Monthly Archives: March 2010

Economic Growth, Not Transformation, Is Key to Curing Long-Term Unemployment

Posted on March 26, 2010 by | Leave a comment

A short time ago, this author commented on economic growth rates necessary to begin reducing the overall unemployment rate.  In doing so, the column glossed over an acute employment problem, the long-term unemployed, that I would now like to revisit in more detail.

The long-term unemployed are those unfortunate workers who have been out of a job for six months or more.  As of February 2010, the long-term unemployed comprise 40 percent of the total unemployed.  The average period of unemployment for these long -term unemployed is about 7 months. Only a year earlier, in February 2009, the long-term unemployed constituted only 22% of the total number of unemployed persons, and even that percent was up from its share of the unemployed at the beginning of the recession in December 2007.

Nobel Prize-winning economist Gary Becker notes on his blog that unemployment generally “is concentrated among the young, less educated, and low skilled. For example, according to the March 10th report of the Bureau of Labor Statistics, (seasonally adjusted) unemployment rates in February of this year was 16% for high school dropouts, 11% for high school graduates, only 8% for persons with some college or associate degrees, and a quite low 5% for persons with a bachelor’s degree and higher levels of education.”  However, “college educated and older workers constitute a much larger percent of the long term unemployed than they do of the total number unemployed. These differences in long-term unemployment are easy to understand. Many kinds of low paying jobs are available to the young and high school dropouts in all parts of the country. This means that these workers can relatively easily find other jobs if they become unemployed, even though the new jobs may not last so long and they may have to seek still other jobs. Finding other jobs with comparable pay to their old ones is much harder for more skilled and experienced workers since they are more specialized in their knowledge. They may have to move to another region to get suitable employment.”

In addition to the struggles the long-term unemployed have financing their consumption, their plight also has effects on the whole economy.  Their rates of consumption drop, they lose confidence in their abilities and their skills deteriorate.  The stress of uprooting their families, not to mention the financial stress, also leads to martial problems, “and not infrequently to divorce,” which has social and economic costs of its own.

Becker suggests, and rightly so, that only economic growth will solve the problem.  The economy has begun growing again, albeit slowly, and so, unemployment will come down just as slowly, unfortunately.  Proposed solutions from Washington, D.C., will either be ineffective or get in the way of economic growth.  Becker states, “Regrettably, the decline [in unemployment] may be particularly slow in the present situation because Congress and the President have created too much uncertainty about, among other things, health care costs to employers, taxes on higher incomes and on businesses, taxes on carbon emissions, caps on the pay of some executives, and the new regulations of lenders. Businesses are reluctant to take on many additional employees until they become more certain about their costs, and the direction the economy is moving in.”

Although health care reform is now a reality, businesses will now have to weigh the costs of new hires.  Small businesses nearing 50 employees will need to calculate whether it is worth hiring more workers and crossing that health care threshold.

The recently passed Hiring Incentives to Restore Employment Act (H.R. 2847) gives companies a subsidy if they hire workers who have been unemployed for longer than a few months and retain those workers for at least 12 months.  Becker comments, “The problem with this proposal [now law as of March 18, 2010] is that the Job Openings and Labor Turnover Survey (or JOLTS-I am indebted to Ed Lazear for bringing these data to my attention-) shows that even during this period of high unemployment, there are about four million new hires every month, and slightly more separations than that when employment is falling. So the great majority of the new hires that would receive a subsidy under such a proposal to stimulate employment would have occurred anyway. The program would end up being another costly subsidy to businesses.”

Transforming the economy, if that is what the President and Congress are after, must come later.  For now, the only emphasis should be on stimulating long-term economic growth and getting people back to work.  Unfortunately, this is not the path taken by Washington, and the consequential risk of a “double dip” of the economy and worsening unemployment is growing.

To view Becker’s full post, please click on the following link: The Long-Term Unemployed: Consequences and Possible Cures – Becker.

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Posted in Economy, Employment Report

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States Likely to Get Federal Bailout Too: Roubini

Posted on March 24, 2010 by | Leave a comment

In it’s weekly newsletter, Roubini Global Economics (RGE) compares certain U.S. states that are in fiscal trouble with the European PIIGS (Portugal, Ireland, Italy, Greece and Spain) and finds that U.S. states will not default on their debt because the federal government is likely to take action to prevent such defaults.  This, of course, would mean a larger fiscal deficit and more problems down the road.

RGE’s note is reproduced below:

This week’s note draws from a new RGE Analysis, “No Greece in the American Machine,” which was pre-released to RGE Direct Access clients on Monday and will be made available to all RGE clients on Wednesday, March 24. The following is a brief summary of some of the macro research included in the piece—the full analysis goes into much greater depth and also includes investment strategy recommendations for clients.

While the global economy is crawling out from the most severe recession and financial crisis of the post-war period, the EZ debt crisis has significantly increased the chances of a double-dip recession in Europe and a global slowdown. Sovereign risk has recently graduated from being an emerging economy (EM) hitch to an advanced economy problem. The Greek debt crisis has occupied center stage of the economic and political debate. It is not just a Greek tragedy – a contagion could spread the virus to Portugal, Spain, Italy and Ireland (See RGE Analysis, The Eurozone’s ‘Bay of PIIGS’). Indeed, at stake is the entire eurozone framework. Yet fiscal sustainability and sovereign risk also loom over other advanced economies like Japan, the UK and the U.S.

A few years back, RGE expressed concerns about the persistence of divergences in the EZ and therefore its long-term success in the paper, Growth Differentials in the EMU: Facts and Considerations. We studied financial integration and channels of interstate risk-sharing and found that since the inception of the EZ, a higher degree of financial integration and cross-county ownership of financial and productive assets has contributed to improved risk sharing in the currency area, though risk-sharing remains significantly lower than in the United States. Going beyond the econometrics, this crisis highlights flaws in the design of the EZ – in this case the lack of political, economic and fiscal federalism, and the absence of a mechanism like those which exist in both the U.S. and Japan to bail out troubled members.

Still, the comparison between U.S. states and EZ troubled members is back in vogue. Projections show that in a matter of a couple of years, the U.S. gross federal debt will exceed GDP and the federal budget will never balance again. This is clearly unsustainable and raises questions about the future of the U.S. “AAA” ratings. While sovereign risk definitely stalks America, it will not follow the same script of the Greek tragedy. It won’t be an undisciplined state or a group of states that will imperil the U.S. framework of a single currency area and fiscal federalism. No single U.S. state displays the same fiscal vulnerabilities inherent in Greece or other PIIGS (Portugal, Ireland, Italy and Spain) at present.

Mathematics tells a compelling story in this regard. The aggregate fiscal deficit of the U.S. states is estimated to be less than 2.0% of total U.S. GDP during 2008-12, and the aggregate debt of state and local governments is estimated to be less than 20% of GDP during 2008-10 – both far below those of several lagging EZ countries. Let’s zoom into some specific, high deficit states: New York, Illinois, New Jersey and California – the NINCs – and compare them with some vulnerable EU countries – Portugal, Italy, Ireland, Greece and Spain – the PIIGS. The fiscal deficit in the NINCs did not exceed 3.0% of GDP during 2008-09; most countries in the PIIGS had deficits larger than 6.0% of GDP. The debt-to-GDP ratios in the NINCs were below 15% during 2008-09; while this ratio was well above 60% for most PIIGS. The difference is even more marked if we look at the interest payments-to-GDP ratio, which was below 1.0% for the NINCs but above 6.0% for most PIIGS. However, interest payments as a ratio of revenues were around 4%-7% in the NINCs and above 10% in Greece and Italy, indicating that high outstanding debt and interest rates pose debt servicing challenges to both the NINCs and the PIIGS as both face weak economic recovery prospects.

Overall, there does not appear to be a Greece among the U.S. states in terms of fiscal and systemic risks. Yet in the broader RGE Analysis from which this note is drawn, we shed light on increasing fiscal deterioration in U.S. states, led by cyclical factors (housing, manufacturing and consumer downturn) as well as structural factors (lack of fiscal discipline during boom years and a structural rise in spending). State governments, like their federal counterpart, might lack the political will for fiscal reforms yet, unlike their federal counterpart, are required to balance their budgets. Sluggish revenues, political obstacles to fiscal reforms and challenges in servicing debt will increase muni downgrades and yields. However, fiscal federalism—under which the federal government transfers funds to the states—and additional federal stimulus for state and local governments to prevent state deficits become a drag on U.S. economic recovery—will help states partially close their budget gaps. Since states cannot file for bankruptcy and are constitutionally required to balance their budgets, they will cut spending and raise taxes to close the remaining budget gaps. Municipalities can file for bankruptcy and will increasingly do so due to weak revenues and high labor costs. However, transfers from federal and state governments, federal subsidy in the muni debt market and ample room to cut spending will allow municipalities to delay interest payments or restructure debt under bankruptcy rather than default. Thus, implicit and explicit federal backstopping will avert a Greece-like risk of default by U.S. states and an EMU-like domino effect among states and municipalities. Fiscal backstopping will however continue to raise the combined U.S. state, local and federal debt burden and interest cost, pushing the painful fiscal adjustment to the future.

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Posted in Economy, Municipal Bonds, Personal Finance

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PIMCO Favors Asia-Pacific Bonds to U.S. and European Debt

Posted on March 24, 2010 by | Leave a comment

Faster economic growth and lower risk of political moves that would harm the economic recovery are two reasons why Pacific Investment Management Co. (Pimco) believes investors should buy the debt of companies and governments in the Asia-Pacific region, rather than the debt of U.S. and European companies and governments.

It makes sense to invest where there is the greatest potential for growth, and emerging markets have greater growth potential in the near term.  Emerging economies will expand between 11 percent and 13 percent within the next year, while the U.S. economy will grow by no more than 3 percent, according to Pimco estimates.

However, much of the impetus to invest in the Asia-Pacific area is to avoid pitfalls created by the financial crisis.  “Politics are going to play a very important role in how an investor looks at asset classes over at least the next 12 months,” said Brian Baker, Pimco Asia’s CEO, in a Bloomberg.com report. “As policymakers withdraw from their fiscal stimulus, and as regulations are put in place in the financial system in the developed world, we run the risk of a policy mistake.”

The Asian unit of Pimco, manager of the world’s biggest bond fund, is focusing on Australian, Indonesian, Philippines and South Korean debt, Baker said. The Newport Beach, California-based firm recommends bonds of Asian companies with stable cash flows and of governments in the region that have adopted “prudent” fiscal and monetary policies to spur growth.  Baker asserts that many emerging market countries have maintained better balance sheets than those in developed markets.  Many developed market countries, including the U.S., have spent a fortune battling the global economic recession, leaving them with potentially unsustainable debt levels (see Deepening Deficits Around the Developed World at The New York Times).

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Posted in Fixed-Income, Foreign Bonds, Investing, Market Commentary, Personal Finance

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Looming Corporate Refinancing Cliff May Not Be So Bad: Fitch

Posted on March 23, 2010 by | Leave a comment

Between 2012 and 2014, $600 billion of leveraged loans are due to mature and must be refinanced.  Economists have pointed to this period as another possible credit crisis for, due to the slow economic recovery, financial institutions will not have sufficiently strong enough balance sheets to extend that much credit, leading to a new wave of defaults, especially in commercial real estate.

However, Fitch Ratings, in a recently released report, states that amend and extend agreements (A&Es), bond-for-loan takeouts, increased capacity within the leveraged loan market (including a revival of the collateralized loan obligations (CLO) market) and pre-payments (both mandatory and voluntary) are likely to absorb much of the demand for refinancing during this period.

‘Taking these factors into account the refinancing cliff will be much flatter and more easily absorbed than originally anticipated,” said Darin Schmalz, Director, Fitch. “Many of the perceived dangers created by the volume of refinancings can be averted.”

In particular, Fitch expects A&E volumes to continue to increase through 2014, allowing the market to redistribute loan maturities to a level more easily absorbed by traditional market sources. Fitch also expects the demand for capital could be a catalyst for renewed CLO activity in the coming years. This CLO activity could contribute meaningfully to the supply of credit available for refinancing.

There are two key swing factors to Fitch’s estimates. First, the degree of economic stability and associated risk of a double-dip recession will influence the size of the gap between the demand for and supply of credit available. Secondly, the trajectory of the equity market and associated expansion/compression of valuations could affect the willingness of lenders and the equity markets (IPO activity) to provide capital for refinancing.

Fitch believes that the market is likely to find a clearing price and terms at which much of the demand for credit can be satisfied. In general, Fitch believes market forces will work in favor of easing pressure created by the refinancing cliff that otherwise could result in an unparalleled spike in loan default volume.

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Posted in Corporate Bonds, Economy

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Health Care Reform is Short-Term Fiscal Stimulus

Posted on March 22, 2010 by | Leave a comment

The passing of the health care bill through reconciliation by the House of Representatives late on March 21, 2010, will likely bring a second significant fiscal stimulus to the U.S. and global economy, according to Adam S. Posen of the Peterson Institute for International Economics.

“In economic terms, healthcare reform should be thought of as giving a prepaid debit card for spending on medical services to 30 million people,” Posen said in a recent Op-Ed in Eurointelligence.   The health care overhaul is expected to extend medical benefits to  as many as 32 million additional paying customers in the next few years. “These people already had access to emergency services—an American citizen who was unemployed or working informally, and therefore did not have insurance coverage, would still be taken in at a hospital if suffering, say, a car crash or workplace injury. What the uninsured did not have was access to longer-term medical evaluation and treatment for their families. For these people, chronic conditions were not dealt with, pharmaceutical prescriptions for heart disease and the like were not available, and prophylactic examinations were out of the question,” Posen asserts.

Thus, the pent-up demand from the approximately 32 million newly insured is likely to spark spending on all types of medical care, including pharmaceuticals.  Thus, even though pharmaceutical companies are going to be asked to contribute $85 billion toward the cost of the bill in the form of industry fees and lower prices paid under government programs over 10 years, they can look forward to tens of billions of dollars in additional revenue as more people with insurance visit doctors and fill prescriptions.

The legislation will also eventually close the gap in Medicare drug coverage, known as the doughnut hole, in which elderly patients must pay for prescription drugs rather than having them covered by the government.  Most significantly, the pharmaceutical industry won concessions on future price controls or more regulation by the federal government.  So, investors should not necessarily give up on drug makers, and especially, biotech firms.

Posen points out that other examples of governments increasing access to health care have led to demand jumps in the first couple of years, followed by a decrease, but still at levels higher than before the legislation became effective because the population of medically insured is higher.

At the macroeconomic level is where things become dicey.  Health care reform , according to Posen, “is a temporary fiscal stimulus, and a sizable one. People who by definition have not been paying into an insurance scheme previously get to spend dollars on medical services. This will be funded by US government borrowing.”   The concern is that, as the world continues to crawl out of a deep economic whole caused by extreme imbalances between countries in debt (e.g the U.S.) and countries with great surpluses (e.g. China), the fiscal stimulus created by U.S. health care reform may be greater than it can pay for because people will not be getting a set amount of medical spending, let alone an amount limited to the small extent of tax increases included in the legislation—they will be getting a new entitlement to medical care, limited only to the amount of their needs.

That can make for an enormous economic impact.  Posen estimates, conservatively, that health care reform would lead to 1.9 percent of GDP in fiscal stimulus a year, until the tax and insurance premia are raised sufficiently to actually cover the spending.  In the short term, this is very good for the U.S. economy, but, long term, very bad for the world economy.   Instead of allowing deleveraging to cure the global imbalances, the United States will simply increase its standing as a deficit nation, because national savings will decline further.  The key to avoiding a recreation of the same imbalances that caused the global financial crisis is getting health care reform paid for without having the temporary deficit turn permanent.  But that, of course, means higher taxes and inflation.

To view Posen’s Op-Ed in full, please click on the following link: Health Care Reform is the Second US Stimulus Package.

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Posted in Economy, Fiscal Stimulus, Heath Care Reform

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