Paradox: Why Do Analysts Say Higher Interest Rates are Driving Bank Stocks Higher, When Earlier They Said Low Rates Were Good for Banks?

As the stock market soars to one record high after another, analysts do not hesitate to tell us why. One popular explanation is that expectations of higher interest rates are pushing up the stocks of banks and other financial companies  (example). Yet not so long ago, the same analysts were telling us that Wall Street in general and banks in particular were getting rich on the “free money” that the Fed was supplying to them at historically low rates (examples here and here). What gives?

To understand how interest rates affect bank profits, we turn to a wonky concept of financial economics known as the duration gap. Setting the precise mathematics to one side (read this if you really care), the duration gap refers to the difference between the maturity of a bank’s assets and its liabilities. If a bank funds itself with from short-term sources like deposits and uses those funds to make fixed rate mortgage loans or buy long-term bonds, then it has a positive duration gap. Interest rates tend to be higher on long-term financial instruments than on those with short maturities, so is the way banks traditionally made a profit.

The downside of the traditional banking model is that a positive duration gap means that profits fall when interest rates rise.  Suppose, for example, that your bank makes 30-year fixed-rate mortgages and funds them with deposits that pay an interest equal to the federal funds rate (the rate on overnight loans that the Fed uses at its primary interest rate target). If the loans earn 4 percent and the fed funds rate is 0.5 percent, you have a nice spread of 3.5 percent  between return on assets and cost of funds, allowing a good profit even after deducting  operating expenses.  However, if short-term rates went up, your bank would be in trouble. If the fed funds rate went up to 2 percent while your old fixed-rate mortgages still brought in just 4 percent your spread would be cut to 1.5 percent and your profits, after operating expenses, might evaporate altogether.

Falling Government Investment Casts Doubt on Pie-in-the-Sky Growth Estimates

•  The budget proposals being prepared by the Office of Management and Budget incorporate revenue estimates based on GDP growth rates of 3 percent or more.
• The proposals include across-the-board decreases in nondefense discretionary spending
• Such cuts will make it difficult to reverse the long decline in government investment, casting doubt on the likelihood of achieving ambitious growth estimates.

Government investment at all levels accounts for only about 15 percent of gross fixed investment in the United States, but its economic significance is greater than that modest share suggests. Government investment affects investors in private industry in several ways through its impacts on growth of the economy as a whole, on suppliers of construction services and materials for government investment projects, and on users of government infrastructure. Negative trends in government investment raise concerns for all of these reasons.

Three charts reveal the extent of these negative trends. The first chart takes a long-term look at gross investment in fixed assets at all levels of government. It shows that total government investment has fallen by about half since the 1960s. Investment at the federal level and at the state and local levels contribute roughly equal shares of the total, but the federal share has fallen more rapidly. Federal gross investment in fixed assets as a share of GDP in 2015 was just a third of its 1961 peak value. >>>

Follow this link to read the full post and view the charts on SeekingAlpha.com

 

Questions Republican Healthcare Reformers Must Answer

Republicans do not yet have a full replacement for the Affordable Care Act (ACA or “Obamacare”), but the outlines of one are emerging. The Policy Brief on Repeal and Replace issued by House Republicans on February 16 points the way toward a three-tier system. It promises to provide  “coverage protections and peace of mind for all Americans—regardless of age, income, medical conditions, or circumstances,” while ensuring “more choices, lower costs, and greater control over your health care.”

Those are lofty aspirations, but reformers will have to address many difficult questions before they can be met. To find realistic answers, they will have to overcome divisions within the party, ideological constraints, outside pressures, and some hard realities of healthcare economics.

Conceptual framework

The new policy brief, and similar plans put forward by Rand Paul, Mark Sanford, Paul Ryan, and others, include many common elements. Together, they point to a three-tier system that, in broad outline, would look like this:

Central tier, for individuals and households with incomes well above the poverty line in which no member suffers from a serious chronic health condition. Such people account for roughly 70 percent of the population and roughly 25 percent of personal healthcare spending. Members of this tier would be served by conventional commercial health insurance. The cost of premiums would be covered by a combination of individual payments, advanceable healthcare tax credits (HCTCs), and employer contributions. Premiums and HCTCs could rise with age, but insurers would not be allowed to charge differential premiums based on pre-existing conditions or to refuse coverage. High-deductible policies would be encouraged by using health savings accounts (HSAs) for covering out-of-pocket costs.

Multiple Job Holders Represent a Still-Untapped Labor Reserve

The Office of Management and Budget is due to release tax and spending plans for the 2018 fiscal year soon. As reported recently by the Wall Street Journal, the plans are expected to be based on relatively optimistic growth forecasts of 3 to 3.5 percent per year, well above consensus estimates. The debate over the realism of the budget plan will turn, to a significant degree, on whether there are a sufficient reserves of untapped labor to support higher growth rates.

Although the headline unemployment rate is approaching levels that the Fed and many other observers equate with "full employment," other indicators, not so well known, suggest that there are still significant untapped labor reserves. This post looks at one such neglected indicator, multiple job holders. (In a post earlier this month, I looked at another neglected indicator, nonemployment index, which also suggests the existence of hidden labor reserves.) >>> 

Follow this link to read the full post at SeekingAlpha.com

Repeal Fuel Economy Standards and Replace Them with a Tax

The Wall Street Journal reports that automakers are asking the EPA to repeal automobile fuel economy standards, known as Corporate Average Fleet Economy (CAFE) standards, which are set to rise to 56 miles per gallon by 2025. Repealing the standards would be a good idea, provided they were replaced by tax designed to achieve an equivalent saving in fuel. A carbon tax would do the job nicely, but an increase in the existing tax on motor fuels would also work.

What, exactly, is wrong with the CAFE standards? The fundamental problem is that they attack the third-party effects, or negative externalities, of motor fuel use, such as pollution, highway congestion, and accidents, only partially and indirectly. As a result, the cost of achieving a given reduction in fuel use via CAFE standards is higher than it would be if the same result were achieved more directly through a carbon tax or an increase in the federal gasoline tax.

What Happened to the OMB Data? Mystery Solved (Partially)

Yesterday I wanted to retrieve some data from the OMB archives, so I went to the usual spot, https://www.whitehouse.gov/omb. There was almost nothing there. All I found were links to “budgetary analysis” of the new administration’s executive orders. The “analysis” pages themselves contain nothing but short paragraphs signed by Acting Budget Director Mark Sandy, which say that the executive orders will not have any significant budgetary impacts. 

I had read of the efforts of paranoid climate scientists to download data from NASA, NOAA, and other sites, fearing that the Trump administration would scrub them all clean, so I got a little paranoid myself. Could it be that the new gang doesn’t want us to have any background data that might be used to put their budget efforts in a bad light?

It turns out that the situation is a little less sinister than it first looked. Turns out that the Obama administration had a “digital transition plan” that archived all the old data. The OMB archives are here, for example. There are no permalinks, though. Any old links you have saved to Obama-era materials take you to a broken link page on the Trump White House site that has a link to the Obama digital transition page. Down at the bottom of that page there is a long list of agency archives, including the one for the OMB. Eventually you can find what you are looking for.

On Thursday, the Senate finally got around to confirming Mick Mulvaney as the new budget director. We can hope he will assign someone to get to work on the amateurish OMB web page that is still there as of today. We can hope that Mulvaney’s people will give us links to the Obama archives. When a new, professional-looking, user-friendly, OMB website appears, we will know that the chaos has settled down in at least one branch of the Trump White House.

Crop Insurance Targeted By Budget Cutters As Deficit Debate Looms

Congress will soon start debating the federal budget for the 2018 fiscal year. As the following figure shows, the Congressional Budget Office projects that after shrinking for several years, the budget gap will soon begin to widen if there are no changes in current policy. Crop insurance is one of several farm programs in the crosshairs of Congressional budget hawks who hope to keep that from happening.

Crop insurance may seem like small change compared to massive programs like health insurance subsidies under the Affordable Care Act, but critics have long targeted it as wasteful. The Heritage Foundation, a consistent ally of budget cutters, characterizes crop insurance, along with other farm subsidy programs, as “a massive transfer of wealth from taxpayers to mostly large agribusinesses that are (or should be) fully capable of managing their business operations without this special treatment.”