Democrats & Liberals Archives

StressTest? Would you feel healthy?

Let’s take a stress test. Let’s say that you wanted to test your financial security. I might put in that test things like: your verified income, housing expenses, debt obligations, and other’s evaluation of your “credit worthiness.” Oh. I see this looks familiar. It looks like a standard credit or home loan application.

Now let's say that in this stress test we allowed you to decide on your own level of debt. For example, you are obliged to pay off that long term loan, but if all goes well you hope to pay that off within the next year. So, let's knock that amount off the list. And that home loan? Well, you're currently paying $1,000 a month, but if you get this loan you will be paying $850 a month. So let's take that figure. Clearly, such assumptions and choices on your part MIGHT misrepresent your financial situation.

Now let's stress test those financial institutions. However it was that the Obama administration originally wanted to test the banks, the banks didn't like. So the banks pushed back. Effectively, they got the calculations of capital needed changed. This is a nice trick if you can do it - and they successfully did it.

But even before the stress test they got something else changed - the way they value their assets. Rather than providing the market value of the mortgages they held, they could provide what they think those assets are worth in a non-distressed market:

Bankers bitterly complained that the current market prices were the result of distressed sales and that they should be allowed to ignore those prices and value the securities instead at their value in a normal market. At first FASB, pronounced FAS-bee, resisted making changes, but that changed within a few days of a Congressional hearing at which legislators from both parties demanded the board act.

Even given the change in accounting rules, and whatever other changes in the "test" that was won by the banks, nine of them still failed. Oh excuse me, they didn't "fail," they did not pass the test. Oh EXCUSE ME! All 19 Banks Pass Stress Tests ("But many require new capital infusions to stay solvent). That little gem is from"Consumer Affairs." In a sop to those we generally think of as "consumers," the article states:

Consumers shouldn't be concerned that their bank was deemed to need more money. Even if a bank failed, deposits of up to $250,000 are insured by the Federal Deposit Insurance Corporation. Besides, the whole idea behind the stress test was to make sure than none of the 19 banks fail.

So what are the consequences for banks who failed, excused me, did not pass, excuse me, passed but could be better? (And people yell about the schools not being tough and honest with students). Well, according to an article at the BBC - "Ten US banks fail 'stress tests' " (emphasis mine):

The treasury secretary said he believed that while the majority of the banks would be able to raise any additional money they need from private sources, if they were unable to do so the government may have to provide them with more taxpayer money.

Well that's telling them!
(Read in a stern and parental voice) "Correct those deficiencies or the taxpayer will give you more money!"


Other pertinent articles

Stress Tests for Beginners. The Baseline Scenario. 5/04/09.

The Mark-to-Market Myth. The Baseline Scenario. 4/02/09.

Fed: Banks Tighten Lending Standards Further. Calculated Risk. 5/04/09. These charts are instructive.

Government Offers Details of Bank Stress Test. Andrews & Dash. NY Times, 2/25/09. (But the article does not)

Stress Test for Banks Exposes Rift on Wall St.. Dash. NY Times, 2/24/09. (Actually pretty good given the successful change to accounting valuing changes)

Posted by Rowan Wolf at May 9, 2009 11:22 AM
Comments
Comment #281478

Rowan, two important details:

First. The Stress test requirements were developed under the assumption that the current economic conditions DO NOT improve going forward. They are improving.

Second. The stress test was designed to insure these banks had sufficient reserves to remain solvent through the next year given the assumption above.

All in all, considering the tests require 75 billion dollars more be raised by half of these banks, to insure they WON’T have to dip into tax payer dollars to continue doing business even if the economy does not improve from here, it appears to be a relatively healthy compromise for the banks, their customers, and their shareholders.

The fact that there was some give and take and negotiation is nothing more than evidence that this government is not running these banks, nor is it interested in becoming the owners of these banks, nor is this government totalitarian in its approach.

On balance, seems like it worked out well given the limitations and constraints upon a democratic government operating under mixed economic policies and rules of capitalism and regulatory oversight to avert the excesses inherent in unbridled capitalism.

Posted by: David R. Remer at May 9, 2009 3:12 PM
Comment #281481

In response to David:

I believe you may have to check a few of your facts. Improving economic conditions should not be confused with economic conditions getting worse at a slower rate. Since aggregate demand has fallen off of a cliff compounded with a slowly increasing national savings rate currently at 5% and unemployment certain to hit double digits, the fundamentals of the economy need to change before a positive 2nd derivative can be interpreted as improving economic conditions.

I haven’t heard anyone mention the “OR ELSE” clause of the SCAP (the official name of the stress test). What happens if these ten institutions refuse to raise the recommended (although the word “required” is actually used) $75 billion.

I don’t follow how the so-called “negotiations” should be interpreted as the government working with the banks and should not be interpreted as the government wanting to run the banks. That seems like a reach. If you want to interpret the negotiations as anything, it should be interpreted as the banks approaching Obama with caution because we all know that if the banks hold out on negotiations, then Obama will go to his pulpit in front of the national media and publicly berate them with populist labels like “speculators”.

Finally, the criteria selected as capital (defined as Tier 1) is the company’s common equity with possible inclusions of preferred equity minus goodwill and tax deferred assets. Not only is that definition of capital nothing more than a load of technical BS (hopefully that acronym needs no explanation), explain to me how the common equity of a bank that is currently trading on the NYSE/NASDAQ/AMEX/OTCBB/etc has anything to do with the soundness and stability of the banks. Why should these banks have to maintain a Tier 1 ratio that has no impact on the operations or cash flows of the business?

In response to the article:
I must admit that I truly appreciate the irony in the sarcastic tone of this piece about an issue that is a complete joke. The only thing that could make this article any better than it is would be an extension of the discussion on the scenario if the bank has to acquire taxpayer funds to raise capital. The US Treasury has graciously agreed to provide banks unable to raise private funds with capital from the CAP (Capital Assistance Program). The CAP will provide taxpayer funds to a stressed bank in exchange for convertible preferred that must pay a cumulative dividend at a rate of 9% per annum, compounding quarterly, with a increase to 20% if certain conditions are not met. If a bank is stressed to the point that it needs capital to withstand hard economic times, why should they be paying out dividends with the same capital needed to act as a buffer against unforeseen losses??? It’s almost as dumb as a credit card company raising interest rates to 20% on a stressed consumer that already can’t afford to pay a 7% interest rate.

As my final rant, it’s not so much that I don’t want the government running the banks, I don’t want them involved at all with the banks if they’re going to promote such boneheaded policies. I’ve seen the fruits of government labor (the airline industry, the auto industry, just to name a few). The banking industry is far more intertwined to the economy than the other two, please spare it.

Posted by: Mike at May 10, 2009 2:33 AM
Comment #281482

David,
I feel that Bernake is being overly optimistic. While i hope that things improve by the end of the year, the global signs push that out through 2010 (IMF, WTO, Britain, etc). even the optimistic Bernake says that the US will experience a “jobless recovery” for some period of time. I believe that is what we had coming out of 2001-2002. Essentially, that means that Wall Street will improve, but the people will not see improvement for some time.

Posted by: rowan at May 10, 2009 9:13 AM
Comment #281483

Mike,
I agree about things not getting bad as fast does not mean that things are getting better. I tend to disagree regarding the financial industry. I do not think that we should be trying to prop up a system that has exploited so many and then crashed taking the world with it. Further, that if we were going to pour money into this maw, that strict regulations should have been job one - not something they’ll get down the line.

What we have seen is an exacerbation of “too big to fail” by encouraging and facilitating institutions that are even larger. That frankly makes no sense whatsoever.

Posted by: rowan at May 10, 2009 9:18 AM
Comment #281485

http://www.blogrunner.com/snapshot/t/reference/timestopics/people/b/ben_s_bernanke/ I’m not saying he’s a saint he’s a very smart learned Man on the depression and a inflation fighter and not a fan of bush’s taxs cuts and nothing like Greenspan i say that in a good way. I personally don’t care for Larry Summers from the clinton days Mr. Summers also helped to pass the Gramm-Leach-Bliley financial “deregulation” of 1999. His hands are not so GD clean.

Posted by: Rodney Brown at May 10, 2009 2:25 PM
Comment #281487

Mike said: “I believe you may have to check a few of your facts. Improving economic conditions should not be confused with economic conditions getting worse at a slower rate.”

And you need to learn the difference between evidence and prediction. Economic conditions are improving from the end of last year - that is demonstrable and evidenced. Your admonition suggests some prediction about the future economic conditions - that is entirely your hopes and wishes apparently since your provide no data, only your hyperbole.

Example: “Since aggregate demand has fallen off of a cliff “

Apparently not so much of it as you imply since more than 90% of the work force is still employed. Which would not be the case were your hyperbole true. A slowly increasing savings rate actually aids aggregate demand, as opposed to a dramatically rising savings rate. And double digit unemployment is very bad for those who are unemployed, but, the unemployment monthly numbers have been dropping for 3 months in a row now which means even if the recession continued for another 12 months, we would not even hit 15% unemployment at the current rate of drop in unemployment. And many signs point to the 2nd half of this year experiencing economic growth in at least 3 of its 6 months.

The “Or Else” clause is the following: depending on which institution threatens bankruptcy or to maintain the new legal requirements for reserves, and what the cascading effects of failure might be, the government will elect to either 1) let the corporation enter bankruptcy, get broken up, put under new management, and the assests sold off to smaller private interests, or 2) the government offers the corporation the option of replacing some, or all, of its board of directors and its executive management with persons approved by the government in return for additional tax payer dollars to buy the corporation more reorganization time. It is not a set of choices any CEO of any of these financial institutions would find preferable. And that is a very, very good thing.

Mike said: “If you want to interpret the negotiations as anything, it should be interpreted as the banks approaching Obama with caution because we all know that if the banks hold out on negotiations, then Obama will go to his pulpit in front of the national media and publicly berate them with populist labels like “speculators”.”

Damn right. The American public tax payers ARE NOT SHAREHOLDERS in many of these financial institutions and their nation and its economy was threatened by these financial institutions. Thank Buddha we have a president who knows how to use that bully pulpit to advantage in dealing with these oligopoly, monopoly wannabe’s.

As for your question, and it is a sound and fair one: “Why should these banks have to maintain a Tier 1 ratio that has no impact on the operations or cash flows of the business?” I will answer this way without any first hand knowledge from Geithner, Summers, or Bernanke as to their reasoning. First, because it has no effect on their daily operations expenditures and profits, it forces them back to earning profits the old fashioned way, by lending, which our economy needs. Second, it stands as a red blinking warning light that the government, not the execs, control the fate of these institutions should they decide to not cooperate with the government’s requirements. Third, the common stock does affect their balance sheet, positively I might add, as their equity prices increase as they have been as confidence is restored, and solvency in both their income and balance sheets is precisely the objective and standard to maintain being imposed by the government. (Again, I add, these are my projections of the reasoning, in answer to your question above; and provide logical and potentially valid reasons for the government’s requirements, though no evidence of such have I been privy to, yet.)

Posted by: David R. Remer at May 10, 2009 3:16 PM
Comment #281488

Rowan said: “I feel that Bernake is being overly optimistic.”

Well, one does not have to justify one’s feelings, only their public proclamations or assertions of fact. In the end, Bernanke may be proved to have been overly optimistic. I think it is just as likely however, that he may be proven to have been pretty much spot on. His actions were spot on in preventing a global financial meltdown. His actions have kept more than 90% of American workers employed in the worst recession since the 1930’s. His empirical data, much of which I have reviewed in the business journals, does appear to support the projection that the recession is ending, and in just a few months, the long road to recovery of jobs, consumer activity, and confidence in both markets and employment will be underway.

Speaking of confidence, Bernanke as Fed Res. Chair is in a role which ABSOLUTELY DEMANDS that he promote confidence in markets and economy. The reason is simply that the absence of confidence ALONE is enough to bring markets and economic activity into contraction. So, the real question is whether his optimism is supported by the data or not, because he has no choice but to publicly proclaim optimism.

So far, the data seems to moving in the direction of supporting his optimism. No doubt, some of that data is being driven by his optimistic outlook. And that is a good thing, when all is said and done.

Posted by: David R. Remer at May 10, 2009 3:24 PM
Comment #281489

Rodney Brown, I am with you. Bernanke does not speak in ideological terms as Greenspan did. He does not operate from either a Friedman nor Keynesian position, but, as far as I can tell from listening to him, from a very pragmatic position based on the numbers, and when he is asked questions bearing on human nature or contemporary economic psychology, he defers to the admission that there is no hard data to support answers along these lines one way or another. He acknowledges that investors invest in the markets to increase their assets and profits. Whether such action is motivated by greed or prudence, he begs off, saying he has no hard data one way or the other. In other words, he does not operate from a hard and fast philosophical ideological point of view, and he has acquired my respect for this, at least.

As for Summers, he has yet to prove himself to me. All I have seen so far is his determination to save the corporations with the admission that substantial reforms in oversight and regulation must be forthcoming. So far, though, he is all talk on that and no action that I can see.

As for Geithner, I actually respect him. He learned what he knew prior to this meltdown from the best in the financial corporate world. But, he appears to me to remain a very active student and learning all the time, which means he is incorporating this meltdown experience into his knowledgebase and acting accordingly. He is play very Hardball with the financial institution execs, not what one would expect of a Treasury Secretary who was in the hip pocket of the industry. And he is young. Which means he has decades to live up to, or live down, his legacy of these years in the Obama Administration. If I were him, I would muster everything in my being to insure the rest of my life did not have to carry the burden of regret or incompetence around everywhere I went. I am optimistic about Geithner’s learning capacity, motives, and abilities. And I think Obama takes care of any philosophical rudderlessness he may otherwise experience.

Posted by: David R. Remer at May 10, 2009 3:39 PM
Comment #281491

Some history on one aspect of bank deregulation in Illinois:

http://www.obre.state.il.us/cbt/STATS/br-hist.htm

and

“Until 1994, federal law prohibited bank branching across state lines. The Riegle–
Neal Interstate Banking and Branching
Efficiency Act (IBBEA) removed these restrictions when enacted in 1994.”

from http://www.citylimits.org/images_pdfs/pdfs/ChicagoFed.pdf

Posted by: ohrealy at May 10, 2009 4:51 PM
Comment #281495

ohrealy, I read the entire IBBEA article, and their conclusion appears to be isolated to Illinois. Their conclusion has no basis, and their charts clearly show this, that what happened in Illinois was likely unique to Illinois. In fact, the history of Illinois banking throughout the article highlights many unique aspects and shared growth events with only a few other states. Hence, they make no case for national banking strategy, only for Illinois, and they are appropriately quite careful to stipulate this.

The Mississippi Case which the Court Ruled in favor of intrastate National Bank Charters, did not have the same effect on most other states as it had on Illinois’ banking system. In Illinois, the effect was to create fear of state banks failures to compete with National Banks, and hence, motivated proponents of banking regulation to move to the other side and oppose previous state bank branching regulations.

And note, that most states did not follow the Unit Banking model of Illinois. Only a handful of other states imposed such restrictions.

Their only conclusion:

Though an overarching objective of the original branching restrictions was to prevent large out-of-state banks from competing with smaller banks, ironically, these restrictions have contributed
to a great deal more local competition in the long run.
stipulates that more local competition amongst banks has been the result. Is this a bad thing?

The article states:

When states introduced statewide branching, banks’ loan losses and noninterest expenses decreased significantly, and these savings were largely
passed along to consumers in the form of lower loan rates.

So, it seems to me the entire article is inconclusive, providing data in evidence and support of more local banking instead of National Banking on the one hand as beneficial to rural and local communities with their deposits going to work in their own communities instead of some big Banking State like N.Y or De., and providing evidence of benefits of the introduction of National Banks increasing competition and customer benefits on the other hand.

Which is precisely what I would expect, not being attached to any ideological view on banking but, adhering to the reality that there are opportunity costs and benefits to any decision in any direction. Whether those costs and benefits result in a net gain for those people affected by the policy, is answered most often in the gray zone in which there are some winners and some losers, and ultimately the test is whether the policy is sustainable, predictable, and reliable, or not, in determining whether there is a net gain.

Posted by: David R. Remer at May 11, 2009 12:32 AM
Comment #281497

David said: “Economic conditions are improving from the end of last year - that is demonstrable and evidenced.”

I respond: But economic conditions are still worse from the end of 2007. Either I failed to identify the reference in your original post to a specific point in time or it wasn’t there to begin with (I’d go with the latter). If I had known you were referencing everything from 01-01-09 to now, I wouldn’t have bothered addressing that point. Second of all, we need to clarify which data we are discussing. For example, GDP has not improved since the end of 08 (-6.1% decline for 09Q1, which means total GDP is lower as of 3-31-09 than it was 12-31-08), but the rate of decline is improving (-6.1% for 09Q1 vs. -6.4% for 08Q4), which is exactly what I was talking about when I said economic conditions are getting worse at a slower rate (the change in the rate of change, aka the second derivative). There’s my facts (which were mislabeled as hyperbole), and I have many more (one of which you mentioned, unemployment) to prove this notion.

David said: Apparently not so much of it as you imply since more than 90% of the work force is still employed. Which would not be the case were your hyperbole true. A slowly increasing savings rate actually aids aggregate demand, as opposed to a dramatically rising savings rate.

I respond: Aggregate demand (AD), which I will explain so that everyone else reading this will know what you and I are talking about, is the inverse relationship between the quantity of output demanded and the price level (thus as one goes up, the other goes down). For example (and it is one of many), gasoline prices have declined from $4/gallon to $2/gallon, however, people are driving less and the quantity of gasoline demanded has also fallen. Either the theory of supply and demand is wrong or AD has indeed fallen off of a cliff. It is a fact that as consumers have retreated even though they can get more bang for their buck.

As you can see, the 90% of people that have not lost their job does not factor into the AD equation, which I why I said “compounded with” and not “which is explained by” in my original post. The unemployment rate has more to do with the sustainability of the new recovery than it does with proving that AD has fallen off of a cliff. If you would like me to explain how the process works, I’d be happy to. Likewise, the savings rate at 5% has implications to the strength of the new recovery, and I’m sure everyone knows the relationship between consuming and saving. What I don’t understand how a gradually increasing savings rate “aids aggregate demand”. What I’m more worried about the long-term psychological dynamics of a comparatively weaker recovery (which will happen with higher savings rate), not to mention the fact that the recovery expected to happen in the 2nd half of 09 is artificial so to speak. Even if G is increasing in Y=C+I+G+NX, it doesn’t mean the economy is better. When people start driving more (and for that matter, spending more) with the prices at these levels, then I’ll start believing in the recovery.

I do agree with your point that we need to have someone who can appropriately use the bully pulpit. However, that someone shouldn’t be a person who waves the hypocrite flag every time he speaks. I don’t see how one can “unite the nation” through bully tactics, especially when that same someone can poke fun at anyone but himself. In his first speech where he gave Chrysler a 30-day deadline, he was laying the groundwork for bankruptcy, then when that reality was actualized 30 days later, he takes a cheap stab at “speculators” rather than take the personal hit that he wasted those 30 days when he should have led Chrysler to that inevitable goal the first time through.

Finally, if you have a link to the “OR ELSE” conditions, I would greatly appreciate it if you could post it. I’ve read over the SCAP releases and I probably filtered that portion out with the rest of the technical BS in those documents. I really would love to know those details because the implications of those conditions are critical going forward - politically, economically and socially.

I also read your post to Rodney Brown analyzing the 3 major players. While those three guys are interesting in their own right, you should do a background on Austin Goolsbee. How does he become a chief economic adviser and make no meaningful contributions to the field of economics? (Probably the same way a man with back taxes becomes Treasury secretary). If you read his piece on “Taxing the rich” in the Journal of Political Economy, and really all you have to do is read the abstract of that paper, you’ll see how ideologically biased and economically ignorant that SOB is.

Posted by: Mike at May 11, 2009 1:14 AM
Comment #281498

DR et al

The stress test is not based on realistic values. The examinations were negotiated with the banks being audited. Valueless paper was assumed to have value because because to do otherwise would force closures of big banks and that is politically untenable. To believe that paper has value one must believe that home prices will will rebound to 2007 levels. They might in about 50 years. The economy can’t wait that long. I am somewhat dissapointed that BHO is so resistant to the kind of bank re-organization recommended by Krugman ,among others. Temporarily nationalize them ,sell assets,let the investors lose some money and reopen them by selling whats left to private parties or sell whats left off and close them. Its more complicated than that,of course, but the big advantage is it would get it over with in a shorter time frame and save taxpayer dollars in the mean time. The shorter time frame means a quicker recovery instead of a long drawn out ,painful one. The way it is being put together means that if they succeeed bankers will get even richer and if they fail taxpayers will be holding the bag once again.


Mike

A minor tax problem that would hardly have been looked at under the Bush administration, alleged hypocracy based on irrelevant mumbo jumbo unfortunatly stains an interesting perpective with partisan vomit. Too bad.
There are some other factors re, gas consumption. A. Habits people developed last time Big Oil tried to steal all the money are not so bad,like stopping on the way home from work to get groceries instead of a separate trip,buying a more efficient car etc.
B. People are still ticked off at Big Oil for trying to steal all the money and like to screw them if they can’C. People are actually concerned with the effect of man made global climate change have have decided to do their part in its solution. I find all these reasons admirable but they are going to scue a purely economic study of that particular market.

Posted by: bills at May 11, 2009 4:36 AM
Comment #281500

To bills,

I think I may need to address that I’m not for tax cuts for the rich, because 1) I’m not rich (by any right or wrong definition of it) and would not benefit from these cuts and 2) the Bush tax cuts were not made with equal cuts in spending. I was merely addressing that Goolsbee’s attempt to justify tax cuts on the rich was a total fallacy. 1) He characterized the rich as CEO’s with stock option payment plans, which is nothing more than a minor subset of the rich (not to mention using any measure of income to define rich is a grave miscalculation). 2) Not only was the characterization of rich wrong, but using stock option payment plans skews the results since stock options exhibit the behavior an asset, not income (which is what tax cuts/hikes affect). If the capital gains tax is raised, then clearly everyone with capital gains will sale this year to take advantage of the lower tax rate, which is what happened when executives exercised their option plans when taxes on the rich were raised in the Clinton administration. 3) His findings suggested that raising taxes on the rich has minimal long-term impact on tax revenues, but his data ranges from 1991-95, given that the tax hike occurred in 1993. 2 years doesn’t justify long-term in any economic sense. Why a longer study wasn’t conducted or wasn’t reported is a mystery (or maybe just a means to justify an end). I want get into my view on taxes since the topic is about the stress test, but I haven’t liked the tax code over the last decade nor do I like the direction it is going.

Also, I do understand changes in consumer behavior and I already knew of the factors you mentioned. Keep in mind that I said there were more examples than just gasoline consumption. For example, take anything that could be classified as discretionary income. I could go through every item, but that would be redundant. You could also make the argument that they are called discretionary for a reason, they are the first items given up. Collectively, people are buying less now at these price levels than they did when prices were last at these levels.I merely used gasoline consumption because it exhibited the same economic behavior as almost any other item, but I wanted an item that had inherent dependency. I could have used food or clothing, although the case was slightly different (a switch from high-end to low-end), it also exhibited the behavior. Likewise, look at housing, rates have plummeted, but because housing is a big-ticket item, it will also exhibit slightly different results. The point to keep in mind is that the last time these items were at these price levels, the quantity of output demanded was greater. When we return to the previous levels of consumption at the current price levels, then we’ll know AD has returned and the recovery is in full swing.

In the end, you are spot on the stress test being a joke, IMO more of a PR event to make the admin look good and instill confidence (albeit fictitious) in the public. Your assessment of giving value to a valueless instrument is also spot on. IMO, the instrument need to be transparent before bought up or removed from bank balance sheets. Like a mutual fund lists its holdings, the MBS’s should list their holdings, the location of the houses for which the loan is written, the financial institution responsible for securitizing the instrument, etc. We’ve went about this entire fiasco backwards, starting with the Bush admin and continuing with this one. First, we bail out the insurance on the derivative instruments, then we devise plan after plan to buy up the derivative instruments, then testing the whole process and giving it a golden seal of approval by the US Govt by authority of BHO, Sec of Treasury, Chairman of Fed BOG, and Chairman of FDIC. The only seal it needs is the BROWN SEAL OF BS. When are we going to address the underlying element: HOUSING? And I’m not suggesting we address housing with a plan that so far only one person can benefit from. Stop foreclosures, quit trying to artificially boost demand in a falling market by forcing rates down. If you want to attack rates, attack them on people who already have a high one and can’t afford it and then prevent the loaner from adjusting that rate at their own whim. ARMs would be the financial equivalent of big oil robbing the consumer, to tie a bow over this whole discussion.

Posted by: Mike at May 11, 2009 1:39 PM
Comment #281501

Mike said: “I respond: But economic conditions are still worse from the end of 2007.”

Yes. It’s called a Recession. Indicators get worse as it approaches, really worse at the bottom, and then the indicators begin improving, and the recession ends with renewed economic growth sooner or later, depending upon what actions are taken and how many people suffer from its effects for how long.

Mike said: “For example (and it is one of many), gasoline prices have declined from $4/gallon to $2/gallon, however, people are driving less and the quantity of gasoline demanded has also fallen. Either the theory of supply and demand is wrong or AD has indeed fallen off of a cliff.”

Mike, it is good and commendable to understand economic theory and ideology. Just DO NOT expect the real world to comply. The real world is not an ideal world. In the case of Gasoline as one of many examples, two real world elements are missing from your equation: Greed and Oligopoly. The Greed element on the part of refiners motivates them to cooperate in price fixing, as if they were a monopoly, by artificially constricting supply to maintain higher profit margins per gal. sold. With greed as motive, the logic is sound, given the inability to predict when demand will rise again, providing expanded profits on volume instead of the difference between cost to produce and delivery and price asked, or profit margin.

This is a common mistake by students of economics. I made these mistakes myself many times. The mistake is to believe the theoretical and explain the real world against the theoretical predictions without questioning the assumptions of the theoretical. The assumption being ignored in your comment is that we have a competitive marketplace without monopolistic behaviors at play.

In other words, your comment and your economic theory are assuming the refineries are well regulated to insure against monopolistic or oligopolic behaviors. And the real world is not cooperating with those assumptions leading folks to follow the theoretical to the wrong conclusions. The refineries ARE engaged in price fixing by cooperative control of supply amongst each other.

This same kind of thing is occurring in health care delivery and product production. It is also occurring in the credit card industry, another bubble bursting as I type which will cost something over 800 billion dollars over the next 10 years by some estimates.

Greed doesn’t follow theoretical assumptions. It follows opportunity to increase profits. Period. That is why a well-regulated and transparent marketplace is essential if monopolistic behaviors are not to harm the economy and nation’s people overall.

Posted by: David R. Remer at May 11, 2009 1:54 PM
Comment #281502

bills said: “The stress test is not based on realistic values.”

Right. It is based on near worse case scenarios. Now, when you get your crystal ball working well enough that all the rest of us can see the future as clearly as you, then we might agree that following near worst case scenarios based on assumptions which can be debated till the cows come home, is not warranted. Until then, these stress tests accomplish the greatest good for all involved, not the greatest good for one and only one interested group in the equation. It is a compromise that meets the needs and cooperation requirements of all parties involved.

It will have to do. The ideal for one party’s interests never reflects reality because other party’s won’t find such proposals ideal to them. And reality is a vegetable soup with many veggies contributing and competing for dominant vegetable in the soup. The healthiest veggie soup is one where a wide variety of vegetables are included in roughly equal measure.

Such was the case with the stress test design, I strongly suspect, with the interests of the banks, customers, shareholders, tax payers, and working Americans all having their interests represented in a more balanced compromise in designing the stress test and assumptions, in order to minimize the potential disabilities, and maximize the potential gain, for all the groups vested in the outcome, given the current circumstances and toxic assets still sitting on bank’s balance sheets and a recession still in place.

Posted by: David R. Remer at May 11, 2009 2:01 PM
Comment #281504

David said: “The real world is not an ideal world. In the case of Gasoline as one of many examples, two real world elements are missing from your equation: Greed and Oligopoly. The Greed element on the part of refiners motivates them to cooperate in price fixing, as if they were a monopoly, by artificially constricting supply to maintain higher profit margins per gal. sold. With greed as motive, the logic is sound, given the inability to predict when demand will rise again, providing expanded profits on volume instead of the difference between cost to produce and delivery and price asked, or profit margin. In other words, your comment and your economic theory are assuming the refineries are well regulated to insure against monopolistic or oligopolic behaviors. And the real world is not cooperating with those assumptions leading folks to follow the theoretical to the wrong conclusions. The refineries ARE engaged in price fixing by cooperative control of supply amongst each other. This same kind of thing is occurring in health care delivery and product production. It is also occurring in the credit card industry, another bubble bursting as I type which will cost something over 800 billion dollars over the next 10 years by some estimates. Greed doesn’t follow theoretical assumptions. It follows opportunity to increase profits. Period. That is why a well-regulated and transparent marketplace is essential if monopolistic behaviors are not to harm the economy and nation’s people overall.

I respond: AD deals with consumer theory. Your entire rebuttal deals with producer theory. While your analysis is conclusive, it is also irrelevant to anything I argued. Please reread my argument and notice that I was describing consumer reaction to prices, whether those prices were determined by pure market forces or price-fixing actors in the market. You’ll also noticed I concurred with bills’ argument of anti-Big-Oil sentiment in the consumer. I cannot refute that argument, but I do know that the consumer also has a short memory, case in point the gas shortages of the 1970s and oil embargoes of the 80s. The consumer has the power to change their activities, both away from something and back to it later. When consumers start buying at the same levels, whether it be food, clothing, oil, etc, I’ll know that recovery is in full swing. I may miss the bottom by an entire year’s time, but I’ll know for sure that the recovery is real and sustainable, not fictitious like the one that is setting up and confirmed by manipulations by the government.

David said: “This is a common mistake by students of economics. I made these mistakes myself many times. The mistake is to believe the theoretical and explain the real world against the theoretical predictions without questioning the assumptions of the theoretical.”

I respond: I am well aware of this. It is the same reason why I criticized Goolsbee in another post. I do not believe absolutely in the theoretical, but I do use the predictive elements of the theoretical. When the theory fails to be predictive, then I reanalyze. AD has fallen off of a cliff (07Q4 as reference point) and there is little data to refute this, why it hasn’t recovered is what I’m interested in. Either this is a lagging response to the fall in prices or the recovery isn’t real, and I see more evidence supporting the latter than the former. Again, only time will tell, if I’m a year late, that is perfectly fine. Nonetheless, it is why it is theoretical, until it is proven right or wrong. If you want to argue on consumer theory, I’ll gladly accept, since most of consumer theory today is based on consumers being price-takers instead of price-negotiators.

Back to the stress test. I don’t want to put words into bills’ mouth, but I interpreted “the stress tests are not based on realistic values”, I assumed he was talking about the values that quantify the relationships between the economic variables and the assets. How do we know the exact value that determines the impact of the unemployment rate on credit card losses, on MBS losses, on loan losses? How do we know that the same relationship exists when the U-rate is 8% and when it is 10% (is it 1-for-1 at 8% and 3-2 at 10%?)? How do we know that the capital buffer (whose definition is based on something that does not affect the firms ability to withstand a loss) is going to be enough? I can’t believe you would lecture me on not questioning assumptions and then take the stress test as “It will have to do”. It it nothing more than a theoretical gamble by the administration because if conditions do get worse and the buffer isn’t enough (either a firm fails or has to seek more capital), the theory will be disproved and the admin is going to look foolish, and you will say that the assumptions of the stress test should have been questioned from the get-go,when you were content as is.

Posted by: Mike at May 11, 2009 2:43 PM
Comment #281505

Well, Mike, what can I say to a student who believes a course has made their commens all-knowing!

In the theoretical world producer theory can be segregated from consumer theory. IN THE REAL WORLD, producers and consumers are inextricably bound to each other and interactive. Aggregate Demand in the real world is as much a product of supply as it is demand. And the assumptions of these theories include non-monopolistic behaviors.

That’s about all I can say to one whose comments demonstrate that they don’t know, what they don’t know. That is the difference between a degree and real world experience. Education leads to folks thinking they know. Real world experience teaches one how much they don’t know and couldn’t learn in a classroom. Education specializes. The Real World doesn’t! The real world is holistic and dynamic and fluid with all specialties of human knowledge, and more beyond that, interacting to create our reality, and our illusions and delusions.

Your conclusion that AD for gasoline is falling off a cliff, is faulty. The inverse relationship between the quantity of output demanded and the price level ONLY holds true in a NON-MONOPOLISTIC environment. You need to go back and review the assumptions of your theories, and insure those assumptions are matched in the real world, BEFORE drawing conclusions based on the theoretical constructs.

Common sense even dictates that your conclusion is wrong. More than 90% of folks are still fueling their autos to go to work. And most of the rest are fueling vehicles to find work. Folks are still consuming gasoline to get to and from school, church, and friends and family they are close to, and they are still going shopping for food and other necessities, and the transportation industry’s total transport mileage has dropped considerably, they are still providing all manner of goods to more than 90% of wholesale and retail outlets in America. And consumers have curtailed only discretionary or unnecessary travel, which limits the gasoline demand only a very small amount. In other words, America is still functioning and consumption is still taking place on only very modest reductions in diesel and gasoline consumption, especially during the non-vacation months of the year.

So, even if you are unwilling to question the authority of the theoretical (i.e. its assumptions), at least let common sense act as a course rule test of the theoretical before jumping to false theoretical conclusions that don’t match real world experience.

A student has learned theoretical constructs created by others. A knowledgeable person has learned to apply those constructs to everything in their experience. A wise person has learned the limitations of those theoretical constructs and where they don’t apply.

Both the undergraduate economics student and the Ph.D. in economics may know what Aggregate Demand is. But, there is a chasm between in where and when they will apply the construct and there is a night and day difference between them in trusting the results of that application. The Ph.D. will continually question the authority of the results. The undergrad student will not question at all, but profess instead. One of education’s little ironies.

Posted by: David R. Remer at May 11, 2009 3:16 PM
Comment #281507

Mike, on all your questions about How do we know, regarding stress tests, the answer is we don’t. But, not knowing the future is not a rationale for inaction. The Stress Tests were needed to accomplish several objectives, only one of which was to force banks to shore up their balance sheets and compensate today for a potentially protracted recessionary bottom, by selling or converting assets, or other means.

Putting them on notice that they are now under the thumb of government oversight and regulation leaving NO room for debate or equivocation of interpretation, was another objective, and a very important one.

And by forcing them to shore up their balance sheets, investor confidence is increased and economic activity is generated. Another crucially important objective. The design of the Stress Test served several objectives at once, and were designed to influence the behavior of more than just the executives of the major toxic asset holding banks.

Bills’ comments seem to fail to acknowledge these multiple objectives and purposes of the Stress Test design. To evaluate that design on only one parametric measure will lead to an incomplete evaluation of its design.

Posted by: David R. Remer at May 11, 2009 3:28 PM
Comment #281513

To David:

Apparently reading wasn’t a point of emphasis in your education. Again, you are countering arguments that I never made (or even suggested for that matter). Take my advice and actually read what I wrote.

Example 1: “Producers and consumers are inextricably bound to each other and interactive.” No crap, sherlock. In my textbook, which I have conveniently dug out to make this post (I will point out that this is sarcasm; since you can’t read, I’m assuming you can’t read between the line either), there is a diagram that shows the goods and cash flows of an interdependent economy. You honestly think I don’t know the two are linked??? Your response, which I quoted almost in its entirety, addressed nothing but producer-related ideas as a means to refute a consumer-related argument (AD). Although the two are connected, you made no attempt to refute consumer-related arguments from the consumer side of the equation, and then berate my failure to see the producer side of the equation. I’m starting to see a trend of hypocrisy in your responses.

Example 2: “That’s about all I can say to one whose comments demonstrate that they don’t know, what they don’t know.” This occurred at the start of the third paragraph, and you added 5 more paragraphs on the same issue. Good thing you were done. Yes, this was a very petty shot at you, but I’ll resort to blaming my education for me not knowing any better.

Example 3: “Your conclusion that AD for gasoline is falling off a cliff, is faulty. The inverse relationship between the quantity of output demanded and the price level ONLY holds true in a NON-MONOPOLISTIC environment. You need to go back and review the assumptions of your theories.” First of all, I said AD (in general) fell off of a cliff. I used gasoline as an example. How many times do I have to point this out??? Second of all, and this one is the one you’re going to need to pay close attention to, in a NON-MONOPOLISTIC environment (or perfectly competitive, as theory so aptly labels it), the relationship between price (P) and quantity demanded (Q) is a completely horizontal line because no firm’s actions can change quantity demanded by changing price. In a MONOPOLISTIC environment, the inverse relationship between Q and P does exist and monopolistic firms face a downward-sloping demand curve. I’ll even give you a free one: In an Oligopolistic environment, the same inverse relationship exists however there is a “kink” in the demand curve because of the “if I lower, they all lower; if I raise, I raise alone” mentality. Why don’t you take your own advice and review theory before responded with what you think you know about theory, then you can say all you want about theory and reality.

Example 4: “Common sense even dictates that your conclusion is wrong. More than 90% of folks are still fueling their autos to go to work….America is still functioning and consumption is still taking place.” Exactly when did I say that consumption of gasoline hit 0 and that the American economy was sitting idle??? The fact is that I DID NOT, and you are again refuting claims I never made. I said that consumers are demanding comparatively less quantities than they did when prices were previously at these levels. I said “AD (in general) fell off of a cliff. If you chart the data of real GDP (quarterly), consumer confidence (monthly), ISM (both mfg and services, monthly), ind. prod. and cap. util. (monthly), you will see that the graphs look like the edge of a cliff starting AROUND 07Q4 (on a technical note, some graphs may show the decline starting before, some after, the key word is around).

Example 5: “A student has learned theoretical constructs created by others. A knowledgeable person has learned to apply those constructs to everything in their experience. A wise person has learned the limitations of those theoretical constructs and where they don’t apply.” You haven’t even learned the theories (evidenced by Example 3), so what comes before student???

Example 6: “Both the undergraduate economics student and the Ph.D. in economics may know what Aggregate Demand is. But, there is a chasm between in where and when they will apply the construct and there is a night and day difference between them in trusting the results of that application. The Ph.D. will continually question the authority of the results. The undergrad student will not question at all, but profess instead. One of education’s little ironies.” More pseudo-intellectual BS, but let’s make a game out of this one for everyone else. Judging by all my posts and Remer’s assertion of grads vs ugrads, which would classify Mike? A: Both, Mike questioned the model and results of Goolsbee’s research, as well as the stress test (but was criticized for doing this), but Mike also admitted to continually using theory’s predictive aspects. According to Remer, the two are mutually exclusive, so maybe his education theory is wrong.

Example 7: “Mike, on all your questions about How do we know, regarding stress tests, the answer is we don’t. But, not knowing the future is not a rationale for inaction.” I never said or suggested the best course was inaction, and for that matter, neither did Bills. If we’re more content in simple objectives being accomplished than we are in pursuing the answers to these questions (which is what a PHD does, according to you), then we’re more ignorant than an undergraduate who simply know only how to profess.

Example 8: “Putting them on notice that they are now under the thumb of government oversight and regulation leaving NO room for debate or equivocation of interpretation, was another objective, and a very important one. And by forcing them to shore up their balance sheets, investor confidence is increased and economic activity is generated. Another crucially important objective. The design of the Stress Test served several objectives at once, and were designed to influence the behavior of more than just the executives of the major toxic asset holding banks.” Actually, these weren’t objectives (as the single objective was clearly stated in both SCAP releases), they are more like unintended consequences (unintended does not imply unnecessary, thought I’d clear that up for you).

Advice for rebuttal: Read carefully, multiple times if necessary. It may also help to have a paper copy of this post so that you can see what you are addressing while you are addressing it. Most importantly, once you click post, it could possibly be on there without change, and I’d hate for another example like #3 to happen.

Posted by: Mike at May 11, 2009 11:51 PM
Comment #281514

Mike,

Your comment to Remer regarding his education is in violation of our Rules for Participation. Read and comply with WatchBlog’s Rules for Participation, or your comment privileges will be suspended.

Posted by: WatchBlog Manager at May 12, 2009 1:22 AM
Comment #281534

Mike et al
Leave us not forget that the last huge price hike in gasoline was the result of speculation and speculation only. Crude oil supplies were in surplus. Even when the oil cartels increased production the prices did not fall. That particular market should not be allowed to exist. It serves no purpose except to enrich the few at the expense of many. Generally a futures market provides a measure of benefit by supplying capital to farmers etc. before harvest. It supplies operating capital. Exxon does not need additional operating capital. The speculators market is purly a means to increase prices and should be banned with its agents hunted down by interpol for all the damage they have done.

DR
Credit where its due. The BHO administartion with the help of the Dem congress, in cooperation with other world leaders, has adopted policies that appears to have pulled the world economy back from the abyss. Good. The problem now becomes one of changing the financial system in ways that prevent these meltdowns from re-occurring. That means re-regulation. That means once again making bankiong boring. It appears that BHO and the Dems are approaching this softly, if at all.


Posted by: bills at May 13, 2009 12:06 AM
Comment #281548

DR
Your comments about my crystal ball were snide and uncalled for. The stress test is unrealistic. This is not just my opinion. The are at least two Nobel winning economist that agree. Its a question of mathematics, not political compromise or PR. Basing public policy on unrealistc data is dangerious. There are other proven approaches to solving the bank problems that would yield quicker results and help prevent a long and painful economic recovery that appear to have been dismissed by the BHO economic team for political reasons. Too bad. There may well be political situation that me and my crystal ball are not privee too, support or little opposition to some facet of health care reform in exchange for not moving forward on zombie bank nationalization perhaps,who knows. One of the pressures on LBJ to continue supporting the Vietnam war was in exchange for right wing support for the War on Poverty. Sausage making and politics,eh?

Posted by: bills at May 14, 2009 5:16 AM
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