Please, don't tax me any more

Mark Thoma says:

For the supply-side types who support tax cuts because they promote economic growth by reducing economic distortions, I guess it's time to start writing the inevitable "think how bad things would have been without the tax cuts" columns. But as you are writing and find yourself tempted to call for further tax cuts to avoid a recession, remember that using tax policy to stimulate the economy and reduce the severity of downturns is Keynesian economics, not supply-side policy, something that many of you have confused in the past. I am not at all opposed to interventions to stabilize the economy, though tax policy is just one of many options (and who gets the tax cuts matters as well), but let's not pretend that using tax policy to stimulate the economy is faithful to supply-side ideals.

Could we please not? Could we please not have this discussion?

The economy has several clear problems:

• Mortgage-backed securities turn out to be much riskier than people thought, which is causing both solvency and liquidity problems in the financial sector.

Central banks have always drawn a line between illiquidity and insolvency. Illiquidity is often viewed as something temporary, an aberration where central bank intervention is permissible. Insolvency, on the other hand, is viewed as something fundamental and abominable and thus to be discouraged. Central bank intervention to restore liquidity to an illiquid market would simply bring prices back to fundamentals. Intervening to bail out insolvent firms would, however, encourage irresponsible behaviour and should be resisted. At least, so the catechism goes.


Central bankers know, though, that the line between illiquidity and insolvency is an extremely fuzzy one, made more so with developments in financial markets. Take, for instance, a mortgage loan made against a house. If the housing market is liquid, loans are easier to come by. The reason is obvious. One of the biggest costs to a lender is that if the borrower defaults, the house has to be repossessed and resold with substantial costs. If, however, houses are selling like hot cakes, then the cost of repossession and resale is likely to be small. Housing loans will appear low risk, the risk premium lenders will charge will be small and housing credit will be plentiful. In turn, this will increase the volume of house sales, increasing liquidity in housing markets. Liquidity thus tends to be self-fulfilling.

But this leads to a problem in assessing whether lenders have been irresponsible or not. A mortgage loan might be perfectly sensible and appropriately priced taking the continued liquidity of the housing market as given. And the same loan may be viewed as reckless, driving a mortgage lender into insolvency, if liquidity in the housing market dries up.

• Subprime borrowers are in big trouble, which could blight many urban areas with foreclosed and shuttered houses
• The subprime borrowers won't feel so hot, either
• Everyone's going to be spending less money, because they're heavily in debt and can no longer use their houses as piggy banks

I find it hard to see how these problems could be either created or destroyed by tax cuts, whether the stimulus you crave is demand- or supply-side. Not only do subprime borrowers not get much in the way of tax cuts, what with being fairly low income and all, but also, they haven't gotten much out of whatever recent economic growth you want to attribute to the Bush tax cuts. On the other side, making hedge fund managers richer wouldn't make them any more solvent. And either fiscal or supply side stimulus would have to be spectacularly amazing to cover the amount of extra spending America has done over the last few years. So couldn't we put away the op-eds on tax cuts for a while, and think about ways to address the housing mess? And please, no arguments for more tax cuts . . . even if fiscal or supply side stimulus were appropriate, they don't work fast enough to stop a financial crisis.

Actually, though, I have to say that I'm pretty impressed with how the debate has gone so far. To be fair, I mostly read the financial pages--but on those pages, there is a serious debate between people who are clearly interested in fixing the damn problem. There is passionate disagreement, but little fulmination about the morals of the borrowers or lenders, or the people arguing for different solutions. It may be the first time in my life I've ever witnessed an economic argument where almost everyone involved seems to feel that the matter is too important to risk hurling ideological brickbats.

(Please, don't send me nutty columns from the left or right wing press; no one's paying attention to the loons right now, and frankly, I just don't want to know.)

Comments

(Please, don't send me nutty columns from the left or right wing press; no one's paying attention to the loons right now, and frankly, I just don't want to know.)

Does that mean we can't quote that loon Kudlow? It leads me to wonder why guys like Kudlow and Cramer(and the dolts at CNBC for that matter) advocate a rate cut when the biggest winners, in the short term at least, will be Wall Street. What they don't want to acknowledge is that cutting rates further will make the dollar tank even more. They won't even talk about the consequences of that.

Posted by Joe Klein's conscience | September 7, 2007 7:50 PM

You could have added industry job cuts as another bullet point. For example, Countrywide just announced 12k more job cuts.

Here's one question I would ask about the mortgage backed securities mess if I were an econoblogger: Why hasn't a consortium of institutional buyers of the securities (e.g., various state and municipal pension funds, endowments, etc.) ponied up their resources to fund their own independent rating agency or two? Perhaps ratings would be more reliable if the ratings agencies weren't getting paid by the issuers whose securities they rate.

Posted by Fred | September 7, 2007 7:54 PM

Fred:
It is easy. One word: credibility. Despite the fact they have been proven corrupt, people trust the three big ratings agencies. I took a finance class last year. I wish I still had it because it had a quote from a small ratings agency head. He bemoaned the fact that the Big Three basically controlled the ratings business for no good reason.

Posted by Joe Klein's conscience | September 7, 2007 8:13 PM

Are the subprime borrowers typically poor? How much have they been borrowing? I got the impression that many people overextended or got a mortgate to pay off credit card debt. These people might be broke, but they could easily have significant incomes.

EI

Posted by Earnest Iconoclast | September 7, 2007 8:52 PM

Regarding the mortgage market constipation:

Actually, if you do a debt restructuring, the borrower has a tax liability for forgiven or even - in some cases - restructured debt. So yes, FURTHER tax cuts could go a long way to working out debt problems for fools who took out mortgages they could not afford and the banks who were foolish enough to make the loan (or the mortgage company that sold the loan to an MBS investor)

Tax relief would help facilitate debt restructuring. As it now stands, a moron home buyer/refinancer could get socked with a big tax bill if their lender restructured or forgave part of their debt. People should not assume that tax treatment is some kind of theoretical parlor game played by economists and dilitante leftwing bloggers. Tax effects have very real consequences on economic decision-making.

Posted by Jozef | September 7, 2007 9:54 PM

there is a serious debate between people who are clearly interested in fixing the damn problem. "

And while they dither, the economy is actually sorting itself out. Sure, the financial world has some clearing up from the bubble, and people have to find new jobs, which sucks, but the financial innovations are with us and remain beneficial. The market is choppy, but steady. The manufacturing sector is growing on the dollar weakness, other sectors are doing fine (watch that advertising world bounce on the upcoming election) and a few quarters of slowness, or few small period reports aren't going to alter the world-wide boom.

Hopefully, the politicians won't do something stupid and make it worse like, for example, legislate that all Savings & Loans immediately and simultaneously dump all their most profitable assets (junk bonds) onto the same market. That would be bad. Please show restraint in offering legislative or monetary fixes. If they do nothing, this'll be a forgotten topic.

Posted by Béziers | September 7, 2007 9:59 PM

Riffing off Fred and Joe_Klein: I thought I'd point out how different the bond and stock markets are different in terms of ratings agencies.

For bonds, the ratings agencies are a) few in number, and b) highly respected.

For stocks, there are a) lots of organizations issuing "ratings" for stocks, and b) none of them really gets a lot of attention in this capacity.

Why is that? I suspect the higher liquidity of stocks compared to (non-developed-economy-gov) bonds makes the prevailing price a better indicator of stocks' fundamental value than bonds.

But that's just a guess.

Posted by Person | September 7, 2007 10:47 PM

Why hasn't a consortium of institutional buyers of the securities (e.g., various state and municipal pension funds, endowments, etc.) ponied up their resources to fund their own independent rating agency or two?

Enormous barriers to entry. Only ratings by a "nationally recognized statistical rating organization" (this is a specific term in the securities laws) are useful to public debt issuers, since only those ratings count for many registration, NASD, and bank regulatory purposes. There are only seven: the big three, Dominion and A.M. Best, and two Japanese companies. For the SEC to admit a credit rating agency as an NRSRO, the agency must show that it has a history of being nationally recognized. You can see the problem here.

Issues are almost always rated by at least two and often all three of the big ones, and they charge fantastic fees for their ratings, up to $100,000 or more (sometimes much more) for each agency depending on the complexity and risk of the issue. It is a major expense for the issuers along with bankers, lawyers, and accountants.

So the market expects the big three, there are high barriers to entry, and issuers don't want to pay any more in fees to these guys anyway.

Posted by Kwyjibo | September 8, 2007 12:57 AM

Person:

For bonds, the ratings agencies are a) few in number, and b) highly respected.

For stocks, there are a) lots of organizations issuing "ratings" for stocks, and b) none of them really gets a lot of attention in this capacity.

Equity research is done by guys at investment banks or financial information companies who go around and rate things based on public information. They use their reports within the organization or sell them. Equity research used to be a way to build relationships with companies and get their investment banking business, but the groups have to be walled apart now. They often do not produce direct revenue.

Bond ratings are done by ratings agencies who get paid by the issuers to give them general corporate ratings and ratings for particular issuances. The agencies meet regularly with companies and have access to nonpublic information. They are hugely profitable, as in 30%-40% income before taxes.

They're entirely different business models. Part of the difference is that bond rating agencies are regulated and their ratings are important for regulatory purposes. Equity research is largely unregulated and has no legal significance.

Posted by Kwyjibo | September 8, 2007 1:16 AM

I love the way lenders immediately twist the debate upside down, conflating their own interests with borrowers' rights.

Banks create money by the act of lending. By lending people more than what they can really afford, and in many cases more than what their houses are really worth, lenders created TOO MUCH MONEY. This caused inflation, which fed back upon itself to create a housing bubble.

So for lenders to pretend that they, in aggregate, did sub prime borrowers a favor is ridiculous. All they did was cause such massive housing inflation that a median-income family almost NEEDS a super-double-bonus option ARM to afford a house.

This is not to say that lenders are evil. It really isn't the Countrywide loan officer's job to consider the macroeconomic consequences of her company's loan products. That's the government's job.

Every time the financial "geniuses" get "innovative," they cause a worldwide panic that threatens the whole economy. People should stop listening to them.

Posted by Jalmari | September 8, 2007 1:55 AM

there are many reasons for the housing crunch to go around, both borrowers and lenders alike. Best long term move would be to move back towards the requirement for some assets that aren't heavily borrowed, as a fraction of income.

Short term is a much dicier problem. I won't repeat alot of what has been said, both good and bad, however, there is a lot of pain out there right now. Personally, I do know a lady at work who overextended, and it happened so gradually she didn't even realize it. She 'owns' a loan on a home, has two vehicles paid off, but her mortgage just ballooned by about 33%. Her income is not particularly good.

Does she deserve a 'reset' of her mortgage payment by federal intervention? I can't see the good for the econpomy on that one, but it would be good for a limited number of those who qualify. It wouldn't provide much in faith in the system, kind of a Chrysler intervention, and it hasn't helped them in the overall.

Perhaps they'll need to lose the house, but have some form of cushion that doesn't put their credit history into the tank, sort of a one time only forgiveness of sins (of course,we know how good that kind of thinking went over with the 1986 Amnesty Bill).

Posted by falkoyn | September 8, 2007 7:47 AM

On the substance of Megan's post: we don't have to have this discussion right now, one supposes. But you have to acknowledge that having instituted a gigantic tax cut which funneled hundreds of billions of dollars to people in the top 1% of earners and put a then-solvent government back in the red, to now, once a new financial crisis looms, say "Now isn't the time to talk about those tax cuts we had 6 years ago! We have to deal with the subprime mortgage catastrophe!" -- looks to tax-cut foes like the con man's "Look! A bear!" as he slips away into the crowd.

Posted by brooksfoe | September 8, 2007 10:25 AM

Jalmari,

Way to see only one side of the picture on your pathway that leads to direct government regulation!

What you say may have an element of truth, to a certain extent (with the exception of requiring the gov. to further involve itself in the loan industry)

But unfortunately, for your argument, banks just didn't say, "hey you want too much money for your house? sure!"

It is the borrowers who decided to:
take the personal financial risk of living in expensive marketplaces instead of moving elsewhere and finding a cheap job

If there is a short supply of houses in places where you want to live in So. Cal, or elsewhere, the price will go up. Add in the fact that thanks to government regulation (which can be both good and bad) a developer just can't start developing homes. He has to cut through miles and miles of red tape for several years before getting started.

So if you want a house, the only people selling them are either individual owners or developers that happen to have their projects nearing completion after 10 years or work, you're going to pay more for it if you don't want to wait.

If you waited, rather than take a lone that your lifestyle can't afford you will be the one who is the fault for the supposeded excess of money in the marketplace.

Maybe the person who took the pricey loan shold have realized they likely could have paid their bills if they made some key changes to their lifestyle - ditch the cable TV, buy a used car, don't go out to eat for dinner, pack a lunch to work, etc etc.

If you want to buy more house than you can afford you need to sacrafice in other areas to make good on your debt. Don't blame the lender for your poor decisions, and certainly don't blame the government for not stepping in and telling the lender exactly how they should handle all their cusomters.

Posted by sam | September 8, 2007 10:33 AM

"finding a cheap job"

should read "finding a cheaper place and potentially cheaper job"

Posted by cdub | September 8, 2007 10:35 AM

I think I said this about 2 weeks ago. You should have written this post instead of talking about taxes. This is the only subject worth even thinking about right now. We are far from safe right now, despite what all the "look at the calm markets" crowd is saying.

"Why hasn't a consortium of institutional buyers of the securities (e.g., various state and municipal pension funds, endowments, etc.)"

lol

Posted by mickslam | September 8, 2007 10:40 AM

Sam,

"But unfortunately, for your argument, banks just didn't say, "hey you want too much money for your house? sure!""

They absolutely did say this.

Posted by mickslam | September 8, 2007 10:48 AM

Mickslam:
Sam doesn't get it. The bigger the loans, the bigger the fees, right? Banks had an incentive to give people ever bigger loans. If a bank isn't going to do due diligence than the bank has responsibility too. There is plenty of blame to go around.

Posted by Joe Klein's conscience | September 8, 2007 12:05 PM

With this: "It really isn't the Countrywide loan officer's job to consider the macroeconomic consequences of her company's loan products. That's the government's job."--type of attitude floating around, can it be any wonder how this event (loan/appraisal scandal/housing bubble) occured (?)

What ever happened to simple ideas, like fiduciary responsibility?

Posted by MEH | September 8, 2007 3:40 PM

Not only do subprime borrowers not get much in the way of tax cuts, what with being fairly low income and all,

You'd better check on that. I'm not sure it's true. I'm a single middle class mother who managed to refinance out of a subprime in January, before my subprime converted from 2 year fixed to variable, which would have shot my monthly payment up by around $500.

I'm now in a so-called "alt A" loan which is barely tolerable; my payments are still high relative to my take home salary -- it's an unending grind to make ends meet, and I HATE seeing how much of what I earn goes to taxes. I don't believe for a second that our politicians, or the bureaucrats who implement their programs, manage the money I send them with integrity.

I probably should have just dumped this house after my ex and I split but I've been trying to maintain some stability for my kid -- I'm in an excellent school district -- and btw refinancing in my state (which I'd need to do AGAIN if I moved, unless I rented) eats up a huge chunk of whatever equity you've managed to accumulate. The trade-off is that there's a good chance I'll be alone & impoverished when I hit 65. Cripes, I WISH I was considered too poor to be taxed. Wouldn't that be nice.

I bet a lot of other subprimers are "working middle class" -- people who are paying income and property tax but, like me, got themselves into a situation where they were stretched too thin and woke up too late to the realization that subprimes are just more rope.

After all, you have to show SOME income to qualify even for a subprime. And you pay property tax if you own a home. So there you go.

Bottom line, I will vote for the presidential candidate who I believe will be most aggressive about cutting taxes. Period. I want more of the money I earn in my pocket, and I want other people to have more money so that the food and other things I need to buy are as cheap as possible.

Posted by K. | September 8, 2007 3:49 PM

Oh, one other thing. Each time I refinanced my house (once to get the subprime, once to get out of it) the single biggest closing cost was: a New York State mortgage tax. And it was THOUSANDS. NYS has made close to ten grand in under three years on my sh#tty little loans. So yeah, sub primers DO pay taxes.

Posted by K. | September 8, 2007 3:57 PM

Re: tax cuts.

Government revenue was falling when the recent tax cuts were instituted. As soon as the cuts went into effect government revenues started rising and have continued to rise.

We have a spending problem.

Giving the drunken sailors in Congress more $$$ will not fix the problem.

Posted by M. Simon | September 8, 2007 5:01 PM

Why would anyone listen to someone who is going to vote for a DHIMMIcRAT, and most likely Obama at that?

Posted by paul a'barge | September 8, 2007 5:14 PM

A recent news article on the "problem" led off by talking about a woman who was underwater and getting a big hike in her ARMS on her THREE houses. Am I supposed to feel sorry enough for her to want MY tax money to help bail her out? Gee,who's next? The losers at the tracks and casinos?

Posted by FJE | September 8, 2007 5:17 PM

"Enormous barriers to entry. Only ratings by a "nationally recognized statistical rating organization" (this is a specific term in the securities laws) are useful to public debt issuers, since only those ratings count for many registration, NASD, and bank regulatory purposes. There are only seven: the big three, Dominion and A.M. Best, and two Japanese companies. For the SEC to admit a credit rating agency as an NRSRO, the agency must show that it has a history of being nationally recognized. You can see the problem here."

Enormous barriers, but perhaps not insurmountable. The nation's public pension funds in particular have plenty of financial and political resources to bring to bear, and there would seem to be a window of opportunity politically with the fire S&P and Moody's are under.

A different solution has been mooted by John Mauldin in his post The Panic of 2007 (some helpful charts here, btw, explaining how triple-A rated CDO tranches were created out of sub-prime mortgage-backed securities):

"Second, the rating agencies need to restore their credibility. Warren Buffett's Berkshire Hathaway owns about 19% of Moody's. I would suggest that Mr. Buffett step in take over the company (much as he did with Salomon years ago) and put his not inconsiderable credibility on the line for all future ratings and the inevitable re-ratings that are going to be done.

The Panic of 1907 was solved by the credibility of one man, J. P. Morgan, who stepped in to provide liquidity. The Panic of 2007 is not a problem caused by lack of liquidity. It is a problem caused by lack of credibility. Morgan could (and did) provide liquidity. Buffett can (and should) provide credibility.

And someone of similar stature needs to step in at S&P and Fitch. (Can Volker be summoned into the trenches yet one more time?) This is not about whether some person or group at the ratings agencies necessarily did anything wrong, although more than a few lawyers will suggest just that. This is about restoring credibility to the ratings and markets as soon as possible. Without someone new at the head, future ratings are likely to be viewed with the skeptical (and correct) question, "Is this from the same group of people who rated that bond that I bought just a few months ago that is down 50%? Why are they right now? Where is the adult supervision? Who has made sure the process is now working?""

Posted by Fred | September 9, 2007 3:23 AM

With this: "It really isn't the Countrywide loan officer's job to consider the macroeconomic consequences of her company's loan products. That's the government's job."--type of attitude floating around, can it be any wonder how this event (loan/appraisal scandal/housing bubble) occured (?)

What ever happened to simple ideas, like fiduciary responsibility

It disappeared. Two years ago one of the places I contacted was Countrywide for a mortgage for my first place, referred by a co-worker. The girl tried to sell me interest only loans for amounts 50% more then what I really needed. She was also giving out massive amounts of cash to my co-worker who was buying up property left and right.

I went suntrust for a 80/20 mortgage and have been pretty happy with it (turned it into a rental since I got a job travelling alot and didn't need such a big place, and am paying it off like that on its own)

Posted by Nick M | September 9, 2007 8:59 AM

"Mortgage-backed securities turn out to be much riskier than people thought, which is causing both solvency and liquidity problems in the financial sector."

I hate to disagree with you on such a minor point but...

Not that there isn't problems with the financial sector, because obviously there are. I disagree about the risk level being misunderestimated. These mortgage folk have been making more money than you-know-Who for about a decade now. Suddenly there is a credit problem because so many dupes, err homeowners took more money out of their house than was there. A lot of people are finding out that they have a three hundred thousand dollar mortgage for a house that's only worth two hundred thousand. Who wouldn't want to bail on that deal the first chance they get? In effect, some inflation would be good for these upside down homeowners, wouldn't it?

So the fat bankers will cry oh woe is me to get whatever handout they can from the stupid government and then go about their business as usual.

The finance companies perfected this technique with the sub prime auto market. They don't care who is in a house they own, they only care what percentage of the houses have a monthly payment coming in. It's just a piece of paper in a portfolio to them. If it takes x number of payments to recoup the investment with a suitable profit then all they need is to get that many monthly payments. It doesn't matter from whom the payments come or if the same person takes more than one turn paying some of the payments.

Streamline and minimize the costs of getting in to and out of a house and just move the sub prime mob from house to house. Get repo'd on Friday and be in a new ride on Monday. It's very lucrative to sell one house five times. It's also very lucrative to get a late fee every month for a large portion of loans.

These guys know exactly what they are doing.

Posted by Incongruities | September 9, 2007 5:46 PM

"Bottom line, I will vote for the presidential candidate who I believe will be most aggressive about cutting taxes. Period. I want more of the money I earn in my pocket, and I want other people to have more money so that the food and other things I need to buy are as cheap as possible. " -K

Other people having more money drives prices up, not down. If you are of modest income and making large mortgage payments and have children, tax cuts or tax hikes will probably not affect you directly.

If you are having trouble paying bills, nobody who is going to cut taxes is going to cut your taxes.

Posted by Njorl | September 10, 2007 4:39 PM