Unemployment rate versus employment to population ratio

Given the tepid new jobs numbers out today, I got interested in private sector versus public sector job growth over the past several years. I went to the Bureau of Labor Statistics website, hoping to get a handle on to what degree the storyline of recovery is different for the two sectors. I wasn't able to find any obvious numbers on that question, but while I was playing around with their data tool, I found something else interesting.

This is a plot of the unemployment rate over the past 6+ years. It topped out at 10.0 in October 2009 and has been falling fairly steadily since and is now around 8%.

This is a plot of the ratio of employed persons to the total population. In October 2009, when the unemployment rate topped out, the employment/population ratio (as a percent) was 58.5. However, while the unemployment rate has declined, the ratio of employed to population has remained static. Since October 2009 it has fluctuated between 58.7 and 58.2, and is currently at 58.4. So the only reason the unemployment rate has gone down (and Republicans have been saying this for a year or more) is because people have stopped identifying themselves as job seekers. I can think of several plausible scenarios in which that might happen:

1) Older workers who planned to retire in a few years but who have become unemployed choose to retire early rather than look for a job.
2) Students choose to pursue further education, delaying entry into the job market.
3) Dual-income households shrink to single-income households.
4) Discouraged unemployed workers decide to depend on welfare and charity rather than work.
5) Employees shift to unreported employment.

There may be other explanations that I'm not thinking of, but it seems to me that all five of these have significant downsides and only a couple of possible upsides. (1) probably means that people aren't sufficiently prepared for retirement financially, and will put an even greater strain on the Medicare/SS system. (2) means that a large pool of job seekers will hit the market at a future point, pushing the unemployment rate statistic back up. (3) means families survive on decreased income. (4) and (5) represent failures of the state, either to encourage productivity among the populace or to fairly distribute taxation. On the other hand (2) means a better educated workforce, which I think is generally a good thing (although not always) and (3) potentially means greater availability of parents to children.

I guess I'm wondering whether this divergence between the two numbers is temporary (in which case the media focus on the unemployment rate leads to a wrong impression of the true state of employment), or whether there's been a permanent shift in the percentage of the US population participating in the job market (in which case I'm unsure, but generally have a negative feeling about, the long-term implications).

Federal budget deficits

I've been reading a lot over the past few days about the current federal budgetary issues. One of the more interesting things I've found is this working paper from Alan Auerbach (UC Berkley economist) on the mid and long term debt projections. He calculates deficit projections under the assumptions of perpetuating the AMT and Medicare Doc fixes and compares it to the CBO scores. Essentially it shows that the CBO score for the budget likely underestimates total deficits over the next 10 years by about $5 trillion. And that's assuming Bush tax cuts expire as does stimulus spending. If those assumptions are reversed it adds another $5 trillion over 10 years.

But for me the real story is Figure 3 (page 22). Under every projection, revenues (as a percent of GDP) will be flat after 2013 and spending (as a percent of GDP) will linearly increase. All non-mandatory (i.e. non-social) spending will fall, as a percentage of the budget as more and more money (absolutely and proportionally) goes to providing social goods.

The good news is Auerbach is reportedly on Obama's short-list to replace Austen Goolsbee as the head of the Council of Economic Advisers. So if he's appointed, and he manages to avoid being captured by Washington interests, maybe he can bring some sense to the budget process.

Do we need to curtail federal spending? If so, how? The paper linked above doesn't make it totally clear, but the tables found here make it clear that the only sector of spending that is increasing (as a proportion of GDP) is mandatory social spending (Medicare, Medicaid, SS, SSDI, etc.). So, for those PVSers who support liberal federal economic policy, can you propose some way of making social spending sustainable?

The Quants: Discussion kick-off

Okay, I guess it's officially time for me to repent of my idleness.  (If I may provide my excuse, I've spent my free time the last few months installing sod, sprinkler, drip irrigation, a garden, and most importantly, building a sandbox).

A few disclaimers: First, I listened to the abridged while navigating California traffic to and from work, so I now feel like I know just enough about the world of quantitative economics to make a fool of myself.  Second, I will be referring to the main characters in this book as "quants" for convenience, even though I recognize that there are those who would consider some or all of the main characters not to be true quants.

Here my discussion questions:

1) Is Wall Street moral?

I wish Patterson ventured more into the morality/ethics of the quants.  I thought he gave some suggestion of how he thinks I should feel about the quants in his description of their decadence, and in his constant gambling analogies.  I think he tried to portray the crash as judgment from on high (i.e. from the god of this 'the truth' he keeps talking about).  But honestly, without a more thorough analysis of the costs and consequences of the various trading strategies the quants employed, I'm not exactly sure how to feel.  For example, were the quants really making money out of thin air (or rather adding value to the overall economy), or is there some group of people that ultimately lost as a result of the money the quants were able to make?

I guess this discussion hints at the question that bugged me most throughout the book.  Where do you draw the line between investing--which I think has a fairly obvious social and economic benefit--and exploitation or gambling?  Is finding a way to beat the market essentially the same as finding a way to beat the dealer, or is there an underlying economic benefit that is realized in, e.g., day trading or arbitrage?  One benefit that was hinted at was that of correcting prices when uninformed traders shift them out of balance.  But does this benefit justify the payout that the "quants" were able to make?  And is it fair to so harshly penalize unwise traders for daring to trade without spending years and millions of dollars in computer systems to gather the same information that the "quants" were able to harvest?

I'm not saying that I think all investment fund managers are evil--I, for one, value some of the services that they theoretically provide--i.e. educating themselves about the best investment opportunities and investing my money based on the information they learn.  But I'm skeptical about the underlying morality of many of the strategies the quants employed.

I guess I see the market as a system (albeit an imperfect system) for allocating capital to the most productive causes, and most other uses of the market seem like exploitations of flaws in the system.  But then again, what do you do to fix things?  You can't, for example, ban short sales simply because (as I suspect) they usually have no benefit to the overall economy, because then what do you do about those times when they do have a benefit?

2) Does the solution have something to do with leverage?

Here's my ignorance shining through, but were the hedge funds at all regulated in their use of leverage?  At any rate, I can see the benefit in having some flexibility to borrow money, but the leverage ratios Patterson mentioned seem very dangerous.  Theoretically, of course, it shouldn't matter.  I firmly believe that, in theory, people should be allowed to be dumb and face the consequences of being dumb.  But when a hedge fund collapses, it's not just the hedge fund (or their investors, or their creditors) that are harmed.  It leaves a hole in the economy.  And when you have enough people acting stupidly enough, with enough leverage involved, it leaves a very big hole in the economy that hurts many who didn't necessarily have it coming to them.

3) Did the quants really play as big of a role in the crash as Patterson makes out?

I really don't know.  I think it's possible.  When you have enough computers trading fast enough for long enough on (inevitably) flawed models with enough leverage, I think systemic consequences are possible.  But I really would like to hear more from Jesse here, because I just don't know enough about the big picture.

4) Should the quants have seen it coming?

I wish the author had also spent time exploring the big picture impact of the various strategies employed by the quants on the rest of the market.  Surely the quants were bright enough to realize that their strategies would have a butterfly effect on the rest of the market, and the effect would become larger the more the strategies were exploited.  That being the case, should someone have, or did someone, recognize that they could have been creating a bubble.

5) Adaptive Market Hypothesis.  Not a question.  But if economic theories were women, and if I weren't already married, I'd be trying to get AMH's number right now.  Not sure where things would go with her though.

6) I made a note to myself to write about the last line(s) of the book.  I erased my audible copy (no, I don't plan on listening to it again), and I can't find the text, so I can't remember why.  I think it may have been related to my favorite Alan Greenspan quote of all time, but I'm not sure.  Anyway, nevermind.

7) What is the moral to Patterson's narrative?

I see Patterson's narrative as his attempt to tell a tragedy--essentially a cross of Icarus and the Tower of Babel.  The problem is, I'm not so sure the real-life characters would have seen things that way.

Well, that's all I have time for.  And I won't be too surprised if no one else picked the book up.  But feel free to comment anyway.

The subprime meltdown

Well Karl has finally baited me enough to get me to weigh in here on the subprime mess. Unfortunately what may seem to many an interesting discussion topic has been for me the cause of many many late nights and a great deal of stress recently. The financial sector is reeling though fortunately my fund has so far weathered it all just fine.

I'll ignore some of the "talking points" I've read here and try and briefly summarize what I view as the source of the problems. I think it's worth remembering that at the heart of all this is of course a huge bubble in residential real estate. It turned out to be self-reinforcing---individuals saw gains in home prices as indications of future gains and piled in---but how did it start and why did it develop? What is clear today is there was a significant increase in consumer demand largely caused by a reduction in the cost of buying a home. There were 3 main culprits here:

1. Excess liquidity provided by the Fed after the tech bubble crash (and 9/11). This kept rates much lower than they would have been without Fed intervention.

2. Securitization. This is the least understood by most people and one I'd like to highlight. I will do my best to do this briefly:

For decades mortgages in the U.S. were serviced by banks who then sold the loans to investors of some kind. Low mortgage rates as well as increased transparency and information flow to potential buyers (the internet helped here) started to increase the size of the mortgage pool held by these "investors" in the last 1990s and early 2000s.

At the same time there were large pools of capital held by "regulated" institutions. These included investment and commercial banks as well as pension funds, insurance companies, etc. Long earlier these institutions had at least partially abdicated the responsibility for risk management to the government. The government told them which assets they were allowed to own and how much of different asset types they were permitted to hold. This was accomplished through the rating agencies---various assets were given ratings by these 3rd party companies and the government regulated how much of various "rated" assets an institution could own. Once "regulated" these institutions became much less concerned about risk management---if the rating agency said it was "AAA" it must be low risk. After all, the government says I can own X% of "AAA" and I own less than that, so my investments are safe.

Some smart trader on Wall St one day figured out how to turn this into a money machine. The answer was "securitization". Here's how it worked: Take a pool of mortgages. By themselves these mortgages might have been too risky for the regulated institutions to own---the rating agencies would not give them a high enough rating. So the smart trader split them into pieces called "tranches". From each pool there would be a series of securities created each paying a particular yield and bearing some part of the losses from the pool. For example the "equity tranche" would pay a high yield but would be exposed to the first 10% of losses in the pool. A "junior tranche" might pay less but would only be exposed to losses from 10% to 30%. Eventually you'd have a "senior tranche" that paid a smaller yield but would only start to lose money once pool losses reached, say, 50%. Now you ask the rating agencies to examine the credit risk of THAT security and they might decide, given the low probability of the pool suffering such steep losses, that it was "AAA". The unregulated guys could own the risky parts while the regulated institutions could own the rest.

Effectively this is just taking advantage of stupid regulation. The government told these institutions they could own a lot of "AAA" securities. The rating agencies didn't have a direct stake in the securities' performance and were not set up to understand the risk of mortgage pool losses reaching 50% (their core competency being evaluation of credit risk in companies). The institutions were foolish to believe the rating agencies and the government. And the smart trader figured out a way to profit off the mistakes of these other institutions.

This process of securitization further reduced mortage rates. Having ready pools of capital prepared to buy securitized mortgage pools meant banks could issue mortgages at lower rates and to less credit-worthy borrowers.

3. Government support for housing. Fannie and Freddie grew their balance sheets and the government pushed an agenda of "housing for everyone". Congress threatened lenders who appeared to discriminate by race (obvious correlations with socio-economic status notwithstanding), geography (though obviously a key variable in housing value), and even income (!). There is no question the administration and congress supported and enabled an aggressive expansion in home ownership. Though I said I would ignore the "talking points" I will say that perhaps the most absurd is that the GSEs (Fannie and Freddie) could not have caused this because they've been around so long. I look forward to its use when Medicare and Social Security become officially insolvent (it must be...er...something else...I mean these programs have been around so long!)

This expansion in demand caused by the above factors set the bubble in motion and, as I mentioned, it was self-reinforcing. This bubble, like all others, eventually cannot be sustained and must pop. The painful correction we have been experiencing and all of the economic carnage derive from this housing problem.

With that, on to the recriminations! In light of the above it is worth asking anyone who points a finger of blame to put it in the context of this housing bubble.

1. Was Bush to blame? Well he did encourage home ownership, the Fed did dramatically lower rates under his administration (though I think it's grossly unfair to blame him for any of that), he did not reduce the ineffective regulation that enabled the securitization disaster. He did try to reform the GSEs which would have made a big difference here. Overall I'd say partial blame. I'd like to understand Karl's claim that the "last 8 years" were particularly culpable---beyond the vague "too little regulation" which I admit I view as empty talking points. I'd also love examples of Bush being hostile to regulation---as a conservative and fan of deregulation I'd love to hear I haven't given him credit where due!

2. Was congress to blame? It failed to reform the GSEs as Bush advocated (this was bi-partisan though certainly majority dem). It certainly encouraged aggressive lending. It failed to address the idiotic regulation of financial institutions. Partial blame.

3. Was Greenspan to blame? Yes, partially, for maintaining aggressive monetary policy longer than needed. Though hindsight is 20/20.

Overall I'd say far too much blame has been thrown around without basis here. The pieces were in place long before all this happened---the GSEs, the regulations on financial institutions, the reliance on aggressive monetary policy to solve every cycle. Those that put all those pieces in place were probably well intentioned and we've all learned much about "unintended consequences" here.

Books can and will be written about all this and I unfortunately don't have the time to mention everything I'd like to. But I would like to briefly examine the issue of regulation specifically here.

I'm afraid this issue is starting to parallel the arguments over schools in the US. Most of us would agree public schools in this country are not great. Some people believe the system is sound but just needs more money. They react to failures by advocating doing what we're doing now, but just more of it. Others argue the system itself is the problem and should be reformed.

Both sides use the failure of schools to claim vindication in their argument. I would argue failure in itself proves neither. In the same way I do not believe the subprime meltdown in any way proves deregulation to be right or wrong. What it proves is that bad regulation, like bad schools, cause problems. You can respond by further increasing regulation (adding funding to the current school system) or by throwing it out (reforming the system itself).

On both issues I obviously favor less government involvement as I view that as a more efficient outcome. Had the government not regulated these institutions as it did would they have bought as many securitized mortages as they did? Would they have actually examined the risks of what they were buying and demanded higher yields (which would have then passed down the line to ultimately higher mortgage rates)? Without government support would the mortage market have grown as dramatically as it did?

The answer is not necessarily deregulation. But one of the principles most clearly evidenced by this crisis is that regulation has unintended consequences---it distorts incentives and markets in ways we cannot foresee. We cannot know that the wave of regulation now being considered will not sow the seeds of the next crisis.

The Proper Role of Government

Admittedly, I am shocked to discover that several of you have drifted toward the political left.  I've been impressed at your attempts to justify your positions and with the respect with which you all appear to be treating each other.  Like Jefferson and Adams, we all have the same end goals and we recognize that we all learn more by the open and friendly debate than if we all came to the table with the exact same perspectives. 

I posted on my own blog the full text of Ezra Taft Benson's essay "The Proper Role of Government" and I highlighted the points that I thought most powerful (well, that most powerfully supported my position anyway).  I'd invite you all to read it and let's discuss.  

I do not hide in the coat-tails of his ethos as a former president of our church to say that I am right and you are wrong. This essay was given as his opinion, not as doctrine nor a church position. So, by all means, if you disagree with something he said in this essay, you won't go to hell by questioning it.

Meltdown

I'd like to here Jesse's thoughts on the current economic sitch, and the changes that should/shouldn't be made in the context of the debate about the role of government.  I don't understand enough to have a real opinion here

Ramblings and overdue comments

All of the following items probably should be comments on various posts (like Karl's), but I find it easier to write one post than 5 comments.

To Glenn

Congratulations is way overdue. The baby pictures were nice, but I especially enjoyed the pictures from the "Hair Raising Experience" blog entry. Today I was reading some articles by Steven Landsburg, including one called Do Daughters Cause Divorce? (Landsburg has written a series of interesting articles for slate.com about Everyday economics: How the dismal science applies to your life.) Anyway, when I read this article, I thought of you Glenn and hope that you can beat the odds.

Glenn, I also enjoyed your post on the Joseph Smith presidential candidacy. We just finished reading the D&C/History of the Church picture scriptures with our daughter, but the bid for the presidency was not a topic that was covered. I understand that it doesn't build testimonies to talk about Joseph's run for the White House, but it doesn't hurt testimonies either.

I'm listening to this book called "Lies My Teacher Told Me". Most of it deals with how our Euro-centric history text books omit or misrepresent the history of people of different races (starting with the Indians) and social classes. The author also has a section on heroification and how he thinks it does people a disservice to talk about historical figures as real people with real struggles that made mistakes. I know there is a limited time in church, so it is important to focus on the most uplifting things. Still, I can't help but feel the church does a bit of a disservice by not talking more about the whole Joseph Smith and things like his presidential bid.

Speaking of books, did anyone else volunteer to be part of the book club core or is it my turn to choose again? If it's my turn, books I have been kicking aroung include one's that I've already read "An Ordinary Man" (About the Hotel Rwanda story), books I've half read "Rough Stone Rolling", and books I plan to read in the near future "The Omnivore's Dilemma". Let me know if you have any opinions.

The Dismal Science and the Environment

So a while back I asked Jesse to post his half finished post on the environment because I wanted to comment on it. I decided that if economics and environmental science are indeed comparable, then I have been underestimating environmental scientists because I have a lot more faith in economic predictions than environmental predictions. Also, I liked Karl's point that you don't have to know when the smoker is going to die to know that smoking is bad. (Aside: I think a more apt analogy than thinking of the US as a smoker would be if the country were a '50's coal miner. Both are eventually going to suffer lung disease, but the coal miner needs the job in a different way than the smoker needs a cigarrette.)

I still feel like environmental scientists have not come up with a viable solution to the problem. Most of the "cures" are worse than the disease. I don't understand why most environmentalists aren't quicker to embrace nuclear power, as it is much more proven than wind, solar, and biofuels. If someone can explain it to me, I'll be one step closer to accepting Obama (our next president?), who often repeats the wind, solar, bio mantra, as the thoughtful person he has a reputation of being.

The Lost Cause

I still haven't come to a firm conclusion about the rightness or wrongness of Lost. In retrospect, watching 3 seasons in 3 months was probably a bit much. My wife has definitely concluded that she won't be watching it, and I definitely feel that I shouldn't spend that much time watching stuff without my wife. So by default, I guess I won't be watching the rest of Lost.

I am starting to look more into devices that can help filter out a lot of the bad stuff because, as Karl pointed out, most episodes of Lost aren't that different than the commercials or other media. Personally, I don't feel offended by most commercials or most episodes of lost, but that may be more of a reflection on me than the media. I don't know. Either way, I figure if there is technology available to help me access cleaner media, then I should try to utilize that technology. I've heard some success stories, but if any of you have had any success, let me know.