Unemployment After The Recession: Mostly Cyclical Says Cleveland Fed

From Federal Reserve Bank of Cleveland Economic Commentary, "High Unemployment after the Recession: Mostly Cyclical, but Adjusting Slowly" by Murat Tasci:

Note: The recession average is the average unemployment rate progression for postwar recessions, and the range is plus or minus one standard deviation.
Source: Bureau of Labor Statistics.

Many economists, policymakers, and forecasters anticipate that the unemployment rate will stay above 9 percent over the near term. Their forecasts typically assume that the underlying trend of the unemployment rate, sometimes dubbed the “natural rate of unemployment,” must have risen over the course of the last recession. But it is more likely, given the size of the drop in aggregate economic activity during the recession (4.15 percent, the largest in postwar U.S. history), that the unemployment rate’s rise is due mostly to cyclical factors. I argue that even if the unemployment-rate trend has not increased, the unemployment rate could still stay high for some time. Moreover, the weakness of the recovery in real output and the slow rate of worker reallocation are likely to keep unemployment from declining to pre-recession levels any time soon.

Obama Health-Care Ruled Unconstitutional

From Bloomberg News, "Obama Health-Care Reform Act Ruled Unconstitutionalby Florida U.S. Judge" by By Andrew M. Harris:

President Barack Obama’s health care law, assailed as an abuse of federal power in a 26-state lawsuit, was ruled unconstitutional by a U.S. judge who said Congress overstepped its authority to regulate commerce.

U.S. District Judge Roger Vinson in Pensacola, Florida, declared the law unconstitutional today in a 78-page opinion.

Read Judge Vinson's complete decision, via The Wall Street Journal, here.

Given Many Choices, Consumers Will Pay More For High Quality And Less For Low Quality

From Columbia Business School Ideas at Work "The Discriminating Consumer: Product Proliferation and Willingness to Pay for Quality" by Sheena Iyengar, Marco Bertini, and Luc Wathieu:

In a series of experiments, the researchers showed that consumers do become more sensitive to quality when facing a dense field of choices — one in which there are a large number of products within a given range of qualities. Shoppers presented with 21 types of chocolate were prepared to pay 33 percent less for a low quality chocolate and 40 percent more for a high quality chocolate relative to those presented with only five different types. The results of further experiments where consumers chose from an assortment of wines or astronomical binoculars revealed that manipulating the perceived density of a choice set could similarly affect shoppers’ sensitivity to quality. The researchers also analyzed sales data from hundreds of lots sold through an auction house over a two-year period, finding that the same phenomenon holds true in the field.

In all cases, consumers were consistently willing to pay more for higher quality products and less for lower quality products. And, when given fewer choices, consumers were far less willing to pay for quality and gravitated toward lower quality, less costly items. They also reported weighting quality as more important when facing larger choice sets.

Read the complete Ideas at Work article here.

A PDF of the researchers' paper is available here.

A Forgotten Freight Transport Method Rediscovered, Aerial Ropeways

From "Aerial ropeways: automatic cargo transport for a bargain" in Low-tech Magazine:

These days, we use them [aerial ropeways] almost exclusively to transport skiers and snowboarders up snow slopes, but before the 1940s, aerial ropeways were a common means of cargo transport, not only in mountainous regions but also on flat terrain, with large-scale systems already built during the Middle Ages.***

***The advantages of aerial cargo ropeways are so numerous that it is no surprise that they are - slowly - being rediscovered. Worries about global warming, peak oil and environmental degradation have made the technology even more appealling. This does not only concern energy use: contrary to a road or a railroad track, a cargo ropeway can be built straight through nature without harming animal and plant life (or, potentially, straight through a city without harming human life). Traffic congestion also plays into the hands of cableways, because the service is entirely free from interference with surface traffic.

Video: Real Mark Zuckerberg On SNL Or Was That Adam Samberg Or Jesse Eisenberg

Interestingly, Mark Zuckerberg has more stage presence and charisma than the actors. While I would be at a loss for words if I met a famous actor, Jesse Eisenberg is at at a loss for words when meeting Mark Zuckerberg for the first time.

At least $50 billion (the valuation of Facebook) can get you on SNL for a few minutes.

To really understand Zuckerberg's power in today's business world, you need to know that IBM and Microsoft fear Google's competitive threat and Google fears Facebook's competitive threat. With a well played hand, Facebook can become the dominate software computer company. Zuckerberg knows how to play bridge. The next two or three years will be very interesting to watch as the four companies compete with each other. IBM's and Google's market capitalizations are just shy of $200 billion and Microsoft's market capitalization is just shy of $240 billion. Facebook is David against the Goliaths.

Video of SNL opening with Mark Zuckerberg meeting Jesse Eisenberg.

Higher Bank Capital Amounts Comment

A comment I posted on The Wall Street Journal article, "Number of the Week: Banks Should Hold More Capital" by Mark Whitehouse:

There is no contradiction. Modigliani and Miller wrote about an ideal situation with no bankruptcy (insolvency) and no taxes. It is a solid foundation to build upon and incorporate real world dynamics.

M-M did not incorporate into their research government backed deposit insurance and too big too fail government intervention. Government intervention through deposit insurance and too big to fail undoes much of Modigliani and Millers arguments. Their main arguments rely on market pricing and risk adjusted pricing of equity and debt. Government intervention, in any sector or industry including banking, interferes with risk adjusted pricing of equity and debt.

Fifty years ago, researchers realized that the addition of tax deductibility of interest expense would push firms to increase their debt levels. Similarly, the increasing risk of bankruptcy with increasing debt levels would push firms away from more debt financing. Whether the two forces offset each other or one dominates if at all is an open research question and much has been written on the topic.

Even at 52 percent capital, banks will go insolvent because banks face not only a valuation insolvency risk, debt value greater than asset value, they face liquidity and cash flow insolvency risk.

A bank with 52 percent capital can face a 'run on the bank' and if its loans and investments are illiquid, cannot be sold quickly in the market and converted into cash at face (par) value prices, it will not have adequate funds to pay withdrawals. If too many depositors withdraw their funds, the bank will face a run, and the government will step in to help with needed funds, or operate the bank, or force a takeover or close the bank and pay depositors from the insurance fund.

Banks face several different forms of insolvency risks and high capital amounts do not solve all the potential solvency problems banks face.

Regulators like capital because it is computable and measurable by a formula, easy to observe and fill in on a form, can be set at a precise level and avoids the appearance that the government acted arbitrarily against a particular bank. High capital amounts are not the end to future bank problems, and a low amount of capital amount is not the cause of bank problems.

Advance 4th Quarter GDP Number, 3,2 Percent, Subject To Big Later Revisions

The US Department of Commerce Bureau of Economic Analysis released the advance GDP number for the fourth quarter 2010. Real GDP increased by 3.2 percent, annualized from the third quarter of 2010.

The advance number is an early estimate of final GDP annualized percent change from the previous quarter and it is often later substantially revised. Check out the recent huge differences between the advance GDP annualized 4th quarter percent change numbers and the final revised GDP annualized 4th quarter percent change numbers in the following table:

Quarter							Advance							Final							Change
2007q4							0.6							2.9							2.3
2008q4							-3.8							-6.8							-3.0
2009q4							5.7							5.0							-0.7
2010q4							3.2							?							?

As you can see from the above table, final 4th quarter 2010 GDP annualized percent change from the 3rd quarter can be significantly different than the initial estimated advance number of 3.2 percent.

I chuckle when I see all the news articles and blogs comparing the latest advance GDP number with previous final GDP numbers. It is an apples and oranges comparison. Advance numbers should be compared against advance numbers and final numbers should be compared against final numbers.

Gladys Horton of the Marvellettes Died: Lead Singer On "Please Mr. Postman"

Gladys Horton of the Marvellettes died Wednesday. She was the lead singer and co-founder of the group. In 1961, "Please Mr Postman" was the first Motown song to reach the number one position on the pop charts.

The New York Times obituary is available here.

Cleveland Fed Predicts 1 Percent Yearly GDP Growth And 1.5 Percent Chance Of Recession

From "Yield Curve and Predicted GDP Growth: January 2011" Federal Reserve Bank of Cleveland:

Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.0 percent rate over the next year, the same projection as in November and December.

Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate that the expected chance of the economy being in a recession next January at 1.2 percent, a slight drop from December’s 1.5 percent and November’s 2.3 percent.

Read the complete Cleveland Fed article and prediction here.

Financial Crisis Inquiry Final Report Available

The Financial Crisis Inquiry Commission released its Final Report on the Causes of the Financial Crisis.

The 660 plus page report with dissenting commissioners' views is available free;
from the Commission here;
from GPO here;
and from my upload on Scribd here.

My personal biases are towards the scientific method, i.e. reproducibility. Since whatever causes presented in the report as an explanation for the financial crisis are not testable, I do not put much faith in the explanations in the report. Our state of financial, banking and economic knowledge has not changed since before the crisis. We did not understand the warning signs of a impending financial crisis before and we do not understand them any better now after the crisis.

The report is more a finger pointing, conventional wisdom, political document about the crisis than scientific inquiry into causes. The conclusions are based on observations without a reliable theory to explain any of the conclusions or causalities. The report fills a human and political need to find causes and blame even when the state of our knowledge does not lend itself to the task.

These types of inquiries remind me of the old beliefs that life could spontaneously occur in meats because maggots would suddenly appear on meat as it was left out in the open. It was later discovered that flies laid their eggs on the meat and the new born flies became larvae, maggots, before they matured into flies. When meat was placed in jars, covered with cloth, etc., no maggots appeared.

The report mentions many banking, financial, and regulatory things that existed before the crisis. Prior existence does not mean it caused the crisis, even if the logical connection exists in the minds of the report commission.

The report is more about closure than it is about finding causes. Unfortunately, it will be used as the basis to propose ineffective new regulations and laws.

CBO's 2011 - 2021 US Budget Deficit Projections

From the CBO summary, "The Budget and Economic Outlook: Fiscal Years 2011 to 2021":

sharply lower revenues and elevated spending deriving from the financial turmoil and severe drop in economic activity—combined with the costs of various policies implemented in response to those conditions and an imbalance between revenues and spending that predated the recession—have caused budget deficits to surge in the past two years. The deficits of $1.4 trillion in 2009 and $1.3 trillion in 2010 are, when measured as a share of gross domestic product (GDP), the largest since 1945—representing 10.0 percent and 8.9 percent of the nation’s output, respectively.

For 2011, the Congressional Budget Office (CBO) projects that if current laws remain unchanged, the federal budget will show a deficit of close to $1.5 trillion, or 9.8 percent of GDP. The deficits in CBO’s baseline projections drop markedly over the next few years as a share of output and average 3.1 percent of GDP from 2014 to 2021. Those projections, however, are based on the assumption that tax and spending policies unfold as specified in current law. Consequently, they understate the budget deficits that would occur if many policies currently in place were continued, rather than allowed to expire as scheduled under current law.

Read the complete CBO summary here.

Read the complete 172 page CBO report here.

Negative Equity Homeowners Are More Likely To Move Than Positive Equity Homeowners

From a recent research paper, "Negative Equity Does Not Reduce Homeowners' Mobility" by Sam Schulhofer-Wohl, Federal Reserve Bank of Minneapolis, Research Department, Working Paper 682, December 2010:

negative-equity homeowners are more rather than less likely to move.***homeowners with negative equity are at least as mobile as those with positive equity, holding other characteristics constant. Homeowners with extremely negative equity are especially mobile.

The paper's complete abstract:

Some commentators have argued that the housing crisis may harm labor markets because homeowners who owe more than their homes are worth are less likely to move to places that have productive job opportunities. I show that, in the available data, negative equity does not make homeowners less mobile. In fact, homeowners who have negative equity are slightly more likely to move than homeowners who have positive equity. Ferreira, Gyourko, and Tracy's (2010) contrasting result that negative equity reduces mobility arises because they systematically drop some negative-equity homeowners' moves from the data.

Read the full research paper here.

Uniform Fiduciary Standard For Retail Investment Advisers And Broker-Dealers Is Unworkable

From the SEC "Study on Investment Advisers and Broker-Dealer" as required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act:

The Staff [of the U.S. Securities and Exchange Commission] therefore recommends establishing a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice about securities to retail customers that is consistent with the standard that currently applies to investment advisers. The recommendations also include suggestions for considering harmonization of the broker-dealer and investment adviser regulatory regimes, with a view toward enhancing their effectiveness in the retail marketplace.

The full staff report is available here.

Fiduciary Standards Are A Pandora's Box Of Legal Problems For Retail Stock Brokers

Investment advisers perform a different function than retail stock brokers.

Investment advisers have specific investment objectives, an investment style, that they use to identify the way they invest or that their clients asked them to follow. For example, an investment adviser may be told by his client, or may identify his investment style in his promotional literature, as one that maximizes dividends and income while preserving capital. Another may identify himself, or be asked by a client, as seeking to maximize capital appreciation; an aggressive investor in small drug and biotech companies with the greatest potential for developing a blockbuster drug; for finding companies with extraordinary gains in profitability over the previous year, or for investing and trading in foreign currencies.

Fiduciary duty compliance for an investment adviser requires fair dealings without conflicts, with transparency and adherence to investment objectives.

Investment advisers and their clients have a mutual, agreed to understanding of investment goals and objectives for the money under advisement. Even if investment policy is never discussed, there is tacit acceptance of the policy by the customer just by going to an adviser who holds himself out to be a particular type of investor manager or adviser.

A retail stock broker, who does not currently by law, regulation or industry practice, have a fiduciary duty to a customer, is a salesperson. Salespeople in all other walks of life generally do not have fiduciary relationships with buyers. Does you supermarket have an obligation to tell you that their store brand is made by the same company you are buying and costs a few cents less? or that you should buy a few more cans of soup this week because prices are going up tomorrow?

Brokers can only sell to a retail customer investments, stocks, bonds, mutual funds, etc., that are on the brokerage firm's approved list. Is a retail broker with a fiduciary obligation required to tell you that the fees or transactions costs for the same investment are lower at another firm?

Are retail brokers with a fiduciary obligation obligated to tell a customer for a mutual fund that mutual fund managers cannot consistently beat an index fund? or that their firm's stock analyst cannot pick winning stocks any better than a someone who randomly picks a stock?

Will brokers be forbidden from selling commodities such as gold and silver to clients because they have a zero correlation with a market investment portfolio and therefore will not over time increase the value of the portfolio?

The functional difference between an investment adviser and a retail broker makes the application of a fiduciary standard impossible to implement effectively.

Imposition of a common fiduciary standard on advisers and brokers will lead to an enormous increase in lawsuits and arbitration claims against retail stock brokers and their firms. It will force the SEC to enact a very limited definition of fiduciary and that will create unmet retail broker client expectations, untold customer confusion and resentment by retail customers.

Let the lawsuits begin.

Overwhelming Lack Of Trust For US Government's Ability To Create Jobs

From "60% Trust Business Leaders More Than Government To Create Jobs" in January 26, 2011 Rasmussen Reports:

60% of Adults think decisions made by U.S. business leaders to help their own businesses grow will do more to help create jobs in America than decisions made by government officials. Just 24% say decisions made by government officials to help the economy grow will do more.

Read the complete report here.

Child's Self Control Is Second Only To IQ In Predicting Adult Success And Health

From "Stage set early for success, or failure: Good self-management by age 3 predicts adult health and wealth" by Bruce Bower in ScienceNews:

Intelligence, as measured by IQ tests, has long held sway as the prime mental influence on health and achievement. But self-control’s close link to adult health and accomplishment remained after researchers accounted for children’s IQ scores and family income. “Self-control and intelligence are both valuable for life success, but after years of effort, IQ has proven difficult to change through interventions,” [Duke University psychologist Terrie] Moffitt says.

Read the complete ScienceNews article here.

Does The Fed Have The Right Information? Reprinted

The following post is a reprint of my January 4, 2008, post on another, short-lived blog of mine. I am reprinting the post because 3 years later there is still a need for solutions to our economic problems of slow GDP growth and high unemployment and there is still an ongoing debate as to what are the best monetary and fiscal action policies to follow:

January 4, 2008

Does the Fed have the right information?

Does the Federal Reserve have the best information to control inflation and maintain employment growth? Has the Fed been too passive in accepting the current supply of economic data?

The Fed, like the rest of us, relies on published economic data, surveys, and anecdotal evidence to assess the state of the economy, and most of that data reflects past or concurrent economic indicators of the health of the economy. The Fed does not have magical powers or a crystal ball to tell it what will happen next. The Fed does not have a secret recipe that makes it a better predictor of the future of the US economy than ordinary investors. But, the Fed does attempt to maintain a sustainable level of economic growth that will cause neither inflation nor excessive unemployment based on all available information.

In fact, the Fed and many economists look at bond yields, including the slope of the yield curve, and stock market prices to assess future GDP because these prices contain investor expectation data about future interest rates, inflation, and economic growth.

But is the Fed too passive in monitoring the current supply of information. Why doesn't the Fed in conjunction with the Treasury create a government issued financial instrument that would reveal more about the future of the US economy than is currently available?

For example, Treasury could issue a GDP linked bond whose semiannual coupon payment would be a fixed percentage of the most recent nominal GDP number at the time of coupon payment. This would force investors, in pricing the bond, to incorporate explicit expectations about future GDP. The price of the bond would reflect the present value of all future GDP growth over the period until maturity. And because the bond would be discounted (present valued) based on nominal interest rates, the current price would be a measure of total real (inflation adjusted) GDP over the life of the bond.

GDP linked treasury bonds, through analysis of embedded forward rates, would allow the Fed to see in what future time periods over the future life of the bonds that the market was predicting a slow down in economic growth. It would also allow the Fed to see if its policies were merely time shifting future economic growth into other periods without actually creating any overall growth in the economy.

Over time, the premium on the rates paid on these bonds over plain treasury bonds would allow for an analysis of the inherent risk of the US economy. And whether this risk changes over time.

Changes in the price and future embedded rates of GDP linked bonds would allow for an analysis of the effect of legislative and other governmental policies on US future economic growth. If the government introduces or discusses policies and there is an immediate decrease in the price of the bonds then clearly the policies are not good for maximizing future economic growth; although, they may have other benefits.

Having a GDP linked treasury bond would allow the US to maximize future economic growth. The bonds would also allow information about future economic activity to be discerned and assigned to a specific future time period. GDP linked bonds would allow the populace to see if our politicians are doing positive things for the future health of the US economy after their terms in office end before we actually are in those time periods.

The Fed does have very good mathematical economic models to project future economic growth. However, like all models, they work only as long as the relationship among the variables remains static or predictable. So for example, one of the Fed's models mistakenly predicted that we should have been in a recession for the last several years because it used historical relationships about the relative investment in fixed capital versus intellectual property and missed the increase investment in intellectual assets. When correcting the model for the actual relationship between intellectual and fixed property investments over the last several years, the model accurately predicted the actual historical economic growth, but failed on a prospective basis because of the change in the relationship of the variables.

The Fed should take a more active role in deciding what information it can obtain from the investment markets, design instruments accordingly, and work with Treasury in issuing and creating liquid markets for these information designed securities.

Deficit Effect Of Ignoring Elimination Of The Employer Tax Deduction In Health Reform

The comment I posted on "What is Health Care Reform?" by Donald Marron that I discussed in my previous post:

I think to complete your [Donald Marron] argument about having a connection to health care to distinguish health care net revenues from the legislative reform net revenues, there needs to be a measurement of legislative opportunity costs, especially if one wants to motivate Congress to act or at least consider the economic effects of legislation on the deficit.

The most important reform for health care, as you rightly mention, is to eliminate the employer tax deduction. The deduction is a 'connected item to health reform' (and we will leave this concept undefined and sort of, I know it when I see it). Allowing the deduction to continue is a lost opportunity to reform health care and a lost opportunity to raise tax revenues $200 billion per year ($ 2 trillion over 10 year budget window). It depends on whether or not you view the marginal costs to include the opportunity costs of not eliminating the deduction.

If the deduction effect were included in the CBO cost analysis, and I believe it should have been, the deficit effect of the passed health reform legislation would start at the point of a deficit of $200 billion per year. Added to the $200 billion would be the additional deficit costs of the items in the legislation less any connected revenue producers, such as the Cadillac tax.

A CBO analysis that included the $200 billion per year foregone revenue would show a truer cost picture of ignoring the elimination of the employer tax deduction in the passed health reform legislation.

Distinguishing 'Health Care Reform' From 'Health Care Reform Legislation'

Read Donald Marron's thoughtful post, "What is Health Care Reform?"

Health care reform increases the federal deficit over the next ten years. The health care reform legislation, however, reduces the deficit.

Read Marron's complete post here.

US Union Membership Continues To Decline

From Statement by Secretary of Labor Hilda L. Solis on Bureau of Labor Statistics report on union members in 2010:

Today, the Bureau of Labor Statistics announced that, in 2010, the unionization rate of employed wage and salary workers was 11.9 percent, down from 12.3 percent in 2009. Among private sector employees, the rate dropped to 6.9 percent from 7.2 percent in 2009.

McKinsey's Assessment Of Obesity's Real Cost

From "The real cost of obesity" in the McKinsey Quarterly Chart Focus Newsletter January 2011:

Click chart to enlarge.
Read the McKinsey & Co article here.