Detailed Abstractions

Yesterday,  the Federal Reserve, through the Federal Open Market Committee (FOMC) released an updated statement about their views on the economy, the prior one having been released on November 4th.

You can read the full text @ the Blog Calculated risk (here).  Among other things in the statement, the main changes in thinking since November are encapsulated in the opening paragraph:

Information received since the Federal Open Market Committee met in November suggests that economic activity has continued to pick up and that the deterioration in the labor market is abating. The housing sector has shown some signs of improvement over recent months….

Of course it has!  With the FHA pushing home loans like Fannie & Freddie have (here @ DetailedAbstractions) & continuing to pay people to buy houses (8K dollar tax credit extended @ LA Times) and property prices declining as the market corrects prior bad incentives (here @ DetailedAbstractions), the result is obvious .  Given non-market, but economic incentives to purchase property, property prices in real terms decrease, therefore demand increases.

What this does not say however is whether this is sustained.  Lots of individuals for instance took advantage of the Cash for Clunkers program (here @ DetailedAbstractions) mainly resulted in a short-term boost in car sales, but at the expense of lower future sales.

This of course doesn’t mean the housing market isn’t on the rebound, but I see no evidence that really allows this conclusion at this time.

It continues:

…Household spending appears to be expanding at a moderate rate, though it remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit.  Businesses are still cutting back on fixed investment, though at a slower pace, and remain reluctant to add to payrolls; they continue to make progress in bringing inventory stocks into better alignment with sales. Financial market conditions have become more supportive of economic growth.

Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

& there’s the rub…  The Federal Reserve is supposed to be an independent branch of the government outside of any specific administration, but when publishing statements which disagree with basic economic thought one might start to wonder.

In fairness, it could also be just simple self-interest in that they need to justify spending billions on bailing out bad companies., but to use the words, “policy actions stabilized the market” makes this seem unlikely, but I digress.

The main issue with this portion of the statement is that’s its simply untrue.  New policies such as “too big to fail” which the Federal Reserve admitted can’t continue (here @ Business & Media),  have seemingly become official  government policy (here @ Reason Foundation).

Additionally, there is widespread agreement that the new financial regulations the administration is pursuing will result in higher costs of doing business (here @ The Economist, here @ Cato, here @ Reason Foundation, among others).   These new barriers to entry will stifle new business creation, creating less incentive for economic activity.  Additionally, just as “too big to fail” was supposed to fix large interconnected companies, but instead ended up cementing that status for certain corporations, the new regulations are highly unlikely to prevent a  recession for similar reasons from happening again (here @ DetailedAbstractions).

All in all, it seems the Federal Reserve has taken a very short-sighted approach and produced a political paper, not an economic one.

With the recession ending (@MSNBC):

WASHINGTON – More than 90 percent of economists predict the recession will end this year, although the recovery is likely to be bumpy….

Or maybe a double-dip (@Politico.com):

…All that’s enough to convince some observers that the economic recovery is faltering and could be heading for a “double dip” recession. And that would mean the recent green shoots of recovery turn out to be just a pause in a much longer economic slide….

& a stimulus which has saved jobs (@USA Today):

WASHINGTON — States have reported using stimulus money to create or save more than 388,000 jobs so far this year, buttressing the Obama administration’s claim that the $787 billion plan has had a significant impact on the economy….

Or maybe not (@WashingtonExaminer):

…Even if we take at face value the White House claim that it created or saved all these jobs with approximately $150 billion of the economic stimulus money, a little simple math shows the taxpayers aren’t getting any bargains here: $150 billion divided by 650,000 jobs equals $230,000 per job saved or created. Instead of taking all that time required to write the 1,588-page stimulus bill, Congress could have passed a one-pager saying the first 650,000 jobless persons to report for work at the White House will receive a voucher worth $230,000 redeemable at the university, community college or trade school of their choice. That would have been enough for a degree plus a hefty down payment on a mortgage….

Maybe some perspective is needed.  To truly put it in context, let’s look at the Great Depression (@Cato):

…According to most accounts, the stock market crash of October 1929 was the spark that sent the economy spiraling downward.

How could this be? After all, by November 1929, the stock market had started to recover, and by mid-April 1930, it had reached its pre-crash level. Contrary to the received wisdom, massive government failure — not the stock market crash — pushed the United States into the Great Depression….

As written here before (here, here & here), economic predictions are inherently tricky and the government does a very poor job because politics always gets in the way of objective truths.  NBER who is usually the group society follows for when a recession starts and ends told us in December of 2008 that December 2007 was the beginning of the dive demonstrating that most “objective” economic truths are only found in hindsight.

In fact, some brilliant legal minds have made just this point to contemplate delaying financial regulations intended to mitigate similar future scenarios in which we might find ourselves (here).  Richard Posner’s analysis:

The Report is premature in two respects. The first is that it advocates a specific course of treatment for a disease the cause or causes of which have not been determined. Now it is not always necessary to understand the cause of something you don’t like in order to be able to eliminate the effect. If you have typical allergy symptoms you may get complete relief by taking an antihistamine; it is not necessary to find out what you’re allergic to. But generally, and in the case of the current economic crisis, unless the causes of a problem are understood, it will be impossible to come up with a good solution. The causes of the crisis have not been studied systematically, and are not obvious though they are treated as such in the Report. (Remember, the Great Depression of the 1930s ended 68 years ago and economists are still debating its causes.)…

Note – this doesn’t mean that we don’t understand basic incentives and most likely results.  Like chaotic systems in which minor changes in the beginning state of a system can show drastic changes in the end results, our economic system is so complex as to defy attempts to model very specific changes.  Though with hindsight and true analysis, we can get to a point where we know with probabilities what has happened and what will likely happen given specific policies.

For instance, if we make houses cost less by giving tax breaks or whatever, sales will increase for the time that incentive exists.  If the incentive is timed, then some sales will just be premature sales and show corresponding decreases in future quarters.

Meaning, we can use a basic understanding of incentives in order to gauge most likely results, but today only with hindsight can we show real numbers on very specific things such as the stimulus bill’s impact on house sales or jobs.

& even then, given the inherent difficulty in defining a “saved” job and politicians willingness to ignore any data contrary to any rosy picture they wish to present, any economic predictions or numbers coming from politicians should be suspect by default.

For more than 20 years now, with legislation leading back almost 40 years, the United States government has been pushing the idea that every citizen should have a home.

Based upon several studies showing high correlations with positive societal behavior for homeowners, politicians, leaders, non-profits, lots of people pushed for easier access to affordable housing.  In a Federal Reserve report published in 1999, they state:

A number of recent studies attempt to measure whether there are nontraditional benefits to homeownership, such as increases in the success of children (Green and White [5]), citizenship (DiPasquale and Glaeser [3]), and a variety of family outcomes and attitudes (Rossi and Weber [11])….

This is only 1/2 the story of course.  What these studies, our politicians, our leaders, & the rest of them  can’t conclude from this data is whether home ownership actually affects any of these additional traits.  The study itself hints at this:

…Because of the preferential tax treatment accorded homeowners, particularly low-income homeowners, and the large degree of wealth accumulated in housing, these authors argue that it is important to know the full range of homeownership benefits and costs. However, given the difficulty of credibly assigning causality to housing externalities, it is not surprising that such factors have been previously ignored.

In one such paper, Green and White [5] find a strong statistical correlation between homeownership and the likelihood of dropping out of school or becoming pregnant. Yet a reasonable interpretation of their result is that of omitted variable bias. Clearly, homeowners are different from renters along a variety of dimensions. As a result, those factors that are latent in their work, such as parental skills, interest in the educational process, wealth, and family stability, potentially bias upward any homeownership effect….

In other studies, they show correlations between home ownership & wealth accumulation, to help give more force to the “everyone needs a home” meme (study dated 2004):

For many years the federal government has promoted homeownership as an important goal for low-income families. A primary motivation of this policy goal is the concept that owner-occupied housing can be an important means of wealth accumulation, particularly for those lower-income and minority families that are able to purchase homes….

They as well admit the difficulty with this assessment:

…However, very little has been done in the housing literature to determine the importance of housing and non-housing sources of wealth accumulation. This determination has been difficult to address for three reasons. First, detailed wealth information on families is seldom available on a consistent basis. Second, such information on wealth is even less likely to be available over time so that changes in wealth can be observed. Third, the process of housing wealth accumulation is dynamic. Housing wealth accumulation depends critically on how soon a family that is renting becomes a homeowner, whether or not the family graduates to more highly valued owned units over time, or becomes a renter again and never regains homeownership….

With the current practice of press & political standards however, you might be hard pressed to find any evidence that assigning non-traditional benefits to home ownership is anything but an unqualified good.  The majority of reports dealing with low income housing stimulus are positive  (here & here).

In some cases, overly emotional logic is used (here):

After business dried up in May, Jodi Morris’ employer, an insurance agent, stopped sending paychecks.

Since then, the 43-year-old single mother has had to sell almost all of her furniture – her kitchen table and chairs, bed frames, dresser and armoire, and living room set – to pay the bills.  Morris and her 7-year-old daughter, Karly, now sleep on mattresses on the floor of their two-bedroom Ahwatukee apartment. And with no table, the two eat dinner on their cream-colored couch.

An eviction notice that arrived this month threatened to put Morris and Karly out on the street.  But Morris could be the first Phoenix resident to receive a lifeline from the federal government that seeks to rescue those on the verge of homelessness….

& without exception, our government is not immune.  The US government is right now, before the housing crisis even fully contracts (I wrote about it here), spending money to help low income families purchase homes.

Even before the housing crisis though, economists, experts, non-profits, were asking whether home ownership should be considered an unqualified good.  Unfortunately, reports questioning these basic assumptions are a very low percentage compared to the constant noise.

In some cases, even questioning the wisdom of subsidizing low income home ownership has resulted in kill the messenger attacks from non-profit groups, community leads, and even Democratic leadership, by leveling charges of racism.  With a simple misdirection trick, questioning the basic assumptions is anti-low income & since low-income households are generally minorities, questioning these assumptions must be due to institutional racism.   Politicians and leaders everywhere have a grand ole time setting up straw men in a fields of hay while standing by with gasoline and matches, but we should expect more.  We should expect to be able to ask all relevant questions we can and to get answers to as many questions as possible.  Lastly, we should let the data lead to its natural conclusion.

Assuming we truly want the best answers we can get and the best progress we can have, we must be willing to ask tough questions and live with the answers reality presents.

Anything less is little better than just allowing random superficial rhetoric to control policy.  It’s almost like we never moved away from the world Richard Feynman spoke about in 1974:

…But even today I meet lots of people who sooner or later get me into a conversation about UFOS, or astrology, or some form of mysticism, expanded consciousness, new types of awareness, ESP, and so forth. And I’ve concluded that it’s not a scientific world.

In a rush to ensure that no good crisis goes to waste, the Obama Administration, through the Federal Reserve and other bureaucrats are passing “laws” without even a wink & a nod to the public who didn’t elect any of these people to write laws.

In the Washington Post:

The battle to pass regulatory reform legislation in the face of intense opposition launches in earnest Wednesday morning with a hearing featuring Treasury Secretary Timothy F. Geithner, who will once again champion a package of sweeping changes that only Congress has the power to make…

…But outside that spotlight, the Obama administration, and the independent agencies with which it is increasingly synchronized, are moving forward with changes that do not require new laws, but could match or exceed the impact of anything that emerges from Capitol Hill…

I guess talking to the public about things like health care, auto buyouts, and the Olympics were proving to be too difficult.  All those pesky citizens with their rights and stuff standing up in opposition.  It will be much better now that they are out of the way:

…The Federal Reserve is cracking down on Wall Street’s legendary paydays. The Treasury Department plans to require banks to carry larger capital reserves. The Securities and Exchange Commission has eight pending proposals to clean up financial markets….

…The Federal Reserve, meanwhile, is asserting authority to review bank compensation policies. There is widespread agreement that many bankers were paid during the boom for spectacular short-term results achieved by taking massive risks that ultimately produced the global crisis.

Keep in mind this is the exact same government agency who kept interest rates too low even whiles trends were predicting the internet bubble in early 2000 and continued that behavior even when the next bubble, housing, was easily spotted.  I’m sure they’ve learned their lesson.

…The Fed is expected in the next few weeks to release for public comment a proposal instructing banks to make sure that compensation reflects risk. For example, if two employees generate the same amount of profits while taking different amounts of risk, regulators would like to see more reward for the less risky approach….

Oh – this ought to be fun.  The same group who can’t be bothered to even mention that their policies might have had a negative effect are now going to be in a position to tell bankers what they can make based upon what a government agency sees as the risk associated with any particular investment.

That assumes the government has the ability to accurately define risks and define compensation.  Dealing with risks only, the government has a poor track record.  The Soviet Union was much weaker than we thought, Iraq was without weapons we all knew was there, and even in the most recent crisis, politicians pushed Fannie & Freddie right up to the edge of the cliff even as people continued to tell them the drop would hurt.

As Nicholas Taleb, author of The Black Swan said when asked if the housing bubble was a black swan (an outlier), replied, “But to me that wasn’t a black swan; it was a white swan. I knew it would happen and I said so.”

What does Mr. Tableb know anyhow?  After all, the esteemed Mr. Greenspan said the low interest rates weren’t the problem and we all know he doesn’t have any conflict of interest in saying so.

This is the government though.  Why would they go through this exercise in certain failure without at least doubling down? (here):

…The SEC also is flexing its muscles. The commission has proposed restrictions on short selling…

Never mind the fact that short selling by itself can’t force a market go down.  Never mind the fact the government had their hands in this every step of the way.  Never mind the fact that un-elected bureaucrats are subverting the representative process of legislating by making sweeping regulatory overhauls with little oversight.  Never mind economic freedom is just as important to the human condition as social freedom.

Yep, that’s the government, telling us, “never mind”.