Author: Karl Whelan

Sachs on the Geithner Plan

Jeff Sachs has a nice piece in the FT on the Geithner plan.  Sachs is against it and explains his objections with a very clear numerical example.  Of course, readers of this blog have seen this kind of thing here already but Sachs makes an additional useful point that hasn’t been discussed here.

It is no surprise that stock market capitalisation of the banks has risen about 50 per cent from the lows of two weeks ago. Taxpayers are the losers, even as they stand on the sidelines cheering the rise of the stock market. It is their money fuelling the rally, yet the banks are the beneficiaries.

This point is important in an Irish context because our government is discussing its own plan to overpay for bad bank assets.  It is natural for media commentators to interpret stocks going up as good news as usually this corresponds to good news about the broader economy. However, in this case, it should be remembered that stocks are just a claim of a particular group of investors on a particular sequence of future dividend payments.

Bank stocks rising on news that the government is likely to adopt such a plan—and probably rising a lot more if the plan is implemented—should be interpreted as good news for bank shareholders, but not necessarily as good news for the taxpayer.  There are better ways to solve our banking problems and analysis along the lines of “the market is reacting positively to the plan” misleads the public into thinking that plans like this represent good public policy.

Implications of QNA Release for 2009

As I noted before, the Irish media and forecasters tend to focus on the year-average over year-average figure for GDP growth (averaging the four quarters of 2009 and comparing that to the average of the four quarters of 2008).   This figure is important for thinking about things like income tax revenue, which is levied on a calendar-year basis, but it can be misleading as an indicator of the economic growth taking place in the economy during a particular year.  This is because if GDP has fallen a lot coming in to the year, then the average level may be lower than the previous year, even if GDP starts to recover.

This situation exactly applies to measuring the Irish economy right now.  In news that will hardly be surprising to anyone who reads a newspaper, today’s QNA release shows that Irish GDP fell off a cliff in 2008:Q4, with seasonally adjusted real GDP falling 7.1% in 2008:Q4 relative to 2008:Q3—not at an annual rate.   This “base effect” will make the average-over-average figure for 2009 a very poor measure of underlying economic growth.  Here’s some quick calculations.  If Irish GDP stays at its 2008:Q4 level throughout the year (i.e. if we hit bottom in 2008:Q4 and managed to stay there for the year), then average-over-average GDP growth for 2009 would be exactly -5%.

Of course, all the incoming statistics suggest that the economy continued to contract rapidly in the first quarter this year—At 10.4 percent in February, the umployment rate has already risen by 1.8 percentage points since the December level, compared with an increase of 1.4 percentage points between September and December.  If GDP posted another 7 percent decline in 2009:Q1, then even a flat level of GDP for the rest of the year would imply an average-over-average growth rate of -11.6%.

An optimistic scenario would hope that the unemployment figures in the first quarter represent more of a lagged effect and hope to limit declines in the first half of the year to two percent in each of the first and second quarters, followed by a return to growth at, let’s say, a 3 percent annual rate.  This would still imply an average-over-average growth rate of -7.8% for 2009.

I think it’s time for those that use the average-over-average figures to revise their forecasts down.

The Geithner Plan: Quick Numerical Example

Calculated Risk links to video of Austan Goolsbee of the White House Council of Economic advisers, discussing how the Geithner plan aligns the incentives of the public and private sector participants.  I had dubbed this idea a fib but Goolsbee makes it sound plausible: “if the private guy makes money, the government makes money. If the private guy loses money, the government loses money.”   CR links to an example that explains how this plan could still see the private guys make money and the government lose money but it doesn’t explain how the price gets set, which is sort of the crucial issue.  So, here’s a simple numerical example that shows how the price gets set.  The point is probably pretty obvious, but I found it self-instructive to work through the figures.

Continue reading “The Geithner Plan: Quick Numerical Example”

Geithner Plan Published

Official details here and here. It’s pretty much as I described yesterday and I’m no more impressed than before.  In particular, it hardly takes a corporate finance expert to figure out that “The equity co-investment component of these programs has been designed to well align public and private investor interests in order to maximize the long-run value for U.S. taxpayers” is a bit of a fib.   Funnily, toxic (or troubled) assets have now been renamed “legacy assets”!  This terminology might be appropriate if we were dealing with newly-cleansed banks with new ownership and management.  However, as I’m reminded every time I see this man’s happy smiling face, that just ain’t the case.

On the 9.5% Budget Deficit Target

In my comments on John McHale’s recent post and also on the radio at the weekend, I suggested that the government should probably stick to the 9.5% target set out in January’s Addendum document.  While the document did not contain details about how the government was going to make these adjustments, it was still a clear commitment to stick to a particular path to get back towards a 3% deficit by 2013.  If three months later, we were seen to already be well off these targets, the concern would have to be that the international bond market would judge us as being incapable of sticking to a plan.

However, having thought about this a bit, I’d be inclined now to argue that there probably has been so much slippage already this year that sticking to a 9.5% target for the calendar year 2009 may not be a good idea. My impression now is that the implementation gaps in getting the changes in the April 7 budget made effective will mean that we will only see about half of the budgetary improvement that these measures would bring in a full calendar year.  So, for instance, suppose that without adjustments the deficit is likely to be 13.5% for 2009. In that case, getting to 9.5% for the year would require 8 full percentage points of full-year-equivalent adjustments.

A better strategy would be to make adjustments that leave the government running an effective deficit in the second half of the year of 9.5%, and so facing into the 2010 budget in exactly the position that they had promised to be in.  In the example of a no-adjustments deficit of 13.5%, this would amount to running a deficit for 2009 of 11.5%, which could be interpreted as 13.5% for the first half of the year and 9.5% for the second half.

In a sense, this is a recommendation to government as to how to “spin” an outcome which looks like slippage from the January plan as still being, in a sense, consistent with it.  Beyond that, those economic commentators that will want to criticise the government for failing to meet its own plan, if indeed it announces a target higher than 9.5%, should keep in mind that meeting this target would require starting 2010 with a budget deficit well below what was envisaged in that plan.