhelmed with Yellen. The first is the “team player” attack: Yellen is an independent thinker more than she is a loyal deputy to Bernanke. And because she was 3,000 miles away from the action during the financial crisis (she was running the San Francisco Fed), she never became part of the boys’ club which was making enormous decisions on a daily basis in the fall of 2008.

As Irwin puts it, “she was on the outside looking in regarding some of the seat-of-the-pants decisions that were being made over how to rescue the American economy” — and the people who made those decisions are the exact same people who are advising Obama on whom to nominate as Fed chair. They have all worked closely with Summers, they enjoy the way he makes decisions, and they’ve all been through various crises with each other.

The “team player” argument, then, is basically the “one of us” argument, thinly disguised. Which is the first place that the sexism comes in: everybody named as being part of the “team” (Larry Summers, Tim Geithner, Ben Bernanke, Bill Dudley, Don Kohn, Kevin Warsh, Gene Sperling) is undeniably male — and, what’s more, the kind of male who takes great pride in his own intelligence, and loves it when the world knows just how smart he is.

But it gets worse:

She is methodical, not manic. And the prevailing style of the White House insiders advising on the decision leans a bit more toward manic. Geithner, for example, jumps from meeting to meeting, from hearing to phone call, without so much as a set of talking points to work from.

This second reason essentially takes the “team player” argument past its breaking point, to the point at which the Obama team is basically saying “Yellen needs to share our biggest weaknesses.” Sometimes crises move so fast that policymakers have no choice but to make decisions on the fly; when that happens, however, the decisions often turn out to be pretty bad. The story of the European crisis is full of such episodes, but for a domestic example, look no further than the image of Tim Geithner, at the New York Fed, doing his best deranged-Yenta impression as he desperately tries to engineer improbable mergers between Lehman and Barclays, or Citi and Goldman, or just about anybody and just about anybody else. The bankers, to their credit, managed to stand up to the pressure from their primary regulator — but even Geithner would admit that this was not his finest hour. This is not really a criticism of Geithner — we all make bad decisions when we haven’t had remotely enough sleep and we’re extremely stressed. But it’s ridiculous to think that a more deliberative approach is in any way inferior.

Maybe this bias towards the manic is what Obama is really talking about when he says that he wants a Fed chair who’ll be good in a crisis. The implied logic: Yellen is perfectly good if you give her lots of time to sit down and slowly work things out. But crises move fast, and no one thinks faster than Summers. Yellen’s brain isn’t as fast and fecund and facile as Summers’s brain, so we’d better appoint Summers.

Spelled out like that, the argument is downright offensive — and, of course, highly sexist.

“The question,” Irwin writes, “is how Yellin’s cautious approach would work when she is dealing with the full panoply of issues that a Fed chair must grapple with”. The answer, surely, is that the Fed chair is the number one place where, ex ante, a cautious approach is exactly what you would want. Someone who carefully scripts her words before saying anything? Someone who insists on thinking things out before acting? Yes please! The only conceivable reason to believe otherwise is if you’ve already decided, through personal friendship, that you want Summers to be the nominee, and then simply decree that whatever attributes Summers has and Yellen doesn’t are precisely the attributes you’re looking for.

Which brings us to Irwin’s final reason to be uneasy about a Yellen Fed: she’s more worried about reducing unemployment than she is about staving off bubbles. Or something like that — it’s not entirely clear. This of course is exactly as it should be: the Fed has a formal written mandate to reduce unemployment, while for much of its history it has operated with a policy that it’s pretty much impossible to identify bubbles and deal with them in real time. Yellen says that she’s serious when it comes to worrying about bubbles — but for whatever reason she isn’t considered serious enough, compared to Summers. (Which is pretty funny, given the degree to which Summers-era deregulation helped inflate bubbles of the past.)

More to the point, as Brad DeLong notes, it’s simply wrong to say that Yellen’s weak when it comes to identifying bubbles:

Yellen was equal to Ned Gramlich and out in front of all other Federal Reserve policymakers in the 2000s in her real-time worries about the housing bubble. Demonstrated ability to see a bubble and think about its risks in real time is one of Yellen’s strengths, not a weakness.

DeLong’s reaction is telling: he supports Summers, and still finds all of the administration’s arguments to be woefully weak. This entire debate strikes me as one of the most badly-orchestrated trial balloons I’ve seen in a very long time. If the White House wanted to maximize the degree to which people would think the Obama administration to be clubby and sexist and insular and narrow-minded, it could hardly do better than it has done when whispering about Larry at the Fed. And by making it clear that no decision is going to be made for a while, the White House is only ensuring that the same story is going to get repeated ad nauseam for weeks to come.

The chairman of the Fed is a position which requires the trust of the public. Larry Summers does not have that trust: indeed, almost uniquely, he’s mistrusted by the left, by the right, and by Wall Street in equal measure. He is, however, trusted by the president of the United States. Is Obama really so arrogant as to privilege his idiosyncratic personal opinions so highly, when the obvious candidate is right in front of his face? I hope not. But I’m losing optimism.

COMMENT

Is Irwin a mind-reader?
Are suppositions journalism?
Irwin will be made a fool if Obama selects Yellin or another woman

Posted by whoisit | Report as abusive

The bond market’s fear of Summers

Felix Salmon
Aug 19, 2013 22:51 UTC

RTR24R5P.jpg

Well done to Matt Phillips for finding this fantastic photo, by Reuters’s very own Kevin Lamarque, of Larry Summers, wearing his trademark mirthless smile, eyeing the chairman of the Federal Reserve as though he were an appetizer at the Four Seasons. The photo is four years old, but it’s germane right now, because, as Phillips says, markets seem to be freaking out that the man on the left is going to replace the man on the right.

Phillips quotes Julia Coronado of BNP Paribas as saying that a Summers nomination “is starting to get actively priced into markets”, while Morgan Stanley also sees Larry worries behind this chart:

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It’s always hard to prove causality when it comes to market moves, especially ones which happen over the course of a few weeks. Did quantitative easing cause the stock market to rise? Probably, although we can’t know for sure. Did Larry rumors cause the bond market to fall? Maybe — but they certainly can’t account for all of this massive move.

That said, Wall Street unambiguously prefers Janet Yellen to Summers as the next Fed chair, and the bond market in particular is worried that his skepticism about QE will mean that he’ll effectively just go on an extended vacation whenever rates hit zero, coming back only if and when he thinks he should start raising them again.

All of which is to say that Justin Wolfers is wrong when he declares that the market has no preference between Summers and Yellen. He bases his conclusion on the fact that the five-year TIPS spread has barely budged, but he never mentions the huge move in the bond markets, which are much more liquid and therefore more likely to reflect Fed-chair worries.

The market consensus is that Summers would be more aggressive at tapering QE than Yellen, with the result that a Summers Fed would end up spending much less money in the bond markets than a Yellen Fed. That alone would suffice to explain a sell-off in bond prices: you don’t even need any difference in long-term inflation expectations. And if you look at the foreign-exchange markets, it’s abundantly clear that Fed expectations in general, and tapering expectations in particular, are having a very important effect on emerging-market currencies and stock markets.

Still, it’s impossible to disentangle Fed-chair expectations from Fed expectations more generally — and even if it were possible to do that, it would still be impossible to be entirely sure what any particular move in rates meant. After all, the reversion to common sense is probably a good thing, all told — we want markets which look normal, rather than markets which are skewed by zirpy expectations. Theoretically, it’s possible that rates are going up because the markets think Summers will somehow be able to conjure up growth.

The bond markets have moved dramatically over the past couple of months, and no one really knows why. It seems silly to rule out Summers as one of many possible causes — but with any luck we’ve got over our bad Greenspan-era habit of judging the Fed chairman by the movements of markets. The Fed’s biggest and most important job right now is to get a grip on the unemployment rate — something which has pretty much zero correlation with markets.

Still, there does seem to be a decent chance that the markets are sending a signal that (a) Summers is likely to be the next Fed chair, and that (b) they’re not happy about the prospect. Which could set us up for a nice market pop if Obama announces Yellen as the nominee. I’d like that.

COMMENT

Totally agree with Sechel. The idea that Wall St. prefers Yellen is a remarkable bit of smokescreen. Larry has proved his love for WS repeatedly and continuously. He is one of them, and JY is not. Just look at her.

Posted by maynardGkeynes | Report as abusive

Universities shouldn’t be tax exempt

Felix Salmon
Jul 8, 2013 23:47 UTC

I have a piece up at Architect Magazine on Cooper Union, and the real (if slim) possibility that it will lose the tax break from which most of its current income flows. Cooper Union will get $18 million this year in “tax equivalency payments” stemming from its ownership of the land under the Chrysler Building — money which would normally flow to New York City in the form of property taxes, but instead gets diverted to Cooper Union for its own uses. Do the math, and that works out to about $18,200 per enrolled student — a much greater subsidy than New York City provides to any of the students being educated at its own colleges.

Doug Turetsky, of New York City’s State’s Independent Budget Office, says that if Cooper is going to start charging tuition, then “the public purpose of the unusual tax breaks now mostly a thing of the past,” and New York should start collecting property tax on the Chrysler Building rather than letting Cooper Union use all that money for itself. So far, there’s no indication that the attorney general agrees with him; as I say in my piece, the time for the AG to crack down on Cooper was in 2006, rather than now, when the removal of the tax break would mean certain death for the college.

Still, in an ideal world, Cooper Union wouldn’t get this tax break — and neither would NYU be exempt from paying property tax on its buildings, and neither would Harvard be able to invest its endowment tax-free. The tax exemptions that universities receive cause them to behave in a manner which would otherwise be quite irrational: NYU’s expansionism, for instance, is driven in part by the fact that it can extract more economic value out of property than other actors, thanks to all property it buys automatically becoming tax-exempt. And if you look at Harvard’s balance sheet, it has for decades now been a hedge fund with an educational institution attached, the educational institution more than paying for itself in the tax exemption it confers upon the entire endowment.

The dollar value of universities’ tax exemptions is enormous — and it almost goes without saying that if we simply abolished those exemptions, and used the proceeds to spend on higher education, we would get vastly more bang for our buck. The overwhelming majority of the tax expenditures go to the richest universities — the ones who need the money the least. Meanwhile, great institutions like the University of California are slowly starved to death: direct fiscal expenditures, it seems, are much, much easier to cut than more-hidden tax expenditures.

If state and federal governments are going to spend billions of dollars subsidizing tertiary education — and they should — then they should spend those billions wisely, with a focus on education. Instead, they spend those billions through the tax code, with no kind of oversight at all, pushing their thumb on the scales so as to encourage, at the margin, the purchase of buildings and the building-up of large endowments.

A revenue-neutral abolition of universities’ tax exemptions would be a massive gain for pretty much everybody, even if it did have the effect of slightly reducing alumni giving. In fact, it would be a very interesting real-world experiment: if alumni giving didn’t drop very much, that would be a good reason to extend the abolition to the entire charitable-giving nexus more broadly.

I don’t think that Cooper should, or will, lose the tax equivalency payments it receives from the Chrysler Building — they’re no more odious than all the other tax exemptions received by universities across the nation. But if all colleges lost all their exemptions, and got their federal subsidy directly instead of indirectly — now that I would applaud.

COMMENT

I couldn’t agree more with abolishing property tax exemptions for universities. In a city like mine (ypsilanti, mi) we are only 4 sq miles but majority of it is taken up by EMU. And then when pfizer moved out of ypsilanti guess who bought up that massive building and land… university of michigan. It creates such an overwhelming burden on the local municipalities to raise money to cover even the basic expenses. The result is bleeding homeowners dry in taxes. I pay 4k a year on a home only valued at 115,000. The most painful subsidies come at the cost of the residents where these universities are located.

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