Author: WSJ.com: Real Time Economics

Today’s Journal story on the price of sports fandom looks at two economists who have studied the intangible value of having a pro sports team. Not the dollars and cents economic benefits like new taxes or increased real estate values but, rather, the price of all the warm and fuzzy feelings one gets from being a sports fan or just having a team in town.

So Real Time Economics took a moment to talk about the economics of sports stadiums with Jerry Bell, president of Twins Sports Inc., the company that owns the Minnesota Twins — Minnesota’s baseball team. This season the Twins move into Target Field, which taxpayers helped pay for. Some excerpts:

Twins Sports President Jerry Bell (Associated Press)

Economists are starting to study the “welfare value” of sports teams — basically the dollar value of the emotional benefits fans get from their local sports team. What do you think of this idea?
Bell: That’s like saying what would you pay for a memory. Most people attend their first professional baseball game with another family member. If you go to your first game with your father or grandfather, what you paid for you ticket you won’t remember, where you sit you might remember but you will never forget who you went with.
I remember very well the first baseball game I went to. The first date I had with my now wife was at a baseball game. Those are the kinds of things that gathering places like a baseball games or an orchestra do to make you a whole as a community.

Do you think that publicly funded ballparks make sense on the economic argument alone, meaning that they create new taxes and jobs?
Bell: It depends on your alternative for investment. My view is that is does have an economic impact in a targeted sense. It benefits this neighborhood. Does that make a ripple effect in the state economy? Probably not.

As someone who has sold a stadium to your community which do you think resonates more, the economic argument or civic pride?
Bell: Oh, clearly the social aspect. Ten years from now, maybe less, no one will know what this ballpark cost and they won’t care. They’ll either like it and they’ll enjoy coming here or they won’t, and they’ll judge it on that. We want it to be that place that you can escape to on a sunny day.

What is your response to people who say the public shouldn’t be subsidizing private businesses?
Bell: That’s virtually everywhere. Take farms. Everybody believes that a farm subsidy helps the family farmer. The family farmer is now a corporate farmer and the subsidies are going to corporations. We got into this, and I don’t know how we did, but we did, and now it’s in sports as well.

How much public money did the Twins get?
Bell: We paid $200 million and [the public] paid $350 million. The days of getting the public to pay for the whole ballpark are over.

Given the recession and now its disastrous effect on public finances, do you expect to see cities and states take a harder line on paying for stadiums?
Bell: The private side will have to increase some. I don’t know what the right amount is and it depends. There is always a big difference when you want to attract a team — a team is probably going to pay nothing [to move from one city to another]. On the other hand, if you’re a team that has been in a community for a long time you are expected to be different.

Do you expect your stadium will return the tax money put into it with taxes and/or economic benefits?
Bell: I think it has a chance. It depends on the economy. Does the real estate value around the ballpark go up and if it goes up, does it contribute to construction and further development and what kind of real estate taxes does that produce? If all of those things come together over a long period of time, maybe. It’s hard to say.

If you sign catcher Joe Mauer to the huge extension people think he’ll get that would surely help the state’s tax base.
Bell: He does pay Minnesota income taxes.

There’s some buzz in Washington about a tentative bipartisan deal between two lawmakers on the Senate Banking Committee who have been working for weeks to broker a compromise on how to create a “resolution” mechanism to handle the collapse of large financial companies without forcing taxpayers to bail the companies out.

Sens. Mark Warner (D., Va.) and Bob Corker (R., Tenn.) have reached an agreement in principal and are working on getting the final language together. Their deal would still need to be signed off on by the top lawmakers on the panel, Sens. Chris Dodd (D., Conn.) and Richard Shelby (R., Ala.), but it’s the first sign of a bipartisan compromise to come out of the Senate on financial regulation in months and could pave the way for a broader deal.

Their deal would work something like this, according to someone familiar with the talks:

It would create a “presumption” that large, failing financial companies would have to go through a new bankruptcy process. This is different than what the White House proposed, which would give the government immediate control to put large, failing firms through a government-controlled resolution. The Warner/Corker deal would give the government the option to still put failing firms through a government-structured resolution, but they would have to clear hurdles first and it would be a bit more complicated.

The deal still hasn’t been completely filled out, but details were reported Wednesday by Dow Jones Newswires.

The U.S. economy will recover this year, but growth won’t be strong enough to bring down unemployment substantially, bank economists said Friday.

The American Bankers Association said in a statement the consensus of bank economists is for an annualized GDP growth rate of around 3.1% throughout 2010. They see core inflation, which excludes volatile food and energy prices and is closely watched by the Federal Reserve Board, at 1.2%.

“This growth would be just above the economy’s long-term trend, but not enough to reduce the unemployment rate much below 10% by year end,” the group said.

The U.S. economy is emerging from its worst recession in decades. The jobless rate held at 10% in December 2009 as employers cut more jobs than expected. Bank economists expect low inflation will allow the Federal Reserve to hold short-term rates at a record low near zero during the first half of this year.

The United States remains the world’s science and technology leader, but other countries are gaining ground, the National Science Board said Friday in its biennial report on science and engineering.

The U.S. accounted for nearly a third of $1.1 trillion spent on research and development globally in 2007, minted more science and engineering doctorates than any other country, and led the world in innovative activity. Efforts by China and other developing Asian countries to boost their science and engineering capabilities are bearing fruit, however, and the gap between them and the U.S., though still wide, is narrowing.

For the 10 years ending in 2007, spending on research and development grew between 5% and 6% annually in the U.S., Japan and the European Union. R&D spending in India, South Korea and Taiwan grew an average 9% to 10% a year over the same period. In China, it averaged more than 20%.

The U.S. awarded 22,500 doctorates in natural sciences and engineering in 2007, but more than half of them were awarded to foreign nationals. Past experience suggests that rather than return to their native countries, many of those new PhDs will stay in the U.S. The report noted that 60% of temporary visa holders who earned doctorates in science in engineering in 1997 were working in the U.S. in 2007.

U.S. researchers published about a quarter of an estimated 760,000 peer-reviewed research articles in peer-reviewed journals in 2008. Chinese researchers published 8% of the research articles, up from just 1% in 1988.

Despite China’s strides, Chinese researchers accounted for only about 1% of U.S. patents granted in 2008. Despite Chinese government efforts, inventive activity in China “appears elusive, at least as indicated by patents filed in a major Western market,” the report noted.

U.S.-based inventors accounted for 49% of patents granted, down from 55% in 1995.

It’s hard to argue against the fairness of President Barack Obama’s proposed tax on banks to recoup the costs of last year’s bailouts. On logical grounds, though, there is a reason to be skeptical.

Administration officials worry about a credit crunch and want banks to lend more. Banks don’t lend out of thin air — they need liabilities on the other side of their balance sheets to fund new loans. The proposed tax would assess a 0.15% levy on bank liabilities (minus insured deposits.) Taxing bank liabilities after their big bailout might be fair. And as the administration notes, it might be a deterrent to banks against about taking on too much leverage and taking on unwise risks. But it’s not an incentive to lend, something to remember the next time they’re getting bashed for worsening the credit crunch.

It just shows, there are few easy choices in this post-crisis world, and doing what is right often works at cross purposes with doing what is good.

A roundup of economic news from around the Web.

• Executive Pay: On Mother Jones, Joseph Stiglitz talks about executive pay. “How the market has altered the way we think is best illustrated by attitudes toward pay. There used to be a social contract about the reasonable division of the gains that arise from acting together within the economy. Within corporations, the pay of the leader might be 10 or 20 times that of the average worker. But something happened 30 years ago, as the era of Thatcher/Reagan was ushered in. There ceased to be any sense of fairness; it was simply how much the executive could appropriate for himself. It became perfectly respectable to call it incentive pay, even when there was little relationship between pay and performance. In the finance sector, when performance is high, pay is high; but when performance is low, pay is still high. The bankers knew — or should have known — that while high leverage might generate high returns in good years, it also exposed the banks to large downside risks. But they also knew that under their contracts, this would not affect their bonuses.”
• Bank Profits: Barry Ritholtz of the Big Picture says record bank and broker pay is engineered. ” How hard is it for any finance firm to make risk free money when they can borrow form the Federal Reserve at zero, and lend that same cash to the Treasury (by buying bonds) at 3%? I suspect this is essentially the Bernanke/Paulson plan (now Bernanke/Geithner) to slowly recapitalize the banks via the Japanese model, rather than force insolvent institutions to reorganize. What may thwart the massive Fed giveaway is the self-interested institutions, who are not lending, and capturing the lions share of this wealth via bonuses.”
• Fed Future: Tim Duy of Fed Fed Watch sees the Fed standing pat for the near future. “The underlying pace of growth is in doubt. To be sure, manufacturing is getting a boost from inventory correction and pent up demand; the upward trend in industrial production, ISM, capacity utilization, and new order for nondefense, nonair capital goods all look solid. But households are financially hobbled, and net import growth remains lacking. All told, the net impact is to stem the pace of job losses and, if temporary help is an indication, set the stage for actual gains in nonfarm payrolls in the months ahead. But a rapid reversal of the dreary employment setting looks elusive, especially given the likelihood that growth slows as government stimulus wanes in the second half of 2010. Loose cannons like Hoenig aside, all of this should keep monetary policymakers on hold, not pushing to actively contract the Fed’s balance. Further expansion of asset purchases is not out of the cards, as Bullard makes clear. But the bar to additional purchases looks high; the Fed will wait to see how actively evolves before taking that road.”

Compiled by Phil Izzo

Economists, analysts and others weigh in on the Obama administration’s proposed tax on big banks:

• This is not all political. There are valid policy reasons as well for a moderate tax, spread out over a number of years. First, the Emergency Economic Stabilization Act, which authorized the TARP, requires the Administration to eventually propose specific means to recoup any taxpayer losses from the financial industry. The surprisingly swift recovery by the banks makes it reasonable to accelerate that decision. Second, there is a need to show taxpayers that the TARP not only helped them by averting a potential mini-depression that could have resulted from a further financial meltdown, but will have done so at no net cost. This cost issue is an important policy goal in its own right and also increases the probability that Congress and the public might support any remaining actions that need to be taken to deal with the tail end of this financial crisis. – Douglas Elliott, Brookings Institution
• We have mixed feelings about the newly proposed levy on the liabilities of the biggest 50 US banks. As well as being very popular with voters, President Obama’s plan to tax banks makes some sense from an economics perspective; it will recoup some of the taxpayers’ money spent on the financial bailout and, at the margin at least, it will dissuade banks from becoming too big too fail. However, to the extent that it discourages banks from making loans in the future and increases the incentives for banks to use off-balance sheet vehicles, the tax is a bad thing. – Paul Ashworth, Capital Economics
• We are somewhat skeptical that Congress will pass such a tax and if they do, it could be several months before Congress does so. While we think it is tough to predict whether this idea passes or not, we think this adds to the political risk that we have already expected for larger banks for the coming weeks and months. – Brian Gardner, Keefe, Bruyette & Woods
• How Will the Country Survive a Hike in Bank Fees Equal to 0.06 Percent of GDP? That’s the nightmare scenario raised by the big banks in response to President Obama’s proposal to impose a tax on the largest banks equal to 9.0 billion a year. The banks argued that this would be really bad news for the economy since they would pass on the fee to their customers. … It is also worth noting the implication of this claim for the nature of competition in the banking industry. The proposed fee would only apply to banks with assets of more than $50 billion, a relatively small number of banks. If these banks really can pass on higher costs to consumers, then it implies an extraordinary level of monopoly power in the industry, with the large number of small and mid-size banks not providing effective competition to the largest banks. – Dean Baker, Center for Economic and Policy Research
• I’m in favor of the bank tax; what’s not to like about extracting $117 billion from large banks to pay for the net costs of TARP? But it’s by no means enough. … Why $117 billion? Because that’s the current projected cost of TARP. But everyone realizes that TARP was only a small part of the government response to the financial crisis, and the main budgetary impact of the crisis is not TARP, but the collapse in tax revenues that created our current and projected deficits. So why not raise a lot more? – James Kwak, Baseline Scenario
• Maybe President Obama is coming around to the realization that the TARP has indeed been a loser for the taxpayer. He appears, however, to be missing the critical reason why: the bailouts of the auto companies and AIG, all non-banks. This is to say nothing of the bailout of Fannie Mae and Freddie Mac, whose losses will far exceed those from the TARP. Where is the plan to re-coup losses from Fannie and Freddie? Or a plan to re-coup our rescue of the autos? … Econ 101 tells us (maybe the President can ask Larry Summers for some tutoring) corporations do not bear the incidence of taxes, their consumers and shareholders do.   So the real outcome of this proposed tax would be to increase consumer banking costs while reducing the value of bank equity, all at a time when banks are already under-capitalized. – Mark Calabria, Cato Institute

San Francisco’s acrimonious relationship with chain stores might be on the mend as empty storefronts pile up.

American Apparel: unwelcome in San Francisco even among its customers. (Getty Images)

Today’s San Francisco Chronicle notes that the Noe Valley neighborhood is rethinking a 1987 law that banned new restaurants on 24th Street, a commercial vein that runs through the community. The point of the law was to help out local businesses in the neighborhood, but that was before the recession left many storefronts empty.

The article notes that merchants on Union, Clement and Haight Streets — all of which are walkable neighborhood streets with restaurants, small gift shops and the like — have overturned similar restrictions on restaurants over the past three years as the economy has been ailing (the recession began in December 2007).

The restaurant law is one of many San Francisco laws that aim to restrict what kind of businesses can open where, the most restrictive of which was Proposition G, a measure that passed in 2006 — an economic peak — and makes it much harder for businesses with more than 11 locations to open up stores.

The San Francisco Business Times recently opined on the unintended consequences of the city’s harsh anti-chain laws, such as the pain inflicted on local landlords or how it has stunted the growth of local shops that have grown into chain status.

Of course not even the worst recession in a generation is likely to completely mend the long and thorny relationship San Francisco — a liberal bastion that elected its last Republican mayor in 1959 — has had with chain stores. On Valencia Street, just a short walk from 24th Street, protesters donning American Apparel T-shirts recently prevented American Apparel from opening in a vacant storefront.

Paul Volcker, the chairman of President Barack Obama’s Economic Recovery Advisory Board, made a forceful case Thursday against moves to reduce the Federal Reserve’s powers.

Paul Volcker speaks to President Barack Obama. (AFP/Getty Images)

In particular, Volcker, a highly influential former Fed chairman, said the Fed needs to retain its current bank supervisory role, taking issue with legislative proposals to strip it of those powers.

Speaking at a luncheon sponsored by the Economic Club of New York, Volcker said the Fed “needs both the ability to identify” problems in the financial sector “and the instruments to deal with them.”

“In acting as lender of last resort, it must know its counterparties and know them well,” he added.

Volcker got behind the favored position of the Obama administration and of a House bill that would put the Fed at the top of a new systemic-risk regulator structure. By extension, he implicitly opposed a competing Senate proposal that would see the Fed’s powers significantly reduced.

Creating a robust Fed-controlled institution of this sort, which would aim to avoid financial crises by dealing aggressively with failing banks before they infect the broader system, is crucial to deal with the still unresolved “moral hazard” involved with bailing out “too big to fail” banks, Volcker said.

“The old question of institutions being too big to fail looms larger than ever,” Volcker said. Unless regulators are given a robust “resolution authority” to take over failing banks, all other proposed reforms in areas such as accounting rules and banks’ capital requirements “won’t provide the safeguards that we need,” he said.

Using a medical analogy to describe how the systemic regulator would take over failing banks without providing financial bailouts to their management or their shareholders, he said it would comply with the instruction “DNR: Do Not Resuscitate.”

Volcker said he worried that the will to create such an authority is dissipating. He observed that “some market participants seem to be suggesting that the events of the past couple of years were [merely] a bad dream” and so do not require any “really substantial changes in the structured of markets.”

In making these reforms, it is vital that the Fed’s independence and world-wide reputation is kept intact, Volcker said, noting that individuals and leaders around the world look to it for leadership.

“We simply cannot afford…to erode that trust,” he said, especially not while U.S. global leadership in other areas “can no longer be taken for granted.”

“We are plainly overextended in budgetary terms,” Volcker said, noting that the U.S. “relies on the kindness of strangers” to fund its massive fiscal obligations.

Later, asked whether he supported Obama’s recent move to impose a risk-based tax on banks to help rein in the fiscal deficit, Volcker said he did.

“This country and other countries are facing a very real problem as to how they deal with the cost of the losses involved” in the crisis, Volcker said. The bank tax “would seem to me not an unreasonable response to that.”

The following letter was sent by the Federal Reserve to the Senate Banking Committee on the central bank’s role in bank supervision.

Dear Chairman Dodd and Ranking Member Shelby:

Strengthening our financial regulatory system in ways that take the appropriate lessons from the crisis is essential for the long-term economic stability of our country.

To this end, as you know, the Banking Committee has compiled an extensive hearing record and has begun considering specific reform proposals.

A number of your colleagues on the Committee have recently asked for the Board’s views on the importance of the Federal Reserve’s continued role in bank supervision and regulation. In response to these requests, I am enclosing for you and your colleagues a document that discusses (1) how the expertise and information that the Federal Reserve develops in the making of monetary policy enable it to make a unique contribution to an effective regulatory regime, especially in the context of a more systemic approach to consolidated oversight; and (2) how active involvement in supervising the nation’s banking system allows the Federal Reserve to better perform its critical functions as a central bank.

Please let me know if you have any questions or if I can be of assistance. I look forward to working with you in the days ahead as the Committee continues its consideration of regulatory reform proposals.

Sincerely,
Ben S. Bernanke

Read the rest of the letter for the Fed’s full argument

Economists offer their comments on December’s decline in retail sales.

• The 0.3% m/m decline in retail sales in December is a reminder that consumers still aren’t buying into the economic recovery. Without a more significant acceleration in consumption growth that recovery is ultimately doomed to disappoint. – Paul Ashworth, Capital Economics
• On balance in spite of the disappointing sales in December the trajectory of total consumer spending on a quarter over quarter basis is improving…The disappointment with holiday sales in December seems to be more a result of a shift in spending patterns rather than another poor Christmas shopping season. Sales in October and November rose very robustly (1.2%, and 1.8%, respectively). It seems as though concerned retailers began offering price discounts on merchandise earlier than normal and holiday shoppers took advantage of it. Sales at generally merchandisers increased 0.7% and 0.5% in the previous two months and then dropped 0.8% in December. Since merchants choose to be very conservative in their inventory stocking for the holiday period, the large discounts that encourage sales in January will likely be much smaller than normal. – Brian Fabbri, BNP Paribas
• Weaker than expected report. While much of the downside surprise in December sales was offset by an upward revision to November, the result is no change to our expectation for consumption in Q4, but a weaker ramp heading into Q1. –Morgan Stanley
• The pattern of recent economic data matched the weather for most of the country over the last two months of 2009 with a warm November and a cooler than expected December… Apparently, no one wanted to buy a television in the snow. Electronics and appliance store sales fell with a thud by 2.6 percent. But other categories were also weak. Food and beverage store sales dipped by 0.8 percent as did sales at general merchandise stores. Clothing store sales slipped by 0.6 percent, the same for sales at restaurants and bars. Despite a 2.8 percent increase in unit auto sales for the month of December, retail sales for autos fell by 0.2 percent, suggesting deeper discounting and a shift to smaller cars. – PNC
• Today’s retail sales report suggests slighter softer consumption growth in Q4 of 1.8% compared with our baseline forecast of 2.0%. We are still tracking about 5% for Q4 GDP growth. While today’s report only has a modest effect on Q4 GDP because the weakness in December was partly offset by stronger November data, it does mean a more feeble Q1 kick off. As such, we believe there are downside risks to our forecast for Q1 GDP to increase 5%. – Michelle Meyer, Barclays Capital Research
• We would advise against looking at either the November or the December results for retail sales in isolation. The combination of an increased emphasis on “Black Friday” and “Cyber Monday” sales in November and lousy weather in late December likely played havoc with spending patterns relative to past norms and thus made the seasonal adjustment task a more vague exercise than usual. Still, with fundamentals facing the consumer still terrible…reality is probably closer to the December outcome than November’s result. –Joshua Shapiro, MFR, Inc.
• Overall, despite the surprisingly weak headline print in December, the performance of retail sales in the last quarter of 2009 suggests some significant positive momentum on consumer spending and may augur well for Q4 GDP. Notwithstanding this, with the U.S. labour market remaining quite weak and consumer credit continuing to decline, we expected consumer spending growth in the coming months to be relatively soft. –Millan L. B. Mulraine, TD Securities

Americans are split on whether President Barack Obama’s policies will help their personal lives and the economy, but the majority agrees the country is headed down the wrong path.

Some 55% said the country is seriously off track compared to 34% who said it was headed in the right direction, according to Allstate and National Journal’s Heartland Monitor Poll released Thursday.

“There’s disappointment in the leadership of our society,” said Ed Reilly, CEO Americas of FD International Ltd., a communications and consulting group.

Americans were closely divided on the proper role of government, but a slightly larger fraction said it is not the solution to economic problems, it’s part of the problem.

Still, poll respondents had a slightly more favorable view of government officials than of big business. Those surveyed said they were least likely to trust major corporations to manage financial risks, ranking them below national banks and elected officials. Much of that is from the perception that, after taxpayers bailed out businesses and banks alike, those companies have returned to profitability at a time when the average consumer is still hurting.

“The businesses gained and that sense of betrayal I think is reflected in the poll,” said S. Joe Bhatia, president and chief executive officer of the American National Standards Institute.

Looking at the federal government’s policies in the past year, 40% of Americans said banks and investment companies benefited most from those policies and 20% said major corporations did. Just 9% said middle class individuals reaped the benefits. The best thing companies could do to regain Americans’ trust would be to pay back the bailout money as soon as possible, poll respondents said.

Poll respondents largely agreed that, in the wake of this recession, individuals, companies and government may change their behavior in the short term, but they will likely return to making irresponsible financial decisions because they have not been held accountable.

“I was disappointed in the continued growth in the trust deficit,” Allstate chief executive Thomas Wilson said in an interview. “Whether it’s business or government, most Americans are saying ‘none of these institutions are working for us.’”

Despite their discontent, the Americans surveyed were still divided when it came to judging the Obama Administration’s policies: 37% said its actions would increase opportunities for people like them to get ahead whereas 34% said it would decrease opportunities. A quarter said his policies would have no impact.

In a similar split, 46% of respondents said Obama’s economic policies over the past year led to a record deficit and failed to end the recession or slow job losses. Another 43% disagreed, saying the policies helped avoid a worse economic crisis and are laying the foundation for an economic recovery.

The poll highlights how broad-based the recession’s effects have been. A full 48% said they’ve made significant reductions in spending, nearly a third said they dipped into savings or pension funds to make ends meet. And 31% said they had lost a job or been unemployed for a sustained period.

Many don’t expect things to improve this year. Just 37% said they think their personal financial situation will get better in 2010, compared to 41% who said it would stay the same and 20% who said it would get worse.

Evaluating the effects of specific government policies, more Americans said TARP, financial assistance to U.S. auto companies and health care reform would hurt the economy — and their own financial situations — than those who said it would help. But more Americans said the stimulus bill would help both the economy and their own financial situations. On cap and trade respondents were split, saying it would help the economy but hurt their personal finances.

The poll surveyed 1,200 adults from Jan. 3-7 and has a margin of error of plus or minus 2.8%.

A roundup of economic news from around the Web.

• Stimulus: On Econbrowser, Menzie Chinn looks at the CEA’s latest look at the stimulus. “Output is only 1.59% above baseline, while employment is 2.25% above baseline. In both cases, economic activity is above what would be expected on the basis of random chance (with 50% confidence, which is admittedly below the conventional levels used, but is not that far away from what is standard in the VAR literature). Employment is, in this case, 2.92 million above baseline, rather than the 2.07 million found in the CEA analysis. The key deficiency of this “projection” approach is that the difference between predicted and actual is a composite of the (potentially offsetting) effects of all the policies undertaken (monetary policy, regulatory policy, non-ARRA fiscal policy, as well as ARRA) as well as other events (rest-of-world GDP collapse, credit crunch).”
• Bank Tax: On Economix, Peter Boone and Simon Johnson say a tax on banks is fine, but it distracts from the main issue. “Yes, a new tax on these profits will raise money. But it will not prevent a major collapse in the future. There is no use discussing tough regulation when the previous regulators are still in charge, and they refuse to admit they were part of a system that egregiously failed. Mr. Bernanke’s speech at the American Economic Association 10 days ago was a big step backward for those — like Thomas Hoenig, head of the Kansas City Fed — who want to send a message that there is a new regime in place to stop future crises. One view of regulation is that you can adjust the rules and make it better; with each crisis we learn more, so eventually we can make it perfect. This appears to be the current White House position. There is even mention of the United States’ becoming “more like Canada,” in the (mythical) sense that we’ll just have four large banks and a quiet life.”
• Crisis Hearings: The Economist’s Free Exchange blog looks at how moral hazard was baked into the market before the government ever intervened. ” On the one hand, if the financial sector couldn’t conceive of a world in which house prices fell, they might also have struggled to conceive of a world in which the financial sector was troubled enough that even relatively small banks would be shielded from collapse, as was the case after Lehman’s failure. On the other hand, it’s not as though the American government had a track record of standing by while large financial institutions got into serious trouble. And even if big banks didn’t have enough of an implicit guarantee to borrow on the same terms as Fannie Mae, firm leaders may still have seen the advantage — banked on it, really — of becoming large enough to wield significant clout in Washington, and of being a serious economic liability in times of trouble. At this point, however, it’s crystal clear that large banks can expect government assistance, and so firms are almost certainly building their too-big-to-fail status into firm calculations. And that’s something which really has to be addressed, or another crisis will follow fast on the heels of the last one.”

Compiled by Phil Izzo

The number of entrepreneurs starting new businesses dropped 10% in the wealthiest nations last year and fell 24% in the U.S., according to a report released Wednesday.

“Throughout the world, would-be entrepreneurs reported greater difficulty in obtaining financial backing for their start-up activities, especially from informal investors– families, friends, and strangers,” says Bill Bygrave of Babson College, one of the founders of the Global Entrepreneurship Monitor, which issued the report.

But sentiment was improving. A quarter of new entrepreneurs in 2009 felt the prospects for their businesses are rosier than a year earlier, according to the report. New entrepreneurs tended to be more optimistic than established business owners.

“Of course, the finding that entrepreneurial activity declined in many countries was not a surprise,” says Niels Bosma, GEM’s director of research and a researcher at Utrecht University, The Netherlands. “What surprised me was that as much as one in four new entrepreneurs in wealthy countries believed that the global slowdown had created more opportunities for their business, not less. This is a significant and interesting group. They are more likely to be young, well-educated and expect to create a lot of jobs for others.”

Confidence alone isn’t sufficient to create new jobs in an economic downturn, and the drop in new businesses highlights the difficulties faced by the job market. About half of the U.S. work force is employed by small firms.

“What is needed is for entrepreneurs to feel comfortable venturing out again, because they are the real engine for creating new jobs. Unfortunately, there is not a silver bullet for entrepreneurs. Each country needs to develop the right formula to encourage business start-ups,” said Kristie Seawright, Executive Director of GEM.

Fed Chairman Ben Bernanke says low interest rates aren’t to blame for the housing boom and bust. WSJ’s Jon Hilsenrath tells Kelly Evans why fellow economists aren’t buying his argument.

U.S. policymakers must prevent a rapidly ballooning public debt from rising above 60% of the nation’s output over the next decade, two nonprofit think tanks said in a report released Wednesday.

U.S. debt, which has grown to more than 50% of gross domestic product from around 40% of GDP only two years ago, will inevitably rise further in 2010 as the government fights the economy’s downturn, said the National Research Council and the National Academy of Public Administration in a report.

But President Barack Obama’s administration must begin to tackle the debt problem with higher taxes or bigger spending cuts from the end of 2011, with the aim of cutting it over several years.

Delaying action for five or 10 years will make addressing the problem more painful and costly, requiring even higher taxes or lower levels of government services, the report noted.

“Increasing debt also may contribute to a loss of investor confidence in the nation’s economy, which would, in turn, lead to even higher interest rates, lower domestic investment, and a falling dollar,” the report said.

Economists have long worried that an aging population and growing health-care costs could cause the U.S. budget deficit and debt to balloon, undermining confidence in the U.S. dollar.

A roundup of economic news from around the Web.

• Will China Rule the World?: Writing for Project Syndicate, Dani Rodrik looks at China’s potential for primacy. “The authoritarian nature of the political regime is at the core of this fragility. It allows only repression when the government faces protests and opposition outside the established channels. The trouble is that it will become increasingly difficult for China to maintain the kind of growth that it has experienced in recent years. China’s growth currently relies on an undervalued currency and a huge trade surplus. This is unsustainable, and sooner or later it will precipitate a major confrontation with the US (and Europe). There are no easy ways out of this dilemma. China will likely have to settle for lower growth. If China surmounts these hurdles and does eventually become the world’s predominant economic power, globalization will, indeed, take on Chinese characteristics. Democracy and human rights will then likely lose their luster as global norms. That is the bad news.”
• Regulation: In the Financial Times, Robert Reich calls for the Obama administration to get tough on Wall Street. ” What is truly remarkable is what Congress and the administration have shown no interest in doing. Large numbers of Americans have lost their homes to bank foreclosures or are in danger of doing so. Yet American bankruptcy law does not allow homeowners to declare bankruptcy and have their mortgages reorganised. If it did, homeowners would have more bargaining power to renegotiate with banks. But neither Congress nor the administration has pushed to change the bankruptcy laws. Wall Street opposes such change and was instrumental in narrowing the scope of personal bankruptcy in the first place.”
• Fed Rate and Crisis: Brad DeLong follows up on his blog of his comments on the Fed and interest rates. ” This is another one of those in which I have to conclude that either I am deranged, or other economics professors like Bordo and Goodfriend are. I believe that prices overreact–that a fall in interest rates that ought to generate a 1% appreciation might generate a 3% one. But even so excessively-relaxed monetary policy relative to any Taylor rule standard looks much too small to generate the housing bubble.” Mark Thoma also weighs in. ” So I think the bubble itself was driven by “cash slopping around in the system” that originated from several sources, the Fed being one, and the regulatory failures (such as failing to provide sufficient transparency so that the smoke from the fire could be spotted in time, and failing to limit leverage) allowed the fire to spread rapidly and do major damage.” Paul Krugman agrees with DeLong. “If our financial system is so high-strung, so manic-depressive, that low rates for a few years can inflate a monstrous bubble, while a few discouraging words from high officials can send them into a tailspin, this doesn’t make the case that policy must walk on eggshells, forgoing any attempt to fight prolonged unemployment. Instead, it makes the case for much, much stronger financial regulation.”

Compiled by Phil Izzo

The Wall Street Journal surveyed economists who are part of the National Bureau of Economic Research’s Monetary Policy Program and asked them whether low interest rates caused the housing bubble. Here is a sampling of their responses, which represents their views and not the NBER:

LAURENCE BALL, JOHNS HOPKINS PROFESSOR: “If only mortgage lenders had insisted on documentation of income, we might not be having this whole discussion.”

MICHAEL BORDO, RUTGERS PROFESSOR: “The Fed didn’t cause the house price boom per se. Its causes were varied including government policy to encourage home ownership going back to the 1930s but especially the CRA (Community Reinvestment Act), lax regulation, inappropriate business practices etc. But loose monetary policy provided much of the fuel.” 

BRAD DELONG, BERKELEY PROFESSOR: “If you believe that the Fed kept the fed funds rate 2% below its proper Taylor-rule value for 3 years, that has a 6% impact on the price of a long-duration asset like housing. Even with a lot of positive-feedback trading built in, that’s not enough to create a big bubble. And it wasn’t the bubble’s collapse that caused the current depression–2000-2001 saw a bigger bubble collapse, and no depression.”

BENJAMIN FRIEDMAN, HARVARD PROFESSOR: “A democracy gets the regulatory policy it chooses.  If the public elects office holders who do not believe in regulation, and those office holders appoint people to head the regulatory agencies who also do not believe in regulation, then there will be no regulation no matter what the statutes say.”

MARK GERTLER, NEW YORK UNIVERSITY PROFESSOR: “If we could go back in history and make one policy change, I’d go after sub-prime lending. Absent non-prime lending, the likely outcome of the housing correction of 2007 would have been a mild recession like 2000-2001, and not the debacle we experienced.”

MARVIN GOODFRIEND, CARNEGIE MELLON UNIVERSITY PROFESSOR: “Interest rate policy was appropriately stimulative in the 2002-3 period. But rates should have been raised less mechanically and more aggressively in 2004-5 on grounds of the usual macroeconomic conditions. The appreciation of house prices was but one of many indicators which called for a somewhat more restrictive interest rate policy at the time. A somewhat tighter stance of interest rate policy then could have cut off the last year or so of the house price appreciation and prevented the worst part of the subsequent adjustment.”

CHRISTOPHER HOUSE, UNIVERSITY OF MICHIGAN PROFESSOR: “While the interest rate was below normal for some time it may not have been far below normal.  In the wake of the 2001 recession, inflation was low (it was below 2 percent for much of 2001 – 2003) and the economy lost jobs for more than two years (job losses continued until roughly August 2003) so it is not unreasonable for the Fed to have kept interest rates low.  The low interest rate likely contributed to the housing boom somewhat but it is unlikely that it was the main cause of the crisis.”

KENNETH KUTTNER, WILLIAMS COLLEGE PROFESSOR: “The ‘bubble’ didn’t really get going until 05-06, by which time the Fed had raised rates to more or less normal levels.”

JEFFREY MIRON, HARVARD PROFESSOR: “The more fundamental way in which the Fed contributed to the bubble was via the “Greenspan put,” namely, the assurances the Fed gave markets that, whatever might happen, the Fed had both the ability and the willingness to clean the mess up afterwards, without too much pain. This stance played a major role in Wall Street’s excessive risk-taking.

JONATHAN PARKER, NORTHWESTERN PROFESSOR: “The Fed did not have the legal authority to change or enforce regulations in most of the areas where these actions could have mitigated the crisis – if the Fed did have such authority or ability, or if any agency did, we could now get by merely by tweaking the system.”

GARY RICHARDSON, UNIVERSITY OF CALIFORNIA IRVINE PROFESSOR: “The connection between low rates and the housing bubble was indirect. Low rates encouraged homeowners to refinance mortgages. To handle this wave of refinancing, financial institutions expanded capacity to write mortgages (roughly doubling employment in the mortgage-writing industry). After the refinancing wave passed, financial institutions kept the expanded mortgage-making resources in use by finding new ways to extend mortgages, which led to the creation of exotic mortgages and the extension of loans to hitherto unqualified buyers.”

CHRIS SIMS, PRINCETON PROFESSOR: “There may not have been a great deal that the Fed itself, without legislative cooperation, could have done about the situation as the housing bubble developed … In the atmosphere of those boom years, anyone who favored increased regulation and damping of the flows of commissions and bonuses that were driving the boom had difficulty making an impact.”

JON STEINSSON, COLUMBIA PROFESSOR: “Excessively easy monetary policy by the Fed played at most a minor role in causing the housing bubble. Those that think that excessively easy monetary policy by the Fed played a major role must think that the Fed can have a major influence on real interest rates for a very sustained period of time. It is not clear to me that this is true.”

As the ranks of the unemployed continue to swell, the competition for open positions is intesifying, according to new data from the Labor Department.

The government’s Job Openings and Labor Turnover survey showed that there were nearly 6.4 unemployed workers, on average, for each available job at the end of November, up from 6.1 in October. Layoffs and discharges were down 3.5% from October at 2.1 million, but the number of job openings was also lower, falling 6.1% to 2.4 million.

On Friday, the Labor Department reported that the economy added 4,000 jobs in November, the month that corresponds to the JOLTS report. Last week’s report also showed an 84,000 decline in jobs for December. The drop last month was larger than expected, but still represented a slowing pace of job cuts over the second half of 2009.

The current recession was characterized by a large jump in layoffs, similar to downturns in the 1970s and 80s. That stands in contrast to more recent recessions when layoffs moved slightly higher but job openings stagnated, exacerbating the “jobless recovery” where hiring lags economic expansion. The similarities to earlier recessions had inspired some hope that when the economy begins to add jobs again, it could come at a faster pace.

But if companies remain reluctant to hire, the labor market could face the worst of both worlds: massive layoffs and depressed levels of job openings.

“While it is all but certain that firings are nearing or at an end, several indicators including today’s data suggest that the pace of hirings could be relatively benign,” said Dan Greenhaus at Miller Tabak. “This is not to say jobs will not be added and this is not to say the labor market is not improving. Just that persons looking for employment still face, as the data stands today, considerable hurdles.”

For anyone who thought the federal regulators were all on the same page regarding the best way to police compensation at banks, think again.

Bair

Tension behind the scenes spilled into a nasty exchange of words at a public meeting of the five-member Federal Deposit Insurance Corp. board of directors. The long and short of it: FDIC Chairman Sheila Bair and two other board directors support proposing a new policy that would tie the fees banks pay for deposit insurance to the risk-profile of the compensation plans at those banks. In other words, if the bank pays executives in a way that the FDIC feels encourages dangerously risky behavior that could ultimately lead the bank to fail, then the FDIC can charge them more for deposit insurance.

Comptroller of the Currency John Dugan, whose agency regulates national banks, and Office of Thrift Supervision acting director John Bowman, whose agency regulates federal thrifts, strongly disagreed with the proposal. They said, among other things, the FDIC was moving too quickly because the Fed and Congress were both looking to address of banker compensation using different standards. They also said it was unclear how much of a factor banker pay really played in causing banks to fail. And Mr. Bowman also suggested it was unclear whether the FDIC even had the authority to assess higher fees based on pay plans. Messrs. Bowman and Dugan voted against the proposal, which narrowly passed 3-2.

Ms. Bair wouldn’t let their criticisms go unanswered, and launched into a lengthy unscripted rebuke:

(The only acronym worth noting is “MLR,” or material loss review. These are conducted after sizable bank failures, when government investigators go through the causes of the collapse)

Ms. Bair: I must say to take a position that we should not even be asking these questions is not one that I can understand. I also cannot understand why we need to keep waiting. We need to keep waiting for this or that, and in the interim, nothing changes. We just maintain the status quo, and the longer we try to [implement] meaningful reforms, the more momentum for that dissipates. We are simply asking the question.
There are a number of MLRs for the smaller institutions that draw quite a clear contributing factor to bank failures on losses. We don’t have MLRs for the larger institutions because they got bailed out. That does not mean to say that we shouldn’t be looking at the huge compensation systems of the larger institutions as well, and how that fed into risk taking and the credit crisis which has obviously imposed massive losses for the deposit insurance fund. We must rely on academic research and other work done by our own staff to determine whether there is cause and effect here. We are asking the question right now but we are obliged to have risk adjusted premiums. And we are obliged to evaluate risk to the deposit insurance fund, and we are obliged to try to factor in those risk elements into our premium structure.
So I think there is nothing we are doing that conflicts with the Fed is doing. It complements that. There is nothing we are doing that conflicts with what the Congress is doing…
To suggest this agency shouldn’t do anything when there is such an overwhelming amount of evidence that this is clearly a contributor to the crisis and to the loses that we are suffering, I just cannot understand that.
John, you made a very good inventory of all the regulatory and statutory provisions dealing with management and compensation, but I must say, how effective have those been? And maybe we should be looking at some other tools as well to again reinforce and complement those supervisory efforts.
I think the regulators have been roundly criticized for not fully exploring the regulatory tools we have at our disposal to address some of the root causes of this crisis…not to even ask the question I think would not be responsible for this board to do.