Subscribe to Dollars & Sense magazine. Recent articles related to the financial crisis. Kwak on Mankiw on the DeficitFrom Baseline Scenario; hat-tip to LF. James Kwak and Simon Johnson have a new book, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, which will be available on March 30th.Greg Mankiw on the Deficit By James Kwak Broken record alert: Another post on the deficit ahead. Wouldn't you rather look at funny pictures of cats? Why do I keep writing these? (Hint: The other side keeps writing them.) You have been warned. Greg Mankiw, noted economics textbook author and former chair of Bush 43's Council of Economic Advisers, has an op-ed on the deficit that is relatively sensible by the standards of recent debate. He points out that modest deficits can be sustainable, that taxes will probably need to go up, and that a value-added tax is a plausible option. He also points out that Obama's projections are based on optimistic economic forecasts that very plausibly may not pan out, and that Obama's main deficit-reduction strategy is to kick the problem over to a deficit-reduction commission, which are valid criticisms. Unfortunately, his bottom line seems to be throwing more rocks at President Obama, under the general Republican principle that since he's the president, everything is his fault: "But unless the president revises his spending plans substantially, he will have no choice but to find some major source of government revenue. Ms. Pelosi's suggestion of a VAT may be the best of a bunch of bad alternatives. Unfortunately, in this new era of responsibility, the president is not ready to face up to the long-term fiscal challenge." Mankiw, not I, brings up the comparison between Bush 43 and Obama: "From 2005 to 2007, before the recession and financial crisis, the federal government ran budget deficits, but they averaged less than 2 percent of gross domestic product. Because this borrowing was moderate in magnitude and the economy was growing at about its normal rate, the federal debt held by the public fell from 36.8 percent of gross domestic product at the end of the 2004 fiscal year to 36.2 percent three years later. . . . What's missing from this comparison? First, the economic growth of 2005-2007 was at best a mixed blessing, as we now know, driven by an unsustainable and ultimately catastrophic credit bubble. Second, and more importantly, the comparison leaves out the long-term trend . . . wait for it . . . Medicare. Here's my favorite chart again, from the 2008 CBO Budget and Economic Outlook. In 2007, Medicare, Social Security, and Medicaid cost 8.9 percent of GDP (see Table 3-1). By 2018, they were already projected to grow to 10.8 percent of GDP; extrapolating forward at constant growth rates, by 2020 they would grow to about 11.3 percent—an increase of 2.4 percentage points over 2007. That, in one number, is the difference between Bush 43 and Obama. (Ongoing patches to the AMT—something that Obama includes in his projections that Bush did not—also grow to $150 billion by 2018, or another 0.7 percent of GDP.) Did Bush 43 do anything about this looming problem? No, because one conservative aspiration since Ronald Reagan has been to crimp government by crippling its finances ("starving the beast"). If Bush had actually reduced the size of government to match his tax cuts, in true conservative fashion, we would face less of a long-term deficit problem now.* But whether by accident or design, it turned out to be politically advantageous to kick the problem down the road and therefore make it harder for his successor to govern. Now, this doesn't change the fact that it's Obama's problem now, and it's his responsibility to do something about it. But Obama realized that the long-term deficit is a health care problem, while Mankiw doesn't even use the word "health" in his op-ed on the deficit. If we don't slow the growth of health care costs, there is no real solution to the deficit problem; the only way out from the budget perspective will be slashing Medicare, but that doesn't solve the problem—it just shifts it onto individuals. And Obama spent much of the last year pushing for health care reform with major cost-cutting components,** attracting support from some Republican health experts (though not from any Republican Congressmen). Now, it would be meaningful to criticize Obama for having the wrong ideas about how to control health care spending, as a few Republicans have done. But to say he's not up to the challenge without mentioning health care misses the real point. Still, it's true that Obama could put forward a more aggressive deficit reduction plan. If I were king, my plan would include modest increases in the Medicare eligibility age, a whole bevy of health care cost reduction initiatives, modest tax increases (pushed out into the future and made contingent on economic recovery) such as eliminating the cap on the Social Security tax and reinstating the estate tax, and bigger tax increases that would kick in if health care cost savings failed to materialize. But in our current political climate, that would be political suicide for any president and would have zero chance of passage. I'm skeptical about the deficit commission, too, but we have collectively backed ourselves into a position where neither party can afford to even propose the necessary steps on its own. The political problem is that there's no politically palatable way to solve the long-term deficit problem. The Republican strategy, after (almost) killing health care reform, is to attack Obama for not having a long-term solution, daring him to propose one so they can then attack him for raising taxes. Yes, that's the way the game is played. That doesn't change the fact that it's a game. * Bush did make an attempt to reform Social Security. But even if we assume he had managed to stop the growth of Social Security completely, the growth in Medicare, Medicaid, and the AMT fix would by themselves account for the difference between the 2005-2007 deficits and the projected 2020 deficit. ** The Senate health care bill only reduces the deficit by a little by year ten, because the CBO gives it very little credit for its cost-cutting measures, particularly the delivery system reforms. It is fair for the CBO to give those reforms little credit, since they are unproven. But it is also important to remember that there is no proven way to reduce health care costs (Paul Ryan's plan reduces government expenditures reliably, but it is no more proven to reduce actual health care costs), so the only way to have any chance to reduce health care costs is to undertake the kind of experimentation proposed by the Senate bill. Read the original post. Labels: deficit, deficit hawks, Greg Mankiw, James Kwak, recession, Simon Johnson, value added tax Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). Root Canals, Rhetoric, or Real Reform?This is from Bankster; hat-tip to comrade Steve S. of United for a Fair Economy. We are glad someone else noticed BHO's root-canal metaphor; it reminded us of the guiding metaphor Arthur MacEwan used in this Ask Dr. Dollar column from our Nov/Dec 2008 issue. Steve pointed us to Simon Johnson's metaphor of Bernanke as an airline pilot who pulls off a miraculous landing, but didn't (and won't) do his safety checks. Perfect.This Week in Banking: Root Canals, Rhetoric or Real Reform? Submitted by Mary Bottari on January 29, 2010 - 08:54 The debate over banks and banking came front and center this week. In his toughest language yet, President Barack Obama vowed to veto financial reform legislation that is not tough enough on Wall Street. "The lobbyists are already trying to kill it," Obama told Congress in his State of the Union address. "Well, we cannot let them win this fight. And if the bill that ends up on my desk does not meet the test of real reform, I will send it back." The President's rhetoric offers an important measure of progress. Now we can be assured that the political elite are paying attention to the poll numbers showing an unprecedented anger at the big banks and the Wall Street bailouts. Democrats are starting to figure out if they don't take up this populist message and run with it in November, the Republicans will. But the rest of the President's speech and the other dramatic developments in the banking world this week indicate that Democratic actions are falling far short of their rhetoric, a pattern that voters are sure to notice. First, the speech. Many had anticipated a big announcement on jobs. With jobless rates in the double digits and a projected 5-10 year haul to get employment back to normal levels, workers were hoping for something big and bold. Instead, Obama proposed $30 billion in TARP funds to get credit flowing to small businesses. $30 billion to put 16 million Americans back to work? $30 billion when the Wall Street bonus pool for a few thousand bankers was $140 billion this month? Democrats will live to regret this missed opportunity. Also on Wednesday, U.S. Treasury Secretary Tim Geithner was called on the carpet once again by irate members of the House for his mishandling of the AIG bailout. To their credit, several Democrats asked the toughest questions. But Geithner bobbed and weaved and no knock-out punches were landed. This is a problem for the Democrats. The whole incident paints an ugly picture of the federal response to the financial meltdown, best described by Representative Edolphus Towns (D-NY): "The taxpayers were propping up the hollow shell of AIG by stuffing it with money and the rest of Wall Street came by and looted the corpse." On Thursday, Federal Reserve Chairman Ben Bernanke was reconfirmed by the Senate for another four year term. His nomination had been in trouble and a record number of senators voted no, but Obama stood by his man and pushed him through. The problem with Bernanke is best summarized by economist Simon Johnson: "Bernanke is an airline pilot who pulled off a miraculous landing, but didn't do his preflight checks and doesn't show any sign of being more careful in the future – thank him if you want, but why would you fly with him again (or the airline that keeps him on)?" While Bernanke may have saved Wall Street, he has shown little interest in using his power as Fed Chairman to aggressively aid Main Street. He is not the man for the job in these tough economic times and that will soon be apparent to the detriment of the Democrats who secured his confirmation. Ultimately, however, the most important developments of the week were played out behind closed doors in the Senate. Senate Banking Chairman, Chris Dodd, made the decision some time ago to try to devise a bipartisan financial reform package. His package of reforms was then handed over to four bipartisan working groups. With thousands of bank lobbyists swarming the hill, it is no surprise that these groups are busily making the Dodd bill worse. The derivatives language is being weakened and bankruptcy is emerging as the preferred method of unwinding financial institutions, which could leave taxpayers to foot the bill for this expensive procedure. To truly end the "too big to fail" problem and crack down on the reckless behavior of the biggest banks, we need strong, specific preventative measures such as leverage limits, capital and margin requirements, limits on counterparty exposures, a ban on proprietary trading and limits on bank size through a low cap on total liabilities. Even Obama's signature reform, an independent consumer agency is in danger of being whittled down to a corner desk in a failed federal agency. The President understands that the Wall Street bailout was "about as popular as a root canal." But if Democrats continue to peddle this type of rhetoric while neglecting meaningful reform as they have done this week, the Republicans will run away with the anti-bailout message and with the election in November. Labels: Bankster, Barack Obama, Ben Bernanke, root canal, Simon Johnson, Steve Schnapp Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). Questions for Bernanke (Simon Johnson)There is somewhat suddenly some opposition to Ben Bernanke's reconfirmation as Fed chair, as reported at the New York Times, Roll Call, and elsewhere, with Barbara Boxer, Russ Feingold, and Bernie Sanders coming out against reconfirmation. On the economics blogs there's some turmoil regarding Bernanke, too, with Calculated Risk saying "we can do better," Brad DeLong saying "Don't Block Ben!" and Paul Krugman saying he's torn.One comment I liked was from Yves Smith at Naked Capitalism, who took issue with the Times article's references to "populist anger" (Krugman, in his blog, also connected Bernanke's changing fortunes with the Mass. special election): The real issue is that the Fed did a horrid job in the run-up to the crisis (although not Chairman at the time, Fed records show that Bernanke was a major architect of the super-low interest rates earlier in this decade that super-charged the credit bubbles, and has long been manifestly uninterested in regulation). So the issue is competence. The public's anger is warranted, and reflects lack of sufficient action on real, festering problems. Here's an interesting piece by Simon Johnson at HuffPo: Ben Bernanke's reconfirmation as chair of the Federal Reserve is in disarray. With President Obama having launched, on Thursday morning, a major new initiative to rein in the power of—and danger posed by—our leading banks, key Senators rightly begin to wonder: Where does Ben Bernanke stand on the central issue of the day? I can't remember whether I posted this piece by David Leonhardt from earlier this month, which counts against Ben, as does the article we ran back in July by Jerry Friedman, Bernanke's Bad Teachers. It will be interesting to see what happens. Labels: Ben Bernanke, Brad DeLong, Christopher Dodd, Paul Krugman, Simon Johnson, The Fed, Yves Smith Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). Financial Crisis Inquiry Commission HearingsThe hearings for the Financial Crisis Inquiry Commission are going on right now. Zachery Kouwe of the New York Times' blog Dealbook is "live-blogging" the hearing right now (how's that for an example of compound-transitive-verbing?!).Meanwhile, today's NYT op-ed section has a nice survey of questions some experts would like to ask the bankers in the hearings. My favorites are from Simon Johnson of MIT and Yves Smith of Naked Capitalism: 1. Describe in detail the three worst investments your bank made in 2007 and 2008—that is, those transactions on which you lost the most money. How much did the bank lose in each case?Read the full list of questions. Speaking of Yves Smith, she had some interesting things to say today about something that is looming behind today's hearings: the Obama administration's recent talk of levying some kind of tax/fine on the big banks--separate from the tax on transactions that many have been calling for, and from the idea of a special tax on bankers' bonuses. (A NYT editorial today (? or yesterday--I can't tell) came out in favor of the new tax/fine, but called for a tax on bonuses on top of that.) But according to Yves, the O. admin. will come out with a more concrete proposal today: Obama to Announce $120 Billion TARP Fee Read the rest of the post. We will be on the lookout for the best analyses of and commentaries on the testimony in today's hearings. If you find something particularly cogent, let us know. Labels: Financial Crisis Inquiry Commission, investment banks, Obama administration, Simon Johnson, TARP program, Yves Smith Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). The Preliminary G20 Financial Reform MeetingYves Smith cautions us to view the communique with caution. She also says this on the quibble on the Basel II (which were wholly ineffective in the run-up to the crisis, and indeed contributed mightily to it) capital adequacy standards between the US and France.Simon Johnson says that assumption that we need modern (characteristic of the last 30 years) finance for economic growth, which all the G20ers seems to assume as gospel, is misconceived. He also says that modern finance has provided, more than anything else, a means for the wealthy to capture state power. The former point cannot be made emphatically enough after the bogus recapitalization of the banks. Finally, perhaps to illustrate the latter point in a particularly enraging way, here's what some of the creative minds in finance have been up to lately. Labels: bailout, banking regulation, Baseline Scenario, financial crisis, G20 summit, insurance industry, international finance, Naked Capitalism, securitization, shadow banking system, Simon Johnson Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). Finance Gone Wild (Simon Johnson)Posted this morning to the NYT Economix blog:Finance Gone Wild By Simon Johnson | September 3, 2009, 7:24 am Simon Johnson, a professor of entrepreneurship at M.I.T.'s Sloan School of Management, is the former chief economist at the International Monetary Fund. What is finance? At one level and in most economics textbooks, this is an easy question with a rather encouraging answer. The financial sector connects savers and borrowers—providing "intermediation services." You want to save for retirement and would obviously like your savings to earn a respectable rate of return. I have a business idea but not enough money to make it happen by myself. So you put your money in the bank and the bank makes me a loan. Or I issue securities—stocks and bonds—that you or your pension fund can buy. In this view, finance is win-win for everyone involved. And financial flows of some kind are essential to any modern economy—at least since 1800, finance has played an important role in America's economic development. Unfortunately, 200 years of experience with real-world finance reveal that it also has at least three serious pathologies—features that can go seriously wrong and derail an economy. First, the financial sector often acquires or aspires to political power. The fact that banks have a great deal of cash on hand always makes it easy or tempting to buy some political favors, and to obtain privilege and power for big financial enterprises. President Andrew Jackson had exactly this struggle with the Second Bank of the United States in the 1830s. Second, the financial sector can obtain disproportionate power over industry. The "money trust" idea of the early 20th century may have been somewhat exaggerated—money cannot be corralled as effectively by private players as can, say, copper or steel—but there is no doubt that 100 years ago, Wall Street banks dominated the process of consolidating railroads and of creating pernicious industrial trusts. Trust-busting required taking on the country's most powerful financiers. Third, finance can also go crazy, running up speculative frenzies. This is what happened the 1920s, leading to the Great Crash of 1929 and the struggle to effectively constrain finance during and after the long, depressed 1930s. Which kind of financial sector pathologies do we face today? Unfortunately: all of the above. And, not just in nature but also in size, we face a financial sector much more potentially debilitating than anything stared down by Jackson, Teddy Roosevelt or Franklin Roosevelt. In our previous showdowns with finance, the sector was small. During the 19th century, the value of financial intermediation services was no more than 1 or 2 percent of gross domestic product, and in the early 20th century, the extent to which real resources—including talented people—were drawn into this sector remained very limited. J.P. Morgan, in his heyday, had great economic and political power, but he never employed more than 100 people. With the growth of a much bigger and more diversified economy after World War II, there was some increase in financial activity as a share of G.D.P., but the really big jump came after the deregulation of the 1980s. Just a few years ago, finance accounted for an astonishing—and unprecedented for the United States—40 percent of all corporate profits, and even today the sector generates around 7 percent of what we measure as G.D.P. Even ardent defenders of finance now concede that the sector may or even should end up significantly smaller as a share of the economy. But at current scale, the financial sector has great ability, through political donations and other means, to maintain its lightly regulated environment. Note that there is nothing (other than the proposed consumer protection agency for financial products) to which the industry has ever objected in the administration's financial reform proposals. And yet the amount of risk-taking that this sector can pursue remains mind-boggling, and its ability to "put" the cost of big failed bets onto the government is undiminished. Financial "innovation" remains mad and bad, and when it all goes wrong—you know who gets the bill. The implications for your future taxes and job security are not good. We need finance, but finance as it currently operates in the United States has become a problem. Yet, with the headline numbers for the economy beginning to improve, the impetus for any real reform of this sector—within the United States or internationally—starts to fade. The likely future is: more of the same, at least until we find a Jackson or a Roosevelt. Read the original post (which includes several hyperlinks). Labels: finance sector, Simon Johnson Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). This Is What We Get for All the Bailout MoneyTwo related posts here: Simon Johnson of Baseline Scenario looks at the shakeout in the banking system that he says is leading to the creation of a two-tier economy that benefits connected-insiders of virtually Naomi Klein proportions (that's him, not me). And here's also a FT piece from early July that goes into the matter in more detail.And Yves Smith discusses one way in which this is being done, via the use of forms of leverage that contributed to the blowup last year. Seems like we really saved the banking system only to increase the likelihood that we'll be hit by it again. I hope, if that happens, we don't repeat this mistake again next time. Labels: bailout, Baseline Scenario, financial crisis, Naked Capitalism, Naomi Klein, Simon Johnson, Yves Smith Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). The Quiet Coup (Simon Johnson)This article, which hypothesizes that an "American financial oligarchy" has (re)emerged and is turning the United States into a Banana Republic, is getting a lot of attention. (See our Jan/Feb 2009 cover story for a related argument, though the meat of this one is the financial elite part.) Krugman mentioned it in his March 29th column. And Brad DeLong has a post about it on his blog, with many comments, some of them interesting. The excerpt I'm giving below is not from the beginning of the article, fyi.The Quiet Coup By Simon Johnson | The Atlantic | May 2009 ... Becoming a Banana Republic In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn't be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn't roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people. But there's a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them. Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a "buck stops somewhere else" sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for "safety and soundness" were fast asleep at the wheel. But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector's profits—such as Brooksley Born's now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside. The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry's ascent. Paul Volcker's monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative. The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services. Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007. The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man). In that period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers: no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression; the reemergence of an American financial oligarchy is quite recent. Read the full article. Labels: Brad DeLong, financial crisis, oligopoly, Paul Krugman, recession, Simon Johnson Please consider donating to Dollars & Sense and/or subscribing to the magazine (both print and e-subscriptions now available!). |
