Trees are growing faster and could buy time to halt global warming. By Urmee Khan
The Telegraph, Apr 06. 2009, 9:01AM BST
The phenomenon has been discovered in a variety of flora, ranging from tropical rainforests to British sugar beet crops.
It means they are soaking up at least some of the billions of tons of CO2 released into the atmosphere by humans that would otherwise be accelerating the rate of climate change.Plants survive by extracting CO2 from the air and using sunlight to convert it into proteins and sugars.
Since 1750 the concentration in the air has risen from of CO2 278 parts per million (ppm) to more than 380 ppm, making it easier for plants to acquire the CO2 needed for rapid growth.
A study by the University of Leeds, published in the science journal Nature, measured the girth of 70,000 trees across 10 African countries and compared them with similar records made four decades ago.
On average, the trees were getting bigger faster and researchers found that each hectare of African forest was trapping an extra 0.6 tons of CO2 a year compared with the 1960s.
If this is replicated across the world's tropical rainforests they would be removing nearly 5 billion tons of CO2 a year from the atmosphere.
Scientists have been looking for a similar impact on crop yields and the experiments generally suggest that raised CO2 levels would boost the yields of mainstream crops, such as maize, rice and soy, by about 13 per cent.
Professor Martin Parry, head of plant science at Rothamsted Research, Britain's leading crop institute, said: "There is no doubt that the enrichment of the air with CO2 is increasing plant growth rates in many areas.
"The problem is that humans are releasing so much that plants can remove only a fraction of it," he said.
Humans are believed to generate about 50 billion tons of the gas each year.
However, scientists have warned against drawing false comfort from such findings. They point out that although levels will boost plant growth, other factors associated with climate change, such as rising temperatures and drought, are likely to have a negative effect.
Fred Pearce, environment consultant for New Scientist, said: "We know that trees do absorb carbon dioxide from the atmosphere and about half is taken up from nature and half of that is by forests. But it doesn't change the story greenhouse gases are accumulating more than 2 per cent a year.
"It won't buy us much time as humans are releasing much more CO2 into the air, but it is useful information if it helps to protect existing forests."
Monday, April 6, 2009
The Chairman of the Joint Chiefs of Staff on the nuclear threat from Tehran
Warnings on Iran. WSJ Editorial
The Chairman of the Joint Chiefs of Staff on the nuclear threat from Tehran.
WSJ, Apr 06, 2009
Benjamin Netanyahu formally became Israel's Prime Minister last week, and he could not have been blunter about the strategic challenge ahead: "It is a mark of disgrace for humanity that several decades after the Holocaust the world's response to the calls by Iran's leader to destroy the state of Israel is weak, there is no condemnation and decisive measures -- almost as if dismissed as routine." He added, "We cannot afford to take lightly megalomaniac tyrants who threaten to annihilate us."
Americans in key positions have noticed this Israeli message. In a meeting Thursday at the Journal, Admiral Mike Mullen, the Chairman of the Joint Chiefs of Staff, told us that "there is a leadership in Israel that is not going to tolerate" a nuclear Iran. Tehran's atomic designs, he said, were a matter of "life or death" for the Jewish state. "The operative word is 'existential.'" When we asked him whether Israel was capable of inflicting meaningful damage to Iran's nuclear installations, his answer was a simple "Yes."
The Admiral was also clear about Iran's challenge to the U.S. "I think we've got a problem now. . . . I think the Iranians are on a path to building nuclear weapons." For the time being his counsel is diplomacy, noting that "Even in the darkest days of the Cold War we talked to the Soviets." But, he added, "we don't have a lot of time."
If Israel decides to strike Iran the consequences -- intended and unintended -- will be felt far and wide, including in Iraq where, Admiral Mullen says, Iran's ability to cause mayhem "has not maxed out at all." We thought readers might like to know how the Chairman sees the threat, and how well he appreciates Israel's peril.
The Chairman of the Joint Chiefs of Staff on the nuclear threat from Tehran.
WSJ, Apr 06, 2009
Benjamin Netanyahu formally became Israel's Prime Minister last week, and he could not have been blunter about the strategic challenge ahead: "It is a mark of disgrace for humanity that several decades after the Holocaust the world's response to the calls by Iran's leader to destroy the state of Israel is weak, there is no condemnation and decisive measures -- almost as if dismissed as routine." He added, "We cannot afford to take lightly megalomaniac tyrants who threaten to annihilate us."
Americans in key positions have noticed this Israeli message. In a meeting Thursday at the Journal, Admiral Mike Mullen, the Chairman of the Joint Chiefs of Staff, told us that "there is a leadership in Israel that is not going to tolerate" a nuclear Iran. Tehran's atomic designs, he said, were a matter of "life or death" for the Jewish state. "The operative word is 'existential.'" When we asked him whether Israel was capable of inflicting meaningful damage to Iran's nuclear installations, his answer was a simple "Yes."
The Admiral was also clear about Iran's challenge to the U.S. "I think we've got a problem now. . . . I think the Iranians are on a path to building nuclear weapons." For the time being his counsel is diplomacy, noting that "Even in the darkest days of the Cold War we talked to the Soviets." But, he added, "we don't have a lot of time."
If Israel decides to strike Iran the consequences -- intended and unintended -- will be felt far and wide, including in Iraq where, Admiral Mullen says, Iran's ability to cause mayhem "has not maxed out at all." We thought readers might like to know how the Chairman sees the threat, and how well he appreciates Israel's peril.
Ukraine Powers Chinese Carriers
Ukraine Powers Chinese Carriers
Strategy Page, April 6, 2009
China is working closely with Ukraine to supply key components for the aircraft carriers China is building. Ukraine supplied many components for Russian carriers back in the days of the Soviet Union (which Ukraine was a part of). Now independent, Ukraine is eager to find customers for local manufacturers that can produce carrier components. Russia is no longer building carriers, despite talk of restarting that program.
Last year, Chinese officials visited Ukraine and inspected the naval aviation training facilities that were built there before the Soviet Union dissolved. Ukraine wants to use those facilities to establish an international center for training carrier aviators.
A major Ukrainian product the Chinese are interested in are ship engines, especially the large ones a carrier would require. Chinese gas turbines are not all that efficient and reliable. The Ukrainian UGT-16000 and UGT-25000 turbines, developed from the DT-59 they have been making since 1975, are major competitors for General Electric models used in large ships. Ukrainian firms build a number of other world class components for large ships, and China is looking to acquire equipment, and technology. Ukraine is aware of the fact that the Chinese steal technology, but right now Ukraine needs the business, and China needs the turbines.
Strategy Page, April 6, 2009
China is working closely with Ukraine to supply key components for the aircraft carriers China is building. Ukraine supplied many components for Russian carriers back in the days of the Soviet Union (which Ukraine was a part of). Now independent, Ukraine is eager to find customers for local manufacturers that can produce carrier components. Russia is no longer building carriers, despite talk of restarting that program.
Last year, Chinese officials visited Ukraine and inspected the naval aviation training facilities that were built there before the Soviet Union dissolved. Ukraine wants to use those facilities to establish an international center for training carrier aviators.
A major Ukrainian product the Chinese are interested in are ship engines, especially the large ones a carrier would require. Chinese gas turbines are not all that efficient and reliable. The Ukrainian UGT-16000 and UGT-25000 turbines, developed from the DT-59 they have been making since 1975, are major competitors for General Electric models used in large ships. Ukrainian firms build a number of other world class components for large ships, and China is looking to acquire equipment, and technology. Ukraine is aware of the fact that the Chinese steal technology, but right now Ukraine needs the business, and China needs the turbines.
WSJ Editorial Page on North Korea's Launch: The condemnations will probably soon become concessions
The Song of Kim Jong Il. WSJ Editorial
The condemnations will probably soon become concessions.
WSJ, Apr 06, 2009
A few hours after the launch Sunday of a long-range multistage rocket, North Korea's state media proclaimed that a communications satellite was in orbit and transmitting "immortal revolutionary paeans" back to Earth. The U.S. military, which apparently had trouble tuning in the "Song of General Kim Il Sung," announced that the satellite had fallen into the Pacific somewhere between Japan and Hawaii.
The technology may have failed to put a satellite into space, but North Korea's launch has succeeded in getting the world's attention. Most of the civilized world spent yesterday denouncing dictator Kim Jong Il's latest provocation, which violated a United Nations Security Council resolution barring the North from testing ballistic missile technology. However, if the international response keeps with past practice, the condemnations will soon give way to concessions. No wonder Kim keeps launching missiles.
The launch was a success, too, as a global advertisement to those in the market for vehicles to deliver weapons of mass destruction. That includes the North's No. 1 customer, Iran, which in February launched a small satellite thanks in part to North Korean missile technology. Iranian observers were reportedly on hand over the weekend at the launch site.
Sunday's fizzle doesn't mean the North didn't learn anything useful for the future of its long-range ballistic missile program. As learning tools, failures can be more instructive than successes, and the Taepodong-2 missile under development has the potential to reach the U.S. West Coast.
Pyongyang's action ought to prompt the Obama Administration to advance the fledgling missile defense system started by President Bush. Instead, the White House reportedly has told the Pentagon to cut spending on missile defense by $2 billion, or about 20%. Defense Secretary Robert Gates is expected to announce these and other budget cuts today.
Programs in jeopardy include the Airborne Laser, a modified 747 designed to take out ballistic missiles seconds after liftoff; expansion of the ground-based interceptor program in Alaska and California; and space-based missile surveillance and tracking. All three are part of the vision for a layered defense, in which the U.S. has several chances to destroy incoming missiles. The Obama Administration has already indicated it wants to go slow in building the "third site," the Europe-based radar and interceptors that would provide another layer of defense from Iranian missiles for the U.S. East Coast.
In 2006, Mr. Bush and Secretary of State Condoleezza Rice squandered the moment after the North's nuclear test when China was ready to apply serious pressure. Instead, they bought Kim's promise to give up his weapons, then let him delay and renegotiate the terms as he went, including agreeing to Kim's demand to take North Korea off the U.S. list of terror-sponsoring nations. Now he's playing the same brinksmanship with the Obama Administration.
This is Mr. Obama's chance to do better. But based on his comments during the campaign, as well as his statement yesterday urging renewed efforts through the Six Party Talks, the President seems unlikely to change course. Kim has every reason to expect that he will eventually get what he wants -- more recognition, more money and energy supplies from the U.S., China and South Korea, and a high likelihood that he'll get to keep his nukes and missiles too.
The condemnations will probably soon become concessions.
WSJ, Apr 06, 2009
A few hours after the launch Sunday of a long-range multistage rocket, North Korea's state media proclaimed that a communications satellite was in orbit and transmitting "immortal revolutionary paeans" back to Earth. The U.S. military, which apparently had trouble tuning in the "Song of General Kim Il Sung," announced that the satellite had fallen into the Pacific somewhere between Japan and Hawaii.
The technology may have failed to put a satellite into space, but North Korea's launch has succeeded in getting the world's attention. Most of the civilized world spent yesterday denouncing dictator Kim Jong Il's latest provocation, which violated a United Nations Security Council resolution barring the North from testing ballistic missile technology. However, if the international response keeps with past practice, the condemnations will soon give way to concessions. No wonder Kim keeps launching missiles.
The launch was a success, too, as a global advertisement to those in the market for vehicles to deliver weapons of mass destruction. That includes the North's No. 1 customer, Iran, which in February launched a small satellite thanks in part to North Korean missile technology. Iranian observers were reportedly on hand over the weekend at the launch site.
Sunday's fizzle doesn't mean the North didn't learn anything useful for the future of its long-range ballistic missile program. As learning tools, failures can be more instructive than successes, and the Taepodong-2 missile under development has the potential to reach the U.S. West Coast.
Pyongyang's action ought to prompt the Obama Administration to advance the fledgling missile defense system started by President Bush. Instead, the White House reportedly has told the Pentagon to cut spending on missile defense by $2 billion, or about 20%. Defense Secretary Robert Gates is expected to announce these and other budget cuts today.
Programs in jeopardy include the Airborne Laser, a modified 747 designed to take out ballistic missiles seconds after liftoff; expansion of the ground-based interceptor program in Alaska and California; and space-based missile surveillance and tracking. All three are part of the vision for a layered defense, in which the U.S. has several chances to destroy incoming missiles. The Obama Administration has already indicated it wants to go slow in building the "third site," the Europe-based radar and interceptors that would provide another layer of defense from Iranian missiles for the U.S. East Coast.
In 2006, Mr. Bush and Secretary of State Condoleezza Rice squandered the moment after the North's nuclear test when China was ready to apply serious pressure. Instead, they bought Kim's promise to give up his weapons, then let him delay and renegotiate the terms as he went, including agreeing to Kim's demand to take North Korea off the U.S. list of terror-sponsoring nations. Now he's playing the same brinksmanship with the Obama Administration.
This is Mr. Obama's chance to do better. But based on his comments during the campaign, as well as his statement yesterday urging renewed efforts through the Six Party Talks, the President seems unlikely to change course. Kim has every reason to expect that he will eventually get what he wants -- more recognition, more money and energy supplies from the U.S., China and South Korea, and a high likelihood that he'll get to keep his nukes and missiles too.
Obama's NK Reaction: More Talks
Obama's NK Reaction: More Talks. By John Bolton
The president sends the wrong messages to Israel and Iran.
WSJ, Apr 06, 2009
Prior to North Korea's launch yesterday of a Taepodong-2 ballistic missile, President Barack Obama declared that such an action would be "provocative." This public statement was an attempt to reinforce the administration's private efforts to urge the Democratic Peoples' Republic of Korea (DPRK) not to fire the missile.
That effort failed, as have countless other attempts to deal softly with Pyongyang. Incredibly, U.S. Special Envoy for North Korea Stephen Bosworth revealed -- just a few days before the launch -- that he was ready to visit Pyongyang and resume the six-party talks once the "dust from the missiles settles." It is no wonder the North fired away.
Once the missile shot was complete, the administration's answer was hand-wringing, more rhetoric and, oh yes, the obligatory trip to the U.N. Security Council so that it could scold the defiant DPRK. Beyond whatever happens in the Security Council, Mr. Obama seems to have no plan whatever.
In 2006, when Pyongyang last lit off a volley of missiles and then exploded a nuclear device, the Security Council responded unanimously with Resolutions 1695 and 1718, which imposed extensive military and some economic sanctions. Unfortunately, the impact of these resolutions was dramatically undercut by subsequent Bush administration diplomacy, which effectively let North Korea off the hook. By re-engaging Pyongyang diplomatically rather than increasing the external pressure, George W. Bush relegitimized the North and gave it yet more time to bargain.
Yesterday's launch is attributable to prior failures, but the global consequences now unfolding are Mr. Obama's responsibility. In fact, Secretary of Defense Robert Gates is expected to announce today deep cuts in the U.S. missile defense program, an extraordinarily ill-advised step.
The initial draft Security Council resolution responding to yesterday's missile launch, written by Japan and the U.S., is weak. It essentially only reaffirms Resolutions 1695 and 1718, and minimally tightens existing enforcement mechanisms. Moreover, China and Russia made it plain before the launch they had no interest in stricter sanctions -- even arguing with a straight face that Pyongyang was only interested in peaceful satellite communications.
What the Security Council will ultimately produce is of course uncertain -- but resolutions almost never get tougher as the drafting and negotiations proceed. Even worse than a weak resolution would be a "presidential statement," a toothless gesture of the Council's opinion. Either way, North Korea has again defied the Security Council, gotten away with its launch with the support of Russia and China, and now will likely confront only pleas by Mr. Obama and others to return to the six-party talks.
Those talks are exactly where North Korea wants to be. From them ever greater material and political benefits will flow to Pyongyang, in exchange for ever more hollow promises to dismantle its nuclear program.
So far, therefore, the missile launch is an unambiguous win for North Korea. (Although not orbiting a satellite, all three rocket stages apparently fired, achieving Pyongyang's longest missile flight yet.) But the negative repercussions will extend far beyond Northeast Asia.
Iran has carefully scrutinized the Obama administration's every action, and Tehran's only conclusion can be: It is past time to torque up the pressure on this new crowd in Washington. Not only is Iran's back now covered by its friends Russia, China and others on the U.N. Security Council, but it sees an American president so ready to bend his knee for public favor in Europe that the mullahs' wish list for U.S. concessions will grow by the minute.
Israel must also be carefully considering how the U.S. watched North Korea rip through "the international community." The most important lesson the new government headed by Prime Minister Benjamin Netanyahu should draw is: Look out for No. 1. If Israel isn't prepared to protect itself, including using military force, against Iran's nuclear weapons program, it certainly shouldn't be holding its breath for Mr. Obama to do anything.
Russia and China must also be relishing this outcome. They will have faced down Mr. Obama in his first real crisis, having provided Security Council cover for a criminal regime, and emerged unscathed. They will conclude that achieving their large agendas with the new administration can't be too hard. That conclusion may be unfair to the new American president; but it will surely color how Moscow and Beijing structure their policies and their diplomacy until proven otherwise. That alone is bad news for Washington and its allies.
Mr. Bolton, a senior fellow at the American Enterprise Institute, is the author of "Surrender Is Not an Option: Defending America at the United Nations and Abroad" (Simon & Schuster, 2007).
The president sends the wrong messages to Israel and Iran.
WSJ, Apr 06, 2009
Prior to North Korea's launch yesterday of a Taepodong-2 ballistic missile, President Barack Obama declared that such an action would be "provocative." This public statement was an attempt to reinforce the administration's private efforts to urge the Democratic Peoples' Republic of Korea (DPRK) not to fire the missile.
That effort failed, as have countless other attempts to deal softly with Pyongyang. Incredibly, U.S. Special Envoy for North Korea Stephen Bosworth revealed -- just a few days before the launch -- that he was ready to visit Pyongyang and resume the six-party talks once the "dust from the missiles settles." It is no wonder the North fired away.
Once the missile shot was complete, the administration's answer was hand-wringing, more rhetoric and, oh yes, the obligatory trip to the U.N. Security Council so that it could scold the defiant DPRK. Beyond whatever happens in the Security Council, Mr. Obama seems to have no plan whatever.
In 2006, when Pyongyang last lit off a volley of missiles and then exploded a nuclear device, the Security Council responded unanimously with Resolutions 1695 and 1718, which imposed extensive military and some economic sanctions. Unfortunately, the impact of these resolutions was dramatically undercut by subsequent Bush administration diplomacy, which effectively let North Korea off the hook. By re-engaging Pyongyang diplomatically rather than increasing the external pressure, George W. Bush relegitimized the North and gave it yet more time to bargain.
Yesterday's launch is attributable to prior failures, but the global consequences now unfolding are Mr. Obama's responsibility. In fact, Secretary of Defense Robert Gates is expected to announce today deep cuts in the U.S. missile defense program, an extraordinarily ill-advised step.
The initial draft Security Council resolution responding to yesterday's missile launch, written by Japan and the U.S., is weak. It essentially only reaffirms Resolutions 1695 and 1718, and minimally tightens existing enforcement mechanisms. Moreover, China and Russia made it plain before the launch they had no interest in stricter sanctions -- even arguing with a straight face that Pyongyang was only interested in peaceful satellite communications.
What the Security Council will ultimately produce is of course uncertain -- but resolutions almost never get tougher as the drafting and negotiations proceed. Even worse than a weak resolution would be a "presidential statement," a toothless gesture of the Council's opinion. Either way, North Korea has again defied the Security Council, gotten away with its launch with the support of Russia and China, and now will likely confront only pleas by Mr. Obama and others to return to the six-party talks.
Those talks are exactly where North Korea wants to be. From them ever greater material and political benefits will flow to Pyongyang, in exchange for ever more hollow promises to dismantle its nuclear program.
So far, therefore, the missile launch is an unambiguous win for North Korea. (Although not orbiting a satellite, all three rocket stages apparently fired, achieving Pyongyang's longest missile flight yet.) But the negative repercussions will extend far beyond Northeast Asia.
Iran has carefully scrutinized the Obama administration's every action, and Tehran's only conclusion can be: It is past time to torque up the pressure on this new crowd in Washington. Not only is Iran's back now covered by its friends Russia, China and others on the U.N. Security Council, but it sees an American president so ready to bend his knee for public favor in Europe that the mullahs' wish list for U.S. concessions will grow by the minute.
Israel must also be carefully considering how the U.S. watched North Korea rip through "the international community." The most important lesson the new government headed by Prime Minister Benjamin Netanyahu should draw is: Look out for No. 1. If Israel isn't prepared to protect itself, including using military force, against Iran's nuclear weapons program, it certainly shouldn't be holding its breath for Mr. Obama to do anything.
Russia and China must also be relishing this outcome. They will have faced down Mr. Obama in his first real crisis, having provided Security Council cover for a criminal regime, and emerged unscathed. They will conclude that achieving their large agendas with the new administration can't be too hard. That conclusion may be unfair to the new American president; but it will surely color how Moscow and Beijing structure their policies and their diplomacy until proven otherwise. That alone is bad news for Washington and its allies.
Mr. Bolton, a senior fellow at the American Enterprise Institute, is the author of "Surrender Is Not an Option: Defending America at the United Nations and Abroad" (Simon & Schuster, 2007).
Aid Keeps Latin America Poor - For real progress, they need the means to accumulate wealth
Aid Keeps Latin America Poor. By Mary Anastasia O'Grady
For real progress, they need the means to accumulate wealth.
WSJ, Apr 06, 2009
Excerpts:
[...]
U.S. Treasury Secretary Tim Geithner has a lot on his plate these days with the banking system on life-support, the economy in recession, and his office in charge of running the master plan to patch up the whole mess.
Still, President Barack Obama's top fix-it man managed to jet down to Medellin, Colombia, a week ago for the Inter-American Development Bank's (IDB) general assembly. His big contribution was to get behind a proposal to nearly triple the development bank's capital.
By supporting the bureaucratic status quo in Latin America, Mr. Geithner strengthens himself politically. All hail the Obama administration's first-string hurler, a man who never meets a problem that can't be solved by throwing more money around. But back in the real world, the expansion of the already menacing IDB is grim news for the serfs who toil in the feudal Latin American systems that the bank calls its "clients."
Drawing on the wisdom of Orwell, this is a good time to repeat what is already manifest: Latin America remains poor and backward not despite multilateral "assistance" but, in a large part, because of it. The IDB has been going at the problem of poverty in Latin America since 1959, but it hasn't acted alone. In the postwar period the World Bank, the International Monetary Fund and untold bilateral agencies have blanketed the region with aid. World-wide foreign aid has boomed. According to the Organization for Economic Cooperation and Development, "in 2008, total net official development assistance (ODA) from members of the OECD's Development Assistance Committee (DAC) rose by 10.2% in real terms to USD 119.8 billion. This is the highest dollar figure ever recorded."
Does it follow that poverty persists because the amounts have been just too measly to do the job? It does for Mr. Geithner and the foreign-aid brigades. But rather than rely on those with vested interests, it's more useful to look at the empirical evidence. A 2006 paper titled "Foreign Aid, Income Inequality and Poverty," from the research department of the IDB itself, looked at the period 1971-2002 and found "some weak evidence that foreign aid is conducive to the improvement of the distribution of income [sic]. When the quality of institutions is taken into account, however, this result is not robust. This finding is consistent with recent empirical research on aid ineffectiveness in achieving economic growth or promoting democratic institutions."
So now that we know it doesn't work, Mr. Geithner wants more of it. This is what the late, great development economist Peter Lord Bauer called "the disregard of reality." In a 1987 essay in the Cato Journal, he called the claim that poverty is a trap that cannot be escaped without external aid an "obvious conflict with simple reality." "All developed countries began as underdeveloped," Bauer wrote. "If the notion of the vicious circle were valid, mankind would still be in the Stone Age at best."
Bauer spent a lifetime studying development. In 1972 he published "Dissent on Development" sharply criticizing aid for its focus on "symptoms and effects" of poverty while "divert[ing] attention from the determinants of development." For Bauer, foreign aid was not just a waste of money; it worked against getting things right in those areas that really matter to progress. Those "determinants" are now widely acknowledged, even by researchers at the World Bank. They produce an annual "Doing Business" survey that looks at the regulatory burden in 181 countries and points out the critical link between economically free people and prosperity.
In a recent book titled "Lessons From the Poor" about successful entrepreneurs in the developing world, researcher Alvaro Vargas Llosa echoes these insights. "The decisive element" in bringing a society out of poverty is "the development of the entrepreneurial reserves that exist in its men and women," Mr. Vargas Llosa writes. "The institutions that grant more freedom to their citizens and more security to their citizens' possessions are those that best facilitate the accumulation of wealth."
It is obvious that economic liberty and property rights are the key drivers of development, and that there is no correlation between the volume of foreign aid a country receives and its respect for these values. Yet what is more troubling is the IDB's reputation for working against liberalization in the region, most notoriously, against the flat tax. With its institutional checkbook it easily overpowers civic groups that try to limit the power of government. In doing so it promotes neither development nor just societies.
For real progress, they need the means to accumulate wealth.
WSJ, Apr 06, 2009
Excerpts:
[...]
U.S. Treasury Secretary Tim Geithner has a lot on his plate these days with the banking system on life-support, the economy in recession, and his office in charge of running the master plan to patch up the whole mess.
Still, President Barack Obama's top fix-it man managed to jet down to Medellin, Colombia, a week ago for the Inter-American Development Bank's (IDB) general assembly. His big contribution was to get behind a proposal to nearly triple the development bank's capital.
By supporting the bureaucratic status quo in Latin America, Mr. Geithner strengthens himself politically. All hail the Obama administration's first-string hurler, a man who never meets a problem that can't be solved by throwing more money around. But back in the real world, the expansion of the already menacing IDB is grim news for the serfs who toil in the feudal Latin American systems that the bank calls its "clients."
Drawing on the wisdom of Orwell, this is a good time to repeat what is already manifest: Latin America remains poor and backward not despite multilateral "assistance" but, in a large part, because of it. The IDB has been going at the problem of poverty in Latin America since 1959, but it hasn't acted alone. In the postwar period the World Bank, the International Monetary Fund and untold bilateral agencies have blanketed the region with aid. World-wide foreign aid has boomed. According to the Organization for Economic Cooperation and Development, "in 2008, total net official development assistance (ODA) from members of the OECD's Development Assistance Committee (DAC) rose by 10.2% in real terms to USD 119.8 billion. This is the highest dollar figure ever recorded."
Does it follow that poverty persists because the amounts have been just too measly to do the job? It does for Mr. Geithner and the foreign-aid brigades. But rather than rely on those with vested interests, it's more useful to look at the empirical evidence. A 2006 paper titled "Foreign Aid, Income Inequality and Poverty," from the research department of the IDB itself, looked at the period 1971-2002 and found "some weak evidence that foreign aid is conducive to the improvement of the distribution of income [sic]. When the quality of institutions is taken into account, however, this result is not robust. This finding is consistent with recent empirical research on aid ineffectiveness in achieving economic growth or promoting democratic institutions."
So now that we know it doesn't work, Mr. Geithner wants more of it. This is what the late, great development economist Peter Lord Bauer called "the disregard of reality." In a 1987 essay in the Cato Journal, he called the claim that poverty is a trap that cannot be escaped without external aid an "obvious conflict with simple reality." "All developed countries began as underdeveloped," Bauer wrote. "If the notion of the vicious circle were valid, mankind would still be in the Stone Age at best."
Bauer spent a lifetime studying development. In 1972 he published "Dissent on Development" sharply criticizing aid for its focus on "symptoms and effects" of poverty while "divert[ing] attention from the determinants of development." For Bauer, foreign aid was not just a waste of money; it worked against getting things right in those areas that really matter to progress. Those "determinants" are now widely acknowledged, even by researchers at the World Bank. They produce an annual "Doing Business" survey that looks at the regulatory burden in 181 countries and points out the critical link between economically free people and prosperity.
In a recent book titled "Lessons From the Poor" about successful entrepreneurs in the developing world, researcher Alvaro Vargas Llosa echoes these insights. "The decisive element" in bringing a society out of poverty is "the development of the entrepreneurial reserves that exist in its men and women," Mr. Vargas Llosa writes. "The institutions that grant more freedom to their citizens and more security to their citizens' possessions are those that best facilitate the accumulation of wealth."
It is obvious that economic liberty and property rights are the key drivers of development, and that there is no correlation between the volume of foreign aid a country receives and its respect for these values. Yet what is more troubling is the IDB's reputation for working against liberalization in the region, most notoriously, against the flat tax. With its institutional checkbook it easily overpowers civic groups that try to limit the power of government. In doing so it promotes neither development nor just societies.
Sitting on evidence of voucher success, and the battle of New York
Democrats and Poor Kids. WSJ Editorial
Sitting on evidence of voucher success, and the battle of New York.
WSJ, Apr 06, 2009
Education Secretary Arne Duncan did a public service last week when he visited New York City and spoke up for charter schools and mayoral control of education. That was the reformer talking. The status quo Mr. Duncan was on display last month when he let Congress kill a District of Columbia voucher program even as he was sitting on evidence of its success.
In New York City with its 1.1 million students, mayoral control has resulted in better test scores and graduation rates, while expanding charter schools, which means more and better education choices for low-income families. But mayoral control expires in June unless state lawmakers renew it, and the United Federation of Teachers is working with Assembly Speaker Sheldon Silver to weaken or kill it.
President Obama's stimulus is sending some $100 billion to the nation's school districts. What will he demand in return? The state budget passed by the New York legislature last week freezes funding for charters but increases it by more that $400 million for other public schools. Perhaps a visit to a charter school in Harlem would help Mr. Obama honor his reform pledge. "I'm looking at the data here in front of me," Mr. Duncan told the New York Post. "Graduation rates are up. Test scores are up. Teacher salaries are up. Social promotion was eliminated. Dramatically increasing parental choice. That's real progress."
Mr. Duncan's help in New York is in stark contrast to his department's decision to sit on a performance review of the D.C. voucher program while Congress debated its future in March. The latest annual evaluation was finally released Friday, and it shows measurable academic gains. The Opportunity Scholarship Program provides $7,500 vouchers to 1,700 low-income families in D.C. to send their children to private schools. Ninety-nine percent of the children are black or Hispanic, and there are more than four applicants for each scholarship.
The 2008 report demonstrated progress among certain subgroups of children but not everyone. This year's report shows statistically significant academic gains for the entire voucher-receiving population. Children attending private schools with the aid of the scholarships are reading nearly a half-grade ahead of their peers who did not receive vouchers. Voucher recipients are doing no better in math but they're doing no worse. Which means that no voucher participant is in worse academic shape than before, and many students are much better off.
"There are transition difficulties, a culture shock upon entering a school where you're expected to pay attention, learn, do homework," says Jay Greene, an education scholar at the Manhattan Institute. "But these results fit a pattern that we've seen in other evaluations of vouchers. Benefits compound over time."
It's bad enough that Democrats are killing a program that parents love and is closing the achievement gap between poor minorities and whites. But as scandalous is that the Education Department almost certainly knew the results of this evaluation for months.
Voucher recipients were tested last spring. The scores were analyzed in the late summer and early fall, and in November preliminary results were presented to a team of advisers who work with the Education Department to produce the annual evaluation. Since Education officials are intimately involved in this process, they had to know what was in this evaluation even as Democrats passed (and Mr. Obama signed) language that ends the program after next year.
Opponents of school choice for poor children have long claimed they'd support vouchers if there was evidence that they work. While running for President last year, Mr. Obama told the Milwaukee Journal-Sentinel that if he saw more proof that they were successful, he would "not allow my predisposition to stand in the way of making sure that our kids can learn . . . You do what works for the kids." Except, apparently, when what works is opposed by unions.
Mr. Duncan's office spurned our repeated calls and emails asking what and when he and his aides knew about these results. We do know the Administration prohibited anyone involved with the evaluation from discussing it publicly. You'd think we were talking about nuclear secrets, not about a taxpayer-funded pilot program. A reasonable conclusion is that Mr. Duncan's department didn't want proof of voucher success to interfere with Senator Dick Durbin's campaign to kill vouchers at the behest of the teachers unions.
The decision to let 1,700 poor kids get tossed from private schools is a moral disgrace. It also exposes the ugly politics that lies beneath union and liberal efforts across the country to undermine mayoral control, charter schools, vouchers or any reform that threatens their monopoly over public education dollars and jobs. The Sheldon Silver-Dick Durbin Democrats aren't worried that school choice doesn't work. They're worried that it does, and if Messrs. Obama and Duncan want to succeed as reformers they need to say so consistently.
Sitting on evidence of voucher success, and the battle of New York.
WSJ, Apr 06, 2009
Education Secretary Arne Duncan did a public service last week when he visited New York City and spoke up for charter schools and mayoral control of education. That was the reformer talking. The status quo Mr. Duncan was on display last month when he let Congress kill a District of Columbia voucher program even as he was sitting on evidence of its success.
In New York City with its 1.1 million students, mayoral control has resulted in better test scores and graduation rates, while expanding charter schools, which means more and better education choices for low-income families. But mayoral control expires in June unless state lawmakers renew it, and the United Federation of Teachers is working with Assembly Speaker Sheldon Silver to weaken or kill it.
President Obama's stimulus is sending some $100 billion to the nation's school districts. What will he demand in return? The state budget passed by the New York legislature last week freezes funding for charters but increases it by more that $400 million for other public schools. Perhaps a visit to a charter school in Harlem would help Mr. Obama honor his reform pledge. "I'm looking at the data here in front of me," Mr. Duncan told the New York Post. "Graduation rates are up. Test scores are up. Teacher salaries are up. Social promotion was eliminated. Dramatically increasing parental choice. That's real progress."
Mr. Duncan's help in New York is in stark contrast to his department's decision to sit on a performance review of the D.C. voucher program while Congress debated its future in March. The latest annual evaluation was finally released Friday, and it shows measurable academic gains. The Opportunity Scholarship Program provides $7,500 vouchers to 1,700 low-income families in D.C. to send their children to private schools. Ninety-nine percent of the children are black or Hispanic, and there are more than four applicants for each scholarship.
The 2008 report demonstrated progress among certain subgroups of children but not everyone. This year's report shows statistically significant academic gains for the entire voucher-receiving population. Children attending private schools with the aid of the scholarships are reading nearly a half-grade ahead of their peers who did not receive vouchers. Voucher recipients are doing no better in math but they're doing no worse. Which means that no voucher participant is in worse academic shape than before, and many students are much better off.
"There are transition difficulties, a culture shock upon entering a school where you're expected to pay attention, learn, do homework," says Jay Greene, an education scholar at the Manhattan Institute. "But these results fit a pattern that we've seen in other evaluations of vouchers. Benefits compound over time."
It's bad enough that Democrats are killing a program that parents love and is closing the achievement gap between poor minorities and whites. But as scandalous is that the Education Department almost certainly knew the results of this evaluation for months.
Voucher recipients were tested last spring. The scores were analyzed in the late summer and early fall, and in November preliminary results were presented to a team of advisers who work with the Education Department to produce the annual evaluation. Since Education officials are intimately involved in this process, they had to know what was in this evaluation even as Democrats passed (and Mr. Obama signed) language that ends the program after next year.
Opponents of school choice for poor children have long claimed they'd support vouchers if there was evidence that they work. While running for President last year, Mr. Obama told the Milwaukee Journal-Sentinel that if he saw more proof that they were successful, he would "not allow my predisposition to stand in the way of making sure that our kids can learn . . . You do what works for the kids." Except, apparently, when what works is opposed by unions.
Mr. Duncan's office spurned our repeated calls and emails asking what and when he and his aides knew about these results. We do know the Administration prohibited anyone involved with the evaluation from discussing it publicly. You'd think we were talking about nuclear secrets, not about a taxpayer-funded pilot program. A reasonable conclusion is that Mr. Duncan's department didn't want proof of voucher success to interfere with Senator Dick Durbin's campaign to kill vouchers at the behest of the teachers unions.
The decision to let 1,700 poor kids get tossed from private schools is a moral disgrace. It also exposes the ugly politics that lies beneath union and liberal efforts across the country to undermine mayoral control, charter schools, vouchers or any reform that threatens their monopoly over public education dollars and jobs. The Sheldon Silver-Dick Durbin Democrats aren't worried that school choice doesn't work. They're worried that it does, and if Messrs. Obama and Duncan want to succeed as reformers they need to say so consistently.
Why the housing crash ruined the financial system but the dot-com collapse did not
From Bubble to Depression? By Steven Gjerstad and Vernon L. Smith
Why the housing crash ruined the financial system but the dot-com collapse did not.
WSJ, Apr 06, 2009
Bubbles have been frequent in economic history, and they occur in the laboratories of experimental economics under conditions which -- when first studied in the 1980s -- were considered so transparent that bubbles would not be observed.
We economists were wrong: Even when traders in an asset market know the value of the asset, bubbles form dependably. Bubbles can arise when some agents buy not on fundamental value, but on price trend or momentum. If momentum traders have more liquidity, they can sustain a bubble longer.
But what sparks bubbles? Why does one large asset bubble -- like our dot-com bubble -- do no damage to the financial system while another one leads to its collapse? Key characteristics of housing markets -- momentum trading, liquidity, price-tier movements, and high-margin purchases -- combine to provide a fairly complete, simple description of the housing bubble collapse, and how it engulfed the financial system and then the wider economy.
In just the past 40 years there were two other housing bubbles, with peaks in 1979 and 1989, but the largest one in U.S. history started in 1997, probably sparked by rising household income that began in 1992 combined with the elimination in 1997 of taxes on residential capital gains up to $500,000. Rising values in an asset market draw investor attention; the early stages of the housing bubble had this usual, self-reinforcing feature.
The 2001 recession might have ended the bubble, but the Federal Reserve decided to pursue an unusually expansionary monetary policy in order to counteract the downturn. When the Fed increased liquidity, money naturally flowed to the fastest expanding sector. Both the Clinton and Bush administrations aggressively pursued the goal of expanding homeownership, so credit standards eroded. Lenders and the investment banks that securitized mortgages used rising home prices to justify loans to buyers with limited assets and income. Rating agencies accepted the hypothesis of ever rising home values, gave large portions of each security issue an investment-grade rating, and investors gobbled them up.
But housing expenditures in the U.S. and most of the developed world have historically taken about 30% of household income. If housing prices more than double in a seven-year period without a commensurate increase in income, eventually something has to give. When subprime lending, the interest-only adjustable-rate mortgage (ARM), and the negative-equity option ARM were no longer able to sustain the flow of new buyers, the inevitable crash could no longer be delayed.
The price decline started in 2006. Then policies designed to promote the American dream instead produced a nightmare. Trillions of dollars of mortgages, written to buyers with slender equity, started a wave of delinquencies and defaults. Borrowers' losses were limited to their small down payments; hence, the lion's share of the losses was transmitted into the financial system and it collapsed.
During the 1976-79 and 1986-89 housing price bubbles, the effective federal-funds interest rate was rising while housing prices rose: The Federal Reserve, "leaning against the wind," helped mitigate the bubbles. In January 2001, however, after four years with average inflation-adjusted house price increases of 7.2% per year (about 6% above trend for the past 80 years), the Fed started to decrease the fed-funds rate. By December 2001, the rate had been reduced to its lowest level since 1962. In 2002 the average fed-funds rate was lower than in any year since the 1958 recession. In 2003 and 2004 the average fed-funds rates were lower than in any year since 1955 when the rate series began.
Monetary policy, mortgage finance, relaxed lending standards, and tax-free capital gains provided astonishing economic stimulus: Mortgage loan originations increased an average of 56% per year for three years -- from $1.05 trillion in 2000 to $3.95 trillion in 2003!
By the time the Federal Reserve began to slowly raise the fed-funds rate in May 2004, the Case-Shiller 20-city composite index had increased 15.4% during the previous 12 months. Yet the housing portion of the CPI for those same 12 months rose only 2.4%.
How could this happen? In 1983, the Bureau of Labor Statistics began to use rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.
With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since "owners' equivalent rent" is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.
With nominal interest rates around 6% and inflation around 6%, the real interest rate was near zero, so household borrowing took off. As measured by the Case-Shiller 10 city index, the accumulated inflation in home-ownership costs between January 1999 and June 2006 was 151%, but the CPI measured a mere 23% increase. As the Federal Reserve monitored inflation in the early part of this decade, home-price increases were no longer visible in the CPI, so the lax monetary policy continued. Even after the Fed began to slowly raise the fed-funds rate in May 2004, the average rate remained low and the bubble continued to inflate for two more years.
The unraveling of the bubble is in many ways the most fascinating part of the story, and the most painful reality we are now experiencing. The median price of existing homes had fallen from $230,000 in July to $217,300 in November 2006. By the beginning of 2007, in 17 of the 20 cities in the Case-Shiller index, prices were falling. Serious price declines had not yet begun, but the warning signs were there for alert observers.
Kate Kelly, writing in this newspaper (Dec. 14, 2007), tells the story of how Goldman Sachs avoided the fate of many of the other investment banks that packaged mortgages into securities. Goldman loaded up on the Markit ABX index of credit default swaps between early December 2006 and late February 2007, as their price dropped from 97.70 on Dec. 4 to under 64 by Feb. 27. But the market was not yet in free-fall: The insurance on AAA-rated parts of the mortgage-backed securities (MBS) remained inexpensive. By mid-summer 2007, concern spread to the AAA-rated tranches of MBS.
At the end of February 2007, the cost of $10 million of insurance on the AAA-rated portion of a mortgage-backed security was still only $68,000 plus a $9,000 annual premium. Housing-market conditions deteriorated further in the first half of 2007. Case-Shiller tiered price sequences in Los Angeles, San Francisco, San Diego and Miami all show serious declines by the summer of 2007. Prices in the low-price tier in San Francisco were down almost 13% from their peak by July 2007; in San Diego they were off 10% by July 2007. Startling developments began to unfold that month. Between July 9 and Aug. 3, 2007, the cost of insuring AAA MBS tranches went from $50,000 upfront plus a $9,000 annual premium for $10 million of insurance to over $900,000 upfront (plus the annual premium).
Once the cost of insuring new mortgage-backed securities skyrocketed, mortgage financing from MBS rapidly declined. Subprime originations plummeted from $160 billion in the third quarter of 2006 to $28 billion in the third quarter of 2007. Mortgage-backed security issuance fell comparably, from $483 billion in all of 2006 to only $30.7 billion in the third quarter of 2007. Other measures of new loan originations were falling at the same time. The liquidity that generated the housing market bubble was evaporating.
Trouble quickly spread from the cost of insuring mortgage-backed securities to problems with credit markets generally, as the spread between short-term U.S. Treasury debt and the LIBOR rate increased to 2.40% from 0.44% between Aug. 8 and Aug. 20, 2007. Since U.S. Treasury debt is generally considered secure, but a bank's loans to another bank carry some risk of default, the spread between these rates serves as an indicator of perceived risk in financial markets.
In one city after another, prices of homes in the low-price tier appreciated the most and then fell the most; prices in the high-priced tier appreciated least and fell the least. The price index graphs for Los Angeles, San Francisco, San Diego and Miami show that in all of these cities, prices in the low-price tier have fallen between 50% and 57%. Moreover, housing prices have continually declined in every market in the Case-Shiller index. According to First American CoreLogic, 10.5 million households had negative or near negative equity in December 2008. When housing prices turned down, many borrowers with low income and few assets other than their slender home equity faced foreclosure. The remaining losses had to be absorbed by the financial system. Consequently, the financial system has suffered a blow unlike anything since the Great Depression, and the source is the weak financial position of the people holding declining assets.
Earlier, during the downturn in the equities market between December 1999 and September 2002, approximately $10 trillion of equity was erased. But a measure of financial system performance, the Keefe, Bruyette, & Woods BKX index of financial firms, fell less than 6% during that period. In the current downturn, the value of residential real estate has fallen by approximately $3 trillion, but the BKX index has now fallen 75% from its peak of January 2007. The financial sector has been devastated in this crisis, whereas it was almost completely unaffected by the downturn in the equities market early in this decade.
How can one crash that wipes out $10 trillion in assets cause no damage to the financial system and another that causes $3 trillion in losses devastate the financial system?
In the equities-market downturn early in this decade, declining assets were held by institutional and individual investors that either owned the assets outright, or held only a small fraction on margin, so losses were absorbed by their owners. In the current crisis, declining housing assets were often, in effect, purchased between 90% and 100% on margin. In some of the cities hit hardest, borrowers who purchased in the low-price tier at the peak of the bubble have seen their home value decline 50% or more. Over the past 18 months as housing prices have fallen, millions of homes became worth less than the loans on them, huge losses have been transmitted to lending institutions, investment banks, investors in mortgage-backed securities, sellers of credit default swaps, and the insurer of last resort, the U.S. Treasury.
In an important paper in 1983, Ben Bernanke argued that during the Depression, severe damage to the financial system impeded its ability to perform its economic role of lending to households for durable goods consumption and to firms for production and trade. We are seeing this process playing out now as loan funds for automobile purchases have withered. Auto sales fell 41% between February 2008 and February 2009. Retail and labor markets too are now part of the collateral damage from the housing debacle. Housing peaked in early 2006. Losses from the mortgage market began to infect the financial system in 2006; asset prices in that sector began to decline at the end of 2006. Meanwhile, equities and the broader economy were performing well, but as the financial sector deteriorated, its problems blindsided the rest of the economy.
The events of the past 10 years have an eerie similarity to the period leading up to the Great Depression. Total mortgage debt outstanding increased from $9.35 billion in 1920 to $29.44 billion in 1929. In 1920, residential mortgage debt was 10.2% of household wealth; by 1929, it was 27.2% of household wealth.
The Great Depression has been attributed to excessive speculation on Wall Street, especially between the spring of 1927 and the fall of 1929. Had the difficulties of the banking system been caused by losses on brokers' loans for margin purchases in 1929, the results should have been felt in the banks immediately after the stock market crash. But the banking system did not show serious strains until the fall of 1930.
Bank earnings reached a record $729 million in 1929. Yet bank exposures to real estate were substantial; as the decline in real estate prices accelerated, foreclosures wiped out banks by the thousands. Had the mounting difficulties of the banks and the final collapse of the banking system in the "Bank Holiday" in March 1933 been caused by contraction of the money supply, as Milton Friedman and Anna Schwartz argued, then the massive injections of liquidity over the past 18 months should have averted the collapse of the financial market during this current crisis.
The causes of the Great Depression need more study, but the claims that losses on stock-market speculation and a monetary contraction caused the decline of the banking system both seem inadequate. It appears that both the Great Depression and the current crisis had their origins in excessive consumer debt -- especially mortgage debt -- that was transmitted into the financial sector during a sharp downturn.
What we've offered in our discussion of this crisis is the back story to Mr. Bernanke's analysis of the Depression. Why does one crash cause minimal damage to the financial system, so that the economy can pick itself up quickly, while another crash leaves a devastated financial sector in the wreckage? The hypothesis we propose is that a financial crisis that originates in consumer debt, especially consumer debt concentrated at the low end of the wealth and income distribution, can be transmitted quickly and forcefully into the financial system. It appears that we're witnessing the second great consumer debt crash, the end of a massive consumption binge.
Mr. Gjerstad is a visiting research associate at Chapman University. Mr. Smith is a professor of economics at Chapman University and the 2002 Nobel Laureate in Economics.
Why the housing crash ruined the financial system but the dot-com collapse did not.
WSJ, Apr 06, 2009
Bubbles have been frequent in economic history, and they occur in the laboratories of experimental economics under conditions which -- when first studied in the 1980s -- were considered so transparent that bubbles would not be observed.
We economists were wrong: Even when traders in an asset market know the value of the asset, bubbles form dependably. Bubbles can arise when some agents buy not on fundamental value, but on price trend or momentum. If momentum traders have more liquidity, they can sustain a bubble longer.
But what sparks bubbles? Why does one large asset bubble -- like our dot-com bubble -- do no damage to the financial system while another one leads to its collapse? Key characteristics of housing markets -- momentum trading, liquidity, price-tier movements, and high-margin purchases -- combine to provide a fairly complete, simple description of the housing bubble collapse, and how it engulfed the financial system and then the wider economy.
In just the past 40 years there were two other housing bubbles, with peaks in 1979 and 1989, but the largest one in U.S. history started in 1997, probably sparked by rising household income that began in 1992 combined with the elimination in 1997 of taxes on residential capital gains up to $500,000. Rising values in an asset market draw investor attention; the early stages of the housing bubble had this usual, self-reinforcing feature.The 2001 recession might have ended the bubble, but the Federal Reserve decided to pursue an unusually expansionary monetary policy in order to counteract the downturn. When the Fed increased liquidity, money naturally flowed to the fastest expanding sector. Both the Clinton and Bush administrations aggressively pursued the goal of expanding homeownership, so credit standards eroded. Lenders and the investment banks that securitized mortgages used rising home prices to justify loans to buyers with limited assets and income. Rating agencies accepted the hypothesis of ever rising home values, gave large portions of each security issue an investment-grade rating, and investors gobbled them up.
But housing expenditures in the U.S. and most of the developed world have historically taken about 30% of household income. If housing prices more than double in a seven-year period without a commensurate increase in income, eventually something has to give. When subprime lending, the interest-only adjustable-rate mortgage (ARM), and the negative-equity option ARM were no longer able to sustain the flow of new buyers, the inevitable crash could no longer be delayed.
The price decline started in 2006. Then policies designed to promote the American dream instead produced a nightmare. Trillions of dollars of mortgages, written to buyers with slender equity, started a wave of delinquencies and defaults. Borrowers' losses were limited to their small down payments; hence, the lion's share of the losses was transmitted into the financial system and it collapsed.
During the 1976-79 and 1986-89 housing price bubbles, the effective federal-funds interest rate was rising while housing prices rose: The Federal Reserve, "leaning against the wind," helped mitigate the bubbles. In January 2001, however, after four years with average inflation-adjusted house price increases of 7.2% per year (about 6% above trend for the past 80 years), the Fed started to decrease the fed-funds rate. By December 2001, the rate had been reduced to its lowest level since 1962. In 2002 the average fed-funds rate was lower than in any year since the 1958 recession. In 2003 and 2004 the average fed-funds rates were lower than in any year since 1955 when the rate series began.
Monetary policy, mortgage finance, relaxed lending standards, and tax-free capital gains provided astonishing economic stimulus: Mortgage loan originations increased an average of 56% per year for three years -- from $1.05 trillion in 2000 to $3.95 trillion in 2003!
By the time the Federal Reserve began to slowly raise the fed-funds rate in May 2004, the Case-Shiller 20-city composite index had increased 15.4% during the previous 12 months. Yet the housing portion of the CPI for those same 12 months rose only 2.4%.
How could this happen? In 1983, the Bureau of Labor Statistics began to use rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.
With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since "owners' equivalent rent" is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.
With nominal interest rates around 6% and inflation around 6%, the real interest rate was near zero, so household borrowing took off. As measured by the Case-Shiller 10 city index, the accumulated inflation in home-ownership costs between January 1999 and June 2006 was 151%, but the CPI measured a mere 23% increase. As the Federal Reserve monitored inflation in the early part of this decade, home-price increases were no longer visible in the CPI, so the lax monetary policy continued. Even after the Fed began to slowly raise the fed-funds rate in May 2004, the average rate remained low and the bubble continued to inflate for two more years.
The unraveling of the bubble is in many ways the most fascinating part of the story, and the most painful reality we are now experiencing. The median price of existing homes had fallen from $230,000 in July to $217,300 in November 2006. By the beginning of 2007, in 17 of the 20 cities in the Case-Shiller index, prices were falling. Serious price declines had not yet begun, but the warning signs were there for alert observers.
Kate Kelly, writing in this newspaper (Dec. 14, 2007), tells the story of how Goldman Sachs avoided the fate of many of the other investment banks that packaged mortgages into securities. Goldman loaded up on the Markit ABX index of credit default swaps between early December 2006 and late February 2007, as their price dropped from 97.70 on Dec. 4 to under 64 by Feb. 27. But the market was not yet in free-fall: The insurance on AAA-rated parts of the mortgage-backed securities (MBS) remained inexpensive. By mid-summer 2007, concern spread to the AAA-rated tranches of MBS.
At the end of February 2007, the cost of $10 million of insurance on the AAA-rated portion of a mortgage-backed security was still only $68,000 plus a $9,000 annual premium. Housing-market conditions deteriorated further in the first half of 2007. Case-Shiller tiered price sequences in Los Angeles, San Francisco, San Diego and Miami all show serious declines by the summer of 2007. Prices in the low-price tier in San Francisco were down almost 13% from their peak by July 2007; in San Diego they were off 10% by July 2007. Startling developments began to unfold that month. Between July 9 and Aug. 3, 2007, the cost of insuring AAA MBS tranches went from $50,000 upfront plus a $9,000 annual premium for $10 million of insurance to over $900,000 upfront (plus the annual premium).
Once the cost of insuring new mortgage-backed securities skyrocketed, mortgage financing from MBS rapidly declined. Subprime originations plummeted from $160 billion in the third quarter of 2006 to $28 billion in the third quarter of 2007. Mortgage-backed security issuance fell comparably, from $483 billion in all of 2006 to only $30.7 billion in the third quarter of 2007. Other measures of new loan originations were falling at the same time. The liquidity that generated the housing market bubble was evaporating.
Trouble quickly spread from the cost of insuring mortgage-backed securities to problems with credit markets generally, as the spread between short-term U.S. Treasury debt and the LIBOR rate increased to 2.40% from 0.44% between Aug. 8 and Aug. 20, 2007. Since U.S. Treasury debt is generally considered secure, but a bank's loans to another bank carry some risk of default, the spread between these rates serves as an indicator of perceived risk in financial markets.
In one city after another, prices of homes in the low-price tier appreciated the most and then fell the most; prices in the high-priced tier appreciated least and fell the least. The price index graphs for Los Angeles, San Francisco, San Diego and Miami show that in all of these cities, prices in the low-price tier have fallen between 50% and 57%. Moreover, housing prices have continually declined in every market in the Case-Shiller index. According to First American CoreLogic, 10.5 million households had negative or near negative equity in December 2008. When housing prices turned down, many borrowers with low income and few assets other than their slender home equity faced foreclosure. The remaining losses had to be absorbed by the financial system. Consequently, the financial system has suffered a blow unlike anything since the Great Depression, and the source is the weak financial position of the people holding declining assets.
Earlier, during the downturn in the equities market between December 1999 and September 2002, approximately $10 trillion of equity was erased. But a measure of financial system performance, the Keefe, Bruyette, & Woods BKX index of financial firms, fell less than 6% during that period. In the current downturn, the value of residential real estate has fallen by approximately $3 trillion, but the BKX index has now fallen 75% from its peak of January 2007. The financial sector has been devastated in this crisis, whereas it was almost completely unaffected by the downturn in the equities market early in this decade.
How can one crash that wipes out $10 trillion in assets cause no damage to the financial system and another that causes $3 trillion in losses devastate the financial system?
In the equities-market downturn early in this decade, declining assets were held by institutional and individual investors that either owned the assets outright, or held only a small fraction on margin, so losses were absorbed by their owners. In the current crisis, declining housing assets were often, in effect, purchased between 90% and 100% on margin. In some of the cities hit hardest, borrowers who purchased in the low-price tier at the peak of the bubble have seen their home value decline 50% or more. Over the past 18 months as housing prices have fallen, millions of homes became worth less than the loans on them, huge losses have been transmitted to lending institutions, investment banks, investors in mortgage-backed securities, sellers of credit default swaps, and the insurer of last resort, the U.S. Treasury.
In an important paper in 1983, Ben Bernanke argued that during the Depression, severe damage to the financial system impeded its ability to perform its economic role of lending to households for durable goods consumption and to firms for production and trade. We are seeing this process playing out now as loan funds for automobile purchases have withered. Auto sales fell 41% between February 2008 and February 2009. Retail and labor markets too are now part of the collateral damage from the housing debacle. Housing peaked in early 2006. Losses from the mortgage market began to infect the financial system in 2006; asset prices in that sector began to decline at the end of 2006. Meanwhile, equities and the broader economy were performing well, but as the financial sector deteriorated, its problems blindsided the rest of the economy.
The events of the past 10 years have an eerie similarity to the period leading up to the Great Depression. Total mortgage debt outstanding increased from $9.35 billion in 1920 to $29.44 billion in 1929. In 1920, residential mortgage debt was 10.2% of household wealth; by 1929, it was 27.2% of household wealth.
The Great Depression has been attributed to excessive speculation on Wall Street, especially between the spring of 1927 and the fall of 1929. Had the difficulties of the banking system been caused by losses on brokers' loans for margin purchases in 1929, the results should have been felt in the banks immediately after the stock market crash. But the banking system did not show serious strains until the fall of 1930.
Bank earnings reached a record $729 million in 1929. Yet bank exposures to real estate were substantial; as the decline in real estate prices accelerated, foreclosures wiped out banks by the thousands. Had the mounting difficulties of the banks and the final collapse of the banking system in the "Bank Holiday" in March 1933 been caused by contraction of the money supply, as Milton Friedman and Anna Schwartz argued, then the massive injections of liquidity over the past 18 months should have averted the collapse of the financial market during this current crisis.
The causes of the Great Depression need more study, but the claims that losses on stock-market speculation and a monetary contraction caused the decline of the banking system both seem inadequate. It appears that both the Great Depression and the current crisis had their origins in excessive consumer debt -- especially mortgage debt -- that was transmitted into the financial sector during a sharp downturn.
What we've offered in our discussion of this crisis is the back story to Mr. Bernanke's analysis of the Depression. Why does one crash cause minimal damage to the financial system, so that the economy can pick itself up quickly, while another crash leaves a devastated financial sector in the wreckage? The hypothesis we propose is that a financial crisis that originates in consumer debt, especially consumer debt concentrated at the low end of the wealth and income distribution, can be transmitted quickly and forcefully into the financial system. It appears that we're witnessing the second great consumer debt crash, the end of a massive consumption binge.
Mr. Gjerstad is a visiting research associate at Chapman University. Mr. Smith is a professor of economics at Chapman University and the 2002 Nobel Laureate in Economics.
Short '06 Lebanon War Stokes Pentagon Debate - Leaders Divided on Whether to Focus On Conventional or Irregular Combat
Short '06 Lebanon War Stokes Pentagon Debate. ByGreg Jaffe
Leaders Divided on Whether to Focus On Conventional or Irregular Combat
Washington Post, Monday, April 6, 2009; Page A01
A war that ended three years ago and involved not a single U.S. soldier has become the subject of an increasingly heated debate inside the Pentagon, one that could alter how the U.S. military fights in the future.
When Israel and Hezbollah battled for more than a month in Lebanon in the summer of 2006, the result was widely seen as a disaster for the Israeli military. Soon after the fighting ended, some military officers began to warn that the short, bloody and relatively conventional battle foreshadowed how future enemies of the United States might fight.
Since then, the Defense Department has dispatched as many as a dozen teams to interview Israeli officers who fought against Hezbollah. The Army and Marine Corps have sponsored a series of multimillion-dollar war games to test how U.S. forces might fare against a similar foe. "I've organized five major games in the last two years, and all of them have focused on Hezbollah," said Frank Hoffman, a research fellow at the Marine Corps Warfighting Laboratory in Quantico.
A big reason that the 34-day war is drawing such fevered attention is that it highlights a rift among military leaders: Some want to change the U.S. military so that it is better prepared for wars like the ones it is fighting in Iraq and Afghanistan, while others worry that such a shift would leave the United States vulnerable to a more conventional foe.
"The Lebanon war has become a bellwether," said Stephen Biddle, a senior fellow at the Council on Foreign Relations who has advised Gen. David H. Petraeus, head of the U.S. Central Command. "If you are opposed to transforming the military to fight low-intensity wars, it is your bloody sheet. It's discussed in almost coded communication to indicate which side of the argument you are on."
U.S. military experts were stunned by the destruction that Hezbollah forces, using sophisticated antitank guided missiles, were able to wreak on Israeli armor columns. Unlike the guerrilla forces in Iraq and Afghanistan, who employed mostly hit-and-run tactics, the Hezbollah fighters held their ground against Israeli forces in battles that stretched as long as 12 hours. They were able to eavesdrop on Israeli communications and even struck an Israeli ship with a cruise missile.
"From 2000 to 2006 Hezbollah embraced a new doctrine, transforming itself from a predominantly guerrilla force into a quasi-conventional fighting force," a study by the Army's Combat Studies Institute concluded last year. Another Pentagon report warned that Hezbollah forces were "extremely well trained, especially in the uses of antitank weapons and rockets" and added: "They well understood the vulnerabilities of Israeli armor."
Many top Army officials refer to the short battle almost as a morality play that illustrates the price of focusing too much on counterinsurgency wars at the expense of conventional combat. These officers note that, before the Lebanon war, Israeli forces had been heavily involved in occupation duty in the Palestinian territories.
"The real takeaway is that you have to find the time to train for major combat operations, even if you are fighting counterinsurgency wars," said one senior military analyst who studied the Lebanon war for the Center for Army Lessons Learned at Fort Leavenworth, Kan. Currently, the deployments to Iraq and Afghanistan have prevented Army units from conducting such training.
Army generals have also latched on to the Lebanon war to build support for multibillion-dollar weapons programs that are largely irrelevant to low-intensity wars such as those fought in Iraq and Afghanistan. A 30-page internal Army briefing, prepared for the Joint Chiefs of Staff and senior Pentagon civilians, recently sought to highlight how the $159 billion Future Combat Systems, a network of ground vehicles and sensors, could have been used to dispatch Hezbollah's forces quickly and with few American casualties.
"Hezbollah relies on low visibility and prepared defenses," one slide in the briefing reads. "FCS counters with sensors and robotics to maneuver out of contact."
Defense Secretary Robert M. Gates is expected to stake out a firm position in this debate as soon as today, when he announces the 2010 defense budget. That document is expected to cut or sharply curtail weapons systems designed for conventional wars, and to bolster intelligence and surveillance programs designed to help track down shadowy insurgents.
"This budget moves the needle closer to irregular warfare and counterinsurgency," Pentagon spokesman Geoff Morrell said. "It is not an abandonment of the need to prepare for conventional conflicts. But even moving that needle is a revolutionary thing in this building."
The changes reflect the growing prominence of the military's counterinsurgency camp -- the most prominent member of which is Petraeus -- in the Pentagon. President Obama, whose strategy in Afghanistan is focused on protecting the local population and denying the Islamist radicals a safe haven, has largely backed this group.
The question facing defense leaders is whether they can afford to build a force that can prevail in a counterinsurgency fight, where the focus is on protecting the civilian population and building indigenous army and police forces, as well as a more conventional battle.
Gen. George W. Casey Jr., the Army's top officer in the Pentagon, has said it is essential that the military be able to do both simultaneously. New Army doctrine, meanwhile, calls for a "full spectrum" service that is as good at rebuilding countries as it is at destroying opposing armies.
But other experts remain skeptical. "The idea that you can do it all is just wrong," said Biddle of the Council on Foreign Relations. Soldiers, who are home for as little as 12 months between deployments, do not have enough time to prepare adequately for both types of wars, he said.
Biddle and other counterinsurgency advocates argue that the military should focus on winning the wars in Iraq and Afghanistan and only then worry about what the next war will look like.
Some in this camp say that the threat posed by Hezbollah is being inflated by officers who are determined to return the Army to a more familiar past, built around preparing for conventional warfare.
Another question is whether the U.S. military is taking the proper lessons from the Israel-Hezbollah war. Its studies have focused almost exclusively on the battle in southern Lebanon and ignored Hezbollah's ongoing role in Lebanese society as a political party and humanitarian aid group. After the battle, Hezbollah forces moved in quickly with aid and reconstruction assistance.
"Even if the Israelis had done better operationally, I don't think they would have been victorious in the long run," said Andrew Exum, a former Army officer who has studied the battle from southern Lebanon. "For the Israelis, the war lasted for 34 days. We tend to forget that for Hezbollah, it is infinite."
Leaders Divided on Whether to Focus On Conventional or Irregular Combat
Washington Post, Monday, April 6, 2009; Page A01
A war that ended three years ago and involved not a single U.S. soldier has become the subject of an increasingly heated debate inside the Pentagon, one that could alter how the U.S. military fights in the future.
When Israel and Hezbollah battled for more than a month in Lebanon in the summer of 2006, the result was widely seen as a disaster for the Israeli military. Soon after the fighting ended, some military officers began to warn that the short, bloody and relatively conventional battle foreshadowed how future enemies of the United States might fight.
Since then, the Defense Department has dispatched as many as a dozen teams to interview Israeli officers who fought against Hezbollah. The Army and Marine Corps have sponsored a series of multimillion-dollar war games to test how U.S. forces might fare against a similar foe. "I've organized five major games in the last two years, and all of them have focused on Hezbollah," said Frank Hoffman, a research fellow at the Marine Corps Warfighting Laboratory in Quantico.
A big reason that the 34-day war is drawing such fevered attention is that it highlights a rift among military leaders: Some want to change the U.S. military so that it is better prepared for wars like the ones it is fighting in Iraq and Afghanistan, while others worry that such a shift would leave the United States vulnerable to a more conventional foe.
"The Lebanon war has become a bellwether," said Stephen Biddle, a senior fellow at the Council on Foreign Relations who has advised Gen. David H. Petraeus, head of the U.S. Central Command. "If you are opposed to transforming the military to fight low-intensity wars, it is your bloody sheet. It's discussed in almost coded communication to indicate which side of the argument you are on."
U.S. military experts were stunned by the destruction that Hezbollah forces, using sophisticated antitank guided missiles, were able to wreak on Israeli armor columns. Unlike the guerrilla forces in Iraq and Afghanistan, who employed mostly hit-and-run tactics, the Hezbollah fighters held their ground against Israeli forces in battles that stretched as long as 12 hours. They were able to eavesdrop on Israeli communications and even struck an Israeli ship with a cruise missile.
"From 2000 to 2006 Hezbollah embraced a new doctrine, transforming itself from a predominantly guerrilla force into a quasi-conventional fighting force," a study by the Army's Combat Studies Institute concluded last year. Another Pentagon report warned that Hezbollah forces were "extremely well trained, especially in the uses of antitank weapons and rockets" and added: "They well understood the vulnerabilities of Israeli armor."
Many top Army officials refer to the short battle almost as a morality play that illustrates the price of focusing too much on counterinsurgency wars at the expense of conventional combat. These officers note that, before the Lebanon war, Israeli forces had been heavily involved in occupation duty in the Palestinian territories.
"The real takeaway is that you have to find the time to train for major combat operations, even if you are fighting counterinsurgency wars," said one senior military analyst who studied the Lebanon war for the Center for Army Lessons Learned at Fort Leavenworth, Kan. Currently, the deployments to Iraq and Afghanistan have prevented Army units from conducting such training.
Army generals have also latched on to the Lebanon war to build support for multibillion-dollar weapons programs that are largely irrelevant to low-intensity wars such as those fought in Iraq and Afghanistan. A 30-page internal Army briefing, prepared for the Joint Chiefs of Staff and senior Pentagon civilians, recently sought to highlight how the $159 billion Future Combat Systems, a network of ground vehicles and sensors, could have been used to dispatch Hezbollah's forces quickly and with few American casualties.
"Hezbollah relies on low visibility and prepared defenses," one slide in the briefing reads. "FCS counters with sensors and robotics to maneuver out of contact."
Defense Secretary Robert M. Gates is expected to stake out a firm position in this debate as soon as today, when he announces the 2010 defense budget. That document is expected to cut or sharply curtail weapons systems designed for conventional wars, and to bolster intelligence and surveillance programs designed to help track down shadowy insurgents.
"This budget moves the needle closer to irregular warfare and counterinsurgency," Pentagon spokesman Geoff Morrell said. "It is not an abandonment of the need to prepare for conventional conflicts. But even moving that needle is a revolutionary thing in this building."
The changes reflect the growing prominence of the military's counterinsurgency camp -- the most prominent member of which is Petraeus -- in the Pentagon. President Obama, whose strategy in Afghanistan is focused on protecting the local population and denying the Islamist radicals a safe haven, has largely backed this group.
The question facing defense leaders is whether they can afford to build a force that can prevail in a counterinsurgency fight, where the focus is on protecting the civilian population and building indigenous army and police forces, as well as a more conventional battle.
Gen. George W. Casey Jr., the Army's top officer in the Pentagon, has said it is essential that the military be able to do both simultaneously. New Army doctrine, meanwhile, calls for a "full spectrum" service that is as good at rebuilding countries as it is at destroying opposing armies.
But other experts remain skeptical. "The idea that you can do it all is just wrong," said Biddle of the Council on Foreign Relations. Soldiers, who are home for as little as 12 months between deployments, do not have enough time to prepare adequately for both types of wars, he said.
Biddle and other counterinsurgency advocates argue that the military should focus on winning the wars in Iraq and Afghanistan and only then worry about what the next war will look like.
Some in this camp say that the threat posed by Hezbollah is being inflated by officers who are determined to return the Army to a more familiar past, built around preparing for conventional warfare.
Another question is whether the U.S. military is taking the proper lessons from the Israel-Hezbollah war. Its studies have focused almost exclusively on the battle in southern Lebanon and ignored Hezbollah's ongoing role in Lebanese society as a political party and humanitarian aid group. After the battle, Hezbollah forces moved in quickly with aid and reconstruction assistance.
"Even if the Israelis had done better operationally, I don't think they would have been victorious in the long run," said Andrew Exum, a former Army officer who has studied the battle from southern Lebanon. "For the Israelis, the war lasted for 34 days. We tend to forget that for Hezbollah, it is infinite."