Archive for September, 2009

America’s Trade Row with China: Weird Scenes Inside the Goldmine?

Wednesday, September 30th, 2009

A recent article in The Economist discusses President Barack Obama’s decision to impose a tariff on tires imported from China. Smeal’s Brian Davis weighs in on the issue by asking important questions about the repercussions of these actions.

The recent decision by the Obama administration to impose tariffs on imported Chinese tires– at first glance, (even second glance) seems “weird” from a rational economic perspective. Why would policymakers want to slaughter the golden goose of free-trade, especially when the domestic economy is still fragile following the events of the housing and banking crisis? Has Obama not learned the lessons of Smoot-Hawley?

Interpretation of the cause and effect of this action is probably more complex than a first-reaction rationale. On one hand, the tire tariff has relatively little effect on American consumers or workers. This is NOT Smoot-Hawley. Domestic producers have mostly abandoned the low-end tire market, with plenty of substitutes for Chinese tires provided by imports from Brazil and Indonesia. The larger question is whether or not this will spark a larger tit-for-tat trade war with China. An all-out trade war would have severe consequences for American exporters relying on access to the growing Chinese market for recovery. Will more special interest groups demand similar concessions?

The article highlights a worrisome trend, that import restrictions and other protectionist actions against China, by developed economies, have nearly doubled since 2007. Is the risk of sparking a trade war worth the chance that China will dismantle many of its trade barriers as a response to U.S. action?

One last perspective on these events is that the Obama administration has used the tariff issue as a bargaining chip to pressure China’s cooperation concerning Iranian nuclear ambitions. However, history has not been kind when countries attempt to use economic sanctions and other barriers to motivate political concessions. For now it’s a matter of wait, see and of course hope.

Tags: China, Davis, Finance, Trade
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Pennsylvania and the G-20

Thursday, September 24th, 2009

With 20 world leaders meeting today and tomorrow for the G-20 summit in Pittsburgh to discuss the health of the world economy, Smeal’s Terrence Guay has penned an article outlining the importance of this meeting for Pennsylvania’s economy. Here’s an excerpt from the article, which appeared in the Patriot-News on Monday, and the Morning Call and Centre Daily Times today:

Why does all of this matter to Pennsylvanians?

The main reason is because the commonwealth’s economy is intertwined in the global economic web. With almost $35 billion in merchandise exports, Pennsylvania sent more goods abroad than all but 10 states in 2008. And it is not just multinational companies that are doing the exporting.

Of the 12,295 companies that exported goods from Pennsylvania in 2007, 10,900 (89 percent) were small and medium-size firms with fewer than 500 employees. Additionally, foreign-controlled companies employed 249,000 workers in Pennsylvania in 2006, the fourth-highest total among the U.S. states, with almost one-third of these jobs in the manufacturing sector.

This means as the global economy goes, so goes Pennsylvania’s economy. The statewide unemployment rate was 8.5 percent in July—the highest in 17 years.

Residents are concerned about the security of their jobs, stability of household incomes and the future well-being of their families. The sooner the global economy recovers, the sooner Pennsylvania’s economy will recover.

Improvement in the health of the global economy will result in more goods and services exported from Pennsylvania to the rest of the world, more investment in the commonwealth by foreign companies, a more stable tax base and more good-paying jobs.

You can hear more on the G-20 summit from Guay and Smeal’s Fariborz Ghadar here.

Tags: Economic Crisis, Economy, Globalization, Guay
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Feel-Good Regulations

Friday, September 18th, 2009

Speaking on Wall Street this week, President Obama renewed his call for a Consumer Financial Protection Agency to “make certain that consumers get information that is clear and concise, and to prevent the worst kinds of abuses” by financial institutions. Smeal’s Edward Ketz, in a forthcoming column, says this proposed new regulatory agency amounts to little more than politics:

What Obama is really trying to do is give American voters the impression that he is in charge, that he cares about them, and that he is improving matters so that the chances of another financial meltdown is infinitesimal.  It is political legerdemain.

As long as managers have perverse incentives to cheat investors and as long as the SEC goes after only the little  guys and ignores managers at Enron, WorldCom, Madoff Investments Securities, and GE, nothing is going to change.  If the Congress and if the president want to improve matters—and I have no idea if they really do—then they must change the set of incentives and disincentives.  To effect real change, the system must punish managers and directors who lie and steal and cover it up with scandalous financial reporting.

More regulation might make society feel better, but that is just an indication that most Americans have little understanding of economics.  They will continue to lose in the stock markets until they insist elected officials do something substantive.

My fear is that Democrats will rally around Obama while Republicans vilify him, similar to the previous administration when Republicans rallied around Bush and Democrats denigrated him.  There is too much partisanship in this country and not enough rational analysis.  Americans need to understand that both presidents have failed us by supporting new legislation and by crippling better enforcement.  (For whatever it is worth, this is one of the reasons I am an Independent.)

Tags: Banking, Economic Crisis, Finance, Ketz, Politics
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The Trouble with Markets and Health Care

Wednesday, September 16th, 2009

In the cover story of September’s The Atlantic, David Goldhill, president and CEO of The Game Show Network, offers the story of his father’s death as a cautionary tale about what Goldhill believes is ailing the U.S. health care system. Smeal’s Dan Cahoy responds to the article on his personal blog, Incentivize!:

[Goldhill's article is] a discussion of the wildly misaligned incentives in the U.S. health care system.  Essentially, the article asserts that a lack of transparency in costs and reimbursement have allowed costs to skyrocket while providing generally poor care. 

… On the topic of health care markets, the underlying conclusion of the article is that many health care costs (at the very least, routine costs) should be paid directly by consumers who can exercise choice and encourage competition.  According the the author, this would solve existing incentive misalignment through a traditional market approach.  The market for LASIK surgery, which is generally not reimbursed by insurance, is used as an example, where costs have significantly decreased since the procedure was introduced.

Total consumer control may not be as attractive as it sounds, as basic health care is not like other markets.  The most important difference is that in many cases we do not want people to choose to forgo treatment, and this may happen if they had to completely internalize the costs.  LASIK is clearly an optional procedure, and people who could benefit from it (like me) lead perfectly happy and healthy lives without it (like me). But prenatal care, hypertension treatments, cancer screening and the like can be demonstrated to positively impact the quality of life and should not be promoted as optional.  Many consumers may not be sophisticated enough to make decisions on heath care spending in every case (like me). In truth, we want a system that encourages people to attain some preventative care and treatments that they might not pay for themselves.  A pure market approach in this context may lead to some undesirable outcomes.

Tags: Cahoy, Health Care, Politics
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Investing in Weather

Tuesday, September 15th, 2009

An article on CNN.com yesterday explained how traders might be able to make money betting on the weather:

You can actually make money speculating that the temperature in Sacramento, California, will be warmer than it normally is. If that’s too dull for your portfolio, you can put money down on the inches of snowfall next winter in Boston, Massachusetts, or the strength of hurricanes in the Gulf of Mexico. These kinds of investments, called weather futures, are trading through the Chicago Mercantile Exchange right now.

… The most basic type of weather-futures contracts allow traders to speculate on changes in the temperature. And in many cases, companies use them like insurance policies. When speculating on temperature, a buyer would pay a premium for the option to wager on future temperatures. If the temperature hits a specified level, then the buyer gets to collect the amount agreed upon by the seller. If it doesn’t, the seller keeps the premium and the contract expires.

How accurate are these weather futures markets? Researchers in Smeal’s Laboratory for Economics Management and Auctions set up some weather markets of their own, and found that the market forecasts were at least as accurate as the major public forecasting services that served as benchmarks for the research: AccuWeather, the BBC, CNN, and the National Weather Service. On average, the temperatures predicted by the Smeal weather markets have been off by only about 6.6 percent.

For more on the weather markets research, click here.

Tags: Economics, Finance, G. Bolton, Kwasnica
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Breaking Up Fannie and Freddie

Thursday, September 10th, 2009

The Mortgage Bankers Association last week called for “Congress to transform Fannie Mae and Freddie Mac into several smaller privately held companies that would issue mortgage securities carrying an explicit government guarantee,” The Wall Street Journal reports.

Smeal’s Brent Ambrose, director of the Institute for Real Estate Studies, explains a few of the pros and cons of the industry group’s plan and details some of the issues currently surrounding Fannie and Freddie:

What do we do with Fannie Mae and Freddie Mac? These Government Sponsored Enterprises (GSEs) were created by Congress to provide liquidity and stability to the U.S. mortgage markets. They carry out this mission by purchasing mortgages from originators and then repackaging them into mortgage-backed securities (MBS) or holding them in their retained portfolios. In 2008, Fannie and Freddie purchased 80 percent of all mortgages originated in the United States and the value of their combined mortgage assets was $1.5 trillion (as of June 30, 2008). They were placed into conservatorship by the Federal Housing Finance Agency (FHFA) on September 7, 2008, as a result of the rapid decline in their capital base during the economic turmoil of last summer. As the housing and capital markets weakened last summer, the value of their assets (i.e. their mortgage holdings) declined significantly while the value of their debt issued to purchase these assets remained fixed. Effectively, Fannie and Freddie were insolvent. Unfortunately, as GSEs, the close relation between them and the federal government created the impression among investors that the debt securities issued by Fannie and Freddie were guaranteed by the federal government. Since being placed into conservatorship, the government converted this “implicit” guarantee into an explicit guarantee and Fannie and Freddie have continued to purchase and securitize mortgages. Their actions are a critical link in the Obama administration’s efforts to support the housing market. However, the future of Fannie and Freddie remains uncertain.

(more…)

Tags: Ambrose, Economic Crisis, Politics, Real Estate
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Over Stuffed

Wednesday, September 9th, 2009

Smeal’s Lisa Bolton explains why consumers often hold on to stuff that they no longer need or even want:

A lot of marketing research concerns itself with the acquisition of goods but what about their disposition? A recent New York Times Magazine article takes readers on a visit to self storage facilities—and did you know that there are seven times more storage facilities than Starbucks coffee shops in America?! It turns out that we are squirreling away all kinds of things, not just in our basements and attics and garages, but in storage units that charge a monthly fee for the privilege. In addition to wondering why people are accumulating so much stuff, all of this storage begs the question:  Why don’t people just get rid of it?

There are a lot of reasons—from sentimental attachment to the efforts involved in disposal itself—but I’ll just focus on two here. First, consumers may be falling prey to the “sunk cost fallacy.” Having invested money in buying something, people continue to (irrationally) focus on these sunk costs rather than focusing on the future costs and benefits. Firms and governments do this too when they continue to invest in new products and projects that are failing and don’t make economic sense—Concorde anyone?

Second, consumers may hang on to all this stuff in order to avoid waste. I don’t mean wasted money (which is a lot like sunk costs) or environmental waste (although that may also be a concern), but instead I am referring to waste arising from “unused utility.” We may have gotten all the use that we want from an item, but, if the item still has additional leftover utility, we will be reluctant to get rid of it. As a result, our storage units start filling up with VCRs and furniture and other items that still have plenty of use left in them—even though we no longer want or need them. Waste not, want not!

Which reminds me: Does anyone need a gently used VCR or high chair? Both have plenty of use left in them! 

P.S. Aside from storage facilities, there are lots of other ways to dispose of your stuff—from Goodwill to Freecycle to our very own Trash to Treasure annual sale here at Penn State. So if you can’t use the stuff yourself, maybe someone else can!

Tags: Consumer Spending, L. Bolton, Marketing
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The Kraft-Cadbury Waltz

Tuesday, September 8th, 2009

Kraft Foods is continuing to pursue its takeover bid for Cadbury despite the fact that Cadbury rejected Kraft’s first bid of $16.7 billion, or about 31 percent more than Cadbury’s Friday per-share closing price. Smeal’s Fariborz Ghadar says this back and forth is all strategy, and he expects the deal to ultimately succeed:

Cadbury’s rejection of Kraft’s initial bid doesn’t mean the deal will not eventually go through. As many analysts are suggesting, both companies are now weighing their options. Kraft is likely considering placing a higher bid, while Cadbury directors are deciding whether to stay independent, seek a higher price, or entertain other potential suitors like Hershey’s or Nestle.

Whatever the final outcome, the deal is going down so far like a well-choreographed dance: Kraft privately bids on Cadbury. The Cadbury board, looking out for its own best interests, rejects the offer. In return, Kraft takes the already-rejected bid public, ratcheting up the pressure on Cadbury’s directors, who reject the offer again. The next step is likely to be a higher price negotiated by the Cadbury board, making everyone look good.

Regardless, such activity is yet another positive sign for our economy. Conditions are improving and we can expect to see more deals like this one and the Disney-Marvel deal as the economy continues its rebound.

Tags: Ghadar, Globalization, M&A
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Audit the Fed?

Tuesday, September 1st, 2009

Rep. Ron Paul told The Wall Street Journal that Rep. Barney Frank, chairman of the House Financial Services Committee, backs Paul’s legislation that would give Congress new authority to audit the monetary policy operations of the Federal Reserve.

Smeal’s Jean Helwege argues that the monetary policy work of the Fed should be independent from second-guessing by Congress, however, she says that Fed Chairman Ben Bernanke needs to maintain the Fed’s impartiality and put an end to its picking and choosing winners and losers in the capital markets:

Rep. Ron Paul has been pushing to rein in the Federal Reserve and has proposed a bill to give the General Accounting Office (GAO) powers to audit it. The Fed is already subject to audit by the GAO when it comes to consumer protection laws and banking regulation, but not with regard to monetary policy. This bill would change that situation, although not so dramatically that the Fed would lose its independence (it’s not clear what the penalty is for any agency failing to live up to a GAO audit, but the Fed would surely get away with even more than the typical government group). Recently, Rep. Barney Frank, who surely is as far along the spectrum away from Ron Paul as any politician can get, voiced support for expanding the GAO’s powers to more thoroughly audit the Fed.

The Fed has pumped billions into financially distressed firms in the last year as part of its effort to revive the economy. These actions clearly fall under the category of monetary policy, not banking regulation, even though most of the money went to banks. Because the Fed traditionally sends more than 95 percent of its revenues to the U.S. government (i.e., it is a source of revenue on the U.S. Treasury budget), any money lost on firms like AIG is truly money spent by the U.S. taxpayer. For that reason, Ron Paul would like to see less of it spent in ways that seem wasteful and bad for the economy in the long run. I suspect that Barney Frank is on board with the plan because he wants some reassurance that the money going to AIG is not being paid out in the form of bonuses to the higher-ups there. 

In contrast, Fed Chair Ben Bernanke would argue that, as part of monetary policy, the Fed, through the FOMC, should be allowed to pursue whatever policies are most helpful toward maintaining price stability and economic growth. He undoubtedly would argue that whatever waste and distaste is associated with AIG, the payoff to society is worth the relatively minor cost. Bernanke believes Americans should trust the Fed chairman to do what is best for the U.S. economy, even if some of it seems illogical or annoys those who want to punish the people who got us into this mess.

Bernanke is right to fight for Fed independence on monetary policy. Determining where the economy is at and how best to maintain low price inflation is a difficult job that is not made any easier by having the public or Congress second-guess the decisions that are ultimately made by the Fed. However, Bernanke’s form of monetary policy involves a tremendous amount of policy that essentially picks winners and losers in the capital markets. By choosing to bail out AIG and not bail out Lehman; by choosing to drag its feet with regard to GM and CIT but to propel Bear Stearns at lightning speed into the arms of JP Morgan Chase; and by choosing to slowly offer assistance at the discount window to insurers but to immediately open it up to investment banks are all decisions that most Americans would rather not leave to Ben Bernanke or any other Fed chairman. These decisions seem capricious and poorly justified in terms of monetary policy and this perception is not at all helped by the e-mails regarding the merger of Bank of America and Merrill Lynch. Either the Fed strictly maintains its independence and avoids bailing out specific institutions or it should expect the people ultimately footing the bill to take notice when several hundred billion dollars are showered on what appear to be worthless ventures.

Tags: Banking, Economic Crisis, Economy, Helwege
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