Its unclear how much hair is actually left in Greece, but its debt has gone from "Haircut" (here and here) to firesale. The first haircut was 50% in October 2011, but by early 2012 more haircuts were on the docket. This is not all that surprising since few economists thought a credible plan for Greek debt management has been presented. So the term "haircut" is actually quite fitting in the context, since regular trips to the barber are the status quo (unless you are bald).

Back to the news, today Greece managed a more permanent solution to its debt troubles: it bought back its own debt (for pennies on the dollar, or better $0.32 – $0,40 cents per dollar of debt) using other peoples' money (the European Financial Stability Facility (EFSF)). Interesting transactions: Europeans paying Greece to buy back Greek debt that is (mostly) held by Europeans. Why?

Haircut or firesale, Greek debt is still forecast rise to a whopping 188% of Greek GDP. Definitely default range. 

George Bush's much hated but much needed TARP program (these days mysteriously attributed to Democrats) resulted in an 8.2% return… Check out (here) if your bank got some – the odds are it did, the list is long.

One line of reasoning holds that Fannie Mae and Freddie Mac – the two quasi governmental agencies that are now in receivership and fully owned by the tax payer – caused the housing bubble. It took until now to inform this discussion with actual data. The NYT has the abstract and the entire report can be found here.

Interestingly, the Federal Housing Finance Agency suggests Fannie and Freddie did not cause the housing bubble, since one can think of the money that poured into the housing market as cash that was piled on on top of Fannie and Freddie's regular annual mortgage financing (in blue below). This reduced Fannie and Freddie's share of the US housing finance by about 50% in 4 years. 

Source: Inside Mortgage Finance

Right now it seems pointless to assign blame, the housing market is getting downright scary. New mortgage delinquencies are still increasing in the US and the decline in overall delinquency (still near all time highs) came only because of some loan modifications that targeted 90+ day delinquent loans.

See Calculated Risk Post: MBA Q2 2010: 14.42% of Mortgage Loans Delinquent or in Foreclosure

These delinquencies are partly explained by the high unemployment, but also by the negative equity that so many Americans now hold:

My plumber in Seattle (making $90/hour) proudly told he stopped paying his mortgage, since he is 20% under water. Scarily, the above chart suggests this level of negative equity is about average for the state.  

Pictures of the Great Recession brought to you by the Center for Budget and Policy Prioritiesnter on Budget and Policy Priorities

Output has recovered in the US

but employment is still absolutely dismal

And there is little evidence for an imminent hiring spree.

New evidence that economists had the entire stimulus vs. no stimulus debate 80 years ago. Damning evidence against economics as a science. What is the definition of progress/consensus if 80 years of theories and data do not produce insights into such fundamental events as great depressions/recessions. This tête-à-tête between Keynes et al. and Hayek et al. can actually be judged with the beautiful hindsight of history. On one side in the ring areJohn Cochrane and Luigi Zingales. On the other side are Paul Krugman and Brad DeLong. Here is Chochrane:

Nobody is Keynesian now, really… Now, we all understand that growth, fuelled by higher productivity, is the key to prosperity… We now understand the links between money and inflation, and the natural rate of unemployment below which inflation will rise… We all now understand the inescapable need for markets and price signals, and the sclerosis induced by high marginal tax rates, especially on investment…

Most of all, modern economics gives very little reason to believe that fiscal stimulus will do much to raise output or lower unemployment. How can borrowing money from A and giving it to B do anything? Every dollar that B spends is a dollar that A does not spend. The basic Keynesian analysis of this question is simply wrong. Professional economists abandoned it 30 years ago…

There is little empirical evidence to suggest that stimulus will work either. Empirical work without a plausible mechanism is always suspect, and work here suffers desperately from the correlation problem… We do know three things. First, countries that borrow a lot and spend a lot do not grow quickly. Second, we have had credit crunches periodically for centuries, and most have passed quickly without stimulus. Whether the long duration of the great depression was caused or helped by stimulus is still hotly debated. Third, many crises have been precipitated by too much government borrowing. 

The government can also help by not causing more harm. The credit markets are partly paralysed by the fear of what great plan will come next. Why buy bank stock knowing that the next rescue plan will surely wipe you out, and all the legal rights that defend the value of your investment could easily be trampled on? And the government needs to keep its fiscal powder dry. When the crisis passes, our governments will have to try to soak up vast quantities of debt without causing inflation. The more debt there is, the harder that will be. 

And in the other side of the ring is Paul Krugman, who can hardly contain himself after reading the Keynes/Hayek debate from 1932:  

First, Hayek was as bad on the Depression as I thought. The claim that “many of the troubles of the world at the present time are due to imprudent borrowing and spending on the part of the public authorities” — in 1932! — is bizarre. The claim that barriers to trade and capital movement were what was preventing recovery is as crazy as … as .. claiming that we’re in a slump because workers decided to take a break in the face of prospective Obama tax hikes.

Second, Keynes pretty much had the policy implications of the General Theory down long before he actually worked out the detailed analysis. I’m especially struck by the way he grasped, right from the start, the point that if higher private spending expands employment in a slump, so does higher public spending.

Third, it’s deeply tragic that we’re having to have this debate all over again, as the world economy slides into deflation and stagnation. 

It may be time to buy Gold. While the precious metal is at all time highs, some highly intelligent commentators see us staring at the abyss:

Willem Buiter, a highly distinguished economists (now chief economist at Citi) believes Europe need not Euro 1 trillion, but Euro 2 trillion in tarp money. Here is his line of reasoning.  I thought it was fitting when I heard the Euro 1 trillion package referred to as "Wundertuete" or "Grab Bag" since no one has any idea if/when/how or how much a country in need could procure from that fund. Paul Krugman thinks Obama's TARP 1 was too small a similar line of reasoning has been proposed byBrad DeLong. If all that money is indeed needed at some point to pull the economy out of the ditch, government debt is going to skyrocket. If these commentators are correct, we're between a rock and a hard place: debt or depression.

On the lighter side, the alternative is to listen to Ed Prescott (also a very intelligent economist, in fact, a Nobel Laureate). He proposes the view (called Real Business Cycles) that business cycles and indeed great recessions or depressions can be modeled as technological retrogression (people forget technology). Sounds strange, I know, but that's just the beginning (via Stephen Williamson):

"Ed Prescott did pathbreaking work in the economics profession, and his Nobel prize is well-deserved. However, I doubt that there were any people in the room yesterday who took Ed seriously. Ed's key points were: 1. Monetary policy does not matter. 2. Financial factors are the symptoms, not the causes, of the recent downturn. 3. The recession was due to an Obama shock, i.e. labor supply fell because US workers anticipate higher future taxes."

Output is turning around, employment has high rock bottom, some think the economy is on an inevitable path to recovery.

The anatomy of the fiscal crises in the US (as told by the SF Fed) predicts a different future. Two pictures peak a 1000 words…

As GDP fell, revenue plummeted 

 Spending adjustments failed to match revenue losses

The result?  "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…"

That has been the fancy catch phrase which describes central banks printing money and using it to purchase government bonds. Just about every text book states that Monetizing Debt will lead to inflationary disaster. 

As the global financial crisis caught the US in a liquidity trap, Ben Bernanke decided to fight it by monetizing debt in astonishingly creative fashion. He instructed the US Central Bank not only to monetize the government's debt (to the tune of $1.2 trillion, but also to purchase another $1.25 trillion of toxic mortgage backed securities that where sloshing in the bond market without any buyers in sight. 

Those unfamiliar with liquidity traps saw the writing on the wall: After deciding to Monetize Debt at a gigantic scale, the US was in for hyperinflation: an "Inflation Bomb". It turns out that these predictions were not true. Prices are still falling in the US.

Now the same discussion is taking place, since the European Central Bank was forced to buy up toxic Greek Government Debt. The WSJ captures the discussion (from the Journal In Education):

QUESTIONS:

1. What is the main reason that the European Central Bank (ECB) is choosing to purchase Greek bonds in the secondary bond markets?

2. Why are critics opposing the ECB's purchase of Greek bonds in secondary bond markets?

3. By buying Greek bonds, how is the ECB influencing the yields on Greek bonds? How in turn does this affect other countries' bond yields (e.g. Spain's)?

4. Explain how the ECB's decision to keep purchasing bonds of distressed European countries can or cannot lead to a) inflation, and b) perpetual fiscal deficits in the long run. 

5. What is the effect of these purchases on the Euro? 

Adam Posen, an external member of the Monetary Policy Committee of the Bank of England,  has a blunt and impatient piece that counters those worrying about "inflation bombs." He does not mince words… Actually, mincing words would be an understatement. This speech must rank high up among the shrillest speeches anyone associated with a central bank has ever given:

When the instrument nominal interest rate is already at de facto zero bound, and the financial transmission mechanism is damaged, buying bonds is the only means central banks have of trying to deliver price stability against deflationary pressures – some form of quantitative or credit easing is the right thing to do. Getting unduly caught up in protecting the appearance of central bank independence is doubly mistaken: first, it will not do any good because it is not that appearance which delivers desirable results; second, it will prevent pursuing the right policy option.

As I indicated at the start, much of the hue and cry about central bank independence in response to the various sorts of bond purchases is awfully shallow. It is adolescent or worse to be so preoccupied with how someone looks, and her supposed reputation among the self-appointed conformists, than with the substance of her actions and values. This holds true whether that someone is a high school student or a monetary policy committee. That has not stopped such preoccupations and nasty name calling from spreading of late regarding central banks. In imagery typical of the preening machismo of financial markets participants and those who report on them, a number of people of late have spoken about the ECB losing its ‘political virginity’ or purity last month.

One is tempted to ignore or dismiss such idle chatter, but let us take it at its vulgar face value to show just how empty these characterizations are. Cultures which make a public fixation of virginal purity, of a stylized maiden’s reputation, tend to be backward superstitious cultures that impede people exercising autonomy and making responsible choices. For society, and arguably for the young persons themselves, what matters is not a young person’s ‘virtue,’ let alone any  reputation for such. What matters for society and for the young person is whether they are promiscuous, engaging in unsafe behavior, or getting pregnant casually, that is whether they behave responsibly.  

The bad news is that the global financial crisis cost banks $2.3 trillion. 

The good news is that the IMF estimated the cost would be $2.8 trillion.

Source: WSJ 

That's good news – because its defined as the end of the recession and the beginning of the recovery. The first graph below indicates what made the Great Recession special: its duration and depth. Lets hope the recovery is faster than the pace the US experienced post 2001. But the odds are its going to be much longer.

Actually, US income has been growing since mid 2009, but as of March 2010, the employment contraction is also over. 

Source 

I should have posted a link to this book a long time ago. It is first class scholarship, combined with an amazing data collection effort, and peppered with anecdotes to make it both thoroughly enjoyable reading as well as an absolute must for anyone who contemplates writing anything about the crisis of 08- …

… that depends on what your objectives are… 

Here is the issue: recent jobs and inventory data seems to indicate that the economy is starting to move off the bottom. However, one Oracle, whose business acumen I happen to trust blindly, tells me that the business community is paralyzed — the men and women who create much of the wealth in the US economy lament that an opportunity was squandered to pass tax cuts that could have rivaled the dramatic Kennedy (D) and Reagan (R) cuts.

First: The Facts:

The Kennedy tax cut (actually passed posthumously as The Revenue Act of 1964) was designed to boost the economy long after the April/1960-February/1961 recession. It was an income tax cut designed to reduce the top tax rate from 91 percent to 70 percent and the top corporate rate from 52 percent to 48 percent. 

The Reagan tax cut, formally known as The Economic Recovery Tax Act of 1981, was enacted in August 1981, at the start of the deep July/1981-November/1982 recession. Its hallmark was a income tax reduction from 70% to 50% for top earners and a reduction from 14% to 11% for low income households. (The 1986 Reagan tax cut subsequently reduced the top tax rate from 50% to 28% while it raised the bottom rate from 11%to 15%. It also increased the (minimum) corporate tax rate).

The 2009 Stimulus, formally known as American Recovery and Reinvestment Act of 2009, was enacted in February 2009, just after financial markets experienced sudden cardiac arrest (or sudden financial arrest, as Ricardo Caballero calls it). The US economy was not only in its worst recession since the Great Depression, but it was also in a liquidity trap, where interest rates are zero and demand is still so anemic that commercial banks deposit funds at Federal Reserve in lieu of lending on projects. The 2009 Stimulus was a one time expenditure package of $878 billion. 37% of the package went to tax cuts ($288 billion), $144 billion (18%) to state/local fiscal relief (mostly Medicaid and education), and $357 billion (45%) to federal social programs and federal spending programs.

Source

Second: The Data

While the Kennedy and Reagan tax cuts were surgically targeted to permanently reduce income taxes, the 2009 Stimulus was designed to deliver a one-time defibrillation to resuscitate the economy. To get an idea of the magnitudes of the various measures, it is helpful to compare apples with apples. Below is a graph that compares the prominent tax cuts and the one-time 2009 stimulus. The graph also adds the recent Bush Tax Cuts (Economic Growth and Tax Reform Reconciliation Act of 2001, Job Creation and Worker Assistance Act of 2002, Jobs and Growth Tax Relief and Reconciliation Act of2003).

Source: Joint Committee on Taxation; TaxFoundation, http://www.recovery.gov/

The magnitude and the focus of these four measures is clearly very different. Also we are comparing the annual effects only – these effects accumulate over time for permanent measures. Reagan and Kennedy tax cuts were smaller per annum, surgically focused on income tax cuts, and permanent. The 2009 Stimulus instead was a one-time hodgepodge of targeted subsidies/pork barrel; The fact that it was not a permanent measure reflects the thoughts of one of the key designers: being timely, targeted, and temporary.

Third: The Theory

Why not provide a corporate tax break or an income tax break as part of the package? Key arguments are related to the type of crisis the US was facing in late 2008, early 2009. The central task of the stimulus was to act quickly and not permanently by stimulating demand. Several members of congress lobbied for permanent tax cuts, but that policy would have missed the mark. While permanent tax cuts may be beneficial for the economy in the long run, they would not serve the purpose of assisting the economy's exit from the liquidity trap. Hence in evaluating policy options, it is important to keep in mind the objective of the 2009 Stimulus.

For a fiscal stimulus to increase growth quickly, the vast majority of economists agree that the policy measure must focus on spending increases and temporary tax rebates for low- and moderate-income families, who are likely to spend the money rather than save it. The alternative of lowering corporate or capital gains tax is often seen as a distant second.

While corporate tax cuts lower the cost of capital and provide incentives to invest, there exists a long literature, starting with noted economist Dale Jorgenson’s work in the 1960s, which consistently documents that the cost of capital plays a much smaller role in determining investment than sales growth. Without prospects for increased sales growth, businesses have no reason to undertake risky investments, no matter how cheap it is. This point is driven home rather decisively by the ineffectiveness of the Fed's latest interest rate cuts in raising investment.

The other argument that economist put forth is that today's corporate tax cuts would largely reward past investments rather than new investments. There may exist good reasons to lower the corporate tax rate (i.e., to remain competitive relative to corporate taxes in other countries, or to eliminate the double taxation because capital pays the tax to the corporation and the profits are again taxed at the corporate level), but it would be an unlikely candidate to jump start the economy out of the liquidity trap. Proponents of lower capital gains tax cuts suggest that it would induce people to invest in riskier assets, such as corporate shares. This lowers the cost of capital and making it easier for companies to obtain financing. The same argument as above, which negated the effectiveness of corporate tax cuts, applies then for capital gains taxation.

There is not much disagreement on the theory among economists. Even Mark Zandi, chief economist of Moody’s Economy.com, and advisor to John McCain’s during the presidential race, rated a corporate tax rate cut as one of the least effective of all tax and spending options to provide the needed jolting stimulus to the economy. He estimates that corporate tax cuts would generate in the short run only 30 cents in economic demand for every dollar spent on the tax cut. So it is certainly true that the tax cuts in the 2009 stimulus do not “pass the supply-side test” as Stephen Entin suggested, but we must keep in mind that the stimulus package was not designed as a supply-side measure. 

This reduces the question to how solid the evidence is that stimulus, not tax cuts are the surest and quickest way to cause the economy to rebound? In terms of aggregate demand and the data that we possess, the effect of spending vis a vis tax cuts can be calculated by the OECD's macroeconomic model. The graphic clarifies why a temporary stimulus should be front loaded with expenditures, but also include tax cuts to maximize the total stimulus effect over time.

Multipliers at horizons of N = {1,2,3,4,5} years after implementation, expressed as the ratio of change in GDP relative to baseline to one percentage point of GDP change in X, where X= {government, consumption spending, wage/salary taxes}. Source:Dalsgard, Andre andRichardson (2001).

Update and Addendum: Conceptually one cannot get away from the fact that comparing a temporary stimulus to permanent policy changes such as tax cuts is is a bit like comparing apples and oranges. So intellectually the interesting question at this stage would be: what permanent changes should President Obama and policy makers undertake today, to foster an economic expansion in the future.

Some economists may think its a bit early to ask that question, since we are still in the liquidity trap (interest rates are still constrained from below at zero and excess reserves are still staggering). This, of course raises the question, whether the past stimulus has not worked (the difibrillation did not work, the patient is still in cardiac arrest), and why.

You guessed it, economists have two options on this: freshwater water economists never saw a liquidity trap and chalked the crisis off to a shift in the population's desire to be voluntarily unemployment (Casey Mulligan's "Great Vacation" hypothesis – this is not a joke). Fresh water economists who think we are still in a liquidity trap do not think the current, second stimulus is nearly large enough (if the first defibrillators 1000 volt shock did not revive the heart, you recharge it and use another 1000 volt jolt, you don't take a 9 volt battery the second time around). 

American observers have always had difficulties following the arguments for a true 4-day work week (not a 4×10 hour work week as in some US firms, but a 4x 8 hour week….).  It is tough to take these arguments seriously given the US work ethic. But hold on! Now some US states are proposing and instituting the 4-day work week FOR SCHOOLS! Here are the links:

Districts Explore Shorter School Week – WSJ.com

How the Four-Day School Week Costs Parents – WSJ

Georgia schools switching to 4-day weeks – USATODAY.com

Four-Day School Week- Good For Budgets But Bad For Kids And Parents

Some U.S. schools move to four-day school week

Hawaii schools to move to four-day week in state cost-cutting measure – The Guardian.co.uk

Source WSJ 

Robert Reich has it right, time to bail out our schools. 

Today, investors (holding an aggregate $10 billion) were willing to PAY the US government for the privilege to park their money at the US Treasury. They accepted a NEGATIVE return on their investment… The jitters aren't over and the economy is nowhere near acceptable health as long as investors bank on the return OF their investment, rather than the return ON their investment. 

House Approves Next Stimulus by CalculatedRisk

Although the Federal Reserve is undertaking extraordinary measures to pump money into the system to get out of the liquidity trap, few are aware what the FED is buying in exchange for the cash it is handing out to increase the liquidity in the system.  The Atlanta Fed analyzes the Fed balance sheet, but Calculated Risk is driving the point home. Is there a downside to the Fed buying Mortgage Backed Securities (MBS) to increase the money supply?

Helpful Teaching Aids from the NY Fed:

Comprehensive graphics that detail the US and international policy response to the crisis.  

DOMESTIC TIMELINE

INTERNATIONAL TIMELINE

Not much of a V

by James Hamilton

The latest auto and employment numbers paint a picture of an economic recovery that remains tepid and potentially fragile.

September was the worst month for U.S. auto sales since February, down 23% from September 2008 and down 41% from the August 2009 outlier.

Data source: Wardsauto.com

Many of us had wondered whether the cash-for-clunkers program would simply cause people who would have bought cars in September or October to buy instead in July and August. Now we seem to have an answer, though General Motors Sales Chief Mark LaNeve believes that low inventories also lost the industry 300,000 potential sales for September. If you average the three months of July, August, and September together, the impression is one of improvement since the terrible first quarter that's still left us below 2008:Q3. Inventory rebuilding should give a cyclical boost at some point, but at the moment this is not looking at all like the sharp recovery some had been hoping for.

Data source: Wardsauto.com

But the biggest worry remains employment. Initial claims for unemployment insurance and number of hours worked are often viewed as leading economic indicators. Initial claims peaked in March, but have improved little since August.

Seasonally adjusted new claims for unemployment insurance (red) and 4-week average (blue), in thousands.

Average hours per week in manufacturing fell back a bit last month, undoing some of the earlier rebound.

Source: FRED

Hours worked for the broader economy remain at the low point for this cycle. 

Source: FRED

And total employment, generally regarded as a coincident economic indicator, continues to plummet, with a quarter million fewer Americans on payrolls in September compared with August (seasonally adjusted). That this is not as rapid a decline as we saw at the start of the year can no longer provide much comfort to anyone.

Source: Calculated Risk

The Aruoba-Diebold-Scotti Business Conditions Index also doesn't care much for the latest numbers, having moved back into significant negative readings.

Aruoba-Diebold-Scotti Business Conditions Index.

Although I expect the GDP numbers later this month to show positive growth for the quarter, further deterioration on jobs is bad news for critical factors like loan defaults and total spending.

Carpe Diem has his usual optimistic take on this. Wish I felt the same way.

While some see green shoots in the rest of the economy, the housing market has definitely not yet hit bottom. Distressing.

Only yesterday did the Fed announce that the 19 major banks are basically ok. Well, half of them have to raise capital, but they won’t be allowed to fail, and with the stroke of some accounting trick (converting preferred stock to common stock) the top 20 banks would be not-so-stressed.  

Bad timing. Today's labor report shows that over 500,000jobs were lost in April. This raises the unemployment rate to 8.9% from 8.4%,and there are no signs that future months will generate significantly smaller job losses. Here is the issue: 8.9% was already the worst case scenario assumed by the "Stress Test" administered by the Fed to the Banks. The FED guidelines are in Table 1 

 Notes: 1)  Percent  change  in  annual  average.   2) Baseline  forecasts  for  real  GDP and  the  unemployment  rate  equal  the average  of  projections  released  by  Consensus Forecasts,  Blue  Chip,  and  Survey  of Professional  Forecasters  in  February.   3) Annual  average.   4) Case‐Shiller  10‐City  Composite,  percent  change,  fourth quarter  of  the  previous  year  to fourth  quarter  of  the  year  indicated.  

 It is a bit worrysome that practitioners, who are required to do do stress tests on a regular basis, judge the whole exercise was more like a spa treatment than a workout.