Feldstein Transcript

Taped, April 6, 2017

Table of Contents

I: The Crisis of ’08 and the Economy Today 0:15 – 30:11
II: On Technology, Trade, Taxes, and Regulation 30:11 – 1:10:30

I: The Crisis of ’08 and the Economy Today (0:15 – 30:11)

KRISTOL: Hi, I’m Bill Kristol. Welcome to CONVERSATIONS. I’m very pleased to be joined today by Harvard economics professor Martin Feldstein, who served as President Reagan’s Chairman of the Council of Economic Advisers. I won’t even begin to detail all your honors and awards.  A major economist in America and someone I’ve learned an awful lot from over the years. So, thank you for joining me.

FELDSTEIN: Delighted to be with you.

KRISTOL: Now you’re going to explain everything here.

FELDSTEIN: As much as I can.

KRISTOL: That’s great. Why don’t we begin with the 2007, 2008 crisis, which I think called into question, for a lot of people, what we thought we knew. Very talented economists were there at the Fed and in the White House, and friends and students of yours, and suddenly we – and people allegedly worked out all these questions of risk and the international financial system – and suddenly we were very close to a – I guess we really were pretty close, weren’t we, to a real financial crash and a great depression. So, how did that happen? What are the lessons?

FELDSTEIN: Well, of course we don’t –

KRISTOL: Were we that close? Let’s talk about it.

FELDSTEIN: I don’t know whether we really were that close, but there’s no doubt that it was a very serious downturn. And so, how did we get there? Well, basically, assets in general were overpriced. Stocks were overpriced, bonds were overpriced, but the thing that was probably most overpriced was individual homes, owner-occupied homes.

That was in part because the Fed had kept interest rates exceptionally low, so it was easy to get mortgages. It was in part because of government programs designed to get low-income people to borrow in order to own a home. And so, what happened was, house prices got bid up way, way beyond the cost of construction. So you knew something was wrong.But the public policy was aimed at promoting housing and allowing people to get mortgages equal to, say, 90 percent, 95 percent of the value of their homes.

And then, the bubble burst, and house prices started coming down. And when they did, what was a 95 percent loan-to-value ratio became a 110 percent loan‑to‑value ratio. So these people owed more than their houses were worth. And at a certain point they said, “Well, why am I paying on this mortgage when I owe more than the house is worth?” And you could actually find a website called “youwalkaway.com,” which explained to people that they had the right to not pay and to walk away, and all that the banks could do was take the home. So you owed $120,000 and your house was worth 90, you walked away from that $120,000 in debt.

So, that triggered a lot of speculation in financial markets – saying, “Well, if that was overpriced and the mortgages based on that and the bonds based on those mortgages were overpriced, then maybe a lot of stuff is overpriced.” And so we had a meltdown, not just in home prices but across the board.

KRISTOL: So yeah, I mean, listening to this as a layman, I think most laymen think of it as financial crisis or Wall Street crisis. But I think what you’re saying is that it’s a housing crisis that became a financial crisis?

FELDSTEIN: Yes, very much so.

KRISTOL: And is that widely accepted or is this –

FELDSTEIN: Yeah, I think so. And, you know –

KRISTOL: Was it at the time, do you think? People saw that?

FELDSTEIN: Yeah, I think they did. The banks froze, because they had all these mortgages, they didn’t know what they were worth. They didn’t know how far house prices would fall, so they didn’t know how much capital they had. The banks didn’t know how much potential lending they could do, and they certainly didn’t know what other banks’ financial position was because it wasn’t what they reported, it was what these mortgages would eventually be worth. So, banks stopped lending to each other, and that’s really what brought the crisis on.

KRISTOL: So it was policy mistake – I mean, one has, presumably, business cycles and recessions, but you think it was policy mistakes that really triggered –

FELDSTEIN: I think it was the policy mistake of allowing super-high loan-to-value ratios. And it was the policy mistake, before ’07, ’08, of keeping interest rates super low, so that mortgage borrowing was encouraged by people who wouldn’t be able to afford it with normal interest rates.

KRISTOL: And these were bipartisan policy mistakes, presumably?


KRISTOL: But liberal in the sense – I mean, I don’t mean this is a polemical way – but trying to be generous, let’s say, to people, to make more people be able to afford houses and to make it cheaper to buy a house. I mean –

FELDSTEIN: Yes, but it wasn’t ideological; it was that the realtors, the homebuilders, all those folks were leaning on their congressmen to keep these policies in place. And, you know, the sad thing is we’ve done it again. After the recession ended and started back up, we said, “Well, we’re not going to make that mistake again. We’re not going to let people borrow 90 percent of the value of a home.” But you can now.

And low-income people can once again get, thanks to Fannie and Freddie and the federal home-loan program, they can get 90-plus percent. And so, if house prices come down again, we’ll see people under water; we’ll see people owing more than they have.

KRISTOL: I want to come back – well, that’s worrisome – to come back to that. But this is a good case; this is a political science sort of matter. But you’ve studied political economy, not just economics. I mean, obviously, citizens are happy to be able to buy houses more cheaply, both because of low interest rates and subsidies.

FELDSTEIN: Sure. Especially if they can walk away if things go wrong. It’s a one-sided bet.

KRISTOL: Right. So that’s also a policy matter, right? That those loans are different from other loans?

FELDSTEIN: Right, exactly.

KRISTOL: What do they call them, no re–

FELDSTEIN: No-recourse loans.

KRISTOL: So you can’t be – your other assets can’t be taken.

FELDSTEIN: Right. Not that these people have a lot of other assets, but the U.S. is unusual in having this free pass of this no-recourse loan.

KRISTOL: Which isn’t true for other loans. Another loan you take out, if you’re – they can –

FELDSTEIN: They can come after you for other things.

KRISTOL: So mortgages are just treated [differently]?


KRISTOL: So that’s a public policy question.


KRISTOL: So we have a – go ahead.

FELDSTEIN: Even in those states – it differs by state – even in those states where the bank can come after you, there’s very tight limits on what they can do. So, they can take so much a week from your paycheck or they can – so, it’s – again, it’s very generous to the borrower.

KRISTOL: So you have a bunch of public policies that are generous to borrowers, because most people are borrowers, and the interest groups have their own interest in selling.


KRISTOL: So you have – all that comes together to create this – now what would – now, normally, one would say, in a kind of pluralistic, you know, interest-group, Madisonian system, there should be others who check, who lean the other way. Right? You know, so to speak – you know?

FELDSTEIN: Yeah. It’s not clear that they’re –

KRISTOL: But who would be leaning against them? Well, the Fed I guess, in the old days. I mean, shouldn’t they be worried about the overall –

FELDSTEIN: Yes, they should. But, Janet Yellen said – a few years ago, two or three years ago – she said in a major speech at the IMF she said, “Financial stability is not our responsibility.” Pretty amazing. She said that’s somebody else’s responsibility. Our mandate is to have low unemployment and price stability. And so, that’s what we’re trying to do.

Now, recently she’s been saying we have to start raising interest rates more rapidly, because one of the things to worry about is inflation and another thing to worry about is financial stability. But, in the run-up to ’07, the Fed was not trying to raise interest rates in order to reduce this, or to put policies in place, or to advocate policies which would limit this kind of very high loan-to-value-ratio borrowing.

KRISTOL: And Congress was leaning that way too.


KRISTOL: So, I suppose though, one could say, okay, well, that’s a housing bubble and –

FELDSTEIN: Biggest asset for almost all Americans.

KRISTOL: But it is the big – but it’s an unusual asset. So it’s different from other bubbles, I guess.


KRISTOL: Different from a commodity or whatever, price spike or something. But then, I suppose, what triggers the real crisis is the financial institutions freezing up, as you said.


KRISTOL: Now, is that – that’s also a policy matter, presumably, or is that inevitable? Is there other –Have we, A) I guess, could that have been dealt with? And have we figured out how to deal with that?

FELDSTEIN: So, what has happened since then is the banks have been required to have much more capital. So, if you start the game with a lot more capital, even if you have significant losses, it’s not such a big problem. And the problem that occurred before – of high loan-to-value ratios, mortgages under water, and all that – there’s much less private securitization, much less creation of bonds backed by these high‑risk mortgages.

So it’s now all in the hands of Fannie Mae and Freddie Mac: meaning the government, meaning you and me – the taxpayers – who will be in trouble if there’s another meltdown.

And so, Wall Street is much less worried about it this time. I think probably wrongly, because if there is another meltdown in house prices, which probably is less likely now, but if there is, then if Joe walks away from his house, which is under water because he owes more than the house is worth, and when they go to sell that house, it’s a distressed sale, prices are driven down, the neighbors’ houses’ prices are driven down. And so even though the mortgages are held on the subprime, the low-quality mortgages may be held by Fannie and Freddie, driving down house prices, more generally, creates a problem for the financial institutions and for the economy as a whole.

KRISTOL: So we’re not –

FELDSTEIN: We’re not out of the woods.

KRISTOL: – out of the woods.

FELDSTEIN: Right. But I wouldn’t say that that today is the largest financial risk. I would say it’s more generally other kinds of assets that are priced way out of line with historic experience.

KRISTOL: And that combined with the amount of debt, I guess, public and private, is worrisome? Or just the assets by themselves?

FELDSTEIN: Well, it’s just the assets by themselves. So, stock market is roughly 70 – the price-earnings ratio – the ratio of share prices to the underlying earnings – is about 70 percent higher than it’s been on average, historically. 70 percent. So that’s just way out of line.

Ten-year treasury bonds pay a yield of less than two and a half percent. You would think in an economy at full employment with moderate but rising inflation that number should be four, four and a half percent. If that interest rate on those bonds went up to four, four and a half percent, you would see a sharp fall in the value of the bonds. So all of that is, to my mind, the biggest financial risk that’s out there.

KRISTOL: And this is a risk that somehow just, this is just the nature of modern economies or modern political economy, or is this –?

FELDSTEIN: It’s the result of 10 years of super-low interest rates. If you’d keep interest rates at almost zero at the short end and two percent at the long end, all these other asset prices are going to fall in line.

KRISTOL: And that’s a policy choice?

FELDSTEIN: And that was a policy choice, in order to drive down the unemployment rate.

KRISTOL: So, bad policy choices that led up to ’07, ’08; we’re making slightly different bad policies – well, related but not that different – bad policy choices now?

FELDSTEIN: Yes, that’s right. No, because we had similar things in, you know, ’04, ’05, ’06—very low interest rates driving up house prices.

KRISTOL: I suppose the politics of that is people like low interest rates because why wouldn’t they?

FELDSTEIN: Right. On the other hand –

KRISTOL: Savers you’d think might not like them, but they don’t seem to have the political power of borrowers, right?

FELDSTEIN: Right. Well, savers – savers almost can never win. So, in the bad old days, which they thought were the good old days, they got interest rates of, say, 7 percent, but inflation was 7 percent; so, on a real basis, they weren’t getting anything. And what’s more, unless they had it in an IRA or some fancy thing like that, they had to pay tax on the 7 percent. So, on an after-tax basis, they were getting a negative return. Now they get zero, but they don’t have to pay any tax on the zero. So they’re actually better off now than they were then.

KRISTOL: But as a matter of overall political economy we have not – you’re not super confident that we’ve fixed the system or all is well?

FELDSTEIN: No, not at all. Not at all. I mean, the economy now is in great shape – looks good, low unemployment, moderate but rising inflation, profits up, business investment up – but very fragile. Because of all of these mispriced assets.

KRISTOL: So that’s interesting because that’s different from the conventional, I’d say, account of the economy, which is almost the reverse: Well, we fixed the Wall Street Stuff – Dodd-Frank, you know, and et cetera. But people, lower-income, working-class people have had no wage growth, everyone’s very familiar by now – with Trump’s victory, especially – you know, this kind of narrative, you might say, about the economy. What about that side of it? How worried are you about sort of people’s incomes, jobs, mobilization, automation, all that stuff? I mean that’s a big question, but –

FELDSTEIN: So, there will obviously be some people who will suffer from all of that. But you have to start with the fact that the economy is essentially at full employment. 4.7 percent is probably unsustainably low unemployment. For college graduates, two and a half percent. Yes, some people have stopped looking, so they’re not counted as unemployed, but that’s a very small number.

KRISTOL: So you don’t buy this argument that – I mean, Trump has now joined what had been traditionally a sort of argument on the left, I’d say, that, you know, there are all these people out there who are unemployed and underemployed who aren’t getting counted. That, you think that’s exaggerated?

FELDSTEIN: It’s a small number, but it’s a – if you look at people who are less than a high-school education, it’s a very high number, but that’s fortunately a very small part of our population. And the general proposition that real incomes haven’t been rising for decades is just a reflection of the way the government creates the statistics.

KRISTOL: Okay, well, that’s interesting. So explain that.


KRISTOL: Because it’s become such a talking point. As I say, in a way it was always more of a, I think, a lefty-criticism-of-America-type talking point, and Republicans could be counted on to say “no, no,” you know, “the markets are working.” But now, of course, we have an unusual Republican president, so everyone’s saying it.

FELDSTEIN: You look at the official statistics and they tell you that over the last 30 years real GDP per capita, real income per capita is up about one and a half percent. And if you throw in the notion that the top income groups have gotten a disproportionate share of that, then it’s easy to say, “Well, the people in the middle are hardly getting any increase at all in their incomes for the last several decades.”

So what’s wrong with that? Basically, the way the government creates the measure of real income has two serious problems: One is what do you do about quality change, and the second is what do you do about new products? And I think we knew these were problems and that they were difficult, and so, maybe, they didn’t quite get it right.

And so I’ve been studying it in detail, and it’s worse than not quite getting it right; it’s just plain wrong. So let me tell you a little more –

KRISTOL: Yes, please.

FELDSTEIN: – about this. So, the Bureau of Labor Statistics, in the Department of Labor, follows a large number of individual products. And they asked the manufacturer, or in the case of services, the producer of the service, they say, “Did your product change since last year?” And if the product changed, they say, well, “How much more did it cost to make this year’s version than it would have cost to make last year’s version?”

So, what’s the extra cost from whatever change you’ve made? And if the manufacturer says, “Well, it didn’t really cost any more; we just came up with a way of making a better product,” then the BLS says, well, “Then there’s no quality change.” So that’s nutty. See –

KRISTOL: So the iPhone, if it doesn’t cost more, is no better than the BlackBerry of many years ago?

FELDSTEIN: That’s right. Right. Right. Or whatever else it may be. If they – if it didn’t cost more, it’s not any better. So, they just miss. And they have a name for this: They call it the “resource cost method of quality adjustment.” But it’s got nothing to do with quality; it’s got to do with the cost of making it.

So in an economy in which smart companies, smart technologists keep improving products, it just doesn’t register. So, I think we’re substantially underestimating the growth of real incomes because we’re not picking up these quality improvements.

KRISTOL: Now would the same be true, for example, for pharmaceuticals? That if a drug doesn’t cost anything more today than it did 20 years ago –

FELDSTEIN: So that’s a great example.

KRISTOL: – but it’s much more effective at preventing me from having a heart attack –?

FELDSTEIN: Right. So, that’s the perfect example. I like to give that example about statins—the drugs that keep us both alive.


FELDSTEIN: So, when statins came along, they – of course there was some dollar amount of sales. They added that to GDP, but nothing for the fact that we would pay a lot for the fact that these drugs will reduce our risk of dying or having a heart attack or a stroke.

Eventually, the statins became the largest-selling class of pharmaceutical drugs. And of course, by then, they added it to the price index that they use for doing these calculations. So, when a statin went off patent and, therefore, its price fell, they said “Aha! There’s a real income increase, because the cost of buying that drug is now cheaper.”

But nothing at all for the lifesaving, nothing for the hospitalization cost reduction, nothing, nothing, nothing. So that’s true of all kinds of new products. They just miss it. They don’t try, even, to get the extra value that’s created in that way.

So I don’t know how big these two things are, but I think they are enormously important, and we’re missing them. So when we say per capita income up one and a half percent on average over the last 30 years, well, maybe it’s three and a half percent; maybe it’s five and a half percent.

KRISTOL: It could be that much off?

FELDSTEIN: It could easily be that because, think about it, there’s nothing for the actual quality improvement, and there’s nothing for the value of newly create products. So –

KRISTOL: So I mean, yeah, it just seems like, in a common sense way, you’re living in a bigger house, you have a car, you know, you have all this technology you didn’t have 30, 40 years ago.


KRISTOL: You have – for all the problems with the health care system – you have better medical care, in the sense that people are less likely to die from various things early and stuff. Yeah, but that’s not really captured.

FELDSTEIN: Not captured. Not captured.

KRISTOL: Yeah. And does that have much of an effect, do you think, on our actual policies or in politics? I guess it does.

FELDSTEIN: I think it does. I think it does, because I think people when – one of the interesting things, if you do surveys, you look at the surveys, people are asked, well, “How is your family doing relative to five years ago?” And the overwhelming answer is “Okay. We’re doing okay.” Of course, there are some who are saying “we’re struggling,” but the overwhelming majority – the Federal Reserve does this survey every few years – people are saying “we’re doing okay.”

Then you ask people in these surveys – Gallup does it and others – “How do you think the U.S. economy is doing?” “Oh, terribly. Terribly.” So of course, people know how their own household is doing; they don’t have a clue how the economy as a whole is doing. All they know about the economy as a whole is what they hear on television, or read in the newspapers, or hear from politicians.

So, I think it very much affects their view of how the economy is doing and how we’re doing as an economic system. Is capitalism working? Are we benefiting from it? And they know that, personally, they must be doing all right—but, of course, they’re nervous about their kids. You know, overwhelmingly, people say, “My children won’t be as well off as I am.” The chance of that being true is about zero.

KRISTOL: Is that right?


KRISTOL: Because that is a big deal, I think, people who study public opinion think. In the last few years, they say – for the first time, maybe – that, you know, that number really started to go up, the pessimism about the future.

FELDSTEIN: So if you look at people who came out of the Depression – as my parents did, your father did – then, of course, they had seen this overwhelming improvement. There was no doubt about it.


FELDSTEIN: But it slowed down, relative to coming out of the depression. But I think there’s no doubt – especially if you correct for all these things that we just talked about – there’s no doubt that we’re going to be seeing higher real incomes. And, of course, if you’re at the 50th percentile in the income distribution and your kids are in the 30th percentile, well, they won’t get the full benefit of whatever this increase is. But it would be very hard, cumulatively, over a matter of decades, for your kids not to be – I don’t mean your kids or my kids; kids in general – not to do as well as their parents.

KRISTOL: And this despite, presumably – or maybe you want to challenge, this isn’t quite right either – the greater advantages to education, and a greater income disparity and life chance disparity, even. And I mean, is some chunk of the country right to be sort of deeply pessimistic about their futures and their children’s futures, assuming their children, let’s say, are at the same sort of educational level?

FELDSTEIN: I haven’t really – I haven’t studied – well, at the same educational level –

KRISTOL: There’s more people.

FELDSTEIN: Then I would say – yeah, more people are having higher education.


FELDSTEIN: But I would say, unless we’re looking at, say, the bottom 10 percentile of where people are – [they] have a much higher probability of being unemployed; we’re seeing evidence of much more drug and alcohol abuse, and higher mortality rates, and so on. But that’s a pathological, small part. We should care about it as a nation, but it’s a small part of our overall system. It’s not the middle class.

KRISTOL: And more, it sounds like you’re saying, a cultural and social problem, perhaps, than a pure economic-opportunity problem.

FELDSTEIN: Yeah. I mean, why are people dropping out and not finishing high school?

KRISTOL: Yeah, that’s not right.

FELDSTEIN: Is it ability? Is it cultural?

KRISTOL: Yeah. That’s not in their interest, so it’s not an economic –


KRISTOL: Now I am struck by, in the public discourse today, the kind of nostalgia for a certain time. It’s not clear exactly when it was when there were all these wonderful, working-class jobs. Now you and I are old enough to remember that these working-class jobs weren’t thought to be so wonderful. At the time I went to college, I read all these books from the preceding 10 and 20 years, sociologists about the anomie, the alienation of, you know, assembly line life, which was not false, incidentally.


KRISTOL: It wasn’t the greatest thing in the world to, you know, move one part to another part for eight hours a day. It wasn’t good for you physically. It wasn’t satisfying.


KRISTOL: When Trump goes around talking about “I’m going to bring coal mining back,” it’s like, Do we want to bring coal mining back? I think you die at age 50 of black-lung disease. I mean, but I’m a little struck, aren’t you, that people are sort of responsive to that message?

FELDSTEIN: Well, it was a guaranteed life income. That’s what it really meant. You went to work for an individual company. The job may not have been fun, but you had friends on the line, and you sat with your lunch pail and you talked over lunch, and then you went back to work, and you knew the job would be there next week, next year.

And but, you know, it’s a tiny fraction now of the total workforce—something like eight percent. Eight percent of total employment are manufacturing-production workers. So that’s history. That’s not a question of coming back or preventing the loss of or stopping competition. It’s eight percent. So it’s nothing.

KRISTOL: So your message to a, I don’t know, working‑class American or, let’s say, a recent immigrant – just to take away all the history here – who comes and, presumably, let’s just say, has a working-class-type job, you know, driving a cab or something like that –driving an Uber, I guess – would be: “Yes, if your kid who stays through high school, gets a decent education, has good work habits and that kind of thing, doesn’t…”

FELDSTEIN: [You] stay out of poverty if you do three things, right? You finish high school; you get married before you have children; and you get a job before you get married. You do all of that, I think the evidence is – that doesn’t mean you’re going to be rich, but it does mean you will be out of, you’ll stay out of poverty.

KRISTOL: Are you worried about the apparent figures of a decline of social mobility or is that also a little overdone in your opinion?

FELDSTEIN: So, my student Raj Chetty, who is a brilliant guy and a creator of some of those statistics, found that, if I can remember correctly, found that absolute social mobility – the probability that if you were in the 30th percentile, your child would be below the 30th percentile – I think his findings were that that wasn’t happening.

KRISTOL: The lack of mobility wasn’t –

FELDSTEIN: The lack of mobility was not happening.

KRISTOL: That’s interesting.

FELDSTEIN: People were as mobile as they used to be. And that hardly got any press attention. So, he’s now been working on – I forget what he calls it – “dynamic mobility” or something like that. And that is whether, taking into account growth, your children will be better off than you were at the same stage in your life. And that depends critically on what the underlying growth rate is.

So if you take the official numbers – the growth rate is one and a half percent – then there’s a good chance that if your child falls from – if you’re in the 50th percentile and your child falls from the 50th percentile to the 30th percentile and there’s hardly any growth, they will be worse off. But that’s only because of this mismeasurement of the underlying trend. So if the trend is three or four percent higher, then it’s very unlikely that the next generation will be worse off.

KRISTOL: So basically, the sort of old cliché that a rising tide lifts, if not all boats, most boats.


KRISTOL: And the best thing you can probably do is provide the rising tide and not try to, you know, micromanage everyone’s boats – if I could torture this metaphor – you sort of think there’s a lot of truth to that?

FELDSTEIN: I think that’s right. Yeah.

KRISTOL: And it’s been too quickly – I’m struck how many people these days sort of just say, “Oh, well, we used to think a rising tide raises,” you know, “lifts all boats, but now we know so much better about the losers from globalization,” et cetera. You hear this so much in Washington, you know.

FELDSTEIN: Right. Right. Small numbers.

KRISTOL: You think small numbers. And so your advice to a policymaker – and leaving aside the politics for a minute – would still be get growth?

FELDSTEIN: Get the economy to grow.

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