Author: WSJ.com: Real Time Economics

Strained budgets in states and local governments don’t just affect the area residents — they can cause a drag on the whole U.S. economy.

Spending from state and local governments fell at a 2% annual rate in the fourth quarter, a revised gross domestic product report showed today. That’s much worse than the 0.3% drop in the original estimate or the 0.6% decline in the third quarter. And upcoming quarters could show similarly bad numbers as revenues continue to fall.

“These administrators are likely to have to fire more workers and obviously cut spending,” said BNP Paribas’ Anna Piretti. “That would have a very large impact.”

Piretti noted that state and local governments are roughly the same size as the manufacturing sector — the area that’s been the main impetus for economic activity so far — and could seriously damp growth.

“If you see substantial weakness there it would offset the strength we’re seeing in manufacturing,” Piretti said.

It’s just another reason for analysts to worry that the economy could remain fragile as long as consumers aren’t contributing more to growth.

Federal Reserve Bank of Kansas City President Thomas Hoenig reiterated his call for interest rates to go back to normal levels sooner rather than later, but warned that the U.S. government’s budget deficit puts pressure on the Fed to keep rates low.

Hoenig

In an interview with C-Span’s “Washington Journal,” Hoenig said one of the issues that he has dealt with is how to bring interest rates back to a more long-term sustainable level from the current “extremely low” and “obviously unsustainable” levels.

“There are some disagreements. That’s one thing about a committee like the [Federal] Open Market Committee where you can have different views, and I do share a different view,” Hoenig, who’s a voting member of the FOMC, said. “We should be going back to more normal levels sooner rather than later.”

Hoenig, known as a more conservative member of the FOMC when it comes to the inflationary pressures stemming from the Fed’s loose monetary stance, said he dissented on the usage of the word “extended period” at the FOMC’s last rate-setting meeting.

“Because I’d like to be in a position, should the economy continue to improve, and I think it will modestly, that we’ll be able to move back to more normal rates sooner rather than later,” he said. “I don’t consider it necessarily in our interest to assure the markets that rates will be zero and they can play the yield curve…because that invites speculative activity.”

Hoenig also said he was “very concerned” about the debt levels in the U.S. and the federal deficit.

“Depending on your assumptions about the economy, that federal debt will grow at an unsustainable level starting immediately, or in a very few years,” Hoenig said. “We do have significant private debt, so that’s in place, so what worries me about that [is] that puts pressure on the Fed to keep interest rates artificially low as you try to deal with that debt.”

President Barack Obama earlier this month unveiled his $3.8 trillion budget for the coming fiscal year, which raises taxes and cuts spending, but which will still leave the U.S. with $8.5 trillion in added debt over the next decade.

Even with tax increases and spending cuts, Obama’s budget would lead to a record deficit of $1.6 trillion this fiscal year, shrinking to $706 billion by 2014, only to begin rising again as retiring Baby Boomers drive up the costs of Medicare and Social Security.

Speaking about the legislation being considered by the Senate’s Banking Committee to take away the Fed’s role of financial markets supervision and oversight of banks, Hoenig said that such proposal is a “tragic mistake.”

“It takes the eyes away from the Federal Reserve in knowing what’s going on in America, not just in Wall Street, but in middle America,” he said. “I very much would hope that the Senate would not take that kind of responsibility away from the Federal Reserve because I think the outcome would be negative or essentially a very bad outcome for banks and for the communities of America.”

State budgets continue to decline as falling sales and income taxes leave them in a deepening pool of red ink, according to a report from the left-leaning Center on Budget and Policy Priorities. State budget shortfalls are nothing new, of course, but they continue to get worse even as the economy gets better. Partly that’s because it takes time for tax collections to catch up with all the havoc in the economy. But taxes also tend to be more closely tied to the job market and retail sales – two areas that have continued to be battered by the recession.

According to the CBPP report:

• 41 States have a cumulative mid-2010 budget shorfall of $38 billion, or 7% of their total budgets.
• 2011 is set to be much worse, with $103 billion in deficits — 17% of the total budgets — across 42 states.
• Assistance from the $787 billion economic stimulus will likely run out before states have seen their taxes recover — meaning budget gaps could continue for several years after the recession is over.

Midyear Budget Deficits

Source: Center on Budget and Policy Priorities
Notes: For some states, a portion or all of these deficits have been closed.
* Amount shown for Washington is for the two-year budget ending in FY2011.

A roundup of economic news from around the Web.

• Safe Dollars: Writing for Project Syndicate, Martin Feldstein says the dollar is safe. “The big risk to any investor is the possibility that inflation will virtually annihilate a currency’s value. That happened in a number of countries in the 1970’s and 1980’s. In Mexico, for example, it took 150 pesos in 1990 to buy what one peso could buy in 1980. That is not going to happen in the U.S. Large budget deficits have led to high inflation in countries that are forced to create money to finance those deficits because they cannot sell longer-term government bonds. That is not a risk for the U.S. The rate of inflation actually fell in the U.S. during the early 1980’s, when the U.S. last experienced large fiscal deficits.”
• Fed Exit: On the Financial Times Michael Bordo and John Landon Lane looks at history to try to figure out when the Fed will move rates. “From this historical perspective, how will the exit strategy play out now? Our evidence suggests that if we follow the patterns of postwar business cycles, and if unemployment has peaked in the fourth quarter of 2009, we may see a tightening in the first quarter of 2010 but more likely in the second quarter. However, if unemployment falls slowly — and if the last two recessions are any guide — the Fed may delay longer. This raises concerns that prolonged maintenance of low rates will fuel future inflation. Indeed, the public’s rush into inflation-protected government bonds may be a harbinger of a future rise in inflation expectations.”
• Grading White House Economists: The Economist aims to see how different groups of White House Council of Economic Advisors fare. “Measured by citation scores per team member, though, the present CEA does not stand out as much. The average score for 2009 works out at 291, much higher than 2008’s 185 (despite multiple citations for the then chairman, Edward Lazear) but well below the average for Mr Mankiw’s team of 2003, when the average was 641. The count for 1982’s “dream team” is an impressive 755. For 1993, when Joseph Stiglitz and Alan Blinder were members of the CEA, and the senior economists included the eventually much-cited David Cutler and Matthew Shapiro, the average score is 736.5. Ms Romer’s team is handicapped by our use of lifetime citation counts, but the difference is still striking. Citations, of course, are an even more flawed measure of quality for staff economists, who tend to be younger. So we ranked the past ten years’ CEAs by the average quality of the economics departments where their senior economists got their PhDs. This too is imperfect, as the rankings do change, albeit slowly. But by this measure, the present cohort of senior staff economists is the second-best-qualified in academic terms of any of the past ten CEAs. It is beaten—but only barely—by the staff assembled by Glenn Hubbard for George Bush junior in 2001. It does even better than Mr Feldstein’s 1982 team. If part of any CEA’s influence comes from the academic prestige of its members and staff, the present council has little to worry about. But it is not yet the most brilliant since the 1960s.”

Compiled by Phil Izzo

The Federal Reserve has pushed short-term interest rates to near zero, flooded the financial system with loans and committed to purchase more than $1.7 trillion of mortgage and Treasury securities to restart a financial system devastated by the debt crisis. After all that, however, financial conditions tightened a bit at the end of 2009, according to a new study produced by a collection of Wall Street and academic researchers.

The reason is that even with exceptionally low interest rates, capital markets aren’t humming and bank lending is weak. One example: Issuance of asset backed securities — which are securities backed by auto loans or credit card debt — was a scant $28.7 billion in the fourth quarter, down from $51.1 billion in the third quarter and $50.1 billion in the second. Levels of commercial paper — the short-term credit many companies used to fund themselves before the financial crisis — were also soft, with outstanding paper at $1.1 trillion at the end of January, compared to $1.3 trillion in September.

In an unusual collaboration, the chief economists from Goldman Sachs and Deutsche Bank teamed up with economists at Princeton University, Columbia University and New York University to produce an index measuring financial conditions. It is an important exercise because financial conditions help to drive economic growth, inflation and asset prices. When money is loose and easy, the economy tends to grow faster in the short-run, though inflation and asset price booms can build. Tight money, on the other hand, is like a lack of oxygen which can strangle growth.

There are already more than a half dozen financial-conditions measures floating around Wall Street, academia and the Fed. Many of them focus on the price of money in the financial system — interest rates — and not the quantity of money. Economists Jan Hatzius (Goldman), Peter Hooper (Deutsche Banks), Frederic Mishkin (Columbia), Kermit Schoenholtz (NYU) and Mark Watson (Princeton) produced a new index the includes many different measures of the amount of money in the financial system, including issuance of asset backed securities and commercial paper and the short-term securities used by investment banks to fund themselves. They included 44 indicators in all. They are presenting the paper today at a gathering on monetary policy in New York which will include several senior Fed officials.

What they found is that after improving markedly in the first half of 2009 — thanks in large part to the Fed’s money pumping exercises — financial conditions tightened again in the second half of the year, unusually so for the early stages of a recovery. “The fact that financial conditions are still impaired, at least in some parts of the system, is consistent with the idea that the recovery is going to be a slow one,” Mr. Hatzius said. “It is consistent with a fairly slow, U-shaped recovery.” It also suggests inflation and bubbles shouldn’t be a big worry in the U.S. — money is cheap but not easily accessible as it was during the boom.

One of the most important drivers of the economists’ financial conditions index was the asset-backed securities markets, where commercial real estate loans, car loans and many other kinds of bank loans were financed during the credit boom. Loans in this market are packaged into securities and sold to investors around the world. In 2006, issuance of asset backed securities — not include residential mortgage backed securities — topped $700 billion, according to the Securities Industry and Financial Markets Association. It was $168 billion last year.

The Federal Reserve has expended huge amounts of energy trying to restart this market, with the creation of a program called the Term Asset-backed Securities Loan Facility, or TALF, which provides cheap, nonrecourse funding to investors who buy these securities. Issuance of the securities perked up after the program was launched last March, but the market remains highly impaired. One problem: Many investors have become less trustful of credit ratings attached to the securities after the bust. Many individuals and firms also remain reluctant to take on more debt.

A similar pattern is showing up in the “repo” loan market, where many securities brokerages and banks funded themselves before the financial crisis hit. In this market, a financial firm uses its securities holdings as collateral for short-term loans, which help it to fund its activities. Panics in this market in 2008 helped to drive firms like Bear Stearns and Lehman Brothers to the brink. The market picked up a bit last year, but at $1.338 trillion in the third quarter, was still less than three-fifths its size in 2007. That also held down the economists’ index. Broader measures of money growth are also soft. M2, a measure of deposits in the banking system and money market funds, contracted at a 0.9% annual rate in the three months through January, according to Fed data.

“It is still the aftermath of the bubble,” says Mr. Hatzius. “The deleveraging still continues.”

The U.K. economy expanded a revised 0.3% in the fourth quarter, reporting stronger growth than originally estimated. The numbers confirm the U.K. economy exited recession in late 2009, and suggest it did so with more momentum than first thought. Below, economists react.

The upward revision to GDP was higher than expected, but the detail of the data gives rise to significant concerns. The upward revisions stemmed in large part from much stronger retail sector output, presumably reflecting purchases having been brought forward ahead of the VAT hike [at the start of 2010]- so strength here is likely to wane. – Ross Walker, RBS European Economics

This upwards revision is an encouraging sign that the economy has been growing stronger, and for longer, than the official data suggest. The details of Q4 demand weren’t particularly robust, though. All of the increase in GDP could be explained by the pace of destocking moderating in Q4 – inventories added 0.5 percentage points to the quarterly growth rate. Final demand, consequently, was still negative. However, that’s not unusual at this stage of the cycle. – Neville Hill, Credit Suisse European Economics

[T]he upward revision will only modestly dilute fears that the economy could suffer relapses over the coming months as it deals with January’s bad weather, the VAT hike, an ending to the car scrappage scheme in March and Quantitative Easing being halted. Faltering growth in Europe is also a concern for export prospects…. Indeed, the significant weather-related hit to a still very fragile [U.K.] economy at the start of 2010 means that there is a very real danger that the economy could suffer renewed contraction in the first quarter. – Howard Archer, IHS Global Insight

Government workers were far more likely to report that they had been injured or fallen ill at work in 2008 and had to take time off compared to private sector employees.

Among state government employees, there were 170 cases of ailments per 10,000 workers that forced them to take time off work, the Labor Department said this week in its report on workplace injuries and illnesses in the public sector. None of the injuries tracked in this series were fatal. State employees took a median of eight days off to recover. For local government workers, the incidence rate was 195 with a median of nine days away from work.

Private workers, however, reported a much lower incidence rate: 113 cases per 10,000 employees.

Service-sector jobs accounted for about half of the injuries for public sector workers because they include professions in health care support and public safety.

People who work in those professions, it turns out, were also more likely to be assaulted. Some 27 state workers for every 10,000 were attacked by another person while at work. More than half of those events took place among correctional officers, psychiatric aides; and psychiatric technicians. Meanwhile, just two out of every 10,000 private workers were assaulted by another person at work.

Overall, sprains and strains were the most prevalent injury among both public and private sector employees.

Incidents of injuries and illnesses tended to be more spread out in the private sector. Nearly 22% took place in the service-sector, another 20% occurred in the transportation industry and nearly 13% took place in production occupations.

Meanwhile, here are some other random factoids:

• Out of a total of 1.4 million injuries and illnesses, 7,690 were from workers being attacked by animals.
• The most likely source of injuries, for all workers, were floors, walkways, ground surfaces.
• Men suffered from nearly 63% of all injuries and illnesses whereas women accounted for 37% of them.
• Local government employees were responsible for 15% of the 1.4 million days-away-from-work that employees in both the public and private sector reported. They only make up 9% of the work force.
• The incidence of falls on the same level for local government employees was more than twice that of private workers. Some 37% of those falls happened to janitors and cleaners; police and sheriff’s patrol officers; elementary school teachers; teacher assistants; and secondary school teachers.

A plan under serious consideration by Senate Banking Committee Chairman Christopher Dodd (D., Conn.), to potentially create a new consumer protection division within the Treasury Department instead of establishing a new entity as originally designed by the White House, triggered a variety of reactions on Thursday. The agency envisioned by the White House was called the Consumer Financial Protection Agency, or CFPA.

White House spokeswoman Jennifer Psaki said the administration’s top priorities “are ensuring the bill includes independent appointment, an independent budget, and an independent ability to set and enforce clear rules of the road to protect American families.” What she didn’t say, though, is that the agency must be a standalone entity, showing how the White House and Mr. Dodd may be converging in this area.

House Financial Services Committee Chairman Barney Frank (D., Mass.) said lawmakers’ experience with the recent credit card legislation, when banks sought to impose higher fees ahead of the law going into effect, highlights the need for a CFPA.

“It showed why you need the agency. Obviously when the Senate acts we’ll see what they’ve got but I’m not ready to start giving things away now,” Mr. Frank said following a hearing on Capitol Hill.

The U.S. Chamber of Commerce, which has aggressively fought the creation of the CFPA, put out a statement saying housing CFPA within Treasury could still pose major problems for businesses.

“While we appreciate the administration’s willingness to consider alternatives, suggestions that the proposed CFPA could be housed within the Treasury Department is merely a victory in form, not in substance,” said Ryan McKee, senior director of the Chamber’s Center for Capital Markets Competitiveness. “Make no mistake about it, this new proposal is nothing more than a wolf in sheep’s clothing.”

The Federal Reserve’s new pay rules for banks are coming into better focus. Its general counsel, Scott Alvarez, was on Capitol Hill explaining how the rules, announced last October, are developing. He sought to draw distinctions between how the rules would affect small banks, big regional banks and the biggest firms. Here’s how he broke it down:

Big Firms, focus on deferred compensation and clawbacks: “It is clear that substantial changes at many firms likely will be necessary to fully conform their practices with principles of safety and soundness. For example, at many firms, the measures and systems needed to make the incentive compensation of non-executive employees appropriately risk sensitive are not well advanced. And, in some cases, the deferred compensation of senior executives is still not subject to downward adjustment based on the full range of potential risks facing the organization, such as liquidity or operational risk. In addition, few firms have processes in place that would allow them to compare incentive compensation payments to risk and risk outcomes.” He addes he expects, “significant progress to improve the risk sensitivity of incentive compensation at [these firms] for the 2010 performance year.”

Smaller banks and regional banks, going light on the little guys:
“Examiners will gather a consistent set of information through regularly scheduled examinations and the normal supervisory process. Information collected from regional organizations will encompass information on their incentive compensation practices and related risk-management and corporate governance processes. The focus of the data collection effort at community banks will be to identify the types of incentive plans in place, the job types covered, and the characteristics, prevalence, and level of documentation available for those incentive plans … After comparing and analyzing the information collected, supervisory efforts and expectations will be scaled appropriately to the size and complexity of the organization and its incentive compensation arrangements. For example, a large regional organization that uses incentive compensation arrangements extensively may require additional supervisory work to understand and assess the consistency of the organization’s practices with principles of safety and soundness. If practice is as expected at community banks, it is likely that very limited, if any, targeted examination work or supervisory follow-up will be required.”

The Federal Reserve has provided all the support it can to the economy, and now is the time to allow those supportive policies to bear fruit, Bank of Dallas President Richard Fisher said in a Dow Jones Newswires interview Thursday.

Fisher

“I would expect rates to stay low for an extended period…given the current forces acting on the economy,” he said. But Fisher added that putting a time frame on the continued maintenance of a near 0% fed-funds rate can’t be done. “People want specificity. You can’t provide specificity here,” he said.

Fisher stressed that when the Fed’s mortgage-buying program ends in March — it will have purchased $1.25 trillion in securities — it will be definitively over. “There may be some real demand for some of this paper” by private investors once the Fed is out of that market, so the exit could be a positive for investors, he said.

Fisher said he couldn’t envision the Fed re-entering the mortgage bond market “unless we have some ungodly crisis I cannot imagine.”

And while the path toward a smaller balance sheet may not be clear right now, “ultimately the goal is to get these mortgage-backed securities off our balance sheet,” Fisher said.

The central banker described the U.S. economic recovery as “tepid,” and tied that to the uncertainty of business leaders in the face of a series of economic shocks and major unresolved legislation on issues such as health care and banking regulation.

But the Fed has space to maintain its current policies. “Inflation is not the issue,” given that it is so low right now, Fisher said. “The real issue right now is how patient the people can be, how patient the Congress can be with regard to this slow healing of the employment situation. It’s going to be a slow path.”

With unemployment to be “uncomfortably high” for some time, “the real issue will be this slow healing of unemployment,” with policy makers aiming to support a return to hiring with a stimulative monetary policy stance.

Fisher isn’t currently a voting member of the interest-rate-setting Federal Open Market Committee.

The Texas-based policy maker declined to offer specific guidance on his preferred path for the Fed’s eventual exit from its current policy stance. A number of central bankers have been outlining how they’d like to see the Fed shrink its balance sheet and tighten policy when the economy is on surer footing, even as they see that day well off in the future.

The Fed will do “whatever is most practicable and efficient,” Fisher said. He said the Fed’s ability to pay interest on bank reserves will play a major role in helping control the inflationary implications of the central bank’s massive balance sheet.

Fisher also said in the interview that the troubles with the government finances of weaker euro-zone members, primarily Greece, may have a small impact on the U.S. “There will be less demand from our goods and services coming from Europe,” but one “has to be careful about exaggerating the impact” of the situation.

The official said the news out of the euro zone carries a broader lesson amid legislation in Congress that could erode the central bank’s independence and theoretically make it more subject to the whims of the political process.

“What we are seeing in Greece and elsewhere underscores the necessity for, and the beauty of, having an independent central bank, because the fiscal authorities have no choice, in Greece or in the [European Union], but to deal with the imbalances that come from reckless fiscal behavior,” Fisher said.

Because of the European Central Bank’s unfettered ability to set monetary policy, local leaders can’t try to inflate their way out of debt crisis, and not being able to do so will ultimately lead to sounder policies, the official said.

European Central Bank staffers conclude that market-based valuation of sovereign risk is a “valid” way to discipline fiscal policy “especially but not only in times of crisis.”

The implication, a trio of economists write, is that there’s “little justification for the claim that governments faced with high risk premiums during the crisis deserve the solidarity of other governments in the euro area.” Two of the authors — Ludger Schuknecht and Guido Wolswijk– are from the ECB. The third, Juergen von Hagen, is from University of Bonn.

The timing of the paper, posted on the ECB’s Web site this week, is noteworthy amid debate over how European governments might craft an assistance package to Greece to help that country deal with its fiscal crisis. A key message is that governments need to have even sounder fiscal policies during expansions to avoid the costs of borrowing during crises. Greece has been criticized for not doing enough to reform its economy and finances last decade when its economy grew above the euro zone’s average.

The authors conclude that bond yield spreads over U.S. and German benchmarks “can still largely be explained on the basis of economic principles during the crisis.” In addition, financial markets “penalize fiscal imbalances much more strongly since the Lehman default in September 2008.”

Whereas before Lehman Brothers an additional percent of deficit over Germany’s resulted in a 3.5 basis point widening in yield spread, after Lehman the spread effect ballooned to 12.6 basis points, the authors estimate.

“The crisis thus seems to have caused a significant change in the markets’ assessment of the governments’ fiscal performance and the cost of profligate fiscal behavior has increased considerably,” they wrote.

“For Greece, Ireland and Portugal…relatively weak fiscal performance explains almost or more than half of the increase in the spreads during the crisis,” the economists write.

Federal Reserve Chairman Ben Bernanke said imbalances created from China’s large holdings of U.S. assets could pose a risk to the financial system.

“It would be a healthier situation if China saved less and we saved more, and as a result they were not accumulating dollar assets so quickly and we had a more balanced financial picture,” Bernanke told the Senate Banking Committee.

“I do think those large capital flows and the potential instability of those flows can be a risk to our financial system,” he said.

Bernanke, who earlier called for China to allow more flexibility in its exchange rate, said keeping the currency pegged to the dollar requires China to buy up a lot of U.S. Treasurys.

China has ceded to Japan the top position of foreign holders of U.S. Treasurys, but Bernanke said there hasn’t been “any significant change” in China’s holdings of U.S. assets. China has continued to acquire dollar reserves despite whether the dollar is rising or falling, he said.

Federal Reserve Chairman Ben Bernanke referred to mortgage-finance giants Fannie Mae and Freddie Mac as a “platypus,” saying they were “neither fish nor fowl.” He suggested strongly that the companies should be privatized during his appearance before the Senate Banking Committee.

Mr. Bernanke didn’t specifically direct Congress to privatize the government-sponsored firms, but did go as far as saying it was an “interesting direction to go,” which in Fedspeak often means something.

With markets under pressure today, Sen. Mike Johanns (R., Neb.) expressed his doubts to Federal Reserve Chairman Ben Bernanke whether low interest rates really are helping the economy. He cited the spike in new jobless claims Thursday and other signs pulling down the Dow Jones Industrial Average Thursday morning.

Federal Reserve Chairman Ben Bernanke. (Reuters)

“I’m beginning to wonder whether low interest rates really have any possibility of spurring this economy,” Mr. Johanns said. “Unless there’s demand, unless we can get consumers back into it, it just seems very unlikely to me you’re going to see much growth. I’m not sure offering somebody an interest rate at 2% rather than 4% is going to get us to the other side.”

Bernanke maintained that “low interest rates do tend to help,” citing improvement in equipment and software investment by big firms that have access to credit at “reasonable rates” in the bond market. He also noted that the Fed’s actions have helped bring down mortgage rates and stabilize demand for housing and house prices.

“The issue we face is, will the growth be fast enough to materially reduce the unemployment rate at a pace we’d like to see,” Bernanke said.

Federal Reserve Chairman Ben Bernanke on Thursday offered one of his most aggressive defenses of the central bank’s role in the future of bank supervision in response to a question from Sen. Richard Shelby (R., Ala.) during an appearance on the Senate Banking Committee.

Here’s his response to a question about why the Fed should be the top cop for large financial companies:

“I think that stripping the Federal Reserve of supervisory authorities in the light of the recent crisis would be a grave mistake for several reasons.

“First, we’ve learned from the crisis large complex financial firms that pose a threat to the stability of the financial system need strong consolidated supervision. That means they need to be seen and overseen as a complete company, reflecting the developments not only in their banks but also in their securities dealers and various aspects of their operations. A bank supervisor, which focuses on looking at credit files, is not prepared to look at the wide range of activities of a complex international financial firm. The Federal Reserve, in contrast, by virtue of its efforts in monetary policy, has substantial knowledge of financial markets, payments systems, economics and a wide range of areas other than just bank supervision. And in our stress tests, we demonstrated that we can use that whole range of multidisciplinary skills to do a better job of consolidated oversight. By the same token, we need to look at systemic risks. Systemic risks themselves also involve risks that can span across companies and into various markets. There, again you need an institution that has a breadth of skills. It’s hard for me to understand why in the face of a crisis that was so complex and covered so many markets and institutions, you would want to take out of the regulatory system the one institution that has the full breadth and range of those skills to address those issues.”

A roundup of economic news from around the Web.

• Labor Market: Antonio Fatas writes about the divergence between jobs and output. “Why is employment growth being so weak in these years? Are there significant structural changes in terms of sectoral composition that can explain the weak behavior of employment growth? For 2009, did restrictions on access to credit cause an abnormal behavior by companies when it comes to hiring and firing? If we are talking about structural changes, we cannot expect a fast recovery in the labor market. If it is all a matter of credit availability then there is some hope that as the economy recovers we see a quick recovery in employment that will feed into faster GDP growth.”
• Drug Legalization: Jeffrey Miron on his blog points to his latest research on the budgetary impacts of drug legalization. “The report estimates that legalizing drugs would save roughly $48.7 billion per year in government expenditure on enforcement of prohibition. $33.1 billion of this savings would accrue to state and local governments, while $15.6 billion would accrue to the federal government. Approximately $13.7 billion of the savings would results from legalization of marijuana, $22.3 billion from legalization of cocaine and heroin, and $12.8 from legalization of other drugs. The report also estimates that drug legalization would yield tax revenue of $34.3 billion annually, assuming legal drugs are taxed at rates comparable to those on alcohol and tobacco. Approximately $6.4 billion of this revenue would result from legalization of marijuana, $23.9 billion from legalization of cocaine and heroin, and $4.0 billion from legalization of other drugs.”
• Failed Bank Assets: The FT’s Alphaville blog looks at bank assets being sold online. “About 200 banks have failed in the US since 2007, leaving FDIC with a number of often-unenviable loans and other financial assets to sell, securitise or use as collateral for bonds. What we hadn’t realised is that the organisation auctions literally everything from failed banks – right down to the furniture and fittings. Many of these seem to wind up on Rick Levin & Associations online auction site. The website is currently hosting at least eight auctions of FDIC failed-bank assets, which are due to finish in the next few weeks. And the pickings are varied; everything from laptops to garden party gazebos, in fact.”

Compiled by Phil Izzo

Senate Banking Committee Chairman Christopher Dodd (D., Conn.) and Sen. Bob Corker (R., Tenn.) met for roughly an hour Wednesday evening with Treasury Secretary Timothy Geithner to discuss the financial regulatory overhaul in Mr. Dodd’s Capitol Hill office. Talks are intensifying as Messrs. Dodd and Corker try to craft a bipartisan deal, and a bill could be introduced soon.
 

Messrs. Geithner and Corker had little to say after the meeting (Geithner simply muttered “OK” to the Secret Service detail waiting for him outside and then turned quickly down the hall flanked by senior Treasury officials Kim Wallace and Michael Barr), but Mr. Dodd stopped for a moment to chat.
 

“We had a good meeting, continue working. No deadlines, no time. Obviously a lot of conversation…we’re just talking through various issues and we respect Tim’s knowledge amd ability so we’re anxious to hear points of view. There’s no deal tonight. We’re working on the bill.”

Senate Banking Committee Chairman Christopher Dodd (D., Conn.) and Sen. Bob Corker (R., Tenn.) met for roughly an hour Wednesday evening with Treasury Secretary Timothy Geithner to discuss the financial regulatory overhaul in Mr. Dodd’s Capitol Hill office. Talks are intensifying as Messrs. Dodd and Corker try to craft a bipartisan deal, and a bill could be introduced soon.
 

Messrs. Geithner and Corker had little to say after the meeting (Geithner simply muttered “OK” to the Secret Service detail waiting for him outside and then turned quickly down the hall flanked by senior Treasury officials Kim Wallace and Michael Barr), but Mr. Dodd stopped for a moment to chat.
 

“We had a good meeting, continue working. No deadlines, no time. Obviously a lot of conversation…we’re just talking through various issues and we respect Tim’s knowledge amd ability so we’re anxious to hear points of view. There’s no deal tonight. We’re working on the bill.”

Economists and others weigh in on Fed Chairman Ben Bernanke’s congressional testimony.

• Bernanke’s prepared testimony reaffirmed that an expected backdrop of low rates of resource utilization, subdued inflation, and stable inflation expectations is consistent with a low for long stance on policy interest rates. –David Hensley, J.P. Morgan Chase
• This is Bernanke reinforcing that rates are not moving in the near term, the Fed will need to tighten rates at some point but the change in the discount rate does not signal a move from “exceptional low rates for an extended period of time.” Inflation subdued and little evidence of wage pressures. –David Semmens, Standard Chartered Bank
• The Fed has gone to great, great lengths to explain exactly how its going to drain reserves and exit from extraordinary stimulus measures. The remaining question, really the only question that’s ever been, pertains to the when. On that front, only a unicorn dressed in drag would expect Ben Bernanke to give provide anything specific on that front. –Dan Greenhaus, Miller Tabak
• The next step is to normalize the wording of the FOMC statement, in particular removing the pledge to keep rates low “for an extended period.” According to NY Fed President Bill Dudley, this language means that the Fed won’t rise its target rate for at least six months. So far, we are projecting that the Fed starts raising rates in late September and removes the “extended period” pledge on the upcoming FOMC meeting in mid-March. However, the fact that Chairman Bernanke reiterated the pledge in his testimony today has clearly increased the risk that the tightening cycle starts later than we currently think — maybe not until early 2011. –Harm Bandholz, Unicredit
• [Bernanke’s] repetition of the rate commitment phrase, coupled with reiteration that the discount rate hike does not signal a change in the policy outlook, makes it crystal clear that the FOMC does not anticipate tigthtening in the near term. –Goldman Sachs
• Asset sales remain the last step the Fed would take when pursuing stimulus removal. First would be reserve balance reduction, second would be rate hikes, and only third would be asset sales. There had been some uncertainty over this because in the earlier Fed Minutes, “several [Fed members] thought it important to begin a program of asset sales in the near future.” It seems that this rift has since been healed… Remarkably, in the Q&A, Bernanke said that unemployment is the “biggest problem we have”. This unquestionably will earn political points, but it is uncomfortably close to the Chairman hinting that the labour market is the more important of the Fed’s dual mandates. –Eric Lascelles, TD Securities
• The more dovish the Fed’s message , the more the market will want to test their Fed’s inflation fighting credibility. For now though, the message is that improved financial market conditions are leading to Fed to unwind the special liquidity support facilities that had been put in place but that these actions do not necessarily carry a broader policy signal. –David Greenlaw, Morgan Stanley
• The Fed has no interest in surprising the markets on policy matters and the outlook for policy depends on slack (especially the unemployment rate), inflation and inflation expectations. Bernanke remains particularly concerned about the outlook for unemployment, which historically has been the major factor determining the timing of the first move to tighten rates. –RDQ Economics
• Demand has picked up a bit but Mr. Bernanke points out that strong growth in the second half of last year was driven by inventories and fiscal stimulus, neither of which will continue to contribute as much to growth looking forward. Still, policy will be tightened “at some point” but there’s no hint this is anywhere in sight. –Ian Shepherdson, High Frequency Economics

Compiled by Phil Izzo

The announcement today by the International Monetary Fund that Zhu Min, deputy governor of China’s central bank, would become a “special advisor” to IMF chief Dominique Strauss-Kahn in May had IMF-ologists puzzling about the significance.

People’s Bank of China Deputy Governor Zhu Min. (Getty Images)

The IMF’s press release said Mr. Zhu would play a role in “strengthening the Fund’s understanding of Asia” — which is the polite way the IMF talks about its inability to get hardly any Asian countries to turn to the IMF for help during the current economic turmoil. (Pakistan and Afghanistan are exceptions.) The IMF’s heavy-handed actions during the Asia financial of 1997 and 1998s still haunt the IMF there, though Latin America, another region where IMF animosity has run deep, is becoming IMF-friendly.

At the very least, says former IMF chief economist Simon Johnson who is now a professor at Massachusetts Institute of Technology, Mr. Zhu will become a candidate for a top slot in the post Strauss-Kahn IMF. The IMF managing director is widely expected to leave the Fund by next year to run for president of France. The next IMF managing director is likely to be the first ever from outside Europe. Mr. Zhu doesn’t seem to have the backing for that, but he might be in line for a deputy managing director job.

From the U.S. and European perspective, though, the IMF’s main job vis-à-vis China is to finally convince Beijing to revalue its currency. There, Mr. Zhu might be an additional hindrance.

At the Davos economic conference last month, Mr. Zhu defended his country’s currency policy, emphasizing the yuan’s stability at a time when many other currencies have been volatile. Brookings Institution economist Eswar Prasad, the IMF’s former China chief, figures Mr. Zhu will continue to take a similar stance at the IMF.

“Mr. Zhu can be quietly but firmly assertive in pushing for the institution to be more sensitive to Asian (read “Chinese”) perspectives,” Mr. Prasad said in an email.

Mr. Johnson is even more emphatic: Mr. Zhu shouldn’t have gotten the IMF job unless China has quietly agreed to revalue. “People from emerging markets should get top jobs at international institutions,” he says, “but not China at the IMF while the Chinese are manipulating their currency.”

At the People’s Bank of China, Mr. Zhu is responsible for international affairs. Before that, he was an executive vice president at the Bank of China. He also worked at the World Bank for six years, and taught economics at Johns Hopkins University and Fudan University.