Mismatch Redux

Fed Focus, ,

It’s encouraging to see Chairman Bernanke continue his pushback against Minneapolis Fed President Narayana Kocherlakota’s theory of structural unemployment in his speech this week:

“Research has found that during and immediately after the serious recessions of 1973 to 1975 and 1981 to 1982, the Beveridge curve also shifted outward, but in both cases it shifted back inward during the recovery.  This temporary outward shift during a deep recession may be the result of a particularly sharp increase in layoffs, which raises unemployment quickly, even as vacancies adjust more slowly.”

That’s a point we’ve been making since Kocherlakota first advanced his jobs mismatch theory back in August 2010. ( For more information, see: Mismatching the Facts http://tlrii.typepad.com/theliscioreport/2010/09/mismatching-the-facts.html )

 

Don’t make promises you can’t keep

Comments & Context

Taking a page from Charles Kindleberger’s research on the increase in credit’s effect on asset prices, David O. Lucca, Taylor Nadauld, and Karen Shen, researchers at the New York Federal Reserve Bank, have posted a paper putting a price on what increased student loan availability has done to college tuition levels. (Link at foot of article.)

This is a careful paper: the authors lay out concerns about their methodology, stress areas where they see weakness, and balance the whole thing against the benefits to our workers and to our nation of an increase in the share of workers with college degrees. Nonetheless, it is a sobering piece of work that should force a number of deep questions, and, one hopes, policy changes.

In opening the discussion the authors note that much study has been devoted in recent years to the relationship between cheap credit and the 2002-6 housing bubble, and point out that although student loans fund a capital investment, whether delineated broadly as an educated work force, or on an individual level, while mortgages fund an asset, credit is crucial to both, and both enjoy the support of government-sponsored programs.

Federal student aid programs are governed by the 1965 Higher Education Act (HEA), which outlined 6 mandates, the fourth, Title IV, authorizing financial aid to support access to post-secondary education through the Federal Pell Grants program and the Federal Direct Loan Program. The researchers looked at three amendments to HEA: the increase in subsidized loan caps in 2007-8 school year; in unsubsidized caps in the 2008-9 school year, and the gradual increase in Pell Grants between 2207-8 and 2010-11 to link changes in tuition following increases access to loan and grant funding.

Although changes in caps theoretically apply to all institutions, the percentage of students who meet the requirement to gain access to those funds is not evenly distributed, and the students at program caps, say those with funding needs larger than the maximum loans available before cap increases, are the ones most likely to take the loans. As of 2012, about 60% of post-secondary students attended four-year public universities, 29% not-for-private private liberal art colleges and research universities, and 11%, Title IV “less-than-two-year” for-profit outfits, largely vocation and specializing in technology, business, photography, and fashion, including cosmetology and hair styling. That last 11% receives more than 77% of their funding through Title IV, with the largest share of near-the-cap students.

Between 2001 and 2012 yearly student-loan initiations increased from $53 billion to $120 billion, and in recent years 90% of those initiations came through federal student aid programs. Over the same stretch, the average tuition “sticker” price in constant 2012 dollars rose from $6,950 to $10,200, or 46%. (The authors focus on sticker rather than net tuition because it is more readily available, and because of the effects of institutional grants and the like.)

The authors found, not surprisingly, that the institutions with most aid exposure before the cap increases underwent “disproportionate” increases in tuition around those changes. For subsidized loans the authors found that 70 cents of each newly available dollar was captured as a tuition increase, and that approximately 55 cents of each Pell Grant dollar was so captured. Highest pass-throughs took place in the more expensive four-year private institutions with “relatively high-income students but average selectivity.”

Regarding this they conclude:

From a welfare perspective, these estimates suggest that, while one would expect a student aid expansion to benefit its recipients, the subsidized loan expansion could have been to their detriment, on net, because of the sizable and offsetting tuition effect.

But it was good for the stock market. On the for-profit front Lucca et al. found evidence of “large abnormal stock market responses for a portfolio of all publicly traded for-profit institutions,” following the passage of the aid increases that summed up to 10% across the segments. They also found that the average increase in the sticker price in these outfits averaged $180, but averaged $56 in the not-for-profit colleges and universities.

Here’s some food for thought via a severe example of tax dollars gone astray. Surely some of the for-profit outfits meet their stated goals, but Corinthian Colleges Inc. (CCI), the largest such for-profit network, was not among them. In April 2015, under Federal criminal investigation, Corinthian closed down its operations, and filed for bankruptcy in May. Charges include misleading students on their career options and Corinthian’s ability to place them following graduation, the graduation rates themselves, and loan issues. California Attorney General alleges CCI targeted single parents close to the poverty level via aggressive marketing. So that’s one place our tax dollars earmarked to increase access to post-secondary education have been. Note to for-profit educators: Don’t make promises you can’t keep.

But we can end on an encouraging note. As is often the case, the action is at the margin. In working to ascertain whether student debt expansion increased access to post-secondary education over the short-haul, the NY Fed researchers found that only the availability of Pell grants increases access. These grants go directly to low-income students, who are most likely to be on the enrollment margin. And although they also push up tuition, they do so at a lower rate than the loan-based increases.

If we’re serious about increasing access to college for those who want to attend, we’d be wise to funnel funds into grant programs that advance that goal, and to do so at the expense of outfits like CCI.

Credit Supply and the Rise in College Tuition: Evidence from the Expansion in Federal Student Aid Programs

The IMF considers the rich, JP Morgan Chase considers everyone, and upcoming budget cuts

Uncategorized

1.  Bas B. Bakker and Joshua Feldman just published an IMF working paper, "The Rich and the Great Recession," that shifts the focus from the role of the middle class to the role of the top 10% in the debate over the macro trends that led into the crisis.

They call both the inequality narrative, that stagnant wages led the middle class to over-borrow the rich's savings, and the wealth narrative, which ignores distribution and blames rollercoastering asset prices, flawed, and advance the idea that the rich, whose debt increased as quickly as that of the lower 90% in their methodology, were "active participants" in the boom that busted. Their work, including modeling, suggests that the savings rate of top 10% followed the same pattern as that of the lower 90%, and their model implies something they call, "…truly striking: between 1993 and 2003, about 55 percent of the increase in consumption came from the rich; over the last ten years, the share was even larger (71 percent)."

They focus on the savings rate from the National Income and Product Accounts, pointing out that in the early 1980s the savings rate was 10% and the share of income going to the top 10% one third, but by 2010 aggregated savings had slipped to 5%, and the upper share of income had risen to one half.

They do not believe, as none of us should, that the only process that would support the inequality scenario on its own, that the savings rate of the top 10% held steady over time while the rate of the lower 90% fell from 10% to zero, is plausible, especially as it requires both groups to have been saving at the same rate in the early eighties. They make the more likely assumption that the savings rate of the rich was well above that of all the rest in 1980, perhaps three times higher, and then fell much harder. Supporting this is the negative correlation between the share of wealth heading into cashmere pockets and the aggregate savings rate of the last 3 decades.

The Flow of Funds, the authors don't even bother with the new moniker, shows the debt of the top 10% rose as quickly as that of the less flush, and was likely a response to the increase of wealth. Wealth to income ratios rose from 721% in 1994 to 912% in 2007 for the top group, and from 373% to 404% for the bottom. With both savings rates traveling along the same curve, it makes sense that the top 10%, who enjoyed the lion's share of income and wealth gains, played a central role in both the boom and bust.

Check their models here.

2. In a study of income and spending patterns of 100,000 of its account holders (a sample drawn from 27 million accounts), the JPMorgan Chase Foundation found high levels of volatility on both sides of the income statement, with close to all experiencing changes of 5% or more from month to month. Over a quarter, 26%, experienced income changes of 30% or more over the course of a year (10% of them a decline, 16% an increase). There was surprisingly little variation by income quintile – in fact the top quintile experienced somewhat more volatility than the bottom. This results generally show more volatility than previous studies have.

Income and consumption changes didn't move in tandem: just 28% of the sample, whom the bank called "responders," showed a tight correlation between the two. Responders were slightly more likely to be in the bottom quintile, to be maxed out on their credit cards, and on a fixed income. A third of the sample were "sticky optimists," meaning consumption increases typically exceed income increases by 10 percentage points or more; most increased consumption despite drops in income. The optimists tended to be higher earners, though obviously that kind of aggressive consumption isn't sustainable over the longer term. The largest share of accounts, 39%, were "sticky pessimists," meaning that consumption increases less than income by more than than 10 points or more. Their consumption rises less than income when income rises, and they cut back on spending when income drops. For a large minority, 39%, income and consumption changes between 2013 and 2014 moved in the opposite direction. The data suggests that few individuals follow a monthly budget: 60% of the sample showed average monthly changes in consumption of greater than 30%.

Of course, it's hard to generalize from just two years of data, but the looseness of fit between income and consumption changes is striking. It'd be interesting to know how these categories have been affected by the Great Recession – are consumers more cautious than they used to be? – but we just don't have the data.

The typical household in the sample just didn't have the savings cushion necessary to weather the income and spending volatility. The bank estimates that a middle-income household should have about $4,800 in liquid assets on hand to cope with normal monthly ups and downs – but they had only about $3,000. The shortfall was present in all but the top quintile.

Both the volatility and lack of cushion found in this study are usually thought to affect lower-income households, but that's clearly not the case. Better financial planning and budgeting could help mitigate the problem, but most Americans experience quite a bit of economic uncertainty. As the report says in its conclusion, "financial insecurity and scarcity exact a mental toll, making it more difficult for people to solve problems, exert self-discipline, and have the mental bandwidth to weigh the costs of borrowing or other short-term solutions."

3. In their April minutes, the FOMC noted that state and local governments cut back on construction spending in the first quarter. Bloomberg's Mark Nicette put together a nice roundup of state finances, citing, among others, the mighty Rockefeller Institute, that shows that despite better collections 32 states face gaps in their FY 2015 and/or 2016 budgets, and that, as we and others have pointed out, adjusted for inflation state revenues have not regained pre-recession peaks. This means new cuts.

As we often mention, the Great Recession is the only one on record where public sector employment fell, and hence could not function as an automatic stabilizer. Nicette ends his piece with a quote from Alabama's two-term Republican Governor Robert Bentley, who just asked for a tax hike (gasp). "We have a real crisis on our hands." 

Like it or not, public employees are generally quite well paid, and they shop in the same stores as everyone else. The Bureau of Economic Analysis assigns a 2.22 economic multiplier to local (N.B.) governmental enterprises, just below residential construction's 2.27, and among the highest. And dead last? Federal banks, credit intermediation and related activities, 1.39. Uh oh.

 

Without fiscal policy, what’s the Fed to do? Part 1

Fed Focus

All evidence suggests to us that when the FOMC finally takes its first long-anticipated step, it will be to take us away from the zero bound, not because they fear the economy is getting too hot, or that there is any real danger of wage inflation, let alone unaggregated healthy wage growth.

In the fall of 2012, current and former Federal Reserve officials, as well as closely affiliated academics, made it clear the central bank is currently “confronted…with a situation that was regarded a few decades ago as merely a theoretical curiosity”: the zero bound.

In one of those papers John Woolford, former member of the New York Fed’s Monetary Policy Advisory Council (and the source of that quote) raised questions about the effectiveness of balance-sheet policies, advocating instead for forward guidance, while acknowledging the danger in central bankers talking too much. Other papers questioned quantitative easing’s ability to do anything about the unemployment rate, noted that the Fed may have fewer options than it suggests, and rang the warning bell on trying to correct macro-economic problems that have historically been addressed through fiscal and monetary policy by monetary policy alone, a bell former Chair Bernanke starting ringing before he left office. Chicago Fed President Charles Evans urged the FOMC to articulate what needs to be done as a first step toward pushing for the fiscal and monetary policies he deemed necessary to get us past the zero bound.

Evans also urged the Fed to adopt a 7/3 policy, where they would maintain their current policy as long as unemployment remained above 7% and inflation below 3%, which he called “an important improvement on current communication policy.”

Better communication policy perhaps, but it would still have left the FOMC in the same position it finds itself in today: we’ve crossed the unemployment rate threshold, but not the inflation bar.

Only the most reckless daredevil would enjoy spending so much time pushed up against the zero bound, but the way out remains the subject of contentious debate and reams of research. The vehemence of the debate, perhaps more of a slugfest, is fueled by the fact that on the other side of the scale, the fiscal side, we have a largely dysfunctional and distrusted government. We’re trying to hash out what should be considered national priorities in a dust-up about fiscal policy.

 

Distributional effects of ultra-low rates, Part 2

Fed Focus

Somewhat humorously, the zero-bound is succeeding where our political system is failing: general discontent has given us some pretty strange bedfellows. The more hawkish voices of course want a more aggressive policy, and are being joined by a growing number of more progressive types who’d like to see corporations making money the hard way—developing new ventures and investing in labor and productivity—instead of through the financial engineering enabled by extremely  low rates.

In a 2013 paper, “QE and ultra-low interest rates: Distributional effects and risks,” McKinsey estimated that in the US, the UK, and the Eurozone governments had garnered about $1.6 trillion while households lost about $630 billion in net interest income by the end of 2012. The authors note that some of those governmental profits fueled the automatic stabilizers, and broke out demographic groups by age, not income. The young were gainers and the old, losers. For households under age 35 who are net borrowers, the gain from lower rates has averaged $1,500 a year; for 35–44, $1,700. But older households with significant interest-bearing assets were losers. Those aged 65–74, -$1,900, and over 75, -$2,700. For the oldest group, that was a hit of 6% of income; for the youngest, a gain of almost 3%. 

They note that non-financial corporations also benefitted, by about $710B, but that had yet to translate into investment, probably because the recession lowered demand expectations. At the time they reckoned the benefit boosted profits by about 5%, one-fourth of the gain since 2007. McKinsey argues that effects of near-zero rates on asset prices were "ambiguous,” but at least in the recent U.S. instance, we’re not really convinced.

As logic would predict, they forecast a reversal of these benefits as interest rates rise. Even with large percentages of fixed-rate mortgages, the authors estimate that in the US household debt service could rise by about 7% for each 100-basis-point increase. The younger net debtors would lose the largest benefit, while the older asset holders gain share. The more capital-intensive industries, utilities, manufacturing, extraction, would take the biggest hit, and this was all before oil prices fell, but companies that “use capital productively,” will be rewarded. What a concept.

 And they forecast an increase in market volatility. No genius points for that, but a nice change.

The Federal Reserve’s most recent Survey of Consumer Finances, for 2013, tells us that increased interest income will be narrowly distributed across households. Although most recent data show that 13.8% of households own stocks directly—which rises to 48% if you include mutual funds and the like—only 1.4% of households own bonds directly. The SCF doesn’t report on bonds owned through mutual funds, but applying the indirect/direct ratio prevailing in stocks to bonds gets us only to 5% of households. About 2% of the middle decile owns bonds (9.2% own stocks), and 6.9% in the top decile. The Fed doesn’t even include a number for bond ownership for the lower decile because it’s very tiny, and the authors note that families in the highest 40% of the income distribution own bonds disproportionately, though much of that is savings bonds. “Ownership of any type of bond other than savings bonds is concentrated among the highest tiers of the income and wealth distributions,” they say.

Debts are more equally distributed. Half—52%—of the bottom 20% is in debt; 84% of the top decile. But the top has a leverage ratio (debt/income) of 8%, compared with 19% at the bottom. Leverage ratios are highest in the middle of the distribution.

Really, what jumps out at you putting this stuff together are the details, like the fact that the fraction of young families with education debt increased from 22.4% to 38.8% between 2001 and 2013, and the fraction of middle-income families who  saved fell significantly.