Monthly Archive for June, 2009


Howard and Costello

With the news that Peter Costello will not be seeking reelection, Peter Martin gives us two stories of Costello’s way of dealing with people.  The first, with Saul Eslake, the chief economist of ANZ, is interesting enough, I guess.  The second one really caught my eye:

Richard Denniss is these days the chief of staff for the Greens’ leader Bob Brown. In 2002 he was the chief of staff to the then Democrats’ leader Natasha Stott Despoja. In Mr Costello’s budget speech that year he had announced that pensioners and other concession card holders would have to pay more for their medicines. Their co-payment would climb from $3.60 to $4.60 per prescription.

The Democrats said they would oppose the measure in the Senate. Some weeks later Senator Stott Despoja and Dr Denniss were summoned to the Peter Costello’s office.

Denniss says Costello took them through page after page of laminated graphs, talking at them for the best part of an hour. The Treasurer seemed surprised to discover that they hadn’t been won over.

“At one point Costello said: Natasha, you don’t appear to understand the numbers. To which she replied: I do understand the numbers Peter, you don’t have them in the Senate and you won’t be passing this bill”.

A few days later the two were summoned to the Prime Minister’s office. Denniss says he had expected Mr Howard to be even worse.

Instead they found Howard “effusive in apologising for being late, come in sit down, can I get you a cup of tea – lots of chit chat, lots of actual conversation”.

The Prime Minister said “I know you spoke to the Treasurer last week and I’m sure he showed you all his graphs” and I understand your position: “we are trying to drive up the price of medicine for sick people, of course the Democrats are going to oppose it”.

And then he said: “How about ten cents? That wouldn’t hurt anyone.” “It absolutely floored us.”

Howard said: “Natasha, you’re the leader, I’m the leader, can’t we just settle this right now?”

Denniss says he found the Prime Minister almost impossible to resist. “His genius was to make us feel powerful.”

Costello by contrast “wanted to wield the power that had been bestowed upon him.”

I find this entirely compelling.  Costello always struck me as a technocrat.  I may not have liked Howard much (and not at all for the latter half of his time as PM), but he knew better than most what any specific audience wanted to hear.


Meta and trumpet-blowing

I’ve just upgraded to version 2.8 of WordPress.  Hopefully it will improve the speed of the site.

Also, a search on google for “fiscal multiplier” puts me at number two at the moment.  I have no idea why.


CDS hilarity

I’m paraphrasing James Hamilton here.

A credit default swap is a contract that pays out if a specified event occurs on the underlying security. Normally, and in this case, the security is some debt and the event is a default on that debt.

There was a pile of $29 million in debt. Specifically, they were (based on) subprime loans in California and a bunch of them were already delinquent.

A brokerage firm from Texas started offering (i.e. selling) credit default swaps on the $29 million. Since so many of the underlying loans were delinquent, it seemed a sure thing that a default would occur and the big boys in New York were happy to buy the CDS contracts.  In fact, they were so sure that the debt would default that they were willing to pay up to 80 or 90 cents for a $1 payout in the event of a default.

Two important things then played a role:  First, credit default swaps are traded “over the counter”, so if you buy one from me you don’t know how many other people have also bought from me or how many they each bought.  Second, there are (currently) no regulations on credit default swaps and in particular, there is no limit to the scale of the CDS market against a particular asset.

In this case, the big banks paid about $100 million for CDS contracts that would pay out $130 million if the debt defaulted.

The brokerage firm took the $100 million, paid off the debt entirely (so it didn’t default) and walked away with $70 million.


On China

Menzie Chinn emphasises that for the purposes of estimating country shares in global GDP, it is necessary to think of them in nominal terms.  On that basis, China is large, but only half the size of the Euro zone and well under half the size of America.  Therefore, he implies, an increase in demand from China won’t really contribute as much to global growth as people might be hoping.

Nevertheless, people do seem to be wondering about China as an engine of global growth in demand.  The reason is simple:  Despite a near catastrophic collapse in world trade, China’s economy is still growing while those of  other export-oriented countries like Japan or Germany are falling precipitously.

Clearly part of the reason for the continued Chinese growth, like in Australia, is the successful use of a fiscal stimulus to boost local demand (the Australian rebound was also helped by the fact that, by not manufacturing much, their decline in investment was offset by a fall in imports and (price) changes in natural resource exports occur with a significant lag).

Brad Setser has explored the Chinese stimulus a little.  He writes:

I initially underestimated the magnitude of China’s stimulus by focusing on the (fairly modest) change in the government’s fiscal balance. It is now clear that the majority of China’s stimulus has been off-budget: the huge increase in lending by state owned banks mattered far more than the change in the budget of the central government. The expected loss on these loans can be considered a form of fiscal stimulus.

Which is a fascinating way to conduct government business.


On the symmetry of employment contraction and recovery in US recessions

A couple of days ago I gave some graphs depicting movements in weekly hours worked per capita during US recessions since 1964.  Towards the end, I gave this graph:

Comparing US recessions in hours worked per capita, centred around their troughs

I thought it might be worthwhile to look at this idea further.  Here is the equivalent graph where movements in hours worked per capita are made relative to their actual troughs rather than their actual peaks:

Comparing US recessions in hours worked per capita, centred around and relative to their troughs

At a first glance, recoveries do appear to be somewhat symmetric to their corresponding contractions, although they do also appear to be a bit slower coming back up to falling down in the first place.

I then identified data pairs that are symmetric in time around each trough (e.g. 3 months before and after the trough) and put them in a scatter-plot:

Scatter plot of falls-to-come in weekly hours per capita against subsequent gains in recovery

Points along the 45-degree line here would represent recoveries that were perfectly symmetric with their preceding contraction.  Notice that for five of the six recessions shown, recoveries are in a fairly tight line below the 45-degree line.  By comparison, the recovery following the ’81-’82 recession was especially rapid – it came back up faster than it fell down.

Excluding the ’81-’82 recession on the basis that it’s recovery seems to have been driven by a separate process, a simple linear regression gives a remarkably good fit:

comparingrecessions_20090605_symmetry_scatter_excl_81-82

This is a very rough-and-ready analysis.  In particular, I’ve not allowed for any autoregressive component to employment growth during the recovery.  Nevertheless, it is suggestive.

There are more serious efforts in looking at this for the economy as a whole (rather than just hours worked).  James Hamilton is not convinced that it will occur this time.  The oddly rapid recovery in hours worked per capita following the ’81-’82 recession should give us reason to agree with Professor Hamilton, not disagree: it shows that the typical recovery is not guaranteed.  Look back at the scatter-plot of all the recessions.  Notice that the recovery following the ’69-’70 recession was actually quite slow.  It’s fitted line is y = 0.252 x.

For me, the big thing that makes me lean towards Professor Hamilton’s fears of a slower-than-typical recovery is the possibility of zombie banks, or as John Hempton argues, zombie borrowers.  Zombie borrowers should worry us because, if they exist, they are keeping hold of the capital that could (and should) be better placed elsewhere in the economy, which means that those more deserving would-be borrowers are not able to expand and employ more people.

As Hempton argues in the second of his posts, on this basis it is a Good Thing ™ that two of the three US car manufacturers have been forced into a bankruptcy-induced contraction.  Note that Ford only really managed to avoid the same fate by borrowing a huge amount just before the credit markets froze.  It probably needs (from the point of view of the economy as a whole) to follow the same process, whether inside or outside the courts.

But the car manufacturers are by no means the only candidates for the “zombie borrower” epithet.  The really big borrower behind all of the mess in the financial sector is the one at the bottom of all the “toxic” CDOs:  the underwater American households.