Beat The Press: A Weekly Round-up of Dean Baker's Commentary on Economic Reporting
How High Are Stock Prices?
The NYT tells us that the price-to-earnings ratios in the stock market are just 16.8, only a bit higher than the long-term average of 15.7. This might make the stock market sound reasonably safe right now, but this misses an important piece of information.
Profits are currently at a cyclical high. Profits fluctuate hugely over the course of the business cycle. For example, the Congressional Budget Office (CBO) projects that profits will revert to their trend share of output over the next several years, so that in 2017, real corporate profits will be just 13 percent higher than in 2006. If this proves right, and stock prices rise in step with corporate profits over the next decade, it implies that real returns in the stock market will be just over 4 percent annually.
By comparison, a completely riskless inflation indexed treasury bond pays a return of 2.6 percent. This means that, if the CBO profit projections are in the ballpark, stockholders will receive a very low risk premium over the next decade.
Posted at 06:29 AM
August 12, 2007
When it comes to cracking down on opponents of the selective protectionism that passes for free trade in Washington policy circles, David Broder is one of the foremost enforcers. He is working overtime this Sunday, denouncing the irresponsibility of the Democratic presidential candidates for not supporting his trade agenda.
Just to remind everyone, these trade deals are slectively protectionist because they only break down some trade barriers, while leaving others in place, and actually strengthening some forms of protectionism. The main barriers that the "free-traders" want to eliminate are the barriers to importing manufactured goods into the United States. Eliminating these barriers has the effect of placing U.S. manufacturing workers into direct competition with low paid workers in the developing world. While this lowers the price of manufactured goods for consumers in the United States, it also reduces the wages of manufacturing workers and less-educated (non-college educated) workers more generally. As a practical matter, the "free-traders" have largely succeeded in removing the barriers to trade in manufactured goods (we can buy anything we want from China), so the remaining deals will have little impact in this regard.
The free-traders are absolutely fine with the protectionist barriers which keep up the wages of highly paid professionals. There are professional and licensing barriers that prevent foreign doctors, lawyers, and other professionals from working in the United States. These barriers cost U.S. consumers hundreds of billions of dollars every year. The "free-traders" don't object to barriers that sustain their own high wages or those of their friends. (They all claim to oppose such barriers, but no one has ever been denounced in the pages of the Washington Post for not supporting liberalized trade in physicians services.)
The protectionist part of these trade deals is increasing the stringency of patent and copyright protection. Almost all of the trade deals pushed by the U.S. increase patent protection for prescription drugs and copyright protection for music, movies, and software. These are incredibly costly forms of protectionism since items that would otherwise be cheap (drugs) or free (downloaded music and software) are made very expensive as the result of government granted monopolies. But, the free traders like pharmaceutical companies and software tycoons more than they like textile workers and autoworkers, so they denounce the opponents of protectionism for their products as "protectionist."
So, it's ad hominum Sunday as Mr. Broder calls out those who aren't with the program. Enjoy the entertainment.
Posted at 08:35 AM
August 11, 2007
Both the NYT and Washington Post are getting into the misinformation business this morning. Both papers claimed that the Fed buys mortgage-backed securities (MBS) as one of the ways in which it injects reserves into the financial system (along with Treasury bonds and bonds issued by government agencies).
This is NOT true. I was shocked to read a Bloomberg column (subsequently corrected) yesterday that reported that the Fed had purchased $19 billion of MBS. This would have been shocking because it would have been an extraordinary departure from the Fed's normal practice, which the Fed would not do unless it viewed the situation as truly desperate.
The reality behind the story was that the Fed has accepted $19 billion in MBS as collateral on loans that it had made to banks through its discount window. The Fed, like any bank, demands collateral when it makes loans, and mortgage-backed securities have long been an acceptable form of collateral on loans from the Fed. The only departure from standard practice was that the Fed encouraged banks to use MBS as collateral. This was clearly an effort, albeit modest, to shore up the market for these assets.
The dealings of financial markets can get quite complicated especially with so many exotic instruments now in circulation. But, the mechanics of the Fed's open market operations are not that difficult to understand. The NYT and Post should get them right.
Posted at 09:27 AM
Tell The Post: The Problem Isn't Subprime
The Post editors are people who are constantly surprised by expected events. I could imagine a Post article headlined "Sun Rises This Morning." Naturally they were caught by surprise by the current problems in the mortgage market. They were probably too busy worrying about the Social Security shortfall projected for 2046.
Today the Post editorialiized (reasonably in my view) against allowing Fannie Mae and Freddie Mac to play a larger role in the mortgage markets. However, the editorial is written from the standpoint that the problem is only in the subprime mortgage market.
Of course the problem is in the housing market more generally. We had an unprecdented run-up of 70 percent in real house prices over the last twelve years. Typcially house prices have been flat in real terms. This has led to an enormous oversupply of housing. The inventory of unsold new homes is more than 50 percent above its 1990 peak and the number of vacant ownership units is almost twice its previous peak. This is guaranteed to put more downward pressure on a housing market in which prices are already falling. The situation will only get worse with tightening credit weakening the demand side of the market.
As prices decline, more homeowners will find that they owe more than the value of their home, which will make default a very inviting option. The reason that most defaults have been in subprime thus far is primarily because these people have little or no reserves on which to draw when they run into problems paying their mortgages. But the underlying problem is falling house prices and this will affect homeowners across the board.
Maybe if the Post didn't rely so much on David Lereah (the author of Why the Real Estate Boom Will Not Bust and How You Can Profit From It) it wouldn't be so surprised by the problems in the housing market.
Posted at 09:27 AM
August 10, 2007
The coverage of the market meltdown includes many assurances from the experts that everything is just fine. I suppose it would be considered rude for reporters to ask why anyone should trust the assessments of people who apparently failed to see the current credit crunch coming.
It would certainly be less rude, and more informative to readers, if they pointed out that their assurances don't make much sense. For example, the NYT reported this morning that American International Group, one of the world's biggest financial firms, assured investors that "that despite its own exposure to subprime loans, the U.S. housing market would have to decline by 30 percent or 40 percent, to Depression-era levels, before it would suffer significant losses."
Well, since real house prices in the United States have risen by 70 percent since 1995, a decline of 30 percent would not even bring them back to their 1995 level in real terms, and still leave them more than 50 percent higher in nominal terms. The 40 percent drop gets us closer, but most people don't think that the 1995 was the depression.
So, the American International Group is giving us a reassurance that is in fact total nonsense. Reporters should be pointing out this out. Tens of millions of people are making important personal financial decisions for themselves right now. The NYT should not be helping the big boys mislead the rest of us.
Posted at 05:34 AM
Surge in Mortgage Applications is NOT a Surge in Mortgages
August 08, 2007
The headline writer at USA Today got it wrong today. We don't know that "home loan demand surges as interest rates drop." The article reports on a large increase in the Mortgage Bankers Association weekly mortgage application index.
I am usually a big fan of this index as an up-to-date source of data on the current state of the housing market. However, recent numbers are likely skewed upward for two reasons. First, while the association gets data from close to half of all mortgage lenders, subprime lenders are under-represented in the index. This means that an important segment of the mortgage market that is contracting rapidly is not getting weighted properly. In addition, some applicants who might have otherwise gone to subprime lenders not included in the survey, are now going to members of the MBA, because the subprime lenders have shut down.
The other reason why the applications number is likely skewed upward is that mortgages are being denied with far greater frequency than was the case a year or even six months ago. While the overwhelming majority of applications were approved last year, the percentage of denials is far higher now. This means that the same number of applications corresponds to fewer mortgage actually being issued. In principle we can adjust for this change if we have current data on the success rate of applications, but lacking this information, we really can't make good comparisons between periods in which the success rate of mortgage applications is likely to differ substantially.
Posted at 09:14 AM
NYT Is Too Obsessed With Bush Bashing to Think Seriously About the Economy
As the economy slows the Fed usually acts to lower interest rates to boost the economy. The NYT says that this is what the Fed should be doing now, except that it can't because if the Fed lowered interest rates, the dollar might fall. The editorial then blames the Bush tax cuts for this problem.
Okay, Econ 101 time. One of the main ways in which lowering interest rates is supposed to affect demand and stimulate the economy is by lowering the dollar and improving our trade balance. A lower dollar makes imports more expensive to people in the U.S., thereby encouraging people to buy domestically produced goods. It also makes our exports cheaper for people living in other countries, thereby encouraging exports. The link between interest rates and the dollar can't be blamed on Bush's tax cuts, it is basic economics.
In fact, we all should want a lower dollar, unless we think that the country should have a trade deficit equal to 5 percent of GDP forever (which of course we can't). As an alternative to the falling dollar, the NYT proposes that we can correct the trade deficit by increasing savings, especially by taking back the tax cuts. (Actually, the main reason that savings are despressed in the U.S. is the housing bubble, which has boosted consumption. The impact of the tax cuts is much smaller.)
But, the NYT is right that higher savings can reduce the trade deficit. There are two routes through which higher savings can reduce the deficit. Other things equal, higher savings slow the economy. (If we have less consumption, and no offsetting increase in other demand, then we have a weaker economy.) When the economy weakens, we buy less of everything, including fewer imports. In other words, if we throw the economy into a severe recession, we can move towards balanced trade.
Is the NYT advocating a severe recession to cure the trade deficit? It seems that they are, because the other mechanism through which increased saving can be expected to reduce the trade deficit is by (drum roll please Ã¢â‚¬Â¦Ã¢â‚¬Â¦..) yes, A LOWER DOLLAR!
Of course the surging trade deficit predated Bush and the tax cuts. The trade deficit went from just 1.2 percent of GDP in 1996 to 3.9 percent of GDP in 2000. You remember 2000, that was the year when we had a budget surplus of more than $200 billion, about 2.4 percent of GDP. It's a bit hard to blame the huge 2000 trade deficit on a budget deficit in the real world. The bottom line here is that the U.S. (under Clinton and Rubin) had a high dollar policy. They said it was a good thing to have a high dollar -- it keeps inflation low.
Of course, in the short-term, a high dollar is good. Just like a tax cut, it can allow people to enjoy higher living standards by consuming goods that they are not paying for. But, in the long-run, the trade deficits from an over-valued dollar are no more sustainable than tax cuts that lead to bloated budget deficits. The dollar is at risk of falling -- in fact must fall -- because Rubin and Clinton allowed it to rise to an unsustainable level. It's that simple.
There are plenty of good reasons for criticizing Bush's economic policies and especially his tax cuts for the wealthy. But Bush can't be blamed for basic economic relationships. The trade deficit can only realistically be addressed by a falling dollar. We cannot blame President Bush for this fact.
Posted at 05:16 AM
August 07, 2007
This is the obvious unasked question in a Financial Times piece on plans for helping homebuyers who stand to lose their homes. It does seem incredible that these people could really have been oblivious to the unprecedented run-up in house prices over the last decade. It would have been reasonable for the FT to question the senators or their staffers about how they could have overlooked the most important force driving the economy.
Incidentally, the bailouts being discussed would quite likely benefit holders of mortgages that might otherwise be nearly worthless. Some of the holders of these mortgages include banks and also hedge funds. Yes, you've heard of hedge funds -- the funds that are managed by people who earn hundreds of millions of dollars but don't have to pay the same tax rates as the rest of us. It is said that hedge fund managers are highly skilled investors. Since they can get the Senate to bail them out when they get in trouble, I suppose this is true.
Posted at 10:58 PM
The media seem to be saying that this is the financial markets' expectation now that Fannie Mae and Freddie Mac might loosen some of their lending restrictions. Fannie and Freddie are implicitly backed up by the government. The business press reported (see the Post for example) that the stock market jumped yesteday on reports that they would loosen restrictions and buy up subprime and jumbo loans that previously would have been excluded from their portfolios.
I would question whether even Fannie and Freddie (with our tax dollars) can support the housing bubble in the long-run, although a few trillion dollars can certainly slow the collapse. It can also give the smart money enough time to unload their positions.
It would be nice to see a bit of analysis of the implications of the sort of intervention that Fannie and Freddie might undertake. Given that we are having a huge debate on whether we can spend another $10 billion a year to provide health insurance to kids, the public would probably be interested in knowing how many trillions Fannie and Freddie might put at risk in an effort to sustain the housing bubble.
Posted at 06:20 AM
Premptive Strike: Productivity Slowdown Gets More Real
The release of revised data puts productivity growth over the last three years at 1.2 percent annually. This is below the 1.5 percent rate of the long 1973-1995 productivity slowdown. It's always possible that growth will bounce back (a downward revision to the jobs numbers will help), but the evidence that the 1995 upturn is over keeps mounting. This is REALLY big news.
USA Today flunks bigtime with an article headlined "Productivity Up." That is not the news in this quarter's report.