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Why Bill Gross is Wrong: Innovation and Long-term Returns on Equity

Posted on August 2, 2012September 18, 2024 by The Progressive Policy Institute

Editor’s Note: This item is cross-posted from Innovation and Growth.

Bill Gross of Pimco has just written a piece where he argues that the real return on stocks in the future will be much lower than the long-term historical average of 6.6%:

Yet the 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes – a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)?

He then goes on to argue that:

The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned.

In a world of slow innovation, Gross is likely to be correct. The economy grows slowly, and it becomes difficult to justify compensating risk capital if risks are not paying off.

The calculation changes, however, if we have big disruptive innovations. Big disruptive innovations offer risk on both the upside and the downside. On the upside, disruptive innovations create a wave of high-growth companies that drive the stock market higher. On the downside, disruptive innovations offer the distinct possibility of driving existing companies out of business, once again accentuating risk. Continue reading “Why Bill Gross is Wrong: Innovation and Long-term Returns on Equity” →

Home Economics: Pressure Mounting for Principal Reduction

Posted on August 2, 2012September 18, 2024 by The Progressive Policy Institute

U.S. Treasury Secretary Tim Geithner has added his voice to the growing chorus calling on U.S. housing regulators to help “underwater” homeowners dig out from under a mountain of negative equity.

Geithner fired off a letter yesterday to Edward DeMarco, acting director of the Federal Housing Finance Agency (FHFA), deploring his agency’s continued opposition to “principal reduction.” He urged DeMarco to reverse his decision not to allow Fannie Mae and Freddie Mac to write down the principal on mortgages held by distressed homeowners.

The day before, FHFA had reaffirmed its stance against principal reduction as a way to reduce costly foreclosures. DeMarco worries that principal reduction would encourage “strategic defaults,” meaning that underwater borrowers would stop making payments on their loans to qualify for a write down. With taxpayers already footing the bill for Fannie and Freddie to the tune of $180 billion, DeMarco is understandably wary of running the bill even higher.

But Geithner believes that reducing loan balances could save money, “the use of targeted principal reduction by the GSEs would provide much needed help to a significant number of troubled homeowners, help repair the nation’s housing market, and result in a net benefit to taxpapers.”

I think Geithner has the better argument. In fact, PPI recently published a creative proposal by Rick Morris, a former Fannie Mae executive, to test the potential of principal reduction as another tool, along with refinancing to help homeowners take advantage of rock-bottom interest rates, for preventing foreclosures.

“Fannie and Freddie can offer “short sales” back to the existing homeowners in return for a share of their home equity,” says Morris in ‘Another Tool in the Toolkit: Short Sales to Existing Homeowners.’ “Unlike foreclosure and traditional short sales, which are to third parties and usually at a discount to true market value, this approach would help support home prices, lower future default risk, and save taxpayers billions of dollars.”

We hope DeMarco will reconsider. But what’s really needed is explicit authorization from Congress to engage in the kind of demonstration project that Morris envisions. This will limit taxpayers’ exposure, while exploring new ways to speed the recovery of U.S. housing markets. Unfortunately, the timing of DeMarco’s decision, right before a five-week recess, probably means that throwing a lifeline to homeowners via principal reduction will be shelved until after the election.

Photo Credit: Lauren Wellicome

Mitt Romney’s Vapid Foreign Policy

Posted on August 1, 2012 by The Progressive Policy Institute

PPI’s Will Marshall detailed Mitt Romney’s recent adventure in the world of foreign policy over at The American Interest. Romney was able to stumble his way through a trip to Britain, Israel, and Poland all while offering very little in the form of substantive policies focusing more on criticisms of President Obama’s foreign policy.

Mitt Romney’s midsummer foray into foreign policy has left Democrats giddy with schadenfreude. More than his stumbling performance abroad, however, it’s the substance of Romney’s views that ought to really give voters pause.

Or, more precisely, lack of substance. With less than 100 days to go, Romney has yet to develop a coherent outlook on U.S. security and leadership in a networked world. What we get instead is GOP boilerplate about American greatness and exceptionalism, and a pastiche of spaghetti-against-the wall criticisms of Obama’s foreign policy.

Romney, of course, wants the election to center on the economy, and he’s offering himself, in effect, as a more experienced and capable CEO. His missteps over the past week, however, raise doubts about his ability to take over as Commander in Chief.

The sequence began with his first major foreign policy address, to the Veterans of Foreign Affairs. It was a pedestrian affair that left even conservative commentators underwhelmed, when they bothered to comment on it at all. Next, Romney embarked on his Grand Tour of three U.S. allies—Britain, Israel and Poland—supposedly dissed by Obama. The point of the exercise was to show that Romney knows how to treat America’s best friends.

Read the entire article HERE

Photo Credit: Austen Hufford

Election Watch: Ad War Heats Up, Romney Goes Abroad

Posted on July 27, 2012September 18, 2024 by The Progressive Policy Institute

The last week has continued the earlier pattern of daily fireworks in the presidential contest (excepting a brief pause in hostilities immediately after the Aurora massacre), but little if any significant movement in the polls. As anyone near a battleground state television can attest, the Obama campaign (and the Priorities USA super PAC) has continued harsh personal attacks on Mitt Romney as an out-of-touch rich man with no emotional connection with the middle class or interest in its aspirations, who is furthermore determined to cut taxes for people like him. The Romney campaign (which is now beginning to get advertising reinforcement from the very deep pockets of conservative super PACs) has responded harshly with a battery of ads and campaign speeches focusing on a clip from an Obama speech in Roanoke wherein he supposedly disrespected the personal contributions to the economy of entrepreneurs (in fact he was paraphrasing a well-known litany by Massachusetts Senate candidate Elizabeth Warren about the reliance of private businesses on public services and investments). It’s not entirely clear whether this intense barrage is intended simply to reinforce the general and long-standing Republican critique of Obama as someone who does not understand how the economy works and believes government is the source of all good things, or is more narrowly targeted at undermining Obama’s relatively strong standing with upscale, college-educated voters.

Continue reading “Election Watch: Ad War Heats Up, Romney Goes Abroad” →

Can American Idol Tell Us if Young People are Going Back to Work?

Posted on July 24, 2012September 18, 2024 by The Progressive Policy Institute

Economists are constantly coming up with offbeat and fun economic indicators. We’ve seen the economy explained through hemlines, long-distance relationships and even the toughness of marine recruiting ads.

In this spirit, let me unveil a new indicator—the American Idol indicator.

This indicator uses the number people attending Idol auditions each year to tell us if younger workers are more discouraged about their employment prospects. The idea here is that people are more likely to go to an AI audition if they have a lot of time on their hands – presumably because they are unemployed, underemployed, or have given up looking for a job. So a rise in the number of auditions might correspond to a rise in the unemployment rate, while a drop in auditions might signal things are getting better.

As it turns out, PPI’s American Idol indicator suggests younger workers are feeling better about their employment prospects over the coming months. The graph below compares the unemployment rate of workers aged 16-29 with the number of American Idol auditions since 2007. Rules of AI auditions stipulate contestants must be American citizens that are between the ages of 15-28.

Continue reading “Can American Idol Tell Us if Young People are Going Back to Work?” →

Election Watch: Romney Fights Bain Allegations, Minority Vote in Question

Posted on July 20, 2012September 18, 2024 by The Progressive Policy Institute

Despite the languorous weather and the decamping of many Americans to Vacationland, the election season is staying lively, and will probably remain so at least until the Olympics begin on July 27.

At the presidential level, there has been a notable contrast between the two campaigns and parties, and very stable polling. The main pro-Obama Super-PAC, Priorities USA, has been conducting heavy battleground state advertising pounding Mitt Romney for Bain Capital’s alleged outsourcing activities and (most recently) for his failure to release more than partial tax returns for just the two most recent years. The president and other Democrats have joined in through earned media outlets. The apparent strategy is to fatally undermine Romney’s use of his business background as a credential for the presidency, and then to go after the controversial GOP policy agenda encompassed in the Ryan Budget, which Romney has embraced. This two-pronged approach is being supplemented by a party-wide effort to make expiration of the Bush tax cuts for those earning over $250,000 a year (which has been polling quite well) as a litmus-test issue separating the two parties decisively.

Continue reading “Election Watch: Romney Fights Bain Allegations, Minority Vote in Question” →

PPI Battleground Home Value Index: Prices Will Only Increase From Here

Posted on July 20, 2012September 18, 2024 by The Progressive Policy Institute

PPI’s monthly look at home values in 16 potential 2012 battleground states–our Battleground Home Values Index, May ’12– confirms values have bottomed, and are now showing price appreciation in the states that will decide the winner of the 2012 Presidential elections. This is welcome news for not only homeowners in battleground states, but for homeowners nationwide. With a clear bottom in values established, the “Big 3” of the housing crisis, Nevada, Arizona and Florida, have all seen prices move to the upside since the end of 2011, with Arizona experiencing a strong 4% move up.

Some Good News That Obama Should Be Touting

Posted on July 19, 2012 by The Progressive Policy Institute

Will Marshall compiled four positive economic stories for Real Clear Politics that President Obama should be making better use of in his campaign for re-election. From farming to exports there are positive signs in the economy according to Marshall.

Despite a string of doleful job and sales reports, there are signs that America is starting to get its productive mojo working again. The good news can’t come fast enough for President Obama, who needs some economic success stories he can point to.

So, at the risk of diverting readers from the cosmically important question of when, exactly, Mitt Romney stopped running Bain Capital, let’s examine four pinpricks of light that have begun to penetrate the economic gloom:

First, check out America’s phenomenally productive farmers; Monday’s Washington Post notes that the agriculture sector last year sold $136 billion worth of goods abroad, boosting farm income to a record $98 billion. When it comes to high quality and affordable food, America is still number one in the world.

But, in a perfect example of the disjuncture between what’s happening in the real world and Washington’s thralldom to entrenched interests, Congress is cooking up new justifications for costly federal subsidies for the thriving agricultural sector. The culprits include supposedly fiscally conservative Republicans, who added callousness to hypocrisy by also voting to slash food stamps for poor families.

Read the entire article HERE

Let’s Kill the Mortgage Interest Deduction and Replace It With This

Posted on July 19, 2012 by The Progressive Policy Institute

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The Atlantic highlights PPI’s proposal to create “HomeK” accounts for home buyers to aid in the purchase of new homes. The article further suggests that such accounts could replace mortgage interest deductions.

The mortgage interest deduction probably isn’t going anywhere soon. Voters are far too fond of it, and politicians are loathe to nix a popular sort-of-kind-of-middle-class entitlement. But while the tax break might be beloved by the people who actually show up on election day, it’s also a highly regressive giveaway to the top 20 percent of American households, who reap 75 percent of the benefit, as my colleague Matt O’Brien wrote yesterday.

So let’s say policy wonks could wave a magic wand and make the mortgage interest deduction disappear. How could we replace the thing? Even though everyone has sobered up a bit about it thanks housing bust, home ownership still has a lot of economic virtues we should want to encourage. For instance, it’s one of the few ways a large portion of this country actually saves. And we really don’t want Americans saving any less than they already are.

Read the entire article HERE.

Another Tool in the Toolkit: Short Sales to Existing Homeowners

Posted on July 19, 2012 by The Progressive Policy Institute

Overview

Edward DeMarco, acting director of the Federal Housing Finance Agency (FHFA), is drawing fire from congressional Democrats for preventing Fannie Mae and Freddie Mac from writing down the principal on home mortgages held by underwater borrowers. With U.S. taxpayers already on the hook for nearly $200 billion in losses incurred by Fannie and Freddie since September 2008, DeMarco understandably doesn’t want to make a bad situation worse.

The lawmakers, however, have a point. The housing slump may be the most significant brake on America’s economic recovery. That’s why it’s worth experimenting with creative ways to help delinquent underwater homeowners dig out from under a mountain of “negative equity.”

Private sector experiences suggest that a carefully conceived principal reduction program could achieve significant savings for U.S. taxpayers by reducing losses at Fannie Mae and Freddie Mac. Such a program could be enacted responsibly and fairly without fueling moral hazard—the risk that borrowers who otherwise would make their mortgage payments go delinquent in an effort to get their principal balances reduced.

In effect, Fannie and Freddie can offer “short sales” back to the existing homeowners in return for a share of their home equity. Unlike foreclosure and traditional short sales, which are to third parties and usually at a discount to true market value, this approach would help support home prices, lower future default risk, and save taxpayers billions of dollars.

I propose that FHFA direct Fannie Mae and/or Freddie Mac to conduct a pilot program to test the technique’s viability and that Congress ask the Congressional Budget Office (CBO) to independently assess the potential savings for U.S. taxpayers should such a program be implemented on a full-scale basis.

The Principal Matter

Foreclosures are very expensive for lenders. In addition to the large costs of carrying, maintaining, and oftentimes improving homes they have foreclosed upon, disposing of the properties in foreclosure sales typically nets less than their fair market value. Similarly, short sales to third parties also usually suffer “distressed sale” discounts to the homes’ fair values. According to the latest LPS Home Price Index data, in today’s depressed real estate markets, foreclosed homes sell at an average discount of 29 percent and short sales at an average discount of 23 percent. And, of course, having on ongoing supply of such properties for sale adds pressure on home prices.

To avoid foreclosures, and thereby minimize their losses, many banks have already reduced principal balances on mortgage loans that they own. They have done this in two ways: by reducing the balances of outstanding mortgages through loan modifications, and by agreeing to short sales of homes which result in the borrowers’ loan obligations going away. In a short sale transaction, the bank lets the borrower sell her home for less than the mortgage loan balance without requiring her to repay the difference. This is a principal writedown for the borrower—it is equal to the amount by which the mortgage loan balance exceeded the sale price of the home in the short sale transaction.

Fannie Mae and Freddie Mac already provide underwater borrowers with relief on mortgage principal by allowing short sales of homes. In fact, both of the government-sponsored enterprises (GSEs) recently announced plans to streamline their short sales processes in order to stimulate the use of the technique. If they and FHFA are comfortable with granting principal reduction through short sales, then they must believe that doing so minimizes losses.

So the debate should not be about whether principal reduction per se can help minimize losses. It does. Rather, we should determine whether there is a better way to implement principal writedowns in order to reduce losses further for the GSEs without also creating meaningful additional moral hazard. Doing short sales of their homes to delinquent underwater homeowners, with them sacrificing some home equity as a cost, has the potential to save the GSEs (and, consequently, U.S. taxpayers) billions of dollars without stimulating moral hazard.

Download the entire report.

Telecom and oil companies top ‘Investment Heroes’ list

Posted on July 19, 2012 by The Progressive Policy Institute

The Washington Post covers Diana Carew’s and Michael Mandel’s Investment Heroes paper, focusing on the strong telecoms and energy presence amongst the leading companies.

AT&T, Exxon Mobil and Wal-Mart are leaders among a top 25 list of corporations still investing within U.S. borders, according to a new study from a progressive think tank.

These “Investment Heroes,” according to the Progressive Policy Institute (PPI), continue to invest domestically in buildings, equipment and software — something most companies have slowed or stopped throughout the lackluster economic recovery. However, telecom and energy companies, which are ubiquitous on the list, are still building broadband infrastructure to keep up with demand and are investing in the discovery of new sources of oil and gas.

The report’s authors, PPI economists Diana Carew and Michael Mandel, have no misconceptions that these companies are doing everything right — they are often criticized for environmental issues, privacy concerns and low tax rates, among other things — but want to point out the positive impact these companies are having when it comes to creating jobs and growth through their domestic investment.

Read the full story here.

Manufacturing and Inflation

Posted on July 17, 2012 by The Progressive Policy Institute

PPI’s Michael Mandel was cited over at Slate about the potential to decrease unemployment through an increase in manufacturing jobs in the United States. While Slate’s Yglesias views this as unlikely, the proposal is nevertheless intriguing.

It might seem odd for the United States to be running such a large trade deficit amid such high unemployment. One of the main reasons to import goods rather than make them yourself is that by importing goods you free up scarce labor to do other things. But right now we’ve freed up labor to enter the unemployment sector. Bad news.

One potentially useful way of thinking about this is through the calculation Michael Mandel deploys to ask what the economy-wide consequences would be of balancing America’s trade in nonoil manufactured goods (PDF). He thinks it would take 3.5 million to 4 million workers to make the requisite stuff. Potentially that would be a very costly change if it involved 4 million fewer people working in hospitals, schools, and restaurants just to get our hands on material goods that we already have. But unemployment is high. So under present circumstances, he writes that this could “reduce unemployment by about 2.3-2.6 percentage points,” which would be a lot.

However, firms don’t locate production abroad for no reason. They do it because it’s cheaper. So if we relied more on domestically made goods, prices would have to be higher

Read the entire article HERE

China’s ‘Sweetheart Deal’ to Foreign Firms

Posted on July 17, 2012 by The Progressive Policy Institute

PPI’s chief economic strategist Michael Mandel discusses whether China does capitalism better than the U.S. on CNBC’s “Closing Bell.”

Can Eminent Domain Help Underwater Homeowners?

Posted on July 17, 2012 by The Progressive Policy Institute

Several California counties are considering a controversial proposal to use their eminent domain powers to offer relief to underwater homeowners. The plan is quietly being shopped to counties hit hardest by the housing crisis, and it seems local politicians are listening.“We have a very large problem that’s causing severe economic problems and part of our exploring ways to deal with it is hearing from people like those representatives of the securities industry,” said San Bernardino County Chief Executive Officer Greg Devereaux.

This has provoked a sharp reaction from Wall Street banks. In a letter to San Bernardino Supervisors, a coalition of securities investors said “Such an action would likely significantly reduce access to credit for mortgage borrowers in the San Bernardino area and other areas that undertake similar actions.”

It’s hard not to sympathize with the the Riverside-San Bernardino-Ontario metro area, where half the mortgages are underwater and the unemployment rate for May was 11.8%. And some progressives may find it hard to be sensitive to the plight of the Wall Street banks that hold most of the underwater mortgages in San Bernardino.

But the basic policy question here is whether the proposed cure would be worse than the disease. Using government’s eminent domain powers to force investors to eat the losses on underwater mortgages is a very drastic remedy to the problem of negative equity. While it could ease the burden on some homeowners, it could also drive private investment out of California housing markets. This would only prolong the housing slump and deepen the state’s economic malaise.

Download the entire brief HERE

Libor Scandal and Public Data Manipulation

Posted on July 16, 2012September 18, 2024 by The Progressive Policy Institute

Editor’s Note: This item is cross-posted from Innovation and Growth.

I found myself reacting to the Libor scandal more strongly than a lot of the earlier revelations of financial institutions misdeeds. First, the banks were just blatant out-and-out lying about a simple number.

Second, their lying led to a distortion of a crucial piece of publicly available data–the Libor rate. In a market economy, intentional misrepresentation of a market price is not a victimless crime –in fact, the victims are everyone who relied on that price to make decisions. That includes regulators who presumably watched Libor as one of their guides to the amount of stress in the global banking system. Here’s a chart of Libor across the key period (downloaded fromhttps://www.fedprimerate.com ).

Continue reading “Libor Scandal and Public Data Manipulation” →