Fitting the Policy to the Problem

To critics of the recovery Barry Ritholtz retorts that what we’ve experienced is just what one would expect in a “balance sheet” recovery:

First, the specifics: By just about every economic metric, this has been a mediocre, subpar recovery. For the first few years following the end of the recession in June 2009, employment increased slowly. Wages to this day have been little changed. Retail sales have been inconsistent; housing has seen soft sales numbers, while price increases have been a function of a lack of inventory caused by limited amounts of home equity and immobility as a consumer try to reduce debt. Gross domestic product growth has been weak and lacking in consistency.

The context is simple: When we discuss expansions, we typically are referring to the later half of a typical economic contraction-expansion cycle. That is what is typically referred to as a post-recession recovery.

However, that huge outlier is a clue that we are using the wrong data set. The post-World War II recession recoveries are the wrong frame of reference; the proper one is the much more severe set of credit-crisis collapses and recoveries.

Economists Carmen M. Reinhart and Kenneth S. Rogoff figured this out before the scale of the crisis even was apparent. In January 2008 they published a paper titled “Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison.” They warned that the U.S. subprime mortgage issue was turning into a full-blown credit crisis, not just a typical recession. I discussed this extensively in February 2008.

The economic researchers were astute enough to not use other recession-recovery cycles as their comparison when discussing the pace of growth in the U.S. economy after what they said would be a collapse caused by subprime mortgages. Instead, they suggested looking at five previous financial crises — Japan (1992), Finland (1991), Sweden (1991), Norway (1987) and Spain (1977).

IMO the greatest problem with his analysis is that he doesn’t take it far enough. However much fiscal stimulus Japan has deployed (Japanese public debt is now well over twice GDP), twenty years on Japan still hasn’t recovered from its financial crisis. Neither has Spain.

Sweden, Finland, and Norway did recover but all nationalized at least some of their banks in one form or another, something we have demurred from doing.

Additionally, the fiscal stimulus we’ve applied has been under the assumption that what was happening was an ordinary cyclic downturn. The sort of stimulus that was applied, first by the Bush Administration and then by the Obama Administration is very unlikely to do much good. Then what has happened to all of that stimulus? Mr. Ritholtz hit that nail directly on the head in a post from six years ago that he labelled as “humor”: it was sent to China. We import too much from China for conventional “pump-priming” stimulus to be particularly useful.

Mr. Ritholtz can’t have it both ways. Either we had a “balance sheet” recession and the policies during and since the recession have been at worst counterproductive or at best ineffectual or the policies have been right and we’ve had the weakest recovery since the end of World War II. Take your pick.

35 comments… add one
  • steve

    Or the policies were correct, but inadequate. They chose the correct drug, they just didn’t give a large enough dose. I still favor the balance sheet recession for the most part. I think we have also uncovered the fact that our economy has been weaker than we thought all along. Absent bubbles, we were a slow growth economy.

    Steve

  • I think we have also uncovered the fact that our economy has been weaker than we thought all along.

    That has been my view. I’ve thought we needed major structural changes for twenty years. I also think that there isn’t enough actual underlying aggregate product to take up up the slack in aggregate demand. The approach in the General Theory assumes excessive product relative to demand.

    Whatever the case it’s obvious we are no longer in the short term and that the cyclic shortfalls in aggregate demand are now structural which means that pump=priming isn’t the solution.

  • ...

    _WE_ were a slow growth economy? They’re still building new hospital wings at every hospital I drive by. You guys in the medical profession have been sucking the rest of us dry for 45 years now, so don’t give me any of that “we” crap.

  • TastyBits

    The people who were running the show did not even know there was a private (shadow) banking sector until it caused the financial collapse, and they still do not realize the size of it. They are like the little girl in the back seat with her plastic steering wheel.

    The problem is not too much or too little debt. The economy needs to create new credit to replace old credit, to service the outstanding debt, and to expand. The problem is the value of the collateral securing the debt is not worth the outstanding value of that debt.

    Unlike debt, credit is an asset, but it has a face value and a market value. If the market value is substantially less than the face value, the asset may become a liability even though it is still performing (payments being made on time). If it is being used as collateral, it can cause the debt to be called or additional collateral to be provided.

    With enough of these assets, a bank can be technically insolvent but still functional. It is a zombie bank, and it will be until its balance sheet can be rectified. To become solvent, the collateral needs to increase in value, or the underwater loans need to be written down, written off, or paid off.

    Pumping more money into the system to create more loans to inflate asset prices is not going to work. Because zombie banks are insolvent, they must be careful about lending, and with higher lending standards, loans are not as profitable. There is also a much smaller pool of available borrowers, and most of them will not take on too much debt.

    Only the top of the money pyramid have any assets that they can use as collateral to create credit instruments, and over the past eight years, they have been able to leverage those assets to increase their wealth substantially – hence, the income gap.

    The reason all these economic theories fail is because they assume the money system is sound – Money can never be created. In physics, the Law of Conservation of Energy states that energy can be neither created nor destroyed. (I realize this is non-technical language, and it is missing a lot of caveats.) If energy could be created at will, the laws of physics would not work, and nobody would know why.

    It is understandable that Keynesians would endorse unsound money. Without it, there is no way for his theories to work. What is surprising is that so called anti-Keynesians also endorse it, and even more surprising is that they claim to be capitalists.

    If any of this clap-trap were to actually work, it would work in Venezuela. Here is a country with a natural resource to be able to sustain the social welfare programs of the left, and if fiat money is no problem, they should have no currency problems. Please, explain that to the people when they cannot buy food.

    The US will probably make it through this because it is large enough. The US will never be Venezuela or Greece or Puerto Rico. It will just take a while to clear the books. In another 5 – 10 years, the problem will fix itself naturally as the debt is paid off or is paid down below the value of the collateral. That is a worst case, but it does not take into account the multiple other factors that could improve or worsen the situation.

  • They’re still building new hospital wings at every hospital I drive by.

    As long as the massive subsidies continue capital spending in healthcare will be a low risk wager.

  • Because zombie banks are insolvent, they must be careful about lending, and with higher lending standards, loans are not as profitable. There is also a much smaller pool of available borrowers, and most of them will not take on too much debt.

    Today’s “greater fools” are called “public pension funds”.

  • steve

    “As long as the massive subsidies continue capital spending in healthcare will be a low risk wager.”

    Get rid of the tax exemption of health care. That said, as long as private insurance continues to drive costs, it will be hard to slow them.

    Steve

  • Ben Wolf

    @Dave,

    The missing component is a national set of protocols for discharging private debts quickly and efficiently. Recall we enacted “bankruptcy reform” a number of years prior to the GFC making it more difficult to do this very thing. Student loans can’t be extinguished in this manner at all. So as in Japan, the deleveraging process is made very, very slow; particularly when the wage growth necessary to retire debt by repayment is also absent.

    We could drive wages up by spending but won’t because our policies are inflation-phobic.

  • ...

    I love how health care expenses are never the fault of the doctors. Not that I’ve ever seen doctors drive anything other than twenty year-old Buick La Sabres, though, so maybe they’re not making all that much.

  • ...

    Anyone else seeing that there are 15 comments but only nine are visible?

  • PD Shaw

    Premium subscribers get Russian spambots.

  • steve

    “I love how health care expenses are never the fault of the doctors.”

    No, they are part of the problem, as i have said many times. However, cut docs salaries to zero and change nothing else and all you get is a one time 7% decrease in costs.

    Steve

  • However, cut docs salaries to zero and change nothing else and all you get is a one time 7% decrease in costs.

    There are probably indirect effects as well. I suspect that physician salaries have both “pull” characteristics as well as “push” characteristics, i.e. if physician salaries go up so do administrator, technician, etc. salaries.

    Additionally, “insurance” companies who function as administrators for self-insuring companies usually charge based on a percentage of claims. Slow the increase in claims and you slow the increase of these “insurers” cut of the take as well. Under the terms of the PPACA actual insurance companies are limited in how much they can bill exclusive of what they’re laying out so their “take” will slow, too.

    I do not and have never advocated cutting physician salaries to zero. That would be absurd. I think there’s ample evidence that present physician salaries are something in the vicinity of 30% higher than they would be without subsidies. I suspect that applies across the board within the healthcare sector but I don’t have evidence at hand to prove it.

    My view continues to be that unless salaries, broadly, in healthcare rise at no faster than the rate at which they’re rising outside of the healthcare sector so long as healthcare continues to be subsidized healthcare will be ipso facto unaffordable.

  • ...

    Aw, man, I gotta pay to see the Russian spambot posts?

  • steve

    “. I think there’s ample evidence that present physician salaries are something in the vicinity of 30% higher than they would be without subsidies.”

    As I said, they need to come down, but I am doubtful just removing subsidies does that. We know, for example, that dentist salaries have increased as fast or faster than doc salaries, and they don’t generally get paid by insurance and aren’t covered by Medicare. Remove subsidies, granted your definition of subsidies is odd, and suppose they work. What happens to the foreign docs coming here? Dries up right away. Now you have shortages, salaries go back up.

    If you want to do this, you need to do largely what we are already doing. Specialist pay has been pretty stagnant for about 15 years. Leave it that way, if you can keep the private insurers under control. You may need govt controls to do that. You actually need to increase PCP pay for a while. Next, pay here may be 30% higher, but education costs are orders of magnitude higher. Take France (please). A year of med school there is about 500 euros a year. In the US, about $50,000. Add in undergrad costs and folks are leaving with $300k-$400k of debt.

    Finally, remember that all of this would lower, on a one time basis, overall medical costs by 2%.*

    Steve

    *As I keep telling you, our better bet is to work on utilization. Find areas where you can use cheaper labor than docs (we are doing this a lot), and actually look at the areas where costs are going up rapidly, addressing those areas rather than shotgunning.

  • granted your definition of subsidies is odd

    My definition of subsidy is standard economics usage. Here are some of our subsidies to healthcare:

    Medicaid
    Medicare
    VA
    the direct PPACA subsidies
    medical licensing
    certificates of need
    requiring prescriptions for drugs
    patents on pharmaceuticals and medical equipment

    Any direct or indirect use of tax dollars in healthcare and any law limiting entry to the healthcare sector is technically a subsidy to healthcare. That’s just the way economists use the language. Healthcare isn’t the only sector that has lots of subsidies. The financial sector is full of them. For example, the FDIC is a subsidy to banks.

  • Andy

    “That said, as long as private insurance continues to drive costs, it will be hard to slow them.”

    Where is the evidence for that? I looked at the numbers from CMS and spendng on private health insurance has ranged from 32-25% of total spending over the last 25 years. Over that same time period out of pocket spending went from 25-12% while CMS (medicare, medicaid, CHIP) rose from 25-36%. In short it doesn’t look like the aggregate data support the conclusion that private insurance is driving costs.

  • steve

    A couple of good studies recently (paywalled) have looked at costs, by which I mean cost per procedure or per patient. What you see is private costs going up, and Medicare/Medicaid following. You are talking about total spending. That depends much more upon demographics. 70 y/o people will always need more meds and procedures than those who are 30 y/o.

    To be clear, there is still some dissent on this. Many see Medicare as providing a floor. A few still think Medicare actually pushes costs, though how they do this while costing less than private coverage has always been a little unclear to me.

    Dave- I would agree with some of those, and not so much with others. I have talked with enough health care economists to know that they would also dispute a lot of those. A lot of those folks are going to get care in some way, and it will be paid for somehow. That doesn’t make it a subsidy just because we use the govt as a way to channel the money.

    Steve

  • TastyBits

    @Dave Schuler

    … For example, the FDIC is a subsidy to banks.

    Unless I am missing something, they are about the only honest broker in town.

    Who is the FDIC?

    The FDIC receives no Congressional appropriations – it is funded by premiums that banks and thrift institutions pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities. The FDIC insures approximately $9 trillion of deposits in U.S. banks and thrifts – deposits in virtually every bank and thrift in the country.

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