Mortgage giants downgraded

This was briefly mentioned in yesterday's post, but I'm giving it its own post for emphasis. The credit ratings of Fannie Mae, Freddie Mac, and other federal entities were downgraded by S&P yesterday:

Standard & Poor's on Monday downgraded the credit ratings of Fannie Mae, Freddie Mac and several other U.S. government entities, reflecting their dependence on federal support.

Included in S&P's latest downgrade were the senior issue ratings on debt issued by Fannie and Freddie, the giant mortgage-finance firms. Ten of the 12 Federal Home Loan Banks, which also provide funding for home loans, also received downgrades.

Is a U.S. debt rating downgrade the end of the world?

The Wall Street Journal cites example of other rich countries that have suffered debt ratings downgrades:

Japan, Canada and Australia, among others, have suffered the ignominy of being downgraded from top credit ratings.

By and large, borrowing costs remained fairly steady and, in some instances, eventually declined. Stock markets wavered but generally rebounded, while the response in currency markets varied widely.

"When [a downgrade] happened in the past, was it the end of the world?" asks Nick Bennenbroek, head of currency strategy at Wells Fargo & Co. "The reaction wasn't positive, but it wasn't extreme."

For the U.S., history suggests the outcome could even be a long-term positive if a downgrade prods policy makers to get the government's fiscal house in order.

While circumstances and economic paths differed, the impacts of the ratings change itself weren't significant, analysts say. One reason is that ratings changes are usually well-advertised in advance, allowing markets to adjust gradually. But more important for the markets than the ratings moves, analysts say, are the country's underlying economic trends.

What happens if U.S. debt gets downgraded?

In this Wall Street Journal video, note the effect on the housing market:

Realtors fear a national debt default will hurt the housing market

...because it will. In fact, they claim the housing market is already being hurt:

The National Association of Realtors®, on behalf of its 1.1 million members, their clients and customers, and the nation’s 75 million homeowners, urges Congress to resolve the mounting debt ceiling crisis before the August 2 deadline.

Until a resolution is reached, Congress will be unable to address the myriad issues facing the nation’s families, communities, and economy. The indecision in Congress is paralyzing progress on other fronts, and it is harming home buyer confidence and negatively affecting home sales.

Typically bearish economist Paul Krugman puts it this way:

Just to make a point that could be overlooked in the confusing discussion about the effects of default on financial markets: It’s true that nobody really knows what effect failure to make full payment on the debt will have. It could produce calamity, or it could be contained, with borrowing rates for the private sector barely affected.

But what we do know is that if the government is forced to slash spending when the money runs out — if it stops sending out Social Security checks, or stops paying vendors, or whatever — this will have a huge negative impact on the economy. We’ll be doing a 1937 squared.

And yes, it will hurt the Washington, DC metro area.

Americans ridding themselves of debt

After a splurge of consumption and debt that accompanied the housing bubble over the past decade, Americans are finally weening themselves off household debt.

This graph shows household debt service payments as a percentage of disposable income:


This graph shows household financial obligations as a percentage of disposable income:


And here is a likely cause of the decline of household debt. The personal savings rate has doubled since the financial crisis began, although it's still half of what it was in 1980.


Luckily, the decline in household debt isn't simply being offset by a rise in the national debt. Oh. Wait. Here's the U.S. budget deficit as a percentage of GDP:

Mankiw: Eliminate the mortgage interest deduction

Harvard economics professor Greg Mankiw advocates eliminating the mortgage interest tax deduction:

One major tax expenditure that the Bowles-Simpson [deficit reduction] plan would curtail or eliminate is the mortgage interest deduction. Without doubt, many homeowners and the real estate industry will object. But they won’t have the merits on their side.

This subsidy to homeownership is neither economically efficient nor particularly equitable. Economists have long pointed out that tax subsidies to housing, together with the high taxes on corporations, cause too much of the economy’s capital stock to be tied up in residential structures and too little in corporate capital. This misallocation of resources results in lower productivity and reduced real wages.

Moreover, there is nothing particularly ignoble about renting that deserves the scorn of the tax code. But let’s face it: subsidizing homeowners is the same as penalizing renters. In the end, someone has to pick up the tab.

Glaeser: Scale back the mortgage interest deduction

Harvard University economics professor Edward Glaeser argues for scaling back the home mortgage interest tax deduction:

REDUCING THE national debt is a great test of our political system. ... Yet last week’s eminently sensible preliminary report of the bipartisan National Commission on Fiscal Responsibility and Reform seems to have brought forth not careful consideration but flights of fury. In particular, the possibility of reforming the home mortgage interest deduction has generated a torrent of ire. While one option mentioned by the report was to eliminate all tax deductions and credits, the more detailed Wyden-Gregg option is to limit the mortgage deduction to exclude second homes, home equity lines, and mortgages over $500,000. Lowering the upper limit on the home mortgage interest deduction should appeal to progressives, who want less largess for the wealthy, and to small-government conservatives, who dislike public paternalism. Unfortunately, the demons of discord seem to have prevented either group from embracing the reform.

The Democrats are haunted by a blue leviathan that calls for massive government transfers for any vaguely middle-class interest group. That monster was working full force last week as progressive pundits argued that capping the mortgage interest deduction at $500,000 would be deeply unfair to middle-class homeowners. Apparently these writers think that the middle class is full of people with million-dollar mortgages. According to the 2007 Survey of Consumer Finance, the median mortgage owed by a family in the top 10 percent of the US income distribution was $200,000. The median price of an existing home sold in September was $171,000. Research by economists James Poterba and Todd Sinai finds that even among households earning more than $250,000, the average mortgage is $300,000.

If liberals defend the home mortgage deduction as a vital bulwark for middle income Americans, then they are ignoring the fact that the home mortgage interest deduction is one of the most regressive parts of the tax code. Poterba and Sinai’s research finds that the average benefit created by the deduction for home-owning families earning over $250,000 is 10 times larger than the average benefit reaped by families earning between $40,000 and $75,000. Progressives also typically worry about global warming, and that concern should lead them to oppose any tax policy, like the mortgage interest deduction, that encourages Americans to build bigger, more energy-intensive homes. ...

Tea Party libertarians should fight the deduction, opposing any use of tax policy to try to manipulate the way we live. Why is it the government’s business to try to bribe us to buy bigger homes and take on more debt? ...

Reforming the home mortgage interest deduction is a good place for both parties to start getting serious.

Can you balance the federal budget?

Here's a graph of federal debt held by the public as a percentage of GDP, from 1970-2009:


With the exception of a few short years at the end of the Clinton administration, politicians have been unable to balance the federal budget for decades. The massive rise in U.S. national debt began under President Reagan as he cut taxes and raised defense spending. Now President Obama's National Commission on Fiscal Responsibility and Reform has proposed to reduce the budget deficit in the medium term (5 year) and balance the budget over the long run (27 years).

Can you do it? The New York Times has a fun little tool to let you try balancing the budget. I did it quite easily, in both the medium term and the long term—and then I just kept going. Through a mix of 70% spending cuts and 30% tax increases, I was able to give the U.S. a budget surplus of over $625 billion in 2030. Try it yourself. If you can't make decisions that balance the federal budget, don't get upset at politicians for being unable to do so. (Hint: Economists project that the long-term growth in federal spending comes mostly from increased entitlement spending as baby boomers enter retirement.)

U.S. national debt hits $13 trillion

The U.S. Total Public Debt has hit a new record:

The U.S. national debt has passed the $13 trillion mark, according to USDebtClock.org, an independent website that tracks the real-time growth of U.S. revenues and spending.

On Tuesday, the national debt stood at $12,995,779,490,444.52, according to the Treasury Department's national debt-tracking website TreasuryDirect.gov.

Federal Debt Held by the Public, a better measure of the national debt because it doesn't count money some parts of the government owe to other parts of the government, is just shy of $8.5 trillion according to TreasuryDirect.gov. To put things in perspective, that's $75,973 per U.S. household.

Here's a graph of Federal Debt Held by the Public as of year-end 2009:

New study: You can't trust Paul Krugman

Economist and New York Times columnist Paul Krugman is heavily politically biased—shocker! Here's the conclusion of a new study published in Econ Journal Watch:

Overall, our research finds that most economists don’t change their positions when the White House changes party. Only two economists changed their tune in a significant or moderate way. The strongest case is Paul Krugman. He explicitly supported deficit reduction in the 1990s and early 2000s under Republican administrations, then changed his view once Clinton entered office in 1993 and the Democrats gained control of Congress in 2006. The case is strengthened due to his large number of comments. He is the most frequent contributor on our list, a fact that reduces the chance of error in our conclusion. Alan Blinder also changed his tune, though in a less significant manner than Krugman. He consistently supported deficit spending that resulted from Democratic policies and criticized deficit spending that resulted from Republican policy.

Four other economists—Martin Feldstein, Murray Weidenbaum, Paul Samuelson, and Robert Solow—changed their tune in a minor way. That leaves eleven economists with strong cases in favor of nonpartisan commentary regarding the budget deficit. Given such consistency, they appear to be close to impartiality.

So, Paul Krugman and Alan Blinder are untrustworthy due to their political bias. Which Democrats can you trust? Christina Romer, Larry Summers, Joseph Stiglitz, Laura Tyson, Alicia Munnell, Janet Yellen, and Robert Lawrence. Which Republicans can you trust? Glenn Hubbard, Michael Boskin, and Paul McCracken.

Only 17 economists were studied—eleven of them Democrats—so the absence of someone from the trustworthy category shouldn't be a bad sign. Ben Bernanke, Greg Mankiw, Robert Shiller, and Jeffrey Sachs are a few well-known economists who weren't studied.

Cash for Clunkers cost $24,000 per car

Edmunds.com has analyzed the car sales numbers during the Cash for Clunkers program and estimated that the marginal cost was $24,000 of our tax dollars for each new car sold:

A total of 690,000 new vehicles were sold under the Cash for Clunkers program last summer, but only 125,000 of those were vehicles that would not have been sold anyway, according to an analysis released Wednesday by the automotive Web site Edmunds.com. ...

The Cash for Clunkers program gave car buyers rebates of up to $4,500 if they traded in less fuel-efficient vehicles for new vehicles that met certain fuel economy requirements. A total of $3 billion was allotted for those rebates.

The average rebate was $4,000. But the overwhelming majority of sales would have taken place anyway at some time in the last half of 2009, according to Edmunds.com. That means the government ended up spending about $24,000 each for those 125,000 additional vehicle sales.

The average rebate value mentioned above seems like bad rounding. It appears the average rebate was closer to $4,348. Here's the math:

$3 billion overall cost ÷ 690,000 cars sold = $4,348 per car total cost

(690,000 / 125,000) × $4,348 = $24,000 per car marginal cost

In an example of regulatory capture (government regulators protecting the industry they are supposed to regulate), the Department of Transportation is defending Cash for Clunkers (i.e. "Car Allowance Rebate System") by saying that it was good for the auto industry:

"It is unfortunate that Edmunds.com has had nothing but negative things to say about a wildly successful program that sold nearly 250,000 cars in its first four days alone," said Bill Adams, spokesman for the Department of Transportation. "There can be no doubt that CARS drummed up more business for car dealers at a time when they needed help the most."

Note that what's good for car dealers is not necessarily what's good for the overall economy, just as what's good for Realtors is not necessarily what's good for the overall economy. Like the first-time home buyer tax credit, Cash for Clunkers is nothing more than wasteful corporate welfare.

The White House has come out with a weak, short-term-oriented defense of the program. Notice, however, that for the most part the left-wing economics bloggers who are usually quick to defend the White House against faulty economic reasoning (e.g. Paul Krugman, Mark Thoma, Calculated Risk) are remaining silent on this one. In fact, left-leaning economist Jeffrey Sachs is out with his own criticism of Cash for Clunkers' supposed climate benefits. Sachs actually makes the mistake of measuring total cost, rather than marginal cost, so the program is actually 5.5 times more wasteful than the numbers he complains about.

Just like the first-time home buyer tax credit, Cash for Clunkers is a handout of our tax money to the special interests who lobby Congress.

Graph: Unsustainable Medicare and Social Security spending

America's entitlement spending commitments are unsustainable:

U.S. federal budget deficit graph: revenues vs. outlays

Click on the image to see a larger version of the graph:

Source.

President Obama to cut deficit in half by 2013? I say B.S.

President Obama is now repeating one of President Bush's false promises.

From the Financial Times:

Barack Obama will this week set the goal of halving the budget deficit he inherited by the end of his first term, while pushing ahead aggressively on healthcare reform, climate change and education.

His first budget, released on Thursday, will show the deficit falling to $533bn (€415bn, £369bn) by fiscal year 2013, compared with an inherited deficit aides estimate at $1,300bn.

From President Bush's 2004 State of the Union speech:

And we should limit the burden of government on this economy by acting as good stewards of taxpayer dollars. In two weeks, I will send you a budget that funds the war, protects the homeland, and meets important domestic needs, while limiting the growth in discretionary spending to less than 4 percent. This will require that Congress focus on priorities, cut wasteful spending, and be wise with the people's money. By doing so, we can cut the deficit in half over the next five years.

Keep in mind that cutting the deficit in half is far different than cutting the national debt in half. Cutting the deficit in half means that government spending will still be contributing to the national debt. In order to reduce the national debt, we need to have a budget surplus, not a deficit.

The $533 billion deficit that Obama hopes for would rank among one of the worst deficits experienced under George W. Bush. In other words, it would be no great accomplishment. Even so, I think Obama is unlikely to achieve it.

A condensed version of I.O.U.S.A.

Video: I.O.U.S.A., condensed to 30 minutes:

Advice for improved national security, a balanced budget, and a cleaner environment

Here is timeless advice from 2006 by Harvard economist Greg Mankiw:

Here's a wacky idea you won't often hear from our elected leaders: We should raise the tax on gasoline. Not quickly, but substantially. I would like to see Congress increase the gas tax by $1 per gallon, phased in gradually by 10 cents per year over the next decade. Campaign consultants aren't fond of this kind of proposal, but policy wonks keep pushing for it. Here's why:

The environment. The burning of gasoline emits several pollutants. These include carbon dioxide, a cause of global warming. Higher gasoline taxes, perhaps as part of a broader carbon tax, would be the most direct and least invasive policy to address environmental concerns.

Road congestion. Every time I am stuck in traffic, I wish my fellow motorists would drive less, perhaps by living closer to where they work or by taking public transport. A higher gas tax would give all of us the incentive to do just that, reducing congestion on streets and highways.

Regulatory relief. Congress has tried to reduce energy dependence with corporate average fuel economy standards. These CAFE rules are heavy-handed government regulations replete with unintended consequences: They are partly responsible for the growth of SUVs, because light trucks have laxer standards than cars. In addition, by making the car fleet more fuel-efficient, the regulations encourage people to drive more, offsetting some of the conservation benefits and exacerbating road congestion. A higher gas tax would accomplish everything CAFE standards do, but without the adverse side effects.

The budget. Everyone who has studied the numbers knows that the federal budget is on an unsustainable path. When baby-boomers retire and become eligible for Social Security and Medicare, either benefits for the elderly will have to be cut or taxes raised. The most likely political compromise will include some of each. A $1 per gallon hike in gas tax would bring in $100 billion a year in government revenue and make a dent in the looming fiscal gap.

Tax incidence. A basic principle of tax analysis -- taught in most freshman economics courses -- is that the burden of a tax is shared by consumer and producer. In this case, as a higher gas tax discouraged oil consumption, the price of oil would fall in world markets. As a result, the price of gas to consumers would rise by less than the increase in the tax. Some of the tax would in effect be paid by Saudi Arabia and Venezuela.

Economic growth. Public finance experts have long preached that consumption taxes are better than income taxes for long-run economic growth, because income taxes discourage saving and investment. Gas is a component of consumption. An increased reliance on gas taxes over income taxes would make the tax code more favorable to growth. It would also encourage firms to devote more R&D spending to the search for gasoline substitutes.

National security. Alan Greenspan called for higher gas taxes recently. "It's a national security issue," he said. It is hard to judge how much high oil consumption drives U.S. involvement in Middle Eastern politics. But Mr. Greenspan may well be right that the gas tax is an economic policy with positive spillovers to foreign affairs.

Is it conceivable that the policy wonks will ever win the battle with the campaign consultants? I think it is. Even after a $1 hike, the U.S. gas tax would still be less than half the level in, say, Great Britain, which last I checked is still a democracy. But don't expect those vying for office to come around until the American people recognize that while higher gas taxes are unattractive, the alternatives are even worse.

The national debt: The growing problem Americans don't care about

This 60 Minutes piece is from a year ago, but the issue is still very relevant.

Medicare: the growing federal budget crisis

Tyler Cowen proposes a solution to the impending Medicare budget crisis:

No matter who sits in the Oval Office next year, there won’t be many degrees of freedom in the federal budget. That’s because spending on entitlement programs is largely locked into place, and the situation will become much worse as Americans age and health care costs rise. Even if the government is conservative in its spending, just paying out promised benefits implies that tax rates will rise to a crushing level — a range of 60 to 80 percent of income — well before the end of this century.

The main problem is Medicare, which reimburses the elderly for many of their health care expenses. As Mark V. Pauly, professor of health care systems at the University of Pennsylvania, has said, “Medicare as we know it today cannot be sustained over the next 50 years and probably will run into financial difficulties within the next 15.”

There’s one important idea lurking in the shadows that neither campaign is keen to talk about: paying out government benefits more efficiently. To put it bluntly, it means paying out full benefits only to those who really need them, and cutting back on payments to everybody else. Most recently, this notion has been proposed by Peter H. Schuck, a Yale law professor, and Richard J. Zeckhauser, a Harvard political economy professor, in their book, “Targeting in Social Programs: Avoiding Bad Bets, Removing Bad Apples.”

“Means testing” — cutting back on payments to the relatively wealthy — is one way to better allocate benefits. For health care costs, this could be done by expanding Medicaid, which is focused on the needs of the poor, and making it an entirely federal program rather than one partly paid for by the states. At the same time, the government would need to limit the growth of Medicare, which is universally applied to all elderly people; as a segment of American society, the elderly are relatively wealthy. With limited resources, it would be better to reallocate health care subsidies toward the poor, whether they are young or old.

Furthermore, inducing the wealthy to pay for their own health coverage would create pressures to lower costs.

An alternative path is to put in place more means testing throughout Medicare. For instance, higher-income older Americans have already been paying larger Medicare premiums and receiving a lower prescription drug benefit; that’s part of what made it possible to expand the prescription benefit within budgetary constraints.

Here is Greg Mankiw's take on means testing for Medicare.

And here, Paul Krugman provides his input.

Massive federal budget deficit so far in 2008

From CNN Money:

The Treasury Department says the federal deficit swelled to $268.7 billion in the first nine months of this budget year as record spending during the period outpaced revenues. ...

The new year-to-date deficit of $268.7 billion was the third-highest on record. A flood of tax rebates, aimed at stimulating the sluggish economy, left the government's coffers and contributed to the bigger deficit, according to an analysis by the Congressional Budget Office.

Spending totaled $2.2 trillion, while revenues came to $1.93 trillion.

The Bush administration estimated in February that the deficit for this year would be $410 billion. That would be just under the all-time high of $413 billion logged in 2004. Some private economists think this year's budget deficit will turn out to be higher than expected as an economic slowdown has cut into tax revenues. ...

So far this budget year, the biggest spending categories are programs from the Health and Human Services Department, including Medicare and Medicaid, $520.4 billion; Social Security, $491.7 billion; military, $439.5 billion; and interest on the public debt, $377.3 billion.

Keep in mind that four years ago, President Bush promised to cut the deficit in half within five years. How's that going? Of course, a recession is not the time to try to balance the budget. According to Keynesian economics, the government should run surpluses during good economic times and deficits during weak economic times. Under President Bush, however, we have been running deficits under both.