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In-Depth Research

http://cbo.gov/ftpdocs/115xx/doc11579/06-30-LTBO.pdf

The Long-Term Budget Outlook

Congressional Budget Office | CBO | August 6, 2010

This Congressional Budget Office (CBO) report examines the pressures on the federal budget by presenting the agency’s projections of federal spending and revenues over the coming decades. Under current laws and policies, an aging population and rapidly rising health care costs will sharply increase federal spending for health care programs and Social Security. Unless revenues increase at a similar pace, such spending will cause federal debt to grow to unsustainable levels. If policymakers are to put the nation on a sustainable budgetary path, they will need to let revenues increase substantially as a percentage of gross domestic product, decrease spending significantly from projected levels, or adopt some combination of those two approaches.

How the Great Recession Was Brought to an End

Alan S Blinder and Mark Zandi | Princeton | July 27, 2010

The U.S. government’s response to the financial crisis and ensuing Great Recession included some of the most aggressive fiscal and monetary policies in history. The response was multifaceted and bipartisan, involving the Federal Reserve, Congress, and two administrations. Yet almost every one of these policy initiatives remain controversial to this day, with critics calling them misguided, ineffective or both. The debate over these policies is crucial because, with the economy still weak, more government support may be needed, as seen recently in both the extension of unemployment benefits and the Fed’s consideration of further easing.

http://cbo.gov/ftpdocs/116xx/doc11659/07-27_Debt_FiscalCrisis_Brief.pdf

Federal Debt and the Risk of a Fiscal Crisis

Economic and Budget Issue Brief | CBO | July 27, 2010

Over the past few years, U.S. government debt held by the public has grown rapidly—to the point that, compared with the total output of the economy, it is now higher than it has ever been except during the period around World War II. The recent increase in debt has been the result of three sets of factors: an imbalance between federal revenues and spending that predates the recession and the recent turmoil in financial markets, sharply lower revenues and elevated spending that derive directly from those economic conditions, and the costs of various federal policies implemented in response to the conditions.

http://www.frbsf.org/publications/economics/letter/2010/el2010-20.pdf

Fiscal Crises of the States: Causes and Consequences

Jeremy Gerst and Daniel Wilson | FRBSF | July 6, 2010

The recession that began in late 2007 severely reduced state tax revenue and increased demand for many public services. In the near term, institutional and political factors limit the options states have for cutting spending and raising taxes. Aid to states in the federal economic program is winding down next year and the situation is likely to get worse before it gets better. Painful budgetary choices lie ahead for many states, though the drag on the national economy should be modest.

http://www.cfr.org/content/publications/attachments/CGS_WorkingPaper10_CapitalFlows06-10.pdf

How Dangerous Is U.S. Government Debt?

Francis E. Warnock | Council on Foreign Relations | June 29, 2010

The dollar’s status as the world’s reserve currency has become a facet of U.S. power, allowing the United States to borrow effortlessly and sustain an assertive foreign policy. But the capital inflows associated with the dollar’s reserve-currency status have created a vulnerability, too, opening the door to a foreign sell-off of U.S. securities that could drive up U.S. interest rates. In this Center for Geoeconomic Studies Capital Flows Quarterly, Francis E. Warnock argues that a sell-off came close to happening in 2009. How the United States uses this reprieve will affect the nation’s ability to borrow for years to come, with broad implications for the sustainability of an active U.S. foreign policy.

Analysis: China Reintroduces Currency Flexibility

Economics Group | Wells Fargo | June 22, 2010

In July 2005, Chinese officials decided to allow some flexibility in the exchange value of the renminbi. However, as uncertainty about global economic prospects spiked in the summer of 2008, the appreciation of the yuan versus the dollar came to a grinding halt and the exchange rate remained essentially fixed over the next two years. Over this past weekend, Chinese officials reverted to their 2005-2008 policy when they announced their intention to “proceed further with reform of the renminbi exchange rate regime and to enhance the renminbi exchange rate flexibility.”

http://www.frbsf.org/publications/economics/letter/2010/el2010-18.pdf

The Fed's Exit Strategy for Monetary Policy

Glenn D. Rudebusch | Federal Reserve Bank of San Francisco | June 14, 2010

As the financial crisis has receded, the Federal Reserve has scaled back its extraordinary provision of liquidity. Eventually, the Fed will remove all remaining monetary stimulus by raising the federal funds rate and shrinking its balance sheet. The timing of such renormalizations depends crucially on evolving economic conditions.

http://americanactionforum.org/files/LaborMktsHCRAAF5-27-10_0.pdf

Labor Markets and Health Care Reform: New Results

Douglas Holtz-Eakin and Cameron Smith | American Action Forum | June 7, 2010

The Patient Protection and Affordable Care Act (PPAC) will have profound implications for U.S. labor markets. The PPAC is fiscally dangerous, raising the risk of higher labor (and other) taxes at a time when the job market is struggling. It provides strong incentives for employers – with the agreement of their employees – to drop employer-sponsored health insurance for as many as 35 million Americans, perhaps leading to widespread turmoil in labor compensation and employee insurance coverage – and raising the gross taxpayer cost of the subsidies to roughly $1.4 trillion in the first 10 years. Finally, the bill exacerbates the already-high effective marginal tax rates on low-income workers. Every worker forced onto the subsidized exchanges will face higher barriers to upward mobility and the pursuit of the American Dream.

http://economics21.org/files/pdfs/commentary/05_24_2010_Whither.pdf

Whither Fannie and Freddie? A Proposal for Reforming the Housing GSEs

Donald Marron and Phillip Swagel | e21 | May 24, 2010

We propose a specific reform of Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSEs) that securitize and guarantee conforming mortgages.  Our plan protects taxpayers and the overall economy from the systemic risk posed by the former GSE model, while ensuring that financing remains available for housing even in periods of credit market strains.  Under this proposal the two firms would become private companies that buy conforming mortgages and bundle them into securities that are eligible for government backing. The reformed firms would not have the investment portfolios that were the main source of risk under their previous structure. The federal government would offer a guarantee on mortgage-backed securities composed of conforming loans. This guarantee would be explicit, backed by the full faith and credit of the United States. To compensate taxpayers for taking on housing risk, Fannie and Freddie would pay an actuarially fair fee to the government in return for the guarantee, and the shareholders of the firms would take losses before the government guarantee kicks in. Other private firms such as bank subsidiaries would be allowed to compete by securitizing conforming loans and purchasing the government guarantee. Over time, entry into these activities would help ensure that the benefits of the government support are passed through to homeowners and would reduce the risk that the failure of any one firm would pose a threat to the housing market or the overall economy.

Are State Public Pensions Sustainable? Why the Federal Government Should Worry About State Pension Liabilities

Joshua D. Rauh | NBER | May 15, 2010
This paper analyzes the flow of state pension benefit payments relative to asset levels and contributions. Assuming future state contributions fund the full present value of new benefits, many state systems will run out of money in 10-20 years if some attempt is not made to improve the funding of liabilities that have already been accrued. The expected shortfalls raise the possibility that the federal government will be faced with a decision as to whether to bail out states driven to insolvency by their pension programs.

How Did a Domestic Housing Slump Turn into a Global Financial Crisis?

Steven B. Kamin and Laurie Pounder DeMarco | Federal Reserve Board | May 6, 2010

The global financial crisis clearly started with problems in the U.S. subprime sector and spread across the world from there. But was the direct exposure of foreigners to the U.S. financial system a key driver of the crisis, or did other factors account for its rapid contagion across the world? The U.S. subprime crisis, rather than being a fundamental driver of the global crisis, may have been merely a trigger for a global bank run and for disillusionment with a risky business model that already had spread around the world.

Bankruptcy's Financial Crisis Accelerator: The Derivatives Players' Priorities in Chapter 11

Mark J. Roe | SSRN | May 5, 2010
Chapter 11 bars bankrupts from immediately repaying their creditors, so that the court can reorganize the debtor without creditors shredding the bankrupt firm’s business. Not so for the bankrupt’s derivatives counterparties, who can seize and liquidate collateral, net out gains and losses, terminate their contracts with the bankrupt, and keep both preferential eve-of-bankruptcy payments and fraudulent conveyances they obtained from the debtor in ways that favor them over other creditors. Their right to jump to the head of the bankruptcy repayment line, ahead of even ordinary secured creditors, warps their pre-bankruptcy incentives both to monitor the pre-bankruptcy debtor and to adjust their investments to better account for counterparty risk, since they do well in any resulting bankruptcy.

Bank Concentration and Crises

Ross Levine, Thorsten Beck and Asli Demirguc-Kunt | NBER | April 27, 2010

Levine, Beck and Demirguc-Kunt find that concentrated banking systems were less likely to have banking crises. They study the impact of bank concentration, bank regulations, and national institutions on the probability of experiencing a systemic banking crisis. In their study, they rely on data gathered from 70 countries over the period 1980-97. It is the first paper to examine the impact of concentration on crises across a broad cross-section of nations while controlling for differences in regulatory policies, national institutions governing property rights and economic freedom, the ownership structure of banks, and macroeconomic and financial conditions.

Too many to fail – An analysis of time-inconsistency in bank closure policies

Viral V. Acharyaa and Tanju Yorulmazerc | Journal of Financial Intermediation | April 27, 2010

While the too-big-to-fail guarantee is explicitly a part of bank regulation in many countries, this paper shows that bank closure policies also suffer from an implicit “too-many-to-fail” problem: when the number of bank failures is large, the regulator finds it ex-post optimal to bail out some or all failed banks, whereas when the number of bank failures is small, failed banks can be acquired by the surviving banks. This gives banks incentives to herd and increases the risk that many banks may fail together. The ex-post optimal regulation may thus be time-inconsistent or sub-optimal from an ex-ante standpoint. In contrast to the too-big-to-fail problem which mainly affects large banks, the study shows that the too-many-to-fail problem affects small banks more by giving them stronger incentives to herd.

/files/pdfs/commentary/04_19_2010_calomiris_mason_governance.pdf

Conflicts of Interest, Low-Quality Ratings, and Meaningful Reform of Credit and Corporate Governance Ratings

Charles W. Calomiris and Joseph R. Mason | e21 | April 19, 2010
Policymakers and academic critics have identified “conflicts of interest” in the rating industry that have led to poor ratings quality, harming investors who purchase over- or mis-rated investments. We address the question of whether conflicts of interest can arise in the ratings industry without the monopoly benefit conferred by regulatory licenses like those given credit rating agencies that operate as Nationally Recognized Statistical Ratings Organizations (NRSRO). We show that incentive conflicts are apparent in the corporate governance rating industry, despite the lack of a formal regulatory role for the agencies.