The Pete Davis Archives

Recessions Start and End Before You Expect Them To

Pete Davis — Mon, 01 Dec 2008 22:43:36 +0000

The National Bureau of Economic Research Business Cycle Dating Committee met by conference call last Friday and declared the recession started last December. This is important for economists, but it can be very frustrating for economic policymakers. Invariably, economic policymakers want to know why it takes almost a year to declare the start of the recession. They might have acted differently had they known. The short answer is that data lags, data is revised several times, and data often conflict on when a recession started or ended. Combat commanders talk about the "fog of war," and economic policymakers face similar uncertainties and pressures to act. Fortunately, our economic policymakers acted early this year and have thrown massive amounts of fiscal and monetary policy stimulus at this recession. It didn't stop the recession from happening, but it almost certainly made it less severe. Fortunately, we'll never know how severe this recession would have been had nothing been done to counteract it.

The Deficit Control Act of 1985 (otherwise known as Gramm-Rudman-Hollings) required the Congressional Budget Office to issue a "low growth report" whenever it projects two consecutive quarters of negative real GDP growth from the past quarter until a year following the current quarter or when the Commerce Department has reported real GDP growth of less than one percent in the most recent quarter and the preceeding quarter. Such a report could trigger a resolution to suspend budget enforcement procedures, but Congress has rejected such resolutions when it had the opportunity as noted in this Congressional Research Service report. The low growth report requirement expired on September 30, 2006, but it had already established in the public's mind that two consecutive quarters of negative real GDP growth equaled a recession.

NBER looks to broader measures of economic activity to make its recession dating determinations. It puts the most weight on payroll employment, but it considers real gross domestic product, real domestic income, real personal income less transfers, real manufacturing and wholesale and retail sales, industrial production, and employment as measured by the household survey as well. These data mark the beginning of the recession as early as last November and as late as last July.

As an economic policymaker, you can't wait until NBER decides the data is conclusive enough to mark an economic downturn. Members of Congress hear from people suffering back home long before that. In this case, what started out in late 2006 as a housing slump concentrated in California, Nevada, Arizona, and Florida, and an ongoing manufacturing slump in the upper Midwest, turned until a recession across the country a year later. Early this year, opinion was still mixed among economists whether we had entered a recession, but when credit markets seized up earely this summer, few doubted that would plunge the real economy into recession, and it did.

Marking the end of a recession is equally difficult because different sectors and different regions of the country emerge from recession at different times, and some areas, like Michigan, never seem to emerge. I look forward to NBER declaring this recession over as soon as possible, but I don't expect it to until almost a year after it ends. That could be as early as a little over a year from now, or it could be as late as nearly two years from now. This looks like a longer and deeper recession than any of us have experienced in our lifetimes.

When Policy Levers Don't Work, Wait Until Traction Can Be Restored

Pete Davis — Sun, 30 Nov 2008 21:51:05 +0000

When you do well in grad school economics, you adhere to first principles, dig deep into well behaved data, and come up with some new result, but only one which reinforces current theory, particularly that of your adviser.

When you attempt public policy, you rarely find out until too long after that what you thought would work didn't work so well. Most professors and most policymakers prefer not to acknowledge that.

When I started out in 1974 as a 23-year old economist on the Joint Committee on Taxation, we really believed we could micromanage the economy with fiscal policy. Future Nobel Prize winner Lawrence Klein had just developed the first large scale macro model of the U.S. economy. It showed with seeming precision exactly how much GDP growth we could get from a tax cut or government spending increase. During the 1975 recession, I formulated the first individual income tax rebate. We were convinced that this would quickly revive the economy. It certainly seemed to do so at the time. It was only later that we learned that the bulk of the rebate had been saved, and that the economy had rebounded for other reasons. Research on the 2001 tax rebate showed that only between 20% and 40% of it was spent on non-durable goods in the first three months after it was received.

Monetary policy came into vogue in the 1980's. Milton Friedman led a revolution among economists away from fiscal policy and toward more careful control of monetary policy to dampen cyclical swings. The only problem was we couldn't seem to find a measure of the money supply that held up to econometric scrutiny. Our results were only as good as the lag structure in those equations, and it eventually became apparent that the false precision of monetary policy theory was no better than the false precision of fiscal policy theory.

Our current recession has provided proof that another rebate of 1¼% of GDP just postponed the recession for a quarter or two and monetary policy has been equally ineffective. What do you do when the policy levers don't work?

Congress and President-elect Obama are poised to adopt a much larger fiscal stimulus bill, on the order of $500 b. Perhaps 1¼% of GDP is not enough. Let's try 3½%. This is like getting stuck in the ditch, spinning your tires, and deciding to spin them even faster to get out. It doesn't work. You need more traction.

The next step will be to spend more money on infrastructure investment, roads, bridges, and other large scale public works. They definitely create jobs, but they take years, not months, to stimulate the economy. They only benefit the economy if they prove more productive than the alternative uses to which that tax money could have been put. A bridge to nowhere is still a bridge to nowhere.

We economists haven't experienced a nationwide "liquidity trap" since the early 1930's. We're in one now. The Fed had cut interest rates to 1% and has pumped hundreds of billions of dollars into the economy, but this has just been "pushing on the string." Almost all of that increased liquidity has been saved by consumers and by banks. No one is lending, and no one is buying.

How do we get traction? Policy traction will return only when banks regain faith that their loans will be repaid and when consumers believe their income is secure enough to spend on credit again. We'll have to wait until we can pay off enough debt. We'll have to wait until we have more faith in our political leaders. We'll have to wait until we're less fearful of a medical emergency with no health insurance. We'll have to wait until we feel more secure. One thing about Americans, they dislike waiting for anything more than just about anyone on the planet. Impatience won't help us. Calm, steady, and forceful policy actions will help, but it will take time. We didn't jump into this economic mess overnight; it will take us a while to get out, hopefully by the end of next year.

Bailout III: Citigroup About To Be Nationalized

Pete Davis — Sun, 23 Nov 2008 21:27:13 +0000

This horror movie keeps getting worse. This morning's New York Times details how Citigroup, under CEO Charles O. Prince III and Robert E. Rubin, took on too much risk in search for every growing profits, only to find the whole enterprise crashing down around them when those risks proved excessive.

What's ahead? My Washington banking sources expect a backdoor nationalization of Citigroup, possibly before 6 p.m. today, when Asian financial markets are poised to hammer Citi stock from $4 to far less 90 minutes from now. That after Citi fell from a 52-week high of $35 in early December, 2007, to its Friday close of $4.

Nationalization of Citi would probably include the injection of billions of dollars more from the Troubled Asset Relief Program (TARP), on top of the $25 b. Citi has already received. Citi is too big to fail. Over half of its deposit come from foreign investors. Thursday, Saudi Prince Alwaleed bin Talal upped his stake in Citi from 4% to 5% in an effort to stave off a bank run. Monday, Citi announced more layoffs, bringing the total to 75,000 out of a total workforce of 375,000. Unfortunately, this probably won't be enough.

Taxpayers are going foot the bill in the end. The trouble is finding the end after bailing out Bear Stearns, Fannie Mae, Freddie Mac, AIG, all major banks, and now Citi for a second time. That doesn't count bridge loans early next year, if its not too late, for GM, Ford, and Chrysler. It also doesn't count the Federal Reserve facilities to keep the commerical paper market afloat and another one that's coming to keep the asset backed securites market (credit cards, student loans, auto loans, etc.). The Fed's balance sheet has already doubled to $1.3 trillion, and it looks like its going further.

If another stimulus bill early next year and a new administration can inspire confidence, hopefully we can emerge from a severe recession late next year with enough economic power in tact to begin chipping away at the the $2 trillion of additional debt the federal government will have accumulated by then.

Feldstein Advocates Auto Bankruptcy, But Auto Bailout Next Year Is More Likely

Pete Davis — Tue, 18 Nov 2008 23:34:26 +0000

In a Washington Post op-ed this morning, Harvard economist and McCain adviser, Martin Feldstein, called for the Big Three automakers to enter bankruptcy to rewrite excessive union contracts. President-elect Obama and Congressional Democrats seem set on providing loans with conditions to restore long-run financial viability similar to the bill hammered out by House Financial Services Chair Barnery Frank yesterday. Although the House is expected to pass it later this week, I doubt it will get through the Senate because of Republican opposition. Next year, something like it is very likely to be enacted.

Auto Industry Bailout Pros and Cons

Pete Davis — Mon, 17 Nov 2008 19:34:13 +0000

After weeks of debate, we're no closer to consensus in Washington on a bailout for the Big Three auto companies.

White House Press Secretary Dana Perino just said the White House would support an amendment to the Section 136 Department of Enerngy program to speed up those loan guarantees of up to $25 b. "We think there is a bipartisan path to getting this done very quickly -- this week." She said Senate Democratic leaders had not revealed their amendment yet or offered to negotiate a compromise. A Senate vote is expected Wednesday. Senate Democratic leaders and the Big Three auto companies want $25 b. from the $700 b. Troubled Asset Relief Fund.

Perino reiterated the Administration's opposition to using TARP to help the auto companies. "That won't happen." she said. When asked if a bankruptcy declaration by any of the auto companies would be acceptable to the White House, she responded that would be "the companies' decision."

President-elect Barack Obama supports direct aid for the Big Three, but he has said taxpayers should be protected too.

The hangup is whether to insist that loans or loan guarantees be conditioned upon an assessment of "financial viability" over the next 10 years as under the Energy Department loan guarantee program or not, as under TARP. Treasury Secretary Hank Paulson has evidently concluded that taxpayer loans should not be given to firms that can't demonstrate their long-run financial viability, although he didn't apply that standard to Bear Stearns, AIG, Fannie Mae, or Freddie Mac.

The Big Three financed Center for Automotive Research has estimated that the demise of the auto industry would cost 239,341 direct jobs, 973,969 supplier jobs, and 1,738,034 other jobs from $150.7 b. less personal income. Federal, state, and local governments would be hit with $14.3 b. of increased transfer payments, $21.1 b. of less Social Security payroll taxes, and $24.7 b. less personal income taxes.

However, today's New York Times makes a point that most economists would make: the demise of the Big Three would not eliminate all Big Three auto jobs. Many, but not all, of those jobs would be picked up by foreign automakers at existing or new plants here in the U.S., but those would be non-union jobs at lower wages and with fewer benefits.

At this point, I don't see how the Big Three automakers avoid major restructuring that may include foreign takeovers. The only question will be whether taxpayer money eases the pain temporarily.

Bailouts II

Pete Davis — Thu, 13 Nov 2008 00:23:45 +0000

Most successful horror movies have multiple sequels; most government bailouts have sequels whether they are successful or not. Treasury's Troubled Asset Relief Program started out as a program to buy toxic mortgage assets, but after the program was enacted on October 3, Treasury Secretary Hank Paulson had second thoughts. Several influential Wall Street investors persuaded him and key members of Congress that it was much more efficient to inject capital directly into ailing financial institutions. That was true, but that hasn't worked too well either, at least not yet.

It turns out that some financial institutions didn't think of themselves as troubled. They didn't want to have their reputations diminished by accepting TARP capital injections. Treasury solved that by forcing them to accept so that no large bank could say it hadn't accepted some TARP money.

Worse still, even the most troubled institutions didn't use the TARP capital injections to make new loans. They hoarded that capital. Most still pay dividends, and a few are considering using their improved capital to takeover other banks -- not exactly what Congress intended.

If you happened to be watching the House debate on C-SPAN just before passage of the TARP legislation around noon on Friday, October 3, three colloquy's occured in rapid succession just before the Emergency Economic Stabilization Act of 2008 passed. A colloquy is a carefully crafted exchange between the manager of the bill and another member stating legislative intent. It's done in hope that a court will abide by it, even though the legislative language in the bill doesn't really say that. In this case EESA authorized the Treasury Secretary to invest TARP funds into commercial and residential mortgage-backed assets (pools of mortgages sold as mortage-backed securities, MBS) or any other financial assets he saw fit to invest in to ease the credit crisis. That language didn't say anything about direct purchases of mortgages, auto loans, or bank capital injections, but the colloquys took care of that.

Except today, Treasury Secretary Hank Paulson held a news conference to say he didn't think direct purchases of mortgages or MBS was the best use of TARP funds, nor were auto loans, although he did back the creation of another Federal Reserve liquidity facility to buy asset backed securities, i.e. auto loans, credit card loans, and student loans. House Financial Services Chair Barney Frank (D-MA) was not pleased and vowed to pass legislation next week in lame duck session to force the use of TARP for the purposes originally intended by Congress. Frank probably won't get President Bush to sign such a bill, but Congress will proceed anyway on the theory that President Obama will sign such legislation when the 111th Congress passes it quickly early next year.

Meanwhile the credit crisis is spilling over into credit cards. American Express became a bank yesterday. Why would they become a bank? So they could accept a TARP capital injection. Credit cards create long liabilities that are supported by short-term loans. If American Express can't rollover old loans into new loans, that is a big problem. Other credit card issuers, mostly banks, have the same problem, and will follow American Express's example.

The Big Three automakers are teetering on the brink of bankruptcy. GM hardly has enough cash to make it through Christmas. President-elect Obama and most in Congress want to offer an immediate $25 b. bridge loan. However, Secretary Paulson said today that he only wants to make such a loan if it will be made to firms where the long-run viability of the firm is not in question, i.e. not the Big Three because they may go bust or be radically restructured next year. That's not what Congress wants to hear either.

Congressman Spencer Bacchus (R-AL) asked the right question at today's House Financial Services hearing: "Where does this end? Will we bailout Circuit City or Starbucks?" TARP is mutating into a different animal than the one Congress created just five weeks ago. Stay tuned for BailoutsIII.

Bad News Friday

Pete Davis — Thu, 06 Nov 2008 00:04:02 +0000

I'll be out of town Friday giving a speech in Las Cruces, New Mexico, and it's a good thing. At 8:30 a.m., the Employment Report is likely to be particularly grim. We may see a 0.2% point jump in the unemployment rate to 6.3%, a loss of over 200,000 jobs on top of the 9.5 million already unemployed.

If that doesn't capture public attention, at 11 a.m. GM will report earnings, or rather massive losses. Over the past few months, GM, Ford, and Chrysler have pleaded with the government for immediate financial help. Although $25 b. loan guaranteed were authorized on September 30 to fund retooling for the production of energy efficient cars in U.S. plants at least 20 years old, those loan guarantees may not be delivered in time to keep GM from being forced into bankruptcy. The financial crisis is spilling onto industrial companies, and GM won't be the last to go under.

What President Obama Will Have To Do First

Pete Davis — Wed, 05 Nov 2008 23:22:32 +0000

President-Elect Obama will hold a press conference someday soon to outline his priorities for the first 100 days of his administration. There's little doubt that the economy will take precedence over all else. A change in war strategy will be an early priority. The government is only funded through midnight, March 6, so much effort will be expended early next year on finishing the unfinished business President Bush left us. It will be May or June before any time opens up to embark on new agenda items.

It's always tempting to take on the really big issues like health care reform or energy independence early on, but those will only become law if President Obama takes very good care to build the political capital necessary to overcome powerful opposition. President Clinton barged ahead with health care reform soon after taking office in 1993, and he suffered the loss of the House Democratic majority the following year over that failed attempt and didn't regain it during his remaining six years in office. That was quite a price to pay.

Health care reform will affect every American and how we spend 16% of GDP. Very powerful interests disagree about how to go about it. Pharmaceutical companies, hospitals, nursing homes, other health care providers, insurers, employers, unions, AARP, and consumers are going to fight a titanic battle that, in my opinion, won't be decided in a few months. It will take more like a few years. It may have to be done in stages. It will have to be implemented gradually. You don't just start over from scratch on something this massive. You have to transition very carefully, compensating most losers and amassing politcal support from prospective winners.

Energy independence has been a front and center political goal ever since it was first called for by President Nixon in 1973. Since then we have pursued one failed policy after another while becoming more dependent upon foreign oil, not less. Hybrids are selling well now, but not fast enough to replace a woefully inefficient auto fleet. Falling energy prices will diminish our enthusiasm for energy efficiency just as it has too many times before.

I want these issues addressed as much as anyone, but I've seen them fumbled too many times before to wish a quick hail Mary play on President Obama. Better to stick to the ground game and make slow steady progress toward the goal.

Presidential Elections and the Stock Market

Pete Davis — Tue, 04 Nov 2008 17:31:19 +0000

Economists have done a lot of research on how U.S. presidential elections affect the stock market. Most of the studies show quite an advantage for equities following the election of Democrats, but a Federal Reserve study concludes there is no consistent relationship if you correct for market volatility and test back to 1852.

The most cited paper was published in the Journal of Finance in October, 2003 by two University of California economists, Pedro Santa-Clara and Rossen Valkanov. They found 9% higher stock market gains for large stocks in Democratic administrations since 1928.

However, Santa-Clara and Valkanov did not correct for swings in market volatility or examine periods before the Depression, when market volatility was lower. In a 2004 paper, two Federal Reserve economists, Sean Campbell and Canlin Li, made those corrections and found that the 9% higher return dropped to 4%. They concluded that market returns don't track with which party wins presidential elections.

Vanguard published an excellent summary of this econometric work on October 23, 2008. In particular, look carefully at Figure 1. It shows that the stock market rose in every year since 1940 and that the massive rebound in 1933 from the lowest levels of the Depression overly influenced the results. It also shows that, after the Depression, the stock market grew almost equally in Republican and Democratic administrations if you drop the 1974 recession (caused by the first energy crisis, which was hardly President Nixon's fault) and the 2001 recession (which was in progress before President Bush 43 took office). Figure 2 shows that the stock market return since 1852 has been virtually the same for Republicans at 8.66% and for Democrats at 8.97%.

This year, we've seen nothing like the decline of 1929, but we've seen enough of a decline for some to hope for a big rebound soon. Check out this handy list of big swings in the Dow Jones average courtesy of Wikipedia. Anything is possible, but I would look for some "selling on the news" of today's election over the next few days and for distinctly negative market reaction to Friday's employment report and Monday's GM earnings (rather massive loss) report. In my opinion, a strong market rebound in the next six months will only occur if stock market participants gain a lot more confidence than they have now that further stimulus and judicious use of Treasury's $700 b. TARP ("Troubled Asset Relief Fund") will remedy the credit crisis and restore economic growth.

Election Guide

Pete Davis — Tue, 04 Nov 2008 16:36:59 +0000

Obama seems headed for a strong win. Intrade shows Senator Obama with a 92.6% chance of winning the presidency with 364 Electoral College votes to 174 for Senator McCain. Other prognosticators are in the same range. Here are the web sites I follow:

http://www.intrade.com/

http://www.realclearpolitics.com/
http://www.fivethirtyeight.com/

http://www.electoral-vote.com/

http://www.electionprojection.com/

http://www.cnn.com/ELECTION/2008/

http://www.cookpolitical.com/

Congress: Democrats expect to pick up at least 8 Senate seats. The Senate is currently 51-49 if you count Joe Lieberman (Ind.-CT) and Bernie Sanders (Ind.-VT) as Democrats. Senator Lieberman may switch parties if he is stripped of his committee chairmanship. Of the 35 seats up this time, the Republicans are defending 23 (including all 5 open seats) and the Democrats 12. The only Democrat in danger in Mary Landrieu (D-LA), and she has recently pulled ahead of State Treasurer John Kennedy, who switched from Democrat to Republican to run against Landrieu. Ten Republican seats are rated tossups or worse: Virginia; Colorado; New Mexico; New Hampshire; Alaska; North Carolina; Oregon; Minnesota; Mississippi; and Georgia.

http://en.wikipedia.org/wiki/United_States_Senate_elections,_2008

Congress: Democrats expect to pick up at least 24 House seats. The House is currently 235D-199R-1vacant(OH-11-D). Democrats are defending 6 open seats (where the incumbent retired), and Republicans are defending 26 seats. Charlie Cook rates 11 Democratic seats as toss-ups or leaning Democratic, and 47 Republican seats as toss-ups or leaning Republican. Up until a few weeks ago, most experts expected an eight to 12 seat pickup for the Democrats, but since then most have doubled those numbers.

http://en.wikipedia.org/wiki/United_States_House_of_Representatives_elections,_2008

Early signs of how the election is playing out:

6 PM EST: Indiana is normally a quick win for the Republicans, but it's a dead heat this time. If Senator Obama wins here, it will probably be a very good night for him.

http://www.realclearpolitics.com/epolls/2008/president/in/indiana_mccain_vs_obama-604.html Watch Kentucky to see if Senate Minority Leader Mitch McConnell (R-KY) wins reelection over businessman Bruce Lunsford. Recent polls show McConnell ahead by six points. If McConnell falters, the Democrats would probably control at least 60 seats. http://www.realclearpolitics.com/epolls/2008/senate/ky/kentucky_senate-917.html

7 PM EST: All eyes will be on Virginia, one of the fastest reporting states, which hasn't voted for a Democratic presidential candidate since Lyndon Johnson in 1964. If Senator Obama wins here, it could be a long night for Senator McCain. Georgia is another normally Republican state that could swing Democratic. Florida will probably be too close to call, but a win by Senator Obama here would make a McCain victory unlikely.

7:30 PM EST: Ohio will probably be too close to call until later in the evening, but if Senator Obama wins here, it will probably be all over for Senator McCain.
West Virginia is another tossup state to watch.

8 PM EST: Most of the East Coast and Midwest close. Pennsylvania, Missouri, and New Hampshire are the swing states to watch.

9 PM EST: The earliest any network is likely to call the election. If Senator Obama crests 200 Electoral College votes by now, the West Coast states (CA-55, OR-7, WA-11) would almost certainly put him over the 270 he needs to win.

Poll closing times: Indiana and Kentucky close first at 6 PM EST, and Hawaii closes last at 1 AM EST. Most of the east coast and the Midwest closes at 8 P EST. New York closes at 9 PM EST, and California closes at 11 PM EST.

http://www.thegreenpapers.com/G08/closing.phtml?format=ac

http://www.cnn.com/ELECTION/2008/poll.closing/

Exit polling will become available at 5 PM EST, but use it with caution. National media have pooled their exit polling to be conducted by Edison Media Research and Mitofsky International in all 50 states. No House races will be covered -- only those for President, Senate, and gubernatorial races will be. These are experienced pollsters, but the 2000, 2002, and 2004 elections proved that exit polling can be misleading. As a result, the networks have become much more cautious about calling elections. Initial results will be limited to demographic turnout information. No winners will be announced until after the polls close.

http://www.cnn.com/ELECTION/2008/poll.closing/

http://abcnews.go.com/Politics/Vote2008/story?id=5973947

http://www.exit-poll.net/

A good State by State rundown of the election by NBC Political Director and former Hotline Editor Chuck Todd is at:

http://www.msnbc.msn.com/id/27478547/

Media coverage starts at:
5 PM EST MSNBC
6 PM EST CNN, Fox News Channel

6 PM EST ABC, CBS, CNBC, C-SPAN, Fox, NBC

9 PM EST PBS

10 PM EST Comedy Central

Most of the major networks will end their coverage at 2 AM EST.

Online coverage worth checking out:

http://www.businessweek.com/technology/content/oct2008/tc20081028_106181.htm

Ballot Initiatives on gay marriage, abortion, affirmative action, and other topics will be decided in 36 states. Voters in 36 states will consider 153 ballot initiatives tomorrow. That fewer than the 162 propositions in 2004 and 204 in 2006. California's Prop 8 on gay marriage is the most widely watched, along with South Dakota's Initiated Measure Number 11 on abortion, and Colorado's Amendment 46 and Nebraska's Measure 24 to effectively outlaw affirmative action programs.

http://www.iandrinstitute.org/BW%202008-1%20Preview%20(v4%2010-24).pdf

http://www.ncsl.org/programs/legismgt/elect/dbintro.htm

Other web sites:

http://www.c-span.org/Politics/

http://elections.foxnews.com/index.html

http://elections.nytimes.com/2008/index.html
http://www.washingtonpost.com/wp-dyn/content/politics/elections/index.html
http://www.washingtontimes.com/elections/

Will There Be A Realignment?

Pete Davis — Tue, 04 Nov 2008 14:55:41 +0000

Stan has it right -- after much inspirational talk about change, delivering change in this town won't come easily. I worked in Congress' inner sanctum in 1981 when President Reagan brought big change on the heels of Jimmy Carter. Reagan cut taxes, but he didn't balance the budget as promised. He swayed the Supreme Court, but he lost the Senate in the 1986 election. His Vice President, George W. Bush, succeeded him, but reversed many of his policies.

Even with a landslide win, Barack Obama will face daunting challenges from the economy, the war, health care, energy, immigration, and etc. He seems intent on facing those challenges squarely, which will cost political capital. He will find that his worst enemies on Capitol Hill are not Republicans, but conservative Democrats who refuse to take his lead. Bill Clinton barely got out of the starting gate before losing control of the House in the 1994 election. Mr. Obama is studying that very carefully in hope of keeping Democratic majorities longer than two years. Keeping them six or eight years will be a feat.

If our economic downturn rivals that of the Depression, and, if Barack Obama becomes the Franklin Roosevelt of our time, a realignment is possible, but it will be at least six or eight years before we can say it has occurred with any certainty.

Alternative Energy Investments and Conservation At Risk From Declining Prices

Pete Davis — Wed, 29 Oct 2008 23:07:20 +0000

If you check back in the last paragraph of my June 3 post, I warned that alternative energy investments and conservation would be at risk if we allowed oil prices to decline too far. I suggested a tax to keep oil prices at the equivalent of $80 a barrel. That seemed like fantasy back then, when crude oil prices were hovering around $125 per barrel. Now that they have dropped to $62 per barrel yesterday, fantasy has become reality.

Robert Samuelson of the Washington Post made the same point in an op-ed today that we should add one cent per gallon to the 18.4 cent federal motor fuel excise tax per month for the next 48 months to preserve energy saving behavior and investment. He rightfully suggested offsetting that tax increase with other tax cuts to keep from damaging the economy. Unfortunately, I doubt Congress or the president will take on the unpopular task of movng us toward energy independence by keeping oil prices high despite all the campaign rhetoric to the contrary.

Just to hammer home the point, a friend recently told me of a neighbor with three kids in college who bought each an SUV last week to take advantage of fire sale prices on the SUV's and of lower oil prices. This behavior will just set us up for the next energy price spike in a few years time.

The Economy In Palm Springs

Pete Davis — Tue, 28 Oct 2008 23:12:45 +0000

I just got back from winning third place in the U.S. Tennis Association's national doubles tournament for 3.5 Senior (over age 50) men in Palm Springs, CA. It was a great getaway from the woes of Wall Street, but not from those of Main Street.

The first headline that greeted me in The Desert Sun was about home foreclosures. I didn't expect foreclosures in Palm Springs, but they had 190 foreclosures in the third quarter of this year. A friend threw us a celebration party Sunday in a tony gated community in Indian Wells -- next door to a boarded up foreclosed home.

We ate at a fancy restaurant in downtown Palm Springs Saturday night. They gave all 21 of us our own room. I saw five other customers there the whole night.

The next day's headline was about increased fees for water. As we drove to the Indian Well Tennis Garden, we passed over a huge dry riverbed. If we make it back next year, there won't be any more grass here.

I didn't stay long enough to here about unemployment or an upsurge in crime or the other characteristics of a severe recession.

I kidded one of my teammates, a stockbroker, that if he was back at work he'd have to answer the phone to sell more stocks and buy more T-bills on which he makes almost no commission, and he didn't laugh.

At least we could still afford to travel to this tournament. Two of my teammates run teams of younger players who made next weekends USTA 3.5 adult mens national tournament at Indian Wells, and both were having trouble getting 20 and 30 year-olds to make the trip because it was too expensive to travel across the country from D.C.

I was grateful to get a respite from Washington economic policy, but I was saddened by what I found in the economy of Palm Springs.

Second Stimulus Bill Before Thanksgiving and a Third Next Spring

Pete Davis — Tue, 21 Oct 2008 01:03:46 +0000

I expect Congress to send President Bush a $150 b. second stimulus bill before Thanksgiving and to send the next president a third stimulus bill next spring. Why? Because the economy is suddenly in a sharp downturn as the financial crisis has spilled over into the real economy. Last month's 6.2% unemployment rate will jump on November 2 and could easily reach 8% early next year. We will end this year having lost just over 1 million jobs from the 146.2 million we started this year with. See page 11 of the President's Council of Economic Advisers Economic Indicators. House Speaker Nancy Pelosi (D-CA) has been calling for more stimulus of at least $100 b. for months, and last week House Minority Leader John Boehner (R-OH) joined the chorus. Fed Chair Ben Bernanke sealed the deal with his endorsement of more fiscal stimulus in testimony this morning before the House Budget Committee.

When my Wall Street clients ask what will be in the second economic stimulus bill, I respond, "Whatever didn't make the first stimulus bill." H.R.5140, the first stimulus bill enacted on February 13, provided rebate checks and small business tax breaks of about 1.1% of GDP during the spring and summer of this year. By congressional standards, it was a very limited bill because it was a compromise between Democrats and Republicans who had very different goals. Now that the Democrats appear poised for a big election victory, if that happens, then Congress will pass the Democratic wish list during a lame duck session that will start on November 17 and dare the Republicans to block it.

November's second stimulus bill will include:

Extended unemployment benefits;
Increased Food Stamps;
Low Income Home Energy Assistance Program (LIHEAP) increases;
At least $25 b. and maybe $50 b. more federal Medicaid cost sharing with the states; and
infrastructure spending on roads and bridges.

Republicans want:

an "all of the above" program to develop domestic sources of energy;
another tax holiday for large corporations to repatriate overseas income;
a 25% top corporate tax rate, down from 35%;
lower capital gains tax rates on small businesses and on newly purchased homes;
expanded FDIC insurance on the entire amount of business transaction deposits;
a guarantee of interbank lending; and
the suspension of minimum withdrawal rules on retirement accounts, so retirees would not be forced to sell financial assets at fire sale prices.

Next year, after six months of worsening employment, Congress will act again, cobbling together another $150 b. of spending and tax cuts aimed at creating jobs with only modest effect.

The first stimulus bill this year was a truly bipartisan effort. I'm not so sure the second one will be, and the third is not likely to be at all.

How stimulative will these efforts be? Probably not as stimulative as the first bill but better than doing nothing. Maybe the first bill added half a percentage point to real GDP during the second and third quarters of this year.

Make no mistake about it, these stimulus bills are bandaids. They help boost the economy a little, but they won't remedy the underlying illness of collapsing home prices and lack of lending. Until confidence is restored so that homebuyers return to the market and banks start lending again, we're in for rough times.

Fiscal Year 2009 Deficit Could Reach $900 b., 6.2% of GDP

Pete Davis — Mon, 13 Oct 2008 22:29:05 +0000

FY09 deficit could reach $900 b. (6.2% of GDP) depending upon how the financial rescue is scored. Over the weekend, I took a very rough cut at where the deficit and public debt may be headed, assuming that Treasury completes $1.2 b. of financial rescue under the Emergency Economic Stabilization Act of 2008 by the end of 2009. These estimates depend crucially upon my assumption that approximately 31% of Treasuries gross debt issuance will ultimately fall upon taxpayers. That derives from the Resolution Trust Corporation's experience during the 1990s. According to the Government Accountability Office, the RTC purchased $402 b. of S&L assets and sold them for $240 b. a few years later. The taxpayers paid $124.6 b. of the difference. Until we have actual data from Treasury on reverse auctions and on capital injections, that's what I'm assuming. CBO and OMB disagree on how to score the net present value of the EESA program. Any final figures will depend upon those scoring decisions. CBO's scorekeeping letter on EESA, H.R.1424, is worth reading. I start off with CBO's latest estimates of September 9 for comparison, BUT they do note include any cost or already completed Treasury financing under EESA.
http://www.cbo.gov/ftpdocs/98xx/doc9852/hr1424Dodd.pdf
http://www.gao.gov/archive/1996/ai96123.pdf

CBO's September 9, 2008 Update $-billion, fiscal years

	2007	2008	2009	2010
Deficit (-) Surplus	-161	-407	-438	-431
%GDP	-1.2	-2.9	-3.0	-2.8
Public Debt	5,035	5,425	5,870	6,319
%GDP	36.9	38.2	39.9	40.8
GDP	13,642	14,210	14,719	15,473

My Very Rough Illustrative Estimate

	2007	2008	2009	2010
Deficit (-) Surplus	-161	-438	-900	-800
%GDP	-1.2	-3.1	-6.2	-5.3
Public Debt	5,035	5,809	6,800	7,700
%GDP	36.9	40.9	47.1	50.8
GDP	13,642	14,210	14,425	15,164

I assumed that Treasury would spend all $700 b. of the EESA and $200 b. of the Fannie Mae and Freddie Mac bailout plus another $300 b. for other bailouts by the end of calendar 2009 and that $400 b. of that would score as an outlay. I reduced GDP by 2% points in FY09 and level adjusted in FY10. I must emphasize this is only an informed guess at this point until we have more information.

$438 b. FY08 deficit expected to be announced by OMB at 2 PM tomorrow. At 2 PM Tuesday, the Office of Management and Budget will announce the official federal deficit for Fiscal Year 2008. Last week, the Congressional Budget Office estimated the FY08 deficit would be $438 b. http://www.cbo.gov/ftpdocs/98xx/doc9818/10-2008-MBR.pdf

Market Gyrations Are Caused By Uncertainty

Pete Davis — Mon, 13 Oct 2008 21:50:04 +0000

The Dow finished up 936 points (11.08%) today. Last Thursday, it finished down 679 points (7.33%). Two weeks ago, on Monday, September 29, it finished down 778 points (6.98%), and the next day, it rose 485 points (4.68%). These are nothing like the gyrations of 1929 through 1933, but they are enough to make your head spin. Check Wikipedia for the complete list of Dow gyrations.

Why does this happen? In one word -- uncertainty. Markets hate uncertainty. When the House failed to pass the Emergency Economic Stabilization Act of 2008 on Monday, September 29, the markets felt they had nowhere to turn for relief and plunged. The next day, after statements by President Bush and congressional leaders, the markets bounced back in anticipation of House passage later in the week.

Last Thursday, as the world's finance ministers and central bankers assembled for the annual World Bank/IMF meetings in Washington, D.C., the markets feared lack of consensus among world leaders on further steps to restore credit markets and plunged. Today, they felt reassured that coordinated worldwide intervention in credit markets would be forthcoming.

One of the reasons political leaders often have problems with the markets is because when they deliver what the markets ask for, the markets often are not satisfied and demand more.

Confidence and trust are the basis for every economic transaction. When confidence is shaken, restoring it is not easy. Often it takes many missteps. Treasury Secretary Paulson thought he and Fed Chair Bernanke had done enough on several occasions this year, only to find that more needed to be done. It's like when you slip on the sidewalk and attempt to keep your feet under you; it often takes several quick steps to stay upright.

The good news is that forceful and coordinated actions are being taken around the world. They will take time to have their full effect, and a sharp recession seems likely for the next six months. Despite fearmongering by the media about a Depression, we will emerge from that recession next year with nowhere near the market gyrations that were experienced from 1929 through 1933.

Financial Rescue Went Global Today, But A Recession Is Upon Us

Pete Davis — Thu, 09 Oct 2008 00:31:39 +0000

Every morning this week the Fed has announced another action to bolster financial markets. At 7 a.m. this morning, the Fed and six other central banks announced a coordinated 50 basis point (half a percentage point) interest rate cut. That's the first global economic policy change ever.

Although stock markets reacted positively this morning, they ended up down this afternoon. Why? Because markets are forward looking, and because they see recession spreading around the world. Europe looks like it will be hard hit, and Japan may not fair much better. Emerging markets will lose at least two or three percentage points of economic growth, but they will still be growing at rates of 6% or 7%. The U.S. seems poised for 2% negative real GDP growth in the fourth quarter of this year, and the first quarter may not be much better. The International Monetary Fund released its World Economic Outlook this morning with a catalog of the bad news. The IMF's John Lipsky summarized the world economy in a speech before the National Association for Business Economics yesterday.

The world's G-7 finance ministers and central bankers will meet Friday in Washington to consider what else they might do to get the world's credit markets functioning again. UK Prime Minister Gordon Brown instituted guarantees of interbank lending and encouraged other countries to follow his lead.

Treasury Secretary Hank Paulson held a press conference this afternoon to say "it'll be several weeks" before Treasury starts purchased "troubled assets" because "...we've got to get it right." He pleaded for patience. Watch it on C-SPAN. Click on the first link below Treasury Secretary Paulson.

This morning, the Committee for Responsible Federal Budget held an excellent panel discussion on the financial rescue and what it will mean for the budget. Watch it on C-SPAN. Click on the second link below Treasury Secretary Paulson. Uncle Sam is about to take on another trillion to a trillion and a half dollars of debt to pull the economy out of the worst financial meltdown since the Depression. A large portion of that will be paid off when assets are sold down the road. There's no way to tell how much the taxpayers will ultimately pay, but I would make a rough estimate based upon the S&L crisis of between $217 b. and $310 b. until proven otherwise.

The good news is that no one knows more about the policy failures that led to the Depression than Ben Bernanke and no one knows more about Wall Street than Hank Paulson. They have reacted very aggressively and in unprecedented fashion to alleviate the financial crisis. This should minimize the recession and job loss. The bad news is that we will have a recession, and the unemployment rate is likely to peak next spring at between 7.5% and 8%.

Will We Get Economic Stabilization?

Pete Davis — Sat, 04 Oct 2008 22:57:46 +0000

Friday's dramatic 263-171 House vote to pass the "Emergency Economic Stabilization Act of 2008" and President Bush's signature a few hours later raises a question: Will it work?

I think it will, but a lot depends upon how well Treasury's reverse auctions go over the next year or so, how quickly our housing market revives, and how quickly confidence is restored in our financial institutions.

For those reverse auctions to succeed, Treasury will have to set high enough prices for "troubled assets" so the financial institutions that hold them will be willing to sell them, but not so high that the taxpayers lose money in two or three years when Treasury starts selling those assets. This won't be an easy task.

For the housing market to revive, banks are going to have to start creating mortgages and investors around the world will have to be willing to buy mortgage backed securities (MBS) again. Even quite credit worthy homebuyers have not been able to get mortgages recently.

For confidence to be restored in financial institutions, their depositors and customers and other financial institutions have to regain faith that they are solvent and are no longer burdened by hidden "troubled assets."

This is quite circular, and that's why the government has to step in. No other institution can make it happen.

It has nothing to do with fairness or economic justice. The taxpayers may suffer even with government intervention. The only certainty is that the taxpayers would suffer a lot more without it.

Last Monday, the House voted down the initial version of H.R.1424 by 205-228 because it was deluged with irate phone calls and emails from people back home objecting to 'bailing out Wall Street." That afternoon, the Dow dropped 778 points, and suddenly the calls starting coming in favor of the bill as retirees saw their investments get hit and as businesses and small banks and even the State of California faced complete shutdowns from lack of credit. That's what really turned the vote around on Friday, the fear of another market collapse.

H.R.1424 was sweetened with $250,000 of FDIC deposit insurance, authority for the SEC to suspend "fair value mark to market accounting,' and with $110 b. of 'tax extenders' and Alternative Minimum Tax relief. The deposit insurance increase will help restore confidence now, but it could create riskier banks down the road. Similarly, confidence may be restored if banks don't have to mark down assets that haven't traded in months, but auditors warn that we should tighten accounting standards, not relax them. The tax relief is almost entirely extending existing tax provisions that were due to expire, so it's not a new tax cut, just the extension of old ones.

The Congressional Budget Office was unable to 'score' H.R.1424's budgetary effects because there are just too many unknowns. It's analysis is well worth reading. It concludes that it is entirely possible the taxpayers may have a net loss, but it will probably be substantially less than $700 b. because it will realize some value from its sale of "troubled assets."

Like a lot of member of Congress last week, I would rather face future economic uncertainties having done everything possible to revive the economy than to refuse to accept the costs imposed by unseen financial malfactors and risk far worse economic carnage.

EESA With $250,000 Of Deposit Insurance Will Sail Through The House Thursday

Pete Davis — Tue, 30 Sep 2008 21:07:56 +0000

A few minutes ago Federal Deposit Insurance Commission Chair Sheila Bair told reporters that she would request a temporary increase in deposit insurance to $250,000. A top Senate Republican staffer just confirmed that Treasury will send up legislative language soon. Earlier today John McCain and Barack Obama endorsed the idea. In my opinion, this ensures that the House will reconsider and pass H.R.3997, the "Emergency Economic Stabilization Act of 2008," Thursday afternoon with this modification.

Members of Congress who voted against the bill have reacted to yesterday's market downturn with pledges to reconsider their votes. They will vote for exactly the bill the voted against yesterday with the addition of the deposit insurance amendment.

Market and governmental gyrations such as this are rare in the U.S. That's what happens when you try to legislate on such important matters too close to an election.

Any good economist will inquire as to who wins from this proposal and who loses. The winners, as one of my Wall Street clients just put it, are "the dumb rich" and businesses who can't keep their working capital accounts below $100,000. The "smart rich" long ago moved their money to safer places. Most Americans don't have more than $100,000 in their bank accounts, and if they do, it's in a retirement account which is insured up to $250,000 already.

The losers down the road will be the taxpayers and conservative banks. The FDIC pays deposit insurance out of a fund paid for with a fee levied on all banks. The more banks that go under at a loss to depositors, the more the fee will go up on the remaining, less risky, banks to pay depositors claims and to replenish the deposit insurance fund. Taxpayers will suffer the economic damage done by banks that take on extra risk and fail in response to the increased level of deposit insurance. For years under Republican presidents and under Democratic presidents, the FDIC has expressed reservations when Congress proposed, as it does almost every year, to increase deposit insurance. The more deposit insurance, the riskier the bank. All those concerns about what we economists call "moral hazard," which got us into this financial mess in the first place, have been swept aside in a rush to "do something for Main Street." So we will increase moral hazard to combat the hangover from excessive and overly risky credit creation -- there's an oxymoron if there ever was one. That's like trying to cure a hangover with more alcohol.

The key to understanding this conundrum is to realize that your elected representatives in Congress are trying to solve a political problem, how to get reelected on November 4. They need political cover. Their president can't provide it, and neither can their leaders, but maybe this deposit insurance increase aimed at "Main Street" can. Those members of the House who voted down the very same bill yesterday that they will vote for the day after tomorrow with only the addition of $250,000 of deposit insurance will have a lot of explaining to do.

The only saving grace in this that I can see other than doing whatever it takes to get credit markets functioning again is that the short run cost in deposit insurance outlays may not be as big as I fear after the "Emergency Economic Stabilization Act of 2008" becomes law in the next few days.

Stabilization Bill Was Just Released. Enactment Late Next Week Is Almost Certain.

Pete Davis — Sun, 28 Sep 2008 22:13:46 +0000

The legislative language of the "Emergency Economic Stabilization Act of 2008" was just released. There were so many hits on the House web site that I can't get it to come up. Fortunately, C-SPAN posted it here.