Free exchange: Savers’ lament

The complex effects of low interest rates on consumption and investment

Dec 1st 2012 | from the print edition

[Greg Ip] WHEN interest rates hit double digits in the late 1970s, house-builders sent planks of wood to the Federal Reserve in protest. With rates stuck near zero, the protests now come from the opposite direction. The retired complain of a “war on savings”.

The Fed cut rates to current levels at the end of 2008 and has promised to keep them there until 2015. Since 2008, personal interest income has plunged 30%, or $432 billion at an annual rate, more than 4% of disposable income. David Einhorn, a hedge-fund manager, likens zero rates to an overdose of jam doughnuts: too much of a good thing. Raghuram Rajan, a former chief economist for the International Monetary Fund, describes the Fed’s policy as “expropriating responsible savers in favour of irresponsible banks”, and thinks it should raise rates modestly.

Monetary policy, the unintended consequences: QE through the looking glass

Nov 29th 2012, 21:37 by G.I. | WASHINGTON, D.C.

Even if you follow central banking, you may not have heard much about Jeremy Stein. He’s a highly regarded finance economist from Harvard University who became a governor this year, and since then he has given only one speech. But judging by the contents of that speech, Mr Stein’s profile seems bound to grow.

The subject of the speech was the Fed’s large scale asset purchases (LSAPs), colloquially known as quantitative easing (QE). It had none of the tantalizing hints about coming Fed actions that attract headlines. Rather, it mucked about in dark, abstruse corners of corporate finance, devoting three of its 19 pages to academic references.

Money-market funds: Running from the shadows

Regulators seek to shore up money-market funds against runs

Nov 24th 2012 | WASHINGTON, DC |

[Greg Ip] THE day after Lehman Brothers went bust on September 15th 2008, America’s oldest money-market mutual fund declared that investors could no longer redeem shares at the customary $1 each. In “breaking the buck”, Reserve Primary Fund became the most prominent part of a broader panic that saw investors pull billions from other money-market funds, a major source of short-term lending to banks and companies. The Treasury was forced to offer a blanket guarantee.

Money-market funds are the quintessential “shadow banks”: companies that mediate between savers and borrowers, just as banks do, but without the government guarantees or oversight of banks. In America these funds, unlike most mutual funds, may amortise their investments so as to round their net asset value (NAV) to a stable $1 per share. They also offer cheque-writing privileges. That encourages investors to treat them as deposits. But if a fall in a fund’s assets threatens its stable NAV, investors will rush to redeem shares, as happened to Reserve Primary Fund, which had about 1% of its $62 billion in assets in Lehman debt.Between 1989 and 2003 there were 144 instances when an American fund needed financial support to maintain its NAV of $1. The founder of Reserve Primary Fund, Bruce Bent senior, and his son, Bruce Bent junior, at first said they intended to support it. On November 12th a jury in New York cleared them of charges of fraud in connection with those statements, but held their management company liable for fraud. Mr Bent junior and the firm were each found liable for one claim of negligence.Reserve Primary Fund was only the second fund (and by far the most important) ever to break the buck. Ultimately, shareholders recovered 99 cents on the dollar. That so slight a loss in an investment could trigger such chaos explains the anxiety among regulators about the potential threat such funds, deemed 100% safe, still pose to the financial system.In 2010 America’s Securities and Exchange Commission (SEC) required money-market funds to shorten the duration of their debt, and raise credit quality and liquidity. In August the agency came close to proposing deeper fixes. But facing fierce opposition from the industry as well as from three of the five SEC commissioners, Mary Schapiro, the agency’s chief, withdrew the proposal.

Into the breach stepped America’s new systemic-risk watchdog, the Financial Stability Oversight Council (FSOC), an umbrella group of financial regulators. On November 13th it exercised its new authority under the Dodd-Frank act by proposing much the same fixes the SEC had put forward: funds could float their net asset value, rather than set it at $1 per share, to remind investors that their capital is at risk; or large investors would have to wait 30 days to withdraw some of their money; or funds would have to maintain capital buffers worth 3% of assets. On November 18th the Financial Stability Board, a club of financial regulators from around the world, issued similar recommendations.

Funds don’t like these proposals any more than the SEC’s. The Investment Company Institute, a trade group, says withdrawal limits and capital buffers would raise costs or depress returns, diverting money to other, less-regulated cash-like products. Money-market fund assets have shrunk from $3.8 trillion at the end of 2008 to $2.9 trillion. Rock-bottom interest rates have made it hard for funds to cover costs and compete with insured bank deposits.

A floating NAV could complicate tax planning by triggering capital gains and losses with each purchase or sale. It would not necessarily stem runs; investors may be as complacent about an asset that barely fluctuates as they are about one that never does. Ultra-short funds, which invest in short-term bonds and have floating NAVs, experienced significant outflows in 2008.

The FSOC invited the industry to submit its own solutions. In the meantime, it will ask the SEC to adopt its recommendations. Should it refuse, the FSOC could implement them with other powers. One option that’s clearly off the table is another Treasury guarantee like that in 2008: Congress has since outlawed it.

The fiscal cliff: Getting down to brass tacks

Finding common ground on cutting spending

Nov 24th 2012 | WASHINGTON, DC | from the print edition

[Greg Ip] IN THE negotiations to reduce America’s long-term deficit and to avoid the “fiscal cliff” of automatic tax increases and spending cuts at the year’s end, Republicans have so far done most of the retreating. But they still want something in return. Emerging from the first—and so far only— negotiating session with Barack Obama on November 16th, Mitch McConnell, the leader of the Republican minority in the Senate, said he was “prepared to put revenue on the table, provided we fix the real problem.” By that he meant entitlements, in particular the big three: Social Security, Medicare and Medicaid—pensions, and health care for the elderly and poor, respectively. On November 20th John Boehner, the Republican speaker of the House, demanded that Mr Obama’s health-care plan should also be on the table.Cutting these entitlements challenges Democratic orthodoxy almost as much as higher taxes challenges Republican.

Tax reform: Opening bids

Barack Obama and Republicans grope towards common ground on taxes

Nov 17th 2012 | WASHINGTON, DC | from the print edition

 THE election dust had barely settled when Barack Obama and his Republican adversaries returned to their traditional rhetoric over taxes. “Raising tax rates is unacceptable,” John Boehner, the Speaker of the House of Representatives, declared on November 8th. The next day Mr Obama said “I am not going to ask students and seniors and middle-class families to pay down the entire deficit while people like me, making over $250,000, aren’t asked to pay a dime more in taxes.”Optimists, however, took note of what the men did not say: Mr Boehner did not rule out raising tax revenues. Mr Obama did not explicitly insist that the two top income tax rates, now 33% and 35%, return to 35% and 39.6%, as they are scheduled to do when George W. Bush’s tax cuts expire at the end of this year.

America’s taxes: Higher taxes the easier way

Setting a cap on deductions is a better starting point than raising tax rates

Nov 17th 2012 | from the print edition

[Greg Ip] AMERICA’S presidential election was supposed to be a head-clearing referendum on the size of government. It was not: voters split their vote, giving Barack Obama a second term and Republicans in the House of Representatives another big majority. Yet in one respect the election has clarified matters. Mr Obama has long argued that repairing America’s finances will require raising more tax as well as cutting spending. Influential Republicans, most importantly including John Boehner, the Speaker of the House, now appear to agree.This comes not a moment too soon. In less than two months America will reach a “fiscal cliff”, when George W. Bush’s tax cuts will expire and automatic spending cuts will take effect (seearticle). The economy could suffer a fiscal tightening of as much as 5% of GDP over a full year, easily enough to bring on recession.

How to solve the fiscal cliff: The Obamney tax plan

Nov 8th 2012, 23:33 by G.I. | WASHINGTON, D.C.

This post has been updated.

PRESIDENTS choose their words carefully. So when Barack Obama talked of  “tax reform” but not “tax rates” in his acceptance speech early Wednesday, he was presumably sending a signal. And it was similarly significant that later that day John Boehner repeatedly stated his opposition to higher tax “rates” rather than tax revenue.

Within those two statements lies the nucleus of a deal: raising tax revenue through some means other than higher tax rates.

The budget deficit: To the cliff, and beyond

Barack Obama and the Republicans have precious little time to act

Nov 10th 2012 | WASHINGTON, DC | from the print edition

[Greg Ip] A DAY after receiving a thumbs-up from voters, Barack Obama got a thumbs-down from the stockmarket, which fell 2%, its biggest fall in a year. Blame the threat of higher taxes on dividends and capital gains and tougher treatment of banks and fossil fuels, but blame also the sad fact that the election failed to resolve the biggest question hanging over the economy: how to deal with the deficit.

Mr Obama needs to come up with an answer, fast. Within two months some $700 billion of tax increases and spending cuts kick in (roughly 5% of GDP over a full year—see table). So much austerity so quickly would suffocate the recovery. But moving the cliff leaves the underlying problem intact: on current policies the deficit, 7% of GDP in the last fiscal year, will still be over 5% a decade from now, and the debt held by the public will climb from 73% of GDP to 90%.

The economy and the election: The macroeconomics mandate

Nov 7th 2012, 14:19 by G.I. | WASHINGTON

HAD Barack Obama lost to Mitt Romney yesterday, the explanation would have barely taken up a sentence: the economy defeated him. Mr Romney’s mission from day one was simple. Pound home the message that Mr Obama took a bad economy and made it worse, and leave the facts to do the rest: unemployment stuck at around 8% and four straight years of trillion-dollar deficits.

That Mr Obama won is thus a victory not just for him personally but for macroeconomics.

Corporate savings: Dead money

Cash has been piling up on companies’ balance-sheets since before the crisis

Nov 3rd 2012 | WASHINGTON, DC | from the print edition

[Greg Ip] MONETARY stimulus gets you only so far. In America, third-quarter profits and revenues for companies in the S&P 500 index appear to have fallen year on year for the first time since 2009, according to Thomson Reuters. Profits for roughly half the firms in the European Stoxx 600 have fallen short of expectations so far.

Companies in search of a culprit may want to glance in the mirror. Firms are trimming their budgets for everything from technology-consulting services to semiconductor equipment in the face of what Sir Martin Sorrell of WPP, a British advertising and marketing giant, calls four “grey swans” (unlike black swans, people know about grey ones). The four worries unnerving business are: the euro-zone crisis; upheaval in the Middle East; a possible recession in China; and America’s economic health and “fiscal cliff”—the combination of tax increases and spending cuts scheduled to occur at the end of this year.

This is not a new problem.