The Fuel for the Financial Crisis Fire

Many of the people I've talked to about the financial crisis like to suggest that the cause for the financial crisis was the change in lending practices of Fannie Mae during the Clinton Administration (1999). Although these changes did increase the risk on the balance sheet of the largest mortgage lender in the US, I don't feel this played a significant role in getting us to where we are now.

The reason, because in 1999 and until April 2004, the amount of capital that could be leveraged by investment banks was capped. However, this rule changed on April 24, 2004 for any investment bank over $5 billion in market capitalization. Banks who qualified were now allowed to almost double the amount of leverage. Who qualified under this little known rule change? Just 5 companies.... maybe you remember them: Bear Sterns, Lehman Brothers, Merrill Lynch, Mogan Stanley, and Goldman Sachs.

So before the rule change, the fuel that could be put on the fire was at least known and limited, after the rule change, the fuel [read potential disaster] almost doubled.

This is a slideshow by the NY Times. What's great about this is the actual audio from the meeting when this rule change was debated and passed.

"The Day the SEC Changed the Game"

http://www.nytimes.com/interactive/2008/09/28/business/20080928-SEC-multimedia/index.html

Econ Forum 2/23/09 @ Millersville University

An Inconvenient Monetary Base?

Recently, a student of mine shared with me a YouTube video of a Glenn Beck (Fox News) piece on... well, that's what I'm not sure about.

You tell me, what's the chart about and what point is Beck trying to make?

http://www.youtube.com/watch?v=C7Xu3xUkpEE


If you said that the chart is about our national debt and Beck is making the point that it's immoral to leave such a large national debt as the one he appears to point to in the chart... well, you are wrong. Join the majority of people who watch Beck and, sadly, I think Beck believes this too. However, I do agree with the point Beck is trying to make about the national debt, if only it had anything to do with the debt.

What Glenn Beck actually has in the unlabeled chart is the "Adjusted Monetary Base and Reserves" from the St. Louis Federal Reserve Bank (go here to see the actual chart: http://research.stlouisfed.org/fred2/series/AMBNS).

The adjusted monetary base is a measure of the currency in circulation and the cash reserves banks have in an account with the Federal Reserve (both required and excess reserves). In essence, this is the Fed's balance sheet, specifically the Fed's liabilities. In September 2008, this measure began to grow faster than during any other time since the beginning of the Federal Reserve System. There are a couple of reasons for the excessive growth in the monetary base since September 2008. First, the Fed has been adding to the excess reserves of banks by buying distressed bank assets and replacing them with Treasury bills. The Fed then engages in open market operations and buys the Treasury Bills, giving the banks excess cash. Hence, what was not on the Federal Reserves balance sheet before the crisis is now on their balance sheet, some of which is in the form of bank reserves. The idea here is that with these excess reserves (instead of "toxic" assets) and added liquidity, the banks will have the ability and incentive to make new loans.

Second, and I feel the most significant factor in the growth of the monetary base, is that the Fed began to pay interest on the reserves of banks starting in October 2008. Before this time, any bank reserves held by the Fed came at a significant opportunity cost because they did not earn interest. Hence banks only kept their "required" minimum reserves in their account with the Fed. Since the change, banks began putting their excess reserves in their Fed account. Why? Well, to earn interest and because the Fed appears to be a much safer place to put money than in the hands of borrowers in such an uncertain economy. Yes, this policy does seem to go against the idea of getting banks to loan money, but the Fed argues that this measure is important in their ability to manage interest rates in this environment (for the Fed's explanation read: http://www.newyorkfed.org/markets/ior_faq.html).

So think about it. If you are a bank and you had excess reserves before this rule change, you might consider loaning the money out to the public or other banks, albeit cautiously. But now that the Fed is paying interest, and although it's not a great return on excess reserves, given the alternative which is to lend to the public in this economic environment, I think I'd go with the Fed too. Hence, the Fed's balance sheet has soared and the Adjusted Monetary Base has soared and that's what Beck had in his chart as he went up his "An Inconvenient Debt" lift.

What's this all mean? Well, for one, this does not have much to do with the national debt which is what I took away from Beck's video. It means that there is a significant amount of bank reserves waiting for some stability in the economy and when that happens, it would be logical to expect banks to lend to the public. With a significant amount of potential lending, there is a risk of inflation but we are a long way from there and the Fed has tools to control the amount of lending when the time is right.

I know, I know... you question the Fed's ability to control or time anything... that will have to wait for another post.

Stimulus Bill = Government Jobs for Recent Grads

It is even hard for the experts to predict how many and where new jobs will be created from the stimulus bill. But it seems obvious to me that in order for the government to manage various aspects of the stimulus bill, they will need to hire workers. I think this is one place where job creation is almost certain. I asked one of my students, Jillian Golomboski, to find out some information and here is what she has to report.

With the troubled state of the economy, it is scary as a student to think about attempting to find a job after college graduation. However, the recently passes stimulus bill is predicted to save or create 3.5 million jobs across the US which some people are optimistic about. As a college student in hopes of getting a job after graduation, or as a graduate in the middle of a job search, it would be nice to have a way of finding the government jobs that are being created.

These jobs can be searched for at USAjobs.gov which is a government website that is similar to other job search engines but is specific to government positions. This website is a great place to find new jobs that are opening due to the recently signed stimulus bill. On the site, you can search for a specific position you may be looking for, a certain city you may want to live in, or both. You can also find info about which jobs are currently in high demand. The website allows you to post a resume so recruiters can contact you or you can apply for positions online and send your resume in yourself.

As a member of the site, USAJOBS will keep you updated by sending you alerts and updates on the latest listings. The site will give you tips on searching for jobs so you can find the position you are looking for and the site has guides that can help you with the basic tasks of applying for a job.

In addition, studentjobs.gov is a website that can be helpful for current students. It can help you find internships in both government and non government organizations. It also connects you with different websites to search for careers, many of which are government related.

written by Jillian Golomboski

Lesson on "Real" vs. "Nominal"

Here's a lesson idea that builds off my post in "More Than Just Invisible Hands" about the hidden shift in state funding for students attending the state system universities (Post on February 7, 2009, "The Hidden Shift in Higher Education Funding").



If you want to adjust a series of current dollar values (a.k.a "nominal") like wages, prices, or investment returns, for inflation (a.k.a. "real"), you first need a price index. A price index is created by taking a basket of goods or services and tracking the purchasing power needed to buy the same basket over time. The basket, theoretically, doesn't change resulting in a consistent measure of inflation. There are many price indices available for use depending on what you want to adjust for inflation. The Bureau of Labor Statisics is a good source for price indices and so is Economagic.



The Consumer Price Index is a common price index used to adjust many statistics for inflation. One example is the Cost of Living Adjustment (COLA), that adjusts the amount retirees receive in Social Security benefits. The purpose of the SS system is to provide retirees with an adequate amount of income to live on consistent (to a point) with the standard of living they had when they retired. If SS benefits were not adjusted for inflation, then the purchasing power of the money they receive would buy less and less over time.



There are other price indices that may be better measures of inflation for specific goods or services. If you were interest in adjusting wages for inflation then you would use the "employment cost index" and you could choose a version of the ECI for the particular occupation or industry.



In the post, I was interested in adjusting the appropriation from the state and the cost of tuition and fees for a general measure of inflation so I chose the CPI for all goods and services in the Mid-Atlantic region (since the data represents PA).



Here is an excerpt from my excel spreadsheet.

Year	Nominal State Appropriation per FTE student	CPI - PA,NJ,DE,MD	Real or Inflation Adjusted Appropriation per FTE Student
1983-84	$3,003	105.6
1984-85	$3,182	110.7	$3,148
1985-86	$3,349	112.6	$3,202
1986-87	$3,449	118.9	$3,381
1987-88	$3,497	125.6	$3,572
1988-89	$3,596	129.9	$3,694
1989-90	$3,751	139.4	$3,964
1990-91	$3,711	144.4	$4,106
1991-92	$3,980	147.5	$4,195
1992-93	$3,916	151.3	$4,303
1993-94	$4,196	155.4	$4,419
1994-95	$4,432	159.1	$4,524
1995-96	$4,553	164.3	$4,672
1996-97	$4,567	166.4	$4,732
1997-98	$4,572	169	$4,806
1998-99	$4,736	172.9	$4,917
1999-00	$4,869	177.5	$5,048
2000-01	$4,921	179.9	$5,116
2001-02	$4,842	185.3	$5,269
2002-03	$4,575	189	$5,375
2003-04	$4,294	197.8	$5,625
2004-05	$4,376	204.9	$5,827
2005-06	$4,408	211.6	$6,017
2006-07	$4,564	219.03	$6,229
2007-08	$4,669	218.19	$6,205

FTE = Full Time Equivalent student



As you can see, once you adjust the nominal appropriation for inflation, it starts to fall short of the inflation adjusted value around 1988. By the end of 2008, the two measures are $1600 apart.



To calculate the "real" column, use the following equation:

where t = year of the inflation adjusted value

By adjusting the data for inflation, we can see that despite the nominal value per student increasing every year, the inflation adjusted value should be much more. In other words, the actual contribution from the state subsidizes a lot less of a college education in 2008 than it did in 1984 and students are paying more for their education.

"Buy American" - Really?

Watch CBS Videos Online

I'm watching the 60 minutes episode regarding the "Buy American" aspects of the stimulus package and cannot help but post a comment on the policy. This is a shortsighted policy and it exemplifies the general public's lack of understanding about economics and trade.

By forcing firms to buy American made steel, prices for US steel will rise. The policy eliminates some of the world's largest producers of steel from our markets and removes some of the competitive pressure keeping our steel producers productive and efficient - the same competitive pressure that has led to a resurgence of the US steel industry in the last decade.*

Any microeconomics student will tell you that both of these factors will lead to higher domestic prices. Higher domestic steel prices will decrease the supply of steel intensive products and this will in turn increase the prices of many durable goods. So although this policy may have short run positive effects specific to the domestic steel industry, it has the potential to have much larger and longer lasting costs to the entire economy. On net, the economy, the taxpayer, and the consumer lose.

Many like to argue that one reason to protect domestic industries is that free trade really isn't free - that other countries are playing by a different set of rules and we need to support our domestic industries. But I would ask, why do we care? If China is using its wealth or its citizens' tax dollars to subsidize its steel industry, then what they are basically doing is transferring their wealth to us. We can buy cheap subsidized steel (or cheaper steel from other parts of the world who are trying to compete with China). Caterpillar can build cheaper earth moving equipment. Harley-Davidson can produce cheaper bikes. As the economy turns, builders can use cheaper steel in their buildings. Consumers will buy cheaper washers, dryers, and cars. The money US corporations and consumers save on cheaper steel can go to shareholders, new technologies, and new products. Will the US steel industry be hurt? Yes, but the argument from above is now reversed. The US economy, taxpayer, and consumer stand to benefit by more than what the steel industry loses. On net, this is a win for the US economy.

It is certainly hard to think about the big picture when it’s your husband, wife, or friend who is laid off. But there may be better ways to deal with the problem then protectionist trade policies. “Buy American” will, on net, reduce our GDP and make consumers worse off. So instead, let’s try to conservatively estimate the cost we will likely incur from a “Buy American” policy and use that money to instead create an “Educate Americans” policy where workers who lose their job can receive education and training in other industries and professions or we can invest into new research and development. This way, we are investing into human capital and R&D that have the potential to increase the economic pie and we are not incurring a cost that basically only benefits one industry. Think about this too… what does “Buy American” get us in the long run when the economy recovers... higher steel prices and less efficient steel producers who were protected from their competition?

What will be the reason for government assistance then... bad government policy?

* What's funny about this is that the American steel industry and Nucor are praised during the episode for their resurgence over the last decade. It can be argued that the lack of a bailout of the steel industry over a decade ago and the subsequent bankruptcies of many inefficient steel companies is one of the main reasons for industry's new competitive outlook. Although painful for the people and families associated with the industry at that time, the survival, health, and productivity of the US steel industry today is a direct result.

Even Calvin Needs a Stimulus Bill

I saw the cartoon years ago (big Calvin and Hobbes fan). Recently, this was posted on Greg Mankiw's Blog and it reminded me of how much I enjoy Calvin and Hobbes cartoons.

The Hidden Shift in Higher Education Funding

I recently took a look at the Factbook for the PA State System for Higher Education. As an economist and an employee of a state university, I was interested in the breakdown of funding over time. I noticed that the data regarding state funding and tuition reveune were not adjusted for inflation. After adjusting for inflation, this is what I found:

Click on graph to view

The graph above shows how there has been a significant shift in pushing more of the cost of a college education in the state's "true" public university system on to the student. The magnitude of this "hidden" shift can only be seen once the data are adjusted for inflation.

Educational and General revenue (E&G) per full time student (FTE) is based on tuition and fees. From 1983-1991, the amount of revenue coming from students increased but remained consistent with the rate of inflation. Then in 1992, the amount of revenue from tuition and fees began to rise faster than the rate of inflation. Explanations for the increase in tuition and fees might include the rising costs of higher education (faster than the rate of inflation) and the expansion of the state system. However based on the data regarding the state's appropriation, another explanation emerges - a change in political philosophy resulting in more of the cost burden being borne by students and less by taxpayers.

If, as many in the state legislature have claimed over the years, the reason for increasing tuition and fees ABOVE the rate of inflation is due to the rising cost of a college education, then why not attempt to split the burden between students and taxpayers? After all, the idea of a public higher education system is to provide the state's residents with a more educated and productive labor force (positive externalities) as well as a government solution to the market failure in credit markets for educational loans. But after looking at the inflation adjusted data, it's clear that the cost burden has shifted on to students.

From 1992-2001, the state's budget appropriation per student remained consistent with the rate of inflation. Yet, at the same time, revenue from student tuition and fees was approximately $2000 more than the inflation adjusted amount. Thus for almost a decade, students continued to contribute more to the state system's operations while taxpayers saw no change.

Then, after keeping pace with the rate of inflation from 1984-2000, the inflation adjusted appropriation per full time student began to fall short. Coincidentally, this was the first year for the new Chancellor, Judy Hample. With tuition and fees running above the rate of inflation and appropriations running below, a gap has opened up and the student is falling through.

By the end of the 2008 school year, students were contributing over $12,700 in tuition and fees while the inflation adjusted amount was just over $9800 and they were receiving approximately $4600 in state funding while the inflation adjusted amount was $6200. On an inflation adjusted basis, they were over paying by almost $3000 and under funded almost $1600 in the 07-08 academic year - the hidden shift that has significantly burdened students.

Funding for State Universities in PA

Given recent news regarding the state budget, I thought that I’d post an op-ed that I wrote 2 years ago. Recently, Governor Rendell asked each of the state owned universities to set aside over 4% of their current budget just in case the state wants it back. Yes, these are very difficult times and all parts of government need to sacrifice, but many taxpayers are unaware of the relationship between the various “public” colleges and universities in PA. At a time when state funding is being cut and the true state university system has no other choice but to let it affect quality, is it time to ask the wealthier “state-related” universities to dip into their endowments?

_____
Excerpt from op-ed published in March 2007:

Along with all of the other consumers, property owners, and workers in the state, my tax dollars partially fund the education of students attending the 14 state-owned universities known as the State System for Higher Education (PASSHE). Our tax dollars also partially fund the education of students attending the 4 state-related universities, Penn State, Pitt, Temple, and Lincoln as well as students attending select private institutions.

According to the Department of Education’s Summary of State Appropriations for February 2007 (available at www.pde.state.pa.us), taxpayers spent approximately $465 million on the 14 state-owned universities (PASSHE), $644 million on the 4 state-related universities, and $83 million on select private colleges and universities. Based on published enrollment figures, PASSHE received approximately $4,266 per student. Penn State received approximately $4,093 in taxpayer dollars per student, Pitt received $4,941, Temple received $4,985, and Lincoln received $4,095 per student.

Taxpayers might not realize that although their tax dollars support the education of over 250,000 students, the institutions are not created equal. The University of Pittsburgh has the 8th largest endowment of any public university in the country at $1.6 billion and Penn State ranks 12th with an endowment over $1.2 billion according to the National Association of College and University Business Officers.* Combined, Pitt, Penn State, and Temple have an endowment of over $3 billion, over $20,000 per enrolled student. PASSHE, the 14 state-owned universities, has a combined endowment of $209 million, approximately $1,900 per enrolled student.

All of these institutions provide tremendous benefits for the Commonwealth and the students who attend. Yet as budgets shrink and taxpayers demand more accountability, I feel it is important that taxpayers understand the economics and politics of higher education funding in the Commonwealth.

*Data from 2007