Nice chart from Jim Glassman over at JPMorgan on why we have a such a giant budget deficit:
Josh Barro of the Manhattan Institute give a wonderful explanation of the wisdom of indexing capital gains taxes for inflation. Here is a taste:
But 2011 would be a good time to revisit indexation. First, this could help offset the negative economic effects from the likely rise in the top capital gains rate from 15% to 20%: taxpayers would face higher capital gains tax rates, but they would know that they are protected from tax on inflationary gains. Also, low inflation makes this an opportune time to introduce indexation, as the revenue loss from indexation is linked to the inflation rate, and would therefore be lower than usual.
The fiscal impact of indexation could be reduced by applying it also to the deduction side of the tax code, notably including the mortgage interest deduction. This would mean that only the portion of home mortgage interest in excess of the inflation rate would be deductible. Again, low inflation rates make this a politically opportune time for such a reform, because the near-term effect on tax bills would be small.
I would love to think so. And I know some folks on Wall Street would love to believe. But there are few signs that Obama will change course on taxes. Here is White House economic adviser Jason Furman:
Jason Furman, an economic adviser to President Barack Obama, told a meeting on Tuesday there was a concern that even a temporary extension of the Bush-era tax cuts for the wealthy would be a “foot in the door” to permanent extension.
If America ran its books more like a business, the real state of its finances would be clearer. U.S. budget scorekeepers now predict a $1.34 trillion deficit for 2010, a tad less than forecast in March. Still, it’s an enormous gap. And the headline number lowballs the shortfall.
To be fair, the Congressional Budget Office does its best. The unit is the closest thing associated with Congress to an independent and impartial fiscal judge. As the debate over the costs of healthcare reform showed, the CBO’s analysis affects not only public perception of policy but also its substance.
Yet the CBO still operates under rules set by Congress. And those constraints, whether by design or chance, result in an undeservedly rosy U.S. budget picture. For instance, the CBO calculates that the federal government will run up an additional $6.2 trillion in debt by 2020, raising the U.S. debt-to-GDP ratio to about 69 percent — a high but perhaps tolerable level.
But assuming various tax breaks are extended rather than expiring — an increasingly likely-looking scenario — debt would actually balloon to $11 trillion, or 90 percent of GDP. And if discretionary government spending rises in line with nominal GDP rather than the consumer price inflation used by the CBO, that would tack on another $2 trillion of borrowing. Throw in a few other more realistic assumptions, and the debt-to-GDP ratio ends up in scary territory north of 100 percent by 2020.
Then consider that America’s numbers are reported on a cash-in, cash-out basis. They make no provision for future liabilities such as Medicare and social security. As with companies’ financial figures, it pays to read the footnotes. In a little-noticed report, the U.S. Treasury does annually put out the data needed to calculate America’s liabilities according to business accounting principles. If the government were setting aside the money today needed to fund those liabilities fully, the 2010 deficit would be more like $4.3 trillion, according to the Shadow Government Statistics website.
These are the sorts of numbers CBO budgeteers should ideally be highlighting. If they of all people can’t tell it how it is, politicians will never get real with taxing and spending.
Economist Robert Brusca sums up today’s terrible economic news pretty well:
The day that optimism died. It has a time. It is sort of official: August 19, 2010. … The weak LEI is only bad news of the sort we have been getting. The rise in the jobless claims number posts a 500K number and makes the backtracking official and really bad. … But the report that disturbs me most is the Philly MFG index. The Philly index is actually a very good business cycle index. It does this job better than the ISM for some reason I can’t explain. … Optimism has died and there is a reason. Things are not getting better at even the same rate. Those seeing the economy as getting better are in a distinct and shrinking minority. … Brace yourself. I’m sorry to be the bearer of this bad news. This is not what I had expected. I don’t know how much it will shake markets but I’d eventually expect something that can be measured on the Richter scale.
And a bit from JPMorgan:
In light of the recent string of weak economic data including today’s further rise in initial jobless claims, the forecast for US real GDP growth is being revised down to 1.5% for 3Q10 (from 2.5%) and 2.0% for 4Q10 (from 3.0%). This is the second downward revision to growth in 2H10 and the most important one. The new forecast looks for subpar growth through the second half of this year and for a rise in the unemployment rate towards 10%.
The Recovery Summer has turned into the Summer Bummer. Is the superoptimistic White House taking notice? Perhaps not, given their track record. Brad DeLong and I may disagree on solutions, but he has also noticed the president’s weakness for the sunnyside of things:
Back in December 2008 I thought that prudent macroeconomic policy–policy geared to deal with a 20%-percentile outcome, that could then be cut back if and when it turned out that we had good or even neutral look–involved (a) a $1+ trillion fiscal stimulus, (b) the Federal Reserve taking the size of its balance sheet from $2 trillion to $3 trillion, (c) the Federal Reserve adopting a 3% annual inflation target and taking active steps to hit that target, and (d) the Treasury using its TARP authority to take tail risk on another $1-$2 trillion of risky assets.
We got a real number of $600 billion in effective fiscal stimulus. We really needed more. And we could still have more–(a) requires congressional approval, but (b), (c), and (d) do not and are still on the table.
Perhaps what went on was that the economic advisers gave Obama a 50%-percentile forecast rather than a 20th-percentile forecast, that Obama thinks himself a lucky person who always gets the breaks, and so pushed for policies appropriate to an 80th-percentile forecast?
Bond guru Bill Gross warned on Tuesday that without U.S. government guarantees, only mortgage bonds backed by super-safe loans, would interest him. He frets too much. The funeral of Fannie Mae and Freddie Mac may be coming, but housing support from D.C. will live on. The key question is how much.
The Gross plan would see the two mortgage giants evolve into a fully nationalized, mega-securitization engine. That, along with his suggestion for a massive home loan refinancing plan, could mean an even bigger role for Washington in U.S. housing.
But President Barack Obama’s administration has little appetite for that kind of approach. As it is, an annual $250 billion in government subsidies, according to the Congressional Budget Office, gives a poor return on investment. In a normalized housing environment, mortgage interest rates might be only 0.2 percentage points higher without it, according to studies from Ohio State University and a former Freddie Mac economist. And international comparisons hint that home ownership rates might not owe much to the government’s role, either.
Of course, politics means Washington won’t completely leave the stage. Yet even a middle-course would result in a radically restructured system.
Here’s what the Obama plan might well look like:
1) The feds explicitly backstop mortgage-backed securities issued by government-blessed entities who – in exchange – pay Uncle Sam an insurance fee (counted by budget scorekeepers as revenue.)
2) Fannie and Freddie – whom Rep. Barney Frank says should be “abolished” – are wound down.
3) Under a “Let a thousand flowers bloom” approach, private companies, nonprofits and even cooperatives get government charters to securitize low-risk mortgages for middle-class homes.
4) Mildly more racy loans for McMansions are handled by private issuers, but sans government guarantee.
Any such plan would need GOP support. This outline has the advantage of eventually eliminating Fannie and Freddie — directly blamed by many Republicans for the housing crisis — as well as narrowing and decentralizing the government’s participation in mortgage finance.
Then again, limbo could persist until 2013. With home ownership a political hot button, the matter could become a 2012 election battleground. And both parties would love to have a big issue at play that affects the financial sector to help raise campaign cash. Still, eventually change will come. But Gross shouldn’t worry: there will still be plenty of guaranteed mortgage-backed securities for him and other investors to buy.
The latest Gallup numbers are not good for the White House or congressional Democrats. The overnight tracking has Barack Obama’s approval-disapproval rating at 41 percent-52 percent. Based on the Rahm Emanuel formulation that for every point below 50 percent, the Dems lose five House seats, it looks like the GOP will take the lower chamber. This bit from a Weekly Standard piece I did pretty much explains it:
Declaring a “Recovery Summer” victory tour at the start of June must have looked like a pretty safe wager for the Obama administration. The economy seemed to have shifted firmly into gear during the spring. Lawrence Summers, director of the National Economic Council, told the Financial Times in early April that the economy was “moving toward escape velocity. You hear a lot less talk of ‘W’-shaped recoveries and double-dips than you did six months ago.”
A big reason for White House optimism was a stronger job market. The economy added an average of 320,000 net new jobs a month during March, April, and May, about half of them in the private sector. Granted, the unemployment rate still hovered close to 10 percent. But if the economy kept growing at a 3 percent annual clip or greater—creating lots and lots of new jobs in the process—unemployment would eventually fall, perhaps dramatically. As one White House insider remarked upon reviewing all the macro-indicators and then evaluating the economic team’s performance, “It looks like we got things just about right.
Since then, however, the economy has fallen back to earth, and “Recovery Summer” looks more like a bad bet. Private sector job growth has fallen by two-thirds, and the unemployment rate is still at a sky-high 9.5 percent. And if the size of the U.S. workforce, as measured by the Labor Department, had stayed constant since April—instead of shrinking by a million—the unemployment rate would be 10.4 percent. Jobless claims are at their highest level since February. Worse yet, the expansion is decelerating. After growing by 5.7 percent in the final quarter of 2009 and 3.7 percent in the first quarter of 2010, GDP advanced by just 2.4 percent from April through June, according to the Commerce Department. And new data show the final second-quarter number may actually be closer to flat, with growth for the rest of the year just 1 to 2 percent at best.
CNBC’s John Carney nails it right on the head:
Defenders of Fannie and Freddie insist that their role in making mortgages cheaper is vital to the market and expanding home-ownership.
Economists estimate that over the course of their lifetimes, Fannie and Freddie probably saved homebuyers $100 billion in mortgage payments. That compares very badly to the $145 billion in bailout funds they’ve already received — and horribly with the $386 billion the Congressional Budget Office says the companies will cost taxpayers over the next decade. Homebuyers got cheaper mortgages but at a very stiff price for taxpayers.
Several studies show that the benefit to mortgage rates is quite slight, perhaps as little as 20 basis points.
It may be long past time that US state and local governments start watching their pennies a bit more closely. As new research from George Mason University has found (bold mine):
Since the close of World War II, aggregate state and local spending grew 34 percent faster than the private sector and 37 percent faster than federal government spending. In recent years, the difference in growth rates has widened. From 2000 to 2009, state and local government spending grew nearly twice as fast as the private sector (while over the same period, the federal government grew even faster). … In this paper, I review some of these trends and then estimate what would have happened under an alternate scenario in which spending growth had been restrained. I look at the ten states with the largest FY2009 budget gaps and the ten states with the largest FY2010 budget gaps. Because six states make both lists, I analyze fourteen states in total. For each, I estimate what its FY2009 spending level would have been had its budget grown at the pace of population growth and inflation, beginning in two periods: 1987 and 1995. In twelve of the fourteen states, the entire FY2009 budget gap would have been avoided had the state kept spending at real 1995 per capita levels. In thirteen of the fourteen states, the budget gap would have been avoided had the state kept spending at real 1987 per capita levels.
Interesting to see if any politicians pick up on this argument from former Morgan Stanley economist Andy Xie:
Stimulus is prescribed as a panacea for recession. In today’s global economy, it isn’t effective in the best of circumstances and is outright wrong for what ails the West now.
Trade and foreign direct investment total half of global gross domestic product. Multinational corporations drive both. They shop around the world for the lowest-cost production centers and ship goods to wherever the demand is. Demand and supply are dislocated. So when a government introduces stimulus, the initial increase in demand doesn’t necessarily boost local supply. More importantly, if multinationals decide to invest somewhere else, there wouldn’t be an increase in jobs to sustain the growth in demand beyond the stimulus.
Just as water flows down, stimulus affects low-cost economies more, wherever it is initiated. As the West pours money into the global economy through large fiscal deficits or central banks expanding balance sheets, the emerging economies are drowning in excess liquidity. Everything is turning red-hot.