John Q

Now that Lehman Bros and Merrill Lynch are gone, attention is turning to insurance company AIG. When the first big failure, that of Bear Stearns was coming up, the initial offer of $2 a share suggested that the company was worth less than the building it operated it (the deal was subsequently sweetened, courtesy of the US taxpayer[1]). Looking at AIG, this WSJ story says that, as of last quarter, assets exceeded liabilities by $78 billion, a number that has almost certainly declined since then, given that the $1 trillion asset book includes lots of toxic sludge. But the story also notes that the company’s aircraft leasing subsidiary (where did they get this?) owns planes worth more than $50 billion. So, it looks clear that, apart from the planes, AIG is worth little, nothing or (most likely) a large negative value.

Update Commenters object, correctly, that it isn’t legit to value the planes without taking account of the associated debt. However, after today’s debacles, it doesn’t matter too much. AIG is toast, the only question being whether the Fed will treat it as another Bear or another Lehman. Next cabs off the rank appear to be Washington Mutual and Wachovia, taking the FDIC with them. I even saw GE mentioned somewhere, but it seems too soon for that.

[1] Despite the tough talk and the refusal to bail out Lehman, the Fed has given yet further ground to the banks this time around, agreeing to lend public money against subprime trash.

In the comments to my last post, reader Peter Schaeffer provides exactly what I asked for: a breakdown of the discrepancy between 30 per cent growth in US household income over the last 40 years and 117 per cent growth in income per person. In addition to the factors I’d mentioned (falling household size and growing inequality) Schaeffer notes two more: the fact that GDP has grown faster than national income and the fact that prices faced by households (the CPI-U-RS) have risen faster than the GDP deflator. He provides the details to show that this fully explains the discrepancy.

What should we make of this. As far as the situation of the average American is concerned, the only correction we need to make to the household income figures is to correct for changes in household size. That makes the increase over the last 40 years about 63 per cent, or an annual growth rate of 1.2 per cent. By contrast, the 117 per cent growth in GDP per person implies a rate of just under 2.0 per cent. So, changes in GDP per person (let alone changes in total GDP) are essentially irrelevant as a guide to how the average household is doing.

And of course, the poor have done much worse. Household incomes for the bottom quintile have barely moved for decades. Growth in consumption has been driven largely by increasing access to debt, a process that now looks to have run out of road. That would seem to indicate a looming social crisis. But the coming election will still turn on whether Obama called Palin a pig.

I was at a seminar the other week on inequality in US household income, and I asked the speaker about something that’s puzzled me for a while. I didn’t really get an answer, so rather than do a lot of work myself, I thought I’d try this crowdsourcing all the cool kids are talking about. Here’s the puzzle.

Over the past 40 years or so, real median US household income has risen by about 30 per cent.

US Household income 1965-2005

but real US GDP per person has more than doubled. How can this be ?

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Measured by the dollar amount involved, the nationalisation of the mortgage guarantors Fannie Mae and Freddie Mac, announced today by the Bush Administration, is the largest in history. No less than $5 trillion of assets and obligations have been taken over by the US government in one hit.

Of course, that debt had long been regarded as having an implicit government guarantee and the companies involved were quangos (in the original sense of quasi-NGOs) rather than genuine private firms. Fannie was a government agency privatised in the 1960s, and Freddie was created to provide competiion for Fannie. So even though the US government will now guarantee virtually all new mortgages, this is more an admission of existing reality than a big step towards socialism.

The significance of the event is not in the marginal change in the status of Fannie and Freddie from quasi-private to quasi-public, but in the abandonment of the pretence that the normal operations of financial markets are capable of cleaning up the mess they have created, even with the liberal helpings of public money that have already been dished out.

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Until now, the blogospheric fuss over former TNR diarist Scott Beauchamp has been notable only for the amount of attention paid to disputing utterly trivial anecdotes. But the Beauchamp saga has suddenly and surprisingly collided with the reality of war in Iraq, as Moon of Alabama explains.

Things have gone better than expected (certainly better than I expected) in Iraq over the past year[1]. On the other hand, things are going very badly in Afghanistan. For those, like me (and most at CT I think), who have supported the war in Afghanistan and opposed the war in Iraq, this raises some points to consider.

Most obviously, war is inherently unpredictable and dangerous, and there is no necessary correlation between the justness of a cause and its military success. That means, among other things, that launching a war (or revolution) on the basis of a cause that seems justified to those starting it, but which has little or no hope of success (indeed without strong grounds for expecting a good outcome after the inevitable loss of life on all sides is taken into account), is not glorious but criminally reckless.

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David Weisbach and Cass Sunstein (h/t Nicholas Gruen) have written a piece for the AEI Center for Regulatory and Market Studies[1] weighing into the debate about climate change and discounting, promising “A Guide for the Perplexed”. But their treatment of the topic is only like to add to the perplexity of anyone interested in resolving the issues.

Shorter Weisbach-Sunstein: If ethical considerations suggest that the most appropriate discount rate is 1.4 per cent, but the market rate of return is 5.5 per cent, it’s best to use the 5.5 per cent rate in evaluating climate change policies.

As a hypothetical statement this is broadly correct. Weisbach and Sunstein illustrate the point by considering someone choosing between an investment yielding a 10 per cent increase in value over 2 years and the alternative of putting money in the bank at 6 per cent, which is clearly superior.

The problems arise for the reader who tries to plug in real numbers. According to today’s New York Times the rate of interest on 10-year Treasury bonds is 3.84 per cent. Assuming (optimistically) that the Fed manages to hold inflation at 2.5 per cent over the next years, that’s a real rate of 1.34 per cent, almost exactly equal the rate quoted as justified on ethical grounds.

So to restate Weisbach and Sunstein with real numbers:If ethical considerations suggest that the most appropriate discount rate is 1.4 per cent, but the market rate of return is 1.3 per cent, it doesn’t matter which one you choose.

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The Wall Street Journal has a fascinating article about how corporations like Intel are loading up their general pension funds with obligations to pay massive “supplemental” benefits to senior executives. It’s partly a tax dodge, and partly an example of what Jacob Hacker has called the great risk shift. The extra liabilities increase the risk that the fund will fail, but the top brass can be protected against this eventuality with a trust fund, while the rank and file get to take their chances.

Update To clarify, in response to comments, the pension entitlements of ordinary workers are supposed to be protected by the government through Pension Benefit Guaranty Corporation, and to the extent that this works as expected, risk is shifted to the PBGC rather than to workers. But as both the WSJ story and the discussion below make clear, things don’t always work as planned. Some benefits paid to ordinary workers turn out to be classed as supplemental and therefore lost when the scheme fails.

Although the conversation here takes place under the banner of ‘creative capitalism’ there has been relatively little discussion of creativity in the ordinary sense of the term. Yet the relationship between creativity and capitalism has rarely been more complex and interesting than it is today.

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I’m planning a further post about the notion of ‘creative capitalism’, but before I get on to it, I thought it might be useful to clear up some of the confusion surrounding the alternative view, that managers have a ‘fiduciary obligation’ to act solely in the interests of shareholders, reflected in debate at my blog, at CT here (including this and here) and at the Creative Capitalism blog.

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Lovemore Matombo and Wellington Chibebe, the President and General Secretary of the Zimbabwe Congress of Trade Unions (ZCTU) are facing trial on 30 July on charges trumped up by the Mugabe regime. You can help the struggle to free them by making a statement at We are ZCTU and joining a letter writing campaign.

Check out the photomosaic of these two brave men, made up of 2000 individual photos.

The creative capitalism blog has been set up to examine the idea that corporations could do a job of promoting social goals like improving health in poor countries (that is, better than they do now and better, in at least some ways, than governments or NGOs). Richard Posner objects to this on the ground that corporate managers have a fiduciary obligation to maximise profits. I don’t find this convincing (reposted over the fold).

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After reading this piece on self-plagiarism in the Times Higher Ed Supplement, I couldn’t think of any better response than to reprint verbatim this piece from 2005 (now with a new improved 2008 publication date), including a self-link to a piece which is simultaneously self-referential and self-plagiarising.

It’s over the fold:

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Nationalization, that is. In this piece on doomsday scenarios for Fannie Mae and Freddie Mac (H/T Calculated Risk) the cutely named and quasi-private mortgage packagers and guarantors, Katie Benner says

So what might it look like if the government had to lend a hand? Outright nationalization is an unlikely option given that neither the current administration nor the presidential candidates could afford to support such a move in an election year.

but goes on to imply that the likely alternatives could be far more costly, citing a Standard & Poors estimate of a trillion dollar cost to taxpayers, and possible loss of the US government’s AAA rating. Agency ratings aren’ t reliable indicators, but the US government has been in the category of issuers who are assumed to be exempt from scrutiny. A change in this status would be a huge problem for a big debtor like the US.

Either a bailout or a nationalization of Fannie and Freddie would make the Northern Rock fiasco in the UK pale into insignificance. The Northern Rock case shows that a policy towards financial enterprises in which both failure and nationalization are regarded as unthinkable cannot be sustained. The shareholders of these companies have been happy to accept the higher returns associated with an implicit government guarantee and they should pay the price when the guarantee is needed.