A Reuter’s report by Nick Carey, Special Report: Is America the sick man of the globe?, is almost painful to read as it tries to extrapolate the problems of unemployment from the Detroit, Michigan area to the entire country.
TURNING A BIG SHIP
America now faces “structural” unemployment. Which means unless the world’s largest economy changes in a fundamental way, millions of unskilled workers will remain jobless and economic growth will be sluggish, at best
“The financial sector and America’s wealthiest classes can help grow the economy, but not enough to bring down unemployment,” said Harm Bandholz, chief U.S. economist at UniCredit Research in New York.
None of this means a death spiral is inevitable. A growing number of economists and investors like PIMCO’s Gross say a fix exists: a comprehensive overhaul of America’s education system and retraining programs for the unskilled.
Instead of seeking a solution to the sector’s woes America’s political class sought a different way out, she added. “We decided as a nation to issue debt and focus on the financial sector to counter what was becoming a major structural issue in the 1980s,” Swonk said….
“This mess has been a long, long time coming,” PIMCO’s Bill Gross said. “We should have been getting people out of the unemployment line, re-educating and retraining them for the future. We failed to do that.”
There’s no counterpoint in this long article.
Quick first: I’m less convinced by the arguments that “We decided as a nation to issue debt and focus on the financial sector to counter what was becoming a major structural issue in the 1980s” than I was at the beginning of the year. We’ll talk about this paper next week, but recent research is leading me to believe that the supply curve on debt shifted out in the past 10 years, not the demand curve.
High-level: If the natural rate of unemployment is 5%, and let’s assume there’s been a high increase in “structural unemployment” of 1.25%, that leaves 3.55% related to demand-side issues. That’s 3.55% of the workforce, well over five million people (not counting those dropping out of the labor force), who are out of work as a result of monetary and fiscal policy choices, not because the of the structural and supply side of our economy. People suffering through unemployment, sitting idle when they could be productive.
That 1.25% is a very controversial number, one I think is exaggerated. The San Francisco Fed has looked at it and concluded the (my underline) “Beveridge curve is consistent with an increase in the NAIRU of about 1¼ percentage points or less…The effects of both of these factors are likely to be transitory rather than permanent.”
Housing Markets, Structural Unemployment
Some of that is skills-mismatch, but most people who look at it conclude that it has something to do with the housing bubble. If it is the result of the spillovers and uncertainty of mass foreclosures then cramdown, short-selling, short-term higher inflation targeting and writing down bad mortgage debt held by bondholders and banks would be a solution.
If it is the result of a lack of mobility from not being able to sell an underwater home then cramdown, short-selling, short-term higher inflation targeting and writing down bad mortgage debt held by bondholders and banks would be a solution.
And if it is the result of people being in a state of debt peonage, where a large portion of their income goes to servicing bad underwater debt, then cramdown, short-selling, short-term higher inflation targeting and writing down bad mortgage debt held by bondholders and banks would be a solution.
From the article, you’ll be happy to know that bondholders, who love disinflation and hate writing down bad debt, believe education reform is the real issue. Don’t worry about the fact that inflation is falling when it needs to go up to a sensible target, go beat up on the teacher’s unions! No doubt education reform is important, and I’ll leave it to smarter people than me to handle figuring that out, but is it really causing our current problems?
Productivity
The implications of the article is that there are too many people working in the manufacturing sector and they need to be retrained to other industries. Manufacturing needs to shrink. But we can continue this line of thought. Right now the number of people working-part time for economic reasons who are service workers has doubled. Clearly there are too many people working in the service industry, and it needs to shrink.
The same holds for people working in management, people working in information, people working in all industries and all occupations. Is every single industry, and every single occupation, suddenly suffering from a drop in productivity? That every part of the economy needs to shrink? That’s what makes the retraining arguments so funny. Yglesias summarized this well in a great post:
…the year 2008 wasn’t in the distant past, we can remember what happened and didn’t happen. No American cities were destroyed by nuclear weapons. No draught crippled our agriculture. People didn’t suddenly forget job skills they’d had. What happened was a large negative shock to demand not an earthquake or a flood or a plague. I was there and so were you.
People talk about demand during downturns because in a downturn you have an unusually large number of unemployed people. That’s people producing nothing who the year before were producing something. If there were more demand, they’d produce something.
Now if you look around the world, you can find lots of examples of countries with lower unemployment rates than the United States that are nonetheless poorer than the United States. How does that happen? That happens because when you’re not in a downturn, the only way for a country to improve its living standards is to actually get better at producing stuff. When almost everyone who wants a job has one, the only way to get richer is for people to start being more productive. Productive capacity matters—a lot. But when lots of people who want jobs aren’t doing hobs, you’ve got a different problem. A failure to mobilize the productive people you already have. In the scheme of things, that’s a good problem to have since it’s much easier to solve. But it’s also a much more frustrating problem to solve precisely because there’s no good reason it should be lingering like this.
No doubt things are changing in the economy. They always are. But the crisis we have goes above and beyond any specific occupation and any specific industry. And there are sensible options for us to use.
Rortybomb 
Corporate economists, agents for the aristocracy, say that the solution is to provide better education to workers. But workers didn’t cause this crisis: the aristocracy itself did, the same people who held the stocks and bonds of the Wall Street firms (and BoA) that Bush/Obama bailed out with money the next generation of the general American public will have to pay back via higher taxes and lower government-provided services such as road-maintenance, education, and health care. The only solution to a crime which is perpetrated by the aristocracy and by politicians who did their bidding is revolution, and that’s not going to happen. But improving worker-training isn’t the solution. America’s problem runs deeper.
Regarding the Fed study: “transitory” does not imply “fixable by monetary/fiscal policy”.
“If it is the result of the spillovers and uncertainty of mass foreclosures then cramdown…”
I don’t see how this uncertainty affects the labor market or skill-mismatch in particular.
“If it is the result of a lack of mobility from not being able to sell an underwater home then cramdown…”
I’m not seeing it. Cramdowns would keep people in their houses. How does this *increase* mobility?
Will,
1. I understand what transitory means in this context Will. It means that Congress can yank unemployment benefits eventually, and thus a lot of that SU will go away (for better or worse).
2. Then don’t put any weight on it as an explanation. The IMF study I link to used foreclosures as a variable. I’m just laying out potential arguments. You ever want to buy a house with a foreclosure down the block? 40% of foreclosures are abandoned. That could, in theory, do something to labor supply.
3. Broadly speaking, cramdown would write down the balance of a mortgage to the market rate, which you could then sell without taking a bath you may not be able to borrow to cover. If you could sell your house you are more likely to move. What’s there to see?
I don’t mean to say that the housing market doesn’t affect the labor market. I’m asking how spillovers affect the labor market. From a labor market point of view, I think you’re saying that a bunch of foreclosures would reduce the likelihood that a worker takes a job in an area assuming a good skills-match with him and the job. If the foreclosures reduce the value of houses in that area, wouldn’t the worker just negotiate a lower price for the house?
The thing with cramdowns is that they are pure redistribution from banks to home owners. How will banks respond? Will they reduce supply of home loans? Taking these supply issues into account what is the net affect of cramdowns on the labor market?
Will,
Why not have debtors prisons? Without jailing someone who misses a payment, we are simply reducing the the supply of credit available to everyone else.
If a company goes bankruptcy, should we put shareholders in debtors prisons? If we reduce the liability in which shareholders have to pay bondholders, we are simply encouraging moral hazard and reducing the supply of credit available to everyone else.
I don’t agree with your framing – we have laws about how to handle bad debt, how to handle the exchange of property rights, and how to handle bankruptcy. Reseting bad debt when times go bad is an essential part of the infrastructure of our market, and the way we do it is broken for residential mortgages.
Modification will result in losses. You know what else results in losses? Foreclosures. The only question is which one is greater, and for investors – who expect an lgd of 30 in good times,and I’m hearing rumors of 70 in some regions from old quant friends – this route is worse. With that in mind, the empirical work says that cramdown would have little-to-no effect on credit:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1087816
Though to be clear, if mortgage originators showed a little more caution with how they passed out loans than they did in 2006-2007 I would sleep perfectly well at night.
There’s also the issue of second-liens, where someone can use collateral for a junior lien without seeking permission of the primary lien holder. If this existed in the corporate bond market there would be no market; yet it is how mortgages are currently done in this country. That this hasn’t been fixed – and cramdown is a fix for it – is frankly insulting to our market integrity, and it by definition won’t be fixed in the marketplace by the primary lien holders.
As per foreclosure, yes, I agree with you that structural unemployment, even as driven by housing bubble collapse, is overplayed. I’m trying to be as generous as possible when thinking through their arguments though, and you can say that foreclosures, which you can argue tend to cluster, have spillover effects and depress housing, creates uncertainty.
“If the foreclosures reduce the value of houses in that area, wouldn’t the worker just negotiate a lower price for the house?” But if you buy a house where the value has an implicit component in the neighborhood there’s a lemon problem with the neighborhood. You asking for a lower price lowers the neighbor’s property values, which puts more people underwater, which causes defaults (either strategically or through demand retrenchment). It’s not an absurd story by any means, which is why I investigate it.
Framing? You said you wanted to talk about the labor market and then you start talking about debtor prisons. The question at hand is how do cramdowns help the labor market, given the existence of sizable externalities from foreclosures (a point that you know I don’t buy, but for arguments sake). You say cramdowns help; I’m asking how.
Independent of the labor market, cramdowns may be the best idea since Jesus but its not obvious to me (and apparently not to you) how they help the labor market.
Fair, and my comment was rude. I thought you were asking for a defense of cramdown qua cramdown as I don’t think of them as pure redistribution. My point is if foreclosures themselves cause unemployment through some mechanism ( a point the IMF has suggested, I’m not sure anyone has a good working model, its not particularly my thought) then cram down would tourniquet it. You know I think it’s a weak story and we need to mostly look to demand – which can have a proxy in debt servicing and in underwaterness to foreclosures – for explanations.
Mind you without some mechanism the housing bubble issue and structural unemployment looks weaker, because mobility is going to be a weak story – I’m hearing 40% of properties abandoned at time of foreclosures.
My not having an explicit model ready doesn’t mean to underplay the tragedy of unnecessary foreclosures – huge value lost because of our broken servicing model, neighborhoods and communities destroyed.
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Seems to me the answer is protectionism for our industry. THE problem is that, because of our indifference, the manufacturing has been shifted to other countries. (It is the whole problem behind it all.) Some of those laid off in service need to be reemployed in industry as do all of those laid off in industry. Devise a tariff uh… algorithm(?) whereby incoming goods are taxed according to what the overseas manufacturers pay their workers. Include retaliatory tariffs against countries that directly or indirectly protect their industries against ours. If a country wants to pay workers to demand goods as ours do and is also willing to allow our goods to compete, then everything’s cool.
I’m for trade “war”. I believe we’re in a position to win it. Our fear of industrial confrontation has nearly killed us
I agree a lot with jonboinAR. The *root cause* of this whole mess was running protracted and chronic trade deficits, an unnaturally high dollar, neo-liberal globalization (end of history – free markets save the world yadda yadda), this is what has nearly deindustrialized the US. I’m sure most people who read here have seen this Charlie Rose interview from 1994, but it is worth watching:
http://video.google.com/videoplay?docid=5064665078176641728#
If we can’t do something forever, it will stop and what will happen when we stop running big trade deficits? The dollar will have to be lower – maybe the US$ will no longer be the lone reserve currency for the world at that time (hurray!). We will have to shift BACK to producing more of our own consumption and that means less than a 70% consumption economy. It means higher prices for ordinary goods in the store, but it also will mean a higher level of employment for ordinary workers with average intelligence or less. Yes, automation has reduced the skills needs even in manufacturing, but that’s nothing that an apprenticeship (think Germany here), 1-year certification, or trade schools can’t solve. We don’t need to heavily subsidize advanced education. Dean Baker is dead-on correct about all of the protections that doctors, pharma companies, etc. all enjoy. These people are turning into parasites for the working class along with the banks!
i only mention this because it doesn’t come up from a quick search of your site. but given your interest in the supply-side dimension of credit expansion, are you familiar with the more recent may 2010 paper by mian & sufi that studies housing bubbles via a “land topology-based housing supply elasticity” instrument? lovely wonkfest here:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1397607
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