Author: WSJ.com: Real Time Economics

The U.S. economy has traded a public bubble for a private one, according to this forecast by California forecasting firm Beacon Economics.

The firm’s stance is that the $787 billion federal stimulus package and the Federal Reserve’s near-zero interest rates have propped up the economy but will prove unsustainable and are actually exacerbating some of the imbalances that led to the recession. “The nation seems to be trading in its private bubble for a public one, swapping one set of unsustainable economic drivers for another,” the report said.

The firm cites a lot of familiar problems, such as the deficit and the potential for inflation down the road. (For the record, inflation is so tame right now that some economists are more worried about deflation) And, like many reports that call “bubble,” it is light on specifics as to how, when or if it might pop.

The gist is this: The stimulus and other such measures have prevented a shedding of debts that needs to happen before the economy can return to sustainable growth. The saving rate has grown from its record lows, but has been propped up by tax cuts that have exacerbated the mountain of debt at all levels of government. Property values have fallen, but accounting changes have prevented banks from acknowledging a lot of underwater loans. Even the roaring stock market is artificial, in the firm’s view.

“The rally in the equity markets seems to be occurring despite the fact that overall asset prices still seem too high given our long-run potential for growth. And the bounce in the asset markets overlooks the fact that overall the national deleveraging that needs to occur to shed off record levels of debt has yet to really get underway,” the report said.

This is, obviously, a bearish stance. Beacon’s founder, former UCLA Anderson Forecast economist Chris Thornberg, has done well forecasting bubbles before. He serves on the advisory board of New York hedge fund Paulson & Co., which made many billions of dollars betting on a housing collapse and was subject to a book by Journal reporter Gregory Zuckerman.

To be sure, even Beacon acknowledges that there are ways out of a bubble that don’t involve a pop. “The best-case scenario is that the Federal Reserve and the Obama administration manage to draw down the public bubble slowly, a possibility that private bubbles typically don’t share,” the report says.

The downside? “The worst-case scenario is that the bubble pops rapidly, putting the economy squarely back into another recession — the double dip.”

The U.S. still is feeling the effects of widespread housing bust, but a new report serves as a reminder that large swaths of the nation didn’t experience a boom in home prices and hasn’t suffered from the bust.

New York Federal Reserve staffers Jaison R. Abel and Richard Deitz released a report highlighting the stability of upstate New York’s housing markets. The research notes that while the rest of the U.S. saw a real-estate boom and bust, upstate New York was largely insulated from the cycle.

“Despite upstate’s long-term weak economic growth and population loss, Buffalo, Rochester, and Syracuse all ranked in the top 10 percent of metro areas in terms of home price appreciation in 2009, with Buffalo ranking sixth overall,” the authors wrote.

But upstate New York isn’t alone in bucking the national trend. “Most U.S. metro areas actually experienced more moderate increases in house prices than the nation between 2000 and 2006. In fact, 249 of the 383 metropolitan areas tracked by the Federal Housing Finance Agency saw price increases below the national rate of 8.1% during the boom,” Abel and Deitz said. Many of these areas, in turn, didn’t experience the resulting bust.

The authors say a lack of nonprime lending in these areas played a prominent role in insulating them from the boom and bust. “It is likely that causation runs in both directions — an increase in nonprime lending led to more significant home price appreciation [in boom areas], and more rapid home price appreciation led to a rise in nonprime lending,” the authors stated.

A correction from the boom years was clearly the driving force behind a national decline in home prices, and some regions with little to correct have been largely insulated. However, the trouble in the housing market may not end as the market returns to normal levels. Many metro regions may have been spared a precipitous decline in home prices, but the recession sparked by the drop has left almost no one unscathed. As every part of the country faces middling economic growth and continued long-term unemployment, a second leg down in the housing market could be more geographically widespread.

Paul Volcker, a top adviser to U.S. President Barack Obama, Tuesday expressed optimism that a financial overhaul containing a version of his proposal to limit bank risk would pass in Congress.

Obama adviser Paul Volcker (Getty Images)

The former Federal Reserve chairman defended his proposal to give regulators the power to force banks to get rid of divisions that make risky bets with their capital, in order to help prevent another financial crisis.

“We have a promising possibility of getting agreement here” for a “reasonably good bill,” Volcker said, adding he was more optimistic than a month ago. He was speaking at the Peterson Institute for International Economics.

Senate Democrats on March 15 proposed a financial overhaul that would hurt big Wall Street banks by reining in their profits and requiring them to hold more capital. The proposal includes a version of what Obama has dubbed the “Volcker rule.”

Volcker wants to prevent commercial banks with federally insured deposits from engaging in “proprietary trading,” or doing speculative trading with the company’s money. The Senate bill wouldn’t prohibit certain forms of bank speculation outright, but it would give regulators leeway to enforce limits on a case-by-case basis.

“Let commercial banks be commercial banks,” Volcker said. Although it may be a step back compared to developments in the financial industry over the past decades, it would be a step to a “safer and more productive future.”

Commercial banks were banned from doing speculative trading under Depression-era laws requiring the strict separation of retail and investment banking activities. But those rules were rolled back in the 1990s.

Volcker praised the Senate bill for its provisions that would allow the government to let large financial institution posing a threat to the economy to be wound down in an orderly way.

“We must not let the crisis go to waste. I’m hopeful we’ll proceed this year and get [the financial overhaul] done,” he said.

A proposal to double the percentage limit that determines how much credit unions can lend to small businesses is drawing sharp criticism from commercial lenders, building upon an already thorny relationship between the two.

The Credit Union National Association is lobbying Congress to increase how much credit unions can lend to small business from 12.25% to 25% of a credit union’s total assets, and increase the individual loan amounts that wouldn’t count toward the cap from $50,000 to $250,000.

As policymakers continue to wrangle with how to reduce constrained lending standards to companies, the association — seizing the opportunity put forth by the financial meltdown — said credit unions are viable resources for businesses who need loans.

“The stars are aligned and now is the perfect time for this to happen,” the association’s Senior Vice President John Magill said.

His group has already received support from about 104 lawmakers, who have signed on to legislation easing the restrictions. But opposition from the banking industry has kept the provision out of pending financial services legislation in both chambers.

The bill’s main sponsor, Rep. Paul Kanjorski (D., Pa.), hopes to attach his provision to any future jobs-creation legislation that the House considers, arguing the measure could create more than 100,000 jobs. A companion bill pending in the Senate sponsored roughly a dozen co-sponsors.

Nonetheless, the American Bankers Association doesn’t think now is the time for lawmakers to ease credit union’s business lending restrictions. ABA Congressional Relations Executive Vice President Floyd Stoner labeled the proposal a policy decision that could undermine why credit unions were created.

Stoner took issue with whether credit unions would be serving consumers of “modest means” as indicated by their mission statement. Credit unions are tax-exempt in part because of this mission.

“By a handfull of aggressive credit unions seeking to become ever more bank-like without giving up any of those advantages, it takes the nature of their mission and moves them away from it,” Stoner said.

Additionally, commercial lenders don’t want credit unions impeding on their loan market share, especially during this financial turmoil that has crippled more than 200 banks. Stoner suggested those credit unions that are interested in increasing their investment activity change their business model and become a mutual savings bank, a move that would lead to those credit unions forfeiting their tax exempt status.

According to the credit union association, roughly 2,000 of 8,000 credit unions lend to small businesses. Those lenders account for roughly 1% of total market loans, while their direct loan volume to small businesses is roughly 4.5%. Under the proposal, their total market share could increase to 1.2% and the share of loans to small businesses could rise up to 9%, the credit union association projected.

The association said the cap increases are necessary because roughly 350 credit unions have made loan amounts above $50,000, requiring them to be reported to federal regulators and applied toward credit unions’ 12.25% business lending cap. Within a year or two, those unions will need to stop business lending or slow it to a trickle, Magill said.

ABA’s Stoner, citing data from the federal regulator of credit unions — the National Credit Union Administration — refuted those numbers. Only 37 credit unions are within 1% of approaching the lending cap, Stoner said NCUA’s data showed. He also took issue with how credit unions market share is measured, saying there is no true way to measure it because business loans under $50,000 are not reported to NCUA.

In the meantime, National Credit Union Administration Chairman Debbie Matz, in support of the proposal, sent a letter sent to Treasury officials in February saying the regulator would revise its guidelines to ensure credit union’s projected increase in lending activity doesn’t lead to “unintended safety and soundness concerns.”

Treasury declined to comment, saying the Obama administration has not taken a public position on the proposed legislation.

In early March, Federal Reserve Chairman Ben Bernanke told U.S. lawmakers on the House Financial Services Committee that because credit unions are tax exempt, they should accept that certain activities would be restricted, in particular, how much they can lend to businesses.

The S&P/Case-Shiller 20-city home-price index, a closely watched gauge of U.S. home prices, was mostly flat in January from a month earlier.

The index declined 0.7% from a year earlier. On a month-to-month basis prices fell 0.4% in January from December, but adjusted for seasonal factors the 20-city index was 0.3% higher. The winter months are particularly slow for housing, and seasonal factors play a strong role in price declines. On a seasonally adjusted basis, eight cities posted month-to-month declines. Unadjusted, all but two regions experienced home-price drops.

Los Angeles posted the largest jump in prices, while Chicago posted the biggest drop. Four cities — Charlotte, Las Vegas, Seattle and Tampa — posted new lows following the financial crisis. On a relative basis, Washington, Los Angeles and New York have held up the most, with each of those markets still 70% above their January 2000 levels.

“There is little doubt that housing ’stabilization’ continues although the influx of four million new foreclosures, both on-the-market and shadow inventories that remain elevated, 30 year mortgage rates that are solidly through the 5.1% level and an unemployment rate that remains elevated will all likely continue to put downward pressure on demand and thus prices,” said Dan Greenhaus of Miller Tabak & Co.

• Read the full story.

Below, see data from the 20 metro areas Case-Shiller tracks, sortable by name, level, monthly change and year-over-year change — just click the column headers to re-sort.
(About the numbers: The Case Shiller indices have a base value of 100 in January 2000. So a current index value of 150 translates to a 50% appreciation rate since January 2000 for a typical home located within the metro market.)

Home Prices, by Metro Area

Metro Area	January 2010	Unadjusted Change from December	Seasonally Adjusted Change from December	Year-over-year change
Atlanta	107.04	-1.5%	-0.5%	-2.2%
Boston	153.03	-0.5%	0.3%	1.5%
Charlotte	117.13	-0.6%	-0.1%	-3.1%
Chicago	125.11	-1.7%	-0.8%	-4.4%
Cleveland	103.12	-0.7%	0.7%	0.2%
Dallas	117.26	-1.3%	-0.3%	4.1%
Denver	125.59	-1.3%	0.1%	2.6%
Detroit	71.82	-1.1%	0.1%	-7.4%
Las Vegas	103.82	-0.5%	0.3%	-17.4%
Los Angeles	172.98	0.9%	1.8%	3.9%
Miami	148.32	-0.2%	-0.1%	-6.7%
Minneapolis	122.63	-0.6%	0.7%	1.9%
New York	171.27	-0.3%	-0.3%	-5.3%
Phoenix	111.76	-0.6%	0.8%	-4.6%
Portland	147.29	-1.8%	-0.5%	-4.2%
San Diego	156.95	0.4%	0.9%	5.9%
San Francisco	135.63	-0.6%	0.6%	9.0%
Seattle	145.09	-1.7%	-0.6%	-6.0%
Tampa	138.18	-0.5%	0.5%	-7.4%
Washington	178.02	-0.4%	0.2%	3.5%

Source: Standard & Poor’s and FiservData

A roundup of economic news from around the Web.

• Fiscal Policies: Paul De Grauwe on voxeu looks at the difference in fiscal policy in normal and abnormal recessions. “Should governments continue with fiscal expansion or should it be cut back as soon as possible? This column compares different economic models and argues that the answer depends on the type of recession we are facing. In “normal recessions” the New Keynesian model is best, but in “abnormal recessions” it is the Keynesian model.”
• Debt: Antonio Fatas looks at the difference between gross debt and net debt. “It is clear that the difference between gross and net debt is very large for some countries. While Japan looks like an outlier in terms of gross debt, it is close to Italy and Greece when it comes to net debt. In principle, net debt is a more appropriate measure of government indebtedness. If governments have a significant amount of assets, they need to be considered when thinking about the solvency of their accounts. In some cases the government (at large) holds some of its own debt in pension funds for public employees or the social security fund (this is why in the US the most common measure of government debt is “debt held by the public” which is a measure very similar to the concept of net debt), this debt is not a liability for the government.”
• Education and Employment: Ed Glaeser on Economix notes that education affects employment in indirect ways. “The more than one-for-one relationship between metropolitan area unemployment and the rate predicted by educational composition is an example of what economists call “social multipliers,” which may exist when aggregate relationships are stronger than individual relationships. In this case, the aggregate or metropolitan area relationship between unemployment and education is stronger than the individual relationship between unemployment and education. Social multipliers may occur when one person’s actions, like being unemployment or getting educated, influence everyone else. If one layoff reduces the demand for another person’s work and that leads to another layoff, then the impact of anything that increases unemployment will be multiplied. This is a standard Keynesian argument, but there are reasons to suspect that this isn’t the story behind the overly strong relationship between local unemployment and local education.”

Compiled by Phil Izzo

The global loss of economic output as a result of the banking crisis may be between $60 trillion and $200 trillion, Bank of England Executive Director for Financial Stability Andrew Haldane said Tuesday.

In a speech on the costs of “banking pollution,” Haldane said the direct costs to government of bailing out banks may prove to be small, amounting to less than £20 billion, or a little more than 1% of gross domestic product. In that case, any levy on banks to recoup the cost of the crisis would also be small, less than £1 billion a year in the U.K., and less than $5 billion a year in the U.S.

But he said the direct costs to the government “almost certainly .. underestimate..the damage to the wider economy that has resulted from the crisis.”

“Evidence from past crises suggests that crisis-induced output losses are permanent, or at least persistent, in their impact on the level of output if not its growth rate,” Haldane said. “If GDP losses are permanent, the present value cost of the crisis will exceed significantly today’s cost.”

Haldane estimated that lost output over coming years may total between $60 trillion and $200 trillion for the global economy, and between £1.8 trillion and £7.4 trillion for the U.K. economy.

The guys on the shadow open market committee are old school.

The watchdog group, in existence since the early 1970s, serves as a vehicle to criticize Federal Reserve policy making. Its members are frequently luminaries of the economics profession. Some past members, like current Philadelphia Fed president Charles Plosser, have even gotten called to the big league, getting the chance to set policy for themselves.

The reputation of the shadow outfit arises from the group’s long standing interest in “monetarism” — that is, a focus on the money supply’s influence on the economy. It’s a school that’s out of step with the current practices at the Fed. To be sure, members of the private group hold a diversity of views on economics and monetary policy, but often as not, they end up critical of what policy makers are doing.

Not surprisingly then, an event held by the group in New York Friday found its members worried about the state of monetary policy. The committee members are worried the Fed’s current monetary policy stance–it entails keeping rates very low for a long period of time–is dangerous.

They’re concerned the Fed, having more than doubled its balance sheet, is risking a big breakout in inflation if it doesn’t get to the business of raising interest rate relatively soon.

The committee members also worry the Fed will need to start shedding the $1.25 trillion in mortgage assets on its balance sheet soon, saying sales rather than passive redemptions must do the job.

Rutgers University professor Michael Bordo said 0% interest rates, if continued for much longer, are going to cause a “run up in inflation expectations.” Noting history shows the Fed often ends up “exiting too late,” he said the central bank should be raising rates by summer, lest it engineer an unpleasant inflation situation.

Gregory Hess, of Claremont McKenna College, offered the most aggressive prescription.

“At this point it’s time for the Fed to make an announcement that it’s time to get out of the business” of owning mortgages, he said. The central bank needs to offer a timeline, saying the securities would be sold over the course of one to two years, as the Fed moves back to an all-Treasury balance sheet.

Meanwhile, Marvin Goodfriend, of Carnegie Mellon University’s Tepper School of Business, said the risk for the Fed right now was that market perceptions “are in flux” — Treasury yields spiked this week in a worrisome development — and officials should create the impression they will act to keep inflation under control, lest investor confidence be lost.

The recommendations of the shadow open market committee members are somewhat at odds with the views held by key Fed officials. Last week, Fed Chairman Ben Bernanke told congress the central bank is in no hurry to raise rates, given that there’s essentially no inflation pressure right now, and unemployment is high.

Meanwhile, San Francisco Fed president Janet Yellen, facing a possible elevation to the central bank vice chairman role, sought to counter widespread perceptions she is dovish on monetary policy, in remarks that nevertheless underscored her lack of urgency to tighten monetary policy.

That monetary policy traditionalists are unsettled right now isn’t surprising. The Fed’s balance sheet has gone from just over $800 billion at the start of the crisis to over $2 trillion. Interest rates have been effectively at 0% for over a year, and they’re likely to stay there for months to come. The central bank became the main buyer in the mortgage-backed securities market, among other market interventions.

Much of what’s been done is worrisome when weighed against textbook monetary policy. But against this orthodoxy Fed policymakers have argued that unprecedented events have called for radical action. Time will tell who is right.

A roundup of economic news from around the Web.

• Unskilled College Graduates: Arnold Kling wonders what the value of college is at the margins. “I am just beginning to explore the issue of sorting out the economic value of college at the margin, rather than on average. One aspect of this is to distinguish between college graduates with skills and college graduates without skills, with the further distinction between private sector and public sector employment. I suspect that the average salaries of college graduates are boosted by those of skilled college graduates (engineers) and public-sector-employed college graduates (teachers). I wonder what the average salary looks like in the private sector for the unskilled college graduates (communications majors, majors with the word “studies” in them, etc.).”
• Regulation Reform: David Leonhardt takes an indepth look at regulation reform. ” The obvious reason to re-regulate finance is to prevent the next crisis or at least to make it less damaging. But there are other potential benefits to reform. Consider what has happened to the American economy over the last three decades. Highly leveraged financial firms became a dominant part of the economy. Their profits allowed the firms to recruit many of the country’s most sought-after employees — mathematicians, scientists, top college graduates and top former government officials. Yet many of those profits turned out to be ephemeral. So some of the best minds were devoted to devising ever-more-complex means of creating money out of thin air, the proceeds of which then drew in even more talent.”
• Saving Rate: Yves Smith looks at the connections between the saving rate and income inequality. “Behaviors on both ends of the income spectrum no doubt played into the low-savings dynamic: wealthy who spend heavily, and struggling average consumers who increasingly came to rely on borrowings to improve or merely maintain their lifestyle. And let us not forget: were encouraged to monetize their home equity, so they actually aped the behavior of their betters, treating appreciated assets as savings. Before you chide people who did that as profligate (naive might be a better characterization), recall that no one less than Ben Bernanke was untroubled by rising consumer debt levels because they also showed rising asset levels. Bernanke ignored the fact that debt needs to be serviced out of incomes, and households for the most part were not borrowing to acquire income-producing assets. So unless the rising tide of consumer debt was matched by rising incomes, this process was bound to come to an ugly end.”

Compiled by Phil Izzo

The 2010 Census is likely to be one of the more challenging population counts in recent history, a fact that could raise the cost of the census and reduce the accuracy of the count.

“The recession could make it a lot harder to find people,” says Sean Reardon, a professor at Stanford University, who studies income inequality.

It all comes down to bad timing. The government always knows when the census will be, but the state of the economy is a crapshoot. This year’s census will take place in the aftermath of the worst recession in a generation. While economists say it’s likely the U.S. emerged from recession sometime around summer 2009, the jobless rate is expected to remain well above 9% for the remainder of the year.

The past few censuses, though, have been in relatively prosperous times. The 1980 Census came at the beginning of a recession, and was thus closer to a peak than a trough. The 1990 Census came just before the 1990-1991 recession. The 2000 Census was done well before the March 2001 recession began.

Doing the census in the wake of a deep recession could affect the count in a number of ways. For starters, economic troubles are forcing a lot of people to move around, or to move in with relatives. That means they could be omitted, because they’ll be between homes when the census mailing comes.

Also, census workers seeking people who didn’t answer their surveys will face an arduous task searching through neighborhoods rife with foreclosed homes. The difficulty in finding people, in turn, will raise the cost of the census. The Census Bureau has estimated that each 1% increase in mailed forms saves $85 million, since the government doesn’t have to track those people down.




Assets on the Fed’s balance sheet expanded again in the latest week, rising to $2.295 trillion from $2.290 trillion. With direct bank lending continuing to decline, the bulk of the increase came from the Fed’s purchases of long-term securities. More than $7 billion in new purchases of mortgage-backed securities were added to the balance sheet. The central bank is expected to end its acquisitions by the end of next week. The Fed has a little over $6 billion left to purchase this week to fulfill its $1.25 trillion allocation for MBS, according to Adam Quinones of Mortgage News Daily.

In an effort to track the Fed’s actions, Real Time Economics has created an interactive graphic that will mark the expansion of the central bank’s balance sheet. The chart will be updated as often as possible with the latest data released by the Fed.

In an effort to simplify the composition of the balance sheet, some elements have been consolidated. Portfolios holding assets from the Bear Stearns and AIG rescues have been put into one category, as have facilities aimed at supporting commercial paper and money markets. The direct bank lending group includes term auction credit, as well as loans extended through the discount window and similar programs.

Central bank liquidity swaps refer to Fed programs with foreign central banks that allow the institutions to lend out foreign currency to their local banks. Repurchase agreements are short-term temporary purchases of securities from banks, which are looking for liquidity and agree to repurchase them on a specified date at a specified price.

Click and drag your mouse to zoom in on the chart. Clicking the check mark on categories can add or remove elements from the balance sheet.

After Treasury Deputy Secretary Neal Wolin slammed the U.S. Chamber of Commerce for lobbying against the White House’s effort to overhaul financial market rules, the business group wrote a eight-page letter in an effort to rebut many of the accusations. (Read the full letter.)

The letter, written by David Hirschmann, chief executive of the Chamber’s Center for Capital Markets Competitiveness, outlined many parts of the regulatory overhaul that he argued could have broad impacts on many different types of businesses, not just banks.

He says, for example, a new Consumer Financial Protection Bureau would regulate not just banks and financial companies but “hundreds of thousands of businesses.”

Philadelphia Fed President Charles Plosser (Bloomberg News)

The Federal Reserve should be open to selling some of its portfolio of mortgage backed securities even before it starts raising interest rates, says Charles Plosser, president of the Federal Reserve Bank of Philadelphia. In an interview with the Wall Street Journal in Frankfurt at the tail end of a trip to Europe, Mr. Plosser said he’s comfortable with inflation in the near term, but thinks the Fed should reduce its balance sheet to prevent future price pressures. Mr. Plosser thinks the U.S. will soon be generating jobs, which may help spur an end to the Fed’s use of the “extended period” language in its policy statements.

Following are excerpts from the interview:

What’s your view of fiscal policy and the state of recoveries in the US and Europe?

Plosser: I’m anticipating positive [U.S.] employment growth in the next month or two. The March report may show positive growth as well. The evidence in the U.S. about the sustainability of [the recovery] is growing in the sense that it’s becoming more broad-based. We’re seeing positive signs in more and more pieces of the economy.
I’m hoping that as we become more and more convinced over the next quarters that economic growth is on a good trajectory, we’re going to have to start looking hard at beginning to rein in our accommodative policies because it’s extraordinarily low. Even if we raise the funds rate target to 75 basis points, it’s still extraordinarily low.
Like the U.S., I think there’s evidence Europe is gradually emerging from this recession. It seems to be a little more tentative at this point than in the United States. I think the data, particularly from Germany, there’s some disappointment in the last few months. But I get the sense they continue to be on a track for recovery.
In terms of fiscal policies, certainly many countries around the world, the US included, have engaged in fiscal policies that are quite extraordinary in terms of their size, and I think that should be troubling for all of us. We have to have the fortitude and courage to exit from some of these fiscal policies. The debt levels of many countries are clearly not sustainable.”

What’s your view of inflation in the U.S. given the moderation in core CPI?

Plosser: Core is pretty low, which is fine. One of the things we have to be a little bit careful of, particularly with the core, I think they’re probably a little bit distorted. We’ve had a huge housing shock. Shelter prices in the CPI have fallen substantially. I don’t like taking out elements, but shelter and owners’ equivalent rent are a huge percentage of the core. We have a tendency to use core as a measure of the underlying trend. It’s not that we target core, but is core a useful signal of what the underlying trend in inflation is? I don’t know the answer to that. We have to be very careful.
I’m not terribly concerned, although a lot of people claim that I am, about inflation in the near term. I don’t think that’s where the risks are. I think it’s important for central banks to look at the intermediate and longer term, and I think that’s where the risks are for inflation given the size of our balance sheet. I am cognizant of the fact that that the Fed’s going to have to try to manage its way out of this extraordinarily accommodative liquidity we’ve provided to the economy. We’re going to have to get out from that before we see inflation occurring.”

You’re not a fan of the Fed’s “extended period” phrase in FOMC statements. What do you think needs to happen to remove it?

Plosser: I don’t know the answer to that. We’re struggling with exactly that question. We are discussing these issues and we have to think ahead whether or not we’re ready to change the language even if we’re not ready to change rates. The problem is we’ve used this language for so long it’s kind of tied our hands.

Would employment growth be something that could change things? That’s the one thing in the recovery that we haven’t seen.

Plosser: I think it’s certainly one statistic that would begin to increase the comfort level of a lot of people about the recovery. That clearly would be a good sign for the economy. Obviously the more comfortable we are with the state of the economy, the more we will begin to think about beginning to reverse course here.

When do you think extended period might go?

Plosser: I have no idea. It’s the state of the economy, not the calendar. I’m not quite ready to move today [on interest rates] but the more confidence I get in the state of the economy and its trajectory, the more willing I’m going to be to begin thinking about moving. I’m kind of ready to move on the language. That doesn’t mean I’m ready to move on rates yet. We need to begin to prepare the markets for this.

How quickly can the discount rate be normalized?

Plosser: It depends on a number of things. It’s not clear what we mean by normal. We’re in a different world than we were before the crisis. In particular we’re now paying interest rates on reserve. With interest on reserves we’re moving toward a desirable system which is a corridor system (with interest on excess reserves as the lower bound and discount rate as the upper bound). We’ve got to restrict the volume of excess reserves. We’ve got so many excess reserves floating around the system we could never get fed funds above the lower bound until we get reserves down.
There was this whirl of conversation that we were going to raise the discount rate again. I don’t see us getting greatly involved in that discussion until we have a better idea of how we want to think about our operating procedures.

What about the debate over selling the Fed’s mortgage-backed securities holdings?

Plosser: I don’t think we’ve decided yet. There are different views on this. I’m not as reluctant to sell MBS partly because I think we need to get our balance sheet back to more Treasurys and less MBS. I’m not afraid of selling MBS before we raise interest rates. I think the concern that some people have is the potential impact that might have on mortgage rates directly. My view is that if we thought that during the crisis markets were not functioning right and that it made sense to target specific assets to try to control or reduce spreads of various kinds, that may have been relevant in a crisis when markets weren’t functioning. But that’s not true anymore. Markets are functioning pretty well right now. So the ability for us to target specific assets and the consequences they have for prices of those assets is a lot less. Given the market functioning, I don’t anticipate that selling MBS at a reasonable pace, that that’s going to have a tremendous impact on mortgage rates per se.

What would you need to see in the economy for a tightening cycle to begin?

Plosser: I go back to my view about sustainable growth in real GDP and the signs that go with that. A lot of people refer to the recovery as still fragile. They talk about housing and employment. I don’t single out any one thing. My focus is building confidence that real growth is underway and sustainable. Because when that happens, when real growth picks up, if we don’t change policy in the face of that, then we are actually loosening policy. Because as real growth rates pick up, demand for loans is going to pick up, banks are going start converting their excess reserves into lending–which is not necessarily a bad thing, but they could do that very quickly and then all that liquidity starts flowing into the economy. That is the fuel for inflation.

Some recent home sales data have been weak. Is the US at risk of a double dip in the housing market?

Plosser: It’s been so distorted by the weather. I’m a little hesitant to read too much into these numbers. They were disappointing. We also have to remember that the residential housing sector is a lot smaller part of the economy than it used to be. So I don’t view that as a necessarily conditional variable on which there has to be a strong recovery in housing sales necessarily before we begin to think about normalizing policy.

What’s your view on legislation in the works to revamp financial regulation? Where are the opportunities and risks?

Plosser: I wish I had a clue what Congress is going to do. I don’t. The biggest thing legislation needs to do is we need a fix for too-big-to-fail. If we don’t fix that correctly then we haven’t solved our problems. I don’t care how many regulators you put into the mix, you won’t solve it. I am more a fan of trying to make more use of bankruptcies and less use of regulator or government discretion. I would caution against allowing too much flexibility and too much discretion to the government to bail out somebody as opposed to liquidate them. And I worry a little bit that the bills as written maybe allow too much discretion, because if you’ve got the discretion then you’ve still got the moral hazard.

The Commerce Department said Friday that fourth-quarter gross domestic product grew a little bit less than it had previously estimated, growing at a 5.6% seasonally- and inflation-adjusted rate, rather than 5.9%. But another measure suggested the fourth-quarter rebound was stronger.

Gross domestic income, which in theory should equal GDP, grew at a 6.2% seasonally- and inflation-adjusted annual rate in the fourth quarter. That’s a rebound from the third quarter, where GDI fell 0.4% even as GDP posted 2.2% growth. GDP measures the output of the economy as the sum of expenditures — consumption, plus investment plus government spending plus net exports. GDI measures total income in the economy.

The distinction between GDP and GDI may matter because recent research from Federal Reserve economist Jeremy Nalewaick suggests that GDI may be the more accurate measure. Even with the stronger fourth-quarter growth, GDI is 2.8% below its peak level, whereas GDP is 2% lower. That may explain why job losses have been so much more intense than the contraction in GDP suggests they should have been.

In a research note Thursday, Goldman Sachs economist Jan Hatzius suggested that the more pronounced weakness GDI has shown over the course of the recession would continue in the fourth quarter, pointing to a weaker job market than most economists expect. Goldman Sachs economists’ outlook on jobs is more pessimistic than most: In the Wall Street Journal’s most recent survey of forecasters, they looked for a year-end unemployment rate of 10.2%, compared to an average estimate of 9.4%.

Asked Friday if the stronger fourth GDI might point toward a better job market outlook, Mr. Hatzius acknowledged that “it points in that direction.”

A roundup of economic news from around the Web.

• Capital Markets: Karen Johnson, a former top Fed international economist, asks whether the capital markets failed us. “Securitization forged links between banking and capital markets. It broke down the differences in forms of financial intermediation that had characterized markets previously, especially in the United States, where regulation had put commercial banking in a separate category. Changes in regulation enhanced this process. As a result, U.S. financial markets became even more unified and national — further reducing some persistent inefficiencies. Securitization was an important and useful innovation. However, capital markets are not well-suited to do all the financial intermediation in the economy.”
• Social Security: Diane Lim Rogers talks about what needs to be done to fix Social Security. “Not doing anything about Social Security now would be fine if either: (i) we knew what to do with the much bigger challenge of much more rapidly rising Medicare spending (i.e., we knew how to flatten that health cost curve and were really on the way to doing it), or (ii) we didn’t know what to do to close the much smaller Social Security deficit. But the fact is that it’s hard to know how to solve the Medicare problem and relatively easy (mathematically and economically) to solve the Social Security problem. We know how to solve the latter, and I think most Americans in hearing what some of these solutions are …, would think they were no big deal. Why, just this week my (very socially-conscious) 17-year old daughter, Emily, brought up the unsustainable fiscal outlook and said she didn’t understand why we don’t just raise the retirement age–which is what both Bill Gale (of the liberal-leaning Brookings Institution) and Andrew Biggs (of the conservative-leaning American Enterprise Institute… ok, perhaps more than leaning, but more on the David Frum story later) recommend in the NYTimes piece. Emily spoke of raising the retirement age as a “no brainer”–and not because I’ve brain-washed her but perhaps because she knows her mom will be working forever anyway just to pay for her and her three siblings’ college educations…”
• Job Losses: Mark Thoma points to the Minneapolis Fed’s chart of job losses in postwar recessions. The current downturn in jobs stands out, and not in a good way.

Compiled by Phil Izzo

Things were bad all over the U.S. in 2009, but some areas got hit harder than others.

Overall U.S. per capita income dropped 2.6% to about $31,000. Connecticut, home to many of the titans of finance, continued to be the state with the highest per capita income in the nation at $54,000, but it was in the top 10 in terms of declines from 2008 with a 3.3% drop. Wyoming had the largest personal income drop in the country at 5.9%. Only four states posted gains in per capita personal income with West Virginia coming out on top with a 1.8% increase, though it has seventh lowest level in the nation.

Every state experienced a decline in employment last year. Unsurprisingly, California, the most populous state, lost the most jobs, but its average unemployment rate of 11.4%, fourth highest in the nation, showed that the decline was disproportionate compared to other states. North Dakota, the nation’s third least populous state, had the smallest drop in jobs, but it also had the lowest average unemployment rate.

Home prices, as measured by Federal Housing Finance Agency which only tracks mortgages backed by Fannie Mae and Freddie Mac, posted large declines in bubble areas such as Nevada, Arizona and Florida. But 18 states posted year-to-year gains, according to FHFA whose index may understate declines since it doesn’t track jumbo or subprime loans.

2009 Overview

State	Income (per capita)	Change in income 2008 to 2009	Population (July 2009)	Change# in pop. 2008 to 2009	Jobs lost 2008 to 2009	Average jobless rate	Home prices 2008 to 2009
*United States	$39,138	-2.6%	307,006,550	0.9%	-5,961,600	9.3%	-1.2%
Alabama	$33,096	-1.7%	4,708,708	0.7%	-98,300	10.1%	2.1%
Alaska	$42,603	-3.0%	698,473	1.5%	-2,800	8.0%	-2.8%
Arizona	$32,935	-4.1%	6,595,778	1.5%	-148,200	9.1%	-13%
Arkansas	$31,946	-1.0%	2,889,450	0.8%	-39,000	7.3%	1.5%
California	$42,325	-3.5%	36,961,664	1.0%	-917,800	11.4%	-0.4%
Colorado	$41,344	-3.9%	5,024,748	1.8%	-116,300	7.7%	2.8%
Conn.	$54,397	-3.3%	3,518,288	0.4%	-65,800	8.2%	-3.1%
Delaware	$39,817	-1.4%	885,122	1.0%	-11,700	8.1%	-3.8%
District of Columbia	$66,000	-0.5%	599,657	1.6%	-3,400	10.2%	-0.3%
Florida	$37,780	-3.3%	18,537,969	0.6%	-425,700	10.5%	-8.2%
Georgia	$33,786	-3.1%	9,829,211	1.4%	-200,300	9.6%	-1.2%
Hawaii	$42,009	-0.2%	1,295,178	0.6%	-22,900	6.8%	-13%
Idaho	$31,632	-4.1%	1,545,801	1.2%	-28,500	8.0%	-6.6%
Illinois	$41,411	-2.7%	12,910,409	0.5%	-291,300	10.1%	-4.8%
Indiana	$33,725	-2.4%	6,423,113	0.5%	-140,600	10.1%	1.7%
Iowa	$36,751	-2.0%	3,007,856	0.5%	-50,100	6.0%	0.7%
Kansas	$37,916	-2.5%	2,818,747	0.8%	-63,700	6.7%	1.5%
Kentucky	$31,883	-0.2%	4,314,113	0.6%	-57,800	10.5%	1.6%
Louisiana	$35,507	-1.6%	4,492,076	0.9%	-68,800	6.8%	0.7%
Maine	$36,745	1.0%	1,318,301	-0.1%	-17,500	8.0%	1.0%
Maryland	$48,285	0.3%	5,699,478	0.7%	-73,800	7.0%	-5.5%
Mass.	$49,875	-2.0%	6,593,587	0.8%	-92,600	8.4%	-0.3%
Michigan	$34,025	-2.7%	9,969,727	-0.3%	-193,700	13.6%	-2.8%
Minn.	$41,552	-3.3%	5,266,214	0.7%	-102,100	8.0%	-1.0%
Miss.	$30,103	-0.9%	2,951,996	0.4%	-39,800	9.6%	-1.7%
Missouri	$35,676	-1.9%	5,987,580	0.5%	-107,700	9.3%	0.0%
Montana	$34,004	-1.8%	974,989	0.7%	-22,400	6.2%	-2.6%
Nebraska	$38,081	-2.8%	1,796,619	0.8%	-28,400	4.6%	2.1%
Nevada	$38,578	-5.8%	2,643,085	1.0%	-112,200	11.8%	-17%
New Hampshire	$42,831	-1.4%	1,324,575	0.2%	-13,700	6.3%	-0.5%
New Jersey	$50,313	-2.3%	8,707,739	0.5%	-141,800	9.2%	-3.7%
New Mexico	$32,992	-1.2%	2,009,671	1.2%	-37,800	7.2%	-4.5%
New York	$46,957	-3.8%	19,541,453	0.4%	-252,600	8.4%	-0.9%
North Carolina	$34,453	-2.3%	9,380,884	1.4%	-161,900	10.6%	0.3%
North Dakota	$39,530	-0.9%	646,844	0.8%	-2,100	4.3%	1.2%
Ohio	$35,381	-1.4%	11,542,645	0.1%	-273,400	10.2%	1.0%
Oklahoma	$35,268	-1.9%	3,687,050	1.2%	-76,500	6.4%	3.5%
Oregon	$35,667	-1.9%	3,825,657	1.1%	-99,100	11.1%	-7.4%
Penn.	$39,578	-0.5%	12,604,767	0.3%	-195,000	8.1%	-0.5%
Rhode Island	$41,003	-0.6%	1,053,209	0.0%	-19,300	11.2%	-0.7%
South Carolina	$31,799	-2.1%	4,561,242	1.3%	-72,200	11.7%	1.4%
South Dakota	$36,935	-4.4%	812,383	1.0%	-11,200	4.8%	1.6%
Tenn.	$34,089	-2.1%	6,296,254	0.9%	-139,200	10.5%	-0.6%
Texas	$36,484	-3.5%	24,782,302	2.0%	-412,400	7.6%	0.8%
Utah	$30,875	-3.7%	2,784,572	2.1%	-68,700	6.6%	-7.7%
Vermont	$38,503	0.5%	621,760	0.1%	-2,300	6.9%	-1.3%
Virginia	$43,874	-0.5%	7,882,590	1.1%	-108,600	6.7%	3.1%
Wash.	$41,751	-2.3%	6,664,195	1.5%	-148,600	8.9%	-5.2%
West Virginia	$32,219	1.8%	1,819,777	0.3%	-24,700	7.9%	-2.7%
Wisconsin	$36,822	-2.5%	5,654,774	0.5%	-134,400	8.5%	-1.2%
Wyoming	$45,705	-5.9%	544,270	2.1%	-22,900	6.4%	-6.0%

Sources: Commerce Dept., Labor Dept. FHFA
#Population change July 2008 to July 2009, the most recent available data

Investors should start readying themselves for some strong gains in the labor market.

Why?

It’s because both data and anecdotal evidence point in that direction, at least for a while.

“We are going to be hiring this year,” said Joe Brusuelas, of Stanford-based economic research firm Brusuelas Analytics. He pegs the likely gain in payrolls at around 225,000 for March, up from a loss of 36,000 in February.

Here’s the evidence:

In the first place, the government has started hiring large numbers of temporary workers for the census. That number should peak at around 635,000 in May, according to the Commerce Department. The jobs will be temporary, but they are still jobs and that will likely mean increased spending in the economy and hence likely more hiring.

Even without the census-related boost, Brusuelas said the private sector should add about 50,000 permanent jobs a month if the economy stays on its current trend. That trend-growth rate should edge higher towards the end of the year, with even more jobs being added each month, he said.

Add to that further evidence hidden deep with other data series. Even though the Institute for Supply Management’s Manufacturing Index, which tracks growth in the factory sector, slowed in February, the sub-index for employment was more bullish, showing three months of steady increases.

The employment sub-index within ISM’s Services Index, which tracks the non-manufacturing economy, also showed consistent gains over the same period. The two ISM data points augur improved hiring going forward.

Anecdotally, I’ve seen evidence of a more vibrant job market. Here in New York City, there has been a dramatic decline in service quality at some of the local lunch spots. That is typically a sign that it’s becoming harder for companies either to get quality workers and/or appropriately trained managers.

In addition, not only are there now help-wanted signs in store fronts, but there is also some rather frenetic activity among headhunters. Both things were absent eight months ago.

On the cautious side, Charlotte-based Wells Fargo economist Adam York said the U.S. will need to see first-time unemployment insurance claims dip into the range of around 380,000 to 420,000 before the overall unemployment rate can be expected to drop significantly. Initial jobless claims today fell 14,000 but at 442,000 still are at an elevated level.

Even so, don’t be surprised to see some shockingly large jumps in payrolls at the end of next week and beyond. The real question is: How long will the hiring boom last?

Federal Reserve Chairman Ben Bernanke carves out new ground in his testimony to Congress today, saying the Fed is likely to start at some point gradually to sell some of its large holdings of mortgage backed securities.

Federal Reserve Chairman Ben Bernanke (Reuters)

His goal, he says, is to get his $2 trillion balance sheet down to below $1 trillion. One way to do that is to sell mortgage-backed securities. This matters a lot for millions of Americans because if the Fed sells pieces of its trillion-dollar mortgage portfolio, it could put upward pressure on mortgage rates.

“I anticipate that at some point, we will have a gradual sales process,” Mr. Bernanke said in response to questions by lawmakers.

The timing of these sales is a wildcard. In February, Mr. Bernanke said, “I currently do not anticipate that the Federal Reserve will sell any of its security holdings in the near term, at least until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery.”

In today’s testimony he says: “The sequencing of steps and the combination of tools that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments and on our best judgments about how to meet the Federal Reserve’s dual mandate of maximum employment and price stability.”

In other words, he’s now not ruling out sales of mortgage-backed securities in the short-run. And he’s not saying it will only happen after the Fed starts raising interest rates, as he has said before. This doesn’t mean the Fed is planning to sell down its mortgage backed securities right away. Instead it means it is a live debate within the Fed’s Federal Open Market Committee.

Mr. Bernanke also offered some optimism about the health of the mortgage market as the Fed winds down its mortgage purchases. “We do believe that mortgage markets are performing better,” he said, adding that there’s been “very little negative reaction” in markets to the Fed’s plan to stop buying mortgage securities. Housing more broadly, he added, has become more affordable as home prices and mortgage rates have come down.

A roundup of economic news from around the Web.

• Small Businesses: On the Atlanta Fed’s macroblog, David Altig looks at the connection between small businesses and jobs. “An interesting bit of information about business start-ups has been lurking in the details of the U.S. Bureau of Labor Statistics’ Business Employment Dynamics data on gross job flows. If you look at the share of jobs created by opening businesses — as opposed to jobs created from expansions of existing businesses — that share has actually risen through the middle of 2009 (these data come with an excruciatingly long lag). These opening businesses are weighted heavily toward smaller firms, with somewhere around three-fourths of these businesses being represented by firms with fewer than 10 employees. Of course, job creation has fallen a lot for both big and small businesses. As the Bureau of Labor Statistics’ data from the Job Openings, Layoffs, and Turnover Survey (JOLTS) indicates, the story going forward is not going to be about layoffs and discharges—which have been falling steadily since last spring—but instead job creation, which has bottomed out (though remaining well below prerecession levels).”
• Canadian Banking: Writing for Economix, Peter Boone and Simon Johnson say the Canadian model isn’t the answer for the U.S. banking system. “If Canadian banks were more leveraged and less capitalized, did something else make their assets safer? The answer is yes: guarantees provided by the government of Canada. Today over half of Canadian mortgages are effectively guaranteed by the government, with banks paying a low price to insure the mortgages. Virtually all mortgages where the loan-to-value ratio is greater than 80 percent are guaranteed indirectly or directly by the Canadian Mortgage and Housing Corporation. The system works well for banks; they originate mortgages, then pass on the risk to government agencies. The United States, of course, had Fannie Mae and Freddie Mac, but lending standards slipped and those agencies could not resist a plunge into assets more risky than prime mortgages. Let’s see how long Canada resists that temptation. The other systemic strength of the Canadian system is camaraderie among the regulators, the Bank of Canada and the individual banks. This oligopoly means banks can make profits in rough times — they can charge higher prices to customers and can raise funds more cheaply, in part because of the knowledge that no politician would dare bankrupt them.”
• More Foreclosures: Barry Ritholtz says the U.S. needs more not less foreclosures. “We should allow the real estate market to experience a healthy price normalization process. Even though home prices have fallen dramatically, they have yet to reach their historical means relative to income or the cost of renting. This is to say nothing of the usual careening past the median towards under-valuation that typically follows a massive misallocation of capital… The mortgage mods and foreclosure abatement programs are really all about propping up insolvent banking institutions on the taxpayer dollar at the expense of the middle class. These programs are another losing round of helping Wall Street at the expense of Main Street. It is the worst kind of trickle down economics that has been seen in decades”

Compiled by Phil Izzo

Read a new table of Fedspeak Highlights here.

The U.S. economy would be better off with a system in which there are fewer big financial firms that were at the root of the recent crisis, a top Federal Reserve official signaled on Wednesday.

Hoenig

In a speech at the U.S. Chamber of Commerce, Federal Reserve Bank of Kansas City President Thomas Hoenig endorsed a proposal that could force large banks to get rid of divisions that make risky bets with their capital.

“I suggest that our economy would be better served by a more diverse financial system,” Hoenig said. The growth of big financial companies to a level were they pose a threat to the overall economy has distorted the financial system, the Fed veteran added.

Hoenig, who votes on the Fed’s policy-setting committee, said financial holding companies should be banned from proprietary trading and from investing or sponsoring hedge funds. Trading and private equity investment should be housed in “separately capitalized subsidiaries subject to strict leverage and concentration limitations,” he said.

That’s the essence of the so-called Volcker rule, a proposal made by former Fed Chairman Paul Volcker, now a top adviser for President Barack Obama, that was approved by the Senate Banking Committee Monday as part of a wider financial overhaul. Lawmakers are also considering legislation to let the government wind down failing financial-services companies that are deemed to be systemically risky.

Hoenig said he “couldn’t agree more” with statement often heard of policy makers and financial market experts over the past couple years that if a financial firm is too big to fail, then it is too big.

In defense of smaller banks, Hoenig said they had continued to lend despite being badly hurt by the financial crisis and the recession.

Hoenig didn’t comment on the broad outlook for interest rates and the U.S. economy, but he did suggest that loans were likely to pick up again as the recovery firms.

“The good news, such as it is, is that the market is slowly correcting and credit growth is or will begin flowing to Main Street, providing job growth and economic recovery,” Hoening said. “However, it will not be rapid and I fear it will not be easy.”

The Fed last week kept short-term interest rates at a record low near zero to support the economy’s recovery. The central bank pledged to keep rates close to zero for an “extended period,” which means at least several more months. Hoenig disagreed with maintaining that pledge, fearing it could set the stage for asset price bubbles.