Friday, August 27, 2010 

Economic Events of the Week

Friday – Q2 GDP, Bernanke Speech

Story of the Day
The Parent Model (David Brooks in the New York Times)

Washington Update
An Autopsy of Fannie Mae and Freddie Mac (Economix)

Market Talk
Focus Sharpens on Fed Chairman (Financial Times)
Flow of Imports Drags Down Economic Growth (Washington Post)

Editorials & Opinion
To Overhaul the GSEs, Divide Them into Three Parts (Alex Pollock in AEI)
More Thoughts on What to Expect from the Fed (James Hamilton in Roubini Global Economics)
The Medicare Reform Illusion (Michael Leavitt in Washington Post)
The Yield Spread and the Odds of Recession (DMarron.com)

Story of the Day

The Parent Model (David Brooks in the New York Times)

During the first half of this year, German and American political leaders engaged in an epic debate on the need for stimulus. The Americans borrowed an amount equal to 6 percent of G.D.P. in an attempt to stimulate growth. The Germans spent about 1.5 percent of G.D.P. on their stimulus. Who was right? The early returns suggest the Germans were. The U.S. economy is scuffling along while the German economy is growing at a sizzling 9 percent annual rate. Over the past few years, the Germans have taken brave measures to minimize their disadvantages. As an editorial from the superb online think tank e21 reminds us, the Germans have recently reduced labor market regulation, increased wage flexibility and taken strong measures to balance budgets.

Washington Update

An Autopsy of Fannie Mae and Freddie Mac (Economix)

Fannie's and Freddie's regulator released a report yesterday on the financial condition of the government sponsored enterprises. There are a few key points. First, Fannie and Freddie did not cause the housing bubble. Second, the companies bought and guaranteed bad loans with reckless abandon. Their underwriting standards jumped off the same cliff as every other participant in the mortgage market. Third, some proponents of federal subsidies for mortgage lending have argued that the companies went off the rails by pursuing investments on the side, but that their basic guarantee business was sound. However, the companies’ losses are mostly in their core business of guaranteeing loans, not in their investment portfolios.

Market Talk

Focus Sharpens on Fed Chairman (Financial Times)

A steady decline in the economic data, coupled with sharp falls in the markets since the Fed’s surprise move on August 10 to stop shrinking its balance sheet, mean a ferment of interest in what the US central bank will do next. The spotlight on Ben Bernanke, Fed chairman, will therefore be even brighter than usual when he opens the conference on Friday morning with a half-hour speech on the economic outlook and the Fed’s policy response. To add to the drama, the Bureau of Economic Analysis is likely to highlight the faltering recovery just before Mr Bernanke stands up to speak, by revising second-quarter growth sharply downwards.

Flow of Imports Drags Down Economic Growth (Washington Post)

A widening U.S. trade deficit has become a substantial drag on economic growth as the country's exports struggle to keep pace with the swelling sums that Americans are again spending on imported goods. The rise in the trade deficit, including an abrupt 16 percent spike in June, is a chief reason economists are downgrading estimates for recent U.S. economic growth. Statistics to be released Friday are expected to show that the economy grew more slowly from April to June than initially thought, with a group of analysts polled by Bloomberg cutting their growth estimates to an annualized rate of 1.4 percent, down from 2.4 percent as reported by the government late last month.

Editorials & Opinion

To Overhaul the GSEs, Divide Them into Three Parts (Alex Pollock in AEI)

Since the entire intellectual premise of the Dodd-Frank regulatory expansion act is that government intervention in financial markets will improve things, it was obviously difficult for its supporters to admit that the massive intervention represented by Fannie and Freddie turned out to be a massive government blunder. Does the 21st century need GSEs in order to have securitization of prime mortgage loans? No, it doesn't. As we move into the future mortgage finance system, the prime mortgage market should stand on its own.

More Thoughts on What to Expect from the Fed (James Hamilton in Roubini Global Economics)

There is disagreement within the FOMC. How will it be resolved? I have suggested that ongoing deterioration of economic conditions will be the critical factor that triggers the Fed's next move. On this, Exhibit A might be today's report that new Home sales set an all-time low in July. But in addition to the direct effect on GDP, there may also be financial ramifications of the new downturn in real estate. Of the $1.4 trillion of commercial-real-estate debt coming due by the end of 2014, roughly 52% is attached to properties that are underwater.

The Medicare Reform Illusion (Michael Leavitt in Washington Post)

What's needed is a new vision for Medicare. Instead of micromanaging prices, the federal government should provide oversight of a marketplace in which cost-conscious seniors choose among competing insurance and delivery system options. That's how the new drug benefit works, and costs have come in much lower than expected because genuine price competition drives down costs much more than any payment regulation can. What Congress passed this spring is the illusion of Medicare reform. It does not ease cost pressures but papers over them with unsustainable price controls. It will end in disappointment, just as every other such effort has.

The Yield Spread and the Odds of Recession (DMarron.com)

So how likely is a return to recession? Researchers at the San Francisco Fed took a crack at this question a few weeks ago. Their answer? It depends. When they used a traditional model based on the leading economic indicators, the probability of a second dip turned out to be about 25% over the next two years. When they dropped one indicator from their model, that probability doubled to about 50%.

e21: Economic Policies for the 21st Century is a nonprofit, nonpartisan organization dedicated to economic research and innovative public policies for the 21st century. Drawing on the expertise of practitioners, policymakers, and academics, we aim to advance free enterprise, fiscal discipline, economic growth, and the rule of law.

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