Ireland Tries Vox Clamantis in Deserto

On Friday, Ireland held a referendum on a new treaty -- the so-called Lisbon treaty -- defining the role of the European Union. The treaty was soundly defeated by Ireland's voters, 53.4 to 46.6. This "should" doom the implementation of the treaty, which had to be ratified by all countries.

A couple observations. One, this significant event has hardly been picked up at all in the US mainstream media (hence my "voice crying in the wilderness"). Why the lack of attention? I suspect it has to do with the fact that the mainstream European governments do not really want to talk about it, hence the media is not picking up on it. It is a very substantial event.

Second, related, set of observations. This latest attempt by the European Union to pass a new treaty follows the defeat by French and Dutch voters in 2005 of the even more aggressive new constitution. This time, the new treaty was structured so that it needed only be approved by existing governments, not directly by the voters...except in little Ireland (less than 1% of the EU's voters). One could view this in different ways. One could say that the treaty is simply too complicated to be considered by voters, and therefore it should only be voted on by elected ministers and representatives. My preferred view is to say that the EU officials tried an end-run around the EU's voters, and almost got away with it. They know that citizens are doubtful of the benefits of a larger European government and prefer a regime that maintains autonomy and cultures. From a political choice viewpoint, a large group of beneficiaries of the EU treaty would be, guess who -- government officials. So if you leave the voting to government officials, should we doubt that the treaty will pass? But if you let the folks vote who will pay for the expansion of government, you get the Irish outcome.

It is interesting to see the machinations already beginning to find a way to implement the treaty even with the Irish veto. This just proves why voters should be distrustful of the EU regime: voters reject a treaty TWICE now, yet the bureaucrats, convinced that they are right, just keep moving forward.

Vox Clamantis in Deserto.

Obama's Opportunity is Slipping Away

It seems to me that now is the time for Obama to surge ahead, with some significant speeches, announcements and press. He just nailed the Democratic nomination, and that is indeed an accomplishment of historical dimensions. He should not be letting the media discuss this in a vacuum, which right now appears to be the case. He should grab control of it, right now, and not let the momentum from this slip away. A VP selection of historical dimensions would work -- if it was the right person (who would that be?)

If we go a couple more days without something really significant from the Obama camp, I will put it down as a truly missed opportunity.

Limited Oil Demand Response

The International Energy Agency, IEA, has been cutting its oil demand forecasts, albeit only slightly. I suspect that they are lagging in this regard. See here for a recent update.

Also surprising that they are cutting their forecast of non-OPEC supply. At $130 per barrel, I don't understand why we are not seeing a significant increase in quantity supplied.

Oil Prices and Their Impact

The oil market continues to amaze and bewilder me. As I argued to a friend yesterday, it is not so much why prices are high today, but why they were so low for so long. After hitting the mid- to high-30 dollar range in 1979, we saw the nominal price of oil fall to around $10 per barrel in 1999. The theory of exhaustible natural resources (a la Hotelling) would predict that the real price should increase at the real rate of interest (actually, the price net of marginal extraction cost). With 1979 as a base, that theory currently fits the data quite well: using the CPI as our inflation measure, a $35 price in 1979 becomes $100 in today's dollars; growing that at 1.5% as an estimate of the real rate of interest over the period would yield a price today of $156. Not too far off.

So again, what is surprising is why prices were so low for so long, and why all of a sudden they have increased by so much.

I still am amazed that we are not seeing more demand elasticity than we are. I suspect it will kick in. Along those lines, this article has a quote from John Casesa, who was one of my students in 1984-86. He now runs an auto industry consulting firm. John notes that the auto industry is changing forever: "The trend away from these vehicles (SUVs) is irreversible."

Thus, once the longer term demand effects kick in, with a whole range of consumer and producer substitutions away from crude oil, the reductions in demand will be permanent.

Soon, I will do a posting on a possible explanation for the sudden increase in oil prices that relies on this permanent and significant set of substitution effects. I will present an argument that once certain forces pushed the price of oil past a certain level, the desire by some oil producers to keep prices low to enhance future demand disappeared.

The story is complicated and I am not sure I am all that comfortable with it, but it is worth pursuing.

But for now, let us economists just sit back and watch economic forces at work.

Good News: Roger Pielke Sr. is Blogging Again

One of my absolute favorite websites on climate science was that of Roger Pielke Sr. He had shut the site down some time ago, I suspect because of some very unprofessional comments that were appearing.

But he is back up and running, here.

To get a gist of his point of view, read this posting.

This will be really good to get the daily updates once again.

Energy Tax Stupidity

Populism is running rampant in this time of elections and high oil prices.

McCain, bless his heart, wants to relieve us of the 18 cent Federal gas tax this summer. What should we expect from that? If supply is really inelastic, which it is, then quantity demanded of gasoline cannot increase. So the price to consumers will have to stay the same, i.e., the reduction in tax will end up benefitting the producers.

Ah, but Clinton has come up with the solution to that, one which Obama signs on to as well -- a windfall profits tax on the oil companies. Obviously, Exxon Mobil with its recently reported $11 billion of net income for the last quarter must be rolling in unearned cash. Does anybody even think of how much capital is invested to earn that kind of money? I checked, and Exxon's shareholder's equity is $123 billion, so if that profit level were to persist for a year, the annual return on equity would be about 35%. That is good, but not great -- the kind of return that investors might expect in the far upper tail of the distribution, which is surely where we are now. Those kinds of returns are what balance the lower tail of the distribution, which the oil companies have certainly seen not very long ago.

But can anyone imagine any good that can come from a windfall profits tax? At best, it raises money. If the US government needs additional funds, it can go into the capital markets and borrow, currently at really low interest rates. What do we think will cause less distortion, borrowing or taxes levied on the investment returns of one single industry?

While the candidates try to outdo one another in appealing to the basest sentiments of the electorate, how many of us know what our effective marginal tax rate will be for 2008? Please, can some candidate imitate Ronald Reagan and start talking about rationally addressing our messed up tax code?

Record NH Snowfall for 2008

With the snowstorm we had Thursday night, we have had the most snowfall in New Hampshire since 1873. Now, the snowfall of 113 inches does not quite compare with the normal over 300 inches in the Keewenaw Peninsula of Michigan, but it is still substantial. The roof of my shed did indeed collapse, and as of March 30 (today) I still can't do anything about it because there is still two feet of unmelted snow on top of it.

But from this point forward, the "oldtimers" around here cannot say how the winters of old were so much more severe, with so much more snow (i.e., the climate has really changed...). Unless they are more than 135 years old, we saw more snow this winter than any oldtimer ever did.

My kids will be able to tell stories of that winter of '08, and how the roof on their house collapsed. How they had 37 snow days and had to go to school the entire summer to make up for it. How the cat went outside and got buried in a snowdrift and we didn't find her til the spring...

Al-Sadr Disappoints the Pessimists

The headlines in this morning's newspapers were filled with pessimism over Iraq. My local paper led with: "Basra Effort Falters. Al-Sadr Orders Defiance; U.S. Jets Hit Militia." The story went on to talk about the "faltering" Iraqi government offensive, and how Prime Minister al-Maliki may have "miscalculated" with his offensive.

I could sense the anticipated joy on the part of the liberal media and the Democrats, thinking that this was the beginning of the end of good news coming out of Iraq.

Ah, what a difference a few hours makes. Now the headlines read "Sadr offers a cease fire in Iraq."

Subprime Investments

In my last post, I noted Ben Bernanke's remarks last May about how most subprime mortgages were still making payments.

You might not know it from media reports, but this remains true today.

What are current mortgage default rates? The Mortgage Banker's Association's press release from March 6 states that the delinquency rate for one-to-four unit residential properties was 5.82 percent in the fourth quarter of 2007. In the fourth quarter of 2006, that rate was 4.95 percent. Is that a large or small increase? Beauty is in the eye of the bondholder, I guess. The rates are higher for subprime mortgages; the above numbers are overall.

Going back to Bernanke's point, it remains true that the vast majority of all mortgages, even subprime mortgages, continue to make payments. Consider that fact in light of the tremendous losses reported by banks such as UBS, Citigroup and Bear Stearns. Those losses are reported losses, due to writedowns of the value of securities held by the banks that are backed by mortgages. In many cases, the losses are not due to "mark to market" but due to "mark to model" because market prices simply do not exist. Also, if one looks at the way the trust pools are set up, and the way the cash flows are split across the tranches, it becomes clear that there is quite a lot of "overcollateralization" of the senior tranches. That is, there has to be really significant impairment of the overall mortgage pool backing the securities before most of the securities are hurt. There is also this issue of "excess spread" that creates more of a cushion: the rates that the mortgage holders pay exceeds the rate paid to the securities backed by the mortgages; the excess goes initially into a pool that takes any initial defaults.

You can actually see the default rates for collateralized mortgage pools on a Bloomberg terminal. The data available on one of those is really amazing. Not just prices and rates, but the actual payment performance of the underlying mortgages.

If Bernanke and the Fed are successful in keeping the economy away from recession, or at least deep recession, and at remedying the adverse-selection based credit crunch, then defaults should not increase too much further.

I for one would not be surprised to see some investment banks end up reporting large profits as their securities holdings get revalued upwards.

Ben Bernanke, May 2007

Here is an ironic excerpt from a speech Bernanke gave on the subprime mortgage market on May 17, 2007:

"All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."

Ah, famous last words.

But see my next post for a follow-on discussion of what he said next:

"The vast majority of mortgages, including even subprime mortgages, continue to perform well."