Monday, May 30, 2011

Starving the Beast of Government

Popular Economics Weekly

Bloomberg Businessweek recently highlighted under the banner, “The Most Feared Man in Washington is…” a profile of Grover Norquist, the chief “Enforcer” of the no new taxes pledge taken by 233 of the 240 House Republicans crafted during House Speaker Newt Gingrich’s era of the Contract for America. The pledge binds all of its takers to oppose “any and all efforts” to increase marginal income tax rates and to protect tax deductions and credits, according to Businessweek.

But in fact this pledge has not succeeded in its stated goal of lowering government spending. In fact, it has mainly succeeded in starving the main engine of economic growth, consumers. For each time Republican administrations have cut taxes in the name of shrinking government, it has instead shifted wealth from the lower and middle income classes to the top income brackets, which lowers the overall demand for goods and services.

As former Reagan Budget Director David Stockman said in a April 25 New York Times Op-ed, “While not the stated objective of policy, this reverse Robin Hood outcome cannot be gainsaid: the share of wealth held by the top 1 percent of households has risen to 35 percent from 21 percent since 1979, while their share of income has more than doubled to around 20 percent.

Why hasn’t the no new taxes pledge succeeded? Because Republicans are no better at cutting government spending than Democrats—in fact worse. Republican administrations since Reagan have chosen to borrow to pay for their hot and cold wars, rather than sharing the sacrifice, driving us ever deeper into debt.


There are other reasons for slower growth, of course. A slower growing population with more seniors, saturated consumer markets (more than 2 cars in a garage?), are two of the reasons. But during the period 1951-63, when marginal rates were at their peak—91 to 93 percent—the American economy boomed, growing at an average annual rate of 3.71 percent.  The fact that the marginal rates were what would today be viewed as essentially confiscatory, says New York Times’ pollster Charles Blow, did not cause economic cataclysm—just the opposite: “Whereas during the past seven years, during which we reduced the top marginal rate to 35 percent, average growth was a more meager 1.71 percent.”


Which brings us back to the federal deficit, the reason we are debating methods to starve the beast of government spending in the first place. It was caused first and foremost by the Bush-era tax cuts to the highest marginal tax rates, and on dividends and capital gains earned by the investor class. This in addition to the 2 wars has cost us more than $3 trillion in borrowed money to date, and the reason our deficit is still growing.

Grover Norquist, a Harvard MBA business degree graduate, has chosen to do his economic jousting without even the most basic knowledge of economics, it seems. Economic demand theory teaches that taking money from the pockets of those who spend most of it and transferring it to those who save most of it doesn’t increase demand for products.

Economic historians in particular know that tax cuts without sending cuts do not lower deficits, period, since it chokes off the revenues needed to pay down the deficit. The two largest expansions of debts as a percentage of GDP were during the Reagan and Bush Presidencies—from a low of 47 percent in the 1970s to its current some 80 percent. They were also the administrations that did the most tax cutting, without comparable spending cuts.

Nor do tax cuts—particularly to the highest marginal tax rates—stimulate more growth. In fact, we have seen a historical drop in GDP growth since the decline in highest marginal rates (of 93 percent) that prevailed during the Eisenhower administrations. The only time we have seen a real decline in the federal budget deficit was during the Clinton Presidency, when Clinton and Congress agreed to maintain Pay as You Go budget rules that said spending had to match revenues. The highest marginal tax rate was raised to 39 percent while government spending as a percentage of GDP fell during the Clinton era, so that the annual deficit was actually erased from 1997 to 2001.


Alas, President Reagan wanted to outspend the Russian military, while the GW Bush wanted to invade Iraq without spreading the pain. Instead, he made the call after 9/11 for everyone to go shopping. The problem was that shifting so much wealth to the wealthiest shortchanged consumers, who had to borrow beyond their means to take his advice.

When will we learn the lessons of history? Grover Norquist may be “the most feared man in Washington…” only because we are doomed to repeat our historic mistakes, if we do not now understand how and why the federal deficit was created.

Harlan Green © 2011

Friday, May 27, 2011

Jobs Recovery Continues

Popular Economics Weekly

The jobs recovery continues, despite the doom and gloomers. This was highlighted in the JOLT Survey we put up last week. New job openings totaled 3.1 million this April, up from the low of 2 million in 2009 at the beginning of the recovery.


The hiring is in all sectors, with industrial production leading the way. But retail has picked up, and even construction is beginning to show some life. But first quarter Gross Domestic Product has slowed. The Commerce Department's second estimate for quarter GDP growth was unrevised at up 1.8 percent annualized and came in lower than the consensus forecast for 2.1 percent. The first quarter remains notably softer than the 3.1 percent growth in the fourth quarter.

Unfortunately, final sales of domestic product were revised to an annualized 0.6 percent from the initial estimate of 0.8 percent. Why care about it? The downward revision to final sales was mainly in personal spending, which is consumer expenditures and makes up 70 percent of GDP activity. It is now up 2.2 percent instead of the initial 2.7 percent for the first quarter.


The good news was that corporate profits in the first quarter expanded to $1.450 trillion annualized-up from $1.369 trillion in the fourth quarter, up an annualized 25.6 percent. Corporate profits are up 5.8 percent on a year-on-year basis, compared to up 11.4 percent in the fourth quarter. This means business has more room to expand and probably means a better looking second quarter for growth.

The current headwinds are due both to higher gas prices that have cut consumption and the Japanese Tsunami, that has cut auto production. So Industrial production has slowed, until the production of Japanese vehicles picks up again.


The Conference Board’s Index of Leading Economic Indicators shows a temporary slowdown. The weakest factor is initial jobless claims which sliced off 0.33 percentage points from the index's growth, but that could be temporary due to reduced auto production. Also negative are building permits and the factory workweek. But improved employment should make it positive next month.


More good news was that new homes are beginning to sell again. April sales of new homes added to March's gains, jumping 7.3 percent to a higher-than-expected annualized rate of 323,000. Strong sales drew down supply to 6.5 months from 7.2 in March and 7.9 in February. In a useful signpost for how deeply the residential sector has contracted, only 175,000 new homes are up for sale for the lowest total in data that goes back to 1963!


The improved jobs picture is boosting incomes. And income growth continued to support the consumer sector in April. Spending was moderately strong but largely due to higher prices. Notably, inflation is still on the warm side. As the report's biggest positive, personal income in April posted a 0.4 percent gain equaling the pace in March and matching analysts' forecast. Importantly, the key wages & salaries component increased 0.4 percent, following a boost of 0.3 percent in March.

Year on year, personal income growth for April posted at 4.4 percent, compared to 4.8 percent the prior month. PCEs growth rose a year-ago 4.8 percent, up from 4.4 percent the prior month. The good news is that income growth remains moderately strong. The bad news is that inflation has eaten into those earnings and has restrained real spending. The slowing in real spending may be transitory (a recently favorite word among Fed officials) but softer inflation and healthier income growth are needed, which will only come with businesses using some of their cash hoard to create more jobs.

Harlan Green © 2011

Saturday, May 21, 2011

Jobs Create More Growth

Popular Economics Weekly
Neither party seems to want to tackle the unemployment problem head on. Why? Conservatives have succeeded in shifting the debate to taming the budget deficit, when any improvement in the deficit depends on creating more jobs. It is not enough to shrink government spending, in other words, because that results in more lost jobs. Nor can the debt load shrink without growing tax revenues—either in absolute terms or as a percentage of Gross Domestic Product— and tax revenues do not grow unless employers hire more employees.
The lack of focus on job creation is unfortunate, as more than 15 million are still looking for some kind of full time work, and the labor participation rate of eligible workers has dropped below 60 percent, 6 percent below the norm. What has created more jobs to date? It has mostly been the manufacturing sector exporting to other countries due to the cheaper dollar exchange rate, and the dollar won’t remain so cheap once U.S. growth kicks into high gear.
Yet domestic spending is finally beginning to grow this year, even though banks are still reluctant to lend and wages and salaries are growing less than 2 percent, as opposed to more than 4 percent during good times. Auto companies have been the biggest booster to domestic spending as they continue to sell more vehicles, which has brought retail sales close to pre-recession levels. And that only happened with the government aid to GM and Chrysler. Government spending has never been the problem, in other words, with trillions of dollars being hoarded in corporations and banks that are not being put to use.
Although a large part of retail sales come from higher gas and food prices, overall retail sales on a year-ago basis in April were steady at 7.6 percent. Excluding motor vehicles, sales were up a year-ago 6.9 percent, compared to 6.8 percent in March. Strength was led by food & beverage stores (up 1.2 percent), nonstore retailers (up 1.0 percent), and miscellaneous store retailers (up 0.9 percent). Leading on the down side were electronics & appliance stores (down 2.2 percent), sporting goods, hobby, book & music stores (down 1.9 percent), and furniture & home furnishing (down 1.1 percent).
Another sign that consumer demand is increasing was the drop in business inventories which lag business sales, indicated by the stock-to-sales ratio which fell another tenth to what is a new record low of 1.23. This reading indicates that inventories are too low. But rising sales point ahead to rising production, rising inventory build, and rising employment as well.
In fact, the softer growth in the first quarter was largely due to a sharp upturn in imports, says Econoday (Import totals are deducted from exports as part of the GDP calculations.), some deceleration in personal consumption, a larger decrease in federal government spending, and decelerations in nonresidential fixed investment and in exports. They were partly offset by a sharp upturn in private inventory investment, as businesses seem to be anticipating more demand growth.
The Bureau of Labor Statistics’ monthly JOLT Survey gives us the best employment picture. It shows a steady increase in Job openings (yellow line in graph) from the low of 2 million in 2009 to 3.1 million in April 2011. The total number of monthly Hires is also above 4 million. It is the positive 200,000 plus average monthly difference in Hires vs. Layoffs plus Quits this year that tells us payroll jobs have been trending up.
In fact, consumer spending, which makes up almost 70 percent of GDP spending, is now leading the recovery as we said last week. This is because personal income is growing again (thanks in part to those manufacturing jobs), up 0.5 percent, following a 0.4 percent gain in February.  And the wages & salaries component also rose a moderate 0.3 percent, softening a little from 0.4 percent in February.
Consumers are seeing some erosion in spending power because of higher food and energy prices—the main reason for higher import totals.  Real hourly earnings are average hourly earnings deflated by the Consumer Price Index, and on a year-ago basis, real hourly earnings were down 1.2 percent, compared to down 0.7 percent in March.  Indeed, real wages swing significantly as energy costs rise or fall sharply.  We saw a large gain in real wages in 2008 on the plunge in oil prices but the reverse is currently true.  In recent months, basically, consumer spending has been driven by pent up demand and job growth.  Individual spending power has fallen on average but aggregate earnings are up on higher employment.
The good news may be that as the dollar is appreciating again, consumer spending will pick up the slack in activity. So a higher dollar exchange rate while crimping exports, will moderate retail prices—especially oil and gas prices. Will this embolden the private sector to start spending some of their hoarded $trillions? There will be no significant deficit reduction until private investment picks up further. Since the focus on cutting government spending is in full swing, we have to hope that energy and food prices continue to soften, so that consumers can continue to recover.
Harlan Green © 2011

Wednesday, May 18, 2011

Real Housing Prices Are Rising

The Mortgage Corner

Real housing prices—or prices with inflation discounted—have historically risen one to two percent above the inflation rate, and so been a reliable hedge against inflation. Is that still the case today with our depressed housing market? Several Blogs, including the Atlanta Federal Reserve Blog, maintain that housing prices have stabilized, and over the longer term they are still rising relative to inflation.


They base their conclusion on Robert Shiller’s historical graph of housing prices since 1890 that show prices returning to historical levels that have prevailed since at least the 1950s. It also shows the stratospheric rise of prices during the latest housing bubble that lasted from 1997 to 2006, before bursting. Atlanta Fed’s researcher Dave Altig has compared the Shiller price history to rents, as a measure of fundamental value. I.e., the price-to-rent ratio is a good measure of what homeowners can really afford, since rents track more closely to incomes.

Calculated Risk has posted the most recent update of Dr. Shiller’s data from Barry Ritzholtz’s Big Picture Blog. “A simple back-of-the envelope calculation for this ratio—essentially comparing the path of the S&P/Case-Shiller composite price index for 20 metropolitan regions to the time path of the rent of primary residences in the consumer price index—tells a somewhat different story than the New York Times chart used in the aforementioned Ritholtz blog post”, says Dave Altig of the Atlanta Fed. “According to this calculation, current prices have nearly returned to levels relative to rents that prevailed in the decade prior to the housing boom that began in the late 1990s.”

However, I believe a much more reliable price indicator is the Price to Median Household Income, and that is still 10 percent above the historical norm, at least since 1980 using the S&P Case-Shiller Home Price Index. It shows the ratio at 1.1:1, or 10 percent higher than the norm of 1:1. But household incomes have stabilized and are beginning to rise again with increased employment, which could stop a further decline in housing prices.


The bottom line is that housing prices still seem to be ahead of historical inflation. Home prices rose from 1998 to 2006, along with the consumer price index for consumer goods, then fell sharply during the Great Recession when consumer prices fell.


Keeping in mind the lag time between price fluctuations and consumer buying behavior, the Consumer Price Index has fallen from its 5 percent high in 2008 to 3 percent today and core inflation has declined from 3 to 1.3 percent, a more than 40 percent decline. Though also a ‘back of the envelope calculation’, it does show that housing prices have followed consumer prices down during recessions, and so should rise along with rising prices during this recovery.


There may be a lag of up to one year for that to happen, however. Consumer prices have been rising just since Nov of 2010, due mainly to higher food and gas prices, which may only be short term. So we may have to wait until the end of 2011 to see if inflation is sustained and so capable of boosting housing prices.

Harlan Green © 2011

Saturday, May 14, 2011

We Need a Real Consumer Protection Agency

Financial FAQs

Why is there such an ongoing debate on whether to nominate Harvard Professor Elizabeth Warren as head of the new Consumer Financial Protection Agency that is mandated under the Dodd-Frank banking act? To put it bluntly, there are no regulations with teeth at present that protect consumers from many of the practices of the major financial institutions who control most consumers’ deposits and investments.

The Federal Reserve is attempting to force banks to clean up their foreclosure practices with a recent consent decree signed by 10 of the largest banking institutions. But that doesn’t protect consumers from the abusive practices that spawned all those liar loans and almost caused another Great Depression.

Professor Warren has been making headway with community banks on the necessity to oversee the largest financial institutions. In fact, she told a group of community bankers in San Antonio, Texas that they weren't the bureau's main target. Instead, the biggest part of its budget will be used to police 80,000 nonbank firms that are involved in payday loans, student lending, debt collecting and the mortgage business, but that now largely escape regulation. She also said the agency would be more focused on supervision and enforcement than on writing new rules.

The community banks "are worried, and I don't blame them for being worried," Ms. Warren says, in a recent interview. "So I try to talk to them about the regulatory philosophy of the agency, whether we're an agency that's going to come in and try to say rule, rule, rule or an agency that says let's focus on what we're trying to accomplish by using more of a principles-based approach. We're trying to make these markets transparent, which makes it easier for community banks to compete both with large financial institutions and with their nonbank competitors."

Her message is simple: the consumer “market” for financial products does not operate like a proper market because leading firms (bigger banks and also nonbanks, like some payday lenders) have figured out how to make a great deal of money by confusing their customers.

Of course, there are many honest players – mostly in credit unions and smaller banks.  But when the playing field has been unfairly tilted towards cheating, honest bank executives struggle to stay in business (or to keep their jobs).

“If someone attempted to sell boxed cereal in the same fashion that many financial products are now sold, that person would be drummed out of the cereal business.  The norms of that sector (and many other nonfinancial sectors in the United States) would not stand for this degree of deception and malpractice”, said one critic of the Republican campaign against her nomination.

Transparency is an issue with all financial markets, not just mortgages, of course. The multi-trillion dollar derivatives’ business is controlled by a self-appointed consortium of the major banks. And they are resisting providing a record of their transactions to a central clearing house, a provision of the Dodd-Frank bill that is still being developed.

Why? For the same reason that mortgage lenders could hide the true costs of mortgages until the latest reforms enacted by the Federal Reserve that regulate the disclosure of loan fees and costs.

And, as two Nobelists, economists George Akerlof and Joseph Stiglitz have researched, markets driven by nontransparent or ‘asymmetrical’ information—where insiders have access to information about the investments that general market participants do not—destroys those markets. It in fact drives out the honest investors, causing a general loss of confidence on all financial markets.

So we can see Professor Warren is on a virtuous crusade. She wants to save the financial institutions from themselves—and their own propensities to promulgate the ‘buyer beware’ policies so prevalent on Wall Street that almost caused their own downfall.

Harlan Green © 2011

Tuesday, May 10, 2011

Consumers are Coming Back

Popular Economics Weekly

The consumer is back, with spending on track to approach pre-recession levels by the end of this year.  Why?  Employment is now in a virtuous cycle.  Enough new jobs were created over the past 3 months (200,000+ per month) to trigger greater aggregate demand for goods and services, and consumers are paying down their debts.  One caveat is that if Republicans succeed in further cutting government spending without raising taxes (or allowing the Bush tax breaks to expire), it will mean less revenue to pay down public debt.

The Federal Reserve Bank of New York released the Quarterly Household Debt and Credit Report for the first quarter of 2011 today, which showed signs of healing in the consumer credit markets. Evidence of improvement includes:

• an increase in credit limits, by about $30 billion or 1 percent, for the first time since the third quarter of 2008;
• a steady number of open mortgage accounts, following a period of decline beginning in early 2008;
• continued decline of new foreclosures and new bankruptcies, down 17.7 percent and 13.3 percent respectively in the last quarter;
• a 15 percent decline of total delinquent balances, compared to a year ago; and
• a broad flattening of overall consumer debt balances outstanding.

Non-housing related debt, including credit cards, student loans, and auto loans, declined slightly (less than 1 percent), driven by a noticeable 4.6 percent decline in credit card balances. Credit inquiries, an indicator of consumer demand for new credit, came off their recent peak in the fourth quarter of 2010.

“We are beginning to see signs of credit markets healing gradually and evidence of greater willingness of consumers to borrow and banks to lend,” said Andrew Haughwout, vice president and New York Fed research economist.


Mortgage delinquency rates in particular are the best gauge of a RE recovery, and delinquency rates have declined to 8 percent of total mortgages outstanding, while foreclosures have been holding at 4 percent of mortgages, for some reason.  So we may also see employed buyers returning to home buying.  More cash is becoming available to them, is the bottom line.


Overall retail sales are in recovery, with consumers buying across the spectrum.    The widespread strength in retail sales is encouraging, reflecting greater willingness on the part of consumers to spend.  Some interesting patterns are showing up. 


Gains in furniture & home furnishings; building materials; and electronics & appliance stores suggest that while home sales are anemic, homeowners are starting to spend money on improving the quality of the homes.  Also, increases in very discretionary spending such as food services & drinking places are favorable.  But rising costs for gasoline and food may be cutting into discretionary income and could dampen spending unless offset by continued employment gains.

The bottom line is that consumers now have less debt and so more money to spend.  And businesses have to hire if they want to continue to grow, so look for continued job growth to feed the virtuous cycle.

Harlan Green © 2011

Saturday, May 7, 2011

Jobs Are Returning

Popular Economics Weekly

Can we finally say jobs are returning? Nonfarm payroll employment rose by 244,000 in April, and the unemployment rate edged up to 9.0 percent, but only because more people were looking for work, according to the U.S. Bureau of Labor Statistics. This is while the change in total nonfarm payroll employment for February was revised upward from +194,000 to +235,000, and for March was revised from +216,000 to +221,000.

With commodity (oil, gas, and food) prices still sky high, the Mideast having its own revolutions, and Bin Laden dead, consumers are beginning to shop again, businesses are hiring, and even new-home construction may awaken from its coma.

This means the private sector is finally beginning to put people back to work, and it will create a virtuous cycle. Jobs = more purchasing power = more jobs = etc.

Gains were seen in goods-producing and service-providing sectors. Goods-producing jobs posted a 44,000 boost, following a 37,000 rise in March. For the latest month, manufacturing jobs increased 29,000 after a 22,000 gain in March. Even construction expanded though with a modest 5,000, following a 2,000 uptick the prior month. Mining jumped 11,000 in April.


This is while governments continued to lose jobs. Government jobs fell 24,000, following a 10,000 dip in February, while the private sector added 268,000 jobs. Private service-providing jobs increased 244,000 after a 194,000 rise in March. Trade & transportation was up 71,000 in April with 57,000 coming from retail trade. Other notable gains included professional & business services, up 51,000; health care, up 37,000; and leisure & hospitality, up 46,000.

The unemployment rate ticked up to 9.0 percent from 8.8 percent in March in the Household survey, however, because more began looking for work (+205,000). So are we finally turning the corner on unemployment? All signs point to higher growth ahead. Increased tax revenues have already pushed the debt ceiling deadline back another month, and increased tax revenues are what is needed to bring down the actual deficit as a percentage of Gross Domestic Product.

We know the economy slowed during the first quarter of 2011. However, the detail shows moderate forward momentum. First quarter GDP growth eased to a 1.8 percent annualized pace, following a 3.1 percent boost in the fourth quarter.


It was largely due to a sharp upturn in imports, says Econoday (Import totals are deducted from exports as part of the GDP calculations.), a deceleration in personal consumption, a larger decrease in federal government spending, and decelerations in nonresidential fixed investment and in exports. They were partly offset by a sharp upturn in private inventory investment.

Nonetheless, relative strength was seen in personal spending, investment in equipment & software, and inventory investment.  Exports also continued to rise although not as rapidly as earlier.  Weakness included a drop in government purchases, nonresidential structures, and residential structures. 


The good news is that consumer spending, which makes up almost 70 percent of GDP activity, is now leading the recovery, taking over from the manufacturing sector. This is in part because personal income has been increasing. Wages & salaries rose a moderate 0.3 percent in March, softening a little from 0.4 percent in February, while spending is growing at almost 5 percent annually. 

Harlan Green © 2011

Tuesday, May 3, 2011

What Will Bring Back Housing Market?

The Mortgage Corner

We will know when real estate is in recovery by an increase in the number of new households being formed. The Census Bureau has estimated that just 357,000 new households were formed in the year ending March 2010, when its data were last updated. But analysts are predicting more like 1 million households will be formed in 2011 by children moving away from their parents’ household, as economic conditions—such as job formation—continue to improve.

Many young folk will rent, of course, but with rents rising and mortgage rates and housing prices extremely low, those with good jobs will be tempted to buy housing. And we know why. There are almost no new homes being built.








1 to 4 Units








5+ Units








Manufactured Homes
























Total added to Stock








Calculated Risk recently put out a table of housing production. Numbers are in thousands. It shows what happened during the bubble years 2005-07. More than 5 million units were added to the housing stock, while household formation averaged 1 million per year. So even if all bought homes—and no more than 50 percent actually did—there would be a 2 million unit excess left languishing on the market. Analysts estimate up to 3.5 million were in excess during the Great Recession, and that number has been whittled down to less than 1 million since then.

“In 2010, 1 to 4 unit completions were at a record low 505 thousand,” says Calculated Risk. “This was just below the 535 thousand units completed in 2009 and was far below the previous record low of 712 thousand units in 1982. 1 to 4 units completions are currently on pace for another record low in 2011.”


So an uptick in household formation should boost housing sales, and so reduce the excess inventory—now in the 7 month range for existing homes, and 8 months for new homes on the market. One favorable indicator is pending home sales scheduled to close in 30 to 60 days have also risen over the past two months.


Pending sales jumped 5.1 percent in March due, according to the National Association of Realtors, to better affordability, rising rents and job creation. March's gain was strongly centered in the largest region which is the South where contracts jumped 10.3 percent. Notably, the South had been hard hit by adverse winter weather in February. “The latest report raises the possibility that modest momentum may once again be building for the existing home market,” says Econoday.  Pending home sales are based on contract signings for existing home sales instead of actual closings which show up in existing home sales data.  Pending sales tend to lead existing sales by one to two months, as we said.

It is not just household formation that spurs housing sales, of course. Existing renters will want to own homes when they feel more secure in their jobs, and see housing prices begin to rise again. Case-Shiller says housing prices were holding or rising in just 8 of the 20 metro areas tracked as of February 2011, however.

“The one positive is Washington D.C. with a positive annual growth rate, +2.7 percent, and home prices more than 80 percent over its January 2000 level. Other cities holding on to large gains from 11 years ago include Los Angeles (68.25 percent), New York (65.19 percent) and San Diego (55.05 percent)”

Harlan Green © 2011