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Questions For Christina Romer

Tomorrow, Christina D. Romer, the chair of the President's Council of Economic Advisers (CEA), will appear before the Joint Economic Committee of Congress. Professor Romer is a distinguished macro-economist (with widely cited work on US economic history, including the Great Depression; start with this speech), on leave from the University of California, Berkeley (for more, see her Web page), and represents an important part of the analytical thinking that underpins the administration's recovery strategy.

In particular, her team provides a good deal of the economic input into the administration's most important decisions, for example on autos. She is also responsible for much of the work behind the administration's overall economic growth forecast, although obviously this involves a great deal of back-and-forth with the White House and other agencies.

It does appear, however, that the Council of Economic Advisers has been less involved with the financial sector bailout than you might think. That task seems to have been run more by U.S. Treasury, with substantial input from the National Economic Council at the White House.

The Council of Economic Advisers chief appears before the Joint Economic Committee every year, usually to defend the annual Economic Report of the President. However, the latest report was prepared by President Bush's team, and we have all moved on a great deal since that was put together at the end of 2008, so this is not likely to be an important topic for discussion.

Romer will surely stick closely to the official White House line on most points. But she has in the past provided subtle hints regarding internal administration dissonance on banks, for example, recognizing that this is a deeper issuer than just banks having enough liquidity (i.e., the ability to turn their assets into cash readily). Hopefully, she will expand on her full diagnosis of the banking situation.

She has consistently supported "legacy asset purchases" as part of the solution, and it will be interesting to see if the committee pushes her on this point. Is there any evidence that the latest Treasury plans (known as the PPIP; fact sheet; an analytical review) are making progress? What is the exact analytical case for this approach? When and how will we know if it is working?

With her husband, David Romer, Christina Romer authored an academic paper that argues against the idea that cutting taxes "starves the beast," in the sense that it leads to future spending cuts -- a favorite idea of Ronald Reagan and subsequent conservatives.

The abstract of their paper argues: "The results provide no support for the hypothesis that tax cuts restrain government spending; indeed, they suggest that tax cuts may actually increase spending. The results also indicate that the main effect of tax cuts on the government budget is to induce subsequent legislated tax increases. Examination of four episodes of major tax cuts reinforces these conclusions."

I expect some members of the committee would like to talk about this further.

What are your questions for Romer? Post them below.

--Simon Johnson

By Simon Johnson  |  April 29, 2009; 12:29 PM ET
 
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Next: Christina Romer's Prepared Testimony before Joint Economic Committee

Comments

Question: other than an increase in inflation caused by excessive monetary and fiscal stimulus and all kinds of government debt supproted assistance; what is the fundamental framework for a real recovery with real growth?????

Posted by: chartwell3 | April 29, 2009 1:06 PM | Report abuse

I would want to ask which plan has a better chance of creating more jobs over the next five years -- 1) giving government handouts to the same bank/brokerage management that got us here (didn't Japan try this in the 1990s?) or 2) putting the weak (if not insolvent) banking (and industrial) institutions through a controlled receivership (like the S&L wind-downs of the late 1980s/early 90s). Job-loss may be more severe in the near term with option 2, but option 2 seems to be the only way to free the banking system from the shackles of asset-writedowns that are sure to plague the banking system otherwise. At least that is what I observed in Japan and it crushed job growth for small and medium companies.

Posted by: SimpleCapitalist | April 29, 2009 2:07 PM | Report abuse

Simon;

Following are questions for the JEC:

1st quarter GDP declined 6.1%. This is much worse than what analysts had expected (-4.7%), but still ahead of the 6.3% drop in the 4th quarter. Is it reasonable to expect bank credit to expand in this economic climate or would expansion today represesnt a return to irresponsible lending practices?

In the Great Depression a majority of States introduced moratoria on residential foreclosures. Today, people desperate to reduce living expenses are already on the move. Are you coordinating State efforts to declare foreclosure moratoria or do you see the foreclosure process as helpful in herding the unfortunate toward lower cost-of-living situations?

Do you view CDSs as insurance or securities? If securities, do you think they should be registered in all cases with trading regulated? If insurance, do you think there should be reserves set aside against default? Should insurance contracts ever trade in an after-market, i.e. should I be able to speculate on my neighbors driving or health habits?

How should the rating of securities be handled, by private firms who work for the underwriters, by private firms who work for the buyers of securities or by government?

Do you think leverage within financial institutions should be controlled? Should creating liabilities not declared on the balance sheet be deemed material misrepresentation and carry criminal penalties for the signatories?

What do you think of incentive pay for employees of financial institutions that is not based on "after-the-fact" performance?

Now that taxpayer subsidies, loans and guarantees have reached almost 4 trillion dollars, is it possible to regulate financial institutions such that assets subject to bubbles trade at premiums that realistically reflect risk to our financial system?

Does controlling the size of the financial institution reduce risk to the financial system more effectively than controlling the leverage within institutions?

Can institutions limited as to size compete on equal footing for international business with, say, Canadian banks, which are proportionately enormous yet apparently pose no threat to the Canadian economy?

Thanks,

Bill Bradbrooke

Posted by: BillBradbrooke | April 29, 2009 2:54 PM | Report abuse

This looks like a very good hearing. I have several questions for Dr. Romer, mostly focused on the Administration's economic forecast published last month with the budget outline. That forecast calls for the U.S. economy (under Administration policy assumptions) to contract by 1.2 percent this year, but grow by 3.2 percent next year, and by 4.0 percent in 2011.

Questions:
(1) Following the release by the Commerce Department of its "advance" estimate that the economy contracted at an annual rate of 6.1 percent in the first quarter, you stated in a Bloomberg interview that the Administration was expecting that result, suggesting that you'd already built that into your economic assumptions last month. Using the Commerce Department's estimate for the first quarter, I calculate that the economy would have to grow at about a 2.5 percent annual rate, on average, for the remaining 3 quarters of this year to validate your forecast for 2009. Question: how do you justify the economy growing at roughly its potential rate for the remainder of this year when slack in manufacturing is at postwar lows, and the unemployment rate high and rising? Where would such growth come from?

(2) How does your expectation of near-term recovery square with other current forecasts? For example, the IMF has a much deeper U.S. decline this year than you are forecasting, and a much more tepid rebound next year? Note that the IMF forecast assumes that we get some degree of resolution on financial markets AND at least one more round of stimulus. Moreover, the OECD forecast is even less optimistic than the IMF's. How do you explain your optimism? In light of such alternative expert assessments, do you think the U.S. should consider another round of fiscal stimulus?


(3) The Treasury's approach to resolving the banking crisis has inspired criticism from every political corner of the economics profession. Why are you so confident that this policy is on the right track when so many other experts have suggested that a more forceful approach to recapitalizing banks is more likely to succeed? How can Paul Krugman, Joseph Stiglitz, Simon Johnson, Thomas Hoenig, Paul Romer, Frederic Mishkin, Luigi Zingales (to name but a few)--how can ALL these prominent skeptics be wrong? Given the diversity and prominence of such skeptics, surely you may harbor some uncertainty regarding the effectiveness and robustness of the Treasury's policy--if so, would you please elaborate on your own professional misgivings.

Posted by: e-veblen | April 29, 2009 4:49 PM | Report abuse

In the category of now you know so you can’t say that you didn’t see it coming (e.g. demographic trends) here are some questions:

1) Could Dr. Romer confirm that she is aware of the much-larger-than-subprime Alt-A and prime option-ARM default wave (which is just getting started and will not crest until summer 2011*)? Can she confirm that President Obama is also aware of this new default wave?

2) Does she have an estimate of how many of these Alt-A and prime option-ARMs are too underwater to be refinanced? (My guess is that these option-ARMs were taken out at the peak of the bubble in the hope of making a quick speculative buck by flipping the properties: i.e., Minsky’s ponzi financing.)

3) Assuming that these Alt-A and prime option-ARMs have yet to default because they have yet to reset, could banks get rid of these now-performing-but-soon-to-be-toxic mortgages (and CDOs) with the Private Public Investment Program (PPIP)?

---------------------------------------
*Uhlfelder, Eric, “More Mortgage Meltdown Misery,” Financial Times, February 7, 2009 (google article; see chart).

“A Second Mortgage Disaster On The Horizon?”, CBS 60 Minutes: New Wave Of Mortgage Rate Adjustments Could Force More Homeowners To Default, December 14, 2008 (google for video).

Posted by: msa_intp | April 29, 2009 5:52 PM | Report abuse

4) Under PPIP the default risk of these Alt-A and prime option-ARMs will be transferred to the FDIC. Who should be politically accountable if the FDIC has to raise insurance fees on deposit accounts to replenish its funds? Will Bush-appointee FDIC Chair Sheila Bair be the scapegoat and sacrificial lamb?

5) How could this impact President Obama’s reelection campaign in 2012 should the American people see their skyrocketing monthly banking service fees as a “backdoor tax”? Is spreading this pain around to banks that had prudent lending practices during the bubble fair to their shareholders and depositors?

Do David Axelrod and Valerie Jarrett know about this Alt-A and prime option-ARM default tsunami? Just as Bush’s decision to invade Iraq led to a failed presidency, will Obama’s decision to go forth with a wholesale transfer of default risk to the FDIC under PPIP lead to another failed presidency?

6) What are the policy alternatives to PPIP (e.g., create ultra-clean new banks by recapitalizing old insolvent banks under the resolution authority auspice of “prompt corrective action”), and why is PPIP (with the FDIC on the hook to absorb default risk instead of old bank shareholders and unsecured creditors) the best policy?

Note that under the Fed’s 10% reserve ratio, a $100 billion capitalization will create $1 trillion in fresh lending capacity overnight! -- in which case ultra-clean new banks will have absolutely ZERO excuses not to lend to creditworthy borrowers.

7) Congressional Oversight Panel Chair Elizabeth Warren said on Monday** that the “adverse scenario” used for Geithner’s stress test was “disturbingly close” to current economic conditions; do you agree with her call for a more-adverse second stress test?

---------------------------------------
** “TARP Cop Sees Unstressful Bank Tests,” Reuters, April 27, 2009.

Posted by: msa_intp | April 29, 2009 5:53 PM | Report abuse

My question for Christina Romer is as follows:
Do you agree that banks, which want to continue relying on the financial support by the federal government, must disclose details of stress tests to the public?

The definition of fiancnial government support here includes both the Capital Purchase Program, which under the TARP provided preferred equity to banks, and various liquidity programs, such as CPFF, TALF, TLGP, PPIP, and others, which are putting public funds at risk.

Banks will then have two options:

1) Some banks may choose not to disclose their stress test results. In this case, these banks will be given a certain amount of time to return funds they received under the TARP and stop using any of the liquidity programs which can potentially result in losses to the Federal Reserve, Treasury or the FDIC, or ultimately, losses to the taxpayers.

2) Banks that choose to maintain access to these programs have to publish detailed results of their stress tests. A public oversight body, say, the Joint Economic Committee of the Congress, will need to decide on case by case basis if these banks have to strengthen their capital base to retain access to programs posing potential risk to the Federal Reserve, Treasury or the FDIC. Moreover, the public oversight body will be responsible for deciding if and when stress tests must be repeated, should the economy deteriorate further, beyond the “more adverse scenario” used in the stress tests.

Support by the taxpayers requires full transparency for the taxpayers!

Posted by: LouisBrandeis | April 29, 2009 9:27 PM | Report abuse

Could you please offer a response to the Cogan, Cwik, Taylor, and Wieland (2009) [http://www.stanford.edu/~johntayl/CCTW%20Mar%202.pdf] criticism of your paper with Bernstein? They argue the simulus benefits are about 1/6 of your estimates. The Administration's forecast seems to be based on your analysis, but it is difficult for non-macro people to sort what is important in the models.

Thanks!

Posted by: rc_neal | April 29, 2009 9:53 PM | Report abuse

Hello Simon

Here's my question,
Why is the Obama administration so afraid of taking a majority stake in the troubled banks especially Citi?

The government can come in with a plan to divest it's stake in the future, thereby denationalizing the banks at predetermined future date. The banks can be restructured during the time they are nationalized.

Regards

Posted by: AS10 | April 30, 2009 12:45 AM | Report abuse

1.) Given that the assumptions on which the "stress test" was based have already proved conservative and given that even larger waves of defaults on Alt-A and option-ARM mortgages are expected in 2010 and 2011, should the existing and additional stimulus produce the opportunity for economic growth, how do you expect the financial sector to be able to provide financing for that growth?

2.) Given the same givens as in 1., would it not be prudent to identify sound second tier banks located proximate to each of the top 20 banks, request the FDIC to perform a detailed audit of the balance sheets of these banks and be prepared to pull entire business divisions out of top 20 banks if and when they are shown to be insolvent and transfer them intact to known good banks along with the appropriate additional reserve capital?

3.)When dealing with an insolvent "too big to fail" bank, should not the goal be to break that bank up into units that are not so large as to endanger the entire economy by their failure? What justification can you see for not following such a course of action?

Posted by: daveldesign | April 30, 2009 12:48 AM | Report abuse

Some questions for Christina Romer:

A) About the PPIP:

You were quoted as saying, “What we’re talking about now are private firms that are kind of doing us a favor, right, coming into this market to help us buy these toxic assets off banks’ balance sheets.”

1) Assuming “private firms” includes hedge funds and “us” refers to taxpayers, why don’t hedge funds renounce their “carried interest” tax treatment if they want to do taxpayers a favor?

2) Are these private firms going to do us a favor in their purchases of “toxic assets” by paying more than the bid side of the current market?

3) If the answer to 2) is yes, will their bids exceed the bid side by more than the value of the PPIP’s below-market financing and put option?

4) If the answer to 3) is no, how does the plan help taxpayers, who are providing the below-market financing and put option?

5) If the answer to 3) is yes, why haven’t the private firms bought the assets from the banks without benefit of the PPIP?

6) If the answer to 3) is yes, what will allow the private firms to pay more: superior asset valuation or management skills?

7) If the answer to 6) is superior valuation skills, does this imply that the banks will succeed in selling only their most under-valued assets? Will this improve their solvency?

8) If the answer to 6) is superior management skills, how can the private firms influence the cash flows of the “toxic assets,” which depend on their underlying mortgages, which in turn are a function of house prices, interest rates, unemployment and income levels, and underwater homeowners’ taste for avoiding default?

B) About Wall Street and the administration:

1) During this crisis, the government and the media have tended to lump together commercial and investment banks and treat “the banks’” return to health as a necessary prerequisite to the real economy’s revival. Despite the repeal of Glass-Steagal, even firms that engage in both types of banking maintain this organizational division. What essential functions do investment banks (whether standalone or part of a universal bank) perform in the U.S. economy?

2) Given Wall Street’s history of misconduct, both proven (e.g., municipal yield-burning and Nasdaq market-maker violations) and never-investigated (e.g., front-running in the Treasury market, described at http://ustreasurymarket.com/ ), what resources is the administration devoting to investigating and prosecuting fraud in the mortgage securitization market?

3) President Obama and others in the administration have been critical of Wall Street during the crisis. Which members of the administration were critical of Wall Street prior to the crisis?

4) Tim Geithner and Larry Summers are frequently described as being “close to Wall Street,” yet neither has ever worked at a (for-profit) bank. What are their sources of information on how Wall Street works?

Posted by: formertrader | April 30, 2009 2:39 AM | Report abuse

This might be some somewhat naive (I come from an art background), but as one simple step to breakdown some of the banking oligarchy do you think we should limit or- downright outlaw- lobbying from the financial sector? And if we can not constitutionally ban lobbying can we forbid financial or material "donations"?

This seems like a quick way to get the politicians from feeling so compelled to help out their "friends" during this mess, and maybe without the pressure from the bankers, the politicians will actually feel compelled to do what seems rational- Nationalize?

Posted by: rn69982n | April 30, 2009 10:22 AM | Report abuse

From an economic layman:

In an effort to combat the concept of "Too Big to Fail" (TBTF), is there any possibility of enacting laws similar to those that created the FDIC, mandating a form a sliding-scale self-insurance based on some measure of assets at risk? Wouldn't any solution require a balancing of the moral hazard resulting from the various bank bailouts with the need to develop financial products that provide some true form of economic benefit.

Secondly, what are the strategies, currently under consideration, that address the inherent conflict of interest afflicting the ratings agencies?

Posted by: cafecb750 | April 30, 2009 11:23 AM | Report abuse

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