Tuesday, November 26, 2013

Labor Share of Income

Tyler Cowen links to new research on labor share of income from Elsby, Hobijn, and Șahin.  It's an interesting paper.  Much of the findings demonstrate the difficulty of using these statistics in a precise way.  For instance, they find that in stock options are accounted for when they are exercised, and they tend to be exercised at market high points.  So, recently, there has been a pro-cyclical quality to labor income.  There are periods of underreporting, which miss deferred income in the form of options.  Then, when the options are exercised, they create an overreporting of labor income.  They do not find evidence that reduced unionization is related to lower labor share of income.  But, they also find that the data do not support several neo-classical predictions about relationships between labor and capital, and they also find that more than 3% of the decline in labor share is due to offshoring.

Looking at this post I did on this basic topic, I should have included this graph:
This is compensation as a portion of GDI.  My feeling is that this is still within a fairly tight long term range, but the research noted by Tyler is basically looking at the decline since the 1970s.  (The proportions I use are from table 1.11 of the BEA interactive data tables for National Income and Product Accounts.  Levels can differ, depending on the denominator used, etc., but the trends tend to be the same.)

I tend to have a queasy feeling about the implied moral notions that discussions about these things tend to carry.  There is usually a sense that declining labor share is a problem to be solved.  But, who is to say that labor share hasn't been too high?

I am going to eat some sugar plums tonight, then go to bed and dream of a world where the social convention is to wonder how we can increase capital's share of GDI.  Does that make me a bad person?  If you think so, then I encourage you to visit a place where 100% of compensation goes to labor.  They exist.  Floors tend to be made of dirt there.  You might find that you want to take the first available flight back home from there...except they won't have planes, because planes require capital.  Many places like that are now seeing vast improvements in the conditions of the typical household.  The places that are doing that are doing it by encouraging the profitable allocation of private capital.

My point is that it is very hard to determine the optimal proportion of income that should go to labor.  A mental model that induces concern for decreasing Labor Share but never induces concern for decreasing Capital Share is not a coherent model.  It's a very effective, and widely utilized, model for social posturing, but it would be practically useless as an informational tool.
If we imagine the range of possible outcomes for Labor Share of Income, a society where 100% of income goes to labor is generally going to be a subsistence society.  These societies are usually characterized by a universal lack of individual property rights, so that legal or cultural norms impose a negative rate of return on individual saving, and thus, there is little accumulation of wealth or capital.
A limited access society, where property rights are monopolized by a small set of owners and the mass of the population works for subsistence wages and has a limited ability for accumulation or savings, would have a very low Labor Share of Income.
Developed, free societies with universal property rights populate the area around the tip of the hump.  These societies generally allow for an emergent equilibrium level of Labor Share of Income that moves dynamically around some range.
The level of potential income, optimal labor share, and actual labor share, are constantly moving due to changing cultural, technological, and legal contexts.  If this relationship is smooth and continuous, then we would expect Labor Share of Income to decrease as a result of non-universal capital-related policies or policies that prevent entry into specific markets (these policies include ethanol mandates, health insurance mandates, regulated monopolies, the FDA, non-competitive government procurement, zoning restrictions, etc.).  Universal restrictions of capital would tend to increase labor share (high taxes on capital, pro-labor contract regulations, high levels of public employment, etc.).
To the extent that there are forces pulling in both of these directions, the level of potential income (the height of the hump) is reduced.  If labor share is to the left of the hump, and our reaction is to implement confiscatory capital policies, we won't be climbing the hump.  We will just be lowering the hump as we pull labor share back up.  If we are truly to the left of the hump, the appropriate policy reaction would be to decrease some of these non-universal capital policies.
Even though the list of policies above is long, the US has been better than most at avoiding non-universal capital policies, and it also has a higher labor share than other economies.
But, how can we know if we are to the left of the hump?
The Gross Domestic Income that is not taken by labor is, for the most part, taken by capital.  But this is divided between Consumption of Fixed Capital, which is a measure of deterioration and obsolescence of capital assets, and Net Operating Surplus, which is the remaining income to capital, in the form of profit, interest, and rent.  What we can see here is that, over time, there has been a large decrease in the relative income to capital.  We would expect this to coincide with an increasing Labor Share of Income.
But, as we can see here, this has been a product of an increasing capital base.  An increasing amount of capital has been put to work in the American economy.  Decreasing marginal returns have led to a lower proportional income to capital, but the absolute return to capital has remained within a relatively narrow band.  So, the lower labor income has come at the hand of higher capital deployment, and not from higher capital income.
This is understandable.  As we continue to become wealthier, we should have more capital to deploy.  The net effect of this on Labor Share of Income is not clear.  Long term cultural and technological developments could lead to higher, lower, or stable income shares.
In the end, I propose some basic ideas to guide discussion on this issue:
1) Any discussion prefaced on a naïve notion that decreases in Labor Share of Income are bad, ipso facto, will be unlikely to lead to a productive outcome.
2) This does not make a good proxy for income inequality issues, since high incomes can be a part of both labor and capital.  CEO's and high status athletes earn mostly labor income.  Elsby, Hobijn, and Șahin note that while labor income variance has increased, the increased variance of incomes among proprietors dwarfs that of payroll labor.  The sources of inequality are complex, and I wonder if labor markets mitigate these variances as often as they promote them.
3) A discussion framed in terms of shares of income is framed to miss the most important factor - the height of the hump.  This chart shows the actual Compensation of Employees, over time, compared to the range of compensation share over the past 65 years.  The slope of these trends is, far and away, the most effective way to improve the lot of the average laborer.
If we are considering a policy that is meant to correct the level of Labor Share of Income, which has an ever-moving and unknowable optimum, and if that policy will arguably lower the rate of growth for the economy as a whole, then that policy needs to have a very high bar to top in terms of effectiveness and coherence of purpose.

On the one hand, the research of Elsby, Hobijn, and Șahin suggests that my idealized model certainly won't be supported by all of the data.  But, I think we tend to have an aesthetic response to these issues that leads us astray.  If we see a shrinking labor share of income, we think of the poor worker, putting in long days and barely making ends meet.  We don't have a comparable image when capital's share of income shrinks.  (Why don't we think of our widowed grandmother, trying to extend her nest egg in the face of negative real interest rates?)  But, the tip of the hump in my model is not utopia.  It's a place where there will still be, for now, working poor families.  This is unrelated or tangentially related to labor share of income.  We shouldn't be led by the realities of our current distribution of scarcity away from the most effective means to improve it.  Some of those solutions may be redistributional, but it might be worthwhile to aim for policies that reduce the drag on universal returns to capital as opposed to policies intended to increase that drag, in some sort of misplaced attempt at fairness.
PS:  "Negation of Ideology" comments at themoneyillusion.com.  Here is the beginning and end of the comment:
"People confuse the distributional issue with the labor/capital split. The ideal obviously is for Capital to receive 100% of national income and labor to receive 0%, and the ownership of Capital to be very widespread...............If a farmer that owns his own farm gets a tractor that cuts his workload in half is he angry?"
His comment is profound.  But, it gets at the difficulty of achieving utopia.  Capital is risk.  Accumulation is risk.  Whereas information asymmetries probably mitigate inequality in the labor context, in the capital context outcomes multiply upon themselves, whether those outcomes are skill-based or simply from bad luck.  Could the 100% capital-utopia be stable?

The conundrum is that, clearly, a capital-heavy society is better than a labor-heavy society.  But, a capital-heavy society is probably inevitably less stable with more diverse individual economic outcomes.

Monday, November 25, 2013

Employment and the Economy

A couple months ago, I was a little worried about trends in the JOLTS data.  Here is a graph of the monthly change in the 12 month moving average of Quits, Job Openings, and Hires.

These indicators tend to move up and down together, and since a decline of labor churn is one of the symptoms of a recession, these indicators might prove to be a useful leading indicator for economic headwinds.  In June, all three indicators were testing declines that they had been flirting with for a few months.  Most other indicators seemed to still be signaling a recovering economy, but JOLTS might be an early signal.  Since then, the JOLTS indicators appear to have recovered, and are again growing from month to month.  This suggests that there could be tailwinds in the coming labor market.

Unemployment has been peculiar in this cycle.  This graph shows the total unemployment rate (blue), which has been declining at a pretty linear rate of about 0.8% per year since early 2010.  But, the green line is the unemployment rate after subtracting workers on Emergency Unemployment Insurance (EUI).  It has been basically flat for 4 years.  All of the reduction in unemployment is coming from EUI.  There are only about 1.3 million workers still on EUI, and its rolls are still dropping by nearly a million workers a year, so it appears that, regardless of whether Congress renews it in 2014, it will be a less relevant part of the picture.  Nonetheless, nonrenewal would probably help to bring down the unemployment rate a little more quickly.

Among the other 6.4% of unemployed workers, about 4.6% have been unemployed for less than 26 weeks.  About 1.8% have been unemployed for more than 26 weeks.  Both of these levels have been relatively stable for several years.  In a healthy economy, where the UE rate might dip below 5%, the short duration unemployment rate would be between 3.5-4.5%, plus about 0.75% of workers unemployed for more than 26 weeks.  So, the excess unemployment is mostly related to the long-duration unemployed.

I would blame much of the excess unemployment duration on EUI and demographics.  Older, more educated workers tend to have longer unemployment duration.  The EUI problem will work itself out as the recovery continues, but I expect the demographic factor to buoy the unemployment rate well into the recovery phase, for another decade, at least.  (Here is a link to some of my previous posts on the topic.)
This graph is the long-term level of initial and continued unemployment insurance claims, as a percentage of the labor force.  Three notable pieces of information from this graph are:
1) new claims are at a level historically associated with full employment (UER of 5% or less).

2) In terms of initial claims, the 2009 labor market was roughly as bad as the 1991 labor market.  All of the additional labor market problems were related to unemployment duration.

3) the effect of demographics on unemployment duration are evidenced by the relative growth of continued claims in the last 15 years, as baby boomers have entered to the older age groups.  The currently high relative level of continued claims might also result from the EUI policy.  This measure does not include EUI recipients, but EUI appears to also increase the unemployment duration of those unemployment for less than 26 weeks.

This graph reinforces the idea that normal employment levels are basically recovered.  Short duration unemployment is probably near a long term bottom, which with a typical level of long duration unemployment would put us at an UER of about 5.3%.  Depending on the behavior of the workers currently listed as long term unemployed, this could lead to inflationary pressures even when unemployment is somewhat above 5%.

This graph compares the unemployment rate to continued unemployment insurance claims.  Here, we can especially see the significant amount of unemployment that is due to the long duration unemployed, since the UER is much higher relative to standard UEI recipients than it has been in the past.  The labor recovery over the next couple of years will be a process of bringing that green line down to the level of the red line.  The question is, how quickly will it happen.

The number of long term unemployed once reached 6.7 million, and is now down to 4 million.  That leaves about 3 million additional workers who would need to leave the rolls of the long-term unemployed to bring us back to a normal labor market.  Workers have been leaving the ranks of the long term unemployed at a much higher sustained rate than one might have guessed, with an exit rate staying strong at about 2 million a quarter.  This is in spite of the fact that the total number of workers in this group has declined by about 40% from the peak and in spite of the fact that a normalized short-duration labor market has meant that we are seeing fewer new long-term unemployed.  Reasons for this include:
1) The proportion of long-term unemployed workers covered by EUI has been shrinking, so it has had a decreasing effect on durations over time.
2) A large number of the long term unemployed are marginally attached to the labor force - for instance many are in the older age groups, where they may be near retirement or may have the flexibility to wait for a more robust job market.  So, there are an unusually high amount of transfers between workers classified as unemployed versus not in the labor force.  Some of this reflects the arbitrary status of some workers, especially among the older age groups, which makes trends in the unemployment rate difficult to predict.  (Here is an earlier post about why the decreasing labor force is generally demographic in nature.)

FRED GraphIf the linear rate of unemployment reduction continues, we could hit 6.0% unemployment by the summer of 2015, and labor markets may become inflationary earlier than normal because of structural and demographic issues.  This graph suggests that we are a long way from worrying about any inflationary problems, though.

The blue line is the annual change in the CPI adjusted amount of currency in circulation and the red line is real GDP.  Drops in inflation adjusted currency seem to pre-date drops in real GDP.  The current high rate of increase in currency suggests that current increases in currency are not inflationary and that a negative shock in real GDP is not imminent.

PS. I'm not sure what this last chart is really measuring.  Could this be a product of the Fed's inflation targeting policy?  When inflation adjusted currency growth stops, that means that any real GDP growth has to be related to increased velocity.  We would expect that to happen if real interest rates are rising as part of an accelerating economy, so this wouldn't necessarily make that indicator a leading indicator of a decline in real GDP.

Do these drops in inflation adjusted currency signal times when a relatively larger portion of NGDP growth is coming through inflation?  If that is the case, and the Fed reacts to that development by pulling back currency growth even more, then could the inflation targeting policy be creating a causal retationship between momentarily higher inflation and subsequent recessions?  If that is the case, this would be an example of how inflation targeting causes unnecessary economic contractions that could be avoided with NGDP targeting.

There are a lot of moving parts here.  Please comment if you have insight into this relationship.  Especially comment if you know of some technical error I am making or if the graph is useless in some way I don't understand.

Friday, November 22, 2013

Speculation about movements in 2013 Interest Rate Futures

Interest rates have made several broad moves through 2013.  Here is a graph of Eurodollar futures at four turning points during the year:

The following graph is of deconstructed versions of the Eurodollar forward rates, reflecting the expected date of the first short term rate increase and the rate of the increases that follow.

May 1 was roughly the low point in forward rate expectations.  At that point, the first rate increase was expected at the end of 2015, with a slope of only about 20bp per quarter after that.  I have speculated that this low slope was actually a reflection of inflation uncertainty.  Market expectations of a steeper slope might have been tempered by uncertainty about the Fed's balance sheet, which could have lowered bond yields across the yield curve.

From May 1 to June 14, unexpected improvements in the economy caused the expected date of the first rate increase to move forward, but Fed uncertainty kept the subsequent slope fairly flat.

In June, the Fed clarified its intentions for ending QE3 and eventually planning rate increases.  Bernanke announced an intention to continue pushing rates down.  Rates went up immediately, which was widely attributed to expected tightening, but I believe that the main cause was a reduction in the probability of outlier outcomes in the Fed's balance sheet management, which caused the slope of the yield curve to more accurately reflect market expectations.(1) (2)  As the August 1 snapshot demonstrates, in the weeks following the announcement, the expected date of the first rate increase did not move, but the slope of the yield curve increased.

Since then, we have had the government shutdown and the Obamacare debacle.  In the meantime, economic news has still been fairly stable, and Janet Yellen has become the presumed replacement for Ben Bernanke.  Most observers expect Yellen to be more aggressive with monetary stimulus, which is taken to mean, among other things, that she will wait longer before raising rates.  In addition, there are whispers of the Fed moving its unemployment rate threshold target for raising rates from 6.5% to 6.0%.  That brings us to the current curve (Nov. 20 in the graph), where the rate rise has moved back to the end of 2015, but the slope is now over 30bp per quarter, which reflects a market very confident about a typical interest rate recovery coming out of the zero lower bound.

This gets complicated, because the Fed's stated policy stance and the effect of its stance on interest rates are self-contradictory in their nature.  If the market really does expect the Fed to be more accommodative and to delay a reversal of its Open Market Operations (OMO), then the subsequent boost in economic activity should actually push inflation and real economic growth up, so that the rate increase actually happens sooner.

So, the current expected rate increase seems to be a conservative, naïve (by which I mean unbiased) reflection of the Fed's implied policy stance.  I think both inflation and unemployment are more likely to skew this to a sooner date than to a later date, but I don't think we can expect the slope of the yield curve to get much steeper than this.  So, I think we are still looking at rates in the 2016-2017 time frame coming in roughly in the range they have been dancing around for the past few months, with the current rates being the bottom of the range.

Here is a graph of the slope of the Treasuries yield curve over the past 30 years or so.  The slope is understated at the current time because the zero lower bound makes the slope in the unadjusted treasury curve slightly less steep than pure expectations would normally make at the short end of the curve:

The blue line is the difference between the 1 year treasury rate and the implied 2nd year rate from bootstrapping 1 and 2 year treasuries.  The shadow columns are the actual changes in the forward 1 year rate compared to the immediate 1 year rate.  There are several items of note:

1) Coming out of an interest rate collapse, it is very common for the yield curve slope to top out at about 50bp per quarter, or slightly less.  I think this more or less caps the top end of forward rates that one would need to be prepared for.

2) Well-known research has shown that an inverted or flat yield curve is a very reliable predictor of coming recessions.  But, as reliable as it has been, the 1-2 year forward yield curve has massively underestimated the level of rate reductions that have happened during those recessions.

3) Even outside recessions, the forward yield curve has overstated the actual rise in rates.  During this time, the yield curve overestimated the actual rise in rates in the 1 to 2 year time period by an average of more than 1%!  I realize that there is some maturity premium, but not 1%  within the first 2 years.  On the one hand, I am currently arguing for a short position in forward bonds, so this worries me.  On the other hand, this is at least partly a reaction to the volatile inflation of the 1970's, and may eventually disappear or reverse, especially since interest rates don't really have anywhere to go but up or sideways.

4) The bond market sure looks like it wanted a more aggressive Fed.  Coming out of 2009 in the midst of QE1, forward rates were ready for a standard rate recovery.  Then the Fed cut QE off, and forward rates died.  They picked up again with QE2, and then died again as it also was cut off too early.  They are picking up again.  I hope the natural recovery strength of the economy and the new expectations from Janet Yellen will pull us the rest of the way out as we exit QE3.

Thursday, November 21, 2013

Family Structure and Income Statistics

Russ Roberts linked to a nice paper he did laying out some of the problems with statistical income trends.

Here is a table from page 18 of the paper:

This is a classic Simpson's Paradox situation, which shows up again and again in these income time series.  Poverty rates within each family structure have fallen tremendously.  But over the same period of time, Americans have chosen increasingly to populate the most vulnerable family structures, so the aggregate poverty rate has not dropped very much.

Why does this paradox show up so much in these statistics?  I think it is inevitable.  It's because people have agency, and the statistical aggregation is confused by that agency.  It's similar to the effect of safety mechanisms in cars, where drivers adjust their driving to be more aggressive when they feel safer, so that the new mechanisms tend to reduce injuries, but by a lower amount than what one would have predicted.  Helmets on football players are another example of this issue.

It doesn't matter which way the causation goes.  These statistics are a refutation of the standard haves-and-have-nots, stagnation and bifurcation story that seems to be conventional these days.  That narrative would cause one to expect households to move into structures associated with more social support and lower poverty.  We would see higher poverty levels within each structure, and more households in the married couples with children category, staying together for economic reasons.

If the causation is that fewer married households and more children with single parents leads to higher poverty levels, then this supports the conservative moralistic narrative.  If the causation is that more wealth and income leads to families that are more willing to make trade-offs which result in more vulnerable family structures associated with lower incomes, then this supports an optimistic narrative that broad-based improvements in standards of living have increased the choices available to households.

In any case, the large changes in family structure and the tremendous reductions of poverty levels within each family type point to a society that continues to offer greater opportunity over time to its households.  Just as drivers demonstrate the existence of a variety of priorities when they choose to trade new standards of safety for savings of time, etc., households demonstrate a variety of priorities in addition to household income.  This includes households who have income levels some of us would consider unacceptable or marginal. (I don't intend to paint a portrait of households making coldly rational decisions.  I am sure that many of the priorities and trade-offs that households consider are vastly different than the ones I would consider, and I am sure that many of these choices are demonstrably detrimental.  I don't wish to judge the choices.  I'm just pointing out that they must exist to a much greater extent than they did previously.)

The single women with children category presents a good example.  In 1967, 3.2% of households were poor families in this category (6.2% * 51.2%).  In 2003, 4.4% of households were poor families in this category (11.9% * 37.3%).  So, the net change over 36 years is an addition of 1.4% of poor single mother households.  But this 4.4% can be divided into 2.3% (6.2% * 37.3%) which would have been the total number of poor single mother households if the proportion of household types had been stable, and 2.1% (4.4% - 2.3%) of households who have been induced into this vulnerable household type.

3.2%     Percent of Total Households in 1967 who were poor, headed by single mother
-.9%      Reduction in poverty for existing single mother households from 1967-2003
+2.1%   Additional poor families due to increase in single mother households from 1967-2003
4.4%     Percent of households in 2003 who were poor, headed by single mother

So, a skeptic or moralist might say that this shows how all the social support programs and broad improvements in economic opportunity are fruitless when there are groups of people hurting their own chances for success.  A progressive might look at the aggregate poverty measure and say that this shows how the economy has not provided any improvements for the most vulnerable families.

Those reactions are both short-sighted.  Some of those 1967 households had income problems and some other set of larger problems.  In 2003, those families had fewer income problems and more manageable trade-offs for their other problems, so they addressed those other problems in ways that required a change in family structure and a reduction in income.  We can infer that even though those families show up as poor single mother families, this is a preference over being a non-poor married family.

Some of this growth in vulnerable household types is clearly a reaction to some of the perverse incentives created by public poor relief policies.  This is inevitable in coercive public programs.  It is very difficult to ensure an honest accounting regarding the effects of these policies.  Some of these problems were addressed in the Clinton/Gingrich welfare reforms, and it is disappointing to see some of the current progressive movements against social support programs for the working poor.

All of this suggests that in the battle between agency and structure, agency pulls its share of weight.  We should conclude, then, that the labor market, even at low income levels, is influenced by the demands of laborers.  Pessimism about labor income distribution is overstated, and policies premised on monopsonist low-wage employers are based on inaccurate presumptions.

Of course, there are many improvements to make.  The point isn't to deny the existence of suffering or poverty.  The point is to make sure that we understand what we are dealing with and to use the right tools to create progress.  Further, if seemingly marginalized families do retain influence over their quality of life, then public policy that is premised on a lack of agency will not only be damaging, but it will also deny dignity to the very families that it is meant to support.

The solution isn't to remove choices so that vulnerable women are again forced into unpalatable marriages for economic reasons.  But the solution also isn't to remove choices for the working poor because their choice set is unpalatable to us.  Minimum wage laws, occupational licensing rules, and other limits on freedom in employment contracts reduce the choice set.  Support for some of these laws presumes a lack of choices for poor laborers, so that, in the name of that inaccurate presumption, we limit the choice set even further.

Tuesday, November 19, 2013

Risk Premiums, Reputation, and Actively Managed Mutual Funds

In my previous post, I referenced this FAJ article by Antti Petajisto (Financial Analysts Journal, July/August 2013, Vol. 69, No. 4: 73–93) about the returns to active fund management.  The author found the typical result, that fund managers do have gross returns on average that beat the their benchmarks by about .96%, but that after fees, they lag their benchmarks by -.41%.

But, the author finds that the most active funds are the best performers.  I suspect that we are looking at the same elements that lead to persistent excess returns among low-status (small, low book value, etc.) firms, and that since the mechanisms that cause these varying risk premiums can't play out through fund NAV's, they are reflected in the level of fees relative to the funds' gross alpha.

More after the jump.

Friday, November 15, 2013

Evidence is optional with Finance cynicism

finance.jpgBryan Caplan had a disappointing post about the Finance Industry.  I hate to pick on him, because he's had tons of great posts recently, most of which I haven't commented on.  His post included this graph:

And, he seemed to be under the impression that (1) much of the finance sector's activity involves active stock trading for clients and that (2) active stock trading is a sucker's game.

As a thoughtful intellectual concerned with markets, I would have thought that Bryan would at least entertain the idea that the level of active trading is somewhat related to its usefulness in creating a properly priced market.  I have been meaning to do a post that references this recent FAJ article, (follow up here) which finds that highly active funds beat their benchmarks, even after fees.  On the margin, there may be a little bit too much trading, and there is certainly some trading that seems to be clearly useless, but to think that most active trading could be removed with little cost to market efficiency seems bold.

Besides this fact, other commenters mentioned that secondary equity markets are a small part of the finance sector.  And, Patrick Sullivan pointed out in the comments that:
I notice from the graph that the growth in share of GDP of finance is steady from 1950 til 2000, then it flattens. Should make the 'It was the repeal of Glass-Steagall that caused the financial crisis.' crowd unhappy.
 One of the commenters mentioned that much of the measured value-added of financial firms is due to compliance costs.  I would agree that there is some rent-seeking and some over-selling, but compliance costs and the growth of legitimate services could certainly explain this growth.  Compared to the 1940's, there is massively more need for saving and consumption smoothing today.  Has anyone tried to quantify the level of rent-seeking and over-selling in finance?  My radar goes off when I see sweeping claims made to roused audiences with eager narratives, with little evidence and no concern for scale.  I'd love it if someone can link to any research about this in the comments.

What is this strange tendency for even market-oriented economists to become jaded when they talk about the Finance industry?

There was an op-ed in the Wall Street Journal recently from Andrew Huszar, which begins, "I can only say: I'm sorry, America."  His bio with the article reads:
Mr. Huszar, a senior fellow at Rutgers Business School, is a former Morgan Stanley managing director. In 2009-10, he managed the Federal Reserve's $1.25 trillion agency mortgage-backed security purchase program.
You'd think he'd know what he was talking about.  His piece has been roundly criticized by many more capable than I, so I don't want to rehash the whole piece.  But, the piece strikes me as the sort of writing that has been common in popular finance publishing since the crisis - the story of a former insider who just couldn't take it any more and left finance in order to write an apology to the American people.  Despite their credentials, these authors sometimes seem shockingly ignorant of legitimate arguments for the value of the work they were engaged in.

Here is a portion of a passage from the article:
Despite the Fed's rhetoric, my program wasn't helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn't getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash....
Trading for the first round of QE ended on March 31, 2010. The final results confirmed that, while there had been only trivial relief for Main Street, the U.S. central bank's bond purchases had been an absolute coup for Wall Street.
It took me all of about 2 minutes to check this out.
Here are US mortgage rates since 1972.  That last little part after 2008, where the rates are really low, is the part where rapacious banks were pocketing cash from excess mortgage profits.
FRED Graph

Here is the spread of US mortgage rates minus 10 year treasury rates since 1972.  That last little part after 2008, where the spread is bouncing around its narrow long term range, is the part where rapacious banks were pocketing cash from excess mortgage profits.
FRED Graph

Here is the mortgage-to-10-year treasury spread, compared to the Fed's QE programs.  Fed mortgage security purchases are in red and treasury purchases are in green.  Where the red and green lines are rising elevated, those are the QE periods.  Notice how the mortgage spread shrinks during those times?  So, not only were the banks lowering mortgage rates during the rounds of QE, but they were lowering them even in relation to their cost of capital.
FRED Graph
You would think that Mr. Huszar would have been familiar with these spreads when he was managing the Federal Reserve's $1.25 trillion agency mortgage-backed security purchase program.  But, if you picture the Fed as the Interest Rate Wizard of Oz, it must be difficult to construct a narrative about interest rates when they regularly move in the opposite position direction from the Fed's claimed target.

Mr. Huszar is not the first person to float this idea that the Fed has been flooding the banks with cash, and that the banks have been pocketing the cash instead of performing their patriotic duty by loaning it out to good Americans.  But, leaving empirical evidence aside, how do these people think the world works?

Have the banks always had this monopoly power over mortgage profits?  Why did they choose now to pocket extra cash?

There must be 50 banks within 50 miles of my house that I could shop for a mortgage.  Do these people think the local Credit Union is somehow part of a shadowy cabal of tuxedoed fat-cats secretly setting excessive mortgage rates?  Are banks run by underwear gnomes who are raking in billions by NOT issuing mortgages, even while the Fed begs them to?

Thursday, November 14, 2013

Household Debt Improvement

This seemed like very good news to me today.  The NY Fed released 3rd Quarter household debt numbers, and this sure looks like a turning point to me.  Maybe we need to see a quarter or two of confirmation.  But, my crystal ball says that forward rates have gotten a little too low again, and I would have hoped this report would have helped goose them back up a little bit.  It looks like there might finally be some growth in demand for household credit.  If this is a turning point, could this mean that credit demand growth will be kind of normal in 2014?  Or, could we see a pendulum swing to credit growth above 4% for a couple of years?

Tuesday, November 12, 2013

Monetary Policy in the age of QE

The first comment on this post by Tyler Cowen is interesting:

Doug November 12, 2013 at 3:19 pm
The irony of the past five years is that while central banks have been trying to flood the markets with cheap capital, banking regulators have been significantly tightening the regulatory cost of capital for almost all activities. The two are operating at complete cross-purposes. Interest rates may be zero, but capital charges have become so high that banks can’t do any lending regardless.

The effect of this might be that monetary policy will be less transparent, more fitful, more pro-cyclical, and more subconscious.

I have been preparing for the approaching maturation of the business cycle by considering the Fed's management of their balance sheet, Fed Funds rate, and interest on reserves (IOR).  But, this adds an extra wrinkle to the issue.  Cash is not a constraint, by a long-shot.  What if a sort of unnoticed, pro-cyclical bias creeps into the subtle tactical decisions of bank regulators.  From a monetary policy point of view, operating in a sort of continuous function of interest rate policy, we might hope that the Fed would raise the Fed Funds rate and pull IOR up along with it in order to induce banks to hold onto reserves until the Fed can unwind its Treasury holdings.

But, what if banks have potential credit opportunities now that represent fair value several percentage points above the market rate, but they are currently being held back by capital scarcity and regulatory constraints.  If these constraints are lifted, credit creation could ramp up faster than the Fed can manage it.

I would expect forward interest rates stemming from FOMC policy to be pretty stable, and probably low, but I wonder if this sort of regulatory risk is where an inflation shock scenario could come from.

Required Returns, P/E Ratios, and Wealth Illusion

There is a really interesting article in the current Financial Analysts Journal by William J. Bernstein.  From the abstract:
both theory and long-run empirical data support the notion that economic growth lowers security returns by reducing impatience for consumption and altering the supply–demand dynamics of capital—the price of living in an increasingly prosperous, safe, healthy, and intellectually gratifying world.
I would boil his argument down to the idea that when increased growth comes from capital growth, the extra returns don't accrue to the legacy capital owners, because the growth is accomplished through what is, or can be thought of as, share dilution.  Further, there are diminished returns to additional capital inputs as a proportion of the economy, so the new growth produces a lower rate of return on invested capital.  So, more wealth and economic growth can lower expected returns.  Put in a simpler way, more supply of capital will bid down the return.

These changes take place over decades or centuries, with a lot of noise.  Even over a lifetime, noise and business cycles can overwhelm these longer term effects.  Bonds saw a spike in yields in the 1970's, followed by a long fall, but I don't see a longer downward trend in real short term bond yields in the post-WW II era.  But that is probably not long a enough period of time to see it in that data series, since bonds have long term noise reactions to demographics, inflation regimes, etc.

But, I think it is interesting to look at equity returns here.  Bernstein refers to the long term trend in the Shiller 10 year Cyclically Adjusted P/E ratio (CAPE).  The t-statistic for a rising trend is only 1.65, so this could be statistically stronger, but since P/E is the corollary to yield, we would expect to see this trend in the face of long-term yield declines.

Separately, I have looked at past S&P 500 returns, in nominal, real, total return, and index returns (w/o dividends), and I haven't found a decline in returns over time.  A sine curve can be fit over any version of the S&P 500 or Dow Jones Industrial Average with a pretty good fit.  Here is the nominal index value of the DJIA back to 1928 with a sine curve fitted to it.  As can be seen in the next graph, the annual return of that sine curve has a slight incline.  After adjusting for inflation and for total returns, the returns over time tend to be flat, but none of the long term trends have a long term decline.

This outcome, together with rising P/E ratios, suggests that the declining market yield has been roughly offset by the resulting gain in valuations.  This is analogous to the bond market of the past 30 years.  In the case of bonds, yields have fallen so quickly that the resulting price increases have resulted in a 30 year bull market.  Going forward, bonds will inevitably see lower returns from the flipside of this phenomenon.  Yields may rise, but since they are starting from such low levels, and since the rise itself will create price losses, there is no mechanism that will allow bonds to match the returns of the previous 30 years.

Normally, references to the concern over the long term rise in the PE ratio would relate to a comparison of fundamentals versus price inflation.  But, I think Bernstein's notion invites a more subtle reading.  Bernstein refers to the Gordon growth model as a simple way to think through this.
Gordon Growth Model
If this long-term relationship between capital supply and rates of return holds, then as available capital grows, the required rate of return (k) will decline and growth (g) will decline.  The effect on stock values is indeterminate, but for the broad market, the P/E ratio would increase, since it would move inversely to k.

If capital accumulation continues to grow, and this effect on rates of return exists, then the continued increase in P/E ratios is sustainable.  In fact, it should be expected.  Looking at the first chart, with the long term trend in the CAPE, the trend P/E ratio would equate to a real yield of 7.35% in 1881, 6% in 1950, and 4.9% in 2012.

The trend in PE expansion would add about .3% to the annual return, for a total current expected return of 5.2%.  If trends in required returns over the next 60 years match the previous 60 years, with a required return decreasing to 4% by 2070, the P/E ratio in 2070 would be 25, and the real return on invested capital over that time would be 5%.

These are broad numbers, but my point is that if what we are seeing is a long term downward trend in required returns, then the actual returns over generations will still be very stable, and can be partially sustained by slow inflation in P/E ratios, which itself is a reasonable product of the slowly decreasing return to capital.

There are a lot of confounding factors here.  International capital flows might be increasing US corporate equity returns.  Demographic and cyclical factors will affect interest rates and equity risk premiums over the next few decades to a degree that overpowers this very long-term trend.  But, the point remains that of all the concerns we might have about US equity markets heading into the coming decades, an unsustainable increase in P/E ratios may not be one of them, despite the apparent evidence to the contrary.

There is a concern to consider, though.  This phenomenon involves a kind of wealth illusion, similar to the effect of low rates on bond and home prices in the past 15 years.  The high prices of homes and bonds were justified in the 2000's because of very low long term interest rates.  But, since we conceive of wealth through nominal spot prices, our perception of our level of wealth became very volatile as those prices were whipsawed through the financial crisis.

The relationship between required returns and stock values has the same characteristic.  So, if there is a regime shift in capital behavior in the US that reduces the capital stock, future returns to the remaining capital might increase.  But, those increased future returns will manifest themselves through lower P/E ratios (and lower prices) in the spot market for US equities.  Savers who had experienced a slight boost in their returns as they lived through a period of slightly declining return expectations will suddenly see those gains retracted in this case.

In summary, returns and asset values can experience sustainable boosts from increasing P/E ratios, as long as very long term (centuries long) normal trends remain in place.  P/E ratios will rise and fall through short term and medium term market fluctuations.  The fact that those peaks and valleys are trending higher is not necessarily an immediate concern.  But, this boost comes at the expense of greater pain if we experience an extreme outlier event of a regime shift that includes a capital retrenchment.

Other than typical diversification of regional and asset class exposures, there may not be much that one can do to prepare for an extreme regime shift in capital behavior.  Within the regime that capital planning can manage, the long trend in increasing P/E ratios does not require a significant reduction in our expectations for equity returns over the next generation.  To the extent that far-future returns become significantly lower than the returns we now consider normal, it will because our descendants will be living in a world where capital is not scarce.  That will be a good thing, and it will likely happen long after we have passed.

Monday, November 11, 2013

The wrongness of ideas about the Fed

Don Boudreaux links to this article, where George Will gets just about everything wrong.  But, this is nothing against him.  So many people from all sides of the political spectrum get it wrong.  I'll just take it piece by piece.

"Very low interest rates drive investors into equities in search of higher yields. This supposedly produces a “wealth effect” whereby the 10 percent of Americans who own about 80 percent of stocks will feel flush enough to spend and invest, causing prosperity to trickle down to the other 90 percent. The fact that the recovery, now in its fifth year, is still limping in spite of quantitative easing is, of course, considered proof of the need for more such medicine."
FRED GraphThis isn't how it works.  Here is a graph of high yield bond rates (blue) high yield spreads (red), and the Fed Funds rate (green).  High yield bonds are another supposed area where investors reach for yield, and they correlate highly with equity movements.  There is no evidence here of spreads declining when the Fed Funds rate decreases, there is no evidence of spreads increasing when the Fed Funds rate goes up, and there is no evidence that high yield spreads have been especially low since 2010, while the Fed Funds rate has been near zero and the Fed is supposedly flooding the markets with money.

FRED GraphHere is a graph of the period since Fed Funds hit zero, where I have replaced the Fed Funds rate with excess reserves as a signal of Fed easing.  I presume that everyone agrees that accommodation was ok when spreads were above 10%.  In late 2010, when QE2 was implemented (the rise in the orange line), high yield bond rates held fairly steady.  Spreads (the red line) did fall, but they fell while risk free rates were rising (the green line - 5 year treasuries).  When QE2 was stopped, risk free rates plummeted and spreads shot up.  We see a similar dynamic during QE3.  Here, high yield spreads are fairly stable and high yield rates are being driven up by rising risk free rates.

FRED GraphLet's look at stocks.  Here is the relationship between stock prices and the Fed's balance sheet since 2008.  This is the supposed smoking gun for conventional wisdom.

FRED Graph
Oops - changes at Fred since this was posted have broken this graph.
But how does this compare to the 1970's?  As I pointed out in this post, the correlation between interest rates and equity gains has been reversed in high rate environments compared to low rate environments.  Here is a comparison of the S&P500 to the Fed Funds rate and the inflation rate during that time:

In the 1970's, inflation fluctuated between 6% and 14%.  Equities showed no gains between1973 and 1982, even though inflation was excessive.  These are nominal equity values, so in real terms, equities were seeing huge losses.  It was only after the Fed Funds rate was held at very high real levels and inflation dropped below 5% that equities entered the long term bull market of the 1980's and 1990's.

The reason that Fed accommodation has recently coincided with bullish economic experience and very low inflation is because it's the right policy to have, and because the economy is desperate for loose policy.  If equities rise due to loose money, then why didn't they skyrocket in the 1970's?

Further, there is nothing "trickle down" about this.  The rise in the stock market, as I have shown above, has nothing to do with decreasing yields pushing money into Wall Street.  And, since when are tight credit markets good for the middle class?

"Easing serves two Obama goals."
FRED GraphFirst, Obama appears to buy into the same anti-empirical daydream that George Will does.  There is no evidence that he is particularly intent on easing.  He frequently repeats the same worries about phantom Fed-created bubbles.  He frequently leaves Fed seats open for long periods of time.  Despite his lack of attention, the FOMC is mostly peopled by his appointees at this point, and the FOMC seems to represent his lack of a coherent vision for monetary action.  This inflation rate is hardly the result of a President bent on devaluing the dollar.  Compare this to the earlier chart of inflation in the 1970's.

 "It enables the growth of government by deferring its costs with cheap borrowing."
It would be pretty hard for easing to enable government to defer its costs with cheap borrowing, since Treasury rates have shot up with each round of QE.

"And it redistributes wealth: By punishing savers, it effectively transfers wealth from them to borrowers."
Do you know what's another word for "savers"?  "Wall Street".  It's amazing how a synonym can change your feelings about something.  So, within 2 paragraphs, Will has averred that monetary easing both creates a "wealth effect" for asset owners and also punishes savers.  The mechanism he claims QE works through is lower rates, which, if true, would actually help existing savers who own fixed rate bonds.  He is worried about creating inflation, which would help debtors and homeowners.  And, in any case, the QE's have neither produced lower rates nor excessive inflation.  This is like towing a trailer backwards, down the wrong lane of a freeway, in reverse.  There are so many things wrong here, it is hard to know which way is which.  But, the crazy thing is, Will is the one with the conventional take on this issue.  The whole country seems like they are towing their trailers backwards down the wrong side of the freeway in reverse.

He then proceeds to compare Janet Yellen's coming relationship with the Senate Banking Committee to Arthur Burn's relationship with Richard Nixon.  I suppose Nixon serves as a reminder that apathy is hardly the worst trait we could ask for in a president.  As suboptimal as it is, apathy about monetary policy might be the best policy we could hope for from President Obama.  When he briefly decided to care about it, he was pushing for Larry Summers, who was ready to slay all George Will's phantom monetary demons.

PS.  This is an interesting question about markets, too.  When markets insist on performing in opposition to continued consensus expectations to the contrary, is it because Wall Street is full of fund managers secretly investing against the op-eds of the nation's newspapers?  Or, are markets finding the right prices even though the conscious consensus of the traders themselves is wrong?  I suspect Hayek's "Use of Knowledge in Society" is in high gear.  And, I suppose there is always the possibility that I am wrong.

Sunday, November 10, 2013

P/E Ratios, Equity Returns, and Interest Rates

A couple of posts from Jeff Miller at "A Dash of Insight" reminded me of this old post, where I was considering correlations between interest rates and equities.

Here, Jeff compares P/E ratios to 10 year treasury rates:
Bonds and Stocks

Here is a JP Morgan graph that Jeff references, on the correlation between weekly equity returns and 10 year treasury rate changes, at different rate levels:
JPM Interest Rates and Stocks
At low 10 year rates, rising rates correlate with rising equities.  This is despite the fact that low rates are associated with high P/E ratios.  That relationship would suggest that rising rates would lead to lower P/E ratios, and hence lower prices, creating a negative correlation.
At high 10 year rates, the correlations work together - lower rates mean positive equity returns and higher P/E ratios.
This can be reconciled by the fact that high 10 year rates are the result of loose Fed policy.  Inflation is the risk in this regime.  Higher rates from higher inflation expecations mean higher risk, and thus, lower equity multiples.
A 5% rate on 10 year treasuries suggests a moderate Fed policy, where equity growth is dependent on non-monetary issues.  The 1960's predates the two graphs above, but it was also a period with 4-5% rates on 10 year treasuries, high P/E ratios, and negligible correlation between equities and interest rate changes.  This is roughly the rate area that market monetarists' 5% NGDP target would draw us to.
A low 10 year rate suggests monetary policy that is too tight.  Here the relationship between P/E ratios and rates breaks down, since inflation is not significant in this context.  Lower 10 year rates are the result of more tight monetary policy or negative economic developments, both of which are bearish developments for equities.
In fact, the top graph may show us a P/E ratio that tends to peak at 5-6% rates, falling at rates above and below that range, distributed with a positive skew.  The JP Morgan graph is the first differential of that relationship, with a positive value below 5% and a negative value above 5%.
Market pundits who treat rising rates as a drag on the economy and on equity markets are operating with an incoherent model of how these markets interact.  This appears to include pundits who are members of the Fed's FOMC.  Here is recent S&P500 behavior compared to 10 year rates:
FRED Graph
In June, the Fed announced a continued accommodative policy, which would only change if the economy continued to recover. With this comment:
 Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
Immediately, 10 year rates shot up 40 basis points.  After a brief decline, equities continued climbing, also.

Friday, November 8, 2013

HTCH 2013 Results

Same story with Hutchinson Technology.  Trying our patience on a quarter-to-quarter basis, basic story still intact, less variance in expected outcomes both at the high and low ends of possible outcomes, and more insider open-market buying to help settle our nerves.

I don't have much new to say about it.  I continue to view it as an overweight position with a high expected return.  It might be useful to convert some of the position to other securities as new opportunities are found, but in that case I think it would be useful to retain exposure to HTCH quarterly-report-related price shocks with call options.

I would have hoped to be closer to 125 million units a quarter by now, but we are seeing significant growth in revenues from Seagate, and management is still guiding that 50% of sales will be DSA units by the end of the 2014 fiscal year.

Wednesday, November 6, 2013

Bigoted Thinking Leads to Destructive Policy

Don Boudreaux has this great post on monopsony as an explanation for a harmless minimum wage.  His point, in summary, if I understand him correctly, is that to argue that the minimum wage should be part of immigration policy to lower the demand for low wage immigrant labor, and to simultaneously argue that the minimum wage would not cause unemployment among local workers, would seem to require a contradictory set of assumptions.

I've recently gone through some data to try to quantify the damage from mimimum wage increases.

But, I think, there is another flaw with the type of thinking that supports minimum wage, tight immigration restrictions, and drug laws.  On these policies, people are convinced that we can legislate the world into our image, and so the imagined outcomes of these policies are perceived as a choice between:
workers with low wages vs. workers with high wages
or a community with widespread drug usage vs. a community without widespread drug usage
or a labor market with Mexican immigrants vs. a labor market without Mexican immigrants.

These policies are intertwined, and the policies are so incapable of being effectively implemented that they are ineffective even as serial obstacles.  Many drugs consumed here overcame a closed border and the Drug War to get to the customer.  Likewise, many workers slip through the closed border in order to labor here for below the legal minimum wage.  Some work has even shown that many drug dealers work below the minimum wage.

So, the true comparison is more realistically:
low wage workers with legal protection vs. low wage black market workers
or drug users with a social support network vs. drug users without a social support network
or immigrants with legal protections vs. immigrants without legal protections

In all these cases, the end result of the well-meaning, but overbearing, hand of government restriction, is to harm those who are the most vulnerable.  Why do we insist on these policies in the face of clear evidence of their failures?

One reason, I believe, is the universal human tendency for bigotry - different standards for in-groups versus out-groups.  This tendency doesn't have to be steeped in any sort of extremist hate-mongering.  It can come simply from what Robin Hanson would describe as near vs. far thinking.  We hold two mental models in tension.  A "far" model, which is stripped of detail and where our ideals can thrive unmolested by practical concerns; and a "near" model, which governs our personal daily activity, and where moral compromise and practical decision-making are necessary.

An innocent foundation for bigoted thinking is the tendency for us to be more familiar with the details concerning our in-groups.  So, we are more willing to withhold judgment with our affiliates.  The lack of detail in our understanding of outsiders or groups we don't identify with means that we are more likely to judge them based on our ideals, without accounting for practical realities.

Bryan Caplan recently blogged about the idea that people tend to be more supportive of regulations that are enforced indirectly.  From Caplan:
Governments rely on indirect coercion because direct coercion seems brutal, unfair, and wrong.  If the typical American saw the police bust down a stranger's door to arrest an undocumented nanny and the parents who hired her, the typical American would morally side with the strangers.  If the typical American saw regulators confiscate a stranger's expired milk, he'd side with the strangers.  If the typical American found out his neighbor narced on a stranger for failing to pay use tax on an out-of-state Internet purchase, he'd damn his neighbor, not the stranger.  Why?  Because each of these cases activates the common-sense moral intuition that people have a duty to leave nonviolent people alone.

Switching to indirect coercion is a shrewd way for government to sedate our moral intuition.  When government forces CostCo to collect Social Security taxes, the typical American doesn't see some people violating their duty to leave other people alone.  Why?  Because they picture CostCo as an inhuman "organization," not a very human "bunch of people working together."  Government's trick, in short, is to redirect its coercion toward crucial dehumanized actors like business (and foreigners, but don't get me started).  Then government can coerce business into denying individuals a vast array of peaceful options, without looking like a bully or a busy-body.
When considering immigration in far mode, we judge the immigrants, not based on their needs and incentives, but based on rules and laws.  They shouldn't be here, because it is illegal, and clearly it is important for civilized people to obey laws.  Their violation of that ideal is further proof of the need for opposition.  Those of us who see immigrants in near mode see the dangers of crossing a tightly guarded desert border and the compromises that immigrant families are willing to take as signs of the practical challenges they are facing, and the need for our support.

When we consider their employers in far mode, we again frame our judgment in terms of ideals.  Employers should follow rules and support native workers.  The fact that so many employers are willing to undermine these ideals is further proof of their low moral standing and the need to punish and regulate them.  Those of us who see employers in near mode see a labor market that will inevitably be drawn to utilize available labor.  Even employers with a strong desire to follow the rules and protect native workers will be faced with a market where their businesses either utilize the best available workers, which happen to be illegal immigrants, or fail.

Similar bifurcated mental constructs play out in the minimum wage and Drug War debates, as well as many others.  The problem is that the far-mode approach leads us to punitive solutions that only serve to force the targeted groups into more and more extreme choices, sometimes erupting in violence.

Note that all of these issues involve people engaging in voluntary interactions that meet the community standard, or at least the standards of some subset of the wider community, where emergent norms of conduct serve as the foundation for social protection.  Normally, law would reinforce these standards.  But, in these cases the imposition of punitive "far-mode" strictures undermines those standards.

So, for instance, an immigrant who might, under a different regime, have a choice between staying in Mexico or arranging some sort of regulated border crossing where they work within some broad set of 1st world legal safeguards, is now faced with the choice of staying in Mexico or embarking on a dangerous trek across a desert in order to get black market job, where all the while even the legal authorities are his enemy.

Similarly, an employer who might have been faced with the choice of either failing or hiring immigrant laborers within a 1st world regulatory and legal context, albeit at wages lower than what most Americans would accept, is now faced with the choice of failing or hiring immigrant laborers in a lawless black market where even the legal authorities are the enemy.

Getting back to the minimum wage, the issue would be very similar.  Far view would say that we would prefer all workers to earn at least some minimum level of wages.  If we were an employer, we would certainly do everything we could to ensure that.  Our ideals would demand it.  We then impose punitive strictures that force employers to either fail or meet our standard.  This notion that employers are monopsonists is a way to reinforce a far viewpoint in a way that seems scientific.  "See, empirically, employers really don't have trade-offs!"

I suspect that many people would view these choice sets differently.  They might accept the dilemma of the immigrant, but insist that the employers are intransigent and self-serving - or vice versa.  And our logic in making those distinctions will be impeccable.  It really will.  But, where we are fooling ourselves is not in the logic, but in the mode that we apply the logic.  Where we come down on these issues depends on where we apply the logic in a far mode versus where we apply it in a near mode.

Laws live in the here and now - the near.  This is where I find the economic way of thinking to be so helpful.  The strawman of economic thinking is that it forces everyone into a homo-economicus model which assumes some sort of unrealistic rationality.  This is a misreading of what economic thinking really does, if it is used well.  It pushes us to interpret all people in the context of their trade-offs - in near mode.  It slays bigoted thinking.

The problem with near mode is that this is where messy reality resides.  Solutions may be unavailable or unsatisfying.  Power may be unbalanced.  Scarcity rules.  But we feel a duty to our fellow citizens, and when there is not a satisfying solution, the best available solution to address our discomfort may be a far-mode punishment that, while it doesn't improve the situation, at least provides a seemingly uncooperative bogeyman to blame.

This can be so satisfying to us that we are willing to continue to push our far-mode remedies even when they are clearly doing a massive amount of harm.  The irony is that a developed sense of duty to attend to other people's problems can lead us to carelessly create even worse problems, all the while blaming some other group of people who happen to fall outside of the reach of our empathy.

This is all understandable.  We can't expect the bounds of our empathy to be limitless.  But, at least, we should appreciate our limits.

Rule of thumb:  If we support some legislation that would solve problems if only THOSE people would cooperate, WE are probably the problem.