CBO estimates that the government ran a deficit of almost $1.4 trillion during the first eleven months of the fiscal year (up from $501 billion at this point last year).
CBO reiterated its forecast that the full year’s deficit will also come in around $1.4 trillion (September is usually a month of surplus because of strong tax receipts, but CBO apparently thinks this September will be close to break-even.)
CBO’s estimate is noticeably lower than the administration’s most recent deficit forecast of $1.58 trillion. If the final numbers next month are in line with CBO’s projections, some commentators will thus spin the full year deficit as good news (“the deficit came in lower than the administration expected”), while others will spin it as bad news (“yikes, the deficit was $1.4 trillion”). (As noted in an earlier post, CBO’s summer update was a bit complicated to interpret because its headline deficit estimate used different accounting for Fannie Mae and Freddie Mac than the administration used; on an apples-to-apples basis, however, CBO then forecast a deficit of $1.41 trillion.)
As shown in the following chart, the deficit has exploded for three main reasons:
Next Tuesday is a big day for budget watchers. The Congressional Budget Office will release its updated budget and economic projections in the morning, and the Office of Management and Budget will release its projections later in the day.
CBO isn’t a fan of leaks, so we probably won’t know much about its updated projections until Tuesday. The Obama administration, on the other hand, will likely allow select tidbits out early, as have previous administrations.
Indeed, Bloomberg is already reporting that an administration official told them that this year’s deficit will come in at “$1.58 trillion, about $262 billion less than forecast in May.”
There are several things you should know about this estimate:
The $262 billion difference is largely explained by a single factor: no TARP II. The administration’s original budget included a $250 billion placeholder for additional financial stabilization efforts. Happily, that never happened.
A second big factor, as reported by Bloomberg, is that spending on bank failures has come in $78 billion lower than originally forecast.
That good news is partly offset by the fact that tax revenues are projected to be about $83 billion less than originally forecast (presumably because of the weak economy). All other spending is forecast to be about $17 billion less than originally projected.
In short, the cost of fighting the financial crisis has been much lower than forecast in May, while the rest of the budget has done slightly worse than forecast.
This being Washington, there will be some debate about whether the $1.84 trillion figure from May is the right benchmark for evaluating whether the deficit is lower than forecast. That figure (the “policy deficit”) reflected not only the administration’s expectations about how the economy was affecting the budget, but also the budget impacts of its policy proposals, including the potential TARP II. At the time, the administration also made a second forecast that did not include any policy changes. That “baseline deficit” was $1.62 trillion, almost identical to the new estimate. Folks who use the baseline as a benchmark will thus conclude that the deficit is essentially in line with earlier expectations.
Note: The estimates of this year’s budget deficit will get lots of press (and blog) attention, but they are by no means the most important information in the new projections. The real question is what 2010, 2011, and subsequent years look like. We know the deficits will be scary-looking, but we will have to wait until Tuesday to find out just how scary.
As Stan Collender points out over at Capital Gains and Games, however, the absolute amount of the deficit is not the only thing that matters politically. Also important is how the deficit stacks up relative to expectations. And, as Stan says, there’s good reason to believe that the deficit will come in less than original forecasts.
Back in May, the Obama administration projected that this year’s deficit would come in at $1.84 trillion, assuming enactment of the President’s policies. In June, the Congressional Budget Office came up with a very similar estimate.
Now it’s looking as though the deficit could come in several hundred billion dollars lower than that.
The Citigroup pricing anomaly may be in its final days (earlier posts here and here).
Investors must submit their offers to exchange preferred shares for common shares by this Friday (which may require contacting your broker several days earlier). The common shares will then be delivered to investors on July 30.
The pricing gap between the common and preferred shares remains large (about 10% at the close on Monday), but has narrowed as the exchange date has drawn near.
It thus seems an appropriate time to reflect on what, if anything, the Citigroup anomaly illustrates about economics and finance more broadly. Happily, this week’s Economist carries a quote from Dick Thaler (previously quoted in my post about Catherine Zeta-Jones) that summarizes the lesson perfectly:
Mr Thaler concedes that in some ways the events of the past couple of years have strengthened the [Efficient Markets Hypothesis]. The hypothesis has two parts, he says: the “no-free-lunch part and the price-is-right part, and if anything the first part has been strengthened as we have learned that some investment strategies are riskier than they look and it really is difficult to beat the market.” The idea that the market price is the right price, however, has been badly dented.
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.
JPMorgan Chase & Co, seeking to completely extricate itself from a federal bailout program, has asked the government to auction warrants to buy the bank’s stock, after the Treasury Department demanded too high a price for the bank to buy them back.
This is great news. Treasury should be driving a hard bargain. And JP Morgan should allow private investors to compete to buy the warrants — maybe that will allow JPM to use its capital for better purposes. As an economist, I also welcome the opportunity to find out the market price of the warrants, so we can compare it to what all the modelers have been estimating.
Next question: How do I bid? I hope Treasury does this in a way that lets small investors participate, much as they can in Treasury bond auctions.
Meanwhile, the Congressional Oversight Panel released a report on the warrants. The Panel suggests, albeit with major caveats, that some initial warrant repurchases were done too cheaply:
As I’ve noted in a series of posts (here’s the most recent), there’s an anomaly in the pricing of Citigroup securities. Several issues of Citi’s preferred stock are scheduled to convert into common by the end of the month. Yet the common stock has been trading at a significant premium to the preferred in recent months. As I type this, for example, the common is trading at roughly a 14% premium to the preferred common, even though the conversion is just a few weeks away.
As best I can tell, the only explanation for this pricing anomaly is that Citigroup common stock is very difficult to sell short. So arbitrageurs can’t bid the spread down to levels that would be normal for such a deal.
This anomaly intrigues me for two reasons. First, it appears to be a blatant rejection of strong versions of the efficient markets hypothesis. However, as I will discuss in a later post, the market for Citigroup securities is actually ruthlessly efficient in many ways. As a result, it’s extremely difficult to profit from the anomaly. Sharp financial types have already bid other prices — most notably those for Citi options — to a level where obvious profit opportunities don’t exist.
Second, the anomaly is a big dangling carrot for big-money types to get creative. Markets always try to find ways around imperfections like the limits on short-selling. So I’ve been wondering what creativity would come out of the woodwork. Well, today I got an answer.
Summary: Both Citigroup and Berkshire Hathaway continue to violate the law of one price.
In previous posts (this is the most recent), I’ve pointed out that there are three ways you can purchase common shares of Citigroup:
Simple: Buy shares of common stock.
Preferred: Buy shares of preferred stock that will convert into common.
Synthetic: Use call and put options to replicate the financial returns of owning common stock.
In a perfect world, these three approaches would give nearly identical prices. That’s the law of one price.
Over the past few months, however, Citi securities have been breaking that law. Investors who have been buying common shares have been significantly overpaying relative to the values implied by the prices of the preferred stock and options.