Picking apart Piketty

Here’s Thomas Piketty on the US financial crisis (page 297):

In my view, there is absolutely no doubt that the increase of inequality in United States contributed to the nation’s financial instability. The reason is simple: one consequence of increasing inequality was virtual stagnation of the purchasing power of the lower and middle classes in the United States, which inevitably made it more likely that modest households would take on debt, especially since unscrupulous banks and financial intermediaries, freed from regulation and eager to earn good yields on the enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms.

Where does one begin?

1.  In my view there is plenty of doubt as to whether inequality contributed to the crisis, partly because Europe is much more equal, and had an even worse financial crisis.  In fairness, he did say “contributed,” but my real complaints lie elsewhere.

2.  Why would stable real wages lead to more debt?  More specifically, why would it “inevitably” lead to more debt?  If my wages were stagnant I certainly wouldn’t react by taking on more debt, rather I’d borrow more if I expected my income to rise.  Is there a theory here?

3.  Correct me if I am wrong, but I thought the extra saving injected into the US economy came from the poor Chinese, not “well-to-do” Americans.  Why weren’t the Chinese “inevitably” forced to go into debt?  They were much poorer than Americans.  Yet they saved 50% of their incomes.  Some of this was forced by the government, but nowhere near all of the savings was forced.

4.  Experts say that the risks taken by the banks had little to do with deregulation, that subprime lending and mortgage-backed securities were legal well before “deregulation.”  Lehman wasn’t even a commercial bank.  And wasn’t US banking among the most heavily regulated industries in the world, even after the “deregulation” of the 1980s and 1990s?

5.  Why would “unscrupulous banks” lend on “increasingly generous terms?”  Why no discussion of how the government encouraged banks to lend money to low income people?  In Piketty it’s almost always the evil capitalists, never the well-meaning government bureaucrats.

A few pages later:

The familiar mobility argument is powerful, so powerful that it is often impossible to verify. But in the US case, government data allow us to measure the evolution of wage inequality with mobility taken into account: we can compute average wages at the individual level over long periods of time (ten, twenty, or thirty years). And what we find is that the increase in wage inequality is identical in all cases no matter what reference we choose. In other words, workers at McDonald’s or in Detroit’s auto plants do not spend a year of their lives as top managers of the large US firms, any more than professors at the University of Chicago or middle managers from California do.  One may have felt this intuitively, but it is always better to measure systematically wherever possible.

But at some point in their lives 73% of Americans do reach the top 20% of incomes.  Piketty doesn’t mention that fact.  Yes, most Americans don’t become corporate CEOs, is anyone surprised by that?

Piketty continues (p. 308):

We are free to imagine an ideal society in which all other tasks are almost totally automated and each individual has as much freedom as possible to pursue the goods of education, culture, and health for the benefit of herself and others. Everyone would be by turns teacher or student, writer or reader, actor or spectator, doctor or patient.

That might be ideal for a college professor, for most of the men that I have met during my life that sort of society would be a dystopia.

I love this comment on the very next page:

From 1980 to 1990, under the presidents Ronald Reagan and George H.W. Bush, the federal minimum wage remained stuck at $3.35, which led to a significant decrease in purchasing power when inflation is factored in. It then rose to $5.25 under Bill Clinton in the 1990s and was frozen at that level under George W. Bush before being increased several times by Barack Obama after 2008.

Oh, is that really what happened?  Or is that a very artful attempt at disguising what really happened. The following statement is even truer; see which one more accurately conveys what happened:

President George H.W. Bush increased the minimum wage from $3.35 per hour to $4.25 per hour. Bill Clinton increased the minimum wage from $4.25 per hour to $5.15 per hour. George W. Bush increased the minimum wage in three steps from $5.15 per hour to $7.25 per hour. The first two increases occurred while he was president; the third while Obama was president. Pres. Obama tried and failed to increase the minimum wage.

I wonder if Piketty has something against the GOP?  Of course the average reader of Piketty’s book knows nothing about these details, and takes his information at face value. 

On the very next page Piketty discusses the minimum wage in Germany.  But he forgets to point out that the 2004 labor reforms allowed for a large increase in low-wage German jobs, and that after these reforms the German unemployment rate plummeted while French unemployment increased. Isn’t that evidence important?

Three pages later Piketty provides a balanced discussion of the economic research on the effects of minimum wage laws.  He cites the Card and Krueger study, but no other.  I guess there haven’t been any empirical studies showing minimum wage laws reduce employment, or that they lead to discrimination, or that they reduce fringe benefits.

On pages 330-31 he points out that US corporate managers are now paid far higher salaries than Japanese corporate managers.  He then claims it is “naive” to assert that the pay might reflect productivity.  No mention of the fact that while the Nikkei is up 2 fold since 1982, the Dow is up 20 fold.  I don’t know about you, but I’d rather be a shareholder in US firms getting ripped off by the outrageous pay packages of the American CEOs, rather than invest in Japanese firms with their low paid CEOs.  You get what you pay for.

All that in 40 pages.  And this is pretty much how things go throughout the entire book.  In later posts I’ll pick up after page 331.  Just remember if you read the book that the information is not reliable.  Instead there is a constant left wing bias in facts, interpretation, evidence cited, etc. When he discusses outside sources like Kuznets he does not accurately convey their opinions.  The book has lots of good research, but it is not something that can be completely trusted.  Credulous readers are likely to get a very biased view of the US economy. Over at Econlog I soon do a post discussing Piketty’s views on size of government.

 

 


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64 Responses to “Picking apart Piketty”

  1. Gravatar of Rajat Rajat
    3. July 2014 at 05:38

    Hmm, I think you got it right the first couple of times: a pied piper producing 600 pages of drivel… sounds like a big fat waste of time to me.

  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    3. July 2014 at 07:01

    It’s a masterpiece of circular reasoning and non sequiturs. Consider this from page 42;

    ‘The growth of capital’s share accelerated with the victories of Margaret Thatcher…and Ronald Reagan…marking the beginning of a conservative revolution. Then came the collapse of the Soviet bloc in 1989, followed by financial globalization and deregulation in the 1990s. All of these events marked a political turn in the opposite direction from that observed in the first half of the twentieth century. By 2010, and despite the crisis that began in 2007-2008, capital was prospering as it had not done since 1913. Not all the consequences of capital’s renewed prosperity were negative; to some extent it was a natural and desirable development.’

    Notice that Piketty has failed to point out any ‘negative consequences’–unless we count the crisis of 2007-2008, which hammered capital’s share–and dismisses the startling rise in living standards of the average guy during the years after Thatcher and Reagan.

    Anybody miss two world wars and the Great Depression?

  3. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    3. July 2014 at 07:07

    Here’s an hour of hilarity with Piketty (note, neither the moderator or Warren can pronounce his name correctly);

    http://www.c-span.org/video/?319790-1/book-discussion-capital-21st-century-fighting-chance

    Piketty is now a millionaire (thanks in large part to capitalist Jeff Bezos) and judged by that haircut and clothes, Elizabeth Warren hasn’t missed any paychecks either. The perfect pair to draw to a discussion of the plight of the downtrodden.

    Though the most passion shows in the part about the student loan debt. Sob, sob.

  4. Gravatar of Daniel Daniel
    3. July 2014 at 07:09

    Patrick – politics isn’t about policy. That much should be obvious.

  5. Gravatar of Olasoli Olasoli
    3. July 2014 at 07:22

    You say: Experts say that the risks taken by the banks had little to do with deregulation, that subprime lending and mortgage-backed securities were legal well before “deregulation.” Lehman wasn’t even a commercial bank. And wasn’t US banking among the most heavily regulated industries in the world, even after the “deregulation” of the 1980s and 1990s?

    What kind of experts you’re talking about? I recommend the work of Gary Gorton. The reason to link the deregulation with the crisis is that subprime packages were managed by offshore entities, as special purpose vehicles that were deregulated. The possibility of turning subprime mortgages into bonds with a high credit rating was an excellent deal, banks did not need the government encouraged them to do.

    The link between inequality and the crisis was made by John Plender. The idea is to compensate for stagnating incomes of the middle class in some countries resorted to increased credit especially in the housing sector.

  6. Gravatar of ssumner ssumner
    3. July 2014 at 07:36

    Olasoli. These experts . . .

    http://www.bostonfed.org/economic/ppdp/2012/ppdp1202.pdf

    . . . say it wasn’t deregulation. The risky things banks were accursed of doing were perfectly legal even before deregulation.

    I can’t imagine any reason why slowing real wage growth would cause people to borrow more. You are right that government policies encouraged borrowing, but I doubt that was related to inequality. Nonetheless, I agree thatthose government policies were foolish.

  7. Gravatar of Olasoli Olasoli
    3. July 2014 at 07:53

    I think you’re missing the point, is not that things have gone wrong after a deregulation, but the sectors most closely linked to the crisis as special purpose vehicles owned banks have never been regulated fairly. Banks found an innovative way to use them with the subprime packages.

    I think if the income stagnates, people turn to debt to maintain or increase consumption, particularly if you can borrow on good terms

  8. Gravatar of Doug M Doug M
    3. July 2014 at 08:19

    Regarding regulation / de-regulation — I would say that much instabilities in the system arose because of regulation. Or, more precisely, because of efforts to navigate the subtleties of the regulation.

    “Securitization” exits to move assets off of the balance sheets of financial companies. And, why does the bank want to remove assets on its balance sheet? because the regulators tell them that they cannot issue new loans, or pay dividends until they lower their leverage ratios.

    The CMO, CDO, SIV, ABCP, alphabet soup of mortgage and credit derivatives are all a result of regulatory arbitrage. And the regulators certainly knew it… they new that the banks were creating new and more complex instruments to skirt the spirit of the law, even if they were obeying the letter of the law.

    I am certain that if the underlying collateral were held in a more transparent way, the “sub-prime crisis” would have been easily unwound and contained. Instead, the taint of sub-prime CMOs, polluted a much wider swath mortgage / credit derivatives, and turned a downturn in an obscure corner of mortgage lending, into an international crisis.

  9. Gravatar of dtoh dtoh
    3. July 2014 at 08:22

    Olasoli,

    You are so far of the mark, I’m reluctant to waste energy commenting.

    1. SPVs have nothing to do with avoiding regulation. They’re primarily just a mechanism for structuring the deal. You need an entity which can hold assets and issue securities.

    2. A big part of what went wrong was that the supposedly awful assets which the securities companies were “fraudulently” foisting off on widows and orphans were in large part by…. the securities companies themselves. Funny that.

  10. Gravatar of Olasoli Olasoli
    3. July 2014 at 08:55

    I think the special purposes vehicles were important to practice regulatory arbitrage, especially if the SPV is domiciled offshore, usually in Bermuda, the Cayman
    Islands, or the British Virgin Islands.

    according to gary gorton:

    “Securitization and SPVs can be used to get more attractive
    accounting treatment, to be more tax efficient, to avoid regulations (such as capital requirements), to tap new pools of capital through changing the risk characteristics of an asset…”

    Gary Gorton “Special Purpose Vehicles and Securitization”

  11. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    3. July 2014 at 09:10

    ‘…an obscure corner of mortgage lending….’

    Which grew from about one in every 200 home loans to half of all of them by 2007. All with the encouragement of virtually every federal agency that could add two cents worth of regulation to the mix.

    Prior to the 1990s banks were refusing to make these kinds of loans. Then the Boston Fed announced they were all a bunch of racists for having such outrageous standards as down payments and clean credit histories.

  12. Gravatar of Kevin Erdmann Kevin Erdmann
    3. July 2014 at 09:11

    The first thing an American middle class household does to save is put down a small amount of cash and take out a big honking mortgage. And the misinterpretation of this one basic thing leads to mass insanity where everyone knows that a hollowed out middle class causes a massive “bubble” in housing – the largest middle class asset that is owned by a solid majority of households.
    That deregulation is some powerful black magic.

  13. Gravatar of Steve Steve
    3. July 2014 at 09:28

    I wonder if Bernanke’s claim that house prices rise 100% of the time had something to do with the euphoria, even as the Fed was ruminating about a 0% inflation target.

  14. Gravatar of Steve Steve
    3. July 2014 at 09:41

    “Instead there is a constant left wing bias in facts,”

    Bias involves selective use of facts. It doesn’t entitle Piketty to invent falsehoods and claim them to be facts.

  15. Gravatar of Tom Tom
    3. July 2014 at 10:07

    why slowing real wage growth would cause people to borrow more?

    How about: house prices increased 5% last year? or 6%? or 7%?

    And EVERYBODY who borrows for a house, is making money on it.
    It’s almost a sure thing — the worst case is that the increases stop and it stagnates, and then you sell at the small loss of fees.

    Stagnant wage growth encouraged many folks to be house buying speculators.

    But it’s not clear if, after 1996 and the end of downpayments and credit checks, whether the borrowing would have been different with increasing wages — maybe there would have been even more borrowing, and a bigger bubble.

    The key statistic is probably the % of Americans who lost 10% or more of their net wealth 2006-2008. My guess is that it was over 50%, and this huge net wealth loss causes behavior changes, and reduced purchases.

  16. Gravatar of Peter K. Peter K.
    3. July 2014 at 10:45

    I agree with Piketty. He has the facts right. To take one of your examples, Japan’s stock market has done poorly because of poor monetary policy. With Abenomics, they’re doing better.

    No reaction to Yellen’s discussion of macroprudential policy?

  17. Gravatar of josh josh
    3. July 2014 at 11:56

    It seemed to me Piketty’s main them was increasing capital- share in a slow-growth economy. This has some validity, no? And if that means we should promote tighter labor markets and limit rent-seeking, it sounds kind of appealing.

  18. Gravatar of Robert Robert
    3. July 2014 at 12:51

    “We are free to imagine an ideal society in which all other tasks are almost totally automated….”

    We are free to imagine this…. and we will have to keep imagining this a lot longer if we were to institute a wealth tax.

  19. Gravatar of Robert Robert
    3. July 2014 at 13:01

    Tom,

    “why slowing real wage growth would cause people to borrow more?

    How about: house prices increased 5% last year? or 6%? or 7%?”

    Actually, the housing affordability index was pretty stable from 1992 through to 2004. Then there were two and a bit years of falling affordability and now affordability is at all-time highs.

  20. Gravatar of Jeremy Goodridgde Jeremy Goodridgde
    3. July 2014 at 13:28

    Great write-up: with lots of detailed examples.

  21. Gravatar of Tom M. Tom M.
    3. July 2014 at 15:14

    Patrick,

    “the startling rise in living standards of the average guy during the years after Thatcher and Reagan”

    WTF? I’ve heard conservatives explain why wages have sucked for the “average guy” since Thatcher and Reagan but I’ve never heard anyone say they haven’t. What is the data to back up your assertion that the average guy has seen a rise in living standards?

  22. Gravatar of Frances Coppola Frances Coppola
    4. July 2014 at 13:39

    Scott,

    I’m sorry but there is an awful lot wrong here. In relation to your points 1 through 5:

    1. “Europe…had an even worse financial crisis”.

    No it didn’t. The UK, Ireland and Iceland had a worse financial crisis. In each case it was because the size of the banking sector dwarfed the sovereign, and the banking sector had extensive toxic cross-border liabilities. The rest of Europe – including France – actually fared much better in the financial crisis than the US. The fallout came later, in the sovereign debt crisis of 2011-12. And the severity of THAT crisis was due to the incompetence of the ECB, the idiocy of Eurozone politicians and the insanity of creating a single currency without the institutions to make it work properly.

    2. Why would people borrow when they don’t expect their incomes to rise? I suggest you read Mian & Sufi on this. Their book “House Of Debt” – which is meticulously researched – shows that the principal driver of both borrowing and consumption spending in the run-up to the crisis was rising house prices. I looked at Mian & Sufi’s data, because I couldn’t understand why wealth effects alone would be so strong. What the data showed was that mortgage lenders allowed people to borrow against rising house prices to fund consumer spending and refinance unsecured borrowings. Possibly as much as half of all US consumer spending was financed by borrowing against property in the run-up to the financial crisis. I’ve explained here how a sudden fall in house prices triggered by the Fed raising rates could have caused the sharp cut-back in consumer spending that Mian & Sufi noted: http://www.pieria.co.uk/articles/consumption_booms_and_housing_busts

    3. I agree Piketty is wrong about the source of the capital glut, but so are you. It is nowhere near as simple as “the savings of poor Chinese funded the Western savings glut”. Michael Pettis is instructive on this – have you read “The Great Rebalancing”? It is the net saving of emerging market COUNTRIES – plus Germany and until recently Japan – that make up the savings glut – which may be from households, corporations and/or governments. In the case of China, it is mostly the latter. Countries that have trade surpluses inevitably export capital, and vice versa.

    4. The financial crisis emerged from SHADOW banking, which by its very nature is (or was) unregulated. Shadow banks are customers of regulated banks, because they need access to payments and liquidity. Therefore a crisis in shadow banking can bring down the regulated system, and very nearly did.

    The US banking system has indeed historically been heavily regulated. That is in part why the shadow banking system developed. When you regulate something, people inevitably try to find ways round it. The resulting shadow structures are where crises tend to develop, precisely because they are not regulated.

    5. In the post I’ve linked to above I’ve made the same point as you regarding the role of government in encouraging banks to lend at higher risk. It was one of the drivers of the housing boom. But it was not the only one by any means. Banks were going for market share at the time, and they expected bailout – really that is why Lehman was such a shock.

    Turning to the rest of your post, I have the following observations to make:

    - The Hartz reforms in Germany happened at a time when the Eurozone periphery was building up unsustainable household and sovereign debt. Germany’s recovery was built on the back of its banks taking advantage of the single currency and free movement of capital in Europe to lend heavily to Eurozone sovereigns, households and corporations to finance German exports. At the time of the Eurozone crisis, 40% of German exports went to Eurozone countries and 60% to the whole EU. Even though Germany bailed out many of its banks in the financial crisis, they remain under-capitalized and over-leveraged. Had Germany’s banks been less enthusiastic about cross-border lending, Germany would not have been able to build up such a large trade surplus and would therefore probably have higher unemployment. I would also question whether the Hartz reforms would have caused such a fall in unemployment if Germany had not been part of the single currency. And finally, you should not ignore the role of German trades unions in holding down German wages. In the aftermath of reunification, German trades unions agreed to moderate wage claims in order to encourage employment. The attitude of trades unions in France, where they have not been attempting to reintegrate and rebuild a former Soviet province, is very different.

    - Your comment about “dystopia for men” makes me want to weep. Men have to change their attitude. In the future most men will indeed dip in and out of work, study, caring and unemployment, just as women already do. They had better get used to it.

    - The UK has had a minimum wage for over a decade. Its unemployment rate is similar to the US and considerably lower than much of Europe, including France. I’m aware that there are conflicting academic studies on this, but certainly in the UK it is by no means clear that the minimum wage causes higher unemployment. Indeed, as you probably know, the UK’s employment record has been rather good in the last six years compared to its economic performance: what took a massive hit was productivity.

    - There is zero evidence that the performance of the Dow and the Nikkei bears any relation to the pay of top executives in American and Japanese firms. That is a completely spurious correlation.

  23. Gravatar of Misho ILIEV Misho ILIEV
    4. July 2014 at 14:57

    Frances,

    I agree about shadow banking. But it seems that shadow banking is not going to go away.

    Would you agree that shadow banking should have been backstopped by a Bagehot-like lending?

    Here is an article that briefly develops this idea:

    http://mihaililiev.wordpress.com/2014/06/21/how-shadowy-is-the-shadow-of-the-shadow-banks/

  24. Gravatar of jasmine jasmine
    4. July 2014 at 15:52

    Good article, but this statement seems counterintuitive: “But at some point in their lives 73% of Americans do reach the top 20% of incomes.” Do you have a reference for that statistic?

  25. Gravatar of Eric Falkenstein Eric Falkenstein
    4. July 2014 at 17:48

    So, R>G drives inequality, which is bad. In other words, it would have been better if, given G, R were lower. I wish they were more upfront about this. Those damn billionaires in the 0.1% are ruining my life!

  26. Gravatar of TravisV TravisV
    4. July 2014 at 19:11

    Prof. Sumner,

    You wrote: “That might be ideal for a college professor, for most of the men that I have met during my life that sort of society would be a dystopia.”

    It’s not totally clear to me what point(s) you were trying to make with that sentence……

  27. Gravatar of libert libert
    4. July 2014 at 19:29

    “‘We are free to imagine an ideal society in which all other tasks are almost totally automated and each individual has as much freedom as possible ‘

    That might be ideal for a college professor, for most of the men that I have met during my life that sort of society would be a dystopia”

    A world of unlimited abundance at zero cost? Where people are free to pursue whatever goals they choose at low-to-zero cost? That sounds pretty utopian to me.

    Prof. Sumner: I admire your economic work. Please stick to it. Your delves into politics are…discouraging.

  28. Gravatar of TheMoneyIllusion – Picking apart Piketty « Economics Info TheMoneyIllusion – Picking apart Piketty « Economics Info
    4. July 2014 at 21:01

    […] Source […]

  29. Gravatar of Luis Pedro Coelho Luis Pedro Coelho
    5. July 2014 at 07:48

    “Everyone would be by turns teacher or student, writer or reader, actor or spectator, doctor or patient”

    Piketty wants to abolish professional licensing laws? I’m in!

  30. Gravatar of Frances Coppola Frances Coppola
    5. July 2014 at 08:02

    Misho,

    Definitely. Restricting liquidity support to regulated banks only in a crisis is madness. Regardless of its official status, if it behaves like a bank, treat it like one.

  31. Gravatar of Don Geddis Don Geddis
    5. July 2014 at 08:22

    @Jasmine: “73% of Americans do reach the top 20% of incomes … Do you have a reference for that statistic?

    From an earlier post by Sumner (see point #2), he references this NY Times article on the topic.

  32. Gravatar of Jon Jon
    5. July 2014 at 08:52

    Scott, perhaps the charitable read of Piketty is unexpectedly stagnate real wages “inevitably made it more likely that modest households would take on debt” .

    But you need to replace “take on” with “have higher debt/income ratios in the future.” i.e.,The ratio would have been lower had incomes risen as expected.

    Perhaps it’s a translation issue.

  33. Gravatar of Kevin A Kevin A
    5. July 2014 at 13:54

    Frances Coppola,

    I disagree with your assessment that lack of regulation caused the banking crisis. In fact, I would say the US government, overtime, put itself into a position where it had to enact discipline on banks, and then preformed poorly in enacting discipline.

    The key ingredient you are missing is that conduits (“shadow banks”) used liquidity and credit enhancements to give shadow depositors on balance sheet recourse in the event a shadow bank failed. Essentially, the regulated financial system was bringing the shadow banking system on its balance sheet, a risk a free market would have demanded more interest for and one that the FDIC should have charged more “insurance premiums” for (but didn’t).

    The FDIC thought it was a great idea to charge insurance premiums for consumer deposits based on a static rubric rules which gave the best rates for “AAA” assets. The result was financial institutions generating as much high risk “AAA” assets as they possibly could, not to sell to other investors, but to hold for themselves with risk being held by the federal government. “AAA” also let money markets invest in the shadow banks ABCP, a risk, once again, that the FDIC should have either disallowed or charged a higher rate for.

    In the US, the government, through explicit and implicit guarantees, is basically saying: “don’t worry public about a banks portfolio because we are watching the banks.” They then set up bureaucratic rules that banks must follow, and leave all of the investment analysis of a banks portfolio to credit rating agencies. The result is obvious.

    For more on this regulatory arbitrage:
    http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/acharya_richardson_critical.pdf

  34. Gravatar of dtoh dtoh
    6. July 2014 at 01:31

    Kevin A,
    Good analysis and interesting article. In a nutshell, I believe as you say that the government caused the problem by providing and implicit guarantee (TBTF) and then failed to regulate the assets held by the financial institutions. I have argued many times here that the Fed needs to regulate asset/capital ratios by asset class and it needs to be done not just through FDIC rates but on an outright explicit and dynamic basis.

    Further to your point, credit quality (rating) is not the only factor that needs to be taken into account, liquidity is also important so an effective regulatory scheme for controlling asset/equity ratio needs to require higher capital for asset classes that are less liquid.

  35. Gravatar of Frances Coppola Frances Coppola
    6. July 2014 at 10:43

    Kevin,

    Actually I did not say lack of regulation caused the crisis. I said the crisis – like most crises – started in the shadow banking sector, which is by its nature unregulated. That is accurate. However, I would argue that inadequate regulation was a contributory factor in the crisis. The very existence of unregulated entities competing directly with regulated ones is a regulatory failure.

    Unfortunately you contradict yourself in your first paragraph. If a government puts itself in a position where it has to enact discipline on banks, then fails to do so, that IS lack of regulation. You seem to be confusing regulation (activity) with regulations (rules).

    Shadow banks always have on-balance sheet deposits on the liability side of regulated banks. That is necessary in order for them to be able to settle transactions, and it is not generally a problem. It is the ASSET side that is the problem. I’m constantly amazed that people do not understand that regulated banks are the lenders of last resort for shadow banks. When shadow banks get into difficulties, there is inevitably a knock-on impact to the regulated banks that support them. That applies regardless of the amount of their liabilities that actually sit “on” regulated banks’ balance sheets. Rehypothecated collateral, for example, is off-balance sheet – but when those pledges unwind due to defaults further up the chain, or collateral turns out to be worthless, there is an ON balance sheet impact for regulated banks.

    Regarding FDIC: it is not unreasonable to charge lower insurance premia to banks with balance sheets containing large amounts of triple-A rated securities, any more than it is unreasonable to assign those securities lower risk weights for capital adequacy purposes. Indeed we would expect to pay less for insurance for deposits backed by the highest quality, and by implication lowest risk, securities. The problem was that the securities in question did not remotely justify their triple-A rating. Instead of criticitizing FDIC for what was actually a reasonable approach to risk pricing, you should criticize the captive ratings agencies responsible for assigning such inappropriate ratings. In the words of Tolkien, have a care to lay your axe to the right tree.

  36. Gravatar of ssumner ssumner
    6. July 2014 at 13:38

    Frances, 1. I can’t imagine why you would exclude the 2011-12 period from the European financial crisis. Yes, the ECB was idiotic, but so was our Fed.

    2. I never implied that rising housing prices could increase borrowing, I asked why stagnating incomes increase borrowing.

    3. Yes, it wasn’t just Chinese saving (obviously), but the fact that private Chinese citizens save so much seems to undercut Piketty’s thesis. He seem to think only high earners can save enough to become rich. Not so.

    4. The US financial crisis was not caused by “shadow banking” it was caused by ordinary banks making foolish subprime loans.

    5.I know of no economic theory or set of empirical data that links trade surpluses with low unemployment rates. I never claimed that a lack of minimum wage was the only factor in Germany, the 2004 reforms did not even involve minimum wages.
    But they did make it easier to create low wage jobs in Germany, just as it is easier to create those jobs in Britain than France. That seems relevant to the minimum wage debate.

    The burden of proof is on people who claim US CEOs don’t earn their money. They must explain why US companies do so much better than Japanese companies. Piketty suggests it doesn’t seem like productivity is linked to pay. Was not? What’s his argument?

  37. Gravatar of Paul Zrimsek Paul Zrimsek
    6. July 2014 at 16:54

    I didn’t take Kevin to be saying just that the people at the FDIC were a bunch of big stupid stupidheads; I took him to be expressing doubt that more regulation would have done any good, given the fact that the regulators were in the grip of the same plausible-but-erroneous assumptions as were the institutions they were regulating. If the people at the FDIC deserve a free pass for the ex ante reasonableness of their faith in the credit-rating agencies, I see no reason to deny the same to the private actors who were relying on the exact same faith.

  38. Gravatar of Doug M Doug M
    7. July 2014 at 08:23

    Why stagnating incomes increase borrowing….The theory, I don’t ascribe to it, but I have heard it… is that the need to keep up with the Jones’es is powerful.

    If Mr. and Mrs. Smith look out their window and see a new car in the Jones’es driveway, they feel a drop in their personal level of status. The Smith’s feel a powerful need to spend similar levels of money to maintain social standing.

    And the Jones’es seeing how the Smith’s are spending money will also feel the need to keep up, and so the treadmill continues. Real spending must always be rising. If real income is not rising as fast, then borrowing will make up the difference.

  39. Gravatar of Paul Zrimsek Paul Zrimsek
    7. July 2014 at 08:46

    The trouble with the “keeping up with the Joneses” theory is that the Smiths and the Joneses are overwhelmingly likely to belong to the same social class; if the Smiths are stagnating, the Joneses probably are as well, and thus don’t require much keeping up with.

  40. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    7. July 2014 at 08:56

    Piketty is on pace to be a record setter;

    http://online.wsj.com/articles/the-summers-most-unread-book-is-1404417569?mod=trending_now_3

    ‘Yes, it came out just three months ago. But the contest isn’t even close. Mr. Piketty’s book is almost 700 pages long, and the last of the top five popular [Kindle] highlights appears on page 26. Stephen Hawking is off the hook; from now on, this measure should be known as the Piketty Index.’

    I.e.:

    ‘How can we find today’s greatest non-reads? Amazon’s “Popular Highlights” feature provides one quick and dirty measure. Every book’s Kindle page lists the five passages most highlighted by readers. If every reader is getting to the end, those highlights could be scattered throughout the length of the book. If nobody has made it past the introduction, the popular highlights will be clustered at the beginning.’

  41. Gravatar of Unlearningecon Unlearningecon
    7. July 2014 at 11:37

    It’s worth noting that the CEO pay point is yet another one that Piketty deals with explicitly:

    “The most convincing proof of the failure of corporate governance and of the absence of a rational productivity justification for extremely high executive pay is that when we collect data about individual firms (which we can do for publicly owned corporations in all the rich countries), it is
    very difficult to explain the observed variations in terms of firm performance. If we look at various performance indicators, such as sales growth, profits, and so on, we can break down the observed variance as a sum of other variances: variance due to causes external to the firm (such as the general state of the economy, raw material price shocks, variations in the exchange rate, average performance
    of other firms in the same sector, etc.) plus other “nonexternal” variances. Only the latter can be significantly affected by the decisions of the firm’s managers. If executive pay were determined by marginal productivity, one would expect its variance to have little to do with external variances and to depend solely or primarily on nonexternal variances. In fact, we observe just the opposite: it is
    when sales and profits increase for external reasons that executive pay rises most rapidly. This is particularly clear in the case of US corporations: Bertrand and Mullainhatan refer to this phenomenon as “pay for luck.”

    In other words, it’s largely a question of reverse causality.

    Piketty goes into a lot more detail than Sumner gives him credit for, and that is not only true of this example. But I’m not going to waste my time documenting every instance of this: people who genuinely want to know about Piketty’s views should read his book, not Sumner’s reviews of it.

  42. Gravatar of Frances Coppola Frances Coppola
    7. July 2014 at 12:45

    Scott,

    Point 1: indeed it is fair to regard the Eurozone crisis as simply the second phase of the financial crisis. But even then, it is not accurate to say that “Europe” had a worse crisis than the US. The 2011-12 crisis was not on the same scale as the 2007-9 crisis: the failures of banks and corporations were nowhere near as extensive and the ensuing recession was nowhere near as deep for Europe as a whole. Individual countries within Europe did fare very badly – Greece, Latvia, Portugal spring to mind. And the EU still has very high unemployment. But then it has both tight monetary policy and ill-considered fiscal adjustment. The ECB has not handled the second phase of the crisis nearly as well as the Fed handled the first. In fact arguably it caused the second phase when it prematurely raised interest rates in 2011.

    Point 2: Piketty does not say that stagnating incomes cause borrowing. He says that rising debt among low-to-middle income Americans was inevitable when their purchasing power stagnated. That is actually a macroeconomic point. As low-to-middle incomes stagnaged, the rich continued to save because of rising incomes and low marginal propensity to consume (hence rising inequality), and the US continued to import capital because of its trade deficit. Nor was the excess saving limited to high net worth individuals. The corporate sector was running a structural surplus prior to the crisis, as indeed it still is. Had the American low-to-middle income household sector not borrowed to the extent that it did, the American fiscal deficit would have been far higher. This is why Piketty says it was principally rising inequality in the US that caused financial instability, although global imbalances were also a contributory factor.

    Point 3: Chinese households do save a lot, true. And American households save much less, also true. But this is not actually the point Piketty is making. He is discussing national accounting. If Chinese households saved much less, then for China to maintain its trade surplus either its government or its corporate sector – or both – would have to save much more. Countries with trade surpluses export capital: which sector is actually doing the saving needed to create that surplus for export is beside the point.

    Point 4: I agree with you that the subprime crisis originated in the mortgage lending sector. But as usual, it’s not that simple. The two main phases of the financial crisis – the two catastrophic bank runs, respectively in August/September 2007 and September 2008 – both took place primarily in the shadow banking sector, with knock-on impact to the regulated sector as I described, and indeed beyond it to the insurance sector (AIG/monolines) and even non-financial corporations. Lehman itself was a shadow bank.

    I think the US “feast or famine” approach to regulation is a huge problem. Over-regulating one particular type of financial institution while ignoring the rest is a recipe for disaster. Unfortunately too many people still want to go down that route.

    Point 5: Mercantilism connects trade surpluses with low – or even zero – unemployment. Both Germany and China have been pursuing essentially mercantilist macroeconomic policies for about two decades now. Germany is now additionally exporting its mercantilist philosophy to the rest of the EU: the EU itself is now running a trade surplus, which in the presence of both tight monetary and fiscal policy across the entire EU can only grow ever larger.

    Regarding CEO pay: I refer you to Unlearning Econ’s discussion of Piketty’s statistical argument. I would just add that your point about CEO pay ignores local conditions. Japan has been in a depression for twenty years. Poor CEO pay reflects that. If and when Japan emerges from its depression, I would expect the Nikkei to rise and with it, Japanese CEO pay.

  43. Gravatar of Doug M Doug M
    7. July 2014 at 13:28

    Paul Zrimsek…

    “The trouble with the “keeping up with the Joneses” theory is that the Smiths and the Joneses are overwhelmingly likely to belong to the same social class; if the Smiths are stagnating, the Joneses probably are as well, and thus don’t require much keeping up with.”

    The keeping up with the Jones only works if Mr. Smith and Mr. Jones are the same class. Mr. Smith buys a new car. Mr. Jones redecorates his bathroom, and both Mr. Jones and Mr. Smith somehow feel inadequate that they don’t have a car / bathroom. And neither knows where they got the money to pay for these things.

    If Mr. Smith makes substantially more than Mr. Jones, then quickly enough Jones realized he can’t keep up. But Smith is also likely to move to a bigger house in a neighborhood with better schools, and now feel the need to keep up with the Robinson’s.

  44. Gravatar of Mike Sax Mike Sax
    7. July 2014 at 18:22

    ” Why would stable real wages lead to more debt? More specifically, why would it “inevitably” lead to more debt? If my wages were stagnant I certainly wouldn’t react by taking on more debt, rather I’d borrow more if I expected my income to rise. Is there a theory here?”

    Sometimes it seems that some macroeconomists are so steeped in theory as to totally lose any sense of imagination. If my wages are decreasing and my expenses are staying the same-and so increasing-one way I might try to make up for my loss income is through borrowing. Now one reason someone in this position doesn’t do this is because lending institutions won’t lend to them based on a check of their credit history and income.

    However, a drop in lending standards would remove that break

  45. Gravatar of Major_Freedom Major_Freedom
    7. July 2014 at 19:15

    Mike:

    The context is stable real wages. That is the context from which the theory must be advanced.

    Your “imagination” assumes falling real wages (falling wages but constant cost of living).

    Geez.

  46. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    8. July 2014 at 07:04

    ‘However, a drop in lending standards would remove that break’

    Oh, that finally dawns on you, eh, Mike? Now work on where that ‘drop in lending standards’ came from.

  47. Gravatar of Dan Meyer Dan Meyer
    8. July 2014 at 12:07

    Why would “unscrupulous banks” lend on “increasingly generous terms?”

    Easy. We’re talking about mortgages here. And pre-2008, the housing market was on fire. Banks invented balloon mortgages (those “increasingly generous terms”) that they knew folks wouldn’t be able to pay back (“unscrupulous”), but so long as the people they loaned to could sell their house for a profit – the banks took on no risk.

    Why no discussion of how the government encouraged banks to lend money to low income people?

    I’m assuming you’re talking about the CRA. That only applies to FDIC ensured banks. Private entities provided the vast majority of subprime lending.

    Really, though – the argument that the CRA caused the housing bubble has no merits. Here’s a pretty good takedown of that argument: http://rortybomb.wordpress.com/2011/11/01/bloombergs-awful-comment-what-can-we-say-for-certain-regarding-the-gses/

  48. Gravatar of ssumner ssumner
    8. July 2014 at 13:34

    Unlearningecon, There are studies claiming CEO pay is related to expected productivity. Does Piketty discuss those in his book? Where?

    Frances, I´d like to see data comparing the losses in Europe and the US, I´m not convinced.

    I don´t know how people can dramatically increase their debts without borrowing more. Maybe I´m missing something.

    I was making a different point about China. Piketty doesn´t seem to think average Americans earn enough to save much, I think they earn enough to get rich, if only they saved more.

    On balance, US regulations do more harm than good. The only good arguments for regulating the financial sector would be to have regulations that undo the damage of other regs. Perhaps a ban on subprime mortgages. But those are exactly the sort of regulations we don´t do. Instead we encourage subprime lending.

    Germany has had (on average) a higher unemployment rate than the US over the past 20, if I´m not mistaken. So that doesn´t support the claim that trade surpluses reduce unemployment. In any case, I´ve argued that most definitions of “mercantilism” are essentially meaningless, as they confuse the trade and capital accounts. Any definition of mercantilism that includes Germany is utterly meaningless.

    I don´t agree that low CEO pay in Japan is caused by a weak economy, but I could be convinced if you showed me that Japanese CEO pay was high back in the booming 1980s. I doubt it.

    Mike, Common sense does more harm than good in economics. Do you believe people borrowed lots more in the Great Depression?

    Dan, No, I wasn´t talking about the CRA, and I certainly never claimed the crisis was primarily caused by CRA type regs, I don´t believe that. I believe it was a mixture of inept policies in a wide range of areas and poor choices in the private sector. CRA was merely one of many factors. FDIC regs were far more important, as were the GSEs.

    And are loan conditions determined by a market, or by unscrupulous lenders? You can´t have it both ways.

  49. Gravatar of Mike Sax Mike Sax
    8. July 2014 at 16:09

    ” Common sense does more harm than good in economics. Do you believe people borrowed lots more in the Great Depression?”

    No Scott but that’s because none was available. Piketty was discussing a time when the banks made lots of credit available to some people who normally could never dream of receiving it. Piketty’s whole point was that this fall in lending standards enabled many in debt to in fact receive more credit.

  50. Gravatar of Mike Sax Mike Sax
    8. July 2014 at 16:12

    I mean if you can’t afford to meet your basic bills and someone offers you credit you think this is going to tempt no one in debt to take on more?

    If someone for example is about to lose their home but they actually are made an offer of more credit you expect that 100 out of 100 people will prudently turn it down and lose their homes? If not then this isn’t hard to understand

  51. Gravatar of Mike Sax Mike Sax
    8. July 2014 at 16:15

    “The context is stable real wages. That is the context from which the theory must be advanced.”

    Why do I have to adopt that straitjacket? If median income is frozen for 30 years what makes me think that prices are frozen for 30 years as well?

    I find the word ‘stable’ here is pretty euphemistic. Yes your income is frozen-that’s a nice stable wage! Talk about spin.

  52. Gravatar of Fed Up Fed Up
    8. July 2014 at 20:47

    “I can’t imagine any reason why slowing real wage growth would cause people to borrow more.”

    Let’s make it negative. Wages grow by 0% to 2%. Prices using a lower/middle class person’s budget is growing by 3% to 6%. The gov’t comes up with a CPI that says 2%. Would you borrow to maintain your standard of living?

    “I was making a different point about China. Piketty doesn´t seem to think average Americans earn enough to save much, I think they earn enough to get rich, if only they saved more.”

    You should go thru people’s monthly budgets before saying that one.

    “4. The US financial crisis was not caused by “shadow banking” it was caused by ordinary banks making foolish subprime loans.”

    Maybe Frances can help here, but I thought New Century Financial was not an “ordinary bank”.

    Were they really foolish, or did they just think housing prices would not go down so it was OK to lend against that rising collateral without worrying about the ability to repay? Also, did they think the collateral would not go down because bernanke and greenspan said there was not a housing bubble with greenspan saying it was just a little froth.

  53. Gravatar of Paul Zrimsek Paul Zrimsek
    9. July 2014 at 05:05

    The reason why you have to adopt the real-wage “straitjacket” is, first, that that’s what Picketty was talking about (“virtual stagnation of the purchasing power of the lower and middle classes”); second, that that’s the only version supported by the facts, if you care about that sort of thing. Nominal wages have not been stagnating.

  54. Gravatar of Becky Hargrove Becky Hargrove
    9. July 2014 at 09:12

    Re Piketty’s imaginings:
    It’s not just about being free to imagine, but being free to rediscover how people are willing to spend their time among one another.
    http://monetaryequivalence.blogspot.com/2014/07/time-arbitrage-as-gate-to-everyones.html

  55. Gravatar of Jared Jared
    9. July 2014 at 14:03

    “4. The US financial crisis was not caused by “shadow banking” it was caused by ordinary banks making foolish subprime loans.”

    Ugh.. this is 180 degrees wrong!

    Study after study (many of which can, conveniently, be found here: http://www.washingtonpost.com/blogs/wonkblog/wp/2013/02/13/no-marco-rubio-government-did-not-cause-the-housing-crisis/) have shown that the vast majority of “subprime” loans did not come from ordinary banks, nor the GSE’s. For instance, unregulated mortgage brokers originated around 84% of subprime loans in 2006, selling them to non-agency, private label securitizers. Furthermore, the GSEs were losing market share to these private securitizers (Lehman) during the housing boom between 2002-2005. Fannie and Freddie, in their search for profit, tried to keep up, but their heavy losses did not come from the lending side, where they still had standards, but from their investment portfolio, where they had invested in private label securities.
    https://research.stlouisfed.org/conferences/gse/Van_Order.pdf

    There was a buck to made by lending without credit standards and the free market found it. If you don’t believe me, maybe you’ll believe Cato: http://object.cato.org/sites/cato.org/files/serials/files/regulation/2000/10/gunther.pdf

  56. Gravatar of Mike Sax Mike Sax
    9. July 2014 at 18:44

    Paul is you agree that real wages have been stagnant then you are on the same page as Piketty and myself for that matter. To call stagnant wages ‘stable’ is an impressive euphemism.

  57. Gravatar of ssumner ssumner
    11. July 2014 at 01:31

    Everyone, The American middle class circa 2004-06 was the richest the world has ever seen. To claim they were unable to save much more and were “forced” to borrow is utterly ludicrous. The housing bubble was not about people trying to maintain living standards, it was about people trying to get higher living standards, which they could not afford.

    By the way, many researchers have shown that the “data” showing stable real wages is utter garbage. Real wages have been rising for decades.

    Jared, It depends what you mean by ‘financial crisis’. If Asian investors lost money on MBSs initiated by US mortgage brokers then that is hardly a “crisis.” My focus is on the losses to the US banking system, which required government bailouts. I should not have suggested subprime mortgages were the only problem. When US banks failed the largest losses tended to be commercial loans, although subprime loans were also a problem.

    Whether loans were initiated by banks or mortgage brokers is not an important question. The key question is who took the losses that the taxpayers had to bail out.

  58. Gravatar of Fed Up Fed Up
    13. July 2014 at 13:42

    “Everyone, The American middle class circa 2004-06 was the richest the world has ever seen.”

    I doubt that is true without debt.

    “To claim they were unable to save much more and were “forced” to borrow is utterly ludicrous. The housing bubble was not about people trying to maintain living standards, it was about people trying to get higher living standards, which they could not afford.”

    It is not ludicrous at all. What happens when existing home prices start rising more than wages? What happens when prices by a lower/middle class person’s budget start rising more than wages?

    “By the way, many researchers have shown that the “data” showing stable real wages is utter garbage. Real wages have been rising for decades.”

    Better check the data for wealth/income inequality and price inflation measures that overemphasize tradable goods. What happens if price inflation is 4% or more with a lower/middle class person’s budget and gov’t stats say 2% price inflation?

    See charts and other “stuff” here:

    http://www.advisorperspectives.com/dshort/updates/CPI-Category-Overview.php

    “The one thing we can be certain about is this: Increases in inflation will have a painful effect on lower income households, those on fixed incomes, those with higher ratios of tuition, transportation, or medical costs … and all households whose discretionary spending is more dream than reality.”

    “Whether loans were initiated by banks or mortgage brokers is not an important question. The key question is who took the losses that the taxpayers had to bail out.”

    Yes, it is because the capital requirement is probably less than 100%.

  59. Gravatar of ssumner ssumner
    14. July 2014 at 07:44

    Fed up, So those migrant farm workers making $15,000 who took out $600,000 mortgages were just trying to maintain their standard of living?

  60. Gravatar of Fed Up Fed Up
    14. July 2014 at 10:14

    Possibly.

    Assume wages of $15,000 per year and expectations that will stay the same. It happens.

    Assume expectations that rents rise 3% or more per year. It mostly happens.

    Assume expectations that house prices rise 7% or more per year. It happens for awhile.

    At what point would someone “throw in the towel” and say I’m going into debt to benefit from rising house prices instead of not benefiting from rising house prices.

    Buying a more expensive house could lead to bigger capital gains on the house (realized and unrealized).

  61. Gravatar of ssumner ssumner
    15. July 2014 at 09:57

    Fed up, I guess we see the same picture, but interpret it differently.

  62. Gravatar of Fed Up Fed Up
    15. July 2014 at 20:49

    I believe these need to be addressed.

    Some people with positive real “earnings” growth borrow.
    Some people with positive real “earnings” growth do not borrow.

    Some people with negative real “earnings” growth borrow.
    Some people with negative real “earnings” growth do not borrow.

    Why to all of those?

  63. Gravatar of youko youko
    23. July 2014 at 10:15

    Can we just take a moment to mention that Piketty, who likes to pretend that he hasn’t read Marx, basically stole that p308 quote from Marx and Engels’ “The German Ideology.” Its an often cited passage, about how in a post-capitalist social formation the division of labour wouldn’t be rigid and alienate people from authentic work:

    “And finally, the division of labour offers us the first example of how, as long as man remains in natural society, that is, as long as a cleavage exists between the particular and the common interest, as long, therefore, as activity is not voluntarily, but naturally, divided, man’s own deed becomes an alien power opposed to him, which enslaves him instead of being controlled by him. For as soon as the distribution of labour comes into being, each man has a particular, exclusive sphere of activity, which is forced upon him and from which he cannot escape. He is a hunter, a fisherman, a herdsman, or a critical critic, and must remain so if he does not want to lose his means of livelihood; while in communist society, where nobody has one exclusive sphere of activity but each can become accomplished in any branch he wishes, society regulates the general production and thus makes it possible for me to do one thing today and another tomorrow, to hunt in the morning, fish in the afternoon, rear cattle in the evening, criticise after dinner, just as I have a mind, without ever becoming hunter, fisherman, herdsman or critic.”

  64. Gravatar of ssumner ssumner
    23. July 2014 at 10:26

    youko, I’ll have to defend Piketty on this one. I don’t see anywhere near enough similarity to assume influence.

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