Tuesday, June 28, 2011

Marcia Angell and Irving Kirsch – Casting Doubt on the Efficacy of Antidepressant Drugs

There is a disturbing two part article by Marcia Angell reviewing books about the use of antidepressant drugs in the June 23 and July 14 New York Review of Books.  In brief, the article argues that there is significant evidence that clinical trials of antidepressant drugs show that most of the effect of these drugs is from the placebo effect.  Also, according to one of the books reviewed, The Emperor’s New Drugs: Exploding the Antidepressant Myth by Irving Kirsch, the double blind trials may not have been that blind, since patients in the trial experiencing the side effects that these drugs often cause would surmise, as would the doctors in charge of treating them, that they were not being given a placebo but the real drug.  Kirsch hypothesizes that to the relatively small extent that these drugs were better than placebos, it might be due to this “breaking blind” or “enhanced placebo effect.”  The non-enhanced placebo effect is, in fact, quite significant.  If Angell and Kirsch are right, millions of people may have been exposed to powerful drugs which may not have conveyed much if any benefit.  

I do not have any particular expertise to assess the validity of these arguments, but those making them are well-credentialed.  Marcia Angell is a medical doctor, former editor-in-chief of the New England Journal of Medicine, and current Senior Lecturer in Social Medicine at Harvard Medical School.  Irving Kirsch, whose book I have read, is a professor of psychology at the University of Hull in England who has also taught at the University of Connecticut.  He and colleagues have conducted meta-analyses of clinical trials of antidepressant drugs, including one which included unpublished studies submitted by pharmaceutical companies to the Food and Drug Administration (“FDA”) that he and his colleagues obtained through the Freedom of Information Act.  Both he and Marcia Angell obviously have an agenda, but their arguments are not easily dismissed.

One aspect of this that is disturbing is that the FDA is portrayed by Kirsch as being too willing to approve and promote anti-depressant drugs.  In one case, the author claims that the FDA even urged drug companies in 2004 not to report “clinical-trial data that antidepressants are not better than placebos for depressed children.  If the data were made public, they cautioned, it might lead doctors to not prescribe antidepressants…Even if the clinical trials show negative results, an FDA spokesperson was reported to have said to a Washington Post reporter, it doesn’t mean that the drugs are ineffective.  The assumption seems to have been that doctors should prescribe medications that have not been shown to work, until it has been proven that they don’t work.”  If Kirsch’s account is correct, this would seem to be an example of a regulator that is more than just captured, at least on this particular subject. 

I am sure that there are respected medical professionals who strongly disagree with Angell and Kirsch, though I have not found any persuasive rebuttals.  One might even think that those with a contrary view might not want to call attention to the controversy over antidepressants.  But for people who are concerned about healthcare, the article by Marcia Angell is well worth reading.  Among other aspects of this, it is useful to ponder the economic incentives of psychiatrists, who are in competition with psychologists and clinical social workers.  Prescribing drugs is more remunerative than spending an hour with a patient, and it is something the competition cannot do.  Also, the economic incentives of the drug companies are worth considering, as well as the money they spend trying to influence the psychiatric profession.

It is interesting, though, that there does not appear to be a large black market for antidepressant drugs and, as far as I can tell, there is not a lot of spam offering a way to obtain these drugs without a prescription.  On the contrary, what one hears is that some medical professionals have difficulty convincing some patients to keep taking the drugs because of the side effects.  Other patients, though, are convinced of their effectiveness.  For example, Andrew Solomon, who suffered from severe depression, in a very well written and brutally honest book—The Noonday Demon: An Atlas of Depression —argues his belief that antidepressant drugs can be helpful.  His father, it should be noted, is Chairman and CEO of Forest Laboratories, which makes Lexapro, one of the major SSRI antidepressants.  However, given the brutal honesty of the son’s book, which often does not present the author in a very flattering way, I have no reason to doubt that he is sincere in his belief in the efficacy of antidepressant drugs.  

Anecdotal evidence is not enough when considering these drugs, which do have physical effects even if their efficacy for the conditions for which they are prescribed is in some doubt.  In any case, whatever one might believe about antidepressant drugs, Angell makes a good point when she writes:  “At the very least we need to stop thinking of psychoactive drugs as the best, and often the only, treatment for mental illness or emotional distress.  Both psychotherapy and exercise have been shown to be as effective as drugs for depression, and their effects are longer-lasting, but unfortunately, there is not industry to push these alternatives and American have come to believe that pills must be more potent.  More research is needed to study alternatives to psychoactive drugs, and the results should be included in medical education.”  

The Costs of Prescription Drugs

One of the more infuriating aspects of the current discussion on how best to address the long-term U.S. fiscal situation is the focus on Medicare without addressing the out of control costs on healthcare in the U.S. In short, the healthcare situation in the U.S. is a mess and the Affordable Care Act does not address all its problems

One aspect of U.S. healthcare that has always amazed me is how willing the U.S. is willing to subsidize the cost of prescription drugs for the rest of the world. Other countries apply price controls to prescription drugs, but the U.S. does not. However, pharmaceutical companies are more than willing to sell brand name prescription drugs in other countries at lower prices. Why is that?

The reason is that prescription drugs have high research and development costs but are usually not that expensive to manufacture. In economic jargon, they have high fixed costs and low variable costs. What happens is that U.S. consumers pay a larger share of research and development costs than consumers in other countries. Since the costs of manufacturing a drug are usually relatively low, pharmaceutical companies can still make a profit by selling them at lower prices than in the U.S. in other countries, since the U.S. consumer has helped the companies cover their fixed costs.

In other words, in the name of the free market, the U.S. is subsidizing the rest of the world, where there is less of a free market for prescription drugs. Do we really want this system to continue, or should we work with other developed countries in order to negotiate a better cost sharing arrangement?

On the other hand, according to a report of the Center on Budget and Policy Priorities, expenditures for prescription drugs in the U.S. were 35 percent lower in 2010 than projected in 2003 and the costs of the new Medicare Part D is lower than the Congressional Budget Office ("CBO") estimated when Congress was considering the legislation creating this new program in 2003. (Ezra Klein has a post on this: "Does Medicare Part D make the case for Paul Ryan's plan?") However, this is not a reason to be sanguine about prescription drug costs. The Center's report says that the reasons for lower prescription drug expenditures in the U.S. than projected is the growing use of generic drugs combined with many major drugs going off-patent and fewer new major drugs with patent protection coming to market. As for Medicare Part D, costs were also lower according to the report because 6.5 million fewer Medicare beneficiaries enrolled in Part D than expected by the CBO.

Monday, June 27, 2011

The Obama Administration and the Price of Oil

The decision to sell 30 million barrels of oil from the Strategic Petroleum Reserve and to convince the other member countries of the International Energy Agency to match this is an attempt to lower the price of oil and the price of gasoline. The timing is somewhat curious, since gasoline prices had already started coming down. However, gasoline prices, which change frequently, are highly visible and perhaps it was felt that there would be an economic and psychological benefit in getting the price down more, as well as a political one.

The Administration's first reaction when oil prices were going up was to blame speculators and announce investigations into nefarious market activity. Every time the price of oil spikes, some politicians will deliver tough talk about speculation, though there is remarkable silence when the price of oil suddenly falls.

Some of the leadership of the CFTC also wanted to get into this act. As I discussed in a prior post, some of the CFTC commissioners, including the Chairman, are keen on imposing position limits on derivatives, including swaps, based on physical commodities, even if there is no evidence of "excessive speculation," however one might define that term.

It seems to have become clear to the Administration that investigating or trying to restrict speculators was not going to do the trick of reducing oil prices. To accomplish that, they would have to do it the old-fashion way by intervening in the cash market for oil, rather than focusing on those who bet on the future price of oil. But they can't release oil from the SPR indefinitely. If the world economy remains in a slump or is hit by another crisis as the ever more worrying European situation suggests that it might, then the price of oil may remain steady or fall unless the oil producing nations reduce production. If those of us who are worried about current economic prospects are pleasantly surprised by stronger global economic growth, then oil prices are likely to rise.

In other words, the recent decision to add to world oil supplies is only a temporary measure. Perhaps more people will take a road trip this summer or fly somewhere if airline ticket prices are not too high because of this decision to attempt to reduce the price of oil and that may marginally benefit the economy.

Finally, if one is serious about addressing climate change issues, keeping the price of oil relatively low over the longer term is not what you want to do. It is inevitable that we are all going to have to become more careful about our energy consumption, both because of climate change concerns and because of increased demand for energy from some of the emerging market countries.

The CFTC Investigates Suspicious Oil Trading Prior to IEA Announcement

The CFTC is reportedly investigating suspicious price movements in the oil futures markets prior to the announcement of the International Energy Agency in Paris that its 28 member countries would "release" 60 million barrels of oil over a 30-day period to counter "the the ongoing disruption of oil supplies from Libya." Half of this oil is coming from the U.S. Strategic Petroleum Reserve.

The price of oil futures did indeed fall prior to the announcement, which is suspicious. The CFTC, though, would seem to have a tough job getting to what happened and in charging anyone with wrongdoing.

With 28 countries involved in the decision, any leak or hints that something was up could have come from anywhere. Also, insider trading under the Commodity Exchange Act ("CEA") is not the same as under the securities law. In general, trading on non-public information has not been illegal in the futures markets. However, in the Dodd-Frank Act, the CFTC was able to persuade the Congress to add a provision to the CEA known as the "Eddie Murphy Rule." (This comes from the 1983 movie "Trading Places", in which Murphy stars. Part of the plot revolves around speculating on orange juice futures based on knowledge of Agriculture Department data prior to its release. While an amusing though not great movie, I can recommend "Trading Places" as an entertaining introduction to futures markets.)

The new provision of the CEA essentially bans the use of non-public information originating from the federal government in derivatives markets. (For a fuller discussion and the text of the provision, follow this link.) It does not say anything about information originating from a foreign government or international organization. Perhaps the CFTC could make the case that the information is the same as that held by the U.S. government or it could use the broader and vaguer anti-fraud provisions of the CEA. That could make for interesting litigation for those interested in CEA issues, if it ever gets to that point.

In any case, there seem to be formidable investigative and legal obstacles to the CFTC successfully bringing a case against people involved in trading based on advance knowledge of the IEA action. If they cannot catch a big fish, maybe the CFTC will find a relatively small U.S. entity which did something improper and may be willing to settle the charges.

President Obama Disappoints

During the 2008 campaign, Barack Obama demonstrated how good a politician he is.  He did not make any mistakes when Senator McCain tried to rattle him with his “campaign suspension” as the financial market crisis was worsening;  in fact, McCain’s tactic, which might have led an opponent with less political skill than Obama into making political errors, only ended up hurting McCain.  Also, Obama demonstrated how good he was in making political speeches, such as the one he made to turn around the bad publicity he had received concerning his relationship with Reverend Jeremiah Wright.

In light of his obvious political skills, I am surprised by President Obama’s current lackluster political performance.  For example, take last week’s televised speech announcing a schedule of troop withdrawals from Afghanistan.  Whatever one thinks about the policy, a clear problem with the speech is that it was boring.   Even though there was no surprise, since the substance had been already reported in the press, it would seem not that difficult for a speechwriter to make a speech about a current war interesting to listen to, and, for someone with Obama’s public speaking skills, to make one want to listen.  Perhaps he needs a live audience rather than a group of technicians and cameras to motivate him.  As it was, he looked like he was just going through the motions as he read from the teleprompter.   

It does seem that Obama just wants to play an inside game in Washington, and with the Republican majority in the House and the Republican’s blocking ability in the Senate, his political position is more difficult than it was last year.  But what Obama should know is that if you do not like the current political environment, then you should do your best to change it.  That does not need to wait for the next election, by which time it may be too late in any case.

On the wars this country is waging, the Administration has done a poor job of defining goals in Afghanistan and Libya.  If the goals are not terribly clear to the Administration, or if the Administration is divided, then Obama needs to fix that. In any case, the Administration needs to do a better job explaining the rationale for these military actions.  As it is, the goals in Afghanistan and Libya are not terribly clear, which is probably why the public seems to be increasingly skeptical of these military actions.  With Libya, the Administration has gotten itself into a tight corner by claiming that the military effort does not constitute “hostilities” for purposes of the War Powers Resolution, while it is becoming increasingly obvious that NATO is targeting Muammar el-Qaddafi.  If Qaddafi is killed in a NATO bombing raid, what then?  It will not be the end of the story.

In economic policy, the Administration has let the Republicans define the terms of the debate.  Maybe they believe by doing that, the Republicans will be tempted to overreach and hurting themselves. Representative Paul Ryan’s Medicare proposal is an example of such overreach and has hurt the Republicans.  But everyone knows (or should know) that Ryan’s Medicare plan is going nowhere.   What is going somewhere is the notion that serious budget cutting must start now, because government spending “kills” jobs.  In an economy with as much slack as the one we are now experiencing, this is economic nonsense.  Paul Krugman, who continually derides the “Very Serious People” who make this argument on his blog, repeatedly makes the case that this is economic nonsense.  Also, as I noted in a previous post, current Princeton colleague of Krugman and former Fed Vice Chairman Alan Blinder has made this case in a Wall Street Journal op-ed.

Why is Obama letting the Republicans dictate what is responsible economic policy?  The Administration’s counter to the Republicans is not that more fiscal stimulus is needed or even that the current level of stimulus needs to be maintained currently, but only that the rich should bear some of the costs of reducing the deficit in the form of higher taxes.  This is political timidity in the face of a public that is skeptical of deficit spending.  It may be too late politically to change that.  But the role of a political leader is not to just accept that the political consensus constrains policy options.  It is also the role of a political leader to change the political environment when that seems necessary.  The President, more than any other politician, has the ability to use the bully pulpit to change the political environment.  Obama has been amazingly timid in using the bully pulpit, in a way that President Reagan was not, and now Obama has to pin his hopes for reelection on two factors – that the unemployment rate will come down and that the Republicans will nominate a weak candidate for President.  Obama would seem to have what it takes to be an inspirational leader; it is a mystery why he has not used his talents to do this.

The Debt Limit Dance: Delaying a Bad Budget Deal?

The debt limit talks appear to be reaching the final stretch, with the Democrats saying that government revenue increases have to be part of the mix for deficit reduction and the Republicans saying that “tax hikes” are off the table.  Perhaps, there will be an agreement for “revenue enhancements” that are arguably not “tax hikes.”  Maybe not.  If the two sides cannot reach agreement by August 2 (or any revised “drop dead” date), then the most likely outcome is a short-term debt limit increase, because neither side, despite The Wall Street Journal’s editorial page’s best efforts, really wants to risk (and be blamed for) a government default and the ensuing financial market calamity. 

A short-term debt limit increase can take one of two forms.  It can be a small increase, such that Treasury will exhaust it in short order, or it can be a temporary increase, with the debt limit dropping back to the original number on a certain date.  The political advantage of the latter option is that the drop-dead date can be identified with more precision and less questions, and there is nothing like a deadline to force a resolution of some kind.  It might, though, make some people skittish that the parties will not be able to find a solution.

Well, I hope that, if there is no longer-term resolution of the debt limit issue by the beginning of August, the parties are enjoying this dance so much that they want to keep repeating it.  And if that dance delays bad economic policy from being enacted, then maybe it is not such a bad thing.  Make no mistake: cutting current spending with unemployment over 9 percent and monetary policy no longer terribly effective at stimulating the real economy is bad policy, even if the proponents of that have done an excellent job at claiming that this is the responsible thing to do.  On the contrary, the responsible thing is for the government to use whatever tools it has to promote economic growth and reduce unemployment.  If the economy does not produce enough jobs to reduce the unemployment rate for years, the whole debate about what to do about long-term fiscal problems and entitlements will become irrelevant.  Economic despair, hardship, and pessimism have a way of changing political realities and often not in a good way.

Tuesday, June 21, 2011

Wrong Track Economic Policy

Press reports indicate that Vice President Joe Biden and House Majority Leader Eric Cantor are enjoying the meetings they are attending on deficit reduction.  They even have nice things to say about each other. 

Superficially, this may sound good.  Negotiations over a package of deficit reduction measures and a debt limit increase are not marked by rancor, and there may even be an agreement.  If that is true, the likely consensus, at least initially, would be that policymakers are being responsible in addressing the fiscal problems of the U.S. government.

Of course, we do not know what the final package will be, but there is plenty of reason to worry.
For example, press reports indicate that Medicaid cuts may be part of the deal.  It is not clear what form that will take, nor, if there are cuts, when they would take effect.  But cutting Medicaid spending now would be the wrong thing to do.  People who lose their jobs often lose their health insurance; in fact, one of the primary reasons that some people now work is for health insurance.  When people lose their health insurance, they may need Medicaid for their health care needs.  As it should take no leap of imagination to understand, becoming unemployed can be extremely stressful and can increase vulnerability to disease and other health problems.  Do we really want to make things harder for people who are struggling to find jobs in a difficult economy?

Unfortunately, some states are planning to reduce what they provide under this program.  State budgets are under stress as revenues have gone down and Medicaid expenses have gone up because of the poor economy.  Medicaid is a large spending item for the states and is therefore a place where state governments look for possible cuts as they try to bring their budgets into balance.  Federal cuts to Medicaid would make this situation worse for those who need this assistance, even in states that are not cutting their portion of the program.

Also, in general, cutting federal government spending currently is exactly the wrong thing to do when the unemployment rate is over nine percent.  Spending cuts that fall disproportionately on the lower income segment of society, such as cuts in Medicaid and food stamps, while maintaining tax cuts for people much better off is both bad economic and social policy.  Moreover, if there is going to be any hope of getting budget deficits down over the medium-term, the unemployment rate has to come down and the economy has to grow faster.  Increasing fiscal restraint at the current time could have the opposite effect by prolonging the slump.  Do we really want a “lost decade” (or longer)?

In today’s Wall Street Journal, Alan Blinder has an excellent article – “The GOP Myth of ‘Job-Killing’ Spending.”  He makes a persuasive argument that, in the current economic situation, government spending creates jobs rather than destroys them.  Those who think otherwise should read his article.  He concludes:  “…as long as one political party clings to the idea that government spending kills jobs, it’s hard to see how we extricate ourselves from this mess.  As Keynes understood, ideas, whether right or wrong, have consequences.”

While, as Blinder argues, the government should not spend money on stupid projects in order to create jobs, there are plenty of things the government does that are worthwhile.  For example, as many have noted, our infrastructure (such things as bridges, public transportation, and water and sewer systems) is aging and needs to be improved. 

Also, some spending restraint measures that some Republicans are advocating do not have a great deal of fiscal significance, such as cutting subsidies to the Corporation for Public Broadcasting or not increasing the budgets of the SEC and the CFTC.  While arguments can be made for and against the current level of spending for public broadcasting or financial regulation – and I would not dismiss the importance of the issues involved – it is not this type of spending that is significant in either stimulating the economy or increasing the budget deficit.   

In addition, over the longer term, such measures as automatic triggers for spending cuts are unwise.  Spending as a percentage of GDP increases when the economy is in a slump or a recession, because the nominator is increasing as the denominator is stagnant or falling.  Why would one want to interfere with this automatic stabilizing process and make government policy procyclical in an economic slump?  Moreover, if political realities dictate that automatic triggers be circumvented, Congress and the Administration will find a way to do it.  If outright repeal of the triggers is not possible, then there will be a resort to budget gimmickry which can end up costing more money.  (An example of this was the way the George H.W. Bush Administration funded part of the costs of resolving the savings and loan crisis.  To get around the Gramm-Rudman-Hollings restrictions of the time, a funding mechanism for $30 billion of the costs was devised that resulted in higher interest costs than if the Treasury had borrowed the $30 billion by issuing Treasury securities.)

There is reason to worry that the Obama Administration will give the Republicans too much, to the detriment of the economy.  As I have argued in previous posts on the debt limit, the Republicans’ negotiating hand is weaker than it might seem when it comes to using the necessity to increase the debt limit as negotiating leverage to force through their preferred fiscal policies.  While I would not underestimate President Obama’s abilities as a negotiator and political strategist, so far it is not clear what the strategy is.  We’ll see how he and his Administration play the endgame.

Both the Republicans and the Democrats need to be careful.  A prolonged economic slump would not only have huge human costs and make eventually reducing the budget deficit much harder, but it also has potential political consequences that neither political party would find comfortable.  As history demonstrates, economic distress often provides an opening for political extremes of the right and the left to appeal to more people.    

Dangers to the economy not only reside in potentially badly conceived fiscal policy.  Europe is giving plenty of reason to worry, as the Europeans struggle to figure out what to do about Greece and, a much larger country, Spain, has an unemployment rate of around 20 percent.  Troubles in Europe can spread to the U.S. no matter what we do.

But the U.S. should not compound the problem by cutting current government spending because of worry about the budget deficits in the medium- and long-term.  As mentioned, we do not know what will be in the final deal from the Biden-led talks or even if there will be a final deal from that forum.  We also do not know if the Congressional leaders can get a package agreed to by the Administration and the Congressional leadership on deficit reduction and a debt limit increase through the House and Senate.  We can hope that something more or less reasonable will emerge that serves to create jobs currently and makes at least somewhat sensible policy changes over the longer run.  However, the mutual admiration expressed by Biden and Cantor leads one to think that the Administration may be following a triangulation policy, which may or may not be smart politics in the very short run.  It could well be bad politics over the next year or so, if the economy worsens as a result.  

Thursday, June 16, 2011

The Janus Case: Whither the Supreme Court?

A couple of days ago, I saw some news articles about a Supreme Court decision – Janus Capital Group, Inc. v. First Derivative Traders.   The case essentially held that Janus Capital Group (JCG) and a wholly owned subsidiary, Janus Capital Management (JCM), could not be sued for untrue statements in the prospectuses of Janus Investment Fund, the Massachusetts business trust for Janus mutual funds.  The reason given is that, while Janus Capital Management prepared the prospectuses, it cannot be said to have “ma[d]e” the statements contained in the prospectuses.  Only Janus Investment Fund could be deemed to have made the statements for the purposes of SEC Rule 10b-5.  

The case was decided 5-4, with the Justices appointed by Republican presidents on the winning side and those appointed by Democratic presidents dissenting.  Justice Thomas wrote the decision.  While I do not make a habit of reading Supreme Court opinions, I decided to read this one.

The statements in question have to do with using Janus mutual funds for market timing purposes.  The prospectuses say that a fund “may reject any purchase request…if it believes that any combination of trading activity is attributable to market timing or is otherwise excessive or potentially disruptive to the Fund.”  The opinion describes “market timing” in a footnote to be exploiting the daily NAV calculation of mutual funds, when new information affecting the value of securities has come out after the closing price that the fund uses.  For example, a mutual fund may have used closing prices for foreign securities in its daily net asset value (“NAV”) determination, though significant events may have occurred between the closing time abroad and the time the mutual fund determines its NAV.  Apparently, JCG and JCM had at one time entered into secret agreements allowing certain investors, probably hedge funds, to use some Janus funds for market timing.  The Attorney General of New York proceeded against JCG and JCM for this in September 2003 and, when this became public, the price of JCG stock fell significantly.  First Derivative Traders owned JCG stock.

Justice Thomas tortures the English language in arguing that Janus Capital Management did not “make” the statements in the prospectuses.  Also, JCM’s responsibility is more than that of a speechwriter, though Thomas likens the two.  After all, JCM is managing the funds.  Justice Breyer tellingly comments in his dissent:  “What is to happen when guilty management writes a prospectus (for the board [of a mutual fund]) containing materially false statements and fools both board and public into believing they are true?  Apparently under the majority’s rule, in such circumstances no one could be found to have “ma[d]e” a materially false statement—even though under the common law the managers would likely have been guilty or liable (in analogous circumstances) for doing so as principals (and not as aiders and abettors).”

Some of course applaud this decision out of a belief that private litigation has gotten out of hand.  This is certainly the view of The Wall Street Journal editorial page (“A Thwarted Liability Scheme:  The Supremes dismiss another plaintiffs bar money raid—barely,” published June 14, 2011).  And perhaps the Court’s opinion could have been written more persuasively.  As it is, though, one has to wonder what is happening at the Supreme Court, when, in a decision such as this, which does not involve controversial social issues, the Supreme Court divides on partisan and ideological grounds and the Court’s opinion is much less persuasive than the dissent.  This is not the most momentous of decisions, but the decision does seem to rest entirely on form, not substance, in order to achieve a desired result.  Since the case was not decided on Constitutional grounds, Congress can clarify the law by substituting new language if it desires, though I would not expect that to happen anytime soon.  In the meantime, decisions such as this are not reassuring.   

Monday, June 13, 2011

Some More Data on Reserve Balances

A previous post ("Some Comments on Paul Krugman and Monetary and Fiscal Stimulus") discussed the increase in holdings of Treasury notes and bonds from September 29, 2010 to June 1, 2011. It should be pointed out that some other factors served to drain reserves from the banking system. For example, the Fed's holdings of mortgage backed securities (Fannies, Freddies, and Ginnies) fell by about $161 billion. One assumes this was largely due to the paydown of principal on the underlying mortgages. Given a host of factors, the reserve balances of depository institutions held at the Fed increased by about $609 billion from September 29 to June 1. While this is less than the $721 billion increase in the Fed's outright holdings of Treasury bills, notes, and bonds over the period (the Fed's holdings of bills did not change), it is still a huge increase in reserves. (Data from Federal Reserve Statistical Release H.4.1.)

Sunday, June 12, 2011

Dodd-Frank, the CFTC, and the Legal Enforceability of Swap Contracts

Last week there were some news articles concerning worry that provisions of the Dodd-Frank Act which come into effect on July 16 may raise uncertainty concerning the legal enforceability of some over the counter swaps. On June 10, a joint letter of concerned trade associations, including the International Swaps and Derivatives Association ("ISDA") and the Securities Industry and Financial Markets Association ("SIFMA"), expressed concern about this and requested that the CFTC issue an interpretation and various orders to remedy the problem. CFTC Chairman Gary Gensler has said that the CFTC will take action prior to July 16 to remove legal uncertainty.

The Dodd-Frank Act repeals some provisions of the Commodity Futures Modernization Act of 2000 ("CFMA") relating to swaps on July 16. Apparently, the concern is that there is no clear way to distinguish between some swaps and futures contracts (and options thereon) for which transactions are required to be conducted on a CFTC-registered board of trade, raising the question whether certain contracts or transactions in the OTC markets are legally enforceable when the repeal becomes effective on July 16.

The Dodd-Frank Act attempted to deal with this issue in section 739, which put the following language into the Commodity Exchange Act ("CEA"):

"No agreement, contract, or transaction between eligible contract participants or persons reasonably believed to be eligible contract participants shall be void, voidable, or unenforceable, and no party to such agreement, contract, or transaction shall be entitled to rescind, or recover any payment made with respect to, the agreement, contract, or transaction under this section or any other provision of Federal or State law, based solely on the failure of the agreement, contract, or transaction—(i) to meet the definition of a swap under section 1a; or (ii) to be cleared in accordance with section 2(h)(1)."

Apparently the provision that says that a swap is still enforceable even if it does not meet the CEA definition of swap does not alleviate all worries, because the transactions might be "futures contracts," which is not a defined term. The concern is that a losing party to a trade might go to court and argue that it did not have to pay because the transaction was illegal under the CEA.

The legal enforceability issue due to the CEA is not a new concern, and the market developed with this hanging over it during the 1980s and managed to thrive. The CFTC and Congress took various actions over the years to provide legal certainty to the swap market, which worked until Brooksley Born became chair. Her desire to regulate a market where she saw dangers raised a legal enforceability issue for some swaps based on securities. After she left the CFTC, the CFMA put these issues to rest.

With regard to the current situation, it would seem that the CFTC could put out orders and an interpretation along the lines the trade associations propose in their letter, or perhaps take a different approach. While parties could still go to court, I would think the courts would give great deference to the CFTC's views ("Chevron deference").

The Wall Street Journal ran an editorial on June 9 on this subject, "The Hangover, Part III: Another unintended Dodd-Frank consequence." In it they say: "…not everyone is convinced that Gary's web posting is going to defuse the bureaucratic bomb that Chris and Barney have programmed to detonate next month. Mr. Gensler can't prevent private lawsuits if the law becomes murky. It doesn't take too much imagination to see trial lawyers trolling the ranks of underachieving municipal finance officials who might want a do-over after some bad derivatives bets. We could immediately be talking about real money."

Also, over at "Seeking Alpha," Craig Pirrong is exceedingly sarcastic about Gary Gensler on this subject ("Witness What the Sorcerer's Apprentices in Charge Hath Wrought"): "…a CFTC web posting or Gary Gensler writing on his Facebook wall or Tweeting that it's all cool or whatever won't deter firms with big losses from taking a punt on a lawsuit."

I would note that Ed Rosen, a partner at Cleary Gottleib who appears to have been the principal drafter of the trade association letter, is an expert in this area of law and has represented derivatives dealers regarding CEA issues for years. (I know him from my days at Treasury when I worked on derivatives issues, but I have not spoken to him about this current matter.) I am sure he carefully considered the suggestions the trade associations made to the CFTC to reduce the legal uncertainty for their members. I do not know whether he thinks it is worth the effort to try to get Congress to pass legislation, as the WSJ editorial suggests.

The basic problem facing the CFTC is the sheer volume of regulatory projects they have underway. As I am sure Gensler has come to appreciate, he cannot always get his way even though he heads the agency. He needs at least two other commissioners to go along with him. This serves as a check on any one person having too much power, but it makes the process of finalizing regulations, some of which are controversial, more difficult and less efficient than at an agency such as Treasury, where the Secretary's decision is final when there is disagreement among the political appointees under him. It is not surprising that the CFTC has not been able to meet all the Dodd-Frank deadlines. But it is in no one's interest at the CFTC or elsewhere for there to be turmoil in the swaps market because a court has found some contracts to be illegal. While there may be disagreements within the CFTC on how tough regulation of this market should be, the commissioners would seem to be able to agree on a way to resolve this legal uncertainty issue.

(As a caution, this is an exceedingly complex and confusing area of law, and I am not a lawyer. The CEA is known for its ambiguity and the Dodd-Frank Act is a complex and voluminous piece of legislation. I have not consulted any lawyers in writing this post, and it is entirely possible that I have missed something. Nothing here should be considered legal advice.)

Thursday, June 9, 2011

Some Comments on Paul Krugman and Monetary and Fiscal Stimulus

In a June 3 post, Paul Krugman points out that those who have argued that the current large budget deficits would result in an increase in interest rates even with the high unemployment have been wrong. He demonstrates this with a graph of the Treasury 10-year constant maturity yield (nominal) and, in a subsequent post, the 5- and 10-year real yields of Treasury Inflation- Protected Securities ("TIPS").

Paul Krugman is, of course, correct. His comment about those who, so far, have been wrong: "The apologists offer a series of special explanations; it was the Greek debt crisis driving investors into the dollar safe haven; it's the Fed's purchases; whatever. We'll [see] what happens when the latter end at the end of this month, by the way."

Given this comment, it is interesting to look at the magnitude of Fed open market operations with respect to marketable Treasury notes and bonds. (The government trust funds are usually invested in non-marketable securities.)

Using information presented in Federal Reserve Statistical Release H.4.1, the Federal Reserve's holdings of notes and bonds held outright, including TIPS, increased by about $721 billion from September 29, 2010, to June 1, 2011. This is based on face values, including the inflation compensation which is added to the principal of TIPS, which is not significant for these purposes. The Daily Treasury Statement for June 1, 2011, indicates that the net increase of marketable notes and bonds (issues minus redemptions) for the fiscal year, which began on October 1, 2010, was about $974 billion. This is also based on face values, including the inflation adjustment to principal of TIPS.

Thus, the Federal Reserve has taken up about 74 percent of the increase in the face value of marketable Treasury notes and bonds since the beginning of October. This is unprecedented. As Krugman says, we will see what happens when the market has to finance a much larger portion of Treasury's new issues of marketable securities. I am not concerned about the market's capacity to do this, but I do have a nagging worry that, if the increase in supply occurs too quickly, there could be market effects.

One hopes that the Fed knows what it is doing, and, if something unexpected happens, it can move quickly to deal with it. Of course, the inability of the economy to grow fast enough to reduce unemployment and the debt problems in the Eurozone are additional factors which will challenge policymakers. (A government default, even technical, would also pose a severe challenge, but I continue to view that as unlikely, though it is pretty obvious we will get to the brink.)

Krugman has been a powerful voice for both easy monetary policy and stimulatory fiscal policy. While the end of QE2 has to be managed carefully, monetary policy seems to be able to have reached the limits of its ability to spur real growth. Fiscal policy, as Krugman notes, is hampered by the current political situation which is focused on reducing deficits, both short- and long-term. If fiscal policy cannot be used to stimulate the economy and monetary policy is not that effective, then there is little the Obama Administration can do.

Those who argue that we should reduce current government spending seem to believe is that all that is necessary for the economy to grow is for the government to get out of the way.  Maybe, but we may have to wait much longer than they expect for this to happen. They seem to reject the notion that the economy may find an equilibrium point with higher than desired unemployment for a substantial period of time. This idea, of course, is associated with Keynes, and, in some circles, to call someone a Keynesian is considered an insult.

Krugman has recently argued that a major war would result in full employment very quickly, just as World War II ended the Depression. Of course, World War II was not entered into as a way to increase economic growth and increase employment, but that is what it did. Deficit spending worked. While Krugman is not advocating war, he uses the reference to war to make the argument that increased government spending could help us get out of the current slump.

The Administration will not, of course, propose this, given the current political realities. It is hoping that the economy is on the right track and will continue to grow enough so that unemployment begins to come down. In the meantime, the Republicans are using the debt limit impasse to push both current spending cuts and entitlement reform. Current spending cuts are not a good idea with an unemployment rate over 9%, and, as to entitlement reform, this needs to be done, but carefully. Just changing and cutting Medicare drastically without making general reforms to our inefficient health care system is not sensible, and, in any case, is unlikely to be enacted. Tax cuts are always easier to achieve, but anyone who is serious about the long-term deficit should be seeking ways to increase revenues over the long run, not cut them.

In short, the political system is stalled, at least until the next crisis. If anything, the government will reduce its current spending, and it is hard to argue that this will help economic growth, though John Taylor tries. We can all hope that Krugman is wrong and that the economy will grow of its own accord, but I would not bet on it. The Administration appears to have no choice but to make that bet.

Monday, June 6, 2011

John Taylor Playing Politics; More on the Debt Limit

I had thought that there was little more to say about the debt limit until we came close to the "drop dead" date, but then John Taylor comes along and explains why he signed the statement of 150 economists on the need for a debt limit increase to be accompanied by significant spending cuts and budget reforms. John Taylor's chosen venue was the opinion pages of The Wall Street Journal, for which he wrote an article headlined "In Praise of Debt Limit Chicken," which appeared on Thursday, June 2. Professor Taylor of Stanford University and the Hoover Institution, it should be noted, is a former Treasury Under Secretary for International Affairs in the George W. Bush Administration. While debt limit issues were not part of his responsibilities at Treasury, his former position in a senior political post at Treasury (there are only three Under Secretaries) and his reputation as an academic economist means that his opinions will be widely read by those who follow the debt limit impasse.

In his article, Taylor argues that "[i]f politicians just increase the debt limit without simultaneously correcting … rapid spending growth, then they will be expected to do so in the future. In contrast, if they tie any increase in the debt limit to a halt in the explosion of spending, then people will give them better odds that they will control spending in the future." Taylor goes on to say that a possible compromise would be to split the difference between the $2 trillion President Obama proposed in an April 13 speech and the $6 trillion in cuts of the House Budget Resolution over a 10-year period.

There are a number of problems with his argument. I will focus on a few.

No matter what is attached to debt limit legislation about spending over the next 10 years, future Congresses can, and most likely will, change it. Taylor recognizes this issue, and argues that this is why he is against automatic cuts if spending is higher than forecast in the future. He does not explain why he thinks Congress will not change a 10-year budget plan passed in conjunction with a debt limit increase.

In his op-ed, Taylor sticks with numbers and does not address what budget items he would cut. However, on the list of proposed savings in the House Budget Resolution are those from proposed changes to Medicaid and Medicare and repeal of the Patient Protection and Affordable Care Act, and Taylor has praised the Ryan Medicare proposals on his blog. It is fanciful to think that the Democrats and the Republicans will come to an agreement on health care issues in the next two months. For example, neither the Administration nor Congressional Democrats will agree to repeal the health care law. The U.S. does need to get health expenditures under control, both those that the government pays and those that private insurance companies and patients pay. The current system is too expensive and is not delivering the results of the health care systems of many other industrial countries. As the continuing controversy over the Affordable Care Act demonstrates, this will not be done any time soon. Republicans want to make major changes to Medicare and Medicaid and reduce the role of the federal government in health care. Many Democrats do not support major changes in these government programs, especially in Medicare, and are not adverse to a larger role of the federal government in the health care system. How to fix a health care system which is currently inefficient, is burdened by excessive administrative costs, and may have economic incentives for doctors to propose and patients to agree to medical procedures that may not be necessary are difficult policy issues. They should not be decided substantively in a couple of months. With the current ideological differences, it is clear they cannot be decided politically in anything like that time frame.

Finally, as Brad DeLong, a former Treasury Deputy Assistant Secretary in the Clinton Administration, points out in his blog, the argument in the statement of the 150 economists that the absence of spending cuts "will harm private sector job creation" is at odds with what Taylor and his coauthor wrote in their economics textbook about the stimulatory effect of an expansionary fiscal policy.  Many economists would disagree with the idea that current spending cuts will stimulate the economy because it will change expectations about future deficits. Also, related to this point, Taylor does not distinguish between the current budget deficit -- largely the result of such factors as the Bush tax cuts, which have been extended, the costs of military operations in Iraq and Afghanistan, and the economic downturn -- and the medium- and long-term outlook for increased spending on government entitlement programs. What Taylor seems to be saying is that reducing current spending through debt limit legislation will serve to convince economic actors that Congress will stick to a plan to reduce the deficit over the long-term and that this is beneficial to the economy in both the short and long run. The economic argument is open to question, as is the political one. Taylor apparently does not think it is important that everyone in Congress needs to face the electorate and that the membership in Congress changes over time so long as we tie spending cuts to debt limit legislation.

Obviously, Taylor's signing the statement and writing the op-ed is an effort to influence policy. There is nothing wrong with that, but the main assets he has to influence economic policy, in addition to the persuasiveness of his arguments, are his credibility and his reputation as an economist. While his abilities as an economist are not in question, too many articles and actions like this will not help his credibility. He needs to explain his position better, especially if he believes his current views are reconcilable with what he has earlier written, in order not to seem to be molding analysis to favor particular policy outcomes, and he should avoid making political science arguments as facile as those he made in his op-ed.

While I was surprised that Professor Taylor, as a former Treasury official, would use his reputation to enter the political fray in a way that might be read as someone willing to run the risk of default, I was even more surprised that former Secretary of the Treasury and Secretary of State George Shultz, who is also affiliated with the Hoover Institution, was one of the 150 economists who signed the statement for Speaker Boehner. While Taylor may want a political appointment again (I have absolutely no information on whether he does) and Emil Henry, a fundraiser for Mitt Romney, almost certainly does, George Shultz, who is 90 years old, almost certainly does not. He perhaps believes he is doing the right thing by lending his name to pressure the Administration and Congress to make spending cuts, but he should have probably thought harder about what he was lending his name to.

It is anyone's guess as to how exactly the debt limit impasse will be resolved, but I suspect that the Administration will take a page from Bill Clinton's playbook and triangulate. The Obama Administration is hardly as politically liberal as its opponents would like to paint it, and Treasury Secretary Geithner is hardly a leftist; if there are budget cuts that the Administration would like to make that would be opposed by Congressional Democrats, the Administration would be happy to blame the Republicans, who would be pleased to take the credit. There are limits to this, because there may not be enough Republican votes to pass the debt limit in the House, and Speaker Boehner may have to rely on at least some Democratic votes. What he would be willing to give for those votes is not clear at this point. The politics of this are difficult, but the motivation, avoiding an economic calamity and protecting the sterling credit reputation of the U.S., is sufficiently high that the leading politicians involved will have to figure out how to do it. That is their job.

Thursday, June 2, 2011

Greece, the Euro, and the Logic of Engrenage

As many have remarked, the Greek crisis could end in trouble for the euro and the European Union, generally. Germany is naturally reluctant to bail out a country considered to be fiscally irresponsible, but, if they and other European countries do not do enough to contain the Greek crisis, the result could end up in harming not only Greece but the rest of Europe as well. The U.S. is not immune.

I do not have any particular novel observations on how to solve the Greek crisis. But it does bring to mind a metaphor about the European unification project I first learned about during my undergraduate days. The metaphor had to do with small gears turning larger gears. This was the theory of "engrenage," which is associated with one of the early proponents of European unification, the Frenchman Jean Monnet. The idea was that European unity would start with relatively small steps, such as the European Coal and Steel Community, and that this would necessitate more coordination on other matters, eventually leading to more unification measures such as the establishment of the European Common Market.

To a large extent, this has worked. But there has always been the concern that, if the unification project moved too fast, the big gears might lock or reverse direction and the small gears would break. That is the danger Greece poses to the European Union ("EU").

Two decisions Europeans have made are critical – broadening the EU and establishing a common currency. One recalls that, in the early period of the European unification project, French President Charles de Gaulle blocked the United Kingdom from joining the original six members of the European Economic Community. The U.K., of course, is now a member of the EU, and the EU has vastly expanded to include 27 countries. There had been a debate about whether Europe should concentrate on "deepening" its unification or in broadening its membership. It has clearly been decided that broadening was a worthwhile goal.

However, with the decision to introduce a common currency for members that met certain criteria (which in some cases, such as Greece, appear to have been fudged), there has also been an effort at deepening. And here is the place that the logic of engrenage poses dangers. As has now become clear, monetary union is putting increased pressure to come up with a common fiscal policy. That is a difficult step, especially for a Europe with countries facing varied economic conditions and with different cultures. The big gears may slow down or grind to a halt, and the smaller ones may struggle under the strain.

I think the U.K. was right to stay out of the eurozone. As convenient as it is for much of Europe to have a common currency, the problems are now evident. To use a different metaphor, as Europe moved to introducing the euro, I thought that this was putting the cart before the horse. I was, though, both impressed and surprised with the progress the Europeans made and the initially successful replacement of national currencies with the euro.

The reason for my skepticism is that the eurozone does not appear to be an optimum currency area. For one thing, language and cultural barriers greatly impede the geographical mobility of labor. And, as mentioned, the different countries have different fiscal policies. (The different states of the U.S. also have different spending and tax policies, but the federal government does the majority of spending and taxing. Also, while there are certainly cultural differences among different regions of the U.S., they are nowhere near as great as in Europe, and there is a common language.)

While many now think that the euro was introduced in too many countries, it is now a fact. The worldwide economic downturn has revealed problems, and policymakers in Europe, the IMF, and, to an extent, the United States face difficult choices as they attempt to contain the Greek crisis. It is not merely a technical economic problem but also a political problem, both domestically in various countries, and, internationally, among countries. If it is not contained, the dangers to the global economy, including the U.S., are very real.

Wednesday, June 1, 2011

A Quick Comment on the Debt Limit Statement of 150 Economists

Speaker of the House John Boehner issued a press release today announcing that 150 economists had signed a statement that legislation increasing the debt limit should be "accompanied" by significant spending cuts and budget reforms.  The statement, which consists of four sentences, manages to be repetitive; the last sentence is representative:  "An increase in the national debt limit that is not accompanied by significant spending cuts and budget reforms would harm private-sector job growth and represent a tremendous setback in the effort to deal with our national debt."

The economists who signed the statement appear to be more concerned about "our government's spending addiction" than the deficit, and the lack of any mention of taxes reinforces that impression.  The real problem with the statement, though, is that it is about political tactics, not economic policy.  After all, most economists do not have any particular expertise in political science or, more specifically, legislative strategy.  Why is it critical that debt limit legislation be the vehicle for their desired policy outcomes?

In any case, they may well be disappointed by the legislation increasing the debt limit.  They would be more credible if they argued the policy case for the spending cuts and budget reforms that they advocate, rather than giving the Speaker something to wave around as he negotiates with the Administration and tries to stave off the Tea Party influenced members of his caucus.