Michael Kevane

A short note from the St. Louis Fed suggests that much of the decline is anticipated demographic change and inevitably reversal of the extremely high participation rates in the early 2000s (A Closer Look at the Decline in the Labor Force Participation Rate)

The BLS-projected change in the aggregate LFP rate between 2010 and 2020 can be broken into two components: (1) the change in the age composition of the population, and (2) the change in the LFP rates of different age groups. We found that the change in the age composition of the population accounted for most (2.18 out of 2.20 percentage points) of the decline in the aggregate LFP rate over the period. Specifically, this 2.18-percentage-point contribution to the LFP rate decline was mostly driven by a 3-percentage-point decrease in the population share of those 45-54 years old. In contrast to the 2.18-percentage-point decline in the LFP rate that resulted from changes in the age composition of the population, the change in the aggregate LFP rate due to the changes in the LFP rates of different age groups is almost zero on net. It is important to note that this value is the result of dissimilar dynamics of individual groups rather than consistent behavior of the population. For example, the largest contributions to the increase in the aggregate LFP rate are posted by those 55-64 years old (0.63 percentage points) and 65-74 years old (0.65 percentage points). Yet the increases in the LFP rates of these older workers are almost completely nullified by the decreases in the LFP rates of those 16-19 years old (–0.55 percentage points) and 20-24 years old (–0.44 percentage points).

Elisabeth Jacobs at the Washington Center for Equitable Growth, attributes some of the decline to the stalling and reversal of women’s labor force participation, due to the U.S. not reforming labor market institutions to make them more family-friendly.  (Her prepared testimony is an excellent introduction to the issues.)

Women’s labor force participation was driving the overall upward trend in labor force participation through 2000, so the plateau and then decline in women’s participation in the ensuring years is an important factor for explaining the national trend. Understanding why women’s labor force participation has stalled is key to reversing the downward trends in the national rate. In 1990, the United States had the sixth-­‐highest female labor force participation rate amongst 22 high-­‐income OECD countries. By 2010, its rank had fallen to 17th. Why have other high-­‐income countries continued their climb while the United States has stalled? Research by economists Francine Blau and Lawrence Kahn suggests that the absence of family-­‐friendly policies such as paid parental leave in the United States is responsible for nearly a third of the U.S. decline relative to other OECD economies. As other developed countries have enacted and expanded family-­‐friendly policies, the United States remains the lone developed nation with no paid parental leave.

Jacobs, and others, note how important this issue is.  People who participate in the labor force- who have jobs- pay taxes.  The tax revenue funds lots of incredibly valuable public goods and social services.  Fixes to increase labor force participation are thus often very cost-effective from a public finance point of view.  Too often we neglect this perspective.  To take an obvious example: the United States’ comparatively huge incarceration rate takes out of the labor force hundreds of thousands of potential taxpayers, and adds a large cost (supporting those same prisoners).  How inefficient is that, especially when we know that a large fraction of those incarcerated are no significant danger to the public (minor drug and traffic offenses)?

Moreover, the other group whose participation is declining consists of some of the most marginal and vulnerable (to incarceration and addiction) members of our society. According to the Council of Economic Advisers:

Participation rates by educational attainment, previously quite similar, have diverged since the 1960s. In 1964, 98 percent of prime-age men with a college degree or more participated in the workforce, compared to 97 percent of men with a high school degree or less. In 2015, the rate for college-educated men had fallen slightly to 94 percent while the rate for men with a high school degree or less had plummeted to 83 percent.

So let’s ask our Presidential candidates what they hope to accomplish to increase labor force participation, and decide whether to support them based on their answers.

What the hedge funds can do that individual small investors cannot is constantly harass and nip the heels of Puerto Rico, thus possibly securing higher payment eventually.  Bloomberg summarizes the major suits against Puerto Rico that deal with debt repayment:

1. Assured Guaranty Corp. vs. Puerto Rico and its Highways and Transportation Authority: The bond insurer sued late July 21 in a federal court in San Juan, seeking an emergency removal of Promesa’s stay and to stop Puerto Rico from taking toll revenue that repays the agency’s bonds and instead using those funds for other expenses. Assured guarantees repayment on approximately $1.2 billion of Highways debt, according to the compliant.

2. Hedge funds holding general-obligation and commonwealth-guaranteed bonds vs. Garcia Padilla: Aurelius Capital Management, Autonomy Capital, Covalent Partners, FCO Advisors, Monarch Alternative Capital and Stone Lion Capital Partners filed suit July 20 in a federal court in San Juan to stop Puerto Rico from transferring funds away from bondholders. The hedge funds say it violates the Promesa law since the federal legislation prohibits the island from enacting new laws diverting revenue or assets that would violate its constitution.

3. Hedge funds holding 2014 general-obligation bonds vs. Puerto Rico: Aurelius, Autonomy, FCO Advisors and Monarch sued the commonwealth on June 21 in Manhattan federal court, claiming the island cannot use its debt-moratorium law to suspend payments on the 2014 bonds. Puerto Rico’s constitution states that if commonwealth resources are insufficient to meet all of its desired spending, then public debt will be paid first, according to the complaint. Puerto Rico on July 19 filed a notice in the case, claiming the suit falls within Promesa’s stay provision. The court will address that notice. The 2014 general-obligation sale is the only commonwealth bond issuance where creditors can sue in a court off of the island.

4. National Public Finance Guarantee Corp. vs. Garcia Padilla: The bond insurer filed suit on June 15 in a federal court in San Juan, seeking to limit the island’s debt moratorium law. National claims federal bankruptcy law preempts the moratorium legislation. It also violates the U.S. Constitution because it takes the insurer’s property without just compensation and impairs contract rights, National says. The firm insures about $3.8 billion of debt issued by Puerto Rico and its agencies, according to the complaint. Puerto Rico claims Promesa’s stay halts National’s suit.

5. Ambac Assurance Corp. vs. Puerto Rico Highways and Transportation Authority: The bond insurer filed suit on May 10 in a federal court in San Juan, requesting an immediate receiver to manage the Highways agency and claiming that a contract with a third-party operator may divert $115 million away from the Highways authority, which could affect repayment of debt. Ambac guarantees repayment about $472 million of Highways debt, according to the complaint.

6. Hedge funds vs. Puerto Rico’s Government Development Bank: Affiliates of Brigade Capital Management, Claren Road Asset Management, Solus Alternative Asset Management and Fir Tree Partners, which hold Government Development Bank debt, sued the bank on April 4 in a federal court in San Juan. The firms want to stop the bank from directing funds to local agencies as the GDB restructures its debt. The hedge funds on May 20 amended their complaint, seeking to invalidate portions of the island’s debt moratorium law.

7. Bond insurers vs. Garcia Padilla: Assured and Ambac sued the governor on Jan. 7 in a federal court in San Juan to stop Puerto Rico from taking revenue originally used to pay certain agency bonds and using that money instead to cover general-obligation bonds, called a claw back. The insurance companies claim it violates the U.S. Constitution because the action deprives them of their property rights. Financial Guaranty Insurance Co. filed a similar suit on Jan. 19.

But after what seems an exhaustive review of a now voluminous record of transcripts, exhibits and other evidence from multiple official inquiries, Professor Ball concludes there is “no evidence” that the decision-makers “examined the adequacy of Lehman’s collateral, or that legal barriers deterred them from assisting the firm.” Rather, the decision to let Lehman fail reflected a mixture of politics — Mr. Paulson famously said he didn’t want to go down in history as “Mr. Bailout,” and the Bush administration had come under fierce criticism for rescuing Bear Stearns and the mortgage giants Fannie Mae and Freddie Mac — economic policy driven by managing “moral hazard,” and a misguided sense that investors had anticipated a Lehman failure and the consequences would be manageable.

Source: Pointing a Finger at the Fed in the Lehman Disaster – The New York Times

But James Hamilton last week provided a nicer, more intelligible, layman’s summary.

A helicopter drop of money is a permanent /irreversible increase in the nominal stock of fiat base money with a zero nominal interest rate, which respects the intertemporal budget constraint of the consolidated Central Bank and fiscal aut hority/Treasury – henceforth the State. An example would be a temporary fiscal stimulus (say a one – off transfer payment to households, as in Friedman’s example), funded permanently through an increase in the stock of base money. It could also be a permanen t increase in the stock of base money through an irreversible open market purchase by the Central Bank of non -monetary sovereign debt held by the public – that is, QE . The reason is that QE, viewed as an irreversible or permanent purchase of non- monetary f inancial assets by the Central Bank funded through an irreversible or permanent increase in the stock of base money, relaxes the intertemporal budget constraint of the State.

Source: E-Journal Article – helifinal.pdf

A nice empirical application exercise of augmenting the interest parity approach to try to determine what is driving changes in expected exchange rates that then affect the current spot rate.  Here, the authors emphasize sovereign risk, that is, risk that some euro governments might default and that the euro as a currency might not survive.

We identify the drivers of the movements in the euro-dollar exchange rate during the sovereign debt crisis. In particular, we show that the announcement of outright monetary transactions (OMT) by the Governing Council of the ECB during the summer of 2012 played a major role in the euro’s subsequent appreciation. OMT and the reform efforts undertaken by governments at national and European level saw off the risk of a euro-area break up and prompted net capital inflows. We estimate two models. The first is a reduced form high-frequency model, in which the exchange rate is explained by the differentials between interest rates in euros and dollars at both short- and long-term horizons, the sovereign spread in euro-area countries and an index of volatility. The second is a vector autoregressive (VAR) model including GDP growth differentials, short-term nominal interest rate differentials and inflation differentials between the euro area and the U.S., an average of the sovereign spreads of selected euro-area countries, the bilateral trade balance and the euro-dollar nominal exchange rate. Both approaches suggest that the evolution of the sovereign spread supported the value of the euro following the announcement of OMT in the summer of 2012.

Source: Determinants of the Movements in the Euro-Dollar Exchange Rate During the Sovereign Debt Crisis by Alessio Anzuini, Martina Cecioni, Stefano Neri :: SSRN

http://www.bloomberg.com/api/embed/iframe?id=V83mJsOrSAGnLadl5AMRKA

There is a very nice intro at The Third Way on securitization (in the context of The Big Short).  A nice thing they do is link to the SEC filing for a CDO offered by Long Beach Mortgage (that was mentioned in The Big Short).  The filing is more than 200 pages of detail about the bundle of mortgages.  You quickly see why you need Moody’s or some other service to evaluate.  Probably someone has to rewrite the whole “Structured Finance Workstation” using R.

New York, April 30, 2010 — Moody’s Investors Service has downgraded the ratings of 55 tranches from 19 RMBS transactions issued by Long Beach. The collateral backing these deal primarily consists of first-lien subprime residential mortgages. The actions are a result of the continued performance deterioration in Subprime pools in conjunction with home price and unemployment conditions that remain under duress. The actions reflect Moody’s updated loss expectations on subprime pools issued from 2005 to 2007. For details regarding Moody’s approach to estimating losses on subprime pools originated in 2005, 2006, and 2007, please refer to the methodology publication “Subprime RMBS Loss Projection Update: February 2010” available on Moodys.com. To assess the rating implications of the updated loss levels on subprime RMBS, each individual pool was run through a variety of scenarios in the Structured Finance Workstation® (SFW), the cash flow model developed by Moody’s Wall Street Analytics. This individual pool level analysis incorporates performance variances across the different pools and the structural features of the transaction including priorities of payment distribution among the different tranches, average life of the tranches, current balances of the tranches and future cash flows under expected and stressed scenarios. The scenarios include ninety-six different combinations comprising of six loss levels, four loss timing curves and four prepayment curves. The volatility in losses experienced by a tranche due to small increments in losses on the underlying mortgage pool is taken into consideration when assigning ratings. The above mentioned approach “Subprime RMBS Loss Projection Update: February 2010” is adjusted slightly when estimating losses on pools left with a small number of loans. To project losses on pools with fewer than 100 loans, Moody’s first estimates a “baseline” average rate of new delinquencies for the pool (typically 20% for subprime pools). Once the baseline rate is set, further adjustments are made based on 1) the number of loans remaining in the pool and 2) the level of current delinquencies in the pool. The fewer the number of loans remaining in the pool, the higher the volatility and hence the stress applied. Once the loan count in a pool falls below 75, the rate of delinquency is increased by 1% for every loan less than 75. For example, for a pool with 74 loans from the 2005 vintage, the adjusted rate of new delinquency would be 20.20%. If current delinquency levels in a small pool is low, future delinquencies are expected to reflect this trend. To account for that, the rate calculated above is multiplied by a factor ranging from 0.2 to 2.0 for current delinquencies ranging from less than 2.5% to greater than 50% respectively. Delinquencies for subsequent years and ultimate expected losses are projected using the approach described in the methodology publication.

Source: Moody’s downgrades $5.6 Billion of Subprime RMBS issued by Long Beach

As she thinks back on it, Bair views her disagreements with her fellow regulators as a kind of high-stakes philosophical debate about the role of bondholders. Her perspective is that bondholders should take losses when an institution fails. When the F.D.I.C. shuts down a failing bank, the unsecured bondholders always absorb some of the losses. That is the essence of market discipline: if shareholders and bondholders know they are on the hook, they are far more likely to keep a close watch on management’s risk-taking. During the crisis, however, Treasury and the Fed were adamant about protecting debt holders, fearing that if they had to absorb losses, the markets would be destabilized and a bad situation would get even worse. “What was it James Carville used to say?” Bair said. “ ‘When I die I want to come back as the bond market.’

Source: Sheila Bair’s Exit Interview – The New York Times

Quite different from Alan Blinder’s portrayal of Bair.

As an observer of the financial crisis and its aftermath, I have frankly admired most of what she tried to do. She was tough-minded and straightforward. On financial matters, she seemed to have better political instincts than Obama’s Treasury Department, which of course is now headed by Geithner. She favored “market discipline” — meaning shareholders and debt holders would take losses ahead of depositors and taxpayers — over bailouts, which she abhorred. She didn’t spend a lot of time fretting over bank profitability; if banks had to become less profitable, postcrisis, in order to reduce the threat they posed to the system, so be it. (“Our job is to protect bank customers, not banks,” she told me.) And she was a fierce, and often lonely, proponent of widespread mortgage modification, for reasons both compassionate (to help struggling homeowners stay in their homes) and economic (fewer foreclosures would help the troubled housing market recover more quickly).

Source: Sheila Bair’s Exit Interview – The New York Times