14 Tennessee bonds affected by major insurer's downgrade - Nashville, Tennessee - Thursday, 12/20/07 - Tennessean.com
Thursday, 12/20/07
BY STEPHEN BERNARD Associated Press
NEW YORK — A major insurer of bonds was downgraded to "junk" status on Wednesday, a move that could potentially cost banks and local governments billions of dollars.
Credit rating agency Standard & Poor's slashed its credit rating for bond insurer ACA Financial Guaranty Corp. to a non-investment grade "CCC" from investment grade "A." S&P cited concerns about increasing claims from defaults on mortgage-backed bonds, and the risk that those claims could drain the bond insurers of needed capital.
- follow link for story from Tennessean
Bond insurers had made guarantees on collateralized debt obligations (CDOs) (aka - mortgage backed securities). These bonds created by placing mortgages in trusts then selling the pay outs in the form of a bond to investors have the threat of default hanging over them. Something like a trillion dollars in CDOs have been insured by bond insurance companies. The assets the insurers have to back these payment guaranties are something like $20 billion. The downgrades taking place are due to the lack of assets. The default potential is an impact of the subprime crisis. The structure of these CDOs is such that the risk can't be determined now.
The downside is bond insurers insure governments allowing the insurers credit rating to stand for the government's, permitting it to pay a lower interest rate. The stock market had already priced these uncertainties into insurers share price dropping them. Now the rating agencies are getting nervous and starting to question or in this case actually lower the insurers debt rating.
Local government will need to work on improving their debt ratings because the insurers may not be there to provide a higher bond rating. The market has already raised the yield on insured bonds. More and more bond issuers are not using insurance when issuing new bonds because of this. This decreases the available market for municipal bonds because many investors require a bond to have an A or AA before they will buy it. This also means debt costs tax and rate payers more. Perhaps this will lead to an improvement in municipal financial management since that is what ratings are based on.
Thursday, December 20, 2007
Saturday, August 18, 2007
Would a massive tax break increase inflation?
"Would a massive tax break increase inflation?" I saw this question on Yahoo Answers. This is a good general question because there is a lot of discussion concerning this issue.
Yes, a massive tax cut coupled with deficit spending would result in a small increase in (price levels) inflation with a caveat. The caveat is that the change in price level depends upon whether the government borrows to finance the deficit or it creates money. If money creation is the means of financing the deficit then yes a tax cut could increase inflation dramatically. A tax cut coupled with no deficit spending would no impact on inflation.
Fiscal policy is the use of government taxation and expenditure policies for the purpose of achieving macroeconomic goals.1
Inflation is an increase in the average level of prices of goods and services. Inflation can either be due to an increase in price level caused by excessive aggregate demand (demand-pull inflation) or due to an increase in the price level caused by an increase in the cost of production [supply-side] (cost-push inflation). In the case of demand-pull inflation the Aggregate Demand (AD) curve would shift rightward from AD0 to AD1 establishing a new equilibrium point that has shifted upward along the Aggregate Supply curve from equilibrium point E0 to E1 that would represent a higher equilibrium price with a higher level of output. In the case of cost-push inflation, the Aggregate Supply (AS) curve would shift leftward from AS0 to AS1 establishing a new equilibrium point that has shifted upward along the Aggregate Demand curve from equilibrium point E0 to E1 that would represent a higher equilibrium price with a lower level of output (as price increased demand decreased on the AD curve).2
Would a massive tax cut bring inflation? All things remaining the same, in the short run if the tax cut is coupled with a budget deficit, the budget deficit should lead to an increase in demand and thus in output. In the long run, changes in fiscal policy have no effect on output. The continuing need to borrow may increase long-term interest rates. The increase in interest rates offset the direct expansionary effect of lower taxes. The “crowding out” effect of government borrowing requiring a larger share of monies available for investment from the capital markets would reduce capital available for investment in the private sector. This lessens the opportunity for the growth of output in the private sector. This lowers output in the long run. 3
Deficit spending impact on demand is less than one would anticipate because expectations concerning future tax increases have changed. People should save more in anticipation of higher taxes in the future.4 This saving leads to a reduction in consumption leading to a decrease in demand over time.
The net effect of an increase in government deficits financed by borrowing due to a tax cut in the short run is: 1. Increase in output, 2. Small increase in price level, and 3. increase in interest rates. The net effect of an increase in government deficits due to a tax cut in the long run is: 1. No impact on output (return to normal level), 2. Small increase in price level, and 3. Increase in interest rates.
Money creation as the means of financing could actually lead to hyper inflation. Money creation is really more of a monetary policy issue.
My though is that reducing government spending wisely (we need services the government provides) coupled with decreases in taxes would be good for our economy and way of life.
Note 1: Bradley R. Schiller; The Economy Today 4th Edition, 1989; Chapter 7, p 149
2: Schiller, Chapter 7, p 170
3: Blanchard, Oliver; Macroeconomics, 1997, Chapter 29, p 588, 589
4: Blanchard, Chapter 29, p 589
Yes, a massive tax cut coupled with deficit spending would result in a small increase in (price levels) inflation with a caveat. The caveat is that the change in price level depends upon whether the government borrows to finance the deficit or it creates money. If money creation is the means of financing the deficit then yes a tax cut could increase inflation dramatically. A tax cut coupled with no deficit spending would no impact on inflation.
Fiscal policy is the use of government taxation and expenditure policies for the purpose of achieving macroeconomic goals.1
Inflation is an increase in the average level of prices of goods and services. Inflation can either be due to an increase in price level caused by excessive aggregate demand (demand-pull inflation) or due to an increase in the price level caused by an increase in the cost of production [supply-side] (cost-push inflation). In the case of demand-pull inflation the Aggregate Demand (AD) curve would shift rightward from AD0 to AD1 establishing a new equilibrium point that has shifted upward along the Aggregate Supply curve from equilibrium point E0 to E1 that would represent a higher equilibrium price with a higher level of output. In the case of cost-push inflation, the Aggregate Supply (AS) curve would shift leftward from AS0 to AS1 establishing a new equilibrium point that has shifted upward along the Aggregate Demand curve from equilibrium point E0 to E1 that would represent a higher equilibrium price with a lower level of output (as price increased demand decreased on the AD curve).2
Would a massive tax cut bring inflation? All things remaining the same, in the short run if the tax cut is coupled with a budget deficit, the budget deficit should lead to an increase in demand and thus in output. In the long run, changes in fiscal policy have no effect on output. The continuing need to borrow may increase long-term interest rates. The increase in interest rates offset the direct expansionary effect of lower taxes. The “crowding out” effect of government borrowing requiring a larger share of monies available for investment from the capital markets would reduce capital available for investment in the private sector. This lessens the opportunity for the growth of output in the private sector. This lowers output in the long run. 3
Deficit spending impact on demand is less than one would anticipate because expectations concerning future tax increases have changed. People should save more in anticipation of higher taxes in the future.4 This saving leads to a reduction in consumption leading to a decrease in demand over time.
The net effect of an increase in government deficits financed by borrowing due to a tax cut in the short run is: 1. Increase in output, 2. Small increase in price level, and 3. increase in interest rates. The net effect of an increase in government deficits due to a tax cut in the long run is: 1. No impact on output (return to normal level), 2. Small increase in price level, and 3. Increase in interest rates.
Money creation as the means of financing could actually lead to hyper inflation. Money creation is really more of a monetary policy issue.
My though is that reducing government spending wisely (we need services the government provides) coupled with decreases in taxes would be good for our economy and way of life.
Note 1: Bradley R. Schiller; The Economy Today 4th Edition, 1989; Chapter 7, p 149
2: Schiller, Chapter 7, p 170
3: Blanchard, Oliver; Macroeconomics, 1997, Chapter 29, p 588, 589
4: Blanchard, Chapter 29, p 589
Tuesday, July 24, 2007
Fiscal Wake-Up Tour
Last week, I had the privilege to attend the Nashville stop of the Fiscal Wake-Up Tour. I am simply going to discuss my thoughts on the issues raised at this event. If you are interested you need to do more research on the issues explored by the Fiscal Wake-Up Tour on your on to come to an informed decision.
U.S. Comptroller David Walker with the help of the Concord Coalition, Brookings Institute, and Heritage Foundation has been to 22 cities in 21 states to make citizens aware of the pending crisis: federal spending on entitlement programs, such as Medicare, Social Security, and Medicaid; and interest on the federal deficit is increasing faster than the most optimistic hopes for federal revenue growth. Another part of this crisis is the rapid increase in the cost of health care and the coming retirement of the baby boomers.
The Concord Coalition is viewed as a nonpartisan public policy organization with the Heritage Foundation being a conservative think tank and the Brookings Institute a liberal think tank. What all three of these organizations have in common is a realization that federal spending on these programs and interest on debt is unsustainable. Comptroller Walker and the Government Accountability Office are spearheading this education effort.
What does this mean to you and me? Federal programs we all are eligible for at retirement such as Social Security and Medicare will either have to be curtailed in the future or supported by general taxes. The economy will be adversely affected by continuing borrowing to support deficit spending. This will impact our capital markets crowding capital for business investment. Another impact is on our national security, foreigners are holding higher and higher percentages of the federal debt. This will increase their influence in politics of our country.
State and local governments will be effected by a decrease in federal funds. This will mean to continue state and local programs at the same level of service will require increased taxes. The same is true for the federal government if it tries to maintain the same level of services.
These are not easy issues to deal with. The longer we wait the harder and more expensive it will be to deal with these problems. What can you do today? Educate yourself about this pending crisis and let your elected officials know that you want them to act. It will take hard choices to solve this problem. As was stated at this meeting, we cannot grow our way out of the crisis. Let them know your ideas on solving these problems.
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