TIME

The Real Truth About the Wall Street Bailouts

It happens to be the one we already know

It was probably inevitable, which doesn’t make it any less absurd. And it is certainly a reflection of their remarkable success, which doesn’t make it any less unfair. But six years after the spectacularly unpopular Wall Street bailouts, the government rescuers are under fire again—this time, not for their alleged generosity to financial firms, but for their alleged stinginess.

On Monday, a trial began in a lawsuit filed by AIG shareholders who claim the government somehow violated their rights when it rescued the busted insurer and salvaged their worthless investments. But even commentators who have admitted the lawsuit is “asinine” (in the New York Times) and “mostly insane” (in The New Republic) have suggested it’s nonetheless performing a public service, because it’s going to reveal the truth about the Wall Street bailouts. And on Tuesday, the Times ran a blockbuster story quoting unnamed sources who claim the government also could have bailed out Lehman Brothers, the venerable investment bank whose implosion nearly cratered the global economy. Again, the implication is that the official story is askew.

In fact, the lawsuit over the $182 billion AIG bailout is precisely as asinine and insane as it sounds. The government officials who stabilized the world’s most dangerous financial firm were the ones who performed a public service. And they absolutely would have rescued Lehman as well if they could have. Unfortunately, Lehman was hopelessly insolvent, and the government had no legal or practical way to save it without a private buyer willing to take on at least some of its risks. As for the truth about the Wall Street bailouts, well, the truth is already out there.

I have a bias here; I helped former Treasury Secretary Tim Geithner, who helped rescue AIG and tried to rescue Lehman when he was president of the New York Fed, with his memoir, Stress Test. I was even peripherally involved in the AIG case, when Greenberg’s lawyers sought access to transcripts of my conversations with Geithner.

But I wrote a pretty high-octane defense of the AIG bailout back in January 2010, before I ever met Geithner. And it stands up pretty well, except for the part where I said taxpayers would take a hit; in fact, taxpayers ended up earning a $22.7 billion profit on their investment in AIG.

Overall, taxpayers have made more than $100 billion on the bailouts. More importantly, the aggressive U.S. financial response—along with similarly aggressive monetary and (initially) fiscal policies—helped rescue a free-falling economy that was crashing at an 8 percent annual rate. We’ve recovered better than the rest of the developed world—Europe still has 11 percent unemployment—and much better than nations that endured much less damaging financial crises in the past. It’s kind of amazing that we’re still arguing about an emergency response that turned out so much better than anyone, even the emergency responders, expected at the time.

But here we are. Critics still doubt the official story that Lehman could not be saved. They also insist the Fed could have forced AIG’s senior creditors to accept less than 100 cents on the dollar; they’re excited about the lawsuit because they expect it to expose shocking evidence about why the government didn’t insist on haircuts. In fact, these questions have been asked and answered. Geithner tells the story of Lehman and AIG at length in Stress Test. You can find a quick explanation of why Lehman couldn’t be rescued in on pages 206-208 and a quick summary of why AIG’s counterparties didn’t absorb haircuts on pages 246-248. Again, I’m biased, but if you’re interested in this stuff, you should read the whole thing.

Here’s a shorter version. The old conventional wisdom that Geithner and his colleagues were desperate to prevent big Wall Street firms from collapsing during the crisis was basically correct, although I’d say they were right to be desperate. The firms were all dangerously interconnected with the rest of the global financial system at a time when markets had lost confidence in their housing-related assets, and it was clear that any one of them defaulting on its obligations could further depress confidence and spark runs on the others. That’s why when Bear Stearns was failing in March 2008, the Fed helped engineer a deal for JP Morgan Chase to acquire it and stand behind its obligations, providing an emergency loan backed by some of Bear’s sketchiest mortgage securities. And when Lehman was failing that September, Geithner and his colleagues worked feverishly to recruit a buyer for a similar deal, holding a series of emergency meetings documented in crisis books like Too Big to Fail and In Fed We Trust.

So what happened? The only bank willing to buy Lehman and its toxic assets that chaotic weekend was the British firm Barclays—and British regulators balked before a deal could be finalized. That left the Fed without options. It’s only allowed to lend against plausibly solid collateral, and Lehman looked hopelessly insolvent. At the time, then-Fed chair Ben Bernanke and then-Treasury Secretary Hank Paulson suggested publicly that they had chosen to let Lehman fail, because they didn’t want to accelerate the panic by making the government appear powerless. But really, they had been powerless. They knew the consequences of failure would be disastrous. They would have been thrilled to find a way to save Lehman.

In its carefully hedged, anonymously sourced story, the Times is now suggesting some New York Fed officials were “leaning toward the opposite conclusion—that Lehman was narrowly solvent and therefore might qualify for a bailout.” Put it this way: Their bosses did not agree, and neither did the market; as the Times noted, Bank of America had estimated Lehman’s net worth at about negative $66 billion that weekend. In fact, a subsequent study by economists William R. Cline and Joseph E. Gagnon—a study not mentioned by the Times—found that Lehman was at least $100 billion and perhaps $200 billion in the hole at the time.

“Our overall judgment on Lehman is that it was deeply insolvent,” Cline and Gagnon concluded.

One more point about Lehman: Even if the Fed had broken the law to lend into a run on an insolvent firm, and had somehow managed to stabilize Lehman rather than kiss its cash goodbye, it wouldn’t have defused the larger crisis. The government still lacked the authority to inject massive amounts of capital into the financial system—and a Congress that initially refused to grant that authority through the notorious TARP even after Lehman’s failure certainly wouldn’t have granted it before a failure of similar magnitude. Whatever. I guess some people find it comforting to believe the government could have snapped its fingers and ended the crisis early. It’s not a reality-based belief.

The perennial question is how, if the Fed lacked authority to rescue Lehman, it somehow found the authority to rescue AIG the next day. The short answer is that AIG, despite the awful misjudgments of a subsidiary that insured trillions of dollars worth of mortgage securities, had valuable revenue-generating businesses and a plausible claim to solvency. While Lehman was really nothing more than the sum of its toxic assets and shattered reputation as a venerable brokerage, AIG had solid collateral that the Fed could lend against with a decent expectation of repayment.

Ultimately, AIG would receive an astonishing $182 billion in government financing, and it would pay back every dime with interest. Its shareholders, who would have received nothing if the government had let the firm collapse, are now complaining in court that they should have gotten more. In his Times op-ed, Noam Scheiber aptly compared them to “a formerly starving man insisting he deserved filet mignon rather than a rib-eye.” Yet Scheiber argued that their filet mignon demand “may end up serving a constructive purpose.” He thinks the trial underway in Washington will reveal the real reason AIG’s creditors didn’t face haircuts; he doesn’t think the official explanation—that voluntary haircuts were impossible, and involuntary haircuts would have accelerated the panic—makes any sense. Times columnist Gretchen Morgenson not only called the lawsuit a “public service,” she actually portrayed AIG as an innocent victim in the financial crisis, “the patsy at the poker table.”

Uh…no. AIG was as rapacious and reckless as any bank. The government did push for modest haircuts for its creditors that might have saved taxpayers as much as $1 billion, but seven of the eight top creditors flatly refused. Unfortunately, the Fed could not force them to change their minds; several of them weren’t even U.S. firms. And the Fed could not impose the haircuts without forcing AIG into default; the creditors logically concluded a government that was spending $182 billion to avoid a default wasn’t going to create a default on purpose to save $1 billion.

This is the key: In a financial crisis, default is the enemy. The fear that secured debts won’t be repaid in full is the fear that drives panics. The Federal Deposit Insurance Corporation learned this the hard way a week later when it foolishly haircut Washington Mutual’s creditors, instantly triggering a run on the next-weakest bank, Wachovia; its ten-year bonds lost two thirds of their value the day after the haircuts. The whole point of the bailouts was to avoid defaults. This is not “counterintuitive” (Scheiber’s word) to anyone who has endured a financial crisis.

But the critics—who were wrong when they predicted the bailouts would cost trillions, and when they warned that the banking system could not be saved without mass nationalization, and in so many other ways—think the frivolous AIG lawsuit will reveal some dirty backroom deal where Geithner and Lord Voldemort conspired to rip off widows and orphans on behalf of Goldman Sachs. “Traumatic historical episodes often require a high-profile public reckoning before the country can move on,” Scheiber wrote. OK, he then admitted, the financial crisis inspired a litany of those, “but none fully exposed the weakness of Mr. Geithner’s logic.”

Hmm. Maybe it’s someone else’s logic that’s weak. And maybe it’s already time for the country to move on.

MONEY The Economy

China is Slowing. What If Its Housing Bubble Bursts?

Even if the real estate market in the world's second-biggest economy were to collapse, the repercussions may not be bad as you think.

While global investors covet China’s growth — as evidenced by the buzz surrounding Alibaba’s IPO — the Chinese economy is actually slowing down.

In 2013, the world’s second largest economy grew at an annual rate of 7.7%. By 2015, according to a recent report by the Organization for Economic Co-Operation and Development, that will drop to 7.3%. Meanwhile, the U.S. economy’s growth rate is projected to increase by almost one percentage point.

What’s going on? Well, China’s industrial production gains in August slowed to their lowest level since 2008 and retail sales growth declined by a few percentage points year-over-year.

Perhaps most important, the nation’s newly built home prices only grew by 2.5% in July, after surging by 10% at the beginning of the year.

The notion of a housing crisis in an economy more than three times the size of France brings back flashbacks of 2008 and probably a few chills down every investor’s spine.

“A property price crash in the world’s second largest economy would have global implications,” says Wells Fargo Securities economist Jay Bryson.

But those global implications wouldn’t be as worrisome as the U.S. housing collapse six years ago, per Bryson. Here’s why.

The Worst Case

To play out this thought experiment you have to assume that at some point in the near future China’s home prices will experience a decline on the order of what the U.S. experienced over the past decade. (Bryson played out this scenario in a recent report.)

Currently, residential investment makes up a pretty decent portion of the Chinese economy – about 10% of nominal GDP. To put that in context, that ratio was closer to 6% for the U.S. in 2006.

So housing is a big deal in China. If they experienced a value decline like we did, Bryson estimates that would lop off about one percentage point of growth. But the pain wouldn’t stop there.

A collapse in housing prices would result in fewer construction jobs – estimated at around 60 million people in urban China. Jobless workers would spend less, which means that those goods and services the now-unemployed construction workers would normally purchase would not get bought.

If out-of-work construction workers reduce their spending on food and entertainment, the businesses that produce that food and entertainment will make less money and then some of their workers may face unemployment too. Since my spending is your income, lower spending means people have less money in their paychecks, and the nation’s GDP suffers.

Moreover, if housing goes in the tank, banks will see losses, which means they’ll tighten credit, resulting in fewer loans for people to start businesses.

Let’s not forget the actual homeowners. If home prices fall, homeowners’ equity declines as well. (See: Sell, Short). And when people’s chief asset is suddenly worth a lot less, they’re not going to spend as much on other, discretionary items. “Although the lack of data makes it impossible to quantify the wealth effect in China, researchers have found that there is a statistically significant direct relationship in the United States between changes in wealth and changes in consumer spending,” per Bryson’s report.

Lower demand from China means that countries which sell goods to China (think Chile and Australia) will sell less stuff. As corporate profits are squeezed, a global bear market may result.

“Although China may not be as important to global economic growth as the United States, the global economy clearly would not be immune to a major property market downturn in China,” says Bryson.

The Not-So-Bad Case

Freaked out? Breathe deep and take solace in the fact that despite this potentially harrowing dénouement, the world probably wouldn’t endure another global financial crisis. And that’s thanks to responsible Chinese borrowers.

Chinese households usually have to put a lot more money down – 30% on their first home, up to 60% for an individual’s second – than Americans. So if prices were to decline substantially, Chinese homeowners would be in a much better position than Americans back in 2007 to deal with the crisis. For example, household debt-to-disposable income has grown substantially in China since 2007, but it’s still about one-third the size of U.S. households back in 2007.

The world will also feel less of a pinch. When mortgages started going bad in the U.S., foreign financial institutions lost close to $750 billion of the more than $2 trillion in write-downs resulting from the crash. That was because foreign banks owned a lot of U.S. mortgage-backed securities. Not so here. “Chinese mortgages are generally held by Chinese financial institutions in the form of whole mortgages.” So if prices were to drop, Chinese banks would suffer while U.S. one’s most likely wouldn’t.

Lastly, the Chinese government wouldn’t sit on its hands while its economy came crashing down. Beijing’s debt-to-GDP ratio is around 15%, so it has a lot of room to recapitalize its banks if needed.

So what’s an investor to do?

“I don’t lose sleep at night worrying about China, nor should other people,” says Bryson. “But they may want to keep an eye on it.”

TIME Regulation

The Fed Is Staying the Course, and That’s Great

Janet Yellen, chair of the U.S. Federal Reserve, listens to a question during a news conference following a Federal Open Market Committee (FOMC) meeting in Washington on Sept. 17, 2014.
Janet Yellen, chair of the U.S. Federal Reserve, listens to a question during a news conference following a Federal Open Market Committee (FOMC) meeting in Washington on Sept. 17, 2014. Bloomberg/Getty Images

Why boring monetary policy is good

The Federal Reserve’s monthly statement Wednesday was typically dull. Basically, the Fed is staying the course, because the economy is continuing a path of gradual improvement.

The Fed continued its “taper,” reducing the monetary stimulus it’s pumping into the economy by $10 billion for the 10th consecutive month, while announcing that this stimulus—known as “QE3”—should end on schedule next month. The Fed also continued to signal it won’t raise interest rates above zero “for a considerable time,” despite speculation it might soften that language. Fed Chair Janet Yellen then devoted most of her news conference to a mind-numbing discussion of procedural arcana involving “policy normalization principles” and “overnight RRP facilities.”

This is not exciting stuff. But boring monetary policy is an excellent thing to have, especially just six years after a spectacular financial crisis. At the time, the Fed took all kinds of unprecedented actions to save an economy that was contracting at an 8% annual rate and shedding 800,000 jobs a month. Some critics thought those actions would fail to prevent a depression. Others thought they would lead to hyperinflation, a devastating run on the dollar, or a double-dip recession. Instead, we’ve had 54 straight months of job growth. The jobless rate is down from 10% to just over 6% percent. The stock market is booming. Last year, the U.S. had its largest one-year drop in child poverty since 1966, and this year is looking even better. Two of the Fed’s inflation hawks actually dissented from the latest statement, arguing it “does not reflect the considerable economic progress that has been made.”

In other words, things are OK.

Things are not great; as Yellen pointed out, many American families are still dealing with aftershocks of the crisis, including tight credit, lingering debt, depressed wages and a shortage of jobs. Incomes for the non-rich have grown modestly since 2010 and not at all since before the crisis, although tax cuts for the middle class and the poor, tax increases for the rich, and expanded government benefits for the vulnerable have helped offset those trends. It’s true that our recovery from the Great Recession has been slower than previous recoveries from ordinary recessions. But it has been much stronger than previous recoveries in nations that endured major financial crises—and much stronger than Europe’s current recovery. The euro zone’s output has not yet reached pre-crisis levels; it’s still struggling with 12% unemployment and a risk of deflation.

We’re doing a lot better than that. We had more effective bank bailouts, more generous fiscal stimulus—until Republicans took over the House after the 2010 midterms and began demanding austerity—and much more accommodative monetary policy. It’s all worked remarkably well. We’ve faced some headwinds—the contagion from the near-collapse of Greece in 2010, the turmoil after we nearly defaulted on our debt in 2011—but the economy has continued its path of slow but steady growth. That’s why Yellen was able to discuss those mind-numbing “policy normalization principles,” the guidelines the Fed will follow as it starts raising rates and reining in its bloated balance sheet in 2015. We’re approaching normal. And the Fed’s forecast for the next few years also looks pretty decent.

It doesn’t look fantastic. But in 2008, the U.S. suffered a horrific financial shock, with a loss of household wealth five times worse than the shock that preceded the Depression. We’re still dealing with the aftershocks. Many Americans still don’t feel like the economy is working for them, an understandable reaction to persistent long-term unemployment, stagnant wages, and continuing foreclosures.

But as dull as it sounds, it’s working better every year. The lesson of our current plight is not that the system doesn’t work. It’s that financial crises really suck.

MONEY Economy

The Takeaway from the Latest Fed Decision

Federal Reserve Chair Janet Yellen.
Fed chair Janet Yellen says the Fed isn't shifting gears… yet Susan Walsh—AP

Interest rates are going to stay low for a while longer. But the Federal Reserve is thinking about what comes next.

Updated September 17 at 4:40 pm

It’s come to this: The market is obsessed with two magic words and a bunch of tiny dots.

Federal Reserve watchers have long been attuned to the subtlest cues from central bank officials—people used to look at the size of Alan Greenspan’s briefcase for clues—but this has been an unusually big week for minutiae. In anticipation of the Federal Open Market Committee’s 2 p.m. announcement of its latest decisions on monetary policy, markets were waiting to see if the committee would again use the phrase “considerable time” to describe how long it would hold the key short-term interest rate near zero.

They did. Here’s the statement:

The Committee continues to anticipate… that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time…

That’s a relatively dovish signal, suggesting that rate hikes aren’t coming soon. Stock investors pushed prices a bit higher in the hours after the announcement, with the Dow closing at a record high of 17,156. But bond prices declined, with the 10-year Treasury bond yield ticking up to 2.164%. (Bond yields rise when prices fall.)

That may be because there was an asterisk to the “considerable time” language. The Fed also released a statement laying out the steps they’ll take to “normalize” interest rates when it’s time. Message: We aren’t doing it yet, we aren’t doing it right away, but we wanted to let you know we’re thinking about it.

Investors were also closely watching the “dot plot,” a chart showing where different Fed officials think interest rates will land in the coming years and over the long run. The dots didn’t change in a big way since June—most Fed officials want to keep interest rates where they are this year, but see them rising in 2015 as (presumably) the economy improves. Slightly more officials see 2015 as the “lift-off” date for rates than did in June.

The real story is how strongly opinions differ—those dots are pretty spread out after 2014. Fed chair Janet Yellen is widely considered to favor stimulative monetary policy, but this shows that she has to work with a much more hawkish group within the Fed that wants tighter money sooner, to prevent a surprise return of inflation. Right now, though, inflation is below the Fed’s 2% target.

Screen Shot 2014-09-17 at 2.07.46 PM
SOURCE: Federal Reserve

These little signs have taken on outsized importance for two reasons. First, the Fed has played an unusually large role in supporting the (not-so-strong) recovery, by keeping short-term rates as low as they can go since the crisis days of late 2008, and then by buying up trillions of dollars worth of bonds as part of its unusual “quantitative easing” program. Second, investors in both stocks and bonds have been betting that this status quo is only going to change at a measured pace. This seems to have been confirmed.

This story was updated to reflect the market reaction to the Fed announcement.

MONEY Jobs report

How the Fed Will React to Today’s Surprising Jobs News

140905_INV_JobsReport3
altrendo images—Getty Images

The fact that employers created fewer jobs than expected in August only emboldens the Federal Reserve to keep rates low for the time being.

The Fed is unlikely to raise interest rates this year — and not just because of Friday’s disappointing jobs report.

Though the economy fell short of adding 200,000 jobs in August — as it had in the six prior months — the unemployment rate remains at a better-than-expected 6.1%. Consumer confidence, meanwhile, rose in August and the economy grew by a robust 4.2% last quarter.

Many have long-waited for the time when the economy picks up and the Federal Reserve raises interest rates along with it. Even the presidents of the St. Louis and Philadelphia Federal Banks recently said the nation’s central bank should raise interest rates sooner than expected thanks to job gains and slightly rising inflation.

But given muted inflation and the growing concerns in Europe — where the economy threatens to slip back into recession and central bankers are still slashing rates in a desperate attempt to jumpstart business activity in the region — Fed chair Janet Yellen was unlikely to act soon. And today’s Labor Department report, showing that only a modest 142,000 jobs were created in August, only reinforces this.

Jobs

The unemployment rate has already dropped more than half a percentage point this year.

US Unemployment Rate Chart

US Unemployment Rate data by YCharts

But that’s just one way to look at the labor market. Another is the labor force participation rate. Since younger Americans tend to go school, and Baby Boomers are beginning to retire en masse, you can look at the participation rate for workers between the ages of 25 to 54. Before the recession almost 80% of those Americans were working or looking for a job. Now, 77% are. To put that into perspective, 81% of prime aged workers in France participate in the labor force.

Another, more inclusive, employment metric is the so-called U-6 rate of unemployment — which includes unemployed workers, Americans who want to work but have stopped looking for a job, and part-time workers who’d rather put in full-time hours. The U-6 rate has dropped from about 17% after the recession to 12% now, but that’s still close to four percentage points higher than before 2008.

u-6

Here’s Yellen from her Jackson Hole speech a couple of weeks ago:

At nearly 5% of the labor force, the number of such workers is notably larger, relative to the unemployment rate, than has been typical historically, providing another reason why the current level of the unemployment rate may understate the amount of remaining slack in the labor market.

Inflation

Despite predictions of increased inflation thanks to unorthodox monetary policy, deflation has been a bigger concern since the recession than inflation. Nevertheless, some central bank officials are still worried about an unexpected rise in prices thanks to an improving jobs situation and want to head off that potential rise with higher interest rates.

As Philadelphia Fed President Charles Plosser said on a Bloomberg Radio interview, “I would rather us get started raising rates sooner and raise them more gradually than put them off and have to raise them very quickly.”

The Congressional Budget Office disagrees. The non-partisan agency predicted that over the next 10 years inflation will only rise around 2% a year, in a recent report. “CBO anticipates that prices will rise at a modest pace over the next several years reflecting slack in the economy and widely held expectations for low and stable inflation.”

Right now core inflation, according to the Federal Reserve’s preferred measurement, grew by 1.5% in July over the previous 12 months. That’s well below the Fed’s target rate of 2%.

Europe

Depressed Americans need only look across the pond to see how badly our recovery could be going. The Euro zone area experienced no growth in the second three months of 2014. Combine that with ultra-low inflation and you have the recipe for economic stagnation. Even the vaunted German economy stalled.

This three-year experience of little economic traction follows the European Central Bank’s decision to raise interest rates in 2011 during the sovereign debt crisis in order to fight inflation. Quash it they did. Prices recently rose by an annual rate of only 0.3% in August in the 18-country Euro zone, prompting ECB President Mario Draghi (who wasn’t in charge back then) to drop interest rates to an all-time low of 0.05%.

Eventually American consumers will see raises and go off and spend that extra cash. Demand will not stay depressed forever, and the Fed will one day raise interest rates. That decision, though, is more likely to be later than sooner.

MONEY

Job Report Misses Expectations, Fewest Jobs Added in 8 Months

The U.S. economy added only 142,000 jobs in August, the slowest employment growth in 8 months.

The economy added 142,000 jobs in August, substantially missing analyst expectations, according to the latest data from the Bureau of Labor Statistics. Economists had predicted another month of high employment gains, with estimates predicting that 225,000 positions would be added. Instead, the August hiring missed that number by almost 40% and signalled the lowest employment growth in eight months. Unemployment remained virtually static at 6.1%.

The report also showed the number of long-term unemployed persons declined by 192,000 to 3 million in August. This group currently makes up about a third of the overall unemployed population, but has declined by 1.3 million over the past year. The labor force participation rate — the percentage of workforce that is either employed or actively looking for work — remained mostly unchanged at 62.8%.

Friday’s numbers were a surprise considering recent economic growth.

One important question is how the Federal Reserve will interpret the report. As MONEY’s Taylor Tepper reports, Fed chair Janet Yellen has made stronger employment growth a core part of her monetary policy, and has signaled the Fed will raise interest rates only when slack in the labor market decreases. Slow job growth may convince the central bank to hold back on rate increases even longer and wait for further employment gains.

MONEY Jobs

If Jobs Are Back, Where’s My Raise?

Empty pockets of businessman
Dude, where's my raise? Jeffrey Coolidge—Getty Images

Despite good jobs numbers, wages aren't growing much. The reason why is the biggest debate in economics right now

Today’s strong jobless claims data, which show that applications for unemployment benefits dropped again, is one reason to be cheerful heading into the Labor Day weekend.

Yet despite this, and the fact that the unemployment rate is now down to 6.2%, the economy still has this glaring weak spot: Workers aren’t getting serious raises.

Here’s how two important measures of wage growth have done since the recession. (The Brookings Institution keeps a running tab of these and other key economic indicators in the excellent interactive graphic here.)

fredgraph

Basically, what you are seeing is that pay to workers, whether measured as hourly wages or salaries plus benefits, has been running neck-and-neck with inflation of a bit under 2%. As Fed chair Janet Yellen pointed out in her recent speech at a Fed symposium in Jackson Hole, Wyo., wages are also growing less than workers’ productivity.

Why is this happening? Yellen, for one, likely thinks there’s some remaining “slack” in the economy. Employers are still wary about whether there’s growing demand for their stuff, and so they remain slow to hire. The low unemployment figures leave out a large number of workers who have become discouraged after a long time out of work. But if the slack explanation is right, as companies continue to hire, more of those labor-force dropouts will be drawn back into the employment pool. You won’t see companies under serious pressure to raise wages until that process has played out and companies start competing for a scarcer pool of job-seekers.

Yellen points to (though doesn’t endorse) another possible explanation. Many economists believe wages are downwardly “sticky”—even when companies want to cut costs, they’d rather lay people off than reduce the pay of the people they hang onto. That means that for people who kept working after the recession, wages were higher than they’d otherwise be. And now that the economy is (fitfully) coming back, maybe that means there’s also less room for wages to rise.

Another factor, of course, is that both corporate managers and workers are human, and people can take some time to adjust to new economic signals. Back in July, I sat down with a stock fund manager, who talked about what he was seeing going on at the companies he kept in touch with. More than five years after the financial crisis, he said, the corporate culture among top managers had changed. The people in the C-suite got their positions not by expanding their companies and finding great new hires, but by cutting costs. And they got used to a slack labor market. The manager used the specific example of truckers: You always know you can get a guy to drive a truck from your warehouse to your customer on a moment’s notice. So why worry about hiring more truckers?

As it happens, at the New York Times Upshot blog earlier this month, Neil Irwin wrote that this may be changing. A trucking company called Swift told investors it was having hard time finding enough drivers. The company says the problem is that there aren’t enough skilled people, but Irwin wonders if the problem is really that companies just aren’t paying enough. Trucker pay has fallen, in real terms, over the past decade. Irwin writes:

The most basic of economic theories would suggest that when supply isn’t enough to meet demand, it’s because the price—in this case, truckers’ wages—is too low. Raise wages, and an ample supply of workers should follow…. But corporate America has become so parsimonious about paying workers outside the executive suite that meaningful wage increases may seem an unacceptable affront.

The question now is, how strong does the economy have to get before employers are forced to change their thinking?

Related:
If You’re Looking for Work, the Outlook is Brightening
Why the Fed Won’t Care About Higher Prices Until You Get a Real Raise
What’s the Deal With America’s Declining Workforce?

MONEY

Don’t Worry About Inflation Yet, Say Economists

A group of 257 economists say the Federal Reserve is right to keep interest rates low.

A new study shows economists believe the Federal Reserve is doing the right thing by keeping interest rates low.

According to the August Economic Policy Survey, published semiannually by the National Association for Business Economics, 53% of the association’s 257 members said monetary policy was on the right track, while only 39% felt policy was too stimulative.

There has been concern from some quarters that the Fed’s consistently low rates are flooding the market with cheap credit, pushing up the cost of goods. Inflation already appears to have reached the Federal Reserve’s target of 2%, and some, like Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott, think the central bank must act far in advance to prevent prices from rising too quickly.

The Fed has countered that employment and the real estate market must recover further—neither area is back to pre-recession levels—before upping interest rates becomes a viable option. Raising rates while the economy is still weak has the potential to stall GDP growth if businesses once again become reluctant invest money in jobs and capital. MONEY’s Taylor Tepper previously explained how Sweden’s premature interest rate hike has put the brakes on what was once Europe’s most encouraging economic comeback.

For now, at least, economists at the NABE seem to have taken the Federal Reserve’s side.

“Most panelists do not see inflation being a major concern in the coming years,” said Peter Evans, chair of the NABE Policy Survey Committee. “The majority of NABE panelists believe that inflation will be at or near 2% in 5 years.”

However, that support may not be permanent. Evans says the central bank’s approval rating inside NABE has edged downward since last year. All eyes remain on the Fed as it gradually winds down its quantitative easing program and watches the job market for signs of improvement. If inflation picks up, the bank may have to act—or risk a much less favorable approval rating from experts 12 months from now.

MONEY Federal Reserve

The Big Takeaway From Yellen’s Speech. It’s About Jobs

At Jackson Hole, Yellen is greeted by demonstrators who want the Fed to push for more jobs John Locher—AP

Fed Chairman Janet Yellen says the weak economy has room to improve. But many Americans may never get back to work.

Federal Reserve chairm Janet Yellen gave a much-anticipated speech at the Fed’s annual Jackson Hole, Wyo. symposium Friday. The transcript isn’t exactly beach reading. Fed officials, wary of spooking antsy stock and bond traders, can be almost maddeningly obscure. But anyone who’s following the stock market — or looking for a job — should pay attention.

Five years after the financial crisis, the Federal Reserve is still taking extraordinary measures to prop up the economy, including buying up bonds and holding interest rates near zero. Those measures can spur growth as long as the economy isn’t running at full capacity. But once it is, the fear is that they can spur too much inflation.

Officials at the Fed, including the presidents of the regional banks and members of the committee that sets rates, are split into two broad camps. Inflation “hawks” believe it’s time to start weaning the economy from aid. “Doves” favor continued intervention. Earlier this week the release of the minutes of a Fed meeting in late July showed the hawks pressing their point, emphasizing that the economy was improving and raising questions about whether the much-anticipated return to normal interest rates should begin.

Yellen is widely considered a dove. That means on Friday Fed watchers were looking for signs she might be trying to rebut the argument that the economy is running near full tilt. In the event, she seemed to give ammunition to both hawks and doves.

Here are the speech’s highlights:

Yellen starts off both cheering the recovery and reminding us how far we may still have to go.

The unemployment rate, at 6.2 percent in July, has declined nearly 4 percentage points from its late 2009 peak. Over the past year, the unemployment rate has fallen considerably, and at a surprisingly rapid pace. These developments are encouraging, but it speaks to the depth of the damage that, five years after the end of the recession, the labor market has yet to fully recover.

That’s pretty dovish.

But in the bulk of her speech she explains reasons why it’s hard to get a read on the labor market, starting with the fact so many people have been out of work for so long.

Consider first the behavior of the labor force participation rate, which has declined substantially since the end of the recession even as the unemployment rate has fallen. As a consequence, the employment-to-population ratio has increased far less over the past several years than the unemployment rate alone would indicate, based on past experience. For policymakers, the key question is: What portion of the decline in labor force participation reflects structural shifts and what portion reflects cyclical weakness in the labor market?

That’s subtly hawkish. Here’s why: Usually, when the unemployment rate falls more people start looking for work. This time that hasn’t happened to the extent one might expect. The worry is, if there’s a big group of workers who just aren’t going to come back into the work force—because they are just too discouraged, or they don’t have the skills for the current jobs on offer, or maybe because they’ve been replaced by new technology—then maybe there isn’t as much “slack” in the economy as the low participation numbers suggest. Even with a comparatively high number of people working, employers could start to feel pressure to raise wages (creating inflationary pressures) to attract and retain the workers who’ve stayed in the labor force.

Yellen doesn’t answer whether this “structural” worry is justified, but she does flesh out the problem further.

….the rapid pace of retirements over the past few years might reflect some degree of pull-forward of future retirements in the face of a weak labor market.

Translation: Many baby boomers who lost their jobs may simply have decided to retire, rather than seek to reboot their careers.

But then Yellen goes a bit dovish again. She points out that wage growth has in fact been sluggish. That suggests at least some extra slack.

Over the past several years, wage inflation, as measured by several different indexes, has averaged about 2 percent, and there has been little evidence of any broad-based acceleration in either wages or compensation.

In other words, the Fed is still playing wait-and-see. For investors, that suggests more of the fairly bullish status quo: low rates and a slow unwinding of the “quantitative easing” bond-buying program. For people hoping for the job market to come roaring back, the Yellen’s speech sounds a somewhat discouraging note. It suggests that the economy could have shifted into a permanently slower mode, with fewer jobs. Or, at any rate, that there are many at the Fed who are willing to live with that to ensure inflation stays low.

MONEY The Consumer Economy

The Real Reason You’re Not Shopping at Walmart

Female shopper in Wal-Mart store aisle
Patrick T. Fallon—Bloomberg via Getty Images

Despite the improving job market, workers still don’t have that much walking around cash, which means they have less to spend at retailers.

The summer has not been kind to some of America’s largest retailers.

Traffic at Wal-Mart’s U.S. locations, for instance, was down, while sales at stores that had been open for at least a year failed to grow. Macy’s lowered its full-year sales growth projection, and sales at Kohl’s dropped 1.3% in the last three months. Nordstrom’s earnings per share were basically flat.

If you’re noticing a trend, that’s because there is one: Merchants are struggling.

The Commerce Department recently announced that retail sales decelerated in July for the fourth consecutive month, despite the fact that more workers are finding jobs, and the unemployment rate is hovering around 6%. So what’s going on?

Well, one potential answer is that you, the consumer, just don’t have that money to spend. Yes, employers have added more than 200,000 workers a month to their payrolls since February. And yes, the unemployment rate has dropped to 6.2%—about the same as in September 2008. But workers really haven’t seen the benefits of job growth in their bottom lines.

For instance, take a look at real disposable income for U.S. workers. The year-over-year change in disposable income is only 3.9%, below pre-recession levels. “While stronger job growth has played a role in sustaining consumer spending, the slower income growth has served to keep a lid on real spending activity over the past several quarters,” per a recent Wells Fargo Securities economic report.

disposable income

 

Another way to gauge the plight of workers is a metric called the Employment Cost Index (ECI), which is published by the Bureau of Labor Statistics. The ECI measures what it costs businesses to actually employ their workers—so, wages, salaries and fringe benefits like medical care. Before the Great Recession struck in 2007, the ECI gained nearly 3.5% over the prior 12 months. Since the economic recovery, however, employee costs have not risen above 2%.

wages
BLS

Rising wages are a lagging indicator; people only see raises after the jobs picture improves. Which is happening now. Fewer people are filing unemployment claims, and the number of job openings continues to nudge higher. (And traditionally, job openings have an inverse relationship with wage gains.)

So, hopefully, sometime soon demand will pick up, businesses will start giving their workers substantial raises, and those workers will go out and spend their newfound dollars. (After all, my spending is your income.)

What’s good for the economy is sometimes what’s good for Wal-Mart.

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