Kashyap on Greece

Anil Kashyap has an excellent summary of the Greek debt crisis.

He sees government printed IOUs as a much better solution to the banking and payments crisis than for Greece to exit the euro and try to reestablish the Drachma. I agree entirely.

His summary goes back to the beginning, and reminds us that Greece did not get bailed out; Greece's creditors (mainly european banks) got bailed out.

Wages and inflation

Marty Feldstein has a very interesting opinion piece on Project Syndicate. His main point is that micro distortions from social programs (and taxes, labor laws, regulations etc.) are leading many people not to work, and is well stated.

An introductory paragraph poses a puzzle to me, however,

Consider this: Average hourly earnings in May were 2.3% higher than in May 2014; but, since the beginning of this year, hourly earnings are up 3.3%, and in May alone rose at a 3.8% rate – a clear sign of full employment. The acceleration began in 2013 as labor markets started to tighten. Average compensation per hour rose just 1.1% from 2012 to 2013, but then increased at a 2.6% rate from 2013 to 2014, and at 3.3% in the first quarter of 2015.

These wage increases will soon show up in higher price inflation. 

This is a common story I hear. However I hear another story too -- the puzzle that the share of capital seems to have increased, and that real wages have not kept up with productivity.

So, maybe we should cheer -- rising real wages means wages finally catch up with productivity, and do not signal inflation. The long-delayed "middle class" (real) wage rise is here.

I'd be curious to hear opinions, better informed than mine, about how to tell the two stories apart.  

4% growth

I wrote last week on the simple factual question of whether and how often the US has experienced 4% real GDP growth in the past.

The deeper question, is that growth possible again? I answered yes, it's surely possible as a matter of economics. 

A few have asked me "why do so many of your colleagues disagree?" It's a question I hate. It's hard enough to understand the economy, I don't pretend to understand how others respond to media inquiries. And I don't like the invitation to squabble in public. 

It has taken me some time to reflect on it, though, and I think I have a useful answer. I think we actually agree.

As I read through the many economists' quotes in the media, I don't think there is in fact substantial disagreement on the economic question -- is it economically possible for the U.S. to grow at 4% for a decade or more? Their caution is political. They don't think that any of the announced candidates (at least with a prayer of being elected) will advocate, let alone get enacted, a set of policies sufficiently radical to raise growth that much. 

This is a sensible position. When I answer the question, is 4% growth for a decade economically possible, my answer is whether the most extreme pro-growth policies would yield at least that result. A  short list:

• The tax code is thoroughly reformed to do nothing but raise revenue with minimal distortion -- a uniform consumption tax and no income, corporate, estate etc. taxes, or deductions.
• A dramatic regulatory reform. For example 
• Simple equity-financed banking in place of Dodd-Frank. 
• Private health-status insurance (with, if needed, on-budget voucher subsidies) in place of Obamacare. 
• An end to the mess of energy subsidies and interference. No more fuel economy standards, HOV lanes, Tesla tax credits, windmill subsidies, and so on and so on. (If you want to control carbon, a uniform carbon tax and nothing else.) 
• Many agencies cease to exist. 
• No more endless waits for regulatory decisions. 
• No more witch hunts for multibillion dollar settlements.
• Thorough overhaul of social programs to remove disincentives. Most help comes via on-budget vouchers.
• No more agricultural subsidies.
• No more subsidies, period. Fannie and Freddie closed down.  
• Unilateral free trade. 
• Essentially open immigration -- anyone can work.  
• Much labor law rolled back. Uber drivers can be contractors, thank you. Most occupational licenses removed -- anyone can work.  
• Drug legalization.
• School vouchers. 
• And so on. Essentially, every single action and policy is re-oriented toward growth. 

This program removes a lot of level inefficiencies. 10% increase in level over 10 years is 1% more growth per year. Labor force participation increases. The labor force itself grows. We get a spurt of productivity growth just from greater efficiency without needing big investments. And then innovation and new businesses, investment, technology kicks in.

There would be a lot of lawyer, accountant, lobbyist, compliance officer, and regulator unemployment. Well, Uber needs drivers.

Politically, this is free-market libertarian nirvana.

I think my fellow economists might agree that 4% growth for a decade is possible with such a program. In fact, it we can likely get to 4% with much less than all of these policies. They might complain about inequality or other objectives.  But most of all, they might say it's unlikely that the new President and Congress will enact anything like such a program.

That's a very reasonable view. I also agree that typical proposals -- a  small reduction in corporate rates, a twiddle here a tweak there, the typical small promise to improve regulation -- will not have one tenth the needed effect.

But, dear colleagues, they asked us about economic possibility, not our guess about political probability. Let's answer the question they asked us.  It would be better to say: "Sure, 4% growth is economically possible. But I don't think any politician will advocate the policies necessary to produce it."  If we were to say that more often, rather than give up at the outset, we just might get such policies and politicians.

You never know what's "politically feasible." In 1955, civil rights was "politically infeasible." In 2005 gay marriage was "politically infeasible." Politics sticks in the mud for 100 years and then changes faster than we imagine.

I think there actually are quite a few politicians who would do some of the radical things that need to be done. They need to hear from us that it could work, as a matter of economics, and let them handle the politics.

We will soon see a first test: Can any candidate show up in Iowa, and say "Ladies and Gentlemen, government subsidized corn ethanol is a rotten idea." Then, can they say something vaguely coherent on immigration and trade.  The campaign season is young. Let's not prejudge them. 

Growth is just too important to give up on so easily. Sclerotic growth is the economic issue of our time. Economists should be cheering any policy agenda focused on growth.  If you think the policies needed to give us growth are hard, and out of the current political mainstream, that's ever more reason to keep reminding people that growth is possible and needs big changes, not to confuse "it's unlikely they'll do it" with "it's economically impossible."

Update: Response to Noah Smith's comment on this post  here 

Last Greek thoughts

A few salient points that don't seem to be on the top of the outpouring of Greece commentary.

1. Greece seems to be coming to a standstill.  Kerin Hope at FT  (HT Marginal Revolution):

... many [Greeks] have simply stopped making payments altogether, virtually freezing economic activity.

Tax revenues for May, for example, fell €1bn short of the budget target, with so many Greek citizens balking at filing returns. 

The government, itself, has contributed to the chain of non-payment by freezing payments due to suppliers. That has had a knock-on effect, stifling the small businesses that dominate the economy and building up a mountain of arrears that will take months, if not years, to settle.

“Business-to-business payments have almost been paused,” one Athens businessman says. “They are just rolling over postdated cheques.”

 Around 70 per cent of restructured mortgage loans aren’t being serviced because people think foreclosures will only be applied to big villa owners,” one banker said.

2.  If a Greek goes to the ATM and takes out a load of cash, where does that cash come from? The answer is, basically, that the Greek central bank prints up the cash. Then, the Greek central bank owes the amount to the ECB. The ECB treats this as a loan, with the Greek central bank taking the credit risk. If the Greek government defaults, the Greek central bank is supposed to make the ECB good on all the ECB's lending to Greece.  It's pretty clear what that promise is worth.

Some observations on what these stories mean.

1.  The argument is not about "lending" to Greece, i.e. covering this year's primary surplus. The argument is whether the IMF, ECB, and rest of Europe will lend Greece money to... pay back the IMF, ECB, and the rest of Europe. This is a roll over negotiation, not a lending negotiation.

The loans were not intended to be paid back now. The loans were intended to go on for decades. But with conditions. The negotiation is about enforcing or modifying the conditions for a roll-over.

Rolling over short term debt with periodic reviews is a nice incentive mechanism. Foreign policy should try it.

2. The latest proposed agreement includes sharp increases in tax rates.  Now? Are you kidding?

Source: theguardian.com

I am reminded of the story of a town, that had a bridge, that had a 50 mph speed limit. A drunk driver, going 85, caused  horrific crash. The town lowered the speed limit to 25.

What Greece needs is to get going again. That is, to persuade anyone that this is a good country to start a business, invest, hire people, and so forth.  In particular, if Greece is to pay back debts, it has to become an export-oriented growth economy, and run trade surpluses Higher VAT, higher corporate taxes, and higher taxes on successful entrepreneurs are hardly the way to go about attracting investment.

I think of taxes in terms of incentives. Keynesians look at aggregate demand. Either way, raising tax rates, now, in an economy where nobody is paying much of anything because they see the big explosion ahead seems destined, pragmatically, to raise no revenue. And, incidentally and humanely, to further crater the economy.

Despite cuts, the Greek government is still spending north of 50% of GDP. If you want to get primary surpluses, that seems the place to cut.

But with an economy at a standstill, major structural reform (like, go back and put back in the structural reforms that Syriza scuttled on arrival) seems like a more promising short-term set of conditions. And we'll see you on the next big roll-over.

3. Rolling over post-dated checks is a fascinating story to a monetary economist. Money is created when needed, apparently.

4. The bank run, or "jog." Remember, the big Greek bailout already happened. Private investors, largely European banks, who held Greek government debt got to sell their debt to government and IMF. Bailouts are creditor bailouts.

One way of viewing the current slow motion crisis is an invitation for ordinary Greeks to join these investors. Take euros out of the bank. The government default will happen, possibly with bank closures, capital controls, currency exit, and expropriation. But lending to Greek banks is now bailed out, with the losses sent to Europe via the ECB, just as German bank's lending to Greek banks was bailed out in the first round. Too clever, maybe, but that is the effect.

Too clever, really, to describe the situation. It only works if the government actually does exit, and soon. Getting money out of the banks and then defaulting is one thing. But a frozen economy can't go on long.

I repeat: the run and non-payment, freezing the economy, happen largely because people see capital controls, bank account expropriation, grand all-around default (your mortgage might get redenominated to Drachmas too, and forgiven once the bank goes under, so why pay now) and Grexit in the future.  The simplest way to stop the run and economic cratering would be a solid commitment from both sides that government default will not mean Grexit,  capital controls, etc.

5. Without the banks, this would all be simple. Greece could default, stay in the Euro (unilaterally if need be) and Euro zone. One government defaulting on debts to other governments is not a crisis.
All along though, the involvement of the Greek banking system makes it much harder.

Greece has 11 million people, $242 billion GDP and 51,000 square miles. That's as many people as Ohio, the GDP and land area of Louisiana. Why does Greece need its own banking system in a common currency and free market zone?

Think how much easier this would all be if Europe had gotten around to integrating its banking system. In any city in the US, the major banks are all national. If California defaults on state bonds, your Chase bank account is safe, and not because of Federal deposit insurance. Because the bank has no exposure to California bonds.

Imagine if Greeks deposited money in a local branch of a large pan-European bank, backed by assets spread throughout Europe. Imagine if Greeks borrowed money from the same bank, funded by deposits spread throughout Europe. Imagine if, when a remaining Greek bank defaults, the European equivalent of Chase could sweep in, and take over loans and deposits seamlessly. A default by the Greek government on its bonds would be inconsequential to Greek banking.

Why not? Well, such banks would not hold vast amounts of Greek government debt. Such banks would not have Greek ownership, or be controlled by the Greek regulatory system. Such banks would not be available targets of Greek capital controls, or a currency change.

Greece needs an independent, national, banking system about as much as Ohio or Louisiana need independent, state banking systems.

6. And currency. Many economists keep saying how wonderful it is for tiny countries to have their own monetary policy, so they can devalue their way out of crises like these. They advocate "capital controls" (English translation: expropriation of savings). That's how Argentina, say, is such a success story. We may be about to see.

Econ 1

John Taylor is offering his Economics 1, the introductory economics course for Stanford undergraduates, as a free online class. Class starts Monday, June 22.

John's blog post here, and registration page here.

Yes, Martha, apparently there is a free lunch.

Roy's plan

I found two novel (to me) and interesting points in the heath insurance reform plan  put forward by Avik Roy of the Manhattan Institute. (His Forbes articles here.)

First, the ACA establishes that it is ok to help people by subsidizing their purchase of private health insurance. It is not necessary to provide completely free insurance, medicaid, VA, medicare, and so on.

Yes, the health insurance you can buy has been salted up with extras, competition severely restricted, and large insurers so deeply in bed with their regulators that to call insurance "private" is a stretch and "competitive" a dream. But people do have to pay something, if they want better coverage they have to pay more, and the insurers are still nominally private companies.

Second, it is ok to ask people to contribute pretty substantial copayments.  That's a vital component to getting a functioning health care market.

Avik cleverly suggests to ACA opponents not try to throw the whole thing out. Instead, expand on these good parts.  Keep the exchanges, reform and open them up, reform the policy requirements, then slowly transition medicare, medicaid, and even veterans and government workers to exchange policies. Shh, don't call it a "voucher."

If King v. Burwell surrenders to simple logic, it's clear that there will be a quick renegotiation: what reforms do ACA opponents get in return for allowing federal subsidies.  These points offer an interesting direction for that negotiation.

It is sad that the ACA's legal problems are completely unrelated to its economic problems. Whether subsidies go through Federal or State exchanges is an economically irrelevant question. And the Federal Government has the constitutional power to pass all sorts of economically disastrous laws. This divergence is leading to particularly pointless arguments.

Taxes

Source: Wall Street Journal

Today's (June 18) Wall Street Journal has two noteworthy pieces on tax reform, "Rubio's tax mistake" in the Review and Outlook and Rand Paul's "Blow Up the Tax Code and Start Over" Perhaps now that pretty much everyone agrees the tax code is a mess, something will be done about it.

Paul is sure to be pilloried about the 14.5% rate and whether it will generate enough growth to sustain tax revenues and pay for 20% of GDP spending.

But the structure of the tax code is far more important than the rate. It is refreshing to hear a serious presidential candidate stand up to say

"...repeal the entire IRS tax code—more than 70,000 pages—and replace it with a low, broad-based tax of [rate deliberately deleted] on individuals and businesses. I would eliminate nearly every special-interest loophole. The plan also eliminates the payroll tax on workers and several federal taxes outright, including gift and estate taxes, telephone taxes, and all duties and tariffs. 

It's not exactly the structure I would advocate, but close enough. And close enough even if 14.5% becomes 20%. Or adds higher brackets at higher incomes.  We should talk about the structure separately from the rates to avoid all these distractions.

More deeply it's refreshing to hear a serious candidate start from the premise that the first purpose of the tax code is to raise revenue for the government, in a way that hurts growth as little as possible. As opposed to first and foremost subsidize various activities, people, or businesses.

I also appreciate

every year the Internal Revenue Code grows absurdly more incomprehensible, as if it were designed as a jobs program for accountants, IRS agents and tax attorneys.

As if? We know who it was designed by!

Polls show that “fairness” is a top goal for Americans in our tax system. I envision a traditionally All-American solution: Everyone plays by the same rules. This means no one of privilege, wealth or with an arsenal of lobbyists can game the system to pay a lower rate than working Americans. 

We don't need polls to know this. Our tax system is still based on voluntary compliance.  An increasing sense that there are special rules for special well-connected people can send us to Greek levels of compliance if we're not careful.  And high statutory rates have always led inexorably to complex ways for rich and well-connected to get out, a sad lesson that our friends advocating for 70 or 90% statutory rates seem to wish away.

But I don't think Paul goes far enough.

All deductions except for a mortgage and charities would be eliminated.

Et tu, Rand? If we're going to "blow up the tax code and start over," then why would we put in deductions for mortgage interest and charities?

OK, mortgages taken out under the current tax law should get to keep the interest deductibility. We don't change rules in the middle of the game. But why should new mortgages get an interest deduction?

Any deductions are strongly regressive -- If you're paying a 40% marginal rate, you get your interest payments effectively cut by 40%. If you pay a 10% rate, you get a 10% subsidy.  And after a huge financial crisis, what in the world is the US government doing subsidizing debt anyway?

The right answer is to get all subsidizing out of the tax code. If the government wants to subsidize rich people's mortgages, fine, let it pass a spending bill, and send people checks, on budget. It is exactly the same as a matter of economics. If that subsidy would be an unseemly political act that must be hidden as a deduction, then perhaps it is not wise policy.

Similarly, two words should be enough to consider the "charitable" deduction: Clinton Foundation. I'm not complaining here that this institution exists. But why should it be subsidized by the tax code, and why should that subsidy be given preferentially to rich people? Two more words: "Lois Lerner." Recall, she got her power by being in charge of handing out non-profit status.

(Yes, I work for a non-profit university, whose mission I believe is a public good and worthy of philanthropic support. But if we get rid of all special treatment, institutions doing good work, transparently and not funneling money to friends and relatives, should come out ahead.)

Why open the negotiations with a breach in the wall? The best way to negotiate a broaden the base, lower the rate negotiation is with the firm principle that nobody gets special treatment. There is no better way to get a big base of voters on board than, "look, you're going to lose your mortgage interest deduction. That's the price for wiping out the rest of this mess, and in return I'm going to lower your tax rate so much you're going to come out far ahead. Now, lend me your support to make sure we keep all the other deductions and loopholes out." It is commonly claimed that shared sacrifice builds support for a war. A war this will be.

Totally nuts? When Dick Thaler and I agree wholeheartedly on something, perhaps it has some merit.

Noah Smith Writing Lesson

Source Noah Smith

Noah Smith has a good review of the writing in Deirdre McCloskey's review of Thomas Piketty's book.

A lesson for students learning to write papers: Don't needlessly annoy readers before you get to your point. If a reader disagrees, finds something wrong, or insufficiently documented, of if you offend a reader, he or she will leave without getting to the main point.  Once a reader finds one thing he or she thinks is wrong, he or she will distrust the rest of the argument. Grand methodological statements and criticisms of swaths of literature are especially dangerous.

Noah's post is a great example. As you can see, Noah never got to the main point of McCloskey's review, and happily admits it.

And Noah's criticisims are spot on.  The first four pages of McCkoskey's review are full of grand, outrageous, and arguably false statements, having nothing to do with Piketty, inequality, or anything else that follows.  McCloskey, author of a splendid essay on writing in economics, should really have known better.  My review said as much too. Interestingly, I quoted quite a few of the same points Noah found.  (I put that at the bottom of a "too-long post on a far-too-long review of a enormously-too-long book" because  my main point was not about writing and for once I followed my own advice and put the secondary point at the bottom.)

So, dear students, learn the lesson: write the minimum up front needed to make your main point later. If you think everyone runs too many regressions, or you don't like non-cooperative game theory, and unless this point is absolutely necessary to your criticism of Piketty, save it for another day. Only offend people you really really need to offend. Otherwise, you risk having a potential reader like Noah give up in disgust before he gets to your point. Noah, hold your nose and plow on, it gets better.

Four percent?

Timothy Noah from Politico called yesterday to ask if I thought four percent growth for a decade is possible. Story here. In particular he asked me if I agreed with other economists, later identified in the story, who commented that it has never happened in the US so presumably it is impossible.

This prompts me to look up the facts, presented in the charts at left. The top graph is annual GDP growth. The bottom graph gives decade averages. Data here. The red lines mark the 4% growth point. Notice the sad disappearance of growth in the 2000s.

Judge for yourself how far out of historical norms a goal of 4% growth is.

By my eye, avoiding a recession and returning to pre-2000 norms gets you pretty close.  A strong pro-growth policy tilt, cleaning up the obvious tax, legal, and regulatory constraints drowning our Republic of Paperwork (HT Mark Steyn) only needs to add less than a percent on top of that. 4% might be too low a target!

Note the question asks about real GDP not per capita. Adding capitas counts. If you want total GDP to grow, regularizing the 11 million people who are here and letting people who want to come and work and pay taxes counts toward the number. You may argue with the wisdom of that policy, but the point here is about numbers.


This is not a serious answer to the question whether 4% growth is possible. The serious answer looks hard at demographics and productivity, estimates how far below the free-market nirvana level of GDP we are, and estimates how much faster free-market nirvana GDP could grow.  If you think that sand in the gears or inadequate infrastructure or not enough stimulus means we're 20 percent below potential, and potential can grow 2% per year, then 4% growth for a decade follows.

What happened in the past is largely irrelevant, since the US has never experienced free-market nirvana. If you were to look in 1990 at historical Chinese GDP plots to assess whether it is possible for China to grow as it has for the last 25 years, you'd say it's impossible. Conversely, if you were to look at postwar US data you'd say our lost decade of 2% growth can never happen.

But, having asked the question whether four percent is outside of all US historical experience, at least it's interesting to know the answer.

Update. A few commenters asked about my 10 year average plot. I've updated it to include two ways of calculating the 10 year growth rate. The solid line is the ten year percentage growth rate divided by ten. The dashed line is the ten year average of one year growth rates. You can also haggle about compounding,  logs vs levels, which price index to use, long-term inflation measurement (that can add as much as 1%), whether some components of GDP should be excluded and so on. Calculated either way, I conclude that 10 years of 4% growth is not an outlandish impossibility. After all, the policy choices being advocated for 4% growth go a good deal beyond rewinding the clock to exactly the policies and laws of some bygone era. But make up your own minds.

Complete disclosure:

dgdp = 100*(gdp(2:end)./gdp(1:end-1)-1);

dgdp10 = 10*(gdp(1+10:end)./gdp(1:end-10)-1);

dgdp10a = filter(ones(10,1)/10,1,dgdp);

Asset Pricing Summer School

I’m going to offer my online course “Asset Pricing” over the summer. The intent is a “summer school” for PhD students, either incoming or between the first year of foundation courses and the second year of specialized finance courses.

At least one university is going to use this more formally: Require completion of the class for their PhD students (either incoming or between first and second year,) and organize a TA and group meetings around the class. We have found that this sort of social organization helps a lot for students to get through online classes.

The course offers a free “certificate” for achieving a certain grade level in the class, which gives an incentive to actually do the problems. Faculty can tie achievement of the “certificate’ to whatever carrots and sticks they want to offer. For example, one instructor is going to treat achievement of the “certificate” as an assignment for his fall PhD class, and include it in the grade.

Since the class covers most of the basics, this structure may free a faculty member teaching next year to focus the PhD classes on more advanced material. It’s also useful as a “flipped classroom,” allowing the faculty member to spend less time on algebra and derivations, and more on intuition, extensions, and current research.

This session won’t have TAs on my part, though I will monitor the forums and attend to glitches as they crop up.

The class is free. To sign up or see the classes, follow these links

Part 1: https://www.coursera.org/course/assetpricing
Part 2: https://www.coursera.org/course/assetpricing2

The class experience consists of watching short lecture videos, doing the assigned reading, answering quzzes and fairly extensive problem sets, and taking an exam. The course has discussion forums which are quite useful.

The class starts next Monday, June 8. It is open for registration now, and will be open for students to see materials and start work by the end of the week. Part 1 (7 weeks) ends July 27, and Part 2 (7 weeks) ends Sept 14. The two parts may be taken independently. Students not wishing a grade may use these materials freely and just do whatever parts seem interesting. I've also set up the grading pretty flexibly to allow people to adjust their schedules rather than follow the week by week rigid schedule.

This is a bit late notice, but I hope blog readers will pass on notice to PhD students or prospective ones, and to faculty members who are teaching PhDs in the fall and might find this resource useful.

The syllabus:

Part I
Week 1 Stochastic Calculus Introduction and Review. dz, dt and all that.
Week 2 Introduction and Overview. Challenging Facts and Basic Consumption-Based Model
Week 3 Classic issues in Finance. Equilibrium, Contingent Claims, Risk-Neutral Probabilities.
Week 4 State-Space Representation, Risk Sharing, Aggregation, Existence of a Discount Factor.
Week 5 Mean-Variance Frontier, Beta Representations, Conditioning Information.
Week 6 Factor Pricing Models -- CAPM, ICAPM and APT.
Week 7 Econometrics of Asset Pricing and GMM.  Final Exam

Part II
Week 1 a) The Fama and French model b) Fund and performance evaluation.
Week 2 Econometrics of classic linear models.
Week 3 Time series predictability, volatility and bubbles.
Week 4 Equity premium, macroeconomics and asset pricing.
Week 5 Option Pricing.
Week 6 Term structure models and facts.
Week 7  Portfolio Theory and Final Exam

Greek roll-over

The latest Greek debt "crisis" poses an interesting puzzle. (Quotes because it's hard to call something that's been going on this long a "crisis.") Greece needs to come up with $300 million euros by Friday to pay off the IMF. And the most likely source of this money is... the IMF.

What's going on here? Obviously, Greece was going to need decades to pay off loans, in the sense of running primary surpluses to actually work down debt. Why lend Greece money for a short amount of time, then institute regular "crises" about rolling over the debt?

This is part of a larger question. In "A new structure for U. S. Federal debt" I thought about the same question for the U.S. Why does the U.S. continually issue new debt to pay off the old debt? Why not just issue perpetual debt, which automatically rolls over? For the U.S., I couldn't come up with a decent reason.

For Greece, there is a good reason. Yes, in the end, the IMF will most likely lend Greece the money to pay back the IMF. Or maybe the ECB will lend Greece the money to pay back the IMF. But both sides will renegotiate the terms.

The IMF and Europe lent money to Greece with conditions that are politically painful, but that are be beneficial for Greece and for the chance of the money being paid back eventually, at least in the IMF and Europe's eyes. (I don't agree with all the conditions, especially tax increases, but the point here is the negotiation not the wisdom of the terms.) By lending for a year and then renegotiating, they can enforce that Greece actually follows through on the conditions.

If you are going to lend money to a spendthrift relative you might want to do the same thing. Limit the time of help, and in a year we'll see if you're really cleaning up your act.

But this is a two-sided renegotiation. They can only impose conditions if the costs to them of allowing a default are not too large. And Greece will only take the conditions if the costs of default to them are large.  So it is to Greece's interest to make its default as painful to the rest of Europe as possible.

Also by calling it a roll over, though, Greece had an interesting option -- if it didn't like "austerity," it could try other means of reviving their finances and paying off the debt. It's too late for that one.

Doug Diamond and Raghu Rajan in a series of papers have been arguing that short-term debt allows lenders to monitor and discipline the borrowers. "Short" here can mean years, any debt that has to be rolled over a few times before being eventually paid off. This situation seems like a good instance of their theory.

Back to the U.S., though, this does not strike me as a good argument that the U.S. should voluntarily issue debt that needs to be rolled over. So I'm still in favor of perpetuitites for the U.S.

The Wall Street Journal's Greek Debt Timeline is an interesting perspective on this issue. I excerpted the full set of payments, and the payments due in 2015 and 2016 below. Of course, as debt is rolled over, new payments take the place of old ones.

 Except "treasury bill holders," the debt until 2020 is almost all due to governments. A small slice of "private investors" starts showing up after that. So for the next 5 years, this really is about IMF and ECB lending money (presuming nobody else wants to) to pay back loans to the IMF and ECB.

The 2015 and 2016 graphs make it even clearer. All the loans are to IMF, ECB or EIB.

But..What about these Treasury bill holders? There is this huge slice of debt that needs to be rolled over this summer. Who is going to do that? Who is holding this debt?

Bank at the Fed

"Segregated Balance Accounts" is a nice new paper by Rodney Garratt, Antoine Martin, James McAndrews, and Ed Nosal.

Currently, large depositors, especially companies, have a problem. If they put money in banks, deposit insurance is limited. So, they use money market funds, overnight repo, and other very short-term overnight debt instead to park cash. If you've got $10 million in cash, these are safer than banks. But they're prone to runs, which cause little financial hiccups like fall 2008.

But there is a way to have completely run-free interest-paying money, not needing any taxpayer guarantee: Let people and companies invest in interest-paying reserves at the Fed. Or, allow narrow deposit-taking: deposits channeled 100% to reserves at the Fed.

(I'm being persnickety about language. I don't like the words "narrow banking." I like "narrow deposit-taking" and "equity-financed banking," to be clear that banking can stay as big as it wants.)

That's essentially what Segregated Balance Accounts are. A big depositor gives money to a bank, the bank invests it in reserves. If the bank goes under, the depositor immediately gets the reserves, which just need to be transferred to another bank. This gets around the pesky limitation that the Fed is not supposed to take deposits from people and institutions that aren't legally banks.

...the funds deposited in an SBA would be fully segregated from the other assets of the bank and, in particular, from the bank's Master Account. In addition, only the lender of the funds could initiate a transfer out of an SBA; consequently, the borrowing bank could not use the reserves that fund an SBA for any purpose other than paying back the lender. ...The bank receives the IOER rate for all balances held in an SBA. The interest rate that the bank pays the lender of the funds deposited in an SBA would be negotiated between the bank and the lender

The reverse repo program achieves the same thing, but many at the Fed seem to regard it with suspicion.

Why is this such a good idea? First, from my perspective, it opens the door to narrow banking; to government provided run-proof electronic money.

Second, emphasized in the paper, SBAs could help "pass through" interest rate rises. Suppose the Fed wants interest rates to be 5%  It starts paying banks 5% on reserves.  Banks will probably start demanding 5% or more on loans, since they can get 5% from the Fed. But banks may not compete on deposits, merrily taking our money at 0% and investing at 5%.  Large institutional investors, who can invest in money market funds, aren't going to sit still for that however, so they SBA accounts should very quickly reflect interest on reserves. In turn, that will put upward pressure on short-term commercial paper, Treasury, and other markets, and provide competition for deposits.

I learned an interesting legality. Are the SBA accounts really run free, exempt from bankruptcy proceedings? Not totally

Under the FDI Act, and subject to certain exceptions that are not applicable here, creditors of a DI [Depository Institution] that is in FDIC receivership are prohibited from exercising their right or power to terminate, accelerate, or declare a default under any contract with the DI, or to obtain possession or control of any property of the DI, without the consent of the receiver during the 90-day period beginning on the date of the appointment of the receiver. For purposes of this paper, it is assumed that the FDIC would act quickly to permit lenders to gain access to SBAs that collateralize their loans. However, this treatment has not been approved by the FDIC, and the decision by the FDIC on treatment of an SBA account in resolution could affect the willingness of firms to participate in these accounts.

That's all putting it mildly. It could also affect the willingness of firms not to run at the first hint of trouble, which is the whole point. Evidently, the FDIC needs to carve exemption from bankruptcy in stone.

A few quibbles

The near elimination of credit risk, which is the hallmark of SBAs, would level the playing field so that all banks could borrow in the overnight money market on equal footing..

Well, not really. Sure, they can borrow on equal footing so long as they put the results right in to the Fed. They cannot borrow for other purposes, like to lend it out to you and me, on equal footing.

The paper also echoes the worry that firms might run to these programs in a crisis

One concern is that SBA take-up could be too large. .. in times of intense stress, which may be characterized by a flight to quality, flows into SBAs could produce a scarcity of reserves that banks use to meet reserve requirements and could also cause (temporary) dislocations in funding markets for nonbank entities.  

I beat up on this view in discussing the overnight RRP program here, so I won't make the same points again. It still makes no sense to me. Flows into SBAs have to come from somewhere; and we're $3 trillion dollars away from required reserves anyway. And will be even further away once this program goes in.

Update: In fact, when you dig in to the paper, it pretty much concludes that these "financial stability" arguments are not important. From p 18

Recently, market observers and policy makers have expressed concerns that uncapped ON RRPs could exacerbate flight-to-quality flows, by providing a risk-free alternative to bank deposits, thereby causing a removal of much needed liquidity from the financial system.  For these reasons, an aggregate cap on the amount that can be invested at the ON RRP facility has been imposed and an auction pricing mechanism has been introduced to ration ON RRPs in the event that bids exceed
the aggregate cap. 

A similar concern could arise with SBAs. During a crisis, SBAs might be seen by lenders as an attractive near risk-free investment. However, a "surge" into SBAs i.e., an increased supply of funds by lenders for SBA collateral arrangements, would be accommodated by counterbalancing price movements.... an increase in the federal funds rate, as usable reserve become scarce. Further, because SBAs are supplied competitively, their rate would not adjust, since the rate is "competitively tied" to the IOER rate. The result would be an increase in the spread between the federal funds rate and the rate paid on SBA balances, which would help to arrest the surge and mitigate potential dislocations in funding markets. 

Additional factors could limit the ability of investors to suddenly place large sums of money into loans secured by SBAs. ...

I think there are deeper conceptual problems with the whole argument that offering SBAs, ON RRPs, or floating-rate Treasuries contributes to a run by offering a safe alternative, but in the end we are agreeing just for slightly different reasons.

Reserves for all! Via money funds and overnight RRP, or via narrow deposits at banks. Or, via fixed-value floating-rate Treasuries. Let the run-proof financial system begin to emerge.

Now, if the Fed would only say "and, by the way, any bank that puts all of its deposits in SBAs, and finances all of its lending with equity capital, will be exempt from all the Dodd-Frank regulation and stress tests, because it is obviously completely un-systemic."