Greg Mankiw's Blog

The only way to prevent a deepening recession will be a temporary program of increased government spending.

we propose legislation that moves the reworking function from the paralyzed master servicers and transfers it to community-based, government-appointed trustees. These trustees would be given no information about which securities are derived from which mortgages, or how those securities would be affected by the reworking and foreclosure decisions they make. Instead of worrying about which securities might be harmed, the blind trustees would consider, loan by loan, whether a reworking would bring in more money than a foreclosure.

The government expense would be limited to paying for the trustees — no small amount of money, but much cheaper than first paying off the security holders by buying out the loans, which would then have to be reworked anyway. Our plan would also be far more efficient than having judges attempt this role. The trustees would be hired from the ranks of community bankers, and thus have the expertise the judiciary lacks.

A reception, policy discussion and lunch was offered in Newark, N.J., with David Cutler, Obama for America’s senior health-care adviser, for $500 for a guest or $2,300 for a V.I.P.

The way to do so is through the shared appreciation mortgage, or SAM. The concept is simple: Homeowners are offered the chance to write down a portion of their mortgage debt, but at the same time, they are required to share future appreciation gains with those who helped them out....

For example, a homeowner unable to support payments on a house purchased for $200,000 that today is worth only $150,000 might be offered a write-down of up to $50,000. But this would not be a free lunch.

With the SAM, once the value began appreciating above $150,000, the mortgage holders would be due their share. The details of the write down and the appreciation sharing could be tailored to different circumstances. But one way to give lenders a share of the upside would be to pay back some of the write down if the house is later sold.

The offer would come from the lender (not borrower) in cases in which there is a stop in payment on the mortgage. Offering this on top of a standard write-down is an option that is currently not in their arsenal, a fact that many of them are not aware of (essentially ruled out by the tax code). One offers incentives for the writedown e.g. by exempting the shared appreciation strip from capital gains taxes. This is then part of the workout routine that would be far more attractive than a pure write-down, and often superior to enforcing default.

Suppose someone stops payment on their mortgage without needing to just because this offer is potentially open. They can be offered some powerful discouragement: (a) Increasing share of appreciation with increasing write down; (b) Give lenders ability to check income. There would then be a high % dedicated to the loan (you won't want this if you are doing fine or expect to recover income); potentially, have payments on the mortgage rise with income if one needs to work this angle harder.

The complete incentive system could be designed in a dynamic manner, adjusting as evidence of excessive use came to light.

McCain is one of the few American politicians in either party with the courage and conviction to stand up to protectionist populism. By contrast, Obama embodies protectionism....

McCain has voted 88% of the time against bills creating trade barriers, and 90% of the time against export subsidies for US producers. Few other senators have such a splendid record.

Obama has served a much shorter time in the Senate, and avoided voting on many key issues. He has voted against trade barriers only 36% of the time. He supported export subsidies on the two occasions on which he voted, a 100% protectionist record in this regard.

In 2007, he voted to reduce visas issued to foreign workers (such as Indian software engineers), and to ban Mexican trucks on US roads. He sometimes voted for free trade - he supported the Oman Free Trade Act and a bill on miscellaneous tariff reductions and trade preference extensions. More often he voted for protectionist measures including 100% scanning of imported containers (which would make imports slower and costlier), and emergency farm spending.

In 2005 he voted to impose sanctions on China for currency manipulation, and against the Central American Free Trade Agreement (CAFTA). He voted for the Byrd amendment, a disgraceful bill (later struck down by the WTO) that gifted anti-dumping duties to US producers who complained, thus making complaining more profitable than competitive production.

Obama says the North American Free Trade agreement is a bad one, and must be renegotiated. He has opposed the US-Colombia Free Trade Agreement on the bogus ground that Colombia is not protecting its trade union leaders from the drug mafia. In fact, such assassinations have fallen steadily from 205 in 2001 to just 25 last year. Obama is cynically twisting facts to woo the most protectionist US trade unions. This cannot but worry India, which may also be subjected to bogus slander and trade disadvantages.

By contrast, McCain has consistently voted for open trade. He has opposed federal curbs as well as private curbs on outsourcing to countries like India. He opposed the disgraceful Byrd amendment on anti-dumping duties. He voted against farm subsidies and labour standards for imports (which are not necessarily bad but could become a disguised form of protectionism).

Unlike Obama, McCain voted against imposing trade sanctions on China for supposedly undervaluing its currency to keep exports booming and accumulate large forex reserves. India has followed a similar policy, though with less export success than China. But if indeed India achieves big success in the future, it could be similarly targeted by US legislators and, will need people like McCain to resist.

Obama favours extensive subsidies for US farmers, hitting Third World exporters like India. This has been one of the issues on which the Doha Round of WTO is gridlocked. McCain could open the gridlock, Obama will strengthen it.

Obama also favours subsidies for converting maize to ethanol. The massive diversion of maize from food to ethanol has sent global food and fertiliser prices skyrocketing, hitting countries like India. But McCain has always opposed subsidies for both US agriculture and ethanol. While campaigning, he had the courage to oppose such subsidies even in Iowa, an agricultural state he badly needs to win if he is to become president.

Dear Professor Mankiw,

I wanted to alert you to our paperback edition of Ben Bernanke's ESSAYS ON THE GREAT DEPRESSION.

As the subprime mortgage and credit disasters continue to wreak havoc on world economies and pocketbooks, many are looking to Federal Reserve Chair Ben Bernanke for guidance and leadership in this tumultuous time. Fortunately, our Fed chief is one of the pre-eminent scholars of the Great Depression. Because of the market turmoil, Bernanke's treatment of the Great Depression has been finding a new audience of readers as media, policymakers, businessmen, professionals, and others--both in the US and abroad--seek to understand our present economic situation.

Best wishes,

Andrew

The crisis has also reminded us of the lessons of the technology bubble, Japan’s experience in the 1990s and of the US Great Depression – that finance-led growth is problematic. The wealth and income gains from the easy availability of credit were highly concentrated in the hands of a fortunate few. The benefits also proved temporary. In retrospect, the fact that 40 per cent of American corporate profits in 2006 went to the financial sector, and the closely related outcome – a doubling of the share of income going to the top 1 per cent of the population – should have been signs something was amiss.

Americans are evenly divided on the idea: 45 percent think it is a good idea and 46 percent a bad idea to use some of the money government collects in taxes to "spread the wealth" to others who are less well off. Most Democrats think spreading the wealth is a good idea (66 percent) and most Republicans think it is a bad idea (72 percent).

Clinton now Says: The 'Big Things' Never Included his Tax-cut Vow

Seeking to explain why he is backtracking on a campaign promise to cut taxes for the middle class, President-elect Bill Clinton said Thursday that the plan was never a major theme in his race for the White House.

Mr. Clinton, speaking at a news conference a day after saying he would have to "revisit" his tax-cut plan, said Americans voted for him because of the "big things" he wanted to do.

The middle-class tax cut, he said, was not among them.

He said he was "absolutely mystified" that the news media had perceived it as a major pledge. In interviews Wednesday, Mr. Clinton said that, because of worsening deficit projections, "I have to put everything back on the table."

Mr. Clinton spoke throughout the campaign of the need to redress declining middle-class incomes during the 1980s. He proposed a tax cut for the middle class nearly a year ago, in New Hampshire, and repeated the pledge frequently.

But in the weeks since his election, two things have changed. The government's estimate of growth of the federal budget deficit over the next five years has grown about $60 billion. Also, the new team of Clinton economic advisers has apparently made new calculations and concluded that the tax cut idea is not tenable if Mr. Clinton wants to reduce the deficit and also move ahead with an "investment" program to revive the economy.

when first applied to financial matters in 1976, “subprime” meant a loan offered below the prime rate and typically was offered only to the most desirable borrowers.

In was not until 1993 that it took on a much less enticing guise, with Business Wire referring to a company that “buys subprime loans made ... to creditworthy buyers unable to qualify for loans from banks.” And an O.E.D. editor was moved to write a new definition: “Of or designating a loan, typically having relatively unfavorable terms, made to a borrower who does not qualify for other loans because of a poor credit history.”

Health insurance is not something that is made better by tying it to employment. As a result, essentially all economists believe that universal coverage should be done outside of employment.

Obama is confident that we can come together to find a workable solution. He believes that one strong option to improve Social Security's long-term solvency is asking people who earn more than $250,000 to pay a little more into the system. But Obama will not raise the retirement age or reduce Social Security benefits.

There's a big mathematical hole in Sen. Obama's plans for Social Security. While Obama is vague about the exact tax rate he would apply to people earning over $250,000 and whether they would receive extra benefits in exchange for the new taxes, a best-case scenario is that Obama's plan would fix around 15% of the long-term deficit, adding 3-5 years to the life of the trust fund. He's ruled out cutting benefits or increasing the retirement age, which could otherwise fill the rest of the gap, so it's not clear where the other 85% of the fix comes from. Sen. Obama has put himself in a bit of a box, which is perhaps the best rationale for a post-election commission -- it lets both sides forget about their previous campaign promises.

More than three quarters of those worth $1 million to $10 million plan to vote for Sen. McCain. Only 15% plan to vote for Sen. Obama (the rest are undecided). Of those worth more than $30 million, two-thirds support Sen. Obama, while one third support Sen. McCain.

the theme of this campaign: if it sounds good, say it regardless if it's misleading (or not true).

Sen. Obama's plan would require large employers to either offer insurance or contribute a percentage of the company's payroll toward the cost of taxpayer subsidies....Sen. Obama also plans tax credits to encourage small businesses to offer insurance....Sen. Obama hasn't said where he would mark the line between the large employers who would be punished for not offering insurance and the small ones who would be rewarded if they do.

"Your new tax plan is going to tax me more, isn't it?" the plumber asked [Senator Obama], complaining that he was being taxed "more and more for fulfilling the American dream."

"It's not that I want to punish your success. I just want to make sure that everybody who is behind you, that they've got a chance for success too," Obama responded. "My attitude is that if the economy's good for folks from the bottom up, it's gonna be good for everybody ... I think when you spread the wealth around, it's good for everybody."

The term "distributive justice" is not a neutral one. Hearing the term "distribution," most people presume that some thing or mechanism uses some principle or criterion to give out a supply of things. Into this process of distributing shares some error may have crept. So it is an open question, at least, whether redistribution should take place; whether we should do again what has already been done once, though poorly.

However, we are not in the position of children who have been given portions of pie by someone who now makes last minute adjustments to rectify careless cutting. There is no central distribution, no person or group entitled to control all the resources, jointly deciding how they are to be doled out. What each person gets, he gets from others who give to him in exchange for something, or as a gift. In a free society, diverse persons control different resources, and new holdings arise out of the voluntary exchanges and actions of persons. There is no more a distributing or distribution of shares than there is a distributing of mates in a society in which persons choose whom they shall marry. The total result is the product of many individual decisions which the different individuals involved are entitled to make.

Suppose what New York Times finds is econometrically correct. They might have just found another risk factor for abnormal returns. Democrats sitting in the White House do bring about more risks in stock holdings. Therefore, investors demand higher return to compensate for extra risks they are bearing.

Robert Shiller, professor of finance at Yale University and chief economist for MacroMarkets LLC, tracks what he calls the "Graham P/E," a measure of market valuation he adapted from an observation Graham made many years ago. The Graham P/E divides the price of major U.S. stocks by their net earnings averaged over the past 10 years, adjusted for inflation. After this week's bloodbath, the Standard & Poor's 500-stock index is priced at 15 times earnings by the Graham-Shiller measure. That is a 25% decline since Sept. 30 alone.

The Graham P/E has not been this low since January 1989; the long-term average in Prof. Shiller's database, which goes back to 1881, is 16.3 times earnings.

But when the stock market moves away from historical norms, it tends to overshoot. The modern low on the Graham P/E was 6.6 in July and August of 1982, and it has sunk below 10 for several long stretches since World War II -- most recently, from 1977 through 1984. It would take a bottom of about 600 on the S&P 500 to take the current Graham P/E down to 10. That's roughly a 30% drop from last week's levels; an equivalent drop would take the Dow below 6000.

Congress should pass a law that makes a re-contracting option available to all homeowners living in a zip code where house prices dropped by more than 20% since the time they bought their property....

How do we implement this? Thanks to two brilliant economists, Chip Case and Robert Shiller, we have reliable measures of house price changes at the zip code level. Thus, by using this real estate index, the re-contracting option will reduce the face value of the mortgage (and the corresponding interest payments) by the same percentage by which house prices have declined since the homeowner bought (or refinanced) his property....

In exchange, however, the mortgage holder will receive some of the equity value of the house at the time it is sold. Until then, the homeowners will behave as if they own 100% of it. It is only at the time of sale that 50% of the difference between the selling price and the new value of the mortgage will be paid back to the mortgage holder....

The reason for this sharing of the benefits is twofold. On the one hand, it makes the renegotiation less appealing to the homeowners, making it unattractive to those not in need of it. For example, homeowners with a very large equity in their house (who do not need any restructuring because they are not at risk of default) will find it very costly to use this option because they will have to give up 50% of the value of their equity. Second, it reduces the cost of renegotiation for the lending institutions, which minimizes the problems in the financial system.

Robert Barro has emerged in the Harvard Nobel Pool with 16.2% of all bets. However, the triumvirate of Hansen, Sargent and Sims, who many believe would be chosen together, has garnered nearly 23% of the vote and is the most likely prize, especially when one controls for home bias. Top vote getters as of now are below, although entries can be submitted until Sunday.

Barro 16.2%

Hansen 12.2%

Sargent 6.8%

Fama 6.8%

Hart 5.4%

Diamond 4.1%

Feldstein 4.1%

Sims 4.1%

Thaler 4.1%

Iceland for sale on eBay

LONDON (Reuters) - Great scenery and wildlife but financial situation in need of repair -- collect in person. Iceland, which is going cap in hand to Russia for a 4 billion euro loan to bail out its failed banks, was offered for sale as a wholesale lot on eBay on Friday.

Bidding started at 99 pence but had reached 10 million pounds by mid-morning on Friday.

Globally renowned singer Bjork was "not included" in the sale, according to the notice.

What makes a recession officially turn into a depression?

A recession is when your neighbor loses his job. A depression is when you lose yours.

Blanchard and his IMF colleagues say there is no chance of a repeat of the global depression of the 1930s, because the lessons of that painful decade have been learned.

There are many historical precedents of bad policies following crises. The worst case was after the stock-market crash in October 1929, which produced a truly perfect storm of bad policies. Tax rates rose, tariffs rose (reflecting special interest groups attempting to insulate domestic producers from foreign competition), and both Presidents Herbert Hoover and Franklin Roosevelt strongly promoted industry-labor cartels that were designed to stifle domestic competition.

In the absence of these policies, the Great Depression would almost certainly have been like every other U.S. recession -- short-lived and relatively mild. Normal recovery didn't begin until the most onerous of these policies were reversed, a process that didn't begin until the end of the 1930s when antitrust activity was resumed, and during World War II when the National War Labor Board reduced union bargaining power by limiting negotiated wage increases to cost-of-living adjustments only....

I am particularly concerned about bad policies because significantly higher taxes have been proposed by Barack Obama. His plan would raise the marginal tax rate on the most productive workers more than 10 percentage points -- an increase that would bring us near Western European levels. His plan would also raise capital income taxes, taxing capital gains and dividends at 20%, compared to a 15% rate under Sen. John McCain's plan. A five percentage-point difference might strike you as small, but it is not. I have calculated that a five percentage-point difference in overall capital income taxation over the long haul is equal to a difference in the nation's capital stock of about 18%. This means a 6% difference in GDP and a 6% difference in the average wage rate. This means that real GDP and the average wage would fall, gradually but persistently declining about 6% after 25 years. That's not quite a Great Depression, but a significant step towards one.

What should be done? We should encourage the immigration of prime-age individuals. Beginning in 2007, net immigration fell to half of its level over the previous five years. Increasing immigration would increase the demand for housing and raise home prices. And note that the benefit would be immediate. Home prices -- and the value of subprime obligations -- would rise in anticipation of a higher population base. The U.S. particularly needs highly skilled workers. These workers not only would purchase homes, but would generate higher living standards for all Americans.

The financial crisis provoked three open letters to policy makers. Fundamentalists opposed the plan (here.) Realists supported the plan (here) or supported more discretionary powers for dealing with the crisis without endorsing any specific plan (here.)

A quick look through the lists of economists who signed the various letters shows that the camps do not separate cleanly along the familiar lines of left-versus-right or active-versus-limited government. The key difference lies in the relative weight each side gives to formal models as opposed to judgment.

Fundamentalists have an unswerving faith in models. Policies should always be derived from the best available model. Data should be filtered through a model. If an observation does not fit within the context of a model, it should be excluded from consideration.

Realists are more conscious of the limits of models and more comfortable with a division of labor between the researcher who improves the models and the clinician who makes policy decisions. They recognize that the power of models comes precisely from a commitment to abstraction that filters out potentially important complexity. They believe that useful evidence can accumulate with direct experience as well as through the research process of testing and refining models. They believe that researchers should consider the possibility that the fault lies with the model when its predictions diverge from clinical judgment and that policies should draw on both sources of evidence.

Many times, the confidence fundamentalists have had in abstract models turned out to be well founded and the objections raised by realists who were more focused on details were misplaced. The fundamentalists were right that an airline industry could still function even if airlines could set their own fares; that people could still talk to each other even if they purchased phone service from different companies. The realists pointed to all the complicated details that arise in such markets, details that simple models could not capture. Fundamentalists, correctly, ignored the detail and pushed prescriptions based on the textbook model of competition.

Other times, the models are missing something that is too important. In the study of macroeconomic fluctuations, real business cycle theorists and their descendants, the dynamic stochastic general equilibrium modelers, are the quintessential fundamentalists. Their models are a useful way to make research progress, but in macroeconomic policy making, the great depression, which these models cannot explain, is a decisive data point warning us that the models are incomplete and have to be supplemented by clinical judgment.

Last weekend at the Dupont Circle farmers' market here in DC, I saw a strain of heirloom tomato named "Mortgage Lifter".

There's a curious but robust feature of US presidential elections: when the economy isn't doing well, the incumbent party usually loses.It doesn't matter which party is in power, they usually lose. You can see that now in the online odds for McCain, which have dropped a lot as bad news comes out about the economy. You can talk all you want about other things, but the economy is likely the primary driver here.

The reason I say "curious" is that there's very little evidence that presidents (or the government more generally) have much impact on the current state of the economy. They can influence long-term performance, but in the short term, the US economy, and others, go through periodic ups and downs that we call business cycles. That was true 200 years ago and remains true today. There's some debate about where business cycles come from, but the president's actions are rarely on the list. Nevertheless, it's become good strategy to claim credit for good news and blame the other guys for bad news -- even though neither is likely.

Related link: the idea comes from a series of papers by Yale economist Ray Fair. A nice summary is his 1996 piece.

Here's one possible answer -- the credit crunch has precipitated a massive expansion of money demand -- a scramble for cash. Despite its best efforts, the Fed has not matched this with a sufficient expansion of money supply. As simple IS-LM would predict, this surge in money demand has raised real interest rates (indicating that monetary policy is perhaps still too tight).

Rising real rates on inflation-indexed bonds and falling rates on nominal bonds also tell us that markets expect this surge in money demand to result in near-zero inflation or even deflation in the years ahead. It's starting to look more and more like 1990s Japan, though hopefully for not as long.

What happens to TIPS if deflation occurs?

The principal is adjusted downward, and your interest payments are less than they would be if inflation occurred or if the Consumer Price Index remained the same. You have this safeguard: at maturity, if the adjusted principal is less than the security's original principal, you are paid the original principal.