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.
Some observers have expressed two concerns about the spike in excess reserves:
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.
The St. Louis Fed has a nice one-pager that illustrates how the housing boom differed across homes in different price tiers.
In each of the four cities they examine (Boston, Cleveland, Phoenix, and Tampa), low-priced houses experienced the biggest boom (a relative concept in Cleveland, to be sure) followed by the biggest bust:
The authors interpret this as evidence that:
Middle- and upper-tier home buyers were more insulated from many of [the factors that drove the boom and bust in the prices of low-price tier homes]. They had less need for the newer mortgage products, as most of these consumers were not first time buyers. As homeowners, they had equity to put toward their purchase, in contrast to most lower-tier first-time home buyers.
The pattern is particularly striking in Phoenix, where the price index for low-price homes has now fallen below the indices for middle- and high-price homes.
Last week’s report on residential construction provided more evidence that housing may be beginning to bottom. The headline evidence, noted by most media and economic pundits, is the rebound in housing starts over the past two months:
The rebound is from an extremely low level, so it’s hard to get too excited about it. But it does suggest that the plummeting of the past few years may finally be over.
As I noted last month, however, a bottom in housing starts isn’t a bottom in housing. From a macroeconomic point of view, the key thing is the amount of construction activity, which depends on both housing starts and housing completions. Not surprisingly, house completions plummeted along with housing starts, albeit with a lag reflecting the time needed for construction: Continue reading “Step One of a Housing Bottom”
Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program (affectionately known as SIGTARP), is making headlines with his estimate that the government has provided “potential support totaling more than $23.7 trillion” in fighting the financial crisis. That estimate will be officially released on Tuesday morning in the SIGTARP’s latest quarterly report (you can find an early copy here – ht WSJ).
As the media are already noting (e.g., WSJ and Yahoo), there are many reasons to believe that the $23.7 trillion figure is overstated. For example, as noted in the footnote to the table above, the figure “may include overlapping agency liabilities … and unfunded initiatives [and] … does not account for collateral pledged.” In other words, there may be double-counting, some of the programs won’t happen or are already winding down, and the estimates assume that any collateral is worthless. For example, to get to $5.5 trillion in potential losses on Fannie Mae and Freddie Mac (part of the $7.2 trillion Other category), you would have to assume that all GSE-backed mortgages default and that all houses backing them are worthless.
In short, the SIGTARP estimate is a way upper-bound on likely Federal support to the financial support. That fact shouldn’t detract, however, from the importance of the rest of this report.
Like many other economists (here’s the list of signatories, with a day’s lag), I am troubled by the anti-Fed rhetoric emanating from some parts of the Congress. The Fed has taken a remarkable series of actions that deserve close congressional oversight. But that oversight should not endanger the Fed’s fundamental independence in executing monetary policy.
The petition therefore makes three important points about Fed independence:
First, central bank independence has been shown to be essential for controlling inflation. Sooner or later, the Fed will have to scale back its current unprecedented monetary accommodation. When the Federal Reserve judges it time to begin tightening monetary conditions, it must be allowed to do so without interference.
Second, lender of last resort decisions should not be politicized.
Finally, calls to alter the structure or personnel selection of the Federal Reserve System easily could backfire by raising inflation expectations and borrowing costs and dimming prospects for recovery. The democratic legitimacy of the Federal Reserve System is well established by its legal mandate and by the existing appointments process. Frequent communication with the public and testimony before Congress ensure Fed accountability.
[T]here have already been two rounds of stimulus since the recession started in December 2007. The first, enacted in February 2008 (when I served at the President’s Council of Economic Advisers), provided $168 billion in tax cuts for families and businesses. The second, enacted in February of this year, provided $787 billion in various spending programs and tax cuts. The question we face today is whether to enact a third stimulus, not a second one.
Stimulus aficionados will recognize that, in the interest of brevity, I used dollar amounts that aren’t completely apples-to-oranges. As noted in my previous post on this topic, the $168 billion amount for the first stimulus reflects the gross amount of stimulus in the first couple of years; the long-run, net cost budget cost of the bill is lower. The $787 billion amount for the second stimulus is the ten-year net cost; the initial stimulus is a bit larger. I think the gross impact is a better way to characterize the stimulus effort, but I didn’t want to confuse anyone by referring to an $800+ billion stimulus, when everyone knows it as $787 billion.
Health insurance is not just a health issue. It’s also a jobs issue. Why? Because about 60% of non-elderly Americans get their health insurance through an employer or a labor union. As a result, health insurance and employment are closely related.
As lawmakers consider changes to our system of health insurance, they should therefore keep an eye on the potential implications for jobs and wages. To help them do so, the Congressional Budget Office yesterday released a very helpful brief (see also the accompanying blog entry) that discusses many of the linkages between health insurance and the labor market.
Among other things, CBO reiterates a point I’ve made previously: that the costs of health insurance are ultimately born by workers through lower wages and salaries:
Although employers directly pay most of the costs of their workers’ health insurance, the available evidence indicates that active workers—as a group—ultimately bear those costs. Employers’ payments for health insurance are one form of compensation, along with wages, pension contributions, and other benefits. Firms decide how much labor to employ on the basis of the total cost of compensation and choose the composition of that compensation on the basis of what their workers generally prefer. Employers who offer to pay for health insurance thus pay less in wages and other forms of compensation than they otherwise would, keeping total compensation about the same.
CBO then goes on to discuss a range of potential policies, including ones that would impose new costs on employers. Such policies might require employers to provide health insurance to their workers (an employer mandate), for example, or might levy a fee on employers who don’t provide health insurance (play or pay). CBO concludes that, consistent with the argument above, employers would generally pass the costs of such measures on to their employees through lower wages and salaries. Such adjustments won’t happen instantly, so there may be some short-term effect on employment, but over time the cost will primarily be born by workers through lower compensation.
One exception, however, would be workers who currently earn low wages. As noted on the blog:
Many economists, myself included, refer to the recent boom and bust in house prices as a bubble, whose foundation lay in a combination of credit market excesses and human imperfections. Fundamentals certainly played a role as well, but bubble forces were particularly important.
The housing boom and bust of the last decade, often attributed to “bubbles” and credit market irregularities, may owe much to shifts in economic fundamentals. A resurgence in productivity that began in the mid-1990s contributed to a sense of optimism about future income that likely encouraged many consumers to pay high prices for housing. The optimism continued until 2007, when accumulating evidence of a slowdown in productivity helped dash expectations of further income growth and stifle the boom in residential real estate.
Jim’s argument depends on several related lines of reasoning:
First, he notes that productivity drives long-term income growth and that incomes determine how much families can pay for homes. He then argues that the demand and supply for housing are inelastic and, as a result, rising incomes imply rising house prices. Putting these pieces together, he concludes that faster productivity growth implies faster house price appreciation.
Second, he notes that productivity growth accelerated in the mid-to-late 1990s and then slowed around 2004. The productivity acceleration thus began shortly before house price took off, and the productivity slowdown began shortly before house prices began to collapse.