Four unpleasant options for TARP funding

Despite Secretary Geithner’s statement to the contrary, I still think the Administration is running out of room within the $700 B Troubled Assets Relief Program (TARP). In my last four posts on TARP funding (1 2 3 4), I have stuck to what I think I can demonstrate analytically. I am now going to shift to some educated guessing about what may be going on within the Administration that is contributing to confusion on the outside. The prior posts involved math, while now I am analyzing people, so I am far less certain about what you read here than when I walked through the TARP arithmetic.

I think the senior economic policymakers in the Administration are overconstrained and have several bad options in front of them. This is not an unusual situation, but to a certain extent they put themselves into this box by spending TARP money on every problem that popped up. $50 B on housing, $5 B on auto parts suppliers, $15 B on small business loans, additional unspecified sums for GM and Chrysler, and new as well as old mortgage-backed securities — things add up. I think they’re in a box.

The box has three sides:

  1. They have created expectations among various constituencies for programs announced over the past two months. These expectations would consume most of the remaining $700 B of TARP funds. If their new programs are successful, they will want to expand them to further strengthen financial institutions and markets. If they are unsuccessful, they will need more TARP funds to try something else.
  2. They are justifiably afraid of asking Congress for more TARP funds.
  3. They could create some room for themselves by taking taxpayer funds back from some of the healthy big banks, but they may be worried about the signals that sends about the others.

It appears that they are testing all three sides of this triangular box to figure out which is their least worst option.

Senior Administration policymakers are operating in an ever-changing financial, economic, and legislative environment. When they developed the President’s budget in February, asking Congress for more TARP funds probably seemed difficult but not necessarily impossible. In that circumstance, it was reasonable and responsible for them to put a $250 B placeholder in their budget for a potential future TARP request.

The legislative environment is now much more hostile. It would not surprise me if, for the moment, they have ruled out asking Congress for more TARP funds, and are instead trying to figure out how to create as much room as possible within their existing constraint.

Commenter Wayne Marr asked a good question.

… But the main point is that Obama and team (Larry, Christy, Austan, Geithner, etc) can simply go to [the] well (Congress) since Democrats can pass pretty much what they want. The recovery plan was not named the “Great Bailout:” but the “American Reconstruction and Recovery Plan” or some such nonsense for a reason.

Why not another funding program called “The Better Banking Plan for the 21th Century” to provide more cash for technically insolvent banks? Or those that posed a systemic risk? So does it really matter that we have 30B left of TARP or 100B left for TARP?

While I generally agree that the President has tremendous leverage to get Congress to pass his agenda on a wide range of topics, I seriously doubt that is the case here:

  • 95 of 235 House Democrats voted no the first time on TARP (on September 29, 2008), and 63 House Democrats voted no on the successful vote four days later. Speaker Pelosi now has a significantly larger majority (254), but she would still need Republican votes.
  • TARP is far more unpopular now than last Fall.
  • President Obama could undoubtedly get some House D votes who we (the Bush Administration) could not, but not enough to pass such a bill.
  • I surmise that House Republicans are in no mood to go out of their way to help the majority or the White House, given how aggressively the Speaker and White House have been in passing other legislation without their input. That does not mean that all of them would vote no, merely that the Administration will have a hard sell to make.
  • Finally, even if she had the votes, I would bet heavily against the Speaker bringing up such a bill if she thought the vote would be partisan, because she would conclude that such a vote would expose her House Democrats to too great of a political risk in the next election. I think that she thinks that she would need bipartisan cover from Republicans as a condition for bringing such a bill to the floor.

As background, the Temporary Asset-Backed Securities Loan Facility (TALF) is what the Fed and Treasury are doing together to keep securitization markets going for things like student loans and car loans. They now want to expand it to include securitizations for new mortgages, and to use it to buy toxic mortgage-backed securities. TALF was created during the Bush Administration. This is the second major expansion since President Obama took office.

PPIP is the Public-Private Investment Partnership, Secretary Geithner’s plan to buy toxic assets from banks. It has two parts, one of which works in conjunction with the Fed, and the other with the FDIC.

Secretary Geithner’s comments that they have $135 B of room left in the TARP is testing side #1 of the triangular box to its maximum possible extent. In an attempt to convince people that they have sufficient room, to reassure both markets and the Congress, I think his staff put together the biggest number they could plausibly say with a straight face. They have not, to my knowledge, explained what $135 B of room would mean for the TALF and buying toxic assets, and I fear that such an answer would tremendously disappoint market participants who are expecting a $1+ trillion TALF and a $100 B PPIP. If the Administration has made policy decisions that lock in $135 B of room, then they have scaled something way back beyond what they had previously said publicly.

The Administration faces a choice: scale back these two programs to be smaller than what they had previously suggested to market participants, or squeeze something else hard to create more room within the $700 B limit.

The other option is to get some TARP funds back from the healthiest big banks. Since the law allows the Administration to recycle returned funds for other purposes, every invested dollar repaid can be spent again.

Certain large banks (e.g., JP Morgan Chase and Goldman Sachs) are publicly signaling that they would like to repay the Treasury. It is hard to blame them, considering the political and legislative environment. Martha MacCallum of Fox News pushed me on this point, correctly pointing out that it seems un-American to dissuade banks from paying back the taxpayer.

The banks are reportedly being told “not yet” by the Administration. I will guess that the Administration is concerned about something that worried some of our experts — if healthy banks return their funds, then investors will conclude that every bank who is not returning their funds must therefore be unhealthy.

This logic becomes strained, however, when those banks find other avenues for signaling to the market that they are healthy, as they are doing now by screaming “WE WANT TO GIVE IT BACK.”

At some point the banking policy concern may be overwhelmed by the near-impossibility of getting more funding from Congress and the policy and political undesirability of scaling back on PPIP, TALF, or the housing commitment. If this happens, then the Administration will happily start accepting funds from banks. The numbers are large enough that this could create room for them to do other things, and as a long-run policy matter, we want the taxpayer to be paid back. These are supposed to be temporary investments in the banks, in which public capital substitutes for private capital that was unwilling to show up last Fall.

There is another outside-the-box possibility that I am sure the White House has considered. Part of their resource constraint arises from having made a $50 B TARP commitment to housing.

They could push this program out of the TARP, and ask Congress for these housing funds anew. It would be much easier for a heavily Democratic Congress to pass $50 B for housing than for them to pass the same amount (or much more) for “Wall Streeet banks.”

I would oppose such a request, because I oppose this housing spending inside or outside of TARP. But I’m sure they could pass it, given their large partisan majorities in both bodies. This option would cause the White House political pain on its left, which pushed hard for these programs, and could cause FDIC Chairman Bair heartburn, given her impassioned support for these housing programs.

Things probably look a little different to the folks sitting inside the West Wing and at Treasury than I have described here, but I would wager heavily that a discussion at least similar to this is ongoing within the senior ranks of the Administration. As long as that decision is unresolved, it will be confusing as we try to interpret statements like Secretary Geithner’s that he has $135 B of room within the $700 B TARP allocation. Those policymakers need to balance the benefits of decision-making flexibility with the costs and repercussions, from markets and/or Congress, of the bad news when it is eventually delivered. They may be waiting for the right time to signal that a previous commitment will be scaled back, or instead for the right time to ask Congress for more funds. I think it is better for market participants and Congress to have early clarity, especially if it’s bad news.

In my experience, it is better to deliver the bad news as soon as you have made the decision. Rip off the band-aid quickly.

I will end with a thought experiment. Suppose my analysis is roughly correct. It is easy to figure out what you don’t want to do. It is much more difficult to decide what you do want to do. If the President asked you for your recommendation, what would it be?

  1. Scale back on PPIP and TALF as necessary to avoid having to ask Congress for more funds.
  2. Ask Congress for more funds. Follow-up: how much more?
  3. Tell banks that you welcome them repaying the Treasury early.
  4. Push housing outside of TARP and make a separate request of Congress for those funds.
  5. Wait and hope.

By focusing only on covering the uninsured, are we solving the wrong problem?

By focusing only on covering the uninsured, are we solving the wrong problem?

The traditional Beltway logic on health care reform goes like this:

  • The problem is that 46 million Americans lack health insurance. (I addressed why this number is incorrect and misleading last Thursday.)
  • Government should provide health insurance to those 46 million people, or at least pay for it.
  • Let’s expand a taxpayer-subsidized health insurance program to cover the 46 million, or maybe create a new program.
    • (Alternately: Let’s mandate that everyone has to buy/have health insurance.)
  • This means everyone will have health insurance. We have solved the problem.

Much of the health policy debate centers on how to solve this problem. Liberals want to expand government programs: Medcaid, S-CHIP, Medicare, or the federal employee health benefit program (FEHBP). Conservatives argue that we should instead provide tax incentives to subsidize the purchase of private health insurance.

I fall in the latter camp. My preferred health reform includes taxpayer subsidies for the purchase of private health insurance. But before we jump into the argument about the solution, it is important that we define the problem correctly. Today I would like to challenge the premise that the goal of health reform should be only, or even primarily, to provide taxpayer-subsidized health insurance to those who are uninsured. That defines the problem too narrowly.

Here is my alternate logic:

  • The problems are (a) health insurance is expensive, and (b) the cost of health insurance grows faster than compensation.
  • These two factors (expensive and getting more so) mean that:
    1. Private health insurance gets more expensive each year for the 202 million Americans who have it. This directly squeezes wages when health insurance is provided by an employer, and household budgets no matter how it is purchased.
    2. Uninsured people cannot afford health insurance. Those who can just barely afford it this year risk losing it next year and becoming uninsured as their premiums grow faster than their wages.
    3. Public health insurance expenditures for Medicare, Medicaid, S-CHIP, and FEHBP roughly track private health insurance expenditures over time. High and rapidly-growing health insurance costs therefore crush federal and state government budgets.
  • If we can figure out ways to make health insurance less expensive, and/or slow the growth of health insurance premiums, we will solve all three of these problems.
  • If our solution slows the growth rate of health insurance premiums, we will have a lasting solution, unlike those solutions which just shift costs from one payor to another (usually, the taxpayer).

health insurance cost flowchart

Washington focuses on the blue box problem, driven by the phrases “46 million uninsured” and “universal coverage.” In doing so, policymakers often forget that the red box problem is the primary cause of the blue box problem.

I argue that policymakers should try to solve the red box problem, not the blue box problem, for two reasons:

  1. Solving the red box problem solves the blue box problem of the 11-35 million uninsured. It also helps the 200+ million people who have private health insurance, and it helps solve the #1 problem of federal and state government budgets.
  2. If you just try to solve the blue box problem, and if you do so by shifting the costs onto someone else (the taxpayer), you will end up chasing your tail, because within a few years the growth of health insurance premiums will put you right back where you started. You will create an additional unsustainable burden on the taxpayer.

Rather than just trying to expand taxpayer-financed health insurance to the uninsured, policymakers should try to understand and address why health insurance is expensive and getting more so each year. If they can address the red box problem, they will solve all three symptoms and create a longer-lasting solution.

My alternate logic may seem trivially obvious. Yet in Washington it is frequently forgotten or ignored.

How many uninsured people need additional help from taxpayers?

How many uninsured people need additional help from taxpayers?

When discussing health insurance we frequently hear that there are “46 million uninsured” in America. This figure is from a monthly survey of about 50,000 households done by the Bureau of Labor Statistics and the Census Bureau. This Current Population Survey (CPS) then uses statistical techniques to paint a picture of the entire U.S. population.

Advocates for expanding taxpayer-subsidized health insurance, and their allies in the press, repeat this 46 million number constantly. It paints the following technically accurate but misleading picture:

insured v uninsured

This looks really bad. At least there are more than 250 million people with health insurance – that is clearly a good thing that we never hear it in the press. Still, there’s a lot of red there. It means that in 2007 (15%) of Americans lacked health insurance, according to the CPS. Advocates, some elected officials, and the press round that number up to “1 in 6 Americans.” We hear that there are “46 million uninsured,” and then we jump to the conclusion that government needs to help 46 million people buy health insurance, subsidized by taxpayers.

Let’s look inside that 45.7 million number and see what we can learn. Here is our key graph:

uninsured subpopulations

First, I need to make a technical disclaimer. I had this same detailed breakdown for 2005 data, done by health experts when I was part of the Bush Administration. I now have a 2007 total (45.7 million), and so I have proportionately adjusted the components to match that new total. It is a back-of-the-envelope calculation, but I am confident that it is solid, and it does not move any component by more than two hundred thousand. In addition, the expert analysis I am using ensures that the subdivisions shown above do not overlap. I will slightly oversimplify that point in the following description of the breakdown to make the explanation readable.

Let us walk through the graph from top to bottom.

  • There were 45.7 million uninsured people in the U.S. in 2007.
  • Of that amount, 6.4 million are the Medicaid undercount. These are people who are on one of two government health insurance programs, Medicaid or S-CHIP, but mistakenly (intentionally or not) tell the Census taker that they are uninsured. There is disagreement about the size of the Medicaid undercount. This figure is based on a 2005 analysis from the Department of Health and Human Services.
  • Another 4.3 million are eligible for free or heavily subsidized government health insurance (again, either Medcaid or SCHIP), but have not yet signed up. While these people are not pre-enrolled in a health insurance program and are therefore counted as uninsured, if they were to go to an emergency room (or a free clinic), they would be automatically enrolled in that program by the provider after receiving medical care. There’s an interesting philosophical question that I will skip about whether they are, in fact, uninsured, if technically they are protected from risk.
  • Another 9.3 million are non-citizens. I cannot break that down into documented vs. undocumented citizens.
  • Another 10.1 million do not fit into any of the above categories, and they have incomes more than 3X the poverty level. For a single person that means their income exceeded $30,600 in 2007, when the median income for a single male was $33,200 and for a female, $21,000. For a family of four, if your income was more than 3X the poverty level in 2007, you had $62,000 of income or more, and you were above the national median.
  • Of the remaining 15.6 million uninsured, 5 million are adults between ages 18 and 34 and without kids.
  • The remaining 10.6 million do not fit into any of the above categories, so they are:
    • U.S. citizens;
    • with income below 300% of poverty;
    • not on or eligible for a taxpayer-subsidized health insurance program;
    • and not a childless adult between age 18 and 34.

As a policy matter, we care not about the total number of uninsured, but about the subset of that group that we think “deserves” taxpayer-subsidized health insurance. That is a judgment call that involves some value choices.

I will make one value choice for you and boldly assert that, if you are already enrolled in or eligible for one free or heavily subsidized health insurance program, we can rule you out as needing a second. That simple statement reduces the 45.7 million number down to 35 million, by excluding the Medicaid undercount and Medicaid/SCHIP eligible from our potential target population.

I think most people would also say that the 10.6 million I have labeled as “remaining uninsured” and shaded in yellow above are the most sympathetic target population.

It then gets tricky.

  • Should people with incomes near or above the national median get health insurance subsidized by taxpayers?
  • How about non-citizens? Should we distinguish between documented and undocumented non-citizens? Between those who pay taxes and those who do not? Remember that we are not talking about who should get emergency medical care, but instead who should get taxpayer subsidies to finance the purchase of pre-paid health insurance. Does that change your answer?
  • Many young adults and childless couples are in good to excellent health. Do they deserve subsidies, when they may be making what they believe to be a rational economic decision and using their financial resources for things other than buying health insurance? Should a 25-year old Yale graduate triathlete making $30K per year get his health insurance subsidized by taxpayers if he chooses not to buy it because his budget is tight?

There is no clear right or wrong answer to the above questions. You need to make your own value choices for them.

Now let us look at the effects on the totals for several hypothetical answers to these questions. Remember that the advocates, some elected officials, and press tell us that the numbers are: 46 million uninsured, 15% of the population, and 1 in 6 Americans “are uninsured.” I suggest you try to figure out which of the following is closest to your view.

  1. Ann wants to subsidize everybody, but agrees that we don’t need to double-subsidize. She excludes the Medicaid undercount and Medicaid/SHIP eligible from her target population and ends up with 35 million people. That is still an enormous amount, but it is 10.7 million less than the headline number she heard in the news. Her target population is now 11.7% of the total U.S. population, down from 15%. Put another way, she would like taxpayers to help between 1 in 8 and 1 in 9 Americans who she feels are deserving of subsidies to buy health insurance, rather than the 1 in 6 she heard in the press.
  2. Bob agrees with Ann, but thinks that subsidies should go to the poor, or at least not to those who have above the median (or near median) incomes. His target population is therefore about 25 million people, way down from 46 million. That is 8.4% of the total U.S. population, or 1 in 12 Americans. That is still a huge problem, but it is very different from 1 in 6.
  3. Carla agrees with Bob that subsidies should not go to those with incomes near or above the national median. She also thinks that undocumented citizens should get emergency medical care, but not taxpayer-subsidized pre-paid health insurance. I will guess a 50/50 split between documented and undocumented of the 9.3 million uninsured non-citizen, and I would appreciate it if someone could help me refine this. With this assumption, Carla’s target population is about 21 million, or 7% of the total U.S. population. That is roughly 1 in 14 Americans.
  4. Doug thinks only American citizens with incomes below the national median (and who are not already eligible for another program) should be eligible for additional aid. His target population is therefore the bottom two bars on the graph, or 15.6 million people. That is 5.2% of the U.S. population, or 1 in 19 Americans. If Doug were to further limit subsidies to those below 200% of poverty or 150%, his target population would be a few million people smaller.
  5. Edie agrees with Doug, but thinks that if you are a young adult without kids, you should fend for yourself. Her target population is 10.6 million people, or 3.5% of the total U.S. population. That is 1 in 28 Americans.

These are, of course, not the only possible answers, but I think they are a representative bunch. Even for the most “liberal” set of answers (Ann’s), the headline numbers we hear in the press overstate the extent of the problem by more than 10 million people.

Now even Edie’s narrowest 10.6 million target population is still a lot of people who lack health insurance. So why does it matter that the press gets the numbers wrong?

  1. If we misdiagnose the problem, we could easily design the wrong policy solution. A solid quantitative understanding of who we would like to help and why is important.
  2. Health insurance subsidies cost taxpayers tens of billions of dollars each year. If we target these funds well and prioritize, we can help more of the people whom we think are deserving of additional assistance, and fewer of those who need less help. If we target those funds poorly, we will waste a lot of money. This point is independent of the total amount we spend on subsidizing health insurance.
  3. Health insurance competes with other policy goals for an enormous but still ultimately limited pool of taxpayer funds. We should neither overstate nor understate the problem to be solved, so that the tradeoffs with other policy goals can be considered fairly.

When you hear “46 million uninsured,” or “1 in 6 Americans don’t have health insurance,” remember that this is technically correct but misleading. The more important question is, “How many uninsured people need additional help from taxpayers?”

What’s your answer?

Does the President's budget cut the deficit in half?

Does the President's budget cut the deficit in half?

Budget Director Peter Orszag wrote on his blog yesterday that he thinks “Debt held by the public net of financial assets is the most meaningful measure of current federal debt.”

I wrote earlier today why I think Director Orszag’s new metric is misleading and dangerous. Now, however, I’m going to take his argument and apply it to the President’s budget, for which Director Orszag is responsible.

It seems to me that his own logic invalidates his claim (and therefore President Obama’s statement) that the President’s budget would cut the deficit in half by the end of the President’s first term.

Therefore, while our Budget will run deficits, we must begin the process of making the tough choices necessary to restore fiscal discipline, cut the deficit in half by the end of my first term in office, and put our Nation on sound fiscal footing. (President’s Message on the Budget, page 4)

You will remember from my earlier post that debt held by the public is simply the accumulation of the federal budget deficits and surpluses of prior years. It is the sum of all current and past borrowing by the federal government from those outside the government. The deficit is an annual measurement, and the debt is a total of deficits and surpluses over time.

Director Orszag writes that “the most meaningful measure of current federal debt” should net out financial assets held by the U.S. government. If he believes this when measuring debt, then logically you should do the same with the annual deficit. His logic argues that this year’s projected $1.752 trillion federal budget deficit (OMB numbers) is not as good a measure as if we net out the amount of financial assets the U.S. government will purchase this year, which according to OMB is $915 billion (my calculation from Table S-1 of the President’s Budget). The Director’s logic suggests that he would think that the most meaningful measure of this year’s federal budget deficit is to net out this year’s purchase of financial assets. Instead of $1.752 trillion, the “most meaningful” deficit figure for 2009 would be $837 billion.

If the Director disagrees with me extending his logic from the debt to the deficit, I would be intrigued to hear his rationale.

The President has said that his budget will “cut the deficit in half by the end of my first term in office.” Director Orszag has defined that to mean that the 2013 deficit is less than half of the 2009 deficit, as measured on January 20th before they implemented any policy changes:

We project that the deficit for the current fiscal year, including the recovery and stability plans, will be $1.75 trillion, or 12.3 percent of GDP. Of that, $1.3 trillion, or 9.2 percent of GDP, was already in place when we assumed office.

The President is determined to cut this $1.3 trillion deficit by at least half in four years. This would bring the deficit down to $533 billion by fiscal year 2013. More importantly, it would reduce the deficit to about 3 percent of GDP. (Director Orszag’s testimony before the House Budget Committee, March 3, 2009, p. 2.)

If you take the figures in the President’s budget as face value, the Director hits the goal:

  • He projects that the 2009 deficit will be $1.752 trillion.
  • He projected that the 2009 deficit before enacting their new policies would be $1.3 trillion.
  • He projects a 2013 deficit under the President’s budget of $533 billion. That’s 41% of the $1.3 trillion figure, well below half.

Most economists and budgeteers prefer to measure deficits as a percent of the economy. They easily hit their goal using this measure:

  • He projects that the 2009 deficit will be 12.3% of GDP.
  • He projected that the 2009 deficit before enacting their new policies would be 9.2% of GDP.
  • He projects a 2013 deficit under the President’s budget of 3.0% of GDP, well under half the 2009 deficit. They hit this goal with ease.

But his starting (and ending) point for these measurements includes the purchase in 2009 of more than $900 billion of financial assets by the U.S. government (using OMB numbers). According to his blog post yesterday,

If I take a $100 loan from my bank and stick that amount into my bank account without spending any of it, my family and I aren’t poorer, because even as I owe $100 to my bank, my bank owes $100 to me. On net, and as long as the new asset is equal in value to the new liability, there’s no change in my overall financial state. There’s a similar effect when the federal government borrows money in order to invest in financial assets.

It seems to me that this logic (which I don’t buy) should apply equally to the debt and the deficit. His logic suggests that his starting point in 2009 for measuring “cutting the deficit in half” is inflated by hundreds of billions of dollars used to purchase financial assets.

Look at what happens, though, if instead you look at the deficit net of financial assets purchased:

  • The 2009 deficit, net of financial assets purchased in 2009, is $837 billion.
  • The 2013 deficit, net of financial assets purchased (and sold) in 2013, is $565 billion. That’s 67% of the 2009 deficit, well more than half.

And if we do the same thing as a share of the economy, they still fail to hit the President’s goal:

  • The 2009 deficit, net of financial assets purchased, is 5.1% of GDP.
  • The 2013 deficit, net of financial assets purchased, is 3.2% of GDP. That’s 63% of the 2009 deficit, again well more than half.

Now the Director’s test as stated in his testimony uses the 2009 deficit, measured as of January 20th before President Obama’s policies were enacted, as a starting point. OMB’s public numbers do not allow me to net out the financial assets to develop a precise figure for comparison. But we know that logically it’s not bigger than the $837 billion figure given above, so this ambiguity shouldn’t matter, either for aggregate dollars, or for percent of GDP. If anything, it should mean that they miss their “cut in half” target by an even greater amount.

If Director Orszag thinks that debt held by the public net of financial assets is the most meaningful measure of current federal debt, then it would seem logical that the same should apply to the annual federal budget deficit.

But then, using the Administration’s own numbers, the President’s budget does not come close to meeting the President’s goal of cutting the deficit in half by the end of his first term.

(Note to budget reporters: If you hear a response from OMB and would like to share it with me, I’ll give you my reaction.)

Update (12:20 PM Wed): A friend corrects my statement that the debt is simply the accumulation of past deficits. It’s not. The Credit Reform Act measures credit subsidies (like for federal loan or loan guarantee programs) differently than it measures cash flows, and the deficit does not capture “means of financing and cash management, like when Treasury borrows funds and deposits the cash at the Fed.” I stand corrected on these points. But I don’t think this should change my logic above about whether to net out the purchase or sale of financial assets. I don’t see why the differences between deficit and debt accounting should mean that the purchase or sale of financial assets should be treated differently. If the Director or his staff have an answer, I’m all ears.

Let's not hide $1.4 trillion of IOU's

Let's not hide $1.4 trillion of IOU's

Yesterday on his blog the President’s Budget Director, Peter Orszag, asks himself and then answers the question, “How much does the federal government owe?”

This sounds like a technical question of concern only to “those of us wearing the green eyeshades,” but the Director’s suggested answer has dangerous ramifications, and could mislead, or at least confuse taxpayers and financial market participants.

The Director’s answer makes the federal debt appear $1.4 trillion smaller than the way it is traditionally measured. He argues that we should, in effect, ignore 1.4 million million dollars borrowed by the federal government. That is breathtaking.

Let’s look at the Director’s argument and why I think it’s dangerous.

Most budget experts focus on debt held by the public, which Director Orszag accurately describes as “the amount that the federal government owes to others.” I will expand on that a bit with some concrete numbers:

  • Take the total amount the Federal government will spend this year. Specifically, we’re looking at cash”paid” by the U.S. government to someone outside the government in 2009. A budget wonk would call these outlays. I’ll use the nonpartisan Congressional Budget Office’s numbers for current law, so I get $3.85 trillion of outlays for 2009. That is way (way) above historic norms, in part due to the financial stabilization efforts, and in part due to the new “stimulus” law.
  • Now take the amount the Federal government will collect in revenues this year. This is cash coming into the U.S. government from someone outside it. Almost all of this is taxes. CBO says this is $2.186 trillion of revenues for 2009.
  • If the U.S. government is paying out $3.85 trillion in cash (outlays) this year, but collecting “only” <sigh> $2.186 trillion in cash, then we need to come up with the difference somewhere. That difference is $1.667 trillion for 2009. This is what CBO says is the federal budget deficit for 2009.
  • The U.S. government gets this cash by issuing IOUs to people outside the government, aka Treasury bonds. The government gets cash from anyone who buys Treasury bonds – individuals, firms, and foreign governments.
  • The debt held by the public is simply the accumulation of these IOUs. It is the sum of money owed by the U.S. government to others. (Update: See the caveat at the bottom.)

Nothing I have said so far is the slightest bit controversial, but this is where Director Orszag and I part ways. Tuesday he wrote:

As I said at the beginning of this post, I think the most meaningful measure of federal debt is debt held by the public net of financial assets. If I take a $100 loan from my bank and stick that amount into my bank account without spending any of it, my family and I aren’t poorer, because even as I owe $100 to my bank, my bank owes $100 to me. On net, and as long as the new asset is equal in value to the new liability, there’s no change in my overall financial state. There’s a similar effect when the federal government borrows money in order to invest in financial assets.

Suppose I tweak the Director’s metaphor to make it better fit the current situation and illustrate my point. If he takes a $100 loan from his bank and invests it in the business of his deadbeat neighbor Alan I. Gorp, he still owes the bank $100. The bank cannot loan that $100 to anyone else. His (the government’s) borrowing has “crowded out” borrowing by someone else. And who knows how much his $100 investment will be worth next month? We should care not just about his net position, but also about his total liabilities, and especially about how much he (the government) is borrowing from the bank (private sector).

In normal times this would not be a big difference, because the U.S. government in large part stays away from owning financial assets. Now, however, the federal government is buying equity stakes in banks and other large financial firms, and issuing loans to financial and non-financial firms. Director Orszag’s numbers show that the U.S. government owned $506 billion of financial assets last year, and will buy another $915 billion this year. (I’m subtracting “Debt net of financial assets” from “Debt held by the public” on Table S-1 of the President’s budget.) Those are huge numbers, and have a huge effect on what figure you cite for the federal debt.

If you look at the traditional measure of debt held by the public, which you’ll remember is the sum of all IOUs (Treasury bonds) issued by the Federal government, then under the President’s budget and using OMB numbers, that’s equal to $8.36 trillion. Compared to one year of our entire national output (GDP), that’s almost 59% of GDP.

If, however, you net out OMB’s estimate of the value of the financial assets, then the debt held by the public net of financial assets, is “only” $6.94 trillion, equivalent to almost 49% of GDP. That’s still a big bad number, but it’s $1.4 trillion and 10% of GDP less bad than the debt held by the public numbers. That’s a convenient way to make the problem look much smaller. Director Orszag argues that it is also the “most meaningful measure of current federal debt.”

Here is his key paragraph:

As the federal government has acted to stabilize the financial sector amidst the worst financial crisis since the Great Depression, the federal government has purchased significant financial assets … such as preferred equity stakes in Fannie Mae and Freddie Mac. The federal government will likely take a loss on these purchases, but the assets have value. And just as what my bank owes me should be netted against what I owe the bank in determining the health of my personal finances, the value of these assets should be netted against publicly held debt in determining the health of the government’s finances. … Debt held by the public net of financial assets is the most meaningful measure of current federal debt …” (emphasis added)

I disagree with this last statement, but I think I understand why he says it. From his perspective of the federal budget, he’s netting out some of his liabilities with a somewhat liquid asset that he now holds and hopes someday to sell. He concedes the point, however, that he is including some assets and liabilities with his new measure, but excluding others. This makes his new metric suspect.

From the perspective of the U.S. economy, the “netting” comes from different places. The U.S. Treasury has to issue $905 billion of Treasury bonds this year to raise the cash to buy those financial assets. This makes it harder for private firms and individuals to borrow, because they are competing with the government for cash, so they have to pay a higher interest rate. Those funds are then invested in other parts of the economy.

Another way to see why this is a poor metric is to imagine that the U.S. government were to borrow another trillion dollars by issuing even more Treasuries, and then immediately buy one trillion dollars of credit default swaps with the cash raised. According to Director Orszag’s preferred measure, nothing would have changed, because the two transactions would net out. But clearly we would have just had a major impact on the U.S. (and global) financial economies. U.S. government borrowing in these enormous amounts hurts financial markets, no matter what is done with the funds raised.

Director Orszag touches on another problem with his new metric when he writes “The federal government will likely take a loss on these purchases, but the assets have value.” He’s right, but the value of the particular assets being purchased by the government is highly uncertain. How much is he counting as the value of the $19.4 B loaned (so far) to General Motors? I sure hope he is not counting it at face value. What about the $70 B “invested” in AIG, or the $5.5 B in Chrysler? Any private firm valuing these assets would say their values need to be discounted.

The values of these financial assets are highly uncertain and depend heavily on what assumptions OMB uses about the likelihood of them being repaid. For people to trust this metric, they need to understand how it is calculated, which means that OMB should divulge the discounts they are applying to their financial assets. I will guess that he does not want to divulge those assumptions. I wouldn’t if I had his job.

I think the most meaningful measure of current federal debt is still debt held by the public. I think the public policy debate can be further informed by also disclosing the estimated value of the financial assets held by the U.S. government. But policymakers should not net out the two and use that measure instead of the one that most directly measures how much the U.S. government is borrowing from the private sector. This is particularly true when that new measure hides $1.4 trillion of debt borrowed by the U.S. government from the private sector.

Director Orszag, and those measuring his performance, should continue to use debt held by the public as the most meaningful measure of current federal debt. Budget projections will account for that measure to come down over time as the financial assets are sold and funds recouped.

Net measures can hide meaningful information. This is a theme I will return to often. Any time someone in economic policy gives you a net figure, see if you can learn something more by asking about the components that make up the net calculation.

The President’s Budget is titled “A New Era of Responsibility.” In his February 24th Address to the Congress, the President said,

The only way this century will be another American century is if we confront … the mountain of debt they stand to inherit. That is our responsibility.

A new era of responsibility does not begin with hiding $1.4 trillion of that mountain of debt. These IOU’s will not go away just because we ignore them.


Update (12:20 PM Wed): A friend corrects my statement that the debt is simply the accumulation of past deficits. It’s not. The Credit Reform Act measures credit subsidies (like for federal loan or loan guarantee programs) differently than it measures cash flows, and the deficit does not capture “means of financing and cash management, like when Treasury borrows funds and deposits the cash at the Fed.” I stand corrected on these points. I don’t think this changes my logic above about whether to net out the purchase or sale of financial assets.

The President's strong free trade language in Strasbourg

I would like to compliment and thank President Obama for saying this in Strasbourg, France last Friday:

As we take these steps, we also affirm that we must not erect new barriers to commerce; that trade wars have no victors. We can’t give up on open markets, even as we work to ensure that trade is both free and fair. We cannot forget how many millions that trade has lifted out of poverty and into the middle class. We can’t forget that part of the freedom that our nations stood for throughout the Cold War was the opportunity that comes from free enterprise and individual liberty.

I know it can be tempting to turn inward, and I understand how many people and nations have been left behind by the global economy. And that’s why the United States is leading an effort to reach out to people around the world who are suffering, to provide them immediate assistance and to extend support for food security that will help them lift themselves out of poverty.

All of us must join together in this effort, not just because it is right, but because by providing assistance to those countries most in need, we will provide new markets, we will drive the growth of the future that lifts all of us up. So it’s not just charity; it’s a matter of understanding that our fates are tied together — not just the fate of Europe and America, but the fate of the entire world.

The President’s words have meaning, especially when he is speaking overseas. It is particularly important that he said this in France. French farm subsidies and politics are a key stumbling block on the road to a Doha global free trade agreement.

I wish the President’s negotiators had pushed for language like this in the final G-20 statement.

Can we ever know how many jobs the Obama Administration has saved?

Can we ever know how many jobs the Obama Administration has saved?

Almost two months ago, President Obama set a specific employment goal for his Administration:

I think my initial measure of success is creating or saving 4 million jobs.

It is clear that this “create or save” phrase is now a standard and important part of the Administration’s economic message.

Greg Mankiw quickly identified both the quantitative ambiguity and political creativity in defining the goal in this way. Now that we have a couple of months of data, I’d like to reprise Greg’s post with a concrete example of why this is a misleading metric that is vulnerable to manipulation.

The Bureau of Labor Statistics reported the following on Friday:

Nonfarm employment level, January 2009 134,333,000
… plus change in February -653,000
… plus change in March -661,000
… equals nonfarm employment level, March 2009 133,019,000
Net change in Obama Administration -1,314,000

You can see that the U.S. economy has lost a net 1.314 million jobs since January. Let’s look at it graphically:

net job loss since January 2009

The traditional way to measure jobs “created” or “lost” is by taking the change between the starting point and the ending point of your timeframe. I have displayed this in red on the graph. Administrations are always judged (at least by the press) based on the change in the level of employment from January 20th in their first year to the current level.

I think the traditional way is a poor metric because political and business cycles don’t line up. I will expand on this further in a separate post about starting points, and whether it’s fair to assign blame or credit to the Obama Administration for jobs lost in the first two months of their Administration.(Hint: It’s not, but it is always done so they are stuck with it.) For now I want to focus on the “or saved” point. We start with the factual statement that the U.S. economy has lost a net 1.314 million jobs since the beginning of the Obama Administration.

Suppose, however, that you had anticipated the situation would be even worse. Suppose you had thought that the employment level would be down to 132.5 million in March, rather than the actual 133.0 million. I’ll draw this as a new yellow line on the same graph and label it the “counterfactual baseline.” This is what you could argue you think the employment situation would have looked like, had no new policies been enacted. I should emphasize that the specific yellow line I show here does not represent any numbers cited by the Obama Administration. I have chosen these illustrative numbers to explain the concept.

net job loss since January 2009 with counterfactual

The green line shows actual employment, and it includes the effects of policy changes enacted over the past two months. The yellow line represents the “counterfactual” – what you think (or claim) employment would have looked like had your policies not been enacted. You could argue that the 133.019 million people employed in March is 519,000 more people than would have been employed had your policies not been enacted. (Again, I emphasize so that nobody misconstrues me: I have chosen the numbers for the yellow line to illustrate the concept.) You would be trying to “frame” the numbers by measuring the positive orange change, rather than the negative red change.

In a world with no politics, that could be legit. I hope that the Administration’s policy changes will increase employment to be above what it would otherwise be, had those policies not been enacted. I did not like the so-called “stimulus” bill, and have big questions about the magnitude, efficiency, and timing of the economic benefits, but there is no question on the direction: these policies should be positive for employment, although over a much longer time period than that covered by this graph.

The problem is that the Administration can draw the yellow line anywhere they want it to be. Since the number of jobs “saved” (orange) is the difference between the green and the yellow lines, if you let me draw the yellow line, I can make the orange number as big as I want, and later claim credit for a large number of jobs saved. I would be arguing, “Sure things are bad. But I saved ____ million jobs from where it would have been had we done nothing. I would not be able to prove that this number is correct, but you could not disprove it either.” That’s why it is politically clever. It is specific, can be asserted, and can never be disproven.

As Greg wrote in February:

You can measure how many jobs are created [or lost -kbh] between two points in time. But there is no way to measure how many jobs are saved. Even if things get much, much worse, the President can say that there would have been 4 million fewer jobs without the stimulus.

This makes intuitive sense if you think about it on the personal level. If someone was unemployed on January 20th and they have a job on July 20th, you can understand why it would seem reasonable to count that as one additional job created since the beginning of the Obama Administration, even though policy may have had nothing to do with it.

If you had a job on January 20th, however, and you are in that same job on July 20th, does it seem reasonable to count your job as having been saved by the President’s policies? Maybe it was, but it is easy to see how that could be gimmicked by someone with a political incentive to make the numbers look good. How many of the 134.3 million people who were employed on January 20th would otherwise have lost their job? We’ll never know. A policy wonk would say that “you can neither prove nor disprove the counterfactual.”

You could correctly point out that the Administration has published an economic forecast that implicitly contains projections for employment, so we could at least hold the Administration to the yellow line they implicitly defined when they released their economic forecast in late February. The problem is that these official forecasts get updated every six months, and so the yellow line moves around. It will be impossible to tell how much of the yellow line’s movement from the February forecast to the July revision is legitimate changes in forecasting, and how much is political shading by an Administration that knows it will be judged on this metric. Note that I am not accusing this Administration of biasing their forecast, but instead trying to show that “or save” is an unreliable and misleading metric. We need a reliable factual metric that cannot be gimmicked or manipulated by political advocates from either side of the partisan fight.

The New York Times slipped the President’s phrasing into an editorial on Saturday that argued for even more spending and expansion of union-friendly policies:

It is painfully clear, however, that the law’s potential to create or save a few million jobs will not be enough to combat the current scale of unemployment.

Let’s return to the President’s statement from February 9th. Can we measure that?

Had he said that his Administration would create 4 million jobs, then we would have a simple metric: 134.3 million + 4 million = 138.3 million. Each month, we could compare the nonfarm employment level to 138.3 million to see if it was higher or lower than that goal.

Suppose, however, that a year from now this numbers is instead 133.3 million. If we measure this the way it has been measured for at least the past two Administrations, a fair reporter would write that “the economy has lost a net 1 million jobs since President Obama took office.” But the Administration could argue that employment would have been 129.3 million, and that they therefore saved 4 million jobs. And nobody could prove them right or wrong.

“Create or save” is unreliable and vulnerable to manipulation. Any time I hear it, I know that I am being spun.

What happened to FREE markets in London?

Thanks to Reuters’ MacroScope blog for noticing:

Keith Hennessey, a former top economic adviser to President George W. Bush, saw this one coming. He rightly predicted that the Group of 20 would drop a key word from its communique at the conclusion of the London Summit: Free.

Here is my original post from Wednesday: A quick guide to the G-20 summit.

Unfortunately the problem is even bigger than just dropping the word “free” before “markets.” Let’s compare the text of the November G-20 leaders’ declaration and the April G-20 leaders’ declaration.

Here is the key paragraph from the November summit, hosted in Washington by President Bush. Thanks to President Bush’s negotiators, led by his “Sherpa,” Dan Price, and Treasury Under Secretary for International Affairs Dave McCormick, the following text is incredible. Last November, I wrote about this paragraph: Let’s look at some important wins in the actual text of the declaration. Formerly Communist China and Russia (along with all the other participating nations) agreed to the following text.

12. We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems. These principles are essential to economic growth and prosperity and have lifted millions out of poverty, and have significantly raised the global standard of living. Recognizing the necessity to improve financial sector regulation, we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.

Let’s parse it a bit:

  1. “a commitment to free market principles”
  2. rule of law”
  3. respect for private property”
  4. open trade and investment”
  5. competitive markets”
  6. “and efficient, effectively regulated financial systems.”
  7. we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows”

Now let’s examine yesterday’s text:

3. We start from the belief that prosperity is indivisible; that growth, to be sustained, has to be shared; and that our global plan for recovery must have at its heart the needs and jobs of hard-working families, not just in developed countries but in emerging markets and the poorest countries of the world too; and must reflect the interests, not just of today’s population, but of future generations too. We believe that the only sure foundation for sustainable globalisation and rising prosperity for all is an open world economy based on market principles, effective regulation, and strong global institutions.

Parsing this new language:

  1. “a commitment to free market principles” has been replaced by “based on market principles.” Note that the word “free” is nowhere in the document.
  2. “rule of law” is nowhere in the document
  3. “private property” is nowhere in the document
  4. “open trade and investment” has been replaced by “open world economy” (This one is fine, I think.)
  5. competitive markets” and the word “competitive” are nowhere in the document
  6. efficient, effectively regulated financial systems” has been replaced by “effective regulation, and strong global institutions.”
  7. The over-regulation caution is gone.

What makes this so disappointing is that all G-20 nations agreed to the November text. It should have been an extremely easy lift for negotiators from capitalist countries to insist that this leaders’ declaration merely repeat what the leaders agreed to last November.

Wednesday I wrote, In the short run, it is easy to see how a negotiator might give this up for a more concrete immediate objective. In the long run, few things are as important.

CNN interview today

Heidi Collins of CNN interviewed former Clinton Labor Secretary Robert Reich and me this morning around 10:30 AM on CNN Newsroom.

To my surprise, Secretary Reich and I agreed on a lot. We both came out strong against protectionism, and complimented the G-20 leaders for making a strong statement about this. We’ll see if the leaders follow through this time.

Heidi also asked me about the auto loans. I said I was surprised (and not in a good way) that the Wagoner firing decision was made in the West Wing. That creates an impression that politics, rather than economics or policy, may be involved in the decision. We were careful during the Bush Administration to have decisions about individual firms’ CEOs made outside the White House.

I complimented the President for using the word “free” so much, and for talking about free trade in Strasbourg today, especially given the setback for “free markets” in the G-20 statement.

Secretary Reich and I parted ways on the budget. I argued that we needed much less spending and not to raise taxes. Especially with long-term entitlement spending pressures building, we need to start cutting spending now.

He responded that in the short run, government is the only possible spender, since neither consumers nor businesses are doing so. Had I had time, I would have observed that the spending bills so far, which claim to be short-term stimulus, spend most of their money in 2010 and later. That’s not short-term macro stimulus. That’s just increased government spending.

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