Focus On: Kent Smetters

Is Raising the Minimum Wage a Good Idea?

Posted on February 18, 2013

moneyAt $7.25 an hour, the U.S. federal minimum wage is below that of many developed countries, including Canada, Ireland, the U.K. and France. According to an opinion piece in yesterday’s New York Times by Princeton economist Paul Krugman, inflation has surpassed minimum wage hikes for nearly four decades, so that in real terms, low-wage workers are earning less today than they did in the 1960s. Meanwhile, Krugman notes, “worker productivity has doubled. Isn’t it time for a raise?”

Krugman wrote his op-ed in response to President Obama’s call in his State of the Union address last week to raise the minimum wage to $9 an hour, with additional increases down the line to keep pace with inflation. According to Krugman, it’s a good policy move — one which would have “overwhelmingly positive effects” by helping those Americans who are paid the least.

At issue is the question of whether such an increase would have the unintended consequence of reducing the number of jobs for low-wage workers, because it would cost more to keep them employed. According to Wharton management professor Peter Cappelli, while raising the minimum wage is meant to help low-wage workers, “it’s not so good for people who have to pay it. Most experts recognize that minimum wages aren’t the best way to help low-wage workers. Raising [the wage] probably does lead to some modest reduction in jobs, or leads more employers just to ignore the laws altogether.”

Wharton business economics and public policy professor Kent Smetters agrees that the impact of a minimum wage hike would be limited. “Poverty is mainly the result of family structure and low education, typically with the former producing the latter. The best way to help low-income workers is ultimately to tackle these two problems. The government is only part of the solution,” he says.

In addition, “the timing for a minimum wage hike is not great,” Smetters continues. “The college-educated unemployment rate is only about 3.9%. Instead, most of the current unemployment and labor force dropout is concentrated in potential workers without a college education. Minorities are especially in bad shape. A wage hike right now could, therefore, lead to slower growth in jobs for uneducated and minority workers. I would wait for a more robust economy before increasing the costs of hiring these types of workers.”

What might be a better way of helping low-income workers, if not a raise in the minimum wage? According to Cappelli, “The better alternative is the earned-income tax credit, which gives low-wage workers big tax breaks and doesn’t raise the cost of hiring to employers. But that doesn’t do anything if your income is so low that you don’t pay any federal income tax. So, the administration is pushing to raise the minimum wage because it is about the only tool it has. Political gridlock probably makes it impossible to think about something really novel as an alternative.”

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Not Ready to Retire

Posted on February 5, 2013

828023.TIFThe American dream of working three or four decades and then retiring to a life of well-earned comfort is no longer an option for a surprisingly large number of workers.

According to a new report from The Conference Board titled, “Trapped on the Worker Treadmill,” people between the ages of 45 and 60 who have experienced a job loss, seen their salary reduced or watched the value of their home decline are “much more likely” to consider delaying retirement. More specifically, The Conference Board states, “of respondents aged 45-60, the percent that plans to delay retirement has gone up 20 percentage points in two years.”

This is despite a much-improved economy – including higher housing prices, an upswing in the stock market and increased hiring.

“It’s disconcerting that the two years in which the U.S. economy seemed to finally, if fitfully, turn the corner also left so many more workers compelled to change their retirement plans late in their careers,” says Gad Levanon, director of macroeconomic research at The Conference Board and a co-author of the report, in a quote on the association’s website. “This may benefit some businesses and industries, by reducing labor shortages and skill gaps as experienced workers stick around. At the same time, their delaying retirement can be a significant obstacle to the many companies seeking to cut costs.”

A major factor contributing to the survey’s findings “is the continued depletion of savings,” according to The Conference Board website. “The U.S. recession officially ended in July 2009 and the stock market has rebounded strongly since then. In 2012, however, 62% of 45- to 60-year-olds reported at least a 20% decline in the value of their financial assets since the start of the crisis — up from 42% in 2010.”

“People are finally realizing that living to 120 (which the actuaries are forecasting) is going to be very, very expensive,” notes Olivia Mitchell, Wharton professor of business economics and public policy. “Accordingly, a few more years of work can provide the degrees of freedom many need to offset declines in housing values and 401(k) account balances. Also, medical care costs are going through the roof, which is enough to make many think twice about leaving jobs with health insurance coverage. And finally, the recent research suggests that working longer makes for healthier lives, which may be quite attractive to many.”

Kent Smetters, Wharton professor of business economics and public policy, agrees. “Probably only about a third of baby boomer households have an adequate amount of saving for retirement anyway,” he says. “Of course, part of the reason might be that many people have been out of the market and have not enjoyed recent stock returns. Another reason might be a general fear of risk. But one reason might simply be that as more people approach retirement, they are finally looking at the numbers and simply realizing that they never saved enough in the first place. Most have not.” 

Related to this, Smetters adds, is that “in the old days of 5% interest rates, people used to think that retiring with a million dollars was adequate, because they could safely get $50,000 per year without dipping into their principal. They now realize that they need a lot more since interest rates are so low.” 

Wharton management professor Matthew Bidwell wonders about one of the report’s numbers. “Hopefully, people who are 45 are not planning to retire imminently, so this is not necessarily a comment on their immediate situation, but rather it is tapping into a broader set of beliefs about how their lives will play out,” he says. “It may reflect a general erosion of trust in the ability of the current set-up, in terms of savings institutions and entitlements, to provide for them as they retire.” 

The report’s findings also raise the issue of whether more and more young people are being kept out of the job market – and delaying their own careers — because older people are hanging on longer. Not necessarily, says Bidwell. “I think economists would argue that people who are delaying retirement are doing so in order to earn, and spend, more money than they otherwise would be able to. That spending money ultimately creates jobs.” 

Adds Mitchell, who is also executive director of The Pension Research Council: “The idea that there is a fixed number of jobs has long been discounted by economists. Rather, the labor market tends to be very flexible, so the prediction is that more older workers will [likely] be absorbed relatively easily. In fact, in countries which encourage earlier retirement ostensibly to ‘make way’ for the younger folks, it proves to be very expensive to pay for all the retirement benefits. [Then] tax rates rise so much that it discourages younger employees from working.” 

Which industries are likely to benefit more than others from this trend of delayed retirement? “Probably the industries in which customer care matters – retail trade, service sector – where older employees tend to be more polite, patient and have better phone manners” than younger employees, says Mitchell.

 

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Don’t Expect Big Budget Cuts

Posted on January 4, 2013

A lot of analysts looked at the results of the widely covered “fiscal cliff” negotiations and decided that each side got half a loaf. On the one hand, Democrats secured, in effect, tax increases for very high income Americans that will raise some $600 billion over 10 years. They also won extensions for unemployment payments. On the other hand, Republicans gave up less in tax increases – their biggest single issue — than most observers expected. Federal income and capital gains tax rates of various kinds went up only for individuals with incomes above $400,000 and couples with incomes of more than $450,000. (Congress also made permanent the lower tax rates of the last 10 years that affect most income levels, but which were to expire January 1.)

Both sides now say they want to turn their attention to cutting the budget significantly; haggling over that will likely continue into February or March, with a debt ceiling deadline the next crunch point. It remains an open question whether an impasse will lead to a federal cash flow emergency in which the U.S. can’t pay its bills and sees a reduction in the rating of its debt. In 2011, the United States was only days away from defaulting on various payments, and as a result suffered its first-ever credit-rating reduction.

But for Kent Smetters, Wharton professor of business economics and public policy, that also is a moot question. In his view, the GOP gave up “all of its leverage” by agreeing to tax increases without making budget cuts part of the deal. As a result, he says, “I think that serious cuts are now unlikely…. The common myth is that serious budget cuts can happen after the economy recovers. But, without serious budget cuts, the necessary investments won’t be made if innovators and investors think that their hard work and risk taking will eventually be taxed away. Even if cuts are phased in, a plan is needed right now.”

Smetters is also a former deputy assistant Treasury secretary and economist for the Congressional Budget Office.

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Are Bank Regulators Now Encouraging Fraud?

Posted on December 19, 2012

 

This week, in a seemingly endless stream of bank fraud news, UBS agreed to pay $1.5 billion in a “settlement” to various regulatory agencies in the United States, the U.K. and Switzerland. The fines are part of a settlement of charges alleging the Swiss bank conspired to manipulate the Libor interest rate.

Last week it was HSBC getting nailed for even more — it now it holds the world’s record for the highest bank settlement ever reached – as the British Bank agreed to pay $1.92 billion to U.S. authorities. The charges against the bank were about as serious as it gets – HSBC stood accused of laundering billions of dollars for terrorists and drug kingpins.

On the surface it sounds like quite a whipping for HSBC – but it was not even close to one. For one thing, the settlement amounts to about six weeks of earnings, according to estimates. That is a mere slap on the wrist for such a huge institution. For another thing, no criminal charges were brought against the bank or any of the individuals involved. The official reason, as a column in The New York Times translated it: “Criminal charges could jeopardize one of the world’s largest banks and ultimately destabilize the global financial system.”

Notes Kent Smetters, Wharton professor of business economics and public policy, “I think it shows that the government still does not have a game plan for dealing with too big to fail, despite the passage of Dodd-Frank. As a nation, we have a lot of work to do on properly regulating systemically important institutions if we even let them get away with funneling money to terrorists and drug dealers.”

The HSBC settlement led to countless citations in the press that banks have gone from being “too big to fail” for fear of creating another Lehman moment (the investment bank failure thought to have triggered the world financial crisis) to “too big to jail.” The phrase was first mentioned by Simon Johnson, a former chief economist at the International Monetary Fund and a professor at MIT, earlier this year. At that time Johnson noted that “Among the fundamental principles of any functioning justice system is the following: Don’t lie to a judge or falsify documents submitted to a court, or you will go to jail. Breaking an oath to tell the truth is perjury, and lying in official documents is both perjury and fraud. These are serious criminal offenses, but apparently not if you are at the heart of America’s financial system. On the contrary, key individuals there appear to be well compensated for their crimes.” At the time, Johnson was referring to the so-called “robo-signing” settlement regarding large-scale, fraudulent mortgage foreclosures in the U.S. But the latest offenses are in the same category of violation.

Reducing the threat of criminal prosecution for the largest banks takes away a huge deterrent, the Times points out — “the threat could lose its sting.” That’s putting it mildly compared to what other critics say: If the downside of laundering money for terrorists and drug cartels – or manipulating Libor — is an easily absorbed fine, a simple cost of doing business, then regulators are actually encouraging fraud because banks have shown an aggressive tendency to push through loopholes.

Says Neil Barofsky, a former special inspector general for the Troubled Asset Relief Program, the Justice Department’s “actions with regards to HSBC are beyond unfair: They are downright terrifying for weakening the general deterrence for megabanks, both foreign and domestic, which could rationally interpret yesterday’s actions as a license to steal.”

Regulators want to avoid another financial disaster, naturally. But if some banks are too big to fail, and if, as Smetters points out, new banking regulations fall short of preventing future, systemically important bank failures, then the one lever that may remain is to break banks up and make them smaller.

For more discussion of breaking up megabanks, see this Knowledge@Wharton article:

Should Big Banks Be Broken Up? Yes — or Maybe

For more insight into Simon Johnson’s views on the financial industry, see this Knowledge@Wharton interview: The Coming Meta-Boom and Meta-Bust — One Economist’s View

 

 

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Faculty Perspectives on the Election

Posted on November 7, 2012

In the wake of President Barack Obama’s victory over challenger Mitt Romney in the 2012 presidential election, K@W Today asked Wharton faculty for their perspective on a number of issues that will take center stage in the days and months ahead.

We posed a number of questions, including:

  1. What do you think was the biggest reason for Romney’s loss? What should he have done differently?
  2. What was the biggest reason for Obama’s victory?
  3. An editorial in The Wall Street Journal suggested that Obama got a big boost in the election from two men: Ben Bernanke and his quantitative easing, and John Roberts, who joined four other Supreme Court justices in upholding Obamacare. Do you agree?
  4. The election raised interesting demographic questions. Romney appealed to many white males, while Obama appealed to many Hispanics, Asians, women and African Americans. Does this suggest that Republicans need a better strategy to attract these groups going forward?
  5. What should Obama’s strategy be for dealing with the key issues of unemployment, the fiscal cliff and the deficit?
  6. Is there any reason to think that the Republicans, who control the House of Representatives, will be more willing to work with Obama to get some of these issues resolved? Can the two parties hope to work together?

Here is what we heard:

Peter Cappelli, director of Wharton’s Center for Human Resources:

“Aside from the tactical issues, the fundamental issue in the election was the role of government. The vote was basically split between those who did not think government did much for them economically and those who thought government either did, or should do, something for them. The Democrat/Republican divide always reflects this issue, but it was much starker this time because the Republican position was more extreme, particularly in the proposed cuts for social services.

“The Romney campaign suffered because its proposals seemed to frighten too many voters who feel they need government protection. The Romney ticket also could not shed the baggage from the primaries on social issues – women’s rights and immigration, in particular – that hurt them with those voters.

“The biggest reason for the Obama victory in my mind was that Governor Romney’s various gaffes shifted the contest from being a referendum on President Obama and the poor state of the U.S. economy to being more of a referendum on Governor Romney. Much of the energy on the Democratic side seemed to be [directed] to voting against the Romney ticket.

“There are a hundred things that made a difference to the election. Certainly if Obamacare had been turned down by the Supreme Court, things would have been bad for the President, but then it was bad for the Democrats when the Supreme Court upheld Citizens United. Quantitative easing appears to be helping the economy, but it has been bad news for the President that none of the other treatments before helped much. A lot of other things could have gone differently that would have affected the outcome….

“The big question seems to be how the Republican party, especially in the House of Representatives, will see their effort over the last four years to obstruct anything that would appear to give the President a legislative victory. The goal of that approach was to prevent the President’s reelection. That did not work. So what do they do now?”

Mark V. Pauly, professor of health care management:

On why Romney lost: “The economy recovered enough to take away his main argument for change.”

On The Wall Street Journal editorial: “I do not see that the court decision on health care reform meant more votes for the President. It kept an issue alive — you need to vote Republicans [into office] to get rid of Obamacare — but that was obviously not an important enough issue, nor should it have been since in the short run, relatively few people gain or lose from health care reform.”  

On dealing with the issues of unemployment, the fiscal cliff and the deficit: “Republican control of the House of Representatives will keep us at the same point in discussing these issues as we were before the election.”

On whether the two parties can work together: “Now that the House knows it will have to deal with the President, I expect they will try to get some things resolved that were held hostage to the election. I think the President has used most of the ammunition he has in terms of executive orders and the like, so I expect the House will pull things their way. We will have some tax increase on millionaires and billionaires, but of course we do not have enough [of them], so that will not help the deficit that much. It will just make Democrats feel better.

“I am hoping this will set the stage for bipartisan tax reform along the lines of the Rivlin-Domenici or Bowles-Simpson [debt reduction plans]. Both have big health care parts to them. I think the election gives cover to Republicans to go along a little.”

Kent Smetters, professor of business economics and public policy:

On why Romney lost and Obama won: “Obama had a better ground game — more regional offices, more effort to get out the vote. Romney also focused solely on jobs without painting a broader picture. He should have channeled Reagan a bit more.”

On The Wall Street Journal editorial: “I don’t agree with it. Money injected by [the third round of quantitative easing] is basically just sitting on bank balance sheets. I think that the [Supreme Court decision on health care], if anything, helped mobilize conservatives behind Romney.”

On the demographics question about Obama’s popularity with minorities: “The election raised interesting demographic questions. Romney appealed to many white males, Obama to Hispanics, Asians, women, African Americans and other ‘minorities.’ Does this suggest that Republicans need a better strategy to appeal to these groups going forward? Romney also appealed to married females. But, yes, the Democrats are effective at class war politics. Republicans need to do a better job of explaining how prosperity is better than envy.”

On a strategy for dealing with unemployment, the fiscal cliff and the deficit: “The ‘fiscal cliff’ is a horrible term. Minus five for Bernanke for coming up with it; minus 10 for still being an old school Keynesian. Otherwise, I like him.

“The real cliff is if we keep focusing on the short run without also addressing the huge budget deficit. The problem with the U.S. economy is not the lack of consumption. We have plenty of it. The problem is the lack of investment. We need to address the fiscal cliff by removing some of the uncertainty about future tax rates and returns to investment. Any proposed solution to the fiscal cliff can’t be short-term and [can't work without] comprehensive reform of the tax code and spending side that improves the long-run situation as well.”

On whether the two parties can work together: ”No, they will continue to play chicken. Hopefully, however, it will lead to a grand compromise, like the 1986 Tax Reform Act where Reagan and the House Democrats hammered out a deal that was tenable to both sides.”

Mark Duggan, professor of business economics and public policy:

On why Romney lost and Obama won: “A key reason for Obama’s victory is that the economy has been gaining more momentum over the last few months, with unemployment falling below 8% and job creation relatively strong. This may have given voters more confidence that his policies, such as his help for the auto industry — an important issue in arguably the most important state of Ohio — were working. His handling of Hurricane Sandy also probably helped to give him just a bit more support so that he pulled out wins in pretty much all of the states that were deemed battlegrounds.

“While Florida has still not been called, the races in states like Ohio, Virginia and Colorado were sufficiently close that even a small boost might have helped lead him to victory. Plus his victory margins in Wisconsin, Iowa, New Hampshire and Nevada were somewhat bigger than expected. On the foreign policy front, I think most people felt he won the third debate; that may have helped to tip the balance for many voters, too.”

On issues like the fiscal cliff, taxes and unemployment: “As for big things that are coming down the pike, the President will be negotiating with Congress on what to do about the upcoming fiscal cliff. Effective January 1, 2013, there are a set of spending cuts and tax increases taking effect that will lower the deficit by about $600 billion, which is close to 4% of GDP. While reducing the deficit is important, many think that a change in government policy of this magnitude could put the economy back into recession. Thus, it will be very important for Obama to work with Congress to make the right tradeoff between starting to tackle the deficit and stimulating economic growth.

“Certain parts of the fiscal cliff, like the payroll tax holiday (a 2 percentage point cut in this tax for all workers on their first $115,000 in earnings), are very unlikely to be renewed, but others — like the spending cuts and increases in income taxes — are likely to be negotiated. Long-term deficit reduction is also hugely important, with changes needed to the tax code and to entitlement programs.

“The fact that Obama will now be a second-term President may make it easier for him to confront these challenges as he does not need to worry about being re-elected. Indeed, that is why many support term limits.”

 

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The Fed – the Mouse that Roared

Posted on September 4, 2012

Federal Reserve chairman Ben S. Bernanke’s speech Friday at the gathering of government and academic economists in Jackson Hole, Wyoming, offered strong new indications that the flailing U.S. economy will likely get new stimulus measures from the Fed.

But the measures being discussed are unlikely to have much effect on the economy, other than to artificially bolster stock and commodity prices to some extent. “I have severe doubts that this kind of monetary policy is likely to be beneficial in the long run,” says Wharton finance professor Franklin Allen, who was at the conference. “It has not been in Japan and they have now been following these kinds of policies for many years…. One of the major talking points at the conference was how little real effect all this monetary stimulus is having.”

One reason for that ineffectiveness, many believe, is that interest rates are already so low – actually negative in some cases after accounting for inflation – that further monetary easing has little impact. It’s like trying to “push on a string,” goes an expression sometimes used to explain the ineffectiveness of easing policies in today’s record-low interest rate environment.

A potential QE3 (a third round of so-called quantitative easing) will be effective, however, at distorting market prices through asset price inflation, Allens adds. “That is part of the problem as to why these actions don’t have too much in the way of real effects. They are hiding what the market is telling people…. The reason the stock market is so high at the moment is at least partly because of these interventions. Similarly with commodity prices…. They are distorting prices and not letting the market do its job.”

While no final decisions came out of the Jackson Hole symposium, some action may follow Fed meetings in mid-September. Those actions could include many or all of the following:

  • more asset purchases (treasury- and mortgage-backed types of securities) to hold interest rates near today’s low levels;
  • continuing (and possibly additional) forward guidance on plans to keep interest rates low;
  • lower rates the Fed pays on bank reserves to boost lending; and
  • lower-cost funding for some forms of lending, such as mortgage loans – which would parallel a program recently introduced by the Bank of England.

Such ongoing monetary easing can raise concerns about stoking inflation. But since the economy continues to be weak, and since QE1 and QE2 had little effect on inflation under similar conditions, inflation worries appear small. “In the short run, consumer price inflation is not likely to move up, but in the long run I think there is a risk,” Allen points out.

Instead, the biggest economic risk – with or without QE3 — is continued high unemployment.

So what should or could the Fed do to make lowering unemployment a higher priority? “This also was a big topic at the conference,” Allen says. “I don’t think there is much they can do. Arguably the government can introduce retraining policies and so forth to try and counter the long-term unemployment problem we have. But this is not a Fed policy.”

What the Fed can do is get interest rates “back to 2% so that retirees and people who are saving for retirement stop having to save so much and know that they can survive in the long run without taking excessive risk.” At present, Allen says, financial institutions are getting too many subsidies “at the expense of savers.” The government also needs a serious plan to solve the huge deficit problem long term. “We need to avoid the fiscal cliff, and we also need to avoid a fight over the debt ceiling.”

But, he adds, “I am not optimistic any of this will be done.”

Wharton professor of business economics and public policy Kent Smetters thinks QE3 is not a done deal and has just a 30% to 40% chance of going through. But even if approved, the additional liquidity would help the economy only a “little bit.” Instead, the stimulus will simply add to banks’ excess reserves, leaving banks little incentive to lend out the funds, even thoiugh new lending is supposed to be the purpose of the exercise.

In Smetters’ view, the chief problem with the economy today is a lack of business investment, and that results from the reluctance of banks to lend. “We have an investment problem.”

GDP is made up of four key components: consumer and government spending, net exports and business investment, Smetters points out. Consumer spending and net exports are at average or only slightly below average levels. “Government spending is high.” What’s really lagging is business investment, he says. The slow down in bank lending causing the dearth of investment stems from worries by banks that interest rates will soon go up and leave banks holding unprofitable loans set at today’s lower interest rates.

“Aggregate demand is low, not because of consumers, but because we are still light on investment, and Congress and the President have something to do with that,” notes Smetters. “But we are not pulling the right levers on the Fed side. They need to convince the market we are in a low-risk interest rate environment for the long term – a new normal.”

Thus, he adds, the most effective action that could come out of the recent Fed thinking is additional guidance showing that the Fed plans to keep interest rates low, not just for some specified period into the future, but until the economy shows real signs of revival, Smetters says.

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A Lost Generation’s Big Drop in Family Wealth

Posted on June 18, 2012

The Federal Reserve last week documented just how steeply family income across the U.S. has fallen, and the figures aren’t exactly uplifting.

According to the Survey of Consumer Finances (SCF), done every three years, the median value of family income fell by 7.7% between 2007 and 2010, from $49,600 to $45,800. Meanwhile, median net worth fell 38.9%, from $126,400 in 2007 to $77,300 in 2010 — a reflection of the severe downturn in the housing sector. The last time net worth was this low was 1992.

But the news isn’t all bad. As Wharton business and public policy professor Jeremy Tobacman points out, “This was a terribly serious decline, which has already reversed direction. Remember, the unemployment rate barely began to fall before the start of 2011. Since then, it has fallen slowly but fairly steadily.” He cites the Federal Reserve’s own release about the SCF findings, which states that: “The vast majority of interviews for the 2010 SCF were completed in 2010, but some were completed in early 2011. Thus, the survey data are largely unaffected by changes in economic activity since 2011 — in particular, the rise in the market price of corporate equities, the relative stabilization of house prices, and the start of a decline in the unemployment rate.”

Tobacman suggests that while “these numbers remind us just how terrible the Little Depression has been, they [also] simultaneously impel us to remember that the economy has been improving over the last 18 months.” At the same time, however, “one other fact leaps out from the report, especially during an election season [where] fairness is a touchstone issue: Even at the end of the boom in 2007, half of U.S. households earned less than $49,600 per year.”

Wharton business and public policy professor Kent Smetters also tempers the discouraging report, noting that “most of the decline is the reduction in housing wealth, which is less serious than if it were a reduction in non-housing assets. Non-housing assets are mainly used for putting kids through college, paying down debt, [covering] emergencies, retirement and so forth. So a loss of non-housing wealth can produce a material impact on lifestyle. However, for housing wealth, one’s lifestyle is mainly impacted to the extent that the family was intending to downsize and consume the difference in housing values. To be sure, that happens. But it is less important than a loss in non-housing wealth.”

Nonetheless, he adds, “the reduction in even housing wealth is significant simply because the average American family has so little non-housing assets available. Any loss, even to non-housing assets, becomes important.”

As for whether the decline will reverse itself anytime soon, “It’s very hard to say,” Smetters notes. “The large government deficits certainly don’t help because they will likely translate to lower future after-tax income.” It’s also hard to predict what will happen to home prices.  

His advice to the powers that be in Washington, D.C.? “Spend less.”

Meanwhile, what economic group in the U.S.has been hardest hit by the decline in family income? According to a recent article in the Philadelphia Inquirer titled, “A Generation in Collapse,” Generation X – those who entered the workforce in the late 1980s and early 1990s – “got more scorched than anyone else.” As the article notes, Gen Xers “have been decimated financially at a fragile time, while forming households and raising young families, those ordinary coming-of-age endeavors.” Their median net worth in 2010 was less than half the net worth of those who were their age in 2001 — $42,100 vs. $95,100.

In addition, the article points out, “due to little more than the bad luck of birthdays, a higher proportion of Xers purchased homes while prices were exceptionally high.”  Couple that with the fact that home equity decreased 42.3% between 2007 and 2010 – from $95,300 to $55,000 – and it’s easy to wonder how “this Lost Generation [can] even start to catch up, considering the grim pace of economic recovery.”

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A Good Deal, for Whom?

Posted on February 13, 2012

After months of wrangling, the government last week announced a $26 billion settlement with five of the country’s biggest banks that is designed to offer some relief to homeowners victimized by fraudulent mortgage practices and foreclosure abuses.

The five banks include Bank of America, JPMorgan Chase, Citibank, Wells Fargo and Ally Financial.

The goal of the settlement is to hold the banks accountable for a range of shady dealings — ranging from charging new homeowners excessive fees for insurance policies to evicting current homeowners on the basis of unsubstantiated or false information — and also to jumpstart the moribund housing market.

Observers, however, are skeptical about who this settlement will really help. Some say the banks have gotten off easy even as relatively few homeowners will be helped by the promised aid. A column in Sunday’s New York Times business section, for example, suggests that the payback to people whose properties were wrongly foreclosed on will most likely be less than $2,000 per homeowner. The column also describes the settlement as a “stealth bailout of the major banks” because, as one critic points out, “it will improve the value of the second liens or home equity lines of credit [the banks] own” because these holdings are “worthless if the first mortgages preceding them are underwater.”

Nor is there any expectation that the banks will actually carry through on the promised compensation, the column goes on to say, citing other agreements with the government — such as Countrywide Financial’s predatory lending settlement in 2008 — in which banks failed to live up to the terms of a deal.

Finally, skeptics doubt that the mortgage industry’s reputation will be rebuilt after an agreement that offers too little, too late to help either individual homeowners or the overall housing market.

According to Kent Smetters, Wharton professor of business and public policy, “The agreement ostensibly deals with alleged acts committed by banks during the foreclosure process, including improper papering and fees. However, the remedies in the agreement itself use broad brush strokes that do not sufficiently target the harmed parties, instead benefitting some homeowners who simply borrowed more than they can repay. It is not surprising, therefore, that the help is diluted.”

The real problem, he adds, “is not the total size of payments, but a banking system with insufficient accounting systems and securitization processes that render targeted remedies nearly impossible.”

Wharton real estate professor Susan M. Wachter describes the deal as “a start, a down payment, if you will. It covers only a small share of the market. But for those it helps, it will matter. And it may help put into place a template for solving the far larger part of the problem that is out there.”

Indeed, an article last week in The New York Times notes that the money “will help a relatively small portion of the millions of borrowers who are delinquent and facing foreclosures,” but adds that the agreement remains “the broadest effort yet to help borrowers owing more than their houses are worth.” It predicts that about one million people will be able to get their mortgage debt “reduced by lenders or will be able to refinance their homes at lower rates.”

In addition, the article states, the settlement does not preclude regulators from filing criminal charges against banks or investigating other questionable practices related to the housing market, such as insurance and tax fraud or the bundling of risky mortgages into securities later sold to unsuspecting investors.

 

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