Daily Digest - August 12: What Happens When the Workers Become the Owners?

Aug 12, 2014Rachel Goldfarb

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Is Worker Ownership a Way Forward for Market Basket? (Truthout)

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Is Worker Ownership a Way Forward for Market Basket? (Truthout)

Gar Alperovitz says the current protests at Market Basket are a sign of the desire for community and worker-friendly businesses, which he suggests are easier to achieve with employee ownership.

Surprise! North Carolina Cuts to Jobless Benefits Did Not Help Workers (TAP)

Valerie Wilson lays out the data, which shows that cutting the duration and amount of unemployment benefits did not magically improve the job market in North Carolina.

New York Prosecutors Charge Payday Lenders With Usury (NYT)

State prosecutors charged a group of lenders incorporated across the country with shared (and obscured) ownership of charging illegal interest rates to New Yorkers, reports Jessica Silver-Greenberg.

Give the President (and Yourself) a Break (U.S. News & World Report)

Instead of griping about the President's vacation, lawmakers should work to ensure that all Americans get paid vacation time and are able to use it, writes Pat Garofalo.

Unions Team Up With Fast-Food Owners (Bloomberg Businessweek)

Patrick Clark looks at the uneasy alliance between fast food franchisees and labor unions as they push for fairer franchising laws in California, which unions hope would translate into better working conditions.

It Matters How Rich the Rich Are (Policy Shop)

Matt Bruenig says that we must know how rich the rich are in order to fight poverty, since the distribution of wealth creates poverty. He also asks how we would know if policy is working without that data.

How Student Debt Crushes Your Chances of Buying a Home (WaPo)

Dina ElBoghdady looks at a new study that lays out the complex ways student debt interacts with homeownership, including a close look at total amount of debt and size of payments.

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Daily Digest - August 11: Big Business's Frenemy in the White House

Aug 11, 2014Rachel Goldfarb

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Your Call: The U.S.-Africa Summit and Corporate Taxes (KALW)

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Your Call: The U.S.-Africa Summit and Corporate Taxes (KALW)

Roosevelt Institute Fellow Mike Konczal discusses President Obama's interview with The Economist, and explains the administration's relationship with big business. His segment begins at 34:00.

Libertarian Fantasies (NYT)

Paul Krugman says that the libertarian vision of society bears little resemblance to reality, and references Mike Konczal's recent piece on libertarians and basic guaranteed income as an example.

Paul Ryan's Magical Poverty Tour (AJAM)

Susan Greenbaum points to an existing welfare block grant – the Temporary Assistance for Needy Families program – as proof that Ryan's plan would not serve enough of the eligible families.

Franchise Association Sues Over Seattle’s $15 Wage (MSNBC)

The law requires large businesses, including franchisees, to raise wages faster than smaller ones. Franchisees claims this discriminates against their business model, reports Ned Resnikoff.

Decline in 'Slack' Helps Fed Gauge Recovery (WSJ)

Pedro da Costa explains how the gap between economic resources we have and those that we use, particularly in the labor market, is influencing Federal Reserve decisions about interest rates.

Fed's Fischer Calls U.S. and Global Recoveries Disappointing (Reuters)

Howard Schneider reports on Federal Reserve Vice Chair Stanley Fischer's concerns regarding how central banks must respond to the possibility of permanently slowed growth post-recession.

‘Eat Your Vegetables’ Is Easier for Low-Income Mothers Who Get Help (Pacific Standard)

A new study shows financial incentives at farmers' markets do work to increase vegetable consumption, writes Avital Andrews, which makes a strong case for government nutrition incentives.

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The Score, a New Monthly Column, is Now Live!

Aug 9, 2014Mike Konczal

I'm excited to tell you about The Score, a new monthly economics column page in The Nation magazine, that I'll be writing with Bryce Covert. Each month will have a lead essay based on a chart, along with sidebars of information related to the economy as a whole. Check it out in print if you can, because the formatting of the page itself is very sharp.

It will also be online, and our first column on wealth inequality went up this week. Given so much interest in wealth inequality (it is the basis of the two best works from the left in 2014), what would a wealth equality agenda look like?

The Nation also recently launched The Curve, a great blog on the intersection of feminism and economics, spearheaded by Kathy Geier. It's great to see The Nation moving in this direction, and I hope you check it all out!

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I'm excited to tell you about The Score, a new monthly economics column page in The Nation magazine, that I'll be writing with Bryce Covert. Each month will have a lead essay based on a chart, along with sidebars of information related to the economy as a whole. Check it out in print if you can, because the formatting of the page itself is very sharp.

It will also be online, and our first column on wealth inequality went up this week. Given so much interest in wealth inequality (it is the basis of the two best works from the left in 2014), what would a wealth equality agenda look like?

The Nation also recently launched The Curve, a great blog on the intersection of feminism and economics, spearheaded by Kathy Geier. It's great to see The Nation moving in this direction, and I hope you check it all out!

Follow or contact the Rortybomb blog:
 
  

 

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Daily Digest - August 8: The Man with the Misguided Anti-Poverty Plan

Aug 8, 2014Rachel Goldfarb

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Paul Ryan’s Magical Thinking (The Baffler)

Paul Ryan's belief that poverty is rooted in personal failure isn't the only problem with his anti-poverty plan, writes Ned Resnikoff. It's also impractical to implement and too easily abused.

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Paul Ryan’s Magical Thinking (The Baffler)

Paul Ryan's belief that poverty is rooted in personal failure isn't the only problem with his anti-poverty plan, writes Ned Resnikoff. It's also impractical to implement and too easily abused.

An Interview With the President (The Economist)

While discussing corporate responsibility in this wide-ranging interview, President Obama points out that companies profess to care about social issues, but only lobby for their tax breaks.

Let's Do It! Let's Bring Back Earmarks! (HuffPo)

Ending earmarks has done nothing to reduce American cynicism about government's motives, and has contributed to congressional gridlock, writes Jason Linkins.

When U.S. Companies Skip the Country to Dodge Taxes, Their Shareholders Can Foot the Bill (Quartz)

Since shareholders are hit with a capital gains tax bill when companies use inversion (merging with a foreign company) to avoid taxes, Tim Fernholz says raising those rates could slow the problem.

These 7 Charts Show Why the Rent Is Too Damn High (MoJo)

Erika Eichelberger and AJ Vicens lay out the data explaining shifts in rental housing. They say that reducing government's role in housing finance could direct funds toward affordable rental housing.

New on Next New Deal

Without Public Investment, the U.S. Will Fall Into Chaos

In her video speculation for the Next American Economy project, Sarah Burd-Sharps, Co-Director of Measure for America, predicts that fiscal moderates will push public investment out of fear of a more costly future.

The Pragmatic Libertarian Case for a Basic Income Doesn't Add Up

Roosevelt Institute Fellow Mike Konczal says that Matt Zwolinski's case for a basic income guarantee makes faulty assumptions about what government is already providing through welfare.

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Sarah Burd-Sharps: Without Public Investment, the U.S. Will Fall Into Chaos

Aug 8, 2014

The Next American Economy project brought together 30 experts from various disciplines to envision tomorrow's economic and political challenges and develop today's solutions. Their assignment: be bold, and leave the conventional wisdom -- and their own opinions -- behind. In today's video, Measure of America's Sarah Burd-Sharps looks at the sweeping consequences of the government's failure to invest in the future.

The Next American Economy project brought together 30 experts from various disciplines to envision tomorrow's economic and political challenges and develop today's solutions. Their assignment: be bold, and leave the conventional wisdom -- and their own opinions -- behind. In today's video, Measure of America's Sarah Burd-Sharps looks at the sweeping consequences of the government's failure to invest in the future.

Sarah Burd-Sharps, Co-Director of Measure of America, speculates on the consequences of declining public investment in infrastructure, regulation, education, and more. With government abdicating its basic responsibilities, the U.S. will face increasing chaos -- collapsing bridges, food contamination outbreaks, falling elevators, and unemployed teenagers. Burd-Sharps imagines a moderate political wing moved to act by the rising economic costs of under-investment.

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The Pragmatic Libertarian Case for a Basic Income Doesn't Add Up

Aug 8, 2014Mike Konczal

Cato Unbound has a symposium on the “pragmatic libertarian case” for a Basic Income Guarantee (BIG), as argued by Matt Zwolinski. What makes it pragmatic? Because it would be a better alternative to the welfare state we now have. It would be a smaller, easier, cheaper (or at least no more expensive) version of what we already do, but have much better results.

Fair enough. But for the pragmatic case to work, it has to be founded on an accurate understanding of the current welfare state. And here I think Zwolinski is wrong in his description in three major ways.

He describes a welfare state where there are over a hundred programs, each with their own bureaucracy that overwhelms and suffocates the individual. This bureaucracy is so large and wasteful that simply removing it and replacing it with a basic income can save a ton of money. And we can get a BIG by simply shuffling around the already existing welfare state. Each of these assertions are misleading if not outright wrong.

Obviously, in an essay like this, it is normal to exaggerate various aspects of the reality in order to convince skeptics and make readers think in a new light. But these inaccuracies turn out to invalidate his argument. The case for a BIG will need to be built on a steadier footing.

Too Many Programs?

Zwolinski puts significant weight on the idea that there are, following a Cato report, 126 welfare programs spending nearly $660 billion dollars. That’s a lot of programs! Is that accurate?

Well, no. The programs Zwolinski describes can be broken down into three groups. First you have Medicaid, where the feds pay around $228 billion. Then you have the six big programs that act as “outdoor relief” welfare, providing cash, or cash-like compensation. These are the Earned Income Tax Credit, Temporary Assistance for Needy Families, Supplemental Security Income, Supplemental Nutrition Assistance Program (food stamps), housing vouchers and the Child Tax Credit. Ballpark figure, that’s around $212 billion dollars.

So only 7 programs are what we properly think of as welfare, or cash payments for the poor. Perhaps we should condense those programs, but there aren't as many as we originally thought. What about the remaining 119 programs?

These are largely small grants to local institutions of civil society to provide for the common good. Quick examples involve $2.5 billion to facilitate adoption assistance, $500 million to help with homeless shelters, $250 million to help provide food for food shelters (and whose recent cuts were felt by those trying to fight food insecurity), or $10 million for low income taxpayer clinics.

These grants go largely to nonprofits who carry out a public purpose. State funding and delegation of public purpose has always characterized this “third sector” of civil institutions in the United States. Our rich civil society has always been built alongside the state. Perhaps these are good programs or perhaps they are bad, but the sheer number of programs have nothing to do with the state degrading the individual through deadening bureaucracy. If you are just going after the number of programs, you are as likely to bulldoze our nonprofit infrastructure that undergirds civil society as you are some sort of imagined totalitarian bureaucracy.

Inefficient, out-of-control bureaucracy?

But even if there aren’t that many programs, certainly there are efficiencies to reducing the seven programs that do exist. Zwolinski writes that “[e]liminating a large chunk of the federal bureaucracy would obviously...reduce the size and scope of government” and that “the relatively low cost of a BIG comes from the reduction of bureaucracy.”

So are these programs characterized by out of control spending? No. Here they are calculated by Robert Greenstein and CBPP Staff.

The major programs have administrative costs ranging between 1 percent (EITC) and 8.7 percent (housing vouchers), each proportionate to how much observation of recipients there is. Weighted, the average administrative cost is about 5 percent. To put this in perspective, compare it with private charity. According to estimates by Givewell, their most favored charities spend 11 percent on administrative costs, significantly more than is spent on these programs.

More to the point, there isn’t a lot of fat here. If all the administrative costs were reduced to 1 percent, you’d save around $25 billion dollars. That’s not going to add enough cash to create a floor under poverty, much less a BIG, by any means.

Pays for Itself?

So there are relatively few programs and they are run at a decent administrative cost. In order to get a BIG, you’ll need some serious cash on the table. So how does Zwolinski argues that “a BIG could be considerably cheaper than the current welfare state, [or at least it] would not cost more than what we currently spend”?

Here we hit a wall with what we mean by the welfare state. Zwolinski quotes two example plans. The first is from Charles Murray. However, in addition to the seven welfare programs mentioned above, he also collapses Social Security, Medicare, unemployment insurance, and social insurance more broadly into his basic income. If I recall correctly, it actually does cost more to get to the basic income he wants when he wrote the book in 2006, but said that it was justified because Medicare spending was projected to skyrocket a decade out, much faster than the basic income.

His other example is a plan by Ed Dolan. Dolan doesn’t touch health care spending, and for our purposes doesn’t really touch Social Security. How does he get to his basic income? By wiping out tax expenditures without lowering tax rates. He zeros out tax expenditures like the mortgage interest deduction, charitable giving, and the personal exemption, and turns the increased revenue into a basic income.

We have three distinct things here. We have the seven programs above that are traditionally understood as welfare programs of outdoor relief, or cash assistance to the poor. We have social insurance, programs designed to combat the Four Horsemen of “accident, illness, old age, loss of a job” through society-wide insurance. And we have tax expenditures, the system that creates an individualized welfare state through the tax code.

Zwolinski is able to make it seem like we can get a BIG conflict-free by blurring each of these three things together. But social insurance isn’t outdoor relief. People getting Social Security don’t think that they are on welfare or a public form of charity. Voters definitely don’t like the idea of scratching Medicare and replacing it with (a lot less) cash, understanding them as two different things. And social insurance, like all insurance, is able to get a lot of bang for the buck by having everyone contribute but only take out when necessary, for example they are too old to work. Public social insurance, through its massive scale, has an efficiency that beats out private options. If Zwolinski wants to go this route, he needs to make the full case against the innovation of social insurance itself.

Removing tax expenditures, which tend to go to those at the top of the income distribution, certainly seems like a good way to fund a BIG. However we’ll be raising taxes if we go this route. Now, of course, the idea that there is no distribution of income independent of the state is common sense, so the word “redistribution” is just a question-begging exercise. However the top 20 percent of income earners will certainly believe their tax bill is going up and react accordingly.

So?

Zwolinski is trying to make it seem like we can largely accomplish a BIG by shuffling around the things that state does, because the state does them poorly. But the numbers simply won’t add up. Or his plan will hit a wall when social insurance is on the chopping block, or when the rich revolt when their taxes go up.

The case for the BIG needs to be made from firmer ground. Perhaps it is because the effects of poverty are like a poison. Or maybe it will provide real freedom for all by ensuring people can pursue their individual goals. Maybe it is because the economy won’t produce jobs in the capital-intensive robot age of the future, and a basic income will help ensure legitimacy for this creatively destructive economy. Heck, maybe it just compensates for the private appropriation of common, natural resources.

But what won’t make the case is the idea that the government already does this, just badly. When push comes to shove, the numbers won’t be there.

Follow or contact the Rortybomb blog:
 
  

 

Cato Unbound has a symposium on the “pragmatic libertarian case” for a Basic Income Guarantee (BIG), as argued by Matt Zwolinski. What makes it pragmatic? Because it would be a better alternative to the welfare state we now have. It would be a smaller, easier, cheaper (or at least no more expensive) version of what we already do, but have much better results.

Fair enough. But for the pragmatic case to work, it has to be founded on an accurate understanding of the current welfare state. And here I think Zwolinski is wrong in his description in three major ways.

He describes a welfare state where there are over a hundred programs, each with their own bureaucracy that overwhelms and suffocates the individual. This bureaucracy is so large and wasteful that simply removing it and replacing it with a basic income can save a ton of money. And we can get a BIG by simply shuffling around the already existing welfare state. Each of these assertions are misleading if not outright wrong.

Obviously, in an essay like this, it is normal to exaggerate various aspects of the reality in order to convince skeptics and make readers think in a new light. But these inaccuracies turn out to invalidate his argument. The case for a BIG will need to be built on a steadier footing.

Too Many Programs?

Zwolinski puts significant weight on the idea that there are, following a Cato report, 126 welfare programs spending nearly $660 billion dollars. That’s a lot of programs! Is that accurate?

Well, no. The programs Zwolinski describes can be broken down into three groups. First you have Medicaid, where the feds pay around $228 billion. Then you have the six big programs that act as “outdoor relief” welfare, providing cash, or cash-like compensation. These are the Earned Income Tax Credit, Temporary Assistance for Needy Families, Supplemental Security Income, Supplemental Nutrition Assistance Program (food stamps), housing vouchers and the Child Tax Credit. Ballpark figure, that’s around $212 billion dollars.

So only 7 programs are what we properly think of as welfare, or cash payments for the poor. Perhaps we should condense those programs, but there aren't as many as we originally thought. What about the remaining 119 programs?

These are largely small grants to local institutions of civil society to provide for the common good. Quick examples involve $2.5 billion to facilitate adoption assistance, $500 million to help with homeless shelters, $250 million to help provide food for food shelters (and whose recent cuts were felt by those trying to fight food insecurity), or $10 million for low income taxpayer clinics.

These grants go largely to nonprofits who carry out a public purpose. State funding and delegation of public purpose has always characterized this “third sector” of civil institutions in the United States. Our rich civil society has always been built alongside the state. Perhaps these are good programs or perhaps they are bad, but the sheer number of programs have nothing to do with the state degrading the individual through deadening bureaucracy. If you are just going after the number of programs, you are as likely to bulldoze our nonprofit infrastructure that undergirds civil society as you are some sort of imagined totalitarian bureaucracy.

Inefficient, out-of-control bureaucracy?

But even if there aren’t that many programs, certainly there are efficiencies to reducing the seven programs that do exist. Zwolinski writes that “[e]liminating a large chunk of the federal bureaucracy would obviously...reduce the size and scope of government” and that “the relatively low cost of a BIG comes from the reduction of bureaucracy.”

So are these programs characterized by out of control spending? No. Here they are calculated by Robert Greenstein and CBPP Staff.

The major programs have administrative costs ranging between 1 percent (EITC) and 8.7 percent (housing vouchers), each proportionate to how much observation of recipients there is. Weighted, the average administrative cost is about 5 percent. To put this in perspective, compare it with private charity. According to estimates by Givewell, their most favored charities spend 11 percent on administrative costs, significantly more than is spent on these programs.

More to the point, there isn’t a lot of fat here. If all the administrative costs were reduced to 1 percent, you’d save around $25 billion dollars. That’s not going to add enough cash to create a floor under poverty, much less a BIG, by any means.

Pays for Itself?

So there are relatively few programs and they are run at a decent administrative cost. In order to get a BIG, you’ll need some serious cash on the table. So how does Zwolinski argues that “a BIG could be considerably cheaper than the current welfare state, [or at least it] would not cost more than what we currently spend”?

Here we hit a wall with what we mean by the welfare state. Zwolinski quotes two example plans. The first is from Charles Murray. However, in addition to the seven welfare programs mentioned above, he also collapses Social Security, Medicare, unemployment insurance, and social insurance more broadly into his basic income. If I recall correctly, it actually does cost more to get to the basic income he wants when he wrote the book in 2006, but said that it was justified because Medicare spending was projected to skyrocket a decade out, much faster than the basic income.

His other example is a plan by Ed Dolan. Dolan doesn’t touch health care spending, and for our purposes doesn’t really touch Social Security. How does he get to his basic income? By wiping out tax expenditures without lowering tax rates. He zeros out tax expenditures like the mortgage interest deduction, charitable giving, and the personal exemption, and turns the increased revenue into a basic income.

We have three distinct things here. We have the seven programs above that are traditionally understood as welfare programs of outdoor relief, or cash assistance to the poor. We have social insurance, programs designed to combat the Four Horsemen of “accident, illness, old age, loss of a job” through society-wide insurance. And we have tax expenditures, the system that creates an individualized welfare state through the tax code.

Zwolinski is able to make it seem like we can get a BIG conflict-free by blurring each of these three things together. But social insurance isn’t outdoor relief. People getting Social Security don’t think that they are on welfare or a public form of charity. Voters definitely don’t like the idea of scratching Medicare and replacing it with (a lot less) cash, understanding them as two different things. And social insurance, like all insurance, is able to get a lot of bang for the buck by having everyone contribute but only take out when necessary, for example they are too old to work. Public social insurance, through its massive scale, has an efficiency that beats out private options. If Zwolinski wants to go this route, he needs to make the full case against the innovation of social insurance itself.

Removing tax expenditures, which tend to go to those at the top of the income distribution, certainly seems like a good way to fund a BIG. However we’ll be raising taxes if we go this route. Now, of course, the idea that there is no distribution of income independent of the state is common sense, so the word “redistribution” is just a question-begging exercise. However the top 20 percent of income earners will certainly believe their tax bill is going up and react accordingly.

So?

Zwolinski is trying to make it seem like we can largely accomplish a BIG by shuffling around the things that state does, because the state does them poorly. But the numbers simply won’t add up. Or his plan will hit a wall when social insurance is on the chopping block, or when the rich revolt when their taxes go up.

The case for the BIG needs to be made from firmer ground. Perhaps it is because the effects of poverty are like a poison. Or maybe it will provide real freedom for all by ensuring people can pursue their individual goals. Maybe it is because the economy won’t produce jobs in the capital-intensive robot age of the future, and a basic income will help ensure legitimacy for this creatively destructive economy. Heck, maybe it just compensates for the private appropriation of common, natural resources.

But what won’t make the case is the idea that the government already does this, just badly. When push comes to shove, the numbers won’t be there.

Follow or contact the Rortybomb blog:
 
  

 

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Daily Digest - August 7: What Piketty's 'Capital' Means for Marginalized Americans

Aug 7, 2014Rachel Goldfarb

Click here to subscribe to Roosevelt First, our weekday morning email featuring the Daily Digest.

How Gender Changes Piketty’s ‘Capital in the Twenty-First Century’ (The Nation)

Click here to subscribe to Roosevelt First, our weekday morning email featuring the Daily Digest.

How Gender Changes Piketty’s ‘Capital in the Twenty-First Century’ (The Nation)

Roosevelt Institute | Campus Network National Director Joelle Gamble joins The Nation's roundtable on feminism and the economy to discuss how Piketty's findings affect women and people of color.

New York: Young Ideas for Social Cohesion (UBM's Future Cities)

Jordan Fraade writes about the Roosevelt Institute Summer Academy's NYC Policy Expo as an example of young people not just moving to cities, but developing policy to improve them.

The 1% May Be Richer Than You Think, Research Shows (Bloomberg)

Jeanna Smialek reports on new research that shows the wealth of the 1 percent to be significantly undercounted. She speaks to Roosevelt Institute Chief Economist Joseph Stiglitz, who isn't surprised.

Bank of America Offers U.S. Biggest Settlement in History (NYT)

In reaction to another case that turned out badly, Bank of America has offered a $16 billion settlement for its sale of toxic mortgage securities, write Ben Protess and Michael Corkery.

Cold Porridge For Regular People: The Myth of the Goldilocks Economy (TAP)

Robert Kuttner says that only the wealthy could consider this economic climate not too hot or too cold – for everyone else, there aren't enough jobs and wages are staying flat.

The Market Basket Protests And The American Worker (On Point)

Tom Ashbrook takes a close look at the protests happening at Market Basket supermarkets, in which the managers are pushing to keep a CEO who they feel has workers' best interests at heart.

New on Next New Deal

Progress, Yet No Progress: The Two Lines of Defense Against Too-Big-To-Fail

The largest banks' "living wills," meant to facilitate an orderly bankruptcy process, aren't good enough, and Roosevelt Institute Fellow Mike Konczal says that shows that Too-Big-to-Fail isn't entirely solved.

As Tech Advances, Big Business Will Reap the Benefits

In his video speculation for the Next American Economy project, Robert Litan of the Brookings Institution says that existing businesses are capturing the benefits of new technology, to the detriment of new firms.

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Robert Litan: As Tech Advances, Big Business Will Reap the Benefits

Aug 7, 2014

The Next American Economy project brought together 30 experts from various disciplines to envision tomorrow's economic and political challenges and develop today's solutions. Their assignment: be bold, and leave the conventional wisdom -- and their own opinions -- behind. In today's video, Brookings' Robert Litan presents the evidence that incumbent firms will consume an increasingly large piece of the economic pie.

The Next American Economy project brought together 30 experts from various disciplines to envision tomorrow's economic and political challenges and develop today's solutions. Their assignment: be bold, and leave the conventional wisdom -- and their own opinions -- behind. In today's video, Brookings' Robert Litan presents the evidence that incumbent firms will consume an increasingly large piece of the economic pie.

Robert Litan, Senior Fellow at the Brookings Institution, speculates that the benefits from new technology could be captured by incumbent firms in the short term, to the detriment of business dynamism. Supporting that speculation, he observes two present-day business trends: first, a rising share of national income is going to big incumbent firms; second, firms older than 15 years (incumbents) comprise an increasingly large share of businesses overall. In short, evidence suggests older firms are increasingly dominant in the economy.  

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Progress, Yet No Progress: The Two Lines of Defense Against Too-Big-To-Fail

Aug 7, 2014Mike Konczal

It’s been a week of whiplash when it comes to the issue of Too Big To Fail (TBTF). First the GAO released a report saying that it is difficult to find any bailout subsidy for the largest banks, implying that there's been progress on ending TBTF. Then, late Tuesday, the FDIC and Federal Reserve released a small bombshell saying that the living wills submitted by the 11 largest banks “are not credible and do not facilitate an orderly resolution under the U.S. Bankruptcy Code.” These living wills were designed to make sure that banks could fail without causing chaos in the economy, and this report implies TBTF is still with us.

One of them has to be wrong, right? In order to understand this contradiction it's important to map out where the actual disagreement is. Doing so will also help explain how the battle over TBTF will play out in the near future.

So look - a large, systemically risky financial firm is collapsing! Oh noes! What has happened and will happen?

There are two levels of defense when it comes to ending this firm. The first is through a bankruptcy court, and the second is through the FDIC taking over the firm, much like what it does to a failing regular bank. The next several paragraphs give some technical details (skip ahead if your eyes are already glazing over).

<technical>

As you can see in the graphic above, before the failure, regulators will have failed to use “prompt corrective action” to guide the firm back to solvency. These are efforts regulators use to push a troubled firm to fix itself before a collapse. For example, if bank capital falls below a certain point, the bank can’t pay out bonuses or make capital purchases in order to attempt to make it more secure.

Once a failure happens, there are two lines of defense. The default course of action is putting the firm in bankruptcy, similar to what happened with Lehman Brothers. Why might this be a problem for a major financial firm? The Bankruptcy Code is slow and deliberate, when financial firms often need to be resolved fast. It isn't designed to preserve ongoing firm business, which is a problem when those businesses are essential to the economy as a whole. It can’t prevent runs by favoring short-term creditors. There is no guaranteed funding available to keep operations running and to help with the relaunch. And there are large problems handling the failure of a firm operating in many different countries.

With these concerns in mind, Dodd-Frank sets up a second line of defense. Regulators can direct the FDIC to take over the failed firm and do an emergency resolution (OLA), like they do with commercial banks. In order to active the OLA, there’s a comically complicated procedure in which the Treasury Secretary, the Federal Reserve Board, and the FDIC all have to turn their metaphoric keys.

OLA, particularly with its new "single point of entry" (SPOE) framework, solves many of the problems mentioned above. OLA comes with a line of emergency funding from Treasury to facilitate resolution if private capital isn’t available, as it likely won’t be in a crisis. OLA would also be able to prioritize speed, as well as protect derivatives and short-term credit, stopping potential runs. SPOE, by focusing its energy at the bank's holding company level, also helps to deal with coordinating the failure internationally. However, OLA would be executed by administrators instead of judges, and it could put taxpayer money at risk. (More on all of this here.)

</technical>

The Contradiction

So, what is the battle over? How are we making progress yet also making no progress?

All the innovation in the past 18 months in combating TBTF has taken place at the second line of defense. When Sheila Bair, for instance, says there’s been significant progress in ending taxpayer bailouts, or the Bipartisan Policy Institute releases a statement saying adopting an SPOE approach has the potential to eliminate TBTF, they are referencing the progress that is taking place at this second line of defense.

But there's no progress at the first line of defense. The living wills that regulators found insufficient are, by statute, part of the first line of defense. Dodd-Frank says that if the living will “would not facilitate an orderly resolution of the company under title 11, [Bankruptcy]” then the FDIC and the Fed “may jointly impose more stringent capital, leverage, or liquidity requirements, or restrictions on the growth, activities, or operations of the company.” They purposefully didn't drop the hammer in their announcement, instead telling the banks to go back to the drawing board rather than enforcing stricter requirements. But they can get as aggressive as they want here. 

So the FDIC and the Fed are drawing a line in the sand here - the first line of defense needs to work. The regulators call out the banks for their “failure to make, or even to identify, the kinds of changes in firm structure and practices that would be necessary to enhance the prospects for orderly resolution.” So making this line of defense work will not be a trivial endeavor.

If the first line of defense doesn’t work, why don’t we just rely on the second line? Thomas Hoenig, Vice Chairman of the FDIC and an aggressive opponent of TBTF, released a statement accompanying the regulators' release, specifically saying that they would not find this argument convincing. It’s worth noting how clear he is about this:

“Some parties nurture the view that bankruptcy for the largest firms is impractical because current bankruptcy laws won’t work given the issues just noted. This view contends that rather than require that these most complicated firms make themselves bankruptcy compliant, the government should rely on other means to resolve systemically important firms that fail. This view serves us poorly by delaying changes needed to assert market discipline and reduce systemic risk, and it undermines bankruptcy as a viable option for resolving these firms. These alternative approaches only perpetuate 'too big to fail.'”

That’s a strong statement that they are going to hold the first line.

Note here that the GAO results could still stand. The market's lack of a subsidy could reflect the second line of defense. Or it could reflect that even if they both fail, Congress, which is gridlocked, would not pass a bailout. It's not clear what would happen if a major bank failed, but the market is right not to assume the banks are permanently safe.

Politics

It will be interesting to see how this shakes out. Those who think reform didn’t go far enough like the idea of fighting on the first line, because there is significant leeway to push for more systemic changes to Wall Street. To get a sense of the stakes, Sheila Bair told Tom Braithwaite back in 2010 that she would break up an institution that couldn’t produce a credible living will.

This will also animate the Right, but in a different way. From the get-go, their preferred approach to TBTF was just to create a special new bankruptcy code Chapter, removing any type of independent regulatory administrative state like the FDIC from the issue. It’s not clear if they’ll support regulators pushing aggressively to restructure firms so they can go through the bankruptcy code as it is written right now.

The administration appears to be silent for now. It’s also not clear whether it will see this as a second bite to get higher capital requirements, or if they is happy enough with the second line of denfense as it is. If the second is true, that would be unfortunate. The banks remain undercapitalized and too complex for bankruptcy, and regulators have a responsiblity to make sure each line of defense is capable of stopping the panic of 2008.

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It’s been a week of whiplash when it comes to the issue of Too Big To Fail (TBTF). First the GAO released a report saying that it is difficult to find any bailout subsidy for the largest banks, implying that there's been progress on ending TBTF. Then, late Tuesday, the FDIC and Federal Reserve released a small bombshell saying that the living wills submitted by the 11 largest banks “are not credible and do not facilitate an orderly resolution under the U.S. Bankruptcy Code.” These living wills were designed to make sure that banks could fail without causing chaos in the economy, and this report implies TBTF is still with us.

One of them has to be wrong, right? In order to understand this contradiction it's important to map out where the actual disagreement is. Doing so will also help explain how the battle over TBTF will play out in the near future.

So look - a large, systemically risky financial firm is collapsing! Oh noes! What has happened and will happen?

There are two levels of defense when it comes to ending this firm. The first is through a bankruptcy court, and the second is through the FDIC taking over the firm, much like what it does to a failing regular bank. The next several paragraphs give some technical details (skip ahead if your eyes are already glazing over).

<technical>

As you can see in the graphic above, before the failure, regulators will have failed to use “prompt corrective action” to guide the firm back to solvency. These are efforts regulators use to push a troubled firm to fix itself before a collapse. For example, if bank capital falls below a certain point, the bank can’t pay out bonuses or make capital purchases in order to attempt to make it more secure.

Once a failure happens, there are two lines of defense. The default course of action is putting the firm in bankruptcy, similar to what happened with Lehman Brothers. Why might this be a problem for a major financial firm? The Bankruptcy Code is slow and deliberate, when financial firms often need to be resolved fast. It isn't designed to preserve ongoing firm business, which is a problem when those businesses are essential to the economy as a whole. It can’t prevent runs by favoring short-term creditors. There is no guaranteed funding available to keep operations running and to help with the relaunch. And there are large problems handling the failure of a firm operating in many different countries.

With these concerns in mind, Dodd-Frank sets up a second line of defense. Regulators can direct the FDIC to take over the failed firm and do an emergency resolution (OLA), like they do with commercial banks. In order to active the OLA, there’s a comically complicated procedure in which the Treasury Secretary, the Federal Reserve Board, and the FDIC all have to turn their metaphoric keys.

OLA, particularly with its new "single point of entry" (SPOE) framework, solves many of the problems mentioned above. OLA comes with a line of emergency funding from Treasury to facilitate resolution if private capital isn’t available, as it likely won’t be in a crisis. OLA would also be able to prioritize speed, as well as protect derivatives and short-term credit, stopping potential runs. SPOE, by focusing its energy at the bank's holding company level, also helps to deal with coordinating the failure internationally. However, OLA would be executed by administrators instead of judges, and it could put taxpayer money at risk. (More on all of this here.)

</technical>

The Contradiction

So, what is the battle over? How are we making progress yet also making no progress?

All the innovation in the past 18 months in combating TBTF has taken place at the second line of defense. When Sheila Bair, for instance, says there’s been significant progress in ending taxpayer bailouts, or the Bipartisan Policy Institute releases a statement saying adopting an SPOE approach has the potential to eliminate TBTF, they are referencing the progress that is taking place at this second line of defense.

But there's no progress at the first line of defense. The living wills that regulators found insufficient are, by statute, part of the first line of defense. Dodd-Frank says that if the living will “would not facilitate an orderly resolution of the company under title 11, [Bankruptcy]” then the FDIC and the Fed “may jointly impose more stringent capital, leverage, or liquidity requirements, or restrictions on the growth, activities, or operations of the company.” They purposefully didn't drop the hammer in their announcement, instead telling the banks to go back to the drawing board rather than enforcing stricter requirements. But they can get as aggressive as they want here. 

So the FDIC and the Fed are drawing a line in the sand here - the first line of defense needs to work. The regulators call out the banks for their “failure to make, or even to identify, the kinds of changes in firm structure and practices that would be necessary to enhance the prospects for orderly resolution.” So making this line of defense work will not be a trivial endeavor.

If the first line of defense doesn’t work, why don’t we just rely on the second line? Thomas Hoenig, Vice Chairman of the FDIC and an aggressive opponent of TBTF, released a statement accompanying the regulators' release, specifically saying that they would not find this argument convincing. It’s worth noting how clear he is about this:

“Some parties nurture the view that bankruptcy for the largest firms is impractical because current bankruptcy laws won’t work given the issues just noted. This view contends that rather than require that these most complicated firms make themselves bankruptcy compliant, the government should rely on other means to resolve systemically important firms that fail. This view serves us poorly by delaying changes needed to assert market discipline and reduce systemic risk, and it undermines bankruptcy as a viable option for resolving these firms. These alternative approaches only perpetuate 'too big to fail.'”

That’s a strong statement that they are going to hold the first line.

Note here that the GAO results could still stand. The market's lack of a subsidy could reflect the second line of defense. Or it could reflect that even if they both fail, Congress, which is gridlocked, would not pass a bailout. It's not clear what would happen if a major bank failed, but the market is right not to assume the banks are permanently safe.

Politics

It will be interesting to see how this shakes out. Those who think reform didn’t go far enough like the idea of fighting on the first line, because there is significant leeway to push for more systemic changes to Wall Street. To get a sense of the stakes, Sheila Bair told Tom Braithwaite back in 2010 that she would break up an institution that couldn’t produce a credible living will.

This will also animate the Right, but in a different way. From the get-go, their preferred approach to TBTF was just to create a special new bankruptcy code Chapter, removing any type of independent regulatory administrative state like the FDIC from the issue. It’s not clear if they’ll support regulators pushing aggressively to restructure firms so they can go through the bankruptcy code as it is written right now.

The administration appears to be silent for now. It’s also not clear whether it will see this as a second bite to get higher capital requirements, or if they is happy enough with the second line of denfense as it is. If the second is true, that would be unfortunate. The banks remain undercapitalized and too complex for bankruptcy, and regulators have a responsiblity to make sure each line of defense is capable of stopping the panic of 2008.

Follow or contact the Rortybomb blog:
 
  

 

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Daily Digest - August 6: S&P Provides the Right Diagnosis, But the Wrong Remedy

Aug 6, 2014Rachel Goldfarb

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Mind the Gap: S&P Offers Sharp Economic Warning, Dull Fix (AJAM)

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Mind the Gap: S&P Offers Sharp Economic Warning, Dull Fix (AJAM)

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Lydia DePillis shares Kathryn Slater-Carter's story of how the McDonald's corporate office controlled the operation of her franchise. Slater-Carter is supporting a bill to expand franchisee rights in California.

Yet Another Reason to Extend Unemployment Insurance: It Prevents Foreclosures (TNR)

A new study provides proof that unemployment insurance prevented about 1.4 million foreclosures, and Danny Vinik says this is just another reason Congress should renew extended benefits.

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Changing Demographics and New Funding Strategies Will Expand Entrepreneurship

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Sexual Assault Policies on Campus Need Student Input

Summer Academy Fellow Hayley Brundige examines how campuses are changing their approaches to sexual assault, and finds that activists agree on the importance of centering student voices.

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