Mike Konczal

Roosevelt Institute Fellow

Recent Posts by Mike Konczal

  • The Rules are What Matter for Inequality: Our New Report

    May 12, 2015Mike Konczal

    I’m very excited to announce the release of “Rewriting the Rules of the American Economy” (pdf report), Roosevelt Institute’s new inequality agenda report by Joe Stiglitz. I’m thrilled to be one of the co-authors, as I think this report really tells a compelling story about inequality and the challenges the economy faces.

    Recently there’s been a lot of discussion about a “new” conventional wisdom (“a force to be reckoned with” according to one observer), one in which choices about the rules of the economy are a major driver of the outcomes we see. This is in contrast to the normal narrative about inequality we hear, one in which globalization, technology, or individual choices are the only important parts. I like to think this report is a major advancement in this discussion, bringing together the best recent research on this topic.

    As we argue, inequality is not inevitable: it is a choice that we’ve made with the rules that structure our economy. Over the past 35 years, the rules, or the regulatory, legal and institutional frameworks, that make up the economy and condition the market have changed. These rules are a major driver of the income distribution we see, including runaway top incomes and weak or precarious income growth for most others. Crucially, however, these changes in the rules have not made our economy better off than we would be otherwise; in many cases we are weaker for these changes. We also now know that “deregulation” is, in fact, “reregulation”—that is, a new set of rules for governing the economy that favor a specific set of actors, and that there's no way out of these difficult choices. But what were these changes?

    Financial deregulation exploded both the size of finance and its incomes, roughly doubling the share of finance in the top 1 percent. However, finance grew as a result of intermediating credit in a “shadow banking” sector, which led to disastrous results. It also grew from asset management, a field in which pay is often determined by luck and by fees driven by the increasing prevalence of opaque alternative investment vehicles like hedge funds. For all the resources it uses, finance is no more efficient than it was a century ago.

    Corporate governance also radically changed during this period, led by public policy decisions. CEO pay fundamentally shifted toward a high pay model in the 1980s. The shareholder revolution also changed the nature of investment. We now see finance acting as a mechanism for getting money out of firms rather than into them; similarly, private firms are investing more than public firms. CEOs regularly use buybacks to hit earnings targets and say they’d rather hit accounting goals than invest long-term, indicating that short-termism is now a serious problem for investment and its positive spillovers.

    High marginal tax rates were cut, but there’s no evidence that the high-end marginal tax rate has any effect on growth; cutting it does, however, raise the share of income the top 1 percent takes home. Low taxes don’t just make the equalizing effects of taxes weaker; they also mean that CEOs and other executives in the top 1 percent have more of an incentive to bargain aggressively with boards or seek opportunities for extracting rents, all zero-sum games for the economy. Lowering capital taxes showed no impact on higher investment, but a positive effect on increased capital payouts; capital income growth is one of the main drivers of inequality during this time period.

    During this time, the Federal Reserve’s focus moved toward low and stable inflation at the cost of higher unemployment. Unemployment from weak Federal Reserve action rises the most for low-skilled and minority workers. Inequality generally doesn’t come down unless unemployment is below 6 percent, and this has become less of a priority.

    The rules changed, or were not updated, for the labor market as well. Decreasing unionization has taken a toll on workers’ wages. Men’s inequality, in particular, has risen due to collapsing unionization rates. Women’s inequality has suffered due to a falling minimum wage, which went from 54 percent of the average hourly wage in the late 1960s to just 35 percent now. Labor market protections and institutions that give workers voice and power, in general, have not been updated for a new world of service and care work.

    Though not an effective driver of lower crime rates, a dramatic turn toward mass and punitive incarceration has reduced the employment prospects for millions of Americans, especially people of color. In particular, there’s a dense web of discriminatory codes for those with a record, which pushes them toward second-class citizenship. One estimate finds 38,000 such punitive statutes, with most of them related to employment and having no end date.

    Our institutions and rules haven’t been updated to fully facilitate women’s ability to participate in the labor force. As a result of gender discrimination in the workplace, lack of paid sick and family leave, and the unavailability of affordable child care, women’s participation in the U.S. labor force has declined over the past 15 years, while it increased in most other OECD countries.

    Many people agree inequality is a challenge, but would say that this is all driven by technology and globalization. We discuss this at length in the report, but we don’t find these traditional stories either convincing, in the case of technology, or sufficient, in the case of globalization. Both of these forces are playing out, in quite similar ways, in other advanced countries, whose growth of inequality nowhere mirrors our own. Technology and globalization don’t fall from the sky, but instead are determined in important ways by rules and institutions. This is especially important in the era of free trade agreements, which are really managed trade agreements. These agreements are less about trade and more about the regulatory environment corporations face.

    But rules matter even in these straightforward stories about supply and demand for labor. Advancements in search theory tell us that supply and demand, rather than strictly determining wages, instead place boundaries or endzones on where wages can go. What determines where wages fall within those boundaries is a whole host of economic rules, including bargaining power, institutions, and social conventions. Even in the strong version of these arguments, the rules matter.

    This report describes what has happened, going far deeper than this summary here. It also has a policy agenda focused on both taming the top and growing the rest of the economy. Some may emphasize some pieces more than others; but no matter what this argument about the rules is what is missing in the current debates over the economy. I hope you get a chance to check out the report!

    Follow or contact the Rortybomb blog:
     
      

     

    I’m very excited to announce the release of “Rewriting the Rules of the American Economy” (pdf report), Roosevelt Institute’s new inequality agenda report by Joe Stiglitz. I’m thrilled to be one of the co-authors, as I think this report really tells a compelling story about inequality and the challenges the economy faces.

    Recently there’s been a lot of discussion about a “new” conventional wisdom (“a force to be reckoned with” according to one observer), one in which choices about the rules of the economy are a major driver of the outcomes we see. This is in contrast to the normal narrative about inequality we hear, one in which globalization, technology, or individual choices are the only important parts. I like to think this report is a major advancement in this discussion, bringing together the best recent research on this topic.

    As we argue, inequality is not inevitable: it is a choice that we’ve made with the rules that structure our economy. Over the past 35 years, the rules, or the regulatory, legal and institutional frameworks, that make up the economy and condition the market have changed. These rules are a major driver of the income distribution we see, including runaway top incomes and weak or precarious income growth for most others. Crucially, however, these changes in the rules have not made our economy better off than we would be otherwise; in many cases we are weaker for these changes. We also now know that “deregulation” is, in fact, “reregulation”—that is, a new set of rules for governing the economy that favor a specific set of actors, and that there's no way out of these difficult choices. But what were these changes?

    Financial deregulation exploded both the size of finance and its incomes, roughly doubling the share of finance in the top 1 percent. However, finance grew as a result of intermediating credit in a “shadow banking” sector, which led to disastrous results. It also grew from asset management, a field in which pay is often determined by luck and by fees driven by the increasing prevalence of opaque alternative investment vehicles like hedge funds. For all the resources it uses, finance is no more efficient than it was a century ago.

    Corporate governance also radically changed during this period, led by public policy decisions. CEO pay fundamentally shifted toward a high pay model in the 1980s. The shareholder revolution also changed the nature of investment. We now see finance acting as a mechanism for getting money out of firms rather than into them; similarly, private firms are investing more than public firms. CEOs regularly use buybacks to hit earnings targets and say they’d rather hit accounting goals than invest long-term, indicating that short-termism is now a serious problem for investment and its positive spillovers.

    High marginal tax rates were cut, but there’s no evidence that the high-end marginal tax rate has any effect on growth; cutting it does, however, raise the share of income the top 1 percent takes home. Low taxes don’t just make the equalizing effects of taxes weaker; they also mean that CEOs and other executives in the top 1 percent have more of an incentive to bargain aggressively with boards or seek opportunities for extracting rents, all zero-sum games for the economy. Lowering capital taxes showed no impact on higher investment, but a positive effect on increased capital payouts; capital income growth is one of the main drivers of inequality during this time period.

    During this time, the Federal Reserve’s focus moved toward low and stable inflation at the cost of higher unemployment. Unemployment from weak Federal Reserve action rises the most for low-skilled and minority workers. Inequality generally doesn’t come down unless unemployment is below 6 percent, and this has become less of a priority.

    The rules changed, or were not updated, for the labor market as well. Decreasing unionization has taken a toll on workers’ wages. Men’s inequality, in particular, has risen due to collapsing unionization rates. Women’s inequality has suffered due to a falling minimum wage, which went from 54 percent of the average hourly wage in the late 1960s to just 35 percent now. Labor market protections and institutions that give workers voice and power, in general, have not been updated for a new world of service and care work.

    Though not an effective driver of lower crime rates, a dramatic turn toward mass and punitive incarceration has reduced the employment prospects for millions of Americans, especially people of color. In particular, there’s a dense web of discriminatory codes for those with a record, which pushes them toward second-class citizenship. One estimate finds 38,000 such punitive statutes, with most of them related to employment and having no end date.

    Our institutions and rules haven’t been updated to fully facilitate women’s ability to participate in the labor force. As a result of gender discrimination in the workplace, lack of paid sick and family leave, and the unavailability of affordable child care, women’s participation in the U.S. labor force has declined over the past 15 years, while it increased in most other OECD countries.

    Many people agree inequality is a challenge, but would say that this is all driven by technology and globalization. We discuss this at length in the report, but we don’t find these traditional stories either convincing, in the case of technology, or sufficient, in the case of globalization. Both of these forces are playing out, in quite similar ways, in other advanced countries, whose growth of inequality nowhere mirrors our own. Technology and globalization don’t fall from the sky, but instead are determined in important ways by rules and institutions. This is especially important in the era of free trade agreements, which are really managed trade agreements. These agreements are less about trade and more about the regulatory environment corporations face.

    But rules matter even in these straightforward stories about supply and demand for labor. Advancements in search theory tell us that supply and demand, rather than strictly determining wages, instead place boundaries or endzones on where wages can go. What determines where wages fall within those boundaries is a whole host of economic rules, including bargaining power, institutions, and social conventions. Even in the strong version of these arguments, the rules matter.

    This report describes what has happened, going far deeper than this summary here. It also has a policy agenda focused on both taming the top and growing the rest of the economy. Some may emphasize some pieces more than others; but no matter what this argument about the rules is what is missing in the current debates over the economy. I hope you get a chance to check out the report!

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  • Besides Failing Corporate Finance 101, Holtz-Eakin's Attack on Dodd-Frank Sets a Terrible Priority

    May 8, 2015Mike Konczal

    The American Action Forum jumps into the financial reform debate with a letter on the growth consequences of Dodd-Frank penned by its president, Douglas Holtz-Eakin. This letter is a bad analysis, immediately violating the first thing you learn in corporate finance: capital structure doesn’t dictate funding costs. But there’s a deeper context that makes this letter reckless and a bad development, and I hope they are willing to walk back part of it.

    Why reckless? It’s important to understand the role people like Holtz-Eakin play in the conservative movement. It is less about providing analysis (which is good, because this is a bad analysis), and more about signaling priorities. What should be done about Dodd-Frank if the Republicans win in 2016? This letter signals a new front I haven’t seen before on the right: one focused on going after higher capital requirements. Worse, going after them as if they were, using that conservative trigger word, a “tax.” I think that is a terrible move with serious consequences, and if they are going to do it, they need to do better than this.

    A Bad Analysis

    Americans for Financial Reform and David Dayen give us a solid overview of what is lacking in this analysis. It contains no benefits, confuses one-time and ongoing costs, assumes all costs derive from the cost of capital rather than profits, and so on. I’m also pretty sure there’s an error in the calculations, which would reduce the estimate by a third; I’m waiting for a response from them on that [1].

    But I want to focus on capital requirements. Holtz-Eakin argues that the Solow growth model “can be used to transform the roughly 2 percentage point rise in the leverage ratio of the banking sector” into “a rise in the effective tax rate.” Wait, the tax rate? “The banking sector responded to Dodd-Frank by holding more equity capital,” writes Holtz-Eakin, “thus require it to have greater earnings to meet the market rate of return – the same impact as raising taxes.” Higher capital requirements, in this argument, function just like a tax.

    He concludes that a 2 percentage point rise in capital requirements, much like what we just had, increases the cost of capital somewhere between 2 and 2.5 percent. (I believe I understand that to be the argument, though the paper itself is quick and not cited to any body of research.)

    This is wrong, full stop. The Holtz-Eakin argument is predicated on the idea that capital structure directly affects funding costs. But our baseline assumption should be that there is virtually no impact of capital requirements on cost of capital. Economics long ago debunked the notion that changes in aggregate funding mixes can have an effect on the value of a business itself, much less a widespread, durable, macroeconomic effect. This is a theorem they teach you in Corporate Finance 101: the Modigliani–Miller theorem. And this has been one of the most important arguments in financial reform, with Anat Admati being a particularly influential advocate of pointing this out.

    Just step back and think about what Holtz-Eakin’s model means. If Congress passed a law requiring companies to fund themselves with half as much equity as they did before, would the economy experience a giant growth spurt from changing the aggregate funding mix? No, of course not. The price of capital would simply adjust with this new balance; funding with more equity means funding with less debt, though the business is still the same. Investors are not stupid; they respond to a changing funding mix by simply changing the prices accordingly. This is how markets are supposed to work.

    Of course, the real world doesn’t work exactly like these abstract economic models. If there’s a hierarchy of financing options, which seems reasonable, then moving up or down that ladder can impose some costs. Doug Elliott from Brookings, for instance, writes quite a bit arguing that the idea that equity and higher capital requirement is costless is a dangerous “myth” of financial reform. (Here is Admati responding.)

    So Elliott’s not on the costless side, but does he agree with Holtz-Eakin’s numbers? Not even remotely. According to Elliott’s estimate, the cost of the entirety of Dodd-Frank increases the cost of capital 0.28 percent, and the “low levels of economic costs found here strongly suggest that the benefits in terms of less frequent and less costly financial crisis would indeed outweigh the costs.”

    As shown in the graphic above, a model of higher capital requirements by Kashyap, Stein, and Hanson put the estimate of a 2 percent capital increase at between 0.05 percent (driven by the tax effects) and 0.09 percent (driven by a large slippage of Modigliani-Miller they assume to get a high-end estimate). These are broadly in line with other estimates throughout the past several years. Even the most industry-driven estimates designed to weaken capital requirements don't remotely approach this 2.00+ percent increase.

    (As a coincidence, Elliott did estimate what it would take to make the cost of capital rise Holtz-Eakin’s estimated 2 percent. In his view, it would be capital requirements on the order of 30 percent, which is the reach goal for some. But when you analyze Dodd-Frank and get numbers consistent with 30 percent capital ratios, you are probably doing it wrong.)

    A Worse Priority

    So the estimate is wrong in a fundamental way; but this is less about a specific analysis than it is about setting priorities for the conservative movement when it comes to Dodd-Frank. And if attacking capital requirements becomes a major priority for conservatives, that’s a worrying sign. When conservatives start calling things “taxes,” institutional forces go into play beyond the control of any specific person, and that’s dangerous for a successful reform with lots of support that is important for a better financial system.

    A broad group of people has come together to argue for capital requirements. This includes important commentators across the spectrum, from Simon Johnson to John Cochrane to many others. And there’s good reason for this. The current capital requirement regime hits six birds with one stone: helping with solvency, balancing risk management, making resolution and the ending of Too Big to Fail more credible, preventing liquidity crises in shadow banking, right-sizing the scale and scope of the largest financial institutions, and macroeconomic prudential policy.

    There are disagreements about specifics of what is the best way to do higher capital requirements—quite intense ones, actually. But there’s a broad consensus in favor of them. Having watched this from the beginning, this broad coalition is one of the most promising developments I’ve seen.

    I’m excited to see the right go after Dodd-Frank. Is the argument that there’s too much accountability for consumers now, and we need to gut those regulators at the CFPB? Is it that derivatives regulations are too extensive, and we should build our future prosperity by letting a thousand AIGs bloom? Is it that there should be few, if any, consequences for firms that break the law or commit fraud? (As someone who is worried about over-policing, this is one area where I believe we are criminally under-policed.) Please, by all means, make these arguments.

    But taking on capital requirements with this weak argument is a bad development. The financial market is not understudied, and though nobody has ever found anything like these results, and though it's clear Holtz-Eakin’s analysis doesn’t even engage with this other research, those who think the cost of capital requirements are low could be wrong. But to prove that, we’ll need an analysis far better than the one provided here. And until one has that, the responsible thing is to not unleash the conservative movement against reform that is doing good work and that should be advanced rather than dismantled.

     

    [1] I’m pretty sure for “rL-C” in equation 11 he uses net income ($151.2bn) rather than EBIT ($218.7bn), though, from equation 9, “rL-C” should be pre-tax. However using the wrong number is the only way I can replicate the estimate he has. I’ll update this either way if they respond.

    If I’m right this decreases Holtz-Eakins’ growth costs of regulations by about 30%, meaning that the economy will probably be skyrocketing any second now.

    Follow or contact the Rortybomb blog:
     
      

     

    The American Action Forum jumps into the financial reform debate with a letter on the growth consequences of Dodd-Frank penned by its president, Douglas Holtz-Eakin. This letter is a bad analysis, immediately violating the first thing you learn in corporate finance: capital structure doesn’t dictate funding costs. But there’s a deeper context that makes this letter reckless and a bad development, and I hope they are willing to walk back part of it.

    Why reckless? It’s important to understand the role people like Holtz-Eakin play in the conservative movement. It is less about providing analysis (which is good, because this is a bad analysis), and more about signaling priorities. What should be done about Dodd-Frank if the Republicans win in 2016? This letter signals a new front I haven’t seen before on the right: one focused on going after higher capital requirements. Worse, going after them as if they were, using that conservative trigger word, a “tax.” I think that is a terrible move with serious consequences, and if they are going to do it, they need to do better than this.

    A Bad Analysis

    Americans for Financial Reform and David Dayen give us a solid overview of what is lacking in this analysis. It contains no benefits, confuses one-time and ongoing costs, assumes all costs derive from the cost of capital rather than profits, and so on. I’m also pretty sure there’s an error in the calculations, which would reduce the estimate by a third; I’m waiting for a response from them on that [1].

    But I want to focus on capital requirements. Holtz-Eakin argues that the Solow growth model “can be used to transform the roughly 2 percentage point rise in the leverage ratio of the banking sector” into “a rise in the effective tax rate.” Wait, the tax rate? “The banking sector responded to Dodd-Frank by holding more equity capital,” writes Holtz-Eakin, “thus require it to have greater earnings to meet the market rate of return – the same impact as raising taxes.” Higher capital requirements, in this argument, function just like a tax.

    He concludes that a 2 percentage point rise in capital requirements, much like what we just had, increases the cost of capital somewhere between 2 and 2.5 percent. (I believe I understand that to be the argument, though the paper itself is quick and not cited to any body of research.)

    This is wrong, full stop. The Holtz-Eakin argument is predicated on the idea that capital structure directly affects funding costs. But our baseline assumption should be that there is virtually no impact of capital requirements on cost of capital. Economics long ago debunked the notion that changes in aggregate funding mixes can have an effect on the value of a business itself, much less a widespread, durable, macroeconomic effect. This is a theorem they teach you in Corporate Finance 101: the Modigliani–Miller theorem. And this has been one of the most important arguments in financial reform, with Anat Admati being a particularly influential advocate of pointing this out.

    Just step back and think about what Holtz-Eakin’s model means. If Congress passed a law requiring companies to fund themselves with half as much equity as they did before, would the economy experience a giant growth spurt from changing the aggregate funding mix? No, of course not. The price of capital would simply adjust with this new balance; funding with more equity means funding with less debt, though the business is still the same. Investors are not stupid; they respond to a changing funding mix by simply changing the prices accordingly. This is how markets are supposed to work.

    Of course, the real world doesn’t work exactly like these abstract economic models. If there’s a hierarchy of financing options, which seems reasonable, then moving up or down that ladder can impose some costs. Doug Elliott from Brookings, for instance, writes quite a bit arguing that the idea that equity and higher capital requirement is costless is a dangerous “myth” of financial reform. (Here is Admati responding.)

    So Elliott’s not on the costless side, but does he agree with Holtz-Eakin’s numbers? Not even remotely. According to Elliott’s estimate, the cost of the entirety of Dodd-Frank increases the cost of capital 0.28 percent, and the “low levels of economic costs found here strongly suggest that the benefits in terms of less frequent and less costly financial crisis would indeed outweigh the costs.”

    As shown in the graphic above, a model of higher capital requirements by Kashyap, Stein, and Hanson put the estimate of a 2 percent capital increase at between 0.05 percent (driven by the tax effects) and 0.09 percent (driven by a large slippage of Modigliani-Miller they assume to get a high-end estimate). These are broadly in line with other estimates throughout the past several years. Even the most industry-driven estimates designed to weaken capital requirements don't remotely approach this 2.00+ percent increase.

    (As a coincidence, Elliott did estimate what it would take to make the cost of capital rise Holtz-Eakin’s estimated 2 percent. In his view, it would be capital requirements on the order of 30 percent, which is the reach goal for some. But when you analyze Dodd-Frank and get numbers consistent with 30 percent capital ratios, you are probably doing it wrong.)

    A Worse Priority

    So the estimate is wrong in a fundamental way; but this is less about a specific analysis than it is about setting priorities for the conservative movement when it comes to Dodd-Frank. And if attacking capital requirements becomes a major priority for conservatives, that’s a worrying sign. When conservatives start calling things “taxes,” institutional forces go into play beyond the control of any specific person, and that’s dangerous for a successful reform with lots of support that is important for a better financial system.

    A broad group of people has come together to argue for capital requirements. This includes important commentators across the spectrum, from Simon Johnson to John Cochrane to many others. And there’s good reason for this. The current capital requirement regime hits six birds with one stone: helping with solvency, balancing risk management, making resolution and the ending of Too Big to Fail more credible, preventing liquidity crises in shadow banking, right-sizing the scale and scope of the largest financial institutions, and macroeconomic prudential policy.

    There are disagreements about specifics of what is the best way to do higher capital requirements—quite intense ones, actually. But there’s a broad consensus in favor of them. Having watched this from the beginning, this broad coalition is one of the most promising developments I’ve seen.

    I’m excited to see the right go after Dodd-Frank. Is the argument that there’s too much accountability for consumers now, and we need to gut those regulators at the CFPB? Is it that derivatives regulations are too extensive, and we should build our future prosperity by letting a thousand AIGs bloom? Is it that there should be few, if any, consequences for firms that break the law or commit fraud? (As someone who is worried about over-policing, this is one area where I believe we are criminally under-policed.) Please, by all means, make these arguments.

    But taking on capital requirements with this weak argument is a bad development. The financial market is not understudied, and though nobody has ever found anything like these results, and though it's clear Holtz-Eakin’s analysis doesn’t even engage with this other research, those who think the cost of capital requirements are low could be wrong. But to prove that, we’ll need an analysis far better than the one provided here. And until one has that, the responsible thing is to not unleash the conservative movement against reform that is doing good work and that should be advanced rather than dismantled.

     

    [1] I’m pretty sure for “rL-C” in equation 11 he uses net income ($151.2bn) rather than EBIT ($218.7bn), though, from equation 9, “rL-C” should be pre-tax. However using the wrong number is the only way I can replicate the estimate he has. I’ll update this either way if they respond.

    If I’m right this decreases Holtz-Eakins’ growth costs of regulations by about 30%, meaning that the economy will probably be skyrocketing any second now.

    Follow or contact the Rortybomb blog:
     
      

     

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  • Senator Baldwin is Asking the SEC Questions About "Disgorge the Cash"

    Apr 23, 2015Mike Konczal

    A lot of people were surprised last month when the investment giant BlackRock flagged the rise in stock buybacks and dividend payments as a major economic concern. Its CEO argued that the “effects of the short-termist phenomenon are troubling both to those seeking to save for long-term goals such as retirement and for our broader economy,” and that this was being done at the expense of “innovation, skilled work forces or essential capital expenditures necessary to sustain long-term growth.”

    They are right to be concerned. The cash handed back to shareholders in the form of buybacks and dividends was 95 percent of corporate profits in 2014, climbing from 88 percent the year before and 72 percent in 2010 and expected to go even higher in the future. These numbers are far above historical norms, but they are the culmination of a long process starting in the 1980s. Private investment remains a weak part of the recovery, and it is necessary to investigate the connection between corporate governance and those decisions.

    With that in mind, Senator Tammy Baldwin (D-WI) has sent a letter to the SEC looking for answers on these issues. In particular, she flags whether the SEC’s mission to “foster capital formation and prevent fraud" is jeopardized by short-termism in the market. It will be good to see how the SEC responds, and which other senators and organizations join in with their concerns.

    Personally, I’m happy that it quotes J.W. Mason’s work on profits and borrowing shifting from investment in a previous era to cash leaving the firm now. This issue is a major piece of our Financialization Project here at Roosevelt, and we will continue to develop it in the future.

    I think there are two additional things of interest. One is that this relationship is becoming more of an interest for academic and popular scrutiny. Recent, high-level research is showing that as a result of short-termist pressures, “public firms invest substantially less and are less responsive to changes in investment opportunities, especially in industries in which stock prices are most sensitive to earnings news” compared to private firms before the Great Recession.

    Second, this looks like a centerpiece agenda item for liberals going into 2016. Larry Summers’s Inclusive Prosperity report for the Center for American Progress discusses concerns over short-termism, noting, “it is essential that markets work in the public interest and for the long term rather than focusing only on short-term returns. Corporate governance issues, therefore, remain critical.”

    The problem of short-termism was also in Senator Elizabeth Warren’s big speech on the future of the financial reform agenda, in which she noted we need to change the rules of the economy because we “too often reward short-term risk-taking instead of sustained, long-term growth” and allow CEOs to “manipulate prices in the short-term, rather than investing in the long-term health of their companies.”

    And it will be central to work from the Roosevelt Institute about inequality coming next month. (Get excited!)

    I’m not sure if the right has a response to this issue. One of their core policy goals, removing all taxes on capital, will certainly make the situation worse, as the Bush dividend tax cuts increased dividends payouts without encouraging any real investment or wage growth. If the Republicans want to have real answers about inequality and stagnation, it’s important that they tackle real questions. And short-termism is one of those essential questions.

    Follow or contact the Rortybomb blog:
     
      

     

    A lot of people were surprised last month when the investment giant BlackRock flagged the rise in stock buybacks and dividend payments as a major economic concern. Its CEO argued that the “effects of the short-termist phenomenon are troubling both to those seeking to save for long-term goals such as retirement and for our broader economy,” and that this was being done at the expense of “innovation, skilled work forces or essential capital expenditures necessary to sustain long-term growth.”

    They are right to be concerned. The cash handed back to shareholders in the form of buybacks and dividends was 95 percent of corporate profits in 2014, climbing from 88 percent the year before and 72 percent in 2010 and expected to go even higher in the future. These numbers are far above historical norms, but they are the culmination of a long process starting in the 1980s. Private investment remains a weak part of the recovery, and it is necessary to investigate the connection between corporate governance and those decisions.

    With that in mind, Senator Tammy Baldwin (D-WI) has sent a letter to the SEC looking for answers on these issues. In particular, she flags whether the SEC’s mission to “foster capital formation and prevent fraud" is jeopardized by short-termism in the market. It will be good to see how the SEC responds, and which other senators and organizations join in with their concerns.

    Personally, I’m happy that it quotes J.W. Mason’s work on profits and borrowing shifting from investment in a previous era to cash leaving the firm now. This issue is a major piece of our Financialization Project here at Roosevelt, and we will continue to develop it in the future.

    I think there are two additional things of interest. One is that this relationship is becoming more of an interest for academic and popular scrutiny. Recent, high-level research is showing that as a result of short-termist pressures, “public firms invest substantially less and are less responsive to changes in investment opportunities, especially in industries in which stock prices are most sensitive to earnings news” compared to private firms before the Great Recession.

    Second, this looks like a centerpiece agenda item for liberals going into 2016. Larry Summers’s Inclusive Prosperity report for the Center for American Progress discusses concerns over short-termism, noting, “it is essential that markets work in the public interest and for the long term rather than focusing only on short-term returns. Corporate governance issues, therefore, remain critical.”

    The problem of short-termism was also in Senator Elizabeth Warren’s big speech on the future of the financial reform agenda, in which she noted we need to change the rules of the economy because we “too often reward short-term risk-taking instead of sustained, long-term growth” and allow CEOs to “manipulate prices in the short-term, rather than investing in the long-term health of their companies.”

    And it will be central to work from the Roosevelt Institute about inequality coming next month. (Get excited!)

    I’m not sure if the right has a response to this issue. One of their core policy goals, removing all taxes on capital, will certainly make the situation worse, as the Bush dividend tax cuts increased dividends payouts without encouraging any real investment or wage growth. If the Republicans want to have real answers about inequality and stagnation, it’s important that they tackle real questions. And short-termism is one of those essential questions.

    Follow or contact the Rortybomb blog:
     
      

     

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  • Dissent Masthead and Also Sign Up For My New Newsletter!

    Apr 10, 2015Mike Konczal

    Two bits of exciting news this week.

    First, I'm starting a biweekly newsletter. It'll have what I'm up to, including all the things I've been writing, collected into one place. It'll also have my favorite stuff I've read, random personal stories, and more. (Blame Google Reader for this I suppose.) Oh, and pictures of my dog too. Given the rate at which I'm writing it's probably more of an every other week update; we'll see how it goes. But for now, sign up!

    Second, I'm joining the masthead at Dissent as a contributing editor. Here is the annoucement; I was happy to join even before I knew the excellent people they were bringing on board. Nothing much changes for me, I just get to formalize my relationship with the brilliant team they've built over there and help make it a standard for left thought going forward.

    I also have a review of Naomi Murakawa's new book on liberal punishment in the latest issue. This newest issue is excellent, but the piece on the assistant economy by Francesca Mari is one of the most bizarre and enlightening business pieces I've read recently. Also check out Sarah Jaffe on punk rock feminism and the left once it's out from the paywall (or better, subscribe!).

    Follow or contact the Rortybomb blog:
     
      

     

    Two bits of exciting news this week.

    First, I'm starting a biweekly newsletter. It'll have what I'm up to, including all the things I've been writing, collected into one place. It'll also have my favorite stuff I've read, random personal stories, and more. (Blame Google Reader for this I suppose.) Oh, and pictures of my dog too. Given the rate at which I'm writing it's probably more of an every other week update; we'll see how it goes. But for now, sign up!

    Second, I'm joining the masthead at Dissent as a contributing editor. Here is the annoucement; I was happy to join even before I knew the excellent people they were bringing on board. Nothing much changes for me, I just get to formalize my relationship with the brilliant team they've built over there and help make it a standard for left thought going forward.

    I also have a review of Naomi Murakawa's new book on liberal punishment in the latest issue. This newest issue is excellent, but the piece on the assistant economy by Francesca Mari is one of the most bizarre and enlightening business pieces I've read recently. Also check out Sarah Jaffe on punk rock feminism and the left once it's out from the paywall (or better, subscribe!).

    Follow or contact the Rortybomb blog:
     
      

     

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  • How the End of GE Capital Also Kills the Core Conservative Talking Point About Dodd-Frank

    Apr 10, 2015Mike Konczal

    News is breaking that GE Capital will be spinning off most of its financing arm, GE Capital, over the next two years. Details are still unfolding, but, according to the initial coverage, “GE expects that by 2018 more than 90 percent of its earnings will be generated by its high-return industrial businesses, up from 58% in 2014.”

    It’s good that our industrial businesses will be focusing more on innovating and services rather than financial shenanigans, but this also tells us two important things about Dodd-Frank: it confirms one of the stories about the Act and disproves the core conservative talking point about what the Act does.

    Regulatory Arbitrage

    A very influential theory of the financial crisis is that there were financial firms acting just like banks but without the normal safeguards that traditionally went with banks. There was no public source of liquidity or backstops through the FDIC or the Federal Reserve, a public good capable of ending self-fulfilling panics. There was no mechanism to wind down the firms and impose losses outside of the bankruptcy code. There weren’t the normal capital requirements or consumer protections that went with the traditional commercial banking sector.

    Though we now call this regulatory arbitrage, at the time it was seen as innovation. GE Capital was explicitly brought up as a poster child for deregulation. You can see it in Bob Litan  and Jonathan Rauch’s 1998 American Finance for the 21st Century, which lamented the “twentieth-century model of financial policy” that, using transportation as an analogy, “set a slow speed limit, specified a few basic models for cars, separated different kinds of cars into different lanes, and demanded that no one leave home without a full tank of gas and a tune-up.” GE Capital was explicitly an example of a firm that could thrive with a regulatory regime that “focuses less on preventing mishaps and more on ensuring that an accident at any one intersection will not paralyze traffic everywhere else.”

    This was very apparent in the regulatory space. The fact that GE owned a Utah savings and loan allowed it to be regulated under the leniency of the Office of Thrift Supervision (OTS), so it was able to work in the banking space without the normal rules in place. It was also able to use its high-level industrial credit rating to gamble weaker positions in the financial markets, arbitraging the private-sector regulation of the credit ratings agencies in the process.

    How did that work out? First off, there was massive fraud. As Michael Hudson found in a blockbuster report, one executive declared that “fraud pays” and that “it didn’t make sense to slow the gush of loans going through the company’s pipeline, because losses due to fraud were small compared to the money the lender was making from selling huge volumes of loans.” Then there were the bailouts. The government backstopped $139 billion worth of GE Capital’s debts as it was collapsing and essentially had to manipulate the regulatory space to allow it to qualify for traditional banking protections. So much for not paralyzing traffic, and so much for the old rules not being important.

    Dodd-Frank looked to normalize these regulations across both the shadow and regular banking sectors. It eliminated the OTS and declared GE Capital a systemically risky firm that has to follow higher capital requirements and prepare for bankruptcy with living wills just like we expect a bank to do, regardless of what kind of legal hijinks it is using to call itself something else. And GE Capital, faced with the prospect of having to play in the same field as everyone else, decided it should go back to trying to bring better things to life rather than making financial weapons of mass destruction. That’s pretty good news, and a process that should be encouraged and continued.

    The Collapse of the Conservative Argument

    But there’s one ask GE has as it spins off GE Capital, one that actually disproves the core conservative argument on Dodd-Frank. In the coverage, GE Chairman and CEO Jeff Immelt states directly, “GE will work closely with [the regulators at the Financial Stability Oversight Council] to take the actions necessary to de-designate GE Capital as a Systemically Important Financial Institution (SIFI).”

    Dodd-Frank designates certain financial institutions, mostly over $50 billion in size, as systemically important. Or as the lingo goes, they get designated SIFI status. Those firms have stronger capital requirements and stronger requirements to be able to declare themselves ready for bankruptcy or FDIC resolution if they fail.

    Conservatives, from the beginning, have made this the centerpiece of their story about Dodd-Frank. They argue that SIFI status is a de facto permanent bailout and claim that firms will demand to be designated as SIFIs because it means they will have a favored status. This status gives them easy crony relationships with regulators and allow them to borrow cheaply in the credit markets.

    This has become doctrine on the right; I can’t think of a single movement conservative who has said the opposite. Examples of the mantra range from Peter Wallison of AEI writing “[t]he designation of SIFIs is a statement by the government that the designated firms are too big to fail” to Reason’s Nick Gillespie repeating that “everyone agrees [Dodd-Frank] has simply reinscribed too big to fail as explicit law.” (I love an “everyone agrees” without any sourcing.)

    It’s also the basis of proposed policy. The Ryan budget cancels out the FDIC’s ability to regulate SIFIs, stating that Dodd-Frank “actually intensifies the problem of too-big-to-fail by giving large, interconnected financial institutions advantages that small firms will not enjoy.”

    If that’s the case, GE should be desperate to maintain its SIFI status even though it is spinning off its GE Capital line. After all, being a SIFI means it gets all kinds of favored protections, access, and credit relative to other firms.

    But, instead GE is desperate to lose it. This is genuine; ask any financial press reporter or analyst, and they’ll tell you that GE is very sincere when it says it doesn’t want to be designated as risky anymore, and is willing to take appropriate measures to remove the designation.

    If that’s the case, what’s left of the GOP argument?

    Follow or contact the Rortybomb blog:
     
      

     

    News is breaking that GE Capital will be spinning off most of its financing arm, GE Capital, over the next two years. Details are still unfolding, but, according to the initial coverage, “GE expects that by 2018 more than 90 percent of its earnings will be generated by its high-return industrial businesses, up from 58% in 2014.”

    It’s good that our industrial businesses will be focusing more on innovating and services rather than financial shenanigans, but this also tells us two important things about Dodd-Frank: it confirms one of the stories about the Act and disproves the core conservative talking point about what the Act does.

    Regulatory Arbitrage

    A very influential theory of the financial crisis is that there were financial firms acting just like banks but without the normal safeguards that traditionally went with banks. There was no public source of liquidity or backstops through the FDIC or the Federal Reserve, a public good capable of ending self-fulfilling panics. There was no mechanism to wind down the firms and impose losses outside of the bankruptcy code. There weren’t the normal capital requirements or consumer protections that went with the traditional commercial banking sector.

    Though we now call this regulatory arbitrage, at the time it was seen as innovation. GE Capital was explicitly brought up as a poster child for deregulation. You can see it in Bob Litan  and Jonathan Rauch’s 1998 American Finance for the 21st Century, which lamented the “twentieth-century model of financial policy” that, using transportation as an analogy, “set a slow speed limit, specified a few basic models for cars, separated different kinds of cars into different lanes, and demanded that no one leave home without a full tank of gas and a tune-up.” GE Capital was explicitly an example of a firm that could thrive with a regulatory regime that “focuses less on preventing mishaps and more on ensuring that an accident at any one intersection will not paralyze traffic everywhere else.”

    This was very apparent in the regulatory space. The fact that GE owned a Utah savings and loan allowed it to be regulated under the leniency of the Office of Thrift Supervision (OTS), so it was able to work in the banking space without the normal rules in place. It was also able to use its high-level industrial credit rating to gamble weaker positions in the financial markets, arbitraging the private-sector regulation of the credit ratings agencies in the process.

    How did that work out? First off, there was massive fraud. As Michael Hudson found in a blockbuster report, one executive declared that “fraud pays” and that “it didn’t make sense to slow the gush of loans going through the company’s pipeline, because losses due to fraud were small compared to the money the lender was making from selling huge volumes of loans.” Then there were the bailouts. The government backstopped $139 billion worth of GE Capital’s debts as it was collapsing and essentially had to manipulate the regulatory space to allow it to qualify for traditional banking protections. So much for not paralyzing traffic, and so much for the old rules not being important.

    Dodd-Frank looked to normalize these regulations across both the shadow and regular banking sectors. It eliminated the OTS and declared GE Capital a systemically risky firm that has to follow higher capital requirements and prepare for bankruptcy with living wills just like we expect a bank to do, regardless of what kind of legal hijinks it is using to call itself something else. And GE Capital, faced with the prospect of having to play in the same field as everyone else, decided it should go back to trying to bring better things to life rather than making financial weapons of mass destruction. That’s pretty good news, and a process that should be encouraged and continued.

    The Collapse of the Conservative Argument

    But there’s one ask GE has as it spins off GE Capital, one that actually disproves the core conservative argument on Dodd-Frank. In the coverage, GE Chairman and CEO Jeff Immelt states directly, “GE will work closely with [the regulators at the Financial Stability Oversight Council] to take the actions necessary to de-designate GE Capital as a Systemically Important Financial Institution (SIFI).”

    Dodd-Frank designates certain financial institutions, mostly over $50 billion in size, as systemically important. Or as the lingo goes, they get designated SIFI status. Those firms have stronger capital requirements and stronger requirements to be able to declare themselves ready for bankruptcy or FDIC resolution if they fail.

    Conservatives, from the beginning, have made this the centerpiece of their story about Dodd-Frank. They argue that SIFI status is a de facto permanent bailout and claim that firms will demand to be designated as SIFIs because it means they will have a favored status. This status gives them easy crony relationships with regulators and allow them to borrow cheaply in the credit markets.

    This has become doctrine on the right; I can’t think of a single movement conservative who has said the opposite. Examples of the mantra range from Peter Wallison of AEI writing “[t]he designation of SIFIs is a statement by the government that the designated firms are too big to fail” to Reason’s Nick Gillespie repeating that “everyone agrees [Dodd-Frank] has simply reinscribed too big to fail as explicit law.” (I love an “everyone agrees” without any sourcing.)

    It’s also the basis of proposed policy. The Ryan budget cancels out the FDIC’s ability to regulate SIFIs, stating that Dodd-Frank “actually intensifies the problem of too-big-to-fail by giving large, interconnected financial institutions advantages that small firms will not enjoy.”

    If that’s the case, GE should be desperate to maintain its SIFI status even though it is spinning off its GE Capital line. After all, being a SIFI means it gets all kinds of favored protections, access, and credit relative to other firms.

    But, instead GE is desperate to lose it. This is genuine; ask any financial press reporter or analyst, and they’ll tell you that GE is very sincere when it says it doesn’t want to be designated as risky anymore, and is willing to take appropriate measures to remove the designation.

    If that’s the case, what’s left of the GOP argument?

    Follow or contact the Rortybomb blog:
     
      

     

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