Kevin Drum - July 2011

China Housing Bubble Update

| Fri Jul. 15, 2011 12:40 AM EDT

So is China in a housing bubble? In a recent paper, Christian Dreger and Yanqun Zhang say yes:

Our results indicate the presence of a house-price bubble. In Figure 1 it can be seen that increasing imbalances have emerged over the past two years. For example, real house prices in Shanghai have been 28% above the long run equilibrium in 2008, and 35% in 2009. While the evidence is similar for Beijing, the increase is more spectacular in Shenzhen....In general, the bubble is more pronounced in the special economic zones and the south-eastern coastal regions. Overall, the size of the bubble is 20% in 2008 and 25% in 2009, regardless of whether GDP or population weights are applied.

If their numbers are correct, the Chinese housing bubble isn't as bad as the American housing bubble of the aughts. What's more, it's not fueled by borrowing as strongly as ours was. And what's even more, Chinese borrowing has largely been to buy actual property, not to finance home equity loans.

All of these things together suggest that China's property bubble might not be that bad. On the other hand, it's pretty bad in certain areas, and if the Chinese economy starts to go south it could touch off a vicious cycle of slowing domestic demand and plummeting house prices. It's still something to keep an eye on.

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A Closer Look at the Tea Party's Utopia

| Thu Jul. 14, 2011 6:34 PM EDT

From Benjy Sarlin:

Republican lawmakers are pushing President Obama to put seniors, troops, and bondholders at the front of the line should Congress fail to raise the debt ceiling. The rest? Well, that's up to him.

....But where will the immediate 44% cut in overall spending needed to avoid default come from instead? Michele Bachmann, who has gone so far as to demand the debt ceiling never be raised, dodged questions on the issue Wednesday by simply repeating her assertion that Social Security and troop pay be left sacrosanct.

Asked by TPM about what areas might need to be cut offset their proposed guarantees, Rep. Nan Hayworth (R-NY) offered a similar response, repeating that Social Security, Medicare, military pay, and veterans' benefits should all be off limits. Pressed to name any savings — furloughing federal employees, shutting down various agencies — that might be preferable, she said her focus was only on calling out Obama's threats.

Let's take a brief look at the numbers. The federal government is scheduled to spend about $300 billion in August. Something like $125 billion of that is debt. So if the debt ceiling doesn't get raised, the government can only spend about $175 billion. Very roughly, here's spending for the month of August in the areas Nan Hayworth says are off limits:

Social Security = $60 billion
Veterans benefits = $10 billion
Medicare/Medicaid = $70 billion
Interest payments = $20 billion
Military pay = $15 billion

Total = $175 billion

So there you have it. Nan Hayworth is right: we can fund all of these things without raising the debt ceiling. Unfortunately, that's it. There's really no other prioritizing necessary. There's not a single dollar left for any other function of government. Not defense spending, not the FBI, not foreign embassies, not the court system, not prisons, not disaster relief, not unemployment insurance, not the border patrol, not TSA or the FAA, not roadbuilding, not maintenance of any kind, not national parks, and not pensions for retired federal workers. Not anything. And aside from military personnel, every single employee of the federal government will have to be furloughed.

That's what Nan Hayworth and Michele Bachmann and the rest of the tea party folks apparently want. Quite the small government utopia, isn't it?

Behind the Scenes in Republican-land

| Thu Jul. 14, 2011 4:51 PM EDT

Mike Konczal has a post today that provides a rare inside look at what non-insane Republicans think about their more exuberently ideological colleagues. It's long, and might take a couple of readings to fully appreciate, so I'll just set the stage for you. It's about a Republican member of the Financial Crisis Inquiry Commission, Peter Wallison, who seems a wee bit less interested than he should be in actually getting at the roots of the financial crisis (at one point, he tells his fellow conservatives that it's "very important" they do nothing to "undermine" the goals of the GOP caucus in the House).

On a more technical level, Wallison's big hobbyhorse is making sure that Fannie Mae and Freddie Mac get blamed for the financial crisis. The other Republican members of the FCIC, it turns out, basically know that Wallison is nuts, but they're unsure about whether he's independently nuts or merely parroting the views of a fellow nut at AEI named Edward Pinto. The actors in this melodrama are Wallison; two fellow FCIC members, Bill Young and Douglas Holtz-Eakin; and a couple of Republican staff members. You can read the whole thing here. When you're done, Andy Kroll has more on the story here.

Quote of the Day: Never Trust Simple and Plausible

| Thu Jul. 14, 2011 3:13 PM EDT

From the Time Traveller, in H.G. Wells' The Time Machine:

Very simple was my explanation, and plausible enough — as most wrong theories are!

What was true in the year 802,701 is true in the year 2011 too. Never trust simple and plausible for any problem more interesting than a broken light switch.

Worrying About Long-Term Panic

| Thu Jul. 14, 2011 2:21 PM EDT

Generally speaking, I'm part of the crowd that thinks we should be spending more now and tackling the deficit only in the long term. After all, as Paul Krugman and others point out endlessly, the "bond vigilantes" are nowhere to be seen. Interest rates are at historic lows and investors — as measured by their real-world actions — seem to have no concerns at all about America's ability to grow and service its debt.

However, there's one contrary argument that's long given me pause. Carmen Reinhart and Kenneth Rogoff, who have written the standard reference about the dangers of countries piling on too much debt, make it here:

Several studies of financial crises show that interest rates seldom indicate problems long in advance. In fact, we should probably be particularly concerned today because a growing share of advanced country debt is held by official creditors whose current willingness to forego short-term returns doesn’t guarantee there will be a captive audience for debt in perpetuity.

Those who would point to low servicing costs should remember that market interest rates can change like the weather. Debt levels, by contrast, can’t be brought down quickly. Even though politicians everywhere like to argue that their country will expand its way out of debt, our historical research suggests that growth alone is rarely enough to achieve that with the debt levels we are experiencing today.

Interest rates are low today. Consumer debt overhang continues to dampen demand and generate massive unemployment. Because of this, government borrowing now not only makes sense because it's cheap, it makes sense because it will put people back to work and help get the economy back to its long-term growth trend. Especially given the fragility of the world economy — including but not limited to the property bubble in China, the unsustainable flow of hot money into developing countries, and the crisis of the PIIGS in Europe — this is about the worst possible time to take any chances with economic recovery in America.

And yet. Still. Reinhart and Rogoff have a point: investors can get nervous and start fleeing with virtually no notice. One month they're fat and happy, the next they're running for the doors. Although we should be spending more now to get the economy back on track, this is why a long-term deficit deal with teeth is something that both liberals and conservatives ought to be willing to compromise to achieve.

Moody's Ups the Threat Level to Orange

| Thu Jul. 14, 2011 1:51 PM EDT

Ratings agencies have started warning us that they'll downgrade U.S. debt from AAA if we don't get a debt ceiling agreement soon. But it's never really been clear to me why anyone should care about this, since no one thinks that Moody's or Standard & Poor's has any special insight into the creditworthiness of the U.S. bond market. If there's no debt ceiling deal, then Treasury rates will probably go up, but they'll go up because investors read the newspaper and think that things are getting dicey, not because they got a press release saying that one of the ratings agencies officially put America on credit watch.

But this is different:

At least 7,000 top-rated municipal credits would have their ratings cut if the U.S. government loses its Aaa grade, Moody’s Investors Service said. An “automatic” downgrade affecting $130 billion in municipal debt directly linked to the U.S. would occur if the federal level is reduced, Moody’s said yesterday in a report. Additionally, top-rated securities with no direct links to the national government will be reviewed for similar action.

....Issuers that are partially dependent on the federal government, such as states receiving Medicaid matching funds, also will be reviewed for vulnerability. Medicaid is a health- care program for the poor that is jointly funded by the states and the U.S. Moody’s said Aaa-rated states on average rely on the federal government for a quarter of total spending.

Investors do care about the credit ratings of state and municipal governments, and if a Moody's downgrade affects them, it will have an immediate effect on their ability to raise money. Moody's, I'm sure, knows perfectly well that their rating of federal debt doesn't really matter that much, so this sounds to me like a case of upping the ante. It's a clear threat to Washington to get a deal done or face consequences from Wall Street.

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Protecting the Rich

| Thu Jul. 14, 2011 12:39 PM EDT

Back in the late 80s, when I paid only passing attention to politcs, I had lunch once with a sales manager at the company I worked for. We got to talking about the economy, and after a few minutes his face lit up. "What we need to do is get rid of the capital gains tax!" he told me excitedly. The what? I thought. I happened to know that this guy spent pretty much his entire paycheck and probably had a few thousand dollars in his 401(k) and not much else in the way of serious investments. So why was he convinced that eliminating the capital gains tax, of all things, was the key to salvation?

I was young and naive back then, of course. What I didn't know was that although the 1986 Tax Reform Act had lowered a bunch of taxes, it had increased the capital gains rate — and rich people, who do have huge parts of their income dependent on capital gains, had immediately made reduction or elimination of the capital gains tax a right-wing hobbyhorse. Rush Limbaugh and his dittoheads talked about it endlessly, and obviously my friend had gotten sucked into the vortex. Elimination of capital gains taxes would save the country!

Why bring this up? Because apparently this is a sticking point in the debt ceiling negotiations. Conservatives have long since gotten their capital gains preference restored (the rate is currently 15%, compared to a top rate of 35% for ordinary income), but a tax reform deal that broadens the tax base threatens to increase that rate. According to Politico's David Rogers, "there’s resistance from wealthy interests who fear the president will gain too much leverage to impose tougher standards of progressivity in the tax code — and thereby crimp their capital gains tax breaks." Jon Chait comments:

The broader problem here is that Obama seems to be taking Republicans at their word. He wants shared sacrifice, and they say they want to avoid high rates. Tax reform is a way to accomplish both. But Republicans don't just want to avoid high marginal tax rates. They want rich people to pay low taxes, period. It's not clear Obama understands that.

I suspect that Obama understands this just fine. It's not rocket science, after all. Basically, he's calling their bluff, forcing them to publicly oppose literally every tax break the rich currently enjoy. Get them to pound the table and say nyet often enough, and eventually even the vast huddled masses will finally figure out what really motivates the GOP. Maybe.

The Implosion of Eric Cantor

| Thu Jul. 14, 2011 11:23 AM EDT

Here's a prediction: when all's said and done and the debt ceiling fight is finally over, Eric Cantor is going to be a lot further away from becoming Speaker of the House than he was six months ago. Every days he's looking more and more like a petulant child playing media games and less and less like a principled statesman working in the best interests of the country. He thinks he's being clever and savvy, but the rest of the country is seeing a grasping, opportunistic politician who thinks that posturing for Fox News is more important than facing up to serious problems. He's setting his career back a decade.

UPDATE: Greg Sargent points out that Democrats are apparently doing everything they can to speed up Cantor's demise. Harry Reid lit into him pretty harshly a few minutes ago, but Greg isn't sure this is going to hurt Cantor: "If his intransigence on revenues is earning him high profile criticism from Beltway journalists and from the Senate Majority Leader and even the President, this will only turn him into more of a crusading anti-tax hero in some people’s eyes." Maybe so. But unless he changes his tune pretty quickly, I think he's losing the support of all but the hardest of the hard core.

Republicans in Disarray! Film at 11!

| Thu Jul. 14, 2011 12:52 AM EDT

What really happened at Wednesday's debt ceiling talks? It's hard to say for sure, but apparently Eric Cantor repeatedly proposed some kind of short-term extension of the debt ceiling that President Obama had already said he wouldn't support, and then interrupted to propose it yet again as Obama was wrapping up the meeting. Depending on who you listen to, Obama either "stormed out," or left "angrily," or left "abruptly," or simply left after telling Cantor they'd meet again tomorrow. One way or another, though, it looks like Obama finally got fed up with Cantor's antics and warned him not to try calling his bluff. Joe Klein provides narration:

David Rogers over at Politico, who has been doing this — extremely well — for about as long as I have, has word that the President of the United States monstered down on Representative Eric Cantor in Wednesday’s deficit ceiling squabble. This is so refreshing on so many levels. Cantor has been using this crisis to undermine his leader John Boehner, by playing the Tea Party/Grover Norquist recalcitrance card. The boy badly needed someone to get up in his face and Barack Obama, of all people, apparently did, telling Cantor, in no uncertain terms, that he’d veto any short term deficit ceiling fix or, indeed, any plan that did not include revenue increases. Then Obama walked out, or the meeting ended, depending on whom you talk to.

So what we have now is the Republican party in, yes, disarray — a word used to describe Democrats almost exclusively, back in the day before the crazies took over the GOP store. You have Cantor and the House Teasies opposing any revenue increases, including a tax loophole closing plan that Ronald Reagan and Edmund Burke would have smiled upon. You have Boehner, struck dumb apparently, after his attempt at bipartisan statesmanship with the President was greeted by tossed shoes and catcalls from the Teasies. You have Mitch McConnell, well, I’m speechless about Mitch McConnell….

Republicans in disarray! And apparently even Lindsey Graham agrees. Here he is admitting to reporters that Republicans have been playing games all along:

Our problem is we made a big deal about this for three months. How many Republicans have been on TV saying, "I’m not going to raise the debt limit." You know, Mitch [McConnell] says, "I’m not going to raise the debt limit unless we talk about Medicare." And I’ve said I’m not going to raise the debt limit until we do something about spending and entitlements. So we’ve got nobody to blame but ourselves. We shouldn’t have said that if we didn’t mean it.

Republicans now seem to be a hair's breadth away from outright panic. Graham is right: at this point, no matter how desperately they try to pretend that it's Obama standing in the way of a deal (and that's clearly the conservative talking point of the day), it's simply too obvious that it's Republicans who are unwilling to say yes. Obama is almost embarrassingly eager for a deal, but they won't agree to send him a clean debt ceiling increase, they won't agree to a grand bargain, they won't agree to a medium-sized bargain, and they won't agree to revenue increases even in the form of closing virtually indefensible loopholes on hedge fund moguls and other assorted members of the millionaire class. Hell, a sizeable chunk of the GOP's tea party faction actively thinks that default would be a great thing. They're practically slavering over the possibility while their leaders watch slack-jawed, wondering just how you explain to these guys that, yes, pressing that red button over there would be really, really bad.

The tea party was pretty useful to the GOP leadership for a while. But now it's gone from being a handy campaign tailwind to a Force 5 hurricane on a path to destroy the country, and they don't know what to do about it. Under other circumstances it might be fun to watch them all get their comeuppance over this, but not if it means turning America into a banana republic along the way. They better figure out what to do with their problem children, and they better figure it out fast.

Why Everyone Loves the Mortgage Interest Deduction

| Wed Jul. 13, 2011 7:22 PM EDT

Over at FiveThirtyEight, Bryan McCabe takes on the mortgage interest deduction:

Commentators often talk about the mortgage interest deduction as a prized middle-class benefit that enables households to achieve the American dream of homeownership. But despite their strong support for the deduction, middle-class Americans are not the primary beneficiaries of this federal tax subsidy. Instead, wealthy Americans take home a disproportionate share of the deduction’s benefits.

....It’s not surprising that the wealthy benefit disproportionately from the mortgage interest deduction....What is surprising, however, is that Americans continue to support a housing subsidy that distributes benefits so disproportionately.

I think this is a lot less mysterious than McCabe makes it out to be. It's true that high-income taxpayers get a bigger absolute benefit from the mortgage interest deduction than low-income taxpayers. Of course they do: they have bigger mortgages. But I've added a column to the JCT report that produced the numbers McCabe uses in his post. The extra column shows roughly how big the mortgage interest deduction is as a percentage of income at various levels:

As you can see, it comes to about 2% of income for everyone. (I used the midpoint of each income group for the calculation. The top income group is blank because "average" income is a little tricky to compute for this group.) What's more, although homeownership rates are obviously higher at higher income levels, the homeownership rate is 60% even at incomes as low as $25,000.

So why is the mortgage interest deduction so popular? Because homeownership is pretty widespread even at low incomes and the amount of the deduction is about the same for everyone as a percentage of income. $283 may not seem like much, but to someone with an income of $10-20,000, it's as valuable as $2,856 is to someone with an income of $100-200,000. Result: everyone loves the mortgage interest deduction.