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Archive for July, 2009

The economy contracted at a 1.0% pace in the second quarter, according to the advance estimate from the Bureau of Economic Analysis. That’s bad, of course, but much better than the 5.4% and 6.4% pace of declines in the two previous quarters.

Whenever the GDP data come out, the first thing I look at is Table 2, which shows how much different sectors of the economy contributed to the growth (or, in this case, the decline). The most striking thing about Q2 is how broad the weakness was:

Broad Weakness in Q2 2009

As the chart shows, Q2 witnessed declines in every major category of private demand: consumer spending, residential investment, business investment in equipment and software (E&S), business investment in structures, and exports. Wow.  To find the last time that happened, you have to go all the way back to … the fourth quarter of last year, when it was even more severe. But before that, you have to go back five decades to the sharp downturn of the late 1950s.

Not surprisingly, government spending helped offset the declines in private spending. Most of the boost came from defense spending, but state and local investment also helped (perhaps some glimmers of stimulus?).

A sharp decline in imports, finally, was the biggest contributor to growth in Q2, at least in an accounting sense. It’s important to choose your words carefully here, since declining imports are clearly not the path to prosperity. In a GDP accounting sense, however, import declines do boost measured growth. Why? Well consider the fall in consumer spending. That decline affected both domestic production and imports. GDP measures domestic production, so we need a way to net out the decline in consumer spending that was attributable to imports. That’s one of the factors being captured in the imports figure.

Note: If the idea of contributions to GDP growth is new to you, here’s a quick primer on how to understand these figures. Consumer spending makes up about 70% of the economy. Consumer spending fell at a 1.2% pace in the second quarter. Putting those figures together, we say that consumer spending contributed about -0.9 percentage points (70% x -1.2%, allowing for some rounding) to second quarter growth.

As I mentioned a few weeks ago, today’s GDP release is particularly important because the fine people at the BEA have gone back and made revisions to the entire history of GDP statistics. I will post again once I have a chance to review how history has changed.

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Summary: President Obama and congressional Democrats have good reasons for wanting to eliminate federal guarantees for private student loans. They should keep in mind, however, that the resulting budget savings will likely be much smaller than official estimates suggest.

Health care and defense spending have grabbed most of the budget headlines lately, but they aren’t the only budget battles in Washington.

The latest tussle? Student loans.

The federal government supports college loans in two ways: by making loans directly to students and by guaranteeing loans made by private lenders. The current budget battle has arisen because President Obama and many congressional Democrats want to kill the guarantee program in favor of the direct program. Many Republicans, on the other hand, support private lenders, and thus want the guarantee program to continue.

There are three things you should know about this debate:

1. The guarantee program has experienced two crises in recent years. In 2007, the problem was kickbacks. Private lenders were being overpaid by the program, and some of them started competing for business by giving goodies to student loan officers. President Bush and Congress put an end to that by reducing payments to private lenders. Then the financial crisis hit, and we had the reverse problem: private lenders stopped lending. So President Bush and Congress stepped in with some duct tape and paperclips to keep the guaranteed loan market working. (Actually they gave private lenders a put option — the right to sell the loans back to the government — which many lenders used; in essence, the lenders got paid for originating loans, but didn’t hold them very long.)

In short, the guarantee program has been a headache for policymakers in recent years.

2. Guaranteed loans cost the government more than direct loans. There’s no law of nature that says that has to be the case. In principle, one can imagine a guarantee program that would cost less than direct loans. That could happen, for example, if the private sector is more efficient than the government in making the loans or if the private sector is willing to use student loans as a loss leader to promote other financial products (e.g., credit cards). In practice, however, the government has never been able to calibrate guarantees to the private lenders so that (a) lenders are willing to make the loans and (b) the guarantees cost less than direct loans.

When you put points 1 and 2 together, you can understand why many budget analysts and lawmakers want to kill the guarantee program and have the government make all the loans directly. That’s certainly the way that I am leaning. (If readers have any compelling arguments in favor of the guarantee program, however, I’m all ears.)

In fairness, though, opponents of the guarantee program should acknowledge one complication to their position:

3. Congressional budget procedures are biased in favor of direct student loans over guaranteed loans. As a result, the budget case against guaranteed loans is overstated. It isn’t wrong — we are still talking tens of billions of dollars over the next ten years — but it isn’t as strong as the official numbers suggest. One implication is that eliminating the guarantee program may not save as much money as lawmakers think. That’s important, particularly if lawmakers want to spend those savings on other programs.

This third point is the key to current budget brouhaha over student loans. To understand it fully, we need to delve into a bit of budget arcana.

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This morning’s headlines include some important follow-ups to recent posts:

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Yesterday’s deal between Microsoft and Yahoo is a big boost for Bing. Microsoft’s new engine will power search on Yahoo, raising its visibility and, perhaps, eating into Google’s market leadership.

If the stock market is any guide, Microsoft is getting the better of the deal. As Techcrunch notes, Yahoo’s stock fell 12% on the day, lopping almost $3 billion off its market cap:

yahoodown

Microsoft , on the other hand, was up  about 1.4%  – boosting its market cap by about $3 billion.

The real question, of course, is how the deal will affect Google. GOOG was down about 0.8% (around $1 billion in market cap), a bit more than the decline in the Dow or the Nasdaq. That suggests that Google investors respect the MSFT-YHOO deal, but aren’t running scared just yet.

The logic of the deal seems impeccable. Yahoo is an also-ran in the search space, while Microsoft’s Bing is an exciting new entrant. Just how far Yahoo has trailed in search was driven home for me when I reviewed my posts about the search market (here is a list). Google gets the most attention in those posts, of course, but I also discussed competitors Bing, Wolfram Alpha, and Cuil. But it never occurred to me to mention Yahoo. That oversight is vindicated by today’s deal.

Personally, I am looking forward to having Bing on the Yahoo home page. I’ve spent far too much effort avoiding Yahoo’s search engine (e.g., by uninstalling the annoying Yahoo toolbar that various services foist on you when you get new software). Perhaps now I will have reason to let Yahoo take up a bit more valuable screen space.

Disclosure: I don’t own stock in any of these companies.

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That’s the question posed by a recent staff report from Todd Keister and James McAndrews at the New York Federal Reserve.

Their answer? Because the Federal Reserve has been really, really busy.

Keister and McAndrews begin their analysis by documenting the remarkable increase in excess reserves since the fall of Lehman:

Since September 2008, the quantity of reserves in the U.S. banking system has grown dramatically, as shown in Figure 1. Prior to the onset of the financial crisis, required reserves were about $40 billion and excess reserves were roughly $1.5 billion. Excess reserves spiked to around $9 billion in August 2007, but then quickly returned to pre-crisis levels and remained there until the middle of September 2008. Following the collapse of Lehman Brothers, however, total reserves began to grow rapidly, climbing above $900 billion by January 2009. As the figure shows, almost all of the increase was in excess reserves. While required reserves rose from $44 billion to $60 billion over this period, this change was dwarfed by the large and unprecedented rise in excess reserves.

Excess ReservesSome observers have expressed two concerns about the spike in excess reserves:

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Over the past two years, many policymakers have identified loan modifications as key to fighting the mortgage crisis. The rationale for encouraging modifications appears quite simple: foreclosure is expensive for both the borrowers (who lose their home and their credit worthiness) and lenders (who often recover only a fraction of what they are owed). It would therefore seem that loan modifications — reducing payments so that owners can avoid foreclosure — are a potential win-win for both sides.

From that perspective, the slow pace of modifications appears rather mysterious, with potential causes including (a) stupidity on the part of lenders and servicers, (b) flaws in servicing contracts for securitized mortgages, and (c) borrower reluctance to even speak with their lenders.

Both the Bush and Obama administration have initiated a series of policies to encourage modifications, yet results have not lived up to expectations. The Washington Post has a nice article this morning that walks through one of the reasons for this failure. The basic problem is that the argument in favor of loan modifications focuses on only one kind of borrower: those who would make payments with some help but won’t make payments without that help. However, those borrowers are outnumbered by two other types: those who would pay without help and those who won’t pay even with help.

Foreclosure (more…)

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In my recent paper about how the Congressional Budget Office analyzes health proposals, I noted that one of the most important things that CBO does is to provide additional information about its cost estimates. Cost estimates often can’t speak for themselves, so it’s important that members of Congress and other interested observers ask for additional clarification about key issues.

Well, four leading House Republicans recently took this step, and CBO’s response is a doozy. It contains too much to summarize here, so let me focus on the two most important points:

  • CBO reiterated its conclusion that the introduction of a public plan (as specified in the bill) would not undermine private health insurance markets. Most Americans would continue to get their health insurance through employers.
  • CBO confirmed that the bill would worsen future deficits.

Supporters of the bill will emphasize the first finding as evidence that the public plan won’t gut private insurance markets. Opponents of the bill will emphasize the second finding as evidence that the bill is fiscally reckless.

Neither of these conclusions should be a surprise to anyone, since the basic facts were reported in CBO’s original cost estimate. However, the new letter does provide useful context.

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