Paul Krugman Thinks US Recession Will Be Over By September

For Krugman to be so bold in making that statement, its becoming a media circus. How are you going to take popularity votes from Roubini unless you make these aggressive calls that make everyone sit up and take notice. Even if your call does not work out, you are an outstanding economist, you role in life is to justify and explain why your predictions did not turn out the way you predicted. Great way to stay in the media focus and still be just doing your job, without achieving anything really in the end... mommas, don't let your sons grow up to be economists!!

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The US economy probably will emerge from the recession by September, Nobel Prize-winning economist Paul Krugman said.

"I would not be surprised if the official end of the U.S. recession ends up being, in retrospect, dated sometime this summer," he said in a lecture today at the London School of Economics. "Things seem to be getting worse more slowly. There’s some reason to think that we’re stabilising."

US stocks erased an earlier decline after Krugman made his comments. The Standard & Poor’s 500 Stock Index was little changed at 939.14 in New York after slumping as much as 1.5 per cent earlier, and the Dow Jones Industrial Average gained 1.36 points to 8764.49.

Krugman, a Princeton University economist, has warned recently that the US government hasn’t done enough to help the country’s economy recover. Last month, at a conference in Abu Dhabi, he said the fiscal stimulus is "only enough to mitigate the slump, not induce recovery".

The National Bureau of Economic Research, based in Cambridge, Massachusetts, is the official arbiter of US recessions and expansions. Last week, Robert Hall, the head of the NBER’s business-cycle-dating committee, said it’s "way too early" to say the contraction is over.

The US has been in a recession since December 2007, and the NBER may take months to decide when a trough has been reached. Recent reports have shown an easing of declines in industrial production and other measures that the group reviews when determining whether the economy is in a recession.

Even with a recovery, "almost surely unemployment will keep rising for a long time and there’s a lot of reason to think that the world economy is going to stay depressed for an extended period," Krugman said.

The unemployment rate jumped to 9.4 per cent in May, the highest since 1983, partly reflecting more people joining the labor force to look for work.

The US Federal Reserve’s efforts to stabilise markets - measures that have swelled the central bank’s balance sheet - have helped, Krugman said. "A lot of the spreads in the markets have come down” and “the acute financial stuff seems to have come to a halt," he said.

Fed officials lowered the benchmark interest rate to a target range of zero to 0.25 per cent in December and have switched to using credit programs and outright purchases of Treasuries, mortgage-backed securities and housing agency debt as the main tools of monetary policy.

$US2.31 Trillion

The balance sheet’s size peaked at $US2.31 trillion in December. It has fluctuated around $US2.1 trillion over the past two months.

The Fed’s swollen balance sheet is "a little alarming. In the long run you really don’t want the central banks to be so involved in the business of lending," Krugman said. "But it’s arguably necessary" even if there are questions about "where does it stop?"

p/s photos: Kim Ahep

Opinions On Bad Bank Idea

Overview: Geithner aims to add private funding as a new component of proposals to address the toxic debt clogging banks’ balance sheets next to government guarantees of ring-fenced toxic assets. Aspects of the plan that have been settled include a new round of injections of taxpayer funds into banks, targeted at those identified by regulators as most in need of new capital. Previously, the comprehensive solution that aimed at keeping banks in private hands as outlined in Tim Geithner's confirmation hearing was the set-up of an 'aggregator bank' that buys toxic assets. The main sticking point is the toxic asset valuation issue--> markets gain on prospect of easing mark-to-market accounting rules. Major headache is systemic impact of too-big-to-fail banks. Treasury will outline action plan on February 10.


• Amount of toxic assets: WSJ says combination of guarantee and aggegator bank likely, with the latter buying about $2 trillion in toxic assets. Compare with size of U.S. originated shadow banking system pushing for re-intermediation and access to central bank liquidity is $10 trillion (see Geithner speech June 9). Of these, about $6T in U.S., $4t abroad according to Fed research based on flow of funds data (compare with Goldman estimates (not online) that amount of toxic assets in U.S. is at $5.7T). Moreover, IMF notes in October GFSR that $10T is the likely amount of asset deleveraging at global banks. Simon Johnson estimates U.S. bank rescue will cost $3-4T with net cost to taxpayer of about $1-2T or range of 5-10% of GDP as in past banking crises (via Fortune).

• RGE: for U.S. banks: $1.1T in total loan losses, $600-700bn in current mark-to-market losses based on derivatives and cash bond prices. Compare with Chris Whalen (IRA) estimate for accumulated bank charge offs for 2009 in the neighborhood of $1 trillion vs. $1.5 trillion in Tier 1 Risk Based Capital at all US banks. "The good news, though, is that 2/3 to 3/4 of that loss number comes from the top 4 - Citigroup, Bank of America, JPMorganChase and Wells Fargo, in that order of risk profile."

• Industry proposal with private sector involvement (via Fortune): The idea, as drafted and as articulated by Citigroup's Flexner, is for the government to create a massive new fund to lend money at a fair price to professional investors -- pension funds, hedge funds, private equity funds and endowment funds -- for the sole purpose of providing reliable long-term financing to allow these investors to buy the various "toxic assets" in the secondary market that are now frozen on the balance sheets of financial institutions the world over--> The bet would be that these securities would increase in value over time

• similarly Michael Jaliman 'MBS Economic Freedom Bonds' (without temporary nationalization) and Luigi Spaventa's Brady Bond proposal to clear toxic asset overhang and sever market and funding liquidity negative feedback loop.

• Jeffrey Sachs: The bank can be recapitalized at fair value to taxpayers and without inducing a squeeze on bank capital and lending. The government can swap 20 in government bonds for the 20 in toxic assets plus contingent warrants on bank capital, the value of which depends on the eventual sale price of the toxic assets. The government would then dispose of the 20 in toxic assets at a market price over the course of the next year or two and exercise its contingent warrants at that time. During the period of liquidating the toxic assets, the government would exercise a kind of receivership over the banks in order to prevent asset stripping or 'Hail-Mary' incentives on the part of managers --> In this process, there are no taxpayer bailouts, and there is also no squeeze on bank capital resulting from the exchange of toxic assets at less than face value.
  

• Nouriel Roubini: in the bad bank model the government may overpay for the bad assets as the true value of them is uncertain; even in the guarantee model there can be such implicit over-payment (or over-guarantee that is not properly priced). Thus, paradoxically nationalization may be a more market friendly solution: it creates the biggest hit for common and preferred shareholders of clearly insolvent institutions and – possibly – even the unsecured creditors in case the bank insolvency is too large; it provides a fair upside to the tax-payer; it can resolve the problem of government managing the bad assets by reselling most of the assets and liabilities of the bank to new private shareholders after a clean-up of the bank.

• Robert Pozen: Here's a practical solution to the valuation issue: suppose the Treasury estimates that a toxic asset is worth $700,000. It would pay the bank $560,000 in cash (=80%) plus a capital certificate for $140,000 (=20%). If the government later sold that security for $660,000, the bank would receive an additional cash payment of $80,000 (80% of $100,000, the excess of $660,000 over $560,000). The Treasury would receive the remaining $20,000 of the excess. On the other hand, if the government later sold the security for $550,000, the bank would receive nothing more. The Treasury would absorb a loss of $10,000.

• Willem Buiter (similar arguments by Stiglitz/Romer/Soros): Government should finance and run temporarily one or more good banks, i.e. buy the good assets for which there IS a price by definition and leave the bad assets with the old legacy banks and its shareholders, creditors. Latter will most likely fail and at that point Chapter 7 and 11 are ready--> the state meets its three key objectives: first, its short-run economic stabilisation and crisis-fighting objective; second, its medium and long-term banking sector incentive-enhancing, moral-hazard-minimising objective; and third, its fairness objectives: the polluter pays or, you break it, you own it.

• Paul Krugman: The only way to make effectively insolvent banks viable again without explicit but temporary government takeover and restructuring is if the government pays much more for toxic assets than private buyers are willing to offer. There is no guarantee that paying near fair value prices will make banks solvent again which would require additional capital injections. A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

• Luigi Zingales: Avoid putting any further taxpayer money at risk at all and mandate a sizable debt to equity swap and adjust distributional issues with equity warrants (change in legislation needed).

• Nationalization (Swedish Model):
  Pro: write down toxic assets to market value, then nationalize insolvent banks (receivership) in order to align institution's and taxpayer incentives (Zombie banks are likely to engage in gambling), wipe out equity holders (maybe also debt restructuring needed) instead of subsidizing them with taxpayer money, dismiss management, dispose of them via a new RTC (or bad bank), wind down unviable banks, refinance viable ones, start afresh.
  Con: Government is not in the business of running a commercial bank; potentially large upfront government outlays, what do you do with debt holders?, stigma.

• Backstop guarantee of ring-fenced assets on banks' balance sheets of Citi and BoA:
  Pro: Little upfront outlays for the government
  Con: Open-end government commitment, question of asset valuation unresolved; assets that are good today may turn bad tomorrow (coming loan losses) which may need additional capital, persistent lack of transparency on who holds what, ongoing subsidization of existing share- and debt holders by taxpayers, banks might need additional capital injections.

• Bad Bank or Aggregator Bank (to be run by FDIC):
  Pro: Government purchase of toxic assets off banks' balance sheets contributes to price discovery and helps deleverage balance sheets.
  Con: Big question is at what price should toxic assets be bought? If government buys at market values, many banks will be insolvent anyway as they have to mark down asset values to new price. If price is too high, taxpayer is once again subsidizing eqyity and debt holders. Bernanke advocates 'hold-to-maturity' prices above current market prices.

• 'Bad bank' without nationalization and full writedown of toxic assets to market value is reminiscent of super-SIV that industry did not want to back itself due to asymmetric exposures.

• IMF: Fair value accounting has its problems but it is still the best option available.

p/s photos: Kim Ok Bin

Bashing Conservatives, Nationalising The Banks

by Paul Krugman

Wall Street Voodoo Economics

Published: January 18, 2009

Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans.

But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.

To explain the issue, let me describe the position of a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout.

Why would the government bail Gotham out? Because it plays a central role in the financial system. When Lehman was allowed to fail, financial markets froze, and for a few weeks the world economy teetered on the edge of collapse. Since we don’t want a repeat performance, Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred billion dollars, enough to make it solvent again. But this would, of course, be a huge gift to Gotham’s current shareholders — and it would also encourage excessive risk-taking in the future. Still, the possibility of such a gift is what’s now supporting Gotham’s stock price.

A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

The current buzz suggests, however, that policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward a compromise approach: moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first.

Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, recently tried to describe how this would work: “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?

In my example, Gothamgroup is insolvent because the alleged $400 billion of toxic waste on its books is actually worth only $200 billion. The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth: “We don’t have really any rational pricing right now for some of these asset categories,” Ms. Bair says. But should the government be in the business of declaring that it knows better than the market what assets are worth? And is it really likely that paying “fair value,” whatever that means, would be enough to make Gotham solvent again?

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job. January 19, 2009, 10:24 am

Economists, ideology, and stimulus

There are certainly legitimate arguments against spending-based fiscal stimulus. You can worry about the burden of debt; you can argue that the government will spend money so badly that the jobs created are not worth having; and I’m sure there are other arguments worth taking seriously.

What’s been disturbing, however, is the parade of first-rate economists making totally non-serious arguments against fiscal expansion. You’ve got John Taylor arguing for permanent tax cuts as a response to temporary shocks, apparently oblivious to the logical problems. You’ve got John Cochrane going all Andrew-Mellon-liquidationist on us. You’ve got Eugene Fama reinventing the long-discredited Treasury View. You’ve got Gary Becker apparently unaware that monetary policy has hit the zero lower bound. And you’ve got Greg Mankiw — well, I don’t know what Greg actually believes, he just seems to be approvingly linking to anyone opposed to stimulus, regardless of the quality of their argument.

Needless to say, everyone I’ve mentioned is politically conservative. That’s their right: economists are citizens too. But it’s hard to avoid the conclusion that all of them have decided on political grounds that they don’t want a spending-based fiscal stimulus — and that these political considerations have led them to drop their usual quality-control standards when it comes to economic analysis.

Has there been any comparable outbreak of mass bad economics from good liberal economists? I can’t think of one, although maybe that’s my own politics showing. In any case, what’s happening now is pretty disturbing.

p/s photos: Zhou Wei Tong

Krugman, Nobel Prize Winner, Makes Prediction

Bloomberg /SMH: The winner of the 2008 Nobel Prize for economics said the US is plunging into a ``nasty recession'' with a ``lot of suffering'' to come, even if policy makers succeed in unfreezing the credit markets. ``That's baked in,'' Princeton University professor and New York Times columnist Paul Krugman said in an interview on ``Night Talk'' with Mike Schneider to be broadcast later today on Bloomberg Television. ``There is a lot of downward momentum.'' He said a rise in the unemployment rate to 7% ``seems almost certain'' and he put the odds of an increase to 8% at ``better than even.'' The jobless rate in September stood at a five-year high of 6.1%.

Signs that the economy is falling into a recession multiplied this week with news that retail sales have fallen for three straight months, single-family housing starts hit a 26- year low and consumer confidence plunged the most on record. Krugman voiced some doubts that the steps that Treasury Secretary Henry Paulson is taking to combat the credit crisis will succeed and suggested that more might be needed. Paulson rolled out plans this week to use $US250 billion of taxpayer funds to purchase stakes in thousands of financial firms to try to halt a credit freeze that threatens to bankrupt companies and hammer the job market. ``It's not clear there's enough money,'' Krugman said.

He added that Paulson may also have to insist that the banks use the money they're receiving to make new loans if the plan is to work. ``They may need to be much more interventionist than they have been thus far,'' the Princeton professor said.

p/s photos: Pevita Pearce

Krugman Wins Nobel Prize, On The Current Turmoil

Paul Krugman, the Princeton University scholar, New York Times columnist and unabashed liberal, won the Nobel prize in economics Monday for his analysis of how economies of scale can affect international trade patterns. Perhaps better known as a columnist than an economist to the public, Krugman has also come out forcefully against John McCain during the economic meltdown, saying the Republican presidential candidate is "more frightening now than he was a few weeks ago." Krugman also has derided the Republicans as becoming "the party of stupid." Not one to tone down his opinions, Krugman has compared the current financial crisis to the devastation of the 1930s.

"We are now witnessing a crisis that is as severe as the crisis that hit Asia in the 90's. This crisis bears some resemblance to the Great Depression," Krugman told reporters Monday. But he was optimistic that a global effort aimed at stemming the financial blood loss had taken root. "I'm slightly less terrified today than I was on Friday," he said, referring to the weekend crisis talks among European leaders that led to the nationalization of British banks, unlimited access to U.S. dollars to banks worldwide and efforts to stave off a global recession.

In contrast to his treatment of U.S. officials, Krugman has praised Britain's financial leaders for their nimble response to the credit crisis. In a column Monday in the New York Times, Krugman wrote that British Prime Minister Gordon Brown and Chancellor Alistair Darling "defined the character of the worldwide rescue effort, with other wealthy nations playing catch-up."

Whereas U.S. Treasury Secretary Henry Paulson at first rejected giving financial institutions more money in return for a share of ownership, the British government "went straight to the heart of the problem ... with stunning speed," he wrote. "And whaddya know," Krugman continued, "Mr. Paulson — after arguably wasting several precious weeks — has also reversed course, and now plans to buy equity stakes rather than bad mortgage securities."

The Royal Swedish Academy of Sciences praised Krugman for formulating a new theory to answer questions about free trade and said his theory had inspired an enormous field of research. "What are the effects of free trade and globalization? What are the driving forces behind worldwide urbanization? Paul Krugman has formulated a new theory to answer these questions," the academy said in its citation. "He has thereby integrated the previously disparate research fields of international trade and economic geography," it said.

The award, known as the Nobel Memorial Prize in Economic Sciences, is the last of the six Nobel prizes announced this year and is not one of the original Nobels. It was created in 1968 by the Swedish central bank in Alfred Nobel's memory.

In addition to his work as an economist at Princeton University in New Jersey, where he has been since 2000, Krugman has written for Foreign Affairs, the Harvard Business Review and Scientific American, among other publications.

He graduated with a bachelor's degree from Yale in 1974 and received a Ph.D. from MIT in 1977. Besides teaching at Yale and MIT, he also taught at Stanford.

p/s photos: Aum Patcharapa Chaichua