Author: Daniel Indiviglio

The Federal Reserve just released consumer credit data for November. The moral of the story: consumers are paying off some of their debt and/or not getting much new credit from banks. You might remember all of the demands that Congress put on banks to increase lending during the bailouts. In theory, if they had, then credit outstanding should have increased over that period. Well, I thought it might be fun to see just how effective (or ineffective) that pressure was.

According to the data, banks must not have been too ambitious in providing more consumer credit. In fact, since September 2008, consumer credit outstanding has declined. Here’s a chart:

This shows a decline of 4.4% in total consumer credit outstanding over the period from September 2008 through November 2009. Revolving and non-revolving credit decreased by 10.4% and 0.8%, respectively.

So who’s to blame? Let’s look at how the debt holders have changed the amount of credit they have outstanding to consumers from the third quarter of 2008 to November 2009:

I find this chart rather fascinating.

Observation 1: Wow Federal Government. Your consumer debt outstanding has increased by 72% in less than five quarters! That’s the kind of lending growth that only Uncle Sam can provide.

Observation 2: Finance companies saw a sharp decline. That makes sense, considering so few finance companies are left and how cash poor they are. Think about the struggles of CIT and GMAC. At least banks have deposits. Finance companies have likely had far more trouble securing financing to originate more loans.

Observation 3: Securitization is also way down. Remember, this even includes the Federal Reserve’s programs to prop up the securitization market. Once the Fed withdraws that support, securitization will likely be even slower, meaning that consumers will have a much harder time getting credit.

Observation 4: Commercial banks, credit unions and savings institutions have largely kept their consumer credit portfolios constant in size. So they didn’t do a whole lot of new lending since the bailouts, or at least they didn’t grow the amount of consumer credit on their balance sheets. Any lending they did merely replaced what was paid off or what was written off.

Earlier, Megan revisited the topic of her column in January’s edition of The Atlantic and pondered why everyone apparently “got stupid at once” during the real estate boom. I’d like to suggest an answer: commercial real estate might not have had any choice. I’d suggest that the boom began in residential real estate, and economics dictates that commercial real estate was doomed to follow its path.

Let’s start with the chart Megan mentions from Krugman:

I interpret this graph as showing that the party got started in the residential sector. It wasn’t until the end of 2002 that commercial real estate started showing significant appreciation, exceeding its pre 2001-2 recession level. The way I see it, the commercial real estate boom lagged the residential boom. If you move the red graph back about 8-12 months, it would practically sit on top of the blue one.

Let’s think about the two kinds of commercial real estate, that leased to residents and that utilized by businesses. I think both roads lead to the same result: unavoidable irrational appreciation thanks to the residential market.

Scenario 1: Commercial Real Estate Based On Rental Units

Home prices begin to increase. Since homes and residential rentals are substitute economic goods, when the price for one increases, the demand of the other increases, leading to its price rising as well. Thus, rental prices began to rise with housing prices. That would have led to (fully rational) appraisals of these commercial real estate properties rising, since the associated rental cash flows would be higher.

What if landlords had balked at the appreciation of their rentals? First, they wouldn’t. If you can get a higher rent price as a landlord, then that’s what you do. It would be stupid not to. And as rental prices rose, demand for housing probably began to increase further. A delightful little vicious cycle ensues, as demand for homes and demand for rentals seesaw, leading to higher and higher prices for each.

Scenario 2: Commercial Real Estate Based On Business Inhabitants

So you’ve got home prices increasing. You’ve also got residential rents increasing. On some level, real estate is real estate. What’s to stop commercial developers from abandoning office buildings and constructing more apartment buildings if that space becomes more valuable? Very little.

Indeed, the building where I rent my apartment is managed by a commercial real estate developer that had traditionally specialized in creating office space for companies, but got into the residential game when it thought it could be more lucrative a few years ago. My building remains its only residential property, as the party was over by the time its foray into the space was completed. Of course, in cities you also saw old factories and office space commonly converted into residences.

So commercial builders had two options: charge office tenants more or focus on residences instead. Again, these turn out to be substitute goods from the developer standpoint. The increase in the price of office space per square foot should follow any increase in the price of residential space per square foot. As the profit potential in the residential space increases, the supply begins to fall behind demand in the office/factory space sector, eventually leading to its price appreciating as well and more construction.

Moreover, the economy was roaring on all cylinders during this time period, so businesses could stomach increased commercial real estate prices. As banks got used to relaxing standards for residential real estate, they did the same for commercial real estate. And unlike in the residential space, banks and investors wouldn’t needed to be worried about businesses speculating on commercial real estate or trying to flip their factories or office headquarters like with residential real estate.

Like Megan, I think a whole lot of irrational expectations were a big part of the equation. But I can still kind of see an argument for commercial real estate having been a sort of casualty of the residential real estate boom. I don’t think you can make economic sense of a world where there’s an incredible boom in residential real estate but not in commercial real estate. And the graph above indicates that housing is, indeed, where the growth began. Commercial real estate was forced to follow, and I can’t see how it could have escaped that fate — no matter how rational commercial mortgage originators or borrowers might have been. This, by the way, makes it a little harder to dismiss the theory that that Fannie/Freddie/CRA started the runaway real estate train.

First, the internet. Then smartphones. Now it looks like Google wants its piece of the energy pie as well. The company created a “Google Energy” subsidiary last month. It’s also applied to the Federal Energy Regulatory Commission to be allowed to buy and sell power, like utilities. What exactly does the internet search leader want with energy? To be that much closer to taking over the world? Possibly. But it’s more likely that the company just wants to enhance and protect its profit margin.

The New York Times’ Bits blog reports:

Google said it did not have specific plans to become an energy trader and that its primary goal was to gain flexibility for buying more renewable energy for its power-hungry data centers.

“We want to have the ability to procure renewable energy to offset power usage of our operations,” said Niki Fenwick, a Google spokeswoman. Ms. Fenwick said that having access to more renewable energy could help the company fulfill its goal to become “carbon neutral.”

Right, because Google runs on energy, literally. Think about the thousands of databases and computer terminals sucking power 24-7 at Google’s headquarters each day. Does it really want to have to rely on electric companies to control its energy costs? If it had some power over its energy sources, that could bend its cost curve dramatically.

So what Google is likely doing here is bracing for the inevitable increase in energy prices associated with the depletion of fossil fuels. It would likely prefer to shape its energy destiny by relying on cheaper, renewable energy sources in the years to come. While this has pleasant environmental implications, there’s little doubt that Google has economic reasons for this endeavor as well.

But why the need to trade energy? Because if it eventually goes off the grid and lines up agreements with independent electricity producers, then it could end up with a deficit — or surplus — of energy at any given time. The company would benefit from greater flexibility to buy and sell that energy.

Or maybe it’s just part of Google’s plan for world domination. Perhaps, one day, we’ll all get our energy from Google. And our mobile phones, maps, books, e-mail, videos, searches. . .

Yesterday, I noted the Bloomberg story reporting that the New York Federal Reserve appears to have prevented AIG from fully disclosing the magnitude of its bailout that would go to pay bank swap counterparties. Washington has taken notice. The top Republican on the House Financial Services Committee, Spencer Bachus has sent a letter (.pdf) to committee chair Barney Frank demanding an inquiry. This scandal could have all sorts of repercussions in Washington.

First, here’s part of what Bachus wrote, after outlining the concern:

For all these reasons, our Committee has a duty to convene a Full Committee hearing in order to determine the facts surrounding AIG’s bailout. There is no more urgent business before the Committee and this hearing should be given the highest priority.

Given that the House is finished (for now) with financial regulation, I kind of agree with Bachus. And what might such an inquiry find out?*

First, and foremost, that the Fed hates transparency. Of course, that’s no surprise to anyone who follows the central bank. But this might fuel the fire for Rep. Ron Paul’s quest to reform the Fed. Republicans are — rightly I think — very angry that this kind of information was withheld from Congress when distributing taxpayer money to bailout a firm. I don’t think it’s particularly outlandish that Washington wants to understand how taxpayer dollars are spent. And, to me, it seems highly unethical to urge a firm to purposely withhold that information when they were planning on disclosing it — which is what it appears the NY Fed did.

From a people perspective, this finding could also matter. Fed chairman Ben Bernanke hasn’t been re-confirmed yet. While it has been largely expected that he would be, this news might make that confirmation process a little more difficult. Republicans will certainly question him about the NY Fed’s decision to withhold that information. If it causes a several Democrats to also doubt Bernanke’s ability to lead a reasonably transparent Federal Reserve, then the pendulum could sway away from re-confirmation.

It also reaches into the Treasury, with Geithner in the spotlight. He was the President of the New York Fed during the AIG negotiations. That means the buck stopped with him. We’re already hearing calls for his firing following yesterday’s news, and they may grow louder. President Obama advertised Geithner as a Treasury Secretary that didn’t cater to big Wall Street banks. This news paints quite a different picture.

Finally, the scandal could effect financial regulation. Republicans probably wouldn’t have been on board anyway, but you might see some stricter controls over the Federal Reserve added in now. There was already an amendment requiring a Fed audit, but some more ambitious language could now find its way into the bill’s final version if enough Democrats are also outraged with the NY Fed’s actions.

* Note: Turns out Barney Frank also finds the situation “troubling” and supports a hearing. This should be fun to watch.

The national unemployment rate was unchanged in December at November’s seasonally adjusted rate of 10.0%, says the Bureau of Labor Statistics. The rate also matched consensus expectations. Though the rate was unchanged, the U.S. economy lost 85,000 jobs in December, well above November’s surprising (revised) gain of 4,000 jobs. 85,000 is also worse than the 35,000 that economists predicted. That might not be as bad as it seems, however, as the number of unemployed Americans still managed to decline in December to 15.3 million from 15.4 million in November. This makes for some more ambiguous jobs news, so let’s interpret.

First, here’s how BLS shows the unemployment rate’s progression over the past few years:

And here’s its chart of actual job losses:

This graphic tells me two things. First, November’s wonderful news may, indeed, have been just a blip. However, you could still draw a pretty nice trend from December 2008 through December 2009. If this progression continues, then 2010 should show some actual job growth before too long.

On an industry basis, most of the usual suspects continued to suffer in December. Construction lost 53,000 jobs. Manufacturing lost 27,000. There were, however, 47,000 more temp jobs. That could be sort of good news, as it may indicate that businesses do need more employees, but remain reluctant to hire as many full time workers due to economic uncertainty. Health care continued to be a winner, adding 22,000 workers

If you disregard seasonality, the unemployment rate actually increased in December to 9.7% from 9.4% in November. So, yes, seasonality did play a role in the nationally reported rate remaining unchanged. As I noted last month, however, the seasonally adjusted and non-seasonally adjusted rates appear to be coming together:

The duration of those unemployed also continues to be troubling. Those unemployed for more than 27 weeks increased again, though the numbers declined for the prior two time periods:

The number of discouraged workers is also worsening. I find this possibly the worst news in the report. With 929,000 discouraged workers in December, we’re beginning to near the one million mark. It’s by far the highest number we’ve seen during the recession:

And the broader marginally attached unemployed number is up to a whopping 2.5 million people. Those Americans aren’t reflected in the reported rate of 10.0%, but if they were that rate would jump to 11.4%. If you add in those forced to work part time, then it leaps to 17.3%. That means more than one in six Americans can’t find full-time work.

Even though December’s national unemployment rate was unchanged, I found this report to be surprisingly negative. I would have thought that December would be a very slow month for layoffs, given the holidays. But the economy still lost 85,000 more workers in December, reversing direction from November’s gain of 4,000 jobs. And the soaring number of discouraged workers is also quite bad news. You won’t be able to have a legitimate decline in unemployed Americans until that number comes way down. Of course, for that to happen, the national unemployment rate will first have to go up, with those Americans re-entering the workforce. Let’s hope they find a newfound optimism in 2010 and more job opportunities.

Lastly, readers did fairly well yesterday in prediction this month’s rate. 26% thought the rate would be unchanged at 10.0%. That’s a great deal better than last month, when a mere 5% of respondents correctly predicted November’s rate. One interesting thing to note is that voters appear to be getting quite cautious about their predictions, as a full 70% of guesses were at or +/- 0.1% from the November rate of 10.0%. Here are those results:

Still not clear on why I don’t trust the Federal Reserve to be the systemic risk regulator? Want a great example of a conflict of interest where it urged a firm to withhold information to ensure its bailout go smoothly? Bloomberg provides just that today. It turns out the New York Fed, then under current Treasury Secretary Tim Geithner, may have told AIG to withhold details about the banks that would benefit from its bailout due to its swap agreements. This is ugly stuff.

Bloomberg reports:

AIG said in a draft of a regulatory filing that the insurer paid banks, which included Goldman Sachs Group Inc. and Societe Generale SA, 100 cents on the dollar for credit-default swaps they bought from the firm. The New York Fed crossed out the reference, according to the e-mails, and AIG excluded the language when the filing was made public on Dec. 24, 2008. The e-mails were obtained by Representative Darrell Issa, ranking member of the House Oversight and Government Reform Committee.

The New York Fed took over negotiations between AIG and the banks in November 2008 as losses on the swaps, which were contracts tied to subprime home loans, threatened to swamp the insurer weeks after its taxpayer-funded rescue. The regulator decided that Goldman Sachs and more than a dozen banks would be fully repaid for $62.1 billion of the swaps, prompting lawmakers to call the AIG rescue a “backdoor bailout” of financial firms.

“It appears that the New York Fed deliberately pressured AIG to restrict and delay the disclosure of important information,” said Issa, a California Republican. Taxpayers “deserve full and complete disclosure under our nation’s securities laws, not the withholding of politically inconvenient information.” President Barack Obama selected Geithner as Treasury secretary, a post he took last year.

One annoying thing about the Fed is that it’s perfectly okay with a lack of transparency, or even secrecy, in order to accomplish its goals. It has a sort of the-ends-justify-the-means attitude. This is a precise example of that. Even though regulators, Congress, and the Treasury should have known these details, the Fed must have thought the bailout would run more smoothly without mucking it up with the facts about where the money would ultimately be going.

With news like this, maybe I’m wrong about Geithner: Obama might want to replace him sooner than later after all. One can only hope that his Treasury strives for more transparency than his Fed.

According to a report today, a GM Executive is saying that the upcoming plug-in hybrid Chevy Volt’s price tag might not be as high as originally expected. Back when it was first announced, GM said that it would run a cool $40,000. I said that, although the vehicle’s 230 mile-per-gallon engine will give anyone without one green envy, that high cost prices out most Americans. But if the price does come down, that could capture a great deal more consumer demand — obviously great news for GM. But how low would the price have to come down to begin to make economic sense to American consumers?

Back when I first wrote about the Volt, I did a comparison between the Chevy Volt and the Toyota Corolla. I calculated how many miles you’d have to drive to take advantage of the Volt’s better gas mileage in order to justify its high price. I said that you’d have to drive 229,000 miles to break even. That led me to conclude that virtually no one will be driving a Volt for economic reasons.

But what about those who are willing to spend a little more on green technology — maybe we should compare it to the Toyota Prius. Let’s look at three price scenarios for the Volt and determine how many miles you’d have to drive during the life of your auto loan in order to save money by purchasing the Volt instead of a Prius.

First a few assumptions. I’m assuming a 60-month auto loan, where the borrower puts down 10% in either scenario and pays an interest rate of 7%. According to the Toyota website, the Prius starts at $22,400, which results in a cost of just under $400 per month under the assumptions explained. I’m using the current average price for gas of $2.665. I’m also ignoring plug-in charging costs for the Volt.

Volt Cost Scenario 1: $40,000 (base case)

Here, the Volt owner would have to pay $713 per month on the auto loan. So that makes the Volt’s payment around $314 more than the Prius’. It needs to make up that money in gas savings.

Under this scenario, the Volt owner would need to drive more than 7,750 miles per month (93,000 per year), before it becomes cost effective.

Volt Cost Scenario 2: $30,000

Here, the Volt owner would have to pay $535 per month on the auto loan. So that makes the Volt’s payment around $135 more than the Prius’. It needs to make up that money in gas savings.

Under this scenario, the Volt owner would need to drive more than 3,350 miles per month (40,200 per year), before it becomes cost effective.

Volt Cost Scenario 3: $25,000

Here, the Volt owner would have to pay $446 per month on the auto loan. So that makes the Volt’s payment around $46 more than the Prius’. It needs to make up that money in gas savings.

Under this scenario, the Volt owner would need to drive more than 1,150 miles per month (13,800 per year), before it becomes cost effective.

I think this shows that the Volt’s price will have to come way down in order for most drivers to consider it a good deal based on the better gas mileage for the life of the loan. Obviously, if the owner keeps the car well beyond the life of the loan, then the equation improves. It also improves if gas prices skyrocket. But for the Volt to look like a good deal during the life of the loan with gas prices stable, the average driver won’t want its price to much exceed $25,000. That would be a 37.5% price drop from the originally reported price. I’d be pretty surprised if the final price turned out to be that much lower. So I suspect that, even if today’s report is right and the price drops, the average consumer still won’t find the car that great of a deal from a financial standpoint since the price isn’t likely to decline that drastically.

Of course, I don’t mean to say that the any price decline won’t be welcome from consumers. Surely more people will buy a $35,000 Volt than a $40,000 Volt. But most of those buyers will still be wealthier Americans who care more about the green impact than the dent it makes in their wallets.

Tomorrow morning, we’ll get the final national unemployment reading of 2009, and the ugly economic decade that the month marked the end of. As usual, we’d like to give readers a chance to make a guess at what that number will be. December is a notoriously strange month for hiring and firing, so the number reported could be ultimately misleading in the grand scheme of unemployment trends for 2010. Still, it’s bound to be the subject of much talk, analysis and debate. What will it be?

According to yesterday’s ADP report, 84,000 jobs were lost in December, which was fewer than in November, but more than forecast. Of course, this doesn’t necessarily mean unemployment will rise. Even if jobs showed a net loss in November, there could be all sorts of other variables that take over to skew the national unemployment rate, like discouragement, seasonal retail hiring or workers simply exiting the workforce for the holidays.

Initial weekly jobless claims were also released today for the week ending January 2nd. The number of new jobless claims rose by just 1,000. That’s fewer than the economists’ forecast of 7,000. Of course, I’d suspect that the week between Christmas and New Year’s probably has one of the traditionally lowest layoff rates of the year, so you probably want to take this number with a grain of salt in terms the optimism it portrays.

Last month, readers did particularly poorly in predicting the positive news of a decline in the national unemployment rate from 10.2% in October to 10.0% in November. Only 5% got it right. Meanwhile, around 72% of those who voted thought the unemployment rate would increase, instead of decrease. Obviously, this was one of those times when it felt good to be wrong, but I’ll still hope for a better showing this month. Vote away!

Roll Call speculates that Sen. Christopher Dodd (D-CT) may not be retiring after all — he may trade his office in the Senate’s Russell Building for one in the Treasury. Could he replace Tim Geithner as Treasury Secretary? It’s not beyond the realm of possibility, but I doubt it.

Roll Call says:

For instance, several Democratic Senate aides noted that Treasury Secretary Timothy Geithner is an extremely unpopular figure in the Senate. Geithner has also taken the brunt of the criticism for the administration’s handling of the economy and, these sources speculated, if the country’s financial picture does not brighten before Election Day, he could be the first secretary to leave the administration.

Although Dodd would appear to be well-situated to take control of Treasury if the position were to open, it may not be smooth sailing for his nomination.

I have a few thoughts about this. The conspiracy theorist pragmatist in me wonders if the Obama administration promised Dodd a prominent position — even if it isn’t Treasury Secretary — in order to secure his promise not to seek re-election. Dodd’s prospects of winning in November were relatively dim, and the Obama administration knows that it can’t lose any Senate seats if it wants to push through its ambitious agenda in the second half of its term. Powerful Senators tend not to be meek or humble, so I find it surprising that Dodd wouldn’t want to go down without a fight, unless he had some other incentive to throw in the towel early.

Yet, Roll Call makes an important point about potential trouble with the nomination process. There’s a reason why Dodd may have lost re-election: he’s become a very controversial figure, having been accused of being in bed with the banking and finance industry prior to the crisis. As Faiz Shakir at Think Progress notes:

Dodd’s cozy relations with Countrywide and A.I.G. could subject his nomination to a messy confirmation battle.

Obviously, Republicans won’t make the process easy, but given these allegations, I wonder if even Democrats worry that Dodd is too poisonous, particularly for very prominent administration post like Treasury Secretary. I also think the Obama administration might look like it has egg on its face if it dumps Geithner. Republicans would surely use that as an opportunity to claim that the President is admitting his economic policies administered through Geithner didn’t work. Politically, even if things are still bad in the latter part of this year, the Obama administration might be smarter to just use the “it takes time to clean up a mess this big, so we should stay the course” talking point instead of scapegoating Geithner.

So while I think it’s possible that Dodd could very well end up in the Obama Treasury in some capacity, I’d be pretty surprised if he got the top post. Maybe he could run the one of the new agencies that financial regulation seeks to create — like the Consumer Financial Protection Agency. Something like that seems a lot more likely to me than Dodd replacing Geithner.

I’ve written several times about how the personal savings rate in the U.S. has increased significantly since the beginning of the recession. From a historical perspective, that’s not terribly surprising: when people are worried about the economy, they get a little more prudent with their wallets. But that’s just personal savings, which is only a portion of overall savings in the U.S. It doesn’t take into account total net U.S. savings, which would include corporate and government savings and borrowing. For that number, you find something much different.

Here’s a chart that tells the story, via Bloomberg’s chart of the day from yesterday:

The reason why you’re seeing this other savings statistic plummet is actually kind of obvious: the government has been forced to borrow a great deal of money in order to pay for the stimulus. According to the article accompanying the chart, the overall U.S. savings rate has plummeted to Depression-era levels. Specifically, the article says:

Deficit spending by the federal government reduced net savings at an annual rate of $1.33 trillion during last year’s third quarter. State and local government deficits widened the gap by another $14.9 billion. At the same time, personal and corporate savings increased by a record $983 billion.

This highlights an interesting problem with stimulus. The ramped up spending through borrowing that the government has done isn’t all stimulating the economy — individuals and corporations are saving a significant portion of that. While that’s sure to hamper the government’s efforts, it’s also a wholly rational psychological response on the part of consumers and businesses. Unfortunately, as this chart makes clear, most of the savings that those people and firms are doing will likely end up going towards higher taxes in the years to come in order to pay for all that stimulus spending by the government.

Over at Wired, Ryan Singel writes an ode to what Google’s new Nexus One smartphone could have been, and may still one day be. In a far more detailed manner than I did yesterday, he explains why Google doesn’t need to dominate the market — just have a presence there in the years to come in order to shape mobile data access in a meaningful way. I agree that his imagining must be what Google has in mind.

He wonders when Google will be content exiting the hardware market and focusing on its main business of software and advertising. He says:

Here’s the scenario that might get us there — Google convinces HTC that it’s not suicide to create a phone that can be used on any U.S. 3G network (maybe two — one GSM and one CDMA) and then sells it unlocked. It’s a great phone, and lots of people want it and there’s lots of great apps that run on it.

Users then could then take it to whichever carrier they like, and get a data plan a la carte. The carriers will hate this, perhaps create unfairly high prices and very annoying “device registration fees” — trying to protect the money they make offering phones at an initial discount in exchange for a two-year contract.

But the FCC will have passed a rule forcing carriers to accept any device that doesn’t hurt their network — much as Ma Bell was forced to open its lines — and Google, regulators and consumers will break down those barriers. Or the market could simply take care of it, with a desperate Sprint breaking ranks with the other large US telecoms and accepting a Nexus or any other device with no registration fee and a fair price for users.

And that’s when Google will stop making phones, and you’ll know that the Nexus One actually meant something.

And I think that’s exactly right. One thing I noted yesterday was Google’s decision to offer an unlocked version of the Nexus One — something that Apple has no intention of doing with its iPhone. Of course, this particular unlocked version is pretty weak. Sure, you don’t have to use T-mobile. You can use another GMS network instead. Which means AT&T. But you can’t use AT&T’s 3G data network. You can only use T-mobile’s. In other words, pretty much everyone who buys a Nexus One will be using T-mobile anyway!

But by offering the phone unlocked, I think this shows Google’s future intent. If this were an unlocked phone that could be brought to more networks, then it could start a meaningful revolution. That has to be the next step for Google’s vision to be realized, as Singel explains. Otherwise, it’s hard to see why the company would bother selling smartphones. The Nexus One and its future generations are a means to an end — a different kind of mobile world.

It’s kind of surprising that, from time to time, the debate seems to resurface of whether or not it’s a good idea to tax the daylights out of those earning unusually high incomes. Yet, an Angry Bear blog post pointed me to an argument it agrees with calling for a millionaire surtax. I have trouble with the piece’s logic.

The argument comes from a blog written by an anonymous economics graduate student hilariously titled “Economists For Firing Larry Summers.” Presumably, its author must find Dr. Summers far too conservative. In the post I care about, the writer attempts to make the case for taxing millionaires much, much more. It relies on an example featuring football star Peyton Manning:

Peyton Manning makes about $30 million a year — let’s explore his potential behavioral responses to changes in taxes. Let’s raise Peyton’s taxes by 10%. Under the logic of Alan Liard, Greg Mankiw’s student, and under the logic that all economists know to be the truth, people respond to incentives. Peyton Manning is a person, so he responds to this tax hike by working 6% less, and decides now he’s going to sit for the Colts playoff games since he makes less money per game, and he enjoys watching Tom Brady play in the playoffs more than being there himself. Doesn’t really sound likely, does it?

Of course, the mistake here is that that the author fails to fully understand how incentive works more broadly. If you don’t believe in incentive, then the logic he’s using probably makes perfect sense. So does socialism.

But if you do believe in incentive, and in capitalism, then you know that incentive can produce innovation, progress and economic growth. What I think the author is trying to get at is — even if you have a surtax on millionaires, they’ll still be motivated to excel if they’re making relatively more money than others. I don’t think the writer is arguing for egalitarianism so much as a much more progressive tax code. But I still think the author is wrong.

First, the question, I think, is how progressive such a tax would have to be to matter. I completely agree that in his example above, a 10% higher tax rate probably wouldn’t hurt incentive all that much. But 10% higher taxes for millionaires also wouldn’t produce all that much more tax revenue, which is presumably why you would tax them more. In order to collect a truly substantial amount more from millionaires, you’d have to raise their taxes by more than a few mere percentage points — there aren’t that many of them.

So, really, the example above might not be a big problem, but it also isn’t a solution. You need much higher marginal rates. Yet, the author doesn’t appear to be entirely comfortable with this, as writer isn’t completely unaware of incentive:

But then, you might object, *nobody* would have an incentive to become CEO if their salaries are capped around $1 million (if I was designing a tax system, I would probably not go over 50% on taxes before $3-4 million, but I would make Peyton Manning’s marginal rate closer to 70%…)

Here’s the problem: a much more progressive tax code still hampers incentive — even without any pure caps. Let’s imagine that millionaires taxes were raised by, say, 30% across the board, as he envisions. You have to go back further in the development of Peyton Manning than the author does in the example to really understand a surtax’s effect on innovation and economic growth. The problem is that there might not be anyone to replace Manning, because from a very early age, young football players might not have had enough motivation to excel.

Let’s generalize the example and ditch the football. Imagine you’re a kid, growing up in a lower- or middle-class family. The higher the tax on millionaires, the less reason you’ll have to work your hardest in school, get into the best college, and eventually get a job that could produce the most economic growth. After all, you might do all that work and still end up in a mediocre job, stuck in the middle class, no matter how hard you work. Natural talent and luck also have something to do with it.

The point is that ambition is a high-risk behavior. When you choose to work hard in school instead of partying, endure tens or hundreds of thousand dollars in loans to go to a top college, and/or sacrifice spending more time with your family to get that promotion, you’re making tough choices. Those easier alternatives look pretty attractive, particularly since you can’t be certain that the harder ones will lead to a better life or one day as a millionaire. Gliding through life is definitely an attractive path, so you’re taking a big risk by being so ambitious. I don’t know of any study to back me up, but I’d hypothesize there’s a strong correlation between ambition and low risk aversion for exactly this reason.

And as the author surely knows by studying economics, you should only take a huge risk if there’s a proportionally large reward that could follow. You wouldn’t invest $50,000 in a company with equally likely possible outcomes of losing all your money or making $2,500 profit. You might if that potential profit was $250,000 Similarly, you aren’t going to work hard throughout your early life and in your career if your earnings can never have the potential justify that sacrifice.

So where’s that line? 40% tax? 70% tax? I’m not sure. But the legitimate fear is that if taxes on income are raised to too high a level, then innovation and progress might suffer. The higher the taxes on the rich, the less reward for living an ambitious life.

A column by David Leonhardt in today’s New York Times seems to be getting a lot of notice in the blogosphere. In it, Leonhardt asks the question: if the Fed missed the real estate bubble, how can we expect it to see the next one? I sort of addressed this question on Monday, when I called into question the theory that the Fed needs more power to prevent such future failures. Leonhardt argues something different, and I disagree.

He buys into the idea that the Fed should get more regulatory power because it has the best resources to spot bubbles. Essentially, he’s calling for an apology and an explanation. In other words, he thinks the Fed can better spot bubbles if it’s a little more humble and introspective. I’m not convinced.

Specifically, Leonhardt calls for a sort of commission, charged by Congress, to investigate how bubbles were missed, saying:

In the future, a review process like this could become a standard response to a financial crisis. Andrew Lo, an M.I.T. economist, has proposed a financial version of the National Transportation Safety Board — an independent body to issue a fact-finding report after a crash or a bust. If such a board had existed after the savings and loan crisis, notes Paul Romer, the Stanford economist and expert on economic growth, it might have done some good.

Spotting bubbles is a really hard business. Imagine, for example, if such a report was issued after the tech bubble pop a decade ago. We might have learned how to prevent another tech bubble exactly like the one that formed, under exactly the same initial conditions. Of course, such a scenario would almost certainly never happen again anyway.

And the report certainly wouldn’t have helped with the real estate bubble, which was completely different. No other such report which might have been issued resulting from bubbles throughout the history of the U.S. would have helped either, because we had never experienced a real estate bubble leading to such disastrous consequences. Such reports won’t prevent new, unforeseen kinds of bubbles — which are precisely what we’re trying to avoid. The problem with unexpected systemic risk is that it’s, well, unexpected.

Stopping bubbles once they’ve started is also very difficult — both logistically and politically. This is particularly true for the Fed, whose mission statement includes keeping unemployment as low as possible. Even if the Fed had seen statistics indicating that a dangerous housing bubble might be forming in 2005 and decided to take action — can you imagine the political fallout if it caused a recession resulting in a few percentage points rise in unemployment?

Washington would have gone crazy. Most Americans would have too. How did the Fed know a bubble was forming? What if it was wrong and it hurt the economy for no reason?

I think the only way to ever hope to prevent systemic risk and bubbles — which might simply be impossible anyway — would be through a new, independent agency charged with exactly that task. It should be completely devoid of conflicts of interest. Its sole focus should be mitigating systemic risk. And if it’s also the non-bank resolution authority, then it would have the vested interest to do so, as its insurance fund used to wind-down institutions would suffer if it screws up.

I’ve never accepted the argument that the Fed should be systemic risk regulator just because it’s the most easily equip to do so. There are conflicts of interest that I’ve explained before that could prevent it from excelling in this responsibility. Frankly, even the FDIC would be a better choice to house this new regulator, if it weren’t a separate new agency altogether. Unfortunately, looking at the House’s financial regulation bill, which is likely to resemble whatever becomes law, the Fed will likely get this power anyway.

If I were a debt collector, I would be pretty unhappy about an AP article that came out yesterday. It portrays the career as one for felons and bullies. And indeed, there are some collectors who do use unlawful tactics. But there are also bad eggs in other industries who sometimes break the law. There are dirty doctors, lawyers, cops and hedge fund managers, to name a few. I don’t think the article fairly singles out the collections industry.

In my prior life as a consultant, I actually had the opportunity to meet quite a few debt collectors. It definitely does take a special breed of person to call people up and demand they pay the money they owe. Imagine, for a moment, calling a single mother struggling to make ends meet. She owes, say, $500 on her credit card and is several months delinquent. She tells you that she lost her job and needs her unemployment money to pay the rent and for food for her children. You can hear it in her voice that she’s near tears.

Yet, it’s your job to look past all that. She owes your company money. Her current financial situation doesn’t matter much to your boss, or his boss, or the company’s CEO: she needs to pay the bill.

So what do you do? You have to shrug off her troubles and tell her that she needs to pay. There was a contract in place where she promised to make payments on the card in accordance to what she spent. But do you have no heart?

Talk about a grueling job. What an awful thing to do day-in and day-out. You basically have to demand money from people, most of whom can’t afford to pay. I know it’s something I wouldn’t want to do. Yet, is AP really playing fair in beginning its article about Buffalo’s collection agencies by characterizing these collectors as follows:

When Tobias “Bags of Money” Boyland went looking for a new career after serving 13 years in prison for armed robbery and drug dealing, he quickly found something that suited his sensibilities: He opened a collection agency.

Really? Because this epitomizes anyone willing to help a firm collect money that it’s legally owed? The article continues by explaining that many collectors have gotten in trouble with the law. It even presents a little data showing that complaints about collectors are up. Just look at this chart!

This looks bad, doesn’t it? Look at 2008. It’s increased so much that AP took the time to highlight the associated bar. Eyeing the graph, it looks like the bar went from around 71,000 in 2007 to 79,000 in 2008. That’s an increase of 11%!

But wait a minute — overall delinquencies were also way up. The time period in question was during a deep credit-driven recession. In other words, there were a lot more people getting calls from collectors too. If the number of delinquencies increased by 11% or less, then AP might be onto something. That would imply that complaints are increasing at a greater rate than delinquencies. So how much are delinquencies up from 2007 to 2008?

25% for Consumer Loans (which includes credit cards)
103% for Residential Loans (which includes mortgages)

That’s the increase in delinquencies at the end of 2008 versus the end of 2007, according to the Federal Reserve. In light of this data, it’s pretty clear that there were actually fewer complaints per delinquent account in 2008 than in 2007. The collectors are doing better, not worse.

Now don’t get me wrong. There are some collectors out there who are awful people — criminals even. But as I mentioned at the start of this post, the same could be said for any other industry. And while I admit that it takes a special kind of person to be able to bully struggling people for money, that’s the job. Remember, delinquent borrowers aren’t being unfairly singled out with these firms trying to steal their money; they had contractual agreements and aren’t holding up their end of the deal. So these “bullies” aren’t stealing anyone’s lunch money — they’re trying to prevent people from stealing theirs.

At noon today, Senator Christopher Dodd (D-CT) is expected to announce that he won’t seek re-election. He’s the chairman of the Senate Banking Committee. As you probably know, these days, that’s a particularly important post. This year, it matters even more than usual, as the financial regulation push will make up a major part of Washington’s efforts in 2010. Indeed, Dodd authored the Senate’s financial regulation bill. Will his announcement have any effect on getting this legislation passed?

I think it could. Dodd will be a sort-of lame duck. As a result, his bargaining power will be diminished.

First, you might recall that his proposal is far more ambitious than what the House passed. I think you’ll quickly see those lofty goals fade. It would have been an uphill battle in the Senate to pass something stronger than the House’s version anyway. After all, he was already having trouble. Since he won’t be around next year to follow through with deals made, logrolling will be even more difficult.

In fact, I think his imminent exit could even make it more challenging for the House bill to get through the Senate. As Banking Committee chairman, Dodd had a lot of clout in being able to grant favors and have other Senators wanting him on their good side. Even if his more ambitious regulatory proposals slipped through the cracks, he would certainly have planned to at least fight for what the House wanted. Today’s announcement should knock his influence down a few pegs. That might make it even harder to get meaningful financial regulation through the Senate. And given the Senate’s more moderate stance compared to the House, it wouldn’t have been easy to begin with.

As I’ve said before, Congress will get some financial regulation passed eventually. But Dodd’s decision to announce his retirement today should make the Senate a bloodier battleground in the legislative fight that’s sure to ensue. It could even be more difficult than health care, particularly since there’s now no clear and powerful leader in the Senate to push for financial regulation.

Last week, when you were making sure your champagne was chilled to celebrate the demise of the awful first decade of the 2000’s, GMAC also had reason to rejoice. On December 30th, it got its third bailout from the government. Given the timing, you might have missed this news. Well there’s some more this week: GMAC expects to post a $5 billion loss. For just the 4th quarter. It’s very disappointing to see the government continue to plow money into such a flawed firm.

Let’s quickly review the bailout tally for GMAC thus far. Its fresh $3.8 billion bailout from last week adds to its prior $13.5 billion. This also increases the U.S. government’s stake to 56.3% — a majority share. So congratulations American taxpayers: you now own GMAC too.

And how about the firm’s recent performance? Its full-year loss is now expected to total around $10 billion.

Since I’ve already made the argument that GMAC should be allowed to perish, I guess there’s not a whole lot else for me to analyze on this front, other than just to shake my head in disgust.

It’s doing so poorly mostly because of its terrible mortgage portfolio. Why keep the firm alive? Do we really need it to originate new mortgages? No, we have plenty of other banks to do that. Do we need it for auto loans? No, GM can go elsewhere to get its auto loans financed. Maybe I’m missing something; I still need some help on this one.

The firm doesn’t appear to pose systemic risk to the economy. But its failure probably poses significant risk to Washington’s fundraising efforts. Luckily for those politicians, the news of the latest bailout was neatly drowned out by the New Year’s holiday.

The Federal Trade Commission must not be very busy these days. I say that because of its decision to look into cloud computing. Apparently, it’s worried about the security and privacy implications of storing data remotely. I find this a bizarre target of inquiry.

ReadWrite Enterprise considers the FTC’s investigation, saying:

In the filing, The FTC recognizes the cost savings of cloud computing but has concerns about information being stored remotely:

“However, the storage of data on remote computers may also raise privacy and security concerns for consumers,” wrote David Vladeck, who helms the FTC’s Consumer Protection Bureau.

This statement is puzzling. People have been storing their data remotely since the early 1990s on services that predate the social networks.

That’s exactly what I was thinking. Data has been stored on computers remotely for many years. Moreover, how is remote data storage much more dangerous than on-site data storage? Firms have long had networks that hackers could attempt to break into for quite some time. If hackers attempt to access a cloud computing database, how is that any different from if they just broke into a company’s or individual’s network directly instead?

I’m sure there’s a lot of valuable work that the FTC could be doing. This isn’t it. Let’s hope it just amounts to a waste of time and doesn’t prevent any technological innovation that cloud computing could bring.

I think so. And I certainly hope so. But not many Americans agree with me according to a new Rasmussen poll. Only 38% of respondents believe that the economy will be stronger in a year. Meanwhile 39% think it will be weaker. That’s up 8% from a year ago. I find these results quite surprising and rather troubling.

I both love and hate polls. So often the results are so counterintuitive that I hardly know what to say about them. But they aren’t worthless. The thing to remember is that they’re just polls, nothing more. So what this says is just that 39% of respondents in Rasmussen’s poll believe that the economy will be weaker in a year. According to Rasmussen, this is generally representative of the U.S. population.

But what exactly does this statistic mean? Will unemployment be higher? Will home prices be lower? Will Americans be spending less? Will manufacturing output dive? Will GDP plunge? There are so many measures of economic health and stability that I can’t be sure what those respondents had in mind when they said they believe the economy will be weaker.

Yet, a general feeling of pessimism does mean something, particularly for spending. If that many Americans are still that gloomy about the nation’s economic prospects, then to me that indicates that they’re going to be very cautious with their wallets. And if spending doesn’t pick up much this year, then that could make for a self-fulfilling prophecy. U.S. GDP is very dependent upon consumer spending. Without its revival, the economy will have a hard time gaining its footing.

This also may say something about unemployment. In theory, those polled should include a representative portion of business owners and management. Although we don’t know the exact breakdown, if that subset is also pessimistic at a 39% proportion, then this confirms the idea that employment growth will be quite slow. If management thinks things will be worse in a year, then they’re not going to be doing a whole lot of hiring in 2010.

Don’t get me wrong: we can’t will ourselves into recovery. The financial crisis and the deep recession that followed exposed some real, fundamental structural flaws in the U.S. economy. They won’t be quickly fixed. But pessimism can gunk up a recovery. Psychology matters more in economics when consumers see the glass as half empty.

I have a little trouble imagining that things on a whole will be worse in a year. That would almost certainly mean a double-dip recession is in the cards. If unemployment is over 10% in November 2010, then we’re in a lot of trouble. (And Democrats are really, really in trouble.)

So count me in the more optimistic — but only slightly optimistic — 38%. I think the recovery will be slow, but I can’t believe that things will be even worse in a year. Even with mixed economic indicators, we’re seeing enough green shoots to indicate that the economy isn’t experiencing much further deterioration.

Over the past several months, there have been numerous news stories about the government developing new methods of forcing people and corporations to pay taxes the way the government thinks they ought to be. We’re hearing about Washington cracking down on tax havens and looking harder at how wealthy Americans pay their taxes. Just yesterday I wrote about how the IRS is making sure tax preparers aren’t shady. Now, the New York Times reports that multinationals’ taxes are being more closely scrutinized.

Why all the additional oversight? Because the Uncle Sam needs the money: when wealth is destroyed in a nasty recession, so is potential tax revenue. But given the economic turmoil, the government knows it can’t raise taxes. But when you think about it, is there really any difference between collecting more taxes by: a) forcing people more closely follow the rules and b) just increasing tax rates?

First, a disclaimer: I wholeheartedly believe that individuals and firms should be following all tax laws prescribed, not only technically, but even in spirit. I’m an advocate for a much smaller government, and consequently much lower taxes, but I believe that the way to do that is through legislation — not trying to scam the system. So anyone wanting to pay less in taxes should be lobbying having a talk with lawmakers, not searching for tax loopholes that they can just barely contort their way through.

So I don’t mean to look like I hold a lot of sympathy with would-be tax evaders. I don’t. I think they should pay what they owe. But I also think timing matters.

For example, let’s consider a section from the NY Times piece that I noted above. It says:

Companies like Microsoft and Google have long pushed their effective tax rates down by moving functions to lower-rate jurisdictions like Ireland, which has a low tax rate on royalty income — as low as zero — and a 12.5 percent corporate tax rate, against the 35 percent rate in the United States.

Now, it just so happens that I believe that this shouldn’t be a considered loophole, but that the tax code should clearly state that multinationals can qualify for foreign earnings to be subject to the tax rates which apply in the nations where the business takes place. But let’s pretend for a minute that this was a true loophole. Imagine if U.S. multinationals were taking advantage of the system and paying only 12.5% when they should be paying 35%. In whole numbers, if a company should be paying $35,000, it’s instead only paying $12,500.

If you close the loophole, then aren’t you just effectively raising taxes on these corporations or individuals? Of course you are. The difference is entirely semantic. At the end of the day, taking $22,500 more in taxes is what actually occurs, whether you call that a “tax increase” or “better oversight.”

As a result, even though the government’s heart is sort of in the right place in forcing people and corporations to pay what they really owe, the effect would still be just as negative on the economy as if it simply instituted an across-the-board tax increase to produce the same amount of revenue. As anyone who knows some basic economics can tell you, during a recession, or in the very early stages of recovery, a government isn’t wise to raise taxes. And by increasing oversight, that’s just what it’s doing — even if it sounds good to honest taxpayers. Tax evaders should get theirs, but justice could stand to be delayed for a year or two for the sake of everyone else.

The National Association of Realtors released some discouraging data today about the U.S. housing market. Its Pending Home Sales Index dropped a whopping 16% in November compared to October. It’s still 15.5% higher than it was a year ago, but the month-over-month decline is troubling since the trend had been consistently positive for some time. I think there’s reason to worry.

First, here’s that trend over the past twelve months:

The chart shows how each month’s index value changed versus the prior month. As you can see, it had been positive — meaning the index had been increasing — since February. This graphic also shows that the index fell off a cliff in November. And for anyone who wants to grumble about winter being a slow time for home sales: the index is already seasonally adjusted. On a non-seasonally adjusted basis, it would have decreased by 28%, not 16%.

There are a few things to consider when trying to determine what this drop in pending home sales means. Obviously, supply isn’t exactly drying up — there’s still an awfully big housing inventory. So any change must be more demand driven.

The government home buyers credit should have some effect. You might recall that in early November the first time home buyers’ credit was renewed through next April. At that time it was also expanded to include a smaller credit for most current homeowners. So even though homeowners were no longer rushing to buy a home before the credit would have expired in November, nothing really should have discouraged them from buying a home if they were already considering doing so. Indeed, for current homeowners, November marked the first month that Uncle Sam would give them a little gravy for taking the plunge.

Meanwhile, interest rates were also incredibly low during November — sub-5% for nearly the entire month, according to Freddie Mac. When consumers can get more for their money, it’s particularly surprising they’d be pulling back.

So while some of the decline might be blamed on demand relaxing and being delayed to early 2010 due to the credit’s extension, I think a drop this big is still meaningful. If the index doesn’t increase significantly through the first quarter from this level — or actually continues to decline — then I think you might be seeing the beginning of some home buying fatigue on the part of the American consumer. After all, there are only so many Americans out there who want to buy a home and have the savings and credit profile during this difficult time to do so.

If demand really has been exhausted, that’s extremely bad news for the housing market. 2010 will likely see significant increases in mortgage rates, which will deter some potential homeowners. If that pool of perspective buyers turns out to be quite limited to begin with, we might see housing inventory begin to increase again significantly as foreclosures continue, and prices could plateau — or even erase their 2009 gains.