The National Bureau of Economic Research Business Cycle Dating Committee has just announced its judgement that the current US recession began in December 2007. A year old, and the decline is just beginning to accelerate. As these forecasters quoted in the NY Times say, the recession is virtually certain to be the longest since World War II (in fact, since the 1929-33 slump), and quite possibly the deepest as well.

The only silver lining I can see is that we might not hear any more silliness about the “technical definition” of a recession being two quarters of negative growth.

It’s time once again for the Monday Message Board. As usual civilised discussion and no coarse language.

I haven’t had time to digest the implications of this story which has been around for at least a month, but only now seems to be attracting attention (I’ve seen it in a few different places today). Apparently, short sellers in the US Treasury bond market are failing to deliver the securities they’ve sold. As long ago as 1 October, the shortfall was more than $2 trillion by one report. Via Felix Salmon, here’s Helen Avery in Euromoney.

I’m not an expert on this stuff, but it seems to raise the question of whether bond markets can and should continue to exist in their current form. Maybe the US and other Treasuries should be selling bonds directly, and offering repurchase options to provide liquidity, perhaps using the banks they’ve already part-nationalised to handle the mechanics.

Another note to myself post: an idea I thought I’d blog quickly rather than trying to work through in detail.

One of the big unsolved problems in economics is to explain the risk premium for equity, that is, the fact that the historical average rate of return to equity investment (shares) is much higher (about 6 percentage points) than the average rate of interest on high grade (government or genuinely AAA corporate) bonds, whereas the standard economic model of these things (the consumption-based capital asset pricing model or CCAPM) suggests that the premium should be no more than 0.5 percentage points. The basic idea is that the reason for the premium is that the market portfolio of equity represents a claim on aggregate consumption, so the risk premium must arise from the variability of the growth rate of aggregate consumption and this is small (the growth rate ranges from about 4 per cent in a boom to -3 per cent in a moderately severe recession).

One possible explanation for the puzzle is that equity investment has its own special risks in addition to the riskiness of aggregate consumption. But not any kind of risk will do: the risk has to be correlated with fluctuations in aggregate consumption, that is with the business cycle.

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The failure of Citigroup, which looks increasingly likely to happen in the near future, would mark the end of the beginning of the financial crisis. Until now, the prevailing view has been that the crisis and recession will pass in a year or so, after which things will go back, more or less, to the way they were, with a few less financial institutions, and a bit more regulation. A Citigroup failure would put paid to that idea.

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Longtime reader Jack Strocchi sent me this piece from the Times, reprinted in the Oz, with the headline “Carbon crash hits Europe’s emission trading scheme”. The main point is that, with the economic downturn, the price of carbon permits has fallen. The author concludes that this proves the need for a carbon tax rather than an emissions trading scheme.

This is a fine example of the fallacy of “petitio principii” or, in English, begging the question. This does not (yet) mean what TV commentators seem to think, namely “begging me to raise the question”.* Rather it refers to an argument in support of a proposition which assumes the truth of the proposition in advance. Clearly, if price instability is, in itself, evidence that a program has failed, then you need a program with fixed prices, that is a tax.

The main argument for a carbon tax rather than a trading scheme is that, if there is a lot of uncertainty about the cost of reducing emissions, and not much uncertainty about the damage caused by climate change, a fixed price for emissions (that is, a tax) will get closer to the optimal outcome than a fixed quantity.

But what’s happening here is completely different. The demand for emissions has fallen due to the economic slowdown. The reduction in price offsets the adverse impact of the trading scheme on firms that are already facing hard times. Equally, if the economy booms, the price of permits will rise. This is a clear case when a fixed quantity trading scheme performs better than a tax.

* Of course, meaning is defined by usage, so if a word or phrase is used in a particular way long enough, that becomes the meaning. But “begging the question” in its traditional sense is a useful phrase for which we have no good substitute. For the TV usage, “raising the question” is perfectly adequate.

BrisConnect is a multibillion enterprise set up to build a series of PPP road and buslink projects in Brisbane. The backers are the usual big names like Macquarie Bank and Deutsche Bank.
Yet a Melbourne woman, named Hang Fe, just bought a 10 per cent stake in BrisConnect and you can do likewise if you have a spare $32 000 sitting around (immediate word of advice:DON’T). Shares in BrisConnect are currently trading at 0.1 cents, so Hang Fe’s investment brought her no less than 32 million of them.

The catch (there’s always a catch, isn’t there) is that these are partly paid “stapled securities” carrying with them an obligation to pay an additional $1 a share next April, and a further $1 in early 2010. For 32 million shares, that comes out at $64 million dollars. But most analysts say the value of fully paid shares will be well below $2, so anyone who pays up will lose a lot of money.

It seems safe to say that, at this point, holding BrisConnect shares makes sense only if you have no other assets the company can seize to enforce the $1 payment. For someone in this position, the shares appear to represent a one-way bet, admittedly at long odds. And, presumably, anyone who is in position to pay will be sure to sell out before the payment is due in April: a problem with partly paid shares of which I was unaware until now.

Since the remaining payments almost certainly won’t be made, the obligation will therefore fall on the underwriters. That in turn raises the question of whether the underwriters will still be around, and in a position to pay up, when the money falls due. That seems fairly likely as regards the payment due in 2009, but much less certain as regards Macquarie in 2010. At that point, the whole thing will presumably fall back into the lap of the Queensland government.

Note: I am Not a Financial Advisor, and I don’t claim an exact understanding of either Brisconnect or the implications of buying partly paid shares when you are already insolvent. So, please seek proper advice before going anywhere near this.

Hat-tip: Rabee Tourky alerted me to this

Here’s a post on the credit crisis from my colleague, Rabee Tourky

In a Minneapolis Fed. research paper Chari, Christiano, and Kehoe
examine three claims about the way the financial crisis is affecting the economy as a whole and argue using a number of graphs that all three claims are in fact myths.

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It’s an analysis familiar to most on the Left. Support for laissez-faire is a hypocritical pretence, typified by Republicans who denounce a universal health care scheme as “socialist” while backing huge handouts for wealthy sugar producers.

For cultural and historical reasons, the United States has never had a proper socialist party of any significance[1]. Instead

the socialism we do have is the surreptitious socialism of the strong, e.g. sugar producers represented by their Washington hirelings.

In America, socialism is un-American. Instead, Americans merely do rent-seeking — bending government for the benefit of private factions.

As I say, familiar stuff. But it’s mildly surprising to see it coming from George Will.

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Supporters of social democratic and labour parties have had plenty of experience of seeing their parties in office. Despite some substantial achievements there has been plenty of disillusionment, particularly in the case of coalition governments with centrist or liberal parties. Time after time, the promise of radical transformation has faded to hard slog for modest reforms or even (particularly in times of crisis) capitulation to the demands of capitalist orthodoxy.

By contrast, explicitly libertarian parties have hardly ever scored enough votes to elect candidates, let alone form governments. But now, thanks to New Zealand’s multi-member proportional system, a new government, led by the National Party, has been formed in which the ACT (Association of Consumers and Taxpayers) party (with a bit over 3 per cent of the vote) holds a couple of ministries. ACT was the subject of some enthusiastic commentary in open threads here, and an op-ed piece by John Roskam of IPA in the Fin (paywalled, maybe someone can find a link). They combine libertarian economic policies with the now standard accompaniments of climate change delusionism and coded law-and-order rhetoric.

Unsurprisingly, given the circumstances, the first announcement of the new government was that the longstanding requirement under the Public Finance Act for budget surpluses over the cycle was to be abandoned. At this stage, declining tax revenues are the main factor, but large-scale Keynesian stimulus is going to be needed, and soon.

Labour’s guarantee of bank deposits looks certain to be retained, and there’s every likelihood that more intervention, maybe even nationalisation, will be needed before the financial crisis is resolved.

As far as I can tell, ACT has had to settle for a review of public expenditure (plus the ministers’ jobs) as its price for participation in a government which seems likely to be forced in the direction of interventionism. It will be interesting to see how long they last.